Posted by: The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

81 responses to “Did Banks Act in Good Faith During the Bubble?”

  1. BacktoBasic

    If bank are “unethical” by loaning people momey, does it justify you walk away the mortgage and let the debtor holder or tax payer take the loss. Why can’t you take the bank to the court rather than default your contract? Bank act in good faith by handing your a check and not evict you out of the house no matter the property value up or down. In return, you act in good faith by paying P&I no matter your property value up or down. There is some excuse to default the loan and still ethical: you are sick or lose your job and really can’t pay for your mortgage. What Tim proposes here is you can default the loan cause the house value are below the mortgage. Tim like to see massive default by talking down the property value so he could bottom fishing in the muddy water. This kind of strategy is same as talking stock up and dump once the price is up. It is self intereted.

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  2. DrShort

    + It doesn’t matter if the bank “cared”. It matters that there was no fraud or misrepresentation and that the bank and borrower had a “meeting of the minds.” Did both parties have a common understanding of the terms?

    + A bank selling someone on a “teaser” loan where they can easily afford the first year’s payment, but not the subsequent years is likely bad faith. And depending on how it was represented (“you can easily afford this mortgage!”), not only should the buyer walk, but you could argue there was never a valid contract in the first place and have the mortgage cancelled.

    + In the scenerio you described, I would think the bank wasn’t acting in good faith with respect to the secondary market more than the buyer. Presumably, the bank has a duty to properly underwrite the loans they are originating.

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  3. willcasp

    I see two problems that this process created..
    – this practice may have increased the pool of qualified buyers. This created more demand for real estate, and helped drive prices up. Folks who properly qualified for loans ended up paying higher prices due to this competition.
    – The appriasal process that should provide a safety check for the buyer, was also not working properly due the bank generated buyer pool inflation contributing to price increases. Did not help that appraisers who were giving favorable valuations for loan originators were being rewarded with increased business. Time will tell if this has been fixed.

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  4. ray pepper

    “Tim like to see massive default by talking down the property value so he could bottom fishing in the muddy water.”

    See Tim you are God-like. Look at the power you yield!!

    Your mere words will collapse the PNW housing market.!!!!.Then when you FINALLY buy you can begin to PUMP the market up. Please give me the dates you will initiate this Tim so I can mark my calendar!!

    BtoB are you really that inept?

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  5. DrShort

    By The Tim @ 3:

    And that is where I think the problem lies. I contend that there was no such “meeting of the minds,” and that very often the bank had a far more in-depth understanding of what they were doing than the buyers.

    The bank is always going to have far more understanding since that’s their business. I think it goes into “bad faith” when the loan originator purposely mis-represents the risk and takes advantage of a buyer’s lack of financial sophistication — ie, teaser rate loans, option pay, etc.. For example, telling the customer “you can afford this payment” and then leaving out that it will double in 2 years and then you won’t be able to afford it.

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  6. TheHulk

    BtB, welcome to capitalism. Oh wait, it isn’t really capitalism. It’s socialist capitalism where the small guy always ends up on the losing side since profits are privatized while losses are socialized.

    Here is how banks can and *should* give out loans if they want to prevent walkaways –
    1. Require at least 20 and maybe even 25% down. This ensures buyers have skin in the game.
    2. Banks don’t get a free check either. If a bank makes a mortgage loan, they have to hold between 30 and 50% of that debt on their balance sheet to maturity. This ensures they wont repackage the loans, take the commission and run away.
    3. “Banks” (cough cough Goldman Sachs) are not allowed to repackage loans into fancy derivatives where they can bet for or against such mortgage loans. (This ensures we don’t get a ripple effect from housing going up or down in the economy).

    Banks did not act in “good faith” because they weren’t required to. Strong regulation and laws *might* be able to prevent this from happening in the future. But you can bet your last dollar the finance lobbyists will do anything and everything to prevent such regulation from happening.

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  7. patient

    To the default haters, your fear of the impact on you personally clouds your judgement of the scale of the violations. The borrowers ethical violation when defaulting is imo very minor. The lenders violation when on a large scale setting borrowers up for major pain based on a knowingly inflated, unsustainable appraisal values and weak documentation is very major. The resulting economic impacts of defaults therefore lies mainly with the lenders not the borrowers.

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  8. Scotsman

    RE: TheHulk @ 7

    Your post starts to address my next question- how will (or should) lending standards change in response to a flat or declining market for homes and an increased chance of “walk aways” in such a market? If the banks can’t count on inflating values to bolster their equity cushion over time, will the loans be written differently? Shouldn’t at least 10% down be required in a flat market to assure that the average costs of selling can be covered by the home owner? Other changes?

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  9. Ryan

    Banks and good faith= Oxymoron

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  10. Sci Ry

    The buyer must live with the ethical choices that they make. Just because the bank is acting unethical, it does not absolve the buyer of their ethics. However, this is what I believe lawsuits are for.

    What is being described is a systemic problem. There should be some type of legal recourse for the buyer in these cases. This is what banking regulations and “rule of law” should prevent.

    In this case, when a legal solution appears to be absent (essentially because unethical behavior was legalized – “honestly, we will be nice”), reparations can be make by the government as they try to fix the situation. While not ideal, it is necessary in some case, IMO.

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  11. patient

    RE: TheHulk @ 7 – Good points, I’d bet that many of the people who cries faul at defaulters are supporting low risky low down payments via FHA. It’s because they are not really concerned about morals and ethics but of falling home prices.

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  12. DrShort

    By patient @ 12:

    RE: TheHulk @ 7 – Good points, I’d bet that many of the people who cries faul at defaulters are supporting low risky low down payments via FHA. It’s because they are not really concerned about morals and ethics but of falling home prices.

    Actually I don’t care at all about the morals and ethics. I just think people shouldn’t kid themselves into thinking there aren’t any ethical issues involved.

    What I do care about is that many of these loans are government backed — owned by Fannie and Freddy. And walking away basically takes your underwater loan and throws it onto the backs of the taxpayers.

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  13. One Eyed Man

    RE: The Tim @ 3

    “I contend that there was no such “meeting of the minds,” and that very often the bank had a far more in-depth understanding of what they were doing than the buyers.”

