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NOTE The Case for Walking Away

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All right, it is nine o'clock, and this is the Mises Circle in Las Vegas and at Freedom

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Fest, so I welcome you. It's our first time back in Las Vegas in many years, and it's

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a pleasure to be back in my old hometown. Got to come back and see some empty buildings

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that I financed. Anyway, the first thing I want to do is thank Tammy Holland for giving

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I want to thank Tammy and Mark Skausen. I want to thank our sponsors, of which there are many, Lou Carabini, Atlantic Bullion and Coin, Professional Planning of Easley LLC, Jeff and Alicia Barr, Lee Igloti, Richard Moss. They are the people who have made this happen for us to be here today. So I want to thank them.

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We have a bookstore out front, so we brought lots of paper and ink and cost us money to ship it back.

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So make sure you go out and buy some books and cut down on our shipping costs.

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I want to mention a couple of guys that are near and dear to my heart,

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and certainly Jeff Barr and Leah Gloady who studied under him as well. Murray Rothbard, we are doing this event in honor of Murray Rothbard who taught at UNLV, lived in Vegas for the last years of his life. So Murray had a profound effect on many of us.

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The other gentleman, you may not know, but you will see him in the program. He was a young gentleman in the tribute section named Mike Ziegler.

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Mike Ziegler was a friend of mine. He was my partner in Liberty Watch Magazine. Liberty Watch Magazine did the program for last year and the previous year's Freedom Fest.

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and he was a wonderful guy and passed away late last year at the tender age of 29 so this is for me I appreciate Tammy and Mark honoring him and he wasn't a believer in the afterlife and neither am I but hopefully we're both wrong, right?

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Well, I am the lead-off act, the warm-up act for this conference, and my topic today is

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strategic defaults.

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I don't know if anybody is in that position in this group, but there's plenty of people

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in the western part of the United States and in the San States, if you will, that are possibly

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thinking about strategic default.

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And this is when a homeowner can afford to pay their mortgage, they can afford to make

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the payments, but the home value has dropped considerably below the mortgage balance.

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And there's numerous cases where people paid $500,000 or $600,000 for a home here on the

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West Coast, California, Las Vegas, Florida, wherever it be, paid $500,000, $600,000.

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They might have a $4,300 mortgage.

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That same house is now worth $180,000.

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They could go down the street and buy the same floor plan for $180,000.

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They could move out, leave the previous $4,300 payment behind, and have a $1,200 payment.

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Or they could rent the same home, and they could rent the same home for, say, $1,000.

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So there's a considerable difference.

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And for libertarians, of course, this is a, you know, this is a question of ethics.

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But for our couple who might walk away, or a person who might walk away, or not walk

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away, as the case may be, it would take probably the rest of their lifetime, hopefully, to

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recapture that equity.

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In fact, they probably never would, if there were two or three hundred thousand dollars

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in the hole.

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And this is going to affect a lot of people. According to American core logic, as of the

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middle of last year, a third of all mortgages in the United States were underwater. And

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according to Deutsche Bank report, by next year, nearly half of all mortgages will be

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underwater. So this is going to be an increasing problem and something that a lot of people

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The number of people we're going to have to think about, especially in Las Vegas, where reportedly 81% of all homeowners are underwater, under mortgages.

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Now, the foreclosures don't match the number of people underwater.

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We've got all these people underwater, 15 million people, but last year there was a record 2.8 million people foreclosed upon.

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and foreclosures continue at about $300,000 per month here in 2010.

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So there's a yawning gap between the people who are underwater

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and the actual people that are being foreclosed upon.

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Now, why is that difference?

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Well, there's a law professor at the University of Arizona named Brent White

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who's done a lot of work on this

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And in his view that underwater homeowners aren't walking away because they wish to avoid the shame or guilt associated with foreclosure.

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They have a fear perceived, consequences of foreclosure that in his view are actually much less severe than most homeowners are led to believe.

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He says these emotional constraints are actively cultivated by the government,

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The financial industry and other social control agents in order to induce individual homeowners to act in ways that are against their own self-interest, but which are argued to be socially beneficial.

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So while lenders are out there just seeking profit, our underwater homeowners are encouraged to behave in accordance with social and moral norms that require individuals to keep promises and honor financial obligations.

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Now, mortgages and notes are secured by deeds of trust or contracts.

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Lender provides money today in exchange for a series of payments.

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Money today, in this case, is used to buy a house. In exchange, the borrower and a 30-year mortgage makes 360 monthly payments.

