Principle Versus Principal: The Ethical Dimension Of Underwater Mortgages

by Ethics Newsline editor Carl Hausman

I teach a variety of college courses centering or touching on ethics and face the continual challenge of communicating the notion that the study of ethics is not just a matter of theory or a series of meditations on abstract issues.

Also, I need to somehow show that ethical decision-making isn’t as simple as consulting a rule book where the right and wrong answers are listed in the appropriate columns. (And, of course, justify my job in the process because such a book, if it existed, would obviate the need for ethics professors.)

IGE founder Dr. Rushworth Kidder recognized