    If the borrower understood they had to pay back the money and that the payments on an ARM could go up, there was probably a meeting of the minds from a legal standpoint.

    Underwriting criteria was terrible during this bubble and it was also terrible during the S & L crisis. Bad underwriting results in bad loans. Whose fault is a bad loan caused by bad underwriting, the lender’s or the borrower’s?

    Answer: It’s both.

    If the bank loans hundreds of thousands of dollars based upon bad underwriting standards, they are stupid, and stupid doesn’t cut it in business. They should do a better job of protecting themselves. That’s capitalism.

    And if a borrower borrows hundreds of thousands of dollars without understanding what it will take to make the payments, they aren’t innocent, they’re stupid too. Real Estate finance may not be rocket science, but it can be complex. If you borrow hundreds of thousands of dollars without knowing what you will be required to pay and how you will pay it, you aren’t innocent, you’re a fool. Borrower’s should be held accountable for their actions. Nobody made them borrow the money.

    Why should the borrower be able to walk away without paying the debt. When you remove the buyer’s accountability for his actions you destroy the checks and balances of the market place. This is America, buyer beware. (Isn’t that the libertarian answer to how do you protect the buyer in the market place.) If you expect the loan officer (read salesman) to educate you, you’re trusting the big bad wolf. He’s there to eat, not to educate.

    For all those who think that walking away is the answer, do you consider yourself a free market advocate who hates government regulation. Well, the only reason the bank can’t chase the debtor after a non-judicial foreclosure is because of government regulation contained in the deed of trust act that eliminates the ability to pursue a deficiency after a non-judicial foreclosure. Shouldn’t the borrower have to bear the costs of his stupidity so that the market can properly function. If you are a libertarian, or a strong free market advocate I would think that you would prefer that the market allow for full recourse home mortgages so that the borrower has to bear the costs of his foolishness. How else can the market properly include that cost.

    If the borrower wants a non-recourse loan, they should negotiate a price and down payment appropriate for such the additional risks placed on the lender.

    Those that walk from their mortgage without recourse are the beneficiaries of government regulation. They are being bailed out by regulation.

    Caveat: The above is not necessarily the opinion of the author. I generally agree with drshort on this subject.

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  14. Jillayne

    When trying to determine if a person acted ethically, it is important to first be sure we have all the facts. There are hundreds of thousands of transactions that took place during the bubble. It is not possible to make an over arching generalization of what to do in every single circumstance. There would be too many assumptions! We would need to look at each case individually.

    Here is another way of looking at the problem.

    A corporation has no duty to care for its clients. A corporation’s duty is to its shareholders…to make money within the bounds of the law. A corporation might have a flowery code of ethics that says some pretty things like “we value our customers” and other mostly useless statements. What it comes down to is law. The minimum moral standard for a corporation is the laws governing mortgage lending.

    So one way of solving this problem as a homeowner is to have a competent attorney, who is trained in mortgage lending law, review all the mortgage documents. If the lender did not follow the law, the the homeowner can use the judicial system to his/her advantage.

    Regarding a bank’s duty to underwrite loans, many of the mortgage companies were not banks but firms with a wholesale line of credit who were doing pass-through lending and never had much interest in whether or not the homeowner could repay.

    Dr. Short argues that ppl who were qualified at the teaser rate on an ARM loan would be ethically justified in walking. The lender would argue that the homeowner (likely) had the ability and ethical responsibility to onself to read the documents he/she was signing.

    Dr. Short, during the bubble run-up, the vast majority of loan salesmen were operating like a retail salesperson and owed no duty of informed consent to their customers ( which means to make sure the customer understands what they are signing.) Everything was strictly arms-length. Many of my loan originator students explained to me during the bubble that if customers couldn’t figure out that they were being screwed over, “sucks to be you.”

    Of course the majority of these loan originators are no longer originating.

    This is no longer the case as state and fed lending laws are changing, putting higher duties of care on the shoulders of loan originators.

    The Tim says he believes a homeowner is not ethically obligated to pay his/her mortgage if the bank did not act ethically in good faith.

    I argue that banks and lenders do not care about ethics. They ONLY care about law. This is not an ethical dilemma but a legal decision. Homeowners considering walking away can lose all kinds of sleep pondering the ethical decision. Instead, I argue that homeowners should stop and first hire a competent attorney to help them make a good decision grounded in all the possible legal consequences.

    If a homeowner is without funds to hire an attorney, the Wa State Bar Assoc has created a free legal aid program for Wa homeowners facing foreclosure.

    http://www.mywsba.org/default.aspx?tabID=163

    http://nwjustice.org/

    http://www.dfi.wa.gov/consumers/homeownership/

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  15. Jillayne

    Scotsman,

    Yes you are correct, in a normal functioning market banks/lenders would be requiring more of a downpayment in a declining market. However, we are far, far away from a normal functioning market.

    Fannie and Freddie and FHA are backing 90 percent of the residential loans right now. If we tightened up guidelines dramatically, we would crash the market. Everyone knows this. So instead the taxpayers will shoulder the burden of the bad loans being sold to Fannie and Freddie by the banks, and FHA will take on the min downpayment buyers. This was probably always the plan. Fannie and Freddie are turning into a gigantic Resolution Trust Corp.

    …and we tighten underwriting guidelines gradually. They will continue to tighten s l o w l y through 2011.

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  16. softwarengineer

    RE: Scotsman @ 9

    I’ve Always Wondered Scotsman

    How banks can lend at 3-4% paying as high as 2-3% CD rates and still keep tellers employed and a building with utilities….the answer is they can’t.

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  17. patient

    RE: DrShort @ 13 – Again drShort that is mainly if not fully the fault of the lender and Fannie and Freddie not the borrower. Aim your blame in their direction, support strict bank regulations and stricter F&F and FHA down payment guidelines.

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  18. Jillayne

    Heh, Heh, this is kind of funny.

    http://www.freddiemac.com/news/featured_perspectives/20100503_bisenius.html?intcmp=1007FPDB

    This is Freddie Mac’s EVP asking people not to strategically default because we ought to consider our neighbors and the future cost of lending.

