To the extent that Morgan Stanley is leading by example, the securities colossus is sending an unlikely message to underwater homeowners: Walk away.
The Wall Street firm is itself walking away from five San Francisco office buildings it purchased as part of a landmark $2.43 billion deal near the height of the real estate boom. But don't call it a foreclosure or a default -- not when this kind of money is involved. A spokeswoman interviewed by Bloomberg News called it "a negotiated transfer to our lenders."
The buildings were bought in 2007 by a fund managed by the firm and supplied with cash from Morgan Stanley and investors. They may be worth half the price Morgan Stanley paid just two years ago, according to Bloomberg.
Businesses and corporations walk away from mortgages all the time, says Brent T. White, a law professor at the University of Arizona. But homeowners don't -- largely due to feelings of moral obligation and guilt.
Nevertheless, a quarter of homeowners with a mortgage are currently "underwater," which means they owe more on their property than the house is worth, according to real estate research firm First American CoreLogic. Property prices aren't returning to their boom highs anytime soon. Even those lenders and servicers willing to modify mortgages are balking at writing down principal, government data shows.
So millions of homeowners have to decide: Keep losing money by paying a rotten mortgage? Or simply walk away, like Morgan Stanley?
White recently wrote an academic paper arguing that homeowners should act more like corporations, and base their decisions to walk away on legal and economic reasons, not a sense of perceived moral obligation. By contrast, he wrote, "[t]he clear message to American homeowners from nearly all fronts is that one has a moral responsibility to pay one's mortgage.
It was none other than former Treasury Secretary Hank Paulson who once said: "And let me emphasize, any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator - and one who is not honoring his obligations." The messaging hasn't changed under the Obama administration.
The industry is even blunter. In Thursday's Wall Street Journal, John Courson, the head of the Mortgage Bankers Association, played up the moral argument against walking away, telling the paper: "What about the message they will send to their family and their kids and their friends?"
"It highlights the double standard we have in this country," White says. "Businesses strategically default all the time and, in fact, they should -- they're obligated to maximize profits and minimize losses. But so should homeowners."
And more and more homeowners are, in fact, choosing to "strategically default." More than one million homeowners are expected to go that route this year, nearly double the amount in 2008 and more than four times the level in 2007, according to an analysis by the credit reporting company Experian and Oliver Wyman, a management consulting firm. A study by a team of university academics found that a quarter of defaults are strategic.
The trigger, researchers say, is negative equity. When the value of a house is less than what the bank is owed, borrowers have good reason to break their contracts and walk away.
As White notes, "there is in fact a huge financial upside to strategic default for seriously underwater homeowners -- an upside that is routinely ignored by the media, credit counseling agencies, and other political and economic institutions in 'informing' homeowners about the consequences of default."
Moreover, the costs of default are not nearly as extreme as these same institutions typically misrepresent them to be. In reality: homeowners face no risk of a deficiency judgment in many states or for FHA loans regardless of the state; lenders are unlikely to pursue a deficiency judgment even in recourse states because it is economically inefficient to do so [some states allow lenders to go after homeowners in court]; there is no tax liability on 'forgiven portions' of home mortgages under current federal tax law in effect until 2012; defaulting on one's mortgage does not mean that one's other credit lines will be revoked; and most people can expect to recover from the negative impact of foreclosure on their credit score within a two years (and, meanwhile, two years of poor credit need not seriously impact one's life).
White adds that walking away is nothing more than an "efficient breach" -- a legal theory that calls for parties to sunder a contract if the cost of breaking the deal is less than the cost of maintaining it.
And the social stigma associated with it tends to reduce as more homeowners hear about it.
As the blog Calculated Risk dryly notes: "I wonder if hearing about 'rich' banks that are paying 'large' bonuses walking away from commercial buildings also weakens the social pressure?"