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Simple as that. Notes do not have caveats in there where they say, well, if the collateral falls, go ahead and give us the house back.

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The borrower can or doesn't say the borrower can or should give the house back.

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Although in non-recourse states like California, it's essentially implied, non-recourse meaning that lenders cannot go after other borrower assets to satisfy the lien if the sale of the home does not.

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However, there's at least one lender who had no problem from walking away from their obligations.

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And that was Morgan Stanley. Morgan Stanley, at the top of the real estate market in 07, bought five office buildings in downtown San Francisco for $2.3 billion.

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By last year, they had fallen in half in value. And so, according to their spokeswoman, Alison Barnes, she said,

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She said, this isn't a default or foreclosure situation.

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We are going to give them the properties to get out

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of the loan obligation.

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Now, Morgan Stanley's earnings before interest in taxes

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in 2009 was approaching $7.5 billion.

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In 08, it was approaching $40 billion.

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07, it was $60 billion.

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You get the idea.

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Morgan Stanley strategically defaulted.

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And there's no Morgan or Stanley losing sleep

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over the fact that these, over these buildings

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or the encumbrances they're walking away from.

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In fact, the shareholders of Morgan Stanley

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likely cheered as the company mailed in the keys.

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Now the fact is shareholders would

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consider it the fiduciary responsibility

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of the Management of Morgan Stanley to walk away

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from underwater property loans.

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And in fact, when we talk about fiduciary responsibility,

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this is a part of natural law that's

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been incorporated into Anglo-American legal tradition.

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And this principle underlies the duty of good faith, loyalty,

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and care that applies to corporate officers

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and directors.

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Fiduciary duties of corporate managers

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run to the shareholders and not to the creditors, employees,

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or other stakeholders.

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So the best interest of Morgan Stanley's shareholders

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is clearly for the company to walk away.

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No, it was non-recourse.

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They couldn't go after other Morgan Stanley assets.

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So the fiduciary duty of management was to walk away.

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They didn't have a duty to the company's creditors.

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At the same time, Henry Paulson, you probably remember him, saved the country with the big

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bailout, right?

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He declared that any homeowner who can afford his mortgage payment but chooses to walk away

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from an underwater property is simply a speculator and one who is not honoring his obligation.

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John Corson, the President and CEO of the Mortgage Bankers Association, told the Wall

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Street Journal that those who default on their mortgages should think about the message they're

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sending their family, their kids, and their friends.

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So Morgan Stanley makes a prudent business decision to walk away, improve cash flow for

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for their business. Meanwhile, Secretary Paulson and Mr. Corson want our underwater homeowners

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to just buck up and keep paying. Of course, until they lose their job or they die or something

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like that and then it's okay for them to bail out, I guess.

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Now a 30-year mortgage seems like a bad bet on both sides. I mean, nobody has a crystal

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a ball that remains very clear for 30 years.

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And in a free market libertarian world,

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would lenders make such a deal?

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Or would borrowers, for that matter?

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In fact, in an America that was much freer and much more

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libertarian, the late 1800s, there

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was no such thing as a 30-year mortgage.

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Much of the lending that did occur

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was done by land subdividers, builders, friends,

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and Relatives.

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And the notes that were provided were one and two, three years in length.

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That's it.

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People put down half or a third.

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They had plenty of equity.

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And they had very short terms to their mortgages.

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So essentially, home sales, late 1800s, were seller financed.

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But homeownership was rare.

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Less than 28% of people owned their own home.

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But then after World War II, the government got in the housing business, and they launched

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Own Your Own Home, and they did this with the objective of defeating radical protests

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and restore political stability by encouraging urban workers to become homeowners.

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So during the roaring 20s, there was this vast increase in home ownership, up to 40%,

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and mortgage debt did triple.

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But again, it was this kind of mishmash of second and third mortgages, the rates were

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high, there were balloon payments, et cetera, et cetera.

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And then in 1933, of course, we had the Depression, and in the wake of the Depression, there was

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a series of defaults, a thousand people a day were being foreclosed on, and the government

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intervened to structurally transform the rules of the financial game.

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And ever since, as Professor Thomas Segrouf notes, we are a nation of homeowners and home

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speculators because of the state.