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  19. DrShort

    By Jillayne @ 15:

    Dr. Short argues that ppl who were qualified at the teaser rate on an ARM loan would be ethically justified in walking. The lender would argue that the homeowner (likely) had the ability and ethical responsibility to onself to read the documents he/she was signing.

    Dr. Short, during the bubble run-up, the vast majority of loan salesmen were operating like a retail salesperson and owed no duty of informed consent to their customers ( which means to make sure the customer understands what they are signing.) Everything was strictly arms-length. Many of my loan originator students explained to me during the bubble that if customers couldn’t figure out that they were being screwed over, “sucks to be you.”

    I would argue that when a loan originator starts advising a borrower that the “payment is affordable”, “this is a good loan for you”, and/or reassuring the borrower that the terms are good and fair, that is creating a detrimental reliance in some circumstances. The borrower is now relying on the originators advice and, because of that, not seeking the counsel of another. The loan originator has created a duty to make sure the customer understands by giving advice/reassurance.

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  20. patient

    RE: Jillayne @ 19 – Yeah that is funny, just the right guy to lecture about “social impact”. How much of social impact has Freddies failed business policies had again in billions? Thinking about it, it’s actually not funny at all, just pathetic and disturbing.

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  21. Paul

    RE: willcasp @ 4

    I completely agree, I was working as an Appraisal Assistant for a reputable appraiser during 2 of the boom years. We had two large accounts on 2 different occasions with banks who had been sending us 60 appraisals a month equal to about 22K. When we could not come up with a current market value on a property they were looking for they told us to make it work because prices would go up eventually anyway. When we told them it didn’t work that way and that the value was just too far off to justify they immediatly stopped sending us new appraisal requests and changed to appraisers who was willing to fluff the numbers. The appraiser had been in the business 30 years and said he had never seen anything like it. The loan officers knew what they were doing and the banks turned a blind eye on the practice. They just didn’t care, after all they were selling and packaging these loans and would never see them again. I wish I could say they are getting what they deserve but in the end they still will not see the consequences just we the tax payers who are bailing them out.

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  22. Ryan

    I just read somewhere that the money that has been pumped into Fannie since the housing crisis started is more than double their profits over the past 35 years…or something to that effect. Those guys are donkeys.

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  23. patient

    The whole thing is just a big propaganda drive from the lenders to not only pass the cost of failed business practices to the public but also the blame. It’s shameful but who is surprised, not me.

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  24. joe dirt

    When a ship is sinking and your only chance to save yourself is to shove someone aside and get into the life boat first, then most think only of survival and not ethics. That is what has happened in this financial meltdown. Many buyers know dam well they were greedy and took on too much debt to grab a nice property, thinking prices would keep skyrocketing.
    Now it is every man for himself, and devil take the hindmost. Please spare me the BS about being victimized by the banks – It is just rationalizing.

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  25. The Dude

    By Jillayne @ 16:

    Yes you are correct, in a normal functioning market banks/lenders would be requiring more of a downpayment in a declining market. However, we are far, far away from a normal functioning market.

    I would also say that lenders should require more down payment in a market that appears to be advancing beyond what the fundamentals justify. This protects the lender when the market eventually reverts to mean. This would benefit everyone (except for market timers) as it would stabilize the market by decreasing the size of bubbles.

    Lenders did the exact opposite in the recent housing bubble — they required *less* down payment as the bubble grew larger, which further increased the size of the bubble.

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  26. Markus

    I don’t understand this discussion at all.
    The contract between you and the bank specifically outlines what happens when “you walk away”. It’s in there; 99% written by the bank, not you! By the simple fact that this is a course of action which is described in the piece of paper and agreed to by both parties makes it a course of action as ethical/legal/moral as any other course of action described in the contract.

    The piece that I find astonishing is that on one hand the Supreme Court gives corporate entities the status of personhood (campaign donations, free speech, etc.) but when it comes to moral situation it suddenly is a pure business decision. What is it now, pure business entity or person?

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  27. Jillayne

    The Dude,

    I’m pretty sure this came up when WaMu execs were being grilled in Wa DC. No lender wants to be the first one to tighten underwriting guidelines when it looks like a bubble is forming. To do so would mean your corporation would lose out on millions of dollars in profit as well as lose many employees who would jump ship to ride out the last of the bubble at another firm. Of course that argument holds no weight now because those companies have lots more than they gained at the tail end of the bubble.

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  28. Rhonda Porter

    RE: Jillayne @ 15 – Jillayne, correspondent lenders (CLAs) do care about the quality of the mortgages originated. When/if a mortgage does not perform, they may get to buy it back. Mortgage brokers do not.

    I’m just back from a presentation that Amtrust put on re: the State of the Industry. Buy backs (or “repurchase”) was a pretty hot topic.

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  29. Rhonda Porter

    RE: Paul @ 22 – preHVCC, I had an appraiser approach me for my business…he said he could turn appraisals around in 48 hours and winked at me saying “some things are better not in print, you should call me if you need a certain value”. He did tons of appraisals for a certain large bank who’s no longer around. Some appraisers participated in value fraud in an attempt to get business.

    Let’s just say I stuck with my appraiser who I trusted when he came in with a lower value. I wish I could still work with him.

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  30. Paul

    RE: Rhonda Porter @ 30

    I don’t believe all lenders/banks/brokers were following the same practice, we had some very good clients that chose to work with us because of our honest valuations. Unfortunately the majority did otherwise. It was a culture that encouraged such practices if not always openly often condoning it through silence. I was swept up in the buy now or be priced out forever fever and purchased a home early 2007 (Thankfully purchased at a low price compared to market and I was able to sell my bubble home last summer after my wife lost her job and my hours were cut and only lost about 10k, Renting again now but at least my credit is intact) The officer I worked with tried everything he could to get me into a interest only loan saying it was the future and that my wanting to know what my payments were going to be each month was “Old” depression era thinking. The smart thing for me to do was to get a loan where I paid as little as possible because “homes will always go up in value so take the rest and invest it all in the stock market” I held my ground but I know many people who gave into the pressure of the lender they worked with, so I can’t really blame them for getting fed up and walking. It would take a lot for me to have done the same because I pride myself in fulfilling my obligations. But, if I had been confronted with a situation where I was underwater more than I could make myselft in many years and that would put my family in dire straits for a decade or more I couldn’t say for sure what I would do.

