Strategic default: a soldier’s perspective
This is an issue I’ve been thinking about for over a year now. I recently returned to my Law / Economics student life from a deployment to Afghanistan with an Army Military Intelligence unit. Prior to the deployment, several of the other officers had been stationed at the height of the housing bubble at facilities located near D.C. in Northern Virginia. They lived in very modest homes which were removed from their workplaces by substantial driving distances, but these homes were nevertheless particularly pricey for someone with a family and on a military salary. The humble homes ate significant chunks out of those salaries as the commutes did to the (already scarce) time these men had to spend with their families.
Such are among the many sacrifices of military life even in peacetime. There are, it seems, a multitude of wealthy lawyers inhabiting the good neighborhoods in the concentric circles of significance around the capitol. There is real irony is how their bidding up of the prices of real estate in order to achieve influence over power has muscled out the very men who are entrusted by the nation to wield it.
Despite the high prices that dominated before the crash, when my friends had reported to their new posts they found the local branches of the nation’s largest bank chains exceedingly eager to “serve” them. The companies offered to loan them (well, “originate”) up to 100% of the asking price plus costs with a minimum of fuss, delay, paperwork, or any other prudent diligence. I had a similar, “Really, is that it? That can’t be right. Are you sure that’s all you need?” experience when I received my mortgage in 2005 from Countrywide. Those were the days.
The officers were also heavily encouraged to dabble in those now infamous Option-ARMs and other dangerous financial “innovations”. The temptation must have been intense, but the men were skeptical, conservative types, and they opted for traditional fixed-rate mortgages. The Army is a place where an officer is busy with planning half of the time and busy ignoring those plans the other half because all one can do is a kind of ad hoc improvisation and adaptation to constantly changing circumstances. In few other places will one learn more about the limits, almost futility, of planning for an unknowable future full of unforeseeable and defined by unintended consequences. The Army depends and thrives on the bravery of the Soldiers and the caution of their superiors. “Safety” is akin to an ideology and a way of life. Likewise, these were brave and safe men who chose safe mortgages that were “safe as houses”.
While we were away, about halfway through our deployment, the crash began and something mysterious had gone horribly wrong with the machinery of America. The small equity positions these men has invested in their respective residences were wiped out in a matter of months. By the time they were close to returning to these homes the men were all badly underwater by over one hundred thousand dollars and, what was worse, the Army had reassigned them. They would be required to move promptly upon redeployment. They were simply not in a position to hold out, wait for prices to go back up in the long term, and continue making monthly payments. Unfortunate professional timing had compelled them to buy at the top and sell at the “bottom”. Wasn’t the avoidance of precisely this “fire sale” scenario the purported rationale for the bailouts of the financial institutions? But no extension for families, it seemed.
So, as the depth of the murky trouble in which they were finding themselves became increasingly clear they all found themselves perplexed as to what to do. Their uncertainty had two dimensions – (1) technical and (2) moral. They asked for my assistance and I tried to explain the little information I had learned about short-sales, negotiated settlements, and other ways of dealing with their banks to offload their properties and debt obligations (Virginia is non-recourse). I explained what I knew about what the various consequences – for example to their credit scores – would likely be.
When they were presented with these various options one course of action usually stood out as an obvious winner when measured purely in terms of their financial self-interest. However, they still wondered which fork in the road was the right one ethically. They had each accumulated a small life’s savings over the course of their careers, and they could decide to hand over the entire family education and retirement fund to the bank or choose one of the legal options that would let them try and keep it. What was the right thing to do? Were their wives and children the “shareholders” of the family, the welfare (to include the financial well-being) of which the preservation constituted the highest ethical goal?
With these men, and with many others I would estimate, they sense a moral dimension that should be addressed in their decision-making but they don’t know how to conduct the ethical analysis. They look for guidance and advice in the words of their acquaintances and the acts of their community and national leaders.
Their instinct was that if they had borrowed money from a friend or a neighbor they would feel a deep, almost sacred, obligation to make good on their debt and pay it off in full plus interest as soon as they could manage it. It would be wrong to stiff the guy next door even if you were in trouble and the law would let you get away with it. Their first impulse was to extend the principle to all debts, including the one on their house. That was, after all, the “right thing to do” as they had been taught by their parents and grandparents.
But then the bailouts with taxpayer money started. The “too big to fail” talk began, and then the wave of foreclosures and layoffs and emerging scandals of the unjust excesses of the financial industry, and so on. And these men began to feel that from the personal scale of their little world, their family was also perhaps “too big to fail” by the forfeit of their hard-won life’s savings.
They also started to question how the bailouts could make sense without some of the benefits flowing to innocent and responsible men such as themselves. They all knew some reckless nut next door who lied on his applications and bought six houses to “flip”, each of which more than double what he could conceivably afford. How could this crazy man be permitted to just abandon ship and mail the keys to the banks? And what about all the people who were getting the “shadow bailout” by “strategically defaulting” and purposefully living rent-free until the day of eviction, sometimes a year later? How is it just that these frauds would be the primary beneficiary of the foreclosure delay acts of the state legislatures? All of sudden, what had seemed moral now appeared foolish, even stupid.
And then it never seemed to end — bailouts for the car makers, countless earmarks, and a thousand inexplicable giveaways in the “stimulus”. And these gentlemen are not economists or political scientists and must distill the message of these actions through our hysterical and hyperbolic press which tells these stories in a way so as to make us terrified and irate.
And the point of all of this is that even the meekest law of real estate finance can have a profound effect on our cultural values. The whole moral universe, in regards to debt, has been overthrown for these good and righteous men with whom I went to war. They started out with an inclination as to what the right thing to do was, and then they were unsure. Then they questioned whether they were just being “suckers” and if there really was any kind of moral question at all given what was happening in the world around them.
I wonder what new moral lessons these men, indeed our whole generation, will now teach our children and grandchildren. I’ll guess that the content of these lessons will not include much sense of moral obligation or sympathy towards banks. Perhaps that’s for the best, moral intuitions being supportive of certain beneficial survival instincts in the modern dog-eat-dog financial world where ordinary folks need be constantly on their guard. I hope it doesn’t spillover, baby-with-the-bath-water-like, and create a generational animosity for a free market economy and open society in general. I also hope they find a way to preserve some space for social interactions involving money that aren’t “just business” and where, indeed, it’s sometimes worthwhile to make an non-mandatory personal sacrifice for no other reason than because its the “right thing to do”.