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So Herbert Hoover, he put into effect the Federal Home Loan Bank Act of 1932, Homeowners

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Loan Act of 1933 was put in place by FDR, and then FDR created the monster that is Fannie

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in 1937. And these programs boosted homeownership in a hurry. By 1950, 55% of Americans owned their own home. And by 1970, that was up to 63%. And then with Fannie Mae's mandate to increase loans to low income and high risk borrowers, by 2004, homeownership in America was up to 69%. So government programs have created

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created the typical mortgage deal, an impossibly long term for which to forecast property values,

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interest rates, income levels, and the like. Now when Ben Bernanke was asked about this

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at the height of the property boom, he was asked about home prices possibly getting too

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high, he said, well, I guess I don't buy your premise. It's a pretty unlikely possibility.

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We've never had a decline in house prices on a nationwide basis.

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So what I think is more likely is that house prices will slow, maybe stabilize.

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So there you had the chairman of the Federal Reserve saying that essentially home prices

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would never go down.

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Of course the average Joe and Jane, they're quick to sign on the dotted line, and the

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average mortgage broker is very eager to sign them on the dotted line because they know

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The government, through Fannie Mae and Freddie Mac, is ready to buy that paper in the secondary market.

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So does the individual, back to fiduciary duty, does an individual have a fiduciary duty to oneself?

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Well, the short answer is no.

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By definition, fiduciary means to act in the interest of another person.

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So, we can't have a fiduciary duty to ourselves, but how can it be possible that a corporate entity has a duty of financial prudence, while individuals have a moral duty to destroy their dignity and their finances in the process of honoring a contract that the lenders themselves would not honor if they were put in the same position?

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Aristotle explained that man is a rational being. Man learns what works in the world, natural laws to achieve his desired ends, survival and prosperity.

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And as Murray Rothbard explained in the Ethics of Liberty, the very fact that the knowledge needed for man's survival and progress is not innately given to him or determined by external events

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shows that man has the free will to employ reason or not in that an act set against his

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life and health would objectively be called immoral.

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Now in the same book, Rothbard writes of quote, the perfectly proper thesis that private persons

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and institutions should keep their contracts and pay their debts. But the mortgage market

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is anything but private.

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And as Jim Grant wrote recently in Grant's Interest Rate Observer, 97% of the mortgage

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market is controlled by Fannie Mae, Freddie Mac, or guaranteed by the FHA.

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But now that lenders have learned the hard way that the price of homes can go down, the

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government is now the monopoly provider of mortgages.

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It's hard to imagine that Rothbard would insist that private individuals be poorer and less prosperous by sacrificing to pay Fannie Mae and Freddie Mac, entities that are only in business through taxpayer subsidy, in fact, a taxpayer subsidy that's probably going to total a trillion dollars.

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Rothbard goes on to make the point that relations with the state then become purely prudential and pragmatic considerations for the particular individuals involved, who must treat the state as an enemy with currently prevailing power.

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And since government GSE debt, Fannie Mae and Freddie Mac, is now considered government debt, as Rothbard says, the payment of this debt by taxpayers is coercion.

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So the funds that these GSEs used to buy these mortgages in the first place is obtained through coercion and aggression against private property.

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Such coercion can never be listed from a libertarian point of view, according to Rothbard.

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Rothbard advocating going on to repudiate the entire government debt outright and let the chips fall where they may.

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And in the same article, Rothbard ridicules the Social Security Administration because it has government's bonds in its portfolio.

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It collects interest in payments from the American taxpayer, allowing it to masquerade as a legitimate insurance business.

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It's impossible for me to imagine Murray Rothbard viewing Fannie Mae and Freddie Mac as legitimate mortgage companies.

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He went on to write that if the idea of debt repudiation is considered too harsh,

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But, as he wrote, we first have to rid ourselves of the fallacious mindset that conflates public

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and private, and that treats government debt as if it were productive contract between

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two legitimate property owners.

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Supposing that Freddie, Fannie, B of A, and the rest were left to fail, that mortgage

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Which paper would go to the private market?

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Would it trade at a hundred cents on a dollar?

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I doubt it.

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Not with the collateral being what it is.

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And would a private lender be more likely to negotiate with an underwater homeowner?

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I believe they would.

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But if you're being bailed out by the federal government, you can stand back and not negotiate

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at all.

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Now when asked about the morality of strategic defaults, many people will respond that it's

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okay to default if you can't make the payment, but if you can it's immoral. Now that's similar

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to the ability to pay argument for those who support progressive taxation. As Rothbard

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explained in Power and Market, the ability to pay principle of taxation cannot be justified

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with a logical argument. If the able are penalized, production and services are diminished and

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And in proportion to the extent of that ability, he wrote, the result will be impoverishment

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not only of the able, but of the rest of society, which benefits from their services.

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So people that walk away, like this lady right here, must work for Fannie Mae.