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  31. wreckingbull

    By softwarengineer @ 17:

    RE: Scotsman @ 9

    I’ve Always Wondered Scotsman

    How banks can lend at 3-4% paying as high as 2-3% CD rates and still keep tellers employed and a building with utilities….the answer is they can’t.

    When they can borrow from the government at 0%? Goldman Sachs made complete business model out of this.

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  32. Scotsman

    RE: Jillayne @ 16

    “If we tightened up guidelines dramatically, we would crash the market. Everyone knows this. So instead the taxpayers will shoulder the burden of the bad loans”

    I agree this is the thinking. The irony is that over time the required higher tax rates will have the same impact on the overall health of the economy. There isn’t “something for nothing” to be gained through this strategy, except for political cover.

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  33. Ross Jordan

    By Markus @ 27:

    The piece that I find astonishing is that on one hand the Supreme Court gives corporate entities the status of personhood (campaign donations, free speech, etc.) but when it comes to moral situation it suddenly is a pure business decision. What is it now, pure business entity or person?

    The simple solution is to make the board criminally liable for the firm’s actions. Of course, there’s too many powerful people on boards, so this is unlikely to happen (except some highly publicized extreme cases).

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  34. Ross Jordan

    So here is my question for the readers making the “good faith” argument. If you were acting in good faith when you obtained your mortgage, but the bank was not, are you ethically bound to continue making payments even if it makes no financial sense to continue doing so? I contend that the answer is no.

    Two wrongs don’t make a right. In other words, I don’t think another party’s unethical behaviour excuses you from performing ethically. When another party fails to perform, you can go after them for damages — but I don’t think it’s a strong argument for justifying walking away.

    That said, I don’t think walking away is unethical — because the option is understood (or should be understood) by both parties at loan signing time.

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  35. Pegasus

    Who wants to bet that the bankers get some Senator on their payroll to introduce a law that allows banksters to recoup all of their losses on foreclosures from both those that can pay and walk away and those that can’t pay? Debtors prisons? Debt slaves for life? Too far fetched? Take a look at the last bankruptcy law passed and the last credit card law. I still remember the email I got from Patty Murray claiming she was protecting consumers by voting for it. Thirty percent credit card fees, increased fees for bank accounts. Thanks Bozo. Oops I digressed. Sorry.

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  36. drshort

    By Ross Jordan @ 35:

    That said, I don’t think walking away is unethical — because the option is understood (or should be understood) by both parties at loan signing time.

    The key word is “option”. It’s not an “option”. It’s a “default” or “breach” — meaning you didn’t live up to the agreed terms of the contract. And, generally speaking, purposefully not living up to the terms you agreed to is unethical.

    If it were an option it would be spelled out as such in the contract (like cell phone contracts do).

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  37. Ross Jordan

    By drshort @ 37:

    By Ross Jordan @ 35:
    That said, I don’t think walking away is unethical — because the option is understood (or should be understood) by both parties at loan signing time.

    The key word is “option”. It’s not an “option”. It’s a “default” or “breach” — meaning you didn’t live up to the agreed terms of the contract. And, generally speaking, purposefully not living up to the terms you agreed to is unethical.

    If it were an option it would be spelled out as such in the contract (like cell phone contracts do).

    It’s an option, in the same way that refinancing is an option, or paying your principal faster than expected is an option. In most cases, the default option is spelled out in the mortgage contract; but even if its not explicitly, its implicitly spelled out by the various federal and state laws that special case a mortgage contract (and give it different rules than most other forms of debt).

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  38. Jillayne

    off topic but relevant: “Senate Passes Merkley-Klobuchar Amendment to Protect Homeowners from Deceptive Mortgage Practices” I will post in the open thread.

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  39. pat b

    By Jillayne @ 15:

    Here is another way of looking at the problem.

    A corporation has no duty to care for its clients. A corporation’s duty is to its shareholders…to make money within the bounds of the law. A corporation might have a flowery code of ethics that says some pretty things like “we value our customers” and other mostly useless statements. What it comes down to is law. The minimum moral standard for a corporation is the laws governing mortgage lending.

    Actually Incorrect.

    Any corporation has a duty to not engage in Fraud.

    When a bank’s agents knowingly alter income to show a buyer can afford what they can’t afford, or buries in fine print terms or fudges appraisals?

    That can meet the tests of fraud.

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  40. Dirty_Renter

    I am a dirty renter, thus everything I say must be regarded in a less than favorable light, but there is yet another twist to the bank/borrower moral issue.
    I was Head of RE of a small commercial bank from 1983 – 1995. In 1990 we purchased 2 failed S&Ls, due to our strong capital position. Our average Loan/Deposit ratio was between 50%. The purchases brought was up to 65% and in 1994, we had a vicious Federal CRA audit, due mainly because of our low L/D ratio, thus we were not serving the community from which we were taking deposits. The examiner gave us a poor rating, though he could find no red-lining, just strict underwriting guidelines. Therefore, I contend the government had a larger hand in the lowering of credit standards than most people realize.
    That is all.
    Dirty Renter/ Dirty Ex-Banker?

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  41. CCG

    RE: Dirty_Renter @ 40

    Yep. Banks are subject to the same prisoner’s dilemma as ordinary citizens. You can either lie and/or steal, or you can pay for those who do anyway.

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  42. buystocks

    i think dirty renters shouldn’t be allowed to post

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  43. David Losh

    The deal is that banks deal in the financial markets which are global. Securities are globally based funds, and banks are allowed to sell, buy, and trade in those securities. While the United States may be able to weather this economic storm, many countries will be bankrupted.

    Banks continued to lend, at great risk, even though the rest of the world was in a more precarious position. Mortgage backed securities in Rome, Madrid, Shanghai, or Buena’s Aires were based on extremely optimistic pricing. The assets, globally, were of a contrived value.

    In my opinion, banks were making loans on assets that they knew were over priced. The borrower may not understand how economies work, but it is the banks business to know.

