Friday, May 14, 2010

Moral loan default

The NY Times reported in Jan.:
Some homeowners may keep paying because they think it’s immoral to default. This view has been reinforced by government officials like former Treasury Secretary Henry M. Paulson Jr., who while in office said that anyone who walked away from a mortgage would be “simply a speculator — and one who is not honoring his obligation.” (The irony of a former investment banker denouncing speculation seems to have been lost on him.)

But does this really come down to a question of morality?

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a “norm asymmetry.” In other words, they think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It’s as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical.
A business prof debates White here.

There is a legal fiction that a contract is a legal agreement where the parties understand the terms. And yet millions of people sign mortgage contracts with basic misunderstandings about their legal obligations to pay.

Law schools teach classes on contracts. The subject is not difficult, but the law defines a contract in way that would surprise anyone who has never been to law school.

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