Tuesday, January 4, 2011


My girlfriend was offered a pretty good job in New York City. One of the factors weighing in on the decision of whether to go was her condo. Could she sell it? Rent it out? Walk away? It's no trivial decision and even less so because the value of the condo has plummeted since she purchased it. Even with a very large initial equity position, she's currently underwater on her mortgage.

Then I read a Wall Street Journal article chronicling some other people in similar (actually far worse) situations. One had "strategically" defaulted, basically making the economic calculation that his loss was irrecoverable. From a business standpoint it makes perfect sense, but what about from a moral standpoint?

At first blush I am one to always rail that it's wrong, just plain wrong, to welch on your debts. But, after some thought, I don't believe that's the case. We don't have debtor's prisons and that means that the calculus for giving out loans needs to adjust.

No one gives a loan out of the kindness of their heart. Banks give people money for one simple reason, to make money. And in their decision to lend is a calculation of potential risks; one of those being that they might not get paid back. That risk, along with all others, is embedded in the price of the loan (the interest rate). Banks which severely misjudge risk ought to pay the consequences.

Think about it this way, if you as an investor lend money (buy a bond) to a corporation, you are essentially a bank. When you purchase that bond, you assume certain risks reflected in the price. The bank loaning money to individuals is no different.

Our free market system consists of profits and losses which incentivize certain behavior. Losses punish uneconomical behavior by removing resources from those that can't manage them. An immoral borrower is far less of a concern to society, than the irresponsible lender who enables them.


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