    Simply put they were making loans on properties that looked good from the street, but were falling off a cliff in the back yard. They knew.

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  44. wreckingbull

    RE: Ross Jordan @ 38 – I have to side with Dr. Short on this one, but in the end, this is all so subjective. I think it is more of a ‘remedy’ than an option. The intent of the agreement is that the borrower pays, not defaults.

    I would use a different example than Dr. Short. If you want an example of mutually-agreed options in a mortgage contract, I would look no further than an option-ARM. Both the borrower and lender are agreeing to several mutually acceptable servicing options.

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  45. The Dude

    By Jillayne @ 28:

    The Dude,

    I’m pretty sure this came up when WaMu execs were being grilled in Wa DC. No lender wants to be the first one to tighten underwriting guidelines when it looks like a bubble is forming. To do so would mean your corporation would lose out on millions of dollars in profit as well as lose many employees who would jump ship to ride out the last of the bubble at another firm. Of course that argument holds no weight now because those companies have lots more than they gained at the tail end of the bubble.

    Agreed — this may need to be enforced by regulation. In a recent speech, William Dudley stated that the Federal Reserve should start looking at ways to control asset bubbles:

    http://www.newyorkfed.org/newsevents/speeches/2010/dud100407.html.

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  46. TJ_98370

    During the Jurassic Period, when I was attending college, a professor of a marketing class I was attending told the class that he wanted to buy a Mercedes convertible, BUT THE BANK WOULD NOT FINANCE THE LOAN! In my young, naïve brain, my major thought at that time was – “Here you are a professor in the Business School of U.W. and you had to have a bank tell you that you could not afford a Mercedes?” Assuming that U.W. professors are generally representative of intelligent people (as I am a WSU grad this can be debated further elsewhere), does this not suggest that a lot of folks depend on the judgment of loan officials working at banks and other financial institutions as to whether or not they can afford to make certain major purchases? If this is a prevalent attitude amongst the home-buying public, I can see how people would feel that it was the bank’s fault for “letting” them buy a house that they could not afford.

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  47. Karl

    Ethical ? As a consumer you are resposible for your own “due diligence” . Bankers are salesmen and should be viewed in the same light as any commision compensated individual. Some do maintain a certain level of standards but that should never be assumed. If you sign a contract….you should be bound to it. Sorry, It is all there in the fine print. If you don’t understand it then take the contracts to someone who does……before you sign it!

    We really don’t need a lot of watchdog groups to keep us from doing stupid things. Do your home work, do the math. Main stream media were refering to many of these mortgages as suicide loans fairly early on.

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  48. Herman

    I have a few posts to make on this topic.

    First let me say, a society that does not operate on a basis of ethics would be hostile and expensive. Imagine that in every interaction or transaction you had to guard against a substantial likelihood of deceit and manipulation. It would feel hostile and suspicious. Society’s response is be legally oppressive and expensive, as every situation has to be backed up with stipulations of legal recourse and extensive fact-checking to rule out all forms of deception and gray-area fraud.

    In Vienna (Austria), the streetcars operate on the honor system. You buy a ticket and stuff it in your pocket and nobody checks. The ethical foundation of their city allows them to forego the cost of an expensive system of access controls (e.g. BART).

    We should strive for an ethical, open society.

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  49. Herman

    I never thought I’d say this, but I agree with what BacktoBasic said.

    The lender has the obligation to refrain from manipulating a borrower into a loan that they could not repay. The lender should not intentionally engineer a situation where they examine the borrower’s asset and income, and put forward a loan that is designed to make the borrower default so they can exercise the remedy.

    The lender is not obligated to convey its opinion on whether the asset price will go up or down, only to give the borrower a fair shot at paying back the loan.

    Based on that definition, I think some of the loans made were unethical. But it’s just a small minority of them, as compared to a majority where everything was done above board.

    Strategic defaulting borrowers seem to use a rationale that since SOME loans were unethical, then ALL banks are unethical, therefore MY loan was unethical, therefore I am morally free to default.

    That is flawed logic and self-serving rationalization, to avoid the moral and ethical dillemma.

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  50. Kary L. Krismer

    RE: TJ_98370 @ 47 – Also way back a long time ago, I was at the bank trying to get financing on my yet to be built 89 Ranger. The woman at the bank told me I barely qualified, which I thought was odd. What she didn’t realize is that my RX/7, which was not paid off, was going away. There was no way I could have afforded to keep the RX/7 and buy a new truck, but the bank thought I could.

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  51. Herman

    Contrary to the cynical posts here, the concepts of ethics and good faith are very important in business. It’s important that everyone is working above-board.

    I looked through my contracts from my home purchase and found that it’s there too.

    There is of course the “Good Faith Estimate” where the lender is providing what it believes to be factually correct information about the terms of a loan, to the best of its ability to estimate, pending more information to be provided later in the process. It is described as Good Faith to imply that it would be ethically improper to provide false information to secure the borrow’s business, only later to use it as a bait-and-switch.

    The first words of my loan contract state that, “In return for a loan that I have received, I promise to pay $145,000 plus interest, to the order of the Lender.” Defaulting into remediation is not exercising an option — it’s breaking a promise. The word promise is ethically charged; a promise is a personal guarantee, and breaking a promise is generally considered to be morally wrong.

    In the Financing Addendum to my purchase offer, it states that, “…if Buyer is unable to obtain [insurance] after making a good faith effort and timely gives notice of such inability, then this Agreement shall terminate…”

    I raise these as evidence that even with all the paperwork and legal terms, the principle that everyone is working above board (in good faith) is pervasive in real estate transactions.

    That’s necessary because there is so much gray area, disclosures, and so on in those complex transactions that one cannot hope to legally stipulate and verify their entire way through the process. Reading all of the posts with approval and justification for borrowers to take unethical behavior and break promises is discouraging.

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  52. HappyRenter

    By Herman @ 49:

    First let me say, a society that does not operate on a basis of ethics would be hostile and expensive. Imagine that in every interaction or transaction you had to guard against a substantial likelihood of deceit and manipulation. It would feel hostile and suspicious. Society’s response is be legally oppressive and expensive, as every situation has to be backed up with stipulations of legal recourse and extensive fact-checking to rule out all forms of deception and gray-area fraud.