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So people aren't insisting that they stay in their home and not make their payment.

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That would be morally objectionable.

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But people who walk away pay a considerable price.

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There's the stigma of stiffing a lender, it's going to hurt your credit report, it's going

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to cause your credit to go up in price in the future, it's going to keep you from getting

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credit in the future.

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Fannie Mae now says they're going to lock out borrowers that they think strategically

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defaulted for seven years.

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It may even keep you from getting a job.

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Human Resource Management was polled in 2006 and now employers, 43% of employers now check

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reports when they look at potential hires. Even the TSA, which you may have encountered on your way here, will not accept anyone who has more than $5,000 worth of overdue debt, supposedly.

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After reviewing these folks, I find that hard to believe, but that's the research I've found.

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So mortgage holders, they sign a promissory note, which is a promise to pay, but the contract explicitly details what the penalties are if you don't.

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You relinquish the property, you're not escaping the consequences, you have to live with them.

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Now in the Ethics of Liberty, Rothbard constructs an example about a theater owner contracting with an actor for a performance on a certain date.

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The actor changes his mind, he doesn't appear, so the question is, should the actor be forced to appear?

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And Rothbard says no, that would be slavery.

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Should the actor be forced to reimburse the theater owner for advertising and other expenses?

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No, the actor should not be forced to pay for their lack of foresight and poor entrepreneurship, as Rothbard said.

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But of course, if the actor had been paid in advance and doesn't perform, he should be forced to return the money.

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And Rothbard points out that this would be handled in a libertarian society with a performance bond.

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He wrote that, in short, the theater owners who wish to avoid the risk of non-appearance,

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they should refuse to sign the agreement unless the actor agreed to put up a performance bond in case of non-appearance.

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Well, in the case of mortgage defaults, the collateral to the property is the performance bond.

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If the borrower doesn't pay, the collateral is surrendered, and if that doesn't satisfy

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the debt, in most states, the lender can choose to go after the borrower's other assets.

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Any deficiency or loss the lender suffers is from their lack of foresight and poor entrepreneurship.

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Some also contend that walking away from mortgages will lead to a fall in value of other properties

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in their Neighborhood, and this is immoral because you've damaged your neighbor's property.

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As if we have a duty to help our neighbors out to do all we can to maintain and increase

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property values.

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Well, we don't have that kind of power.

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The denigration of a neighbor's property value can be compared to the cases of slander

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and libel.

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As Rothbard wrote for New Liberty, what the law of libel and slander does in short is

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to argue a property right of someone in his own reputation.

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But a person does not own their reputation and likewise they do not, they may own title

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to their property, but they don't own the reputation or reputed value of their home.

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The reputed value is purely a function of the subjective feelings and attitudes held

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by Other People.

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The same goes for collective feelings and values about the property market.

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Just as a person's reputation fluctuates all the time in accordance with attitudes and

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opinions of the rest of the population, so does the values placed on properties.

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It's an old banker's accent.

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Your first loss is your best loss.

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If you put in a down payment and you've made payments for a while, well, feeding the loss is just good money after bad.

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And the simple fact is, banks know that walking away from underwater mortgages is the most logical thing to do.

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You know, a person doesn't pay taxes because it's the ethical thing to do.

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For most, it's a pragmatic thing to do. The hassle is too much, the potential penalty, jail time, too severe, so most people just pay their taxes.

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You didn't voluntarily sign a note committing to pay taxes, but by paying and staying, you've given your consent.

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You might as well have signed a note. Use the government services because you have to, they are the monopoly provider.

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and since before the Great Depression, government has not only been a cheerleader for home ownership but the monopoly provider of mortgages.

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Government didn't undertake this program rationally, calculating the benefits and considering the losses.

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It's incapable of doing that and the millions losing at this government boondoggle surely are irrational for blindly paying while government papers over

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and Bails Out its Housing Machine. Government can't calculate, but people can, especially those who are hopelessly underwater on their mortgage.

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Paying on an underwater mortgage, like paying your taxes, may be the pragmatic thing to do, but it's surely not the ethical thing to do.

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There will be no salvation for those who sacrifice and put their financial futures at risk to

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remain current on an underwater mortgage. Whether you can pay or not, if it makes sense

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to walk away, that's what a person should do. And now may be the time. Mortgage debt

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forgiveness is a non-taxable event through 2012. So no one's obituary will ever read,

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He was a good and ethical man. He died broke, his family suffered, but he never missed a payment to Fannie Mae. Thank you.