    Isn’t that already the case in the United States of America? For anything you do there is tons of paperwork.

    We should strive for an ethical, open society.

    That was the case in Europe in the Middle Ages when holding your word was a question of honor.

    I think the banks should not have given those loans and the government should have at least warned against giving/accepting those loans. But everybody wanted real estate to go up and up, including the government. So, there was/is a fundamental problem in the system itself. The population was tricked into believing that real estate will keep going up and the government encouraged this view. Now, the system is cleaning itself out.

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  53. Masaba

    RE: Herman @ 52

    It’s hard to argue with Herman’s logic. If a debtor believes that their bank acted in bad faith during the contract process, then they should seek legal recompense, not resort to acting unethically themselves. If not, then they should also act in good faith.

    People who are ‘strategically defaulting’ are truly doing a lot of shady justification to convince themselves that it is ethical.

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  54. Mark

    Ethics doesn’t have anything to do with it. Our culture promotes “survival of the fittest”.

    If the banks are playing by one set of rules, while the borrower is playing by some kind of perceived ethical code, the borrower is going to be eaten alive.

    If the borrower feels that they have taken the moral high ground, they are going to be eaten whole and deserve what they get!

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  55. meadows

    So while we discuss this matter, others have decided and are taking action.

    http://rawstory.com/rs/2010/0513/bankers-jailed-sued-iceland-seeks-culprits-crisis/

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  56. shane

    No, there is nothing wrong with walking away. All the people who say it is wrong are the unethical actors here. They want to keep people as debt slaves in what has clearly become a rigged and immoral financial/political system.

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  57. Scott Weitz

    Anyone want to start a bank?

    I think I could do pretty well borrowing @ 0, getting 3-4% from Treasury and getting levered up 100,000-1.

    Many of the large banks did not have a single down day in ‘trading’ last quarter. What a great system!

    Bankers take money from the govt (ie. taxpayer) , falsify accouting, and pay themselves HUGE bonuses because of their ‘genious’.

    May god bless America.

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  58. David Losh

    I’m going to point you over to the Rain City Guide, http://raincityguide.com/
    Every week there is more and more about the lending process, like that’s going to fix it. Let’s fix the paper work, let’s regulate who can make loans, when, where, and how, like that’s going to fix it.

    There is a house that was listed in my neighborhood that just sold. I know the sellers and looked at the Comparative Market Analysis prepared by an out of area Real Estate Professional who is a friend of the family. The Real Estate professional has been an agent with Windermere for six years so she must know what she is doing, but the CMA was for over half a million dollars at $525K.

    There is no way that property appraised for that amount of money, no way, but it did. It’s sold by another Windermere agent. It is an older home in the middle of a bunch of newer homes.

    So maybe the buyers qualified for the higher loan amount, but the asset, in my personal opinion, is extremely suspect.

    What’s more important here, the ability of the borrower, or the price of the asset? Ultimately when the loan is bundled and sold, what is the criteria? Especially now with unemployment as a factor how secure is the borrowers ability to pay?

    Banks had an obligation to determine the value of the security before they packaged loans. The asset, the value of the asset, is what’s importnat. The borrower, and the promise to pay, is a bit player in this scheme.

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  59. softwarengineer

    I’m For Ethics Too

    The problem is, the rich elite banksters guiding our political process are taking welfare handouts and laughing all the way to their banks. Cars, food, prescription drugs, etc, etc atre getting sold to the American test rats with a plethora of cancer causing toxins in them. Companies are firing Americans and outsourcing, or firing Americans and insourcing…many, blatantly breaking as many employment laws as the worse organized crime sweat shops. I could go on and on, but you get the gist….why should the peons be subject to law restrictions a lion’s share of the rich elite totally ignore?

    Don’t get me wrong, I’m for towing the ethics line with Tim….but it does bring up a remarkably clear crack in our legal system and IMO, left unregulated as it is, the organised crime problem in America is going to grow like a lit mushroom explosive.

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  60. Phil

    There are 2 related questions.

    First…

    The banking system, as a whole, creates the money for that loan at roughly the time the loan is taken out (I know individual banks may have had it in their accounts already, but the system does not.) That is why its called “fiat currency” which is mostly only created when someone borrows it. Any moral obligation is based on a fair trade, which does not exist in a fiat currency world. It is only a legal obligation from legal tender laws that create a repayment obligation. If you were similarly defrauded when borrowing something besides money, you’d have no moral nor legal obligation to repay, in fact you’d have a moral and legal claim against the lender for fraud.

    Second…

    Ethics is essentially a biblical standard, and this debate misses an important additional Biblical point. In addition to the requirement that money be a store of value, it requires all property related debt be extinguished once every 50 years. This apparently so the true value of property can always be known. (This is the Biblical “bubble preventer.”) Thus there is an unusual moral obligation that once every 50 years, no matter what anyone might say, you cannot be in debt over property, nor can anyone else anywhere in the country. It is immoral to be indebted at these times. Any correct moral statement about the obligation of borrowers must also state this fact.

    Tim,
    You’re on the right track, just keep going deeper. The tenor of this moral discussion misses the root points, which is why you can’t get agreement. There is a lot more education to do before people generally understand the moral underpinnings of mortgages.

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  61. Phil

    There are 2 more points to the moral discussion.

    First, the banking system as a whole is creating the money at the time it is borrowed. This is why its called fiat currency. (Individual banks may have it on hand, the system does not.) Only legal tender laws allow this otherwise fraudulent scheme to function. The only moral basis at all is thus a general moral obligation to respect the laws of the land. If a borrower was similarly defrauded with anything besides money, there would be both a moral and perhaps legal claim against the lender.

    Second, the basis for ethics is the Bible, and in this area it not only requires the money to be a store of value, it also requires the extinguishing of all mortgage style debt once every 50 years. This is the ethical “Bubble Preventer.” In is thus immoral for anyone, anywhere in a society, to be in debt once every 50 years. (Personal, and thus gov’t debt is once every 7.)

    Any correct statement of mortgage related morality requires both of these issues to be included. Mortgages as we know them are not generally moral. Both sides are generally immoral.

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  62. Dirty_Renter

    RE: softwarengineer @ 60

    SWE – don’t forget that the original TARP recipients, 9 dirty bankers, paid back TARP and made the US gov billions in interest and subsequent convertible sales. And you seem to have fallen into the mind-numbing populus rant that low interest rates are only a subsidy to the ‘bankstas’, not economic stimulus for the nation as a whole. Geez Louise.
    The latest hate-rant is that the FED’s $1.3T MBS purchase was solely bank-owned toxic sub-prime waste intended only to save the ‘bankstas’. Time will tell…but I bet Uncle Ben makes a nice vig on the MBSs. I’m of the minority opinion that, with the death of the shadow banking system and its $Ts of liquidity in 2008, the FED had no choice but to support the system for a while.
    That is all.
    Dirty Renter

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  63. Dirty_Renter

    By buystocks @ 43:

    i think dirty renters shouldn’t be allowed to post

    :)…what about DOM?

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  64. CCG

    By Phil @ 62:

    First, the banking system as a whole is creating the money at the time it is borrowed. This is why its called fiat currency. (Individual banks may have it on hand, the system does not.) Only legal tender laws allow this otherwise fraudulent scheme to function. The only moral basis at all is thus a general moral obligation to respect the laws of the land. If a borrower was similarly defrauded with anything besides money, there would be both a moral and perhaps legal claim against the lender.

    Exactly. This is the root of the whole problem and it predates even the Fed. The Coinage Act of 1792, Section 19 had the appropriate way to deal with this little problem.

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  65. DrShort

    By Dirty_Renter @ 63:

    RE: softwarengineer @ 60

    SWE – don’t forget that the original TARP recipients, 9 dirty bankers, paid back TARP and made the US gov billions in interest and subsequent convertible sales. And you seem to have fallen into the mind-numbing populus rant that low interest rates are only a subsidy to the ‘bankstas’, not economic stimulus for the nation as a whole. Geez Louise.

    You should also remember that the banks were forced to take the TARP funds even though many didn’t want it. Paulson gave them no choice in the matter.

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  66. rational

    I beg to disagree with the notion of “good faith”. Is there a certified mind reader at the table when the loan documents are signed to sign off that both the lender and the borrower are acting in “good faith”? The binding contract is what is spelled out, in big and fine print, in great detail. If the buyer didn’t care to read or otherwise understand a legal contract, why aren’t they held accountable for that?

    Banks and borrowers entered a contract and the whole thing should have been settled entirely between them. The banks should have tried to get back what they can and the borrowers would have dealt with their personal situation the best they could — either defaulting or negotiating a lower payment or whatever.

    Instead we have the stupid govt stepping in and taking my hard earned tax money and giving it away to the greedy banks and to the idiotic borrowers. I get to pay for that several times over. First by being forced to pay an inflated price for a home and then by bailing out the banks and then watch my home price go down while the bankers are made whole and the borrowers default and merrily move on to a new dream to pursue at someone else’s expense. The whole thing is effing screwed up.

    What incentive does anyone have to work hard and to be responsible with their obligations?

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  67. Lars

    To the “it’s not unethical to walk away if you can’t pay” camp: Just how do you define the inability to pay? How many jobs is someone supposed to take on, how many hours per week? Is it acceptable to have to tap your retirement savings to fulfill your mortgage contract? Are you required to beg your relatives for money? Take on thousands of credit card debt as some people are doing?
    My point is, no average person can “afford” to pay tens of thousands of dollars more for something than it is worth. Just looking at the current cash flow is short sighted and inadequate. Compared to the devastating effect on the personal financial situation, the ethics violation is minor.

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  68. rational

    By Lars @ 68:Just how do you define the inability to pay? How many jobs is someone supposed to take on, how many hours per week? Is it acceptable to have to tap your retirement savings to fulfill your mortgage contract? Are you required to beg your relatives for money? Take on thousands of credit card debt as some people are doing?

    That’s for the borrower to determine before signing a loan. Each person has a different definiton of “affordability”. Borrowers are supposed to think through before making that commitment. Same goes for the lender — they should be comfortable that the borrower can follow through. If not, they shouldn’t be lending.

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  69. Lars

    By rational @ 69:

    That’s for the borrower to determine before signing a loan. Each person has a different definiton of “affordability”. Borrowers are supposed to think through before making that commitment. Same goes for the lender — they should be comfortable that the borrower can follow through. If not, they shouldn’t be lending.

    That might be true for traditional fixed rate mortgages. But in today’s world of adjustable rate mortgages et al, it is more difficult than that.

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  70. Jonness

    “As is often the case, I find that I am learning the most from the people that disagree with me and present their opinions in a well-thought-out, rational manner. Specifically, the best argument that I read in yesterday’s discussion that makes the case for walking away being an unethical choice is that when you sign a mortgage contract, it is assumed that both parties are “acting in good faith,” and have an obligation to do so for the entire term of the contract.”

    Yep! I’m certain that’s exactly what the bank was thinking when they presented the borrower with the contract. “How can I best martyr myself in order to serve the best interest of this good citizen.”

    Let’s get down to the bottom line. When you sign a contract, both parties are acting in good faith they will honor the terms of the contract. You guys are reading way more into it than is written in the contract. You are literally inventing all of this great stuff that isn’t written in the contract. They have a name for people who behave in this manner. And there is a new one born every minute.

    Let’s get back to reality for a few moments. The bank has designed a well-orchestrated business model in an effort to maximize profits. They could give a darn about the other party’s well-being. It’s about profit and stock prices. Anybody who believes otherwise is asleep at the wheel and on a crash course toward a brick wall.

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  71. Jonness

    Banks sell debt. The poorer you are, the more they charge. If you overdraw your bank account by $1, they charge you $35 in overdraft fees. If you miss your $10 credit card payment by a few days, they charge you $35 in late fees.

    People really need to get in reality when it comes to banks, the contracts they offer their customers, and what their true intentions are.

    Let me give people a big tip in life. Predators prey upon the “good” in you. When you try to be good, you fall victim to the predator. If it cuts deep enough, the good in you will be infected with a virus, and your good thoughts will turn into anger, revenge, rage, and various other forms of mental and emotional imbalance.

    As soon as you enter a business agreement where it is “assumed” you will act in a certain manner that is not explicitly stated in the terms of the contract, and you go along with it, you’ve become the counter-party’s prey.

    Practice business with logic, research, and savvy. Practice friends, family, and your neighbors with care, compassion, love, and generosity.

    I see a lot of people have fallen victim to informed consent and are trying to rationalize their decision.

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  72. Jonness

    RE: @ – “I see a lot of people have fallen victim to informed consent and are trying to rationalize their decision. ”

    Hmmm. I’m pretty sure nobody is too bent about being informed about their rights as a patient. Perhaps that should be manufactured consent? :)

    http://www.thirdworldtraveler.com/Herman%20/Manufac_Consent_Prop_Model.html

    “The mass media serve as a system for communicating messages and symbols to the general populace. It is their function to amuse, entertain, and inform, and to inculcate individuals with the values, beliefs, and codes of behavior that will integrate them into the institutional structures of the larger society. In a world of concentrated wealth and major conflicts of class interest, to fulfill this role requires systematic propaganda.”

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  73. Hugh Dominic

    I have a theory about why there is disparity in opinions about this. It could be that the poorer, bottom feeders of our society are not treated with as much respect in their business dealings. To them, banks – maybe even the world – seem harsh, cruel, and indifferent.

    On the other hand, people with money and status get better treatment, more respect, and banks and others make unwritten efforts to win and keep winning our business. We see a more forgiving side of the world, and we respond to the world in kind.

    I guess the question is, which came first? The attitude to treat our associates with respect, or the success?

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  74. Kary L. Krismer

    By Lars @ 68:

    To the “it’s not unethical to walk away if you can’t pay” camp: Just how do you define the inability to pay? How many jobs is someone supposed to take on, how many hours per week? Is it acceptable to have to tap your retirement savings to fulfill your mortgage contract? Are you required to beg your relatives for money? Take on thousands of credit card debt as some people are doing?
    My point is, no average person can “afford” to pay tens of thousands of dollars more for something than it is worth. Just looking at the current cash flow is short sighted and inadequate. Compared to the devastating effect on the personal financial situation, the ethics violation is minor.

    What does the current value of something have to do with their ability to pay for something (absent through a sale)? I can see it could affect their willingness to pay for something, but if they could afford to pay for something when it was worth $400,000, all other things being the same they could afford to pay for it when it’s $300,000.

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  75. Kary L. Krismer

    By Lars @ 70:

    By rational @ 69:
    That’s for the borrower to determine before signing a loan. Each person has a different definiton of “affordability”. Borrowers are supposed to think through before making that commitment. Same goes for the lender — they should be comfortable that the borrower can follow through. If not, they shouldn’t be lending.

    That might be true for traditional fixed rate mortgages. But in today’s world of adjustable rate mortgages et al, it is more difficult than that.

    I’m not sure what your definition of “today’s world” is, but I think 30 year fixed have been under 7% since 2002. Going with a variable rate in such conditions is risky, and a risk that should be fairly easy to understand. Teaser rates are probably worse, but there the risk is probably easier to understand because the payments are virtually certain to go up.

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  76. rational

    By Hugh Dominic @ 74:

    I have a theory about why there is disparity in opinions about this. It could be that the poorer, bottom feeders of our society are not treated with as much respect in their business dealings. To them, banks – maybe even the world – seem harsh, cruel, and indifferent.

    I think it has more to do with those who were responsible with their mortgages and those who weren’t. The folks who didn’t bother to understand how much they could truly afford went on a borrowing binge, supported by banks for all the reasons we now know, and paid higher and higher asking prices. In that process they inflated home prices for everyone. Those who carefully analyzed their mortgage obligations and tried to buy a home within their means found that the longer they waited, the smaller home they could afford, because there were many idiots out there willing to borrow beyond their capacity and buy lot more home than they needed (for “investment”). That was all fine as long as the irresponsible parties were left to their own devices when reality came knocking. We know that isn’t how it is playing out.

    Imagine a cop stopping a speeding car and giving them a big, well deserved ticket. The ticketed drives throws a tantrum, and the cop pulls YOU, you who is following all the rules of the road, and empties your wallet to help the speedster pay his ticket. That’s how a lot of us feel. Punished for being responsible so the idiots can pursue their unaffordable dreams.

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  77. Tony Chinnici

    RE: The Tim @ 3 – Banks have massive negotiating advantages over individuals because they hold the money! They realize that it is simply good business sense to rely on people’s value of a promise (perhaps even prey upon it…if I’m a bitter man). They can afford entire departments of people to decide how many loans they can afford to lose, and most people can’t afford to lose the ONE loan they may have, owing to credit scores (which is mentioned in Brent T. White’s first article as extra collateral that is mentioned nowhere in the loan terms) and down payments committed by that real estate.
    Between banks with the above resources and individuals, there is an inherent imbalance in the ability to both predict AND absorb the negative consequences of a financial decision; this point is compounded by the immediate bailout of the financial industry rather than a moratorium on shifts in loan terms (even a temporary one) that would have cost taxpayer ZERO dollars in direct terms.
    A good analogy would be any story featuring a deal with the Devil: the terms can be as detailed as you like, but the end result tends to be a surprise for the guy who signs on the line which is dotted.

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  78. mydquin

    What about someone who bought their home at the peak of the bubble with a conventional loan from a bank that was not behaving irresponsibly?

    The real problem was created by i-banks that used their power over the credit raters to commit fraud. They are the ones that should be funding these homeowner bailout programs.

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  79. On the Radio: Walk Aways and Puyallup Condos • Seattle Bubble

    [...] your comments and questions. Although I’ve made my position on this issue pretty clear here in the past, my main role on the program today will be to address the overall issue from a more neutral [...]

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  80. Dori Monson Tackles Walking Away from Your Mortgage • Seattle Bubble

    […] Did Banks Act in Good Faith During the Bubble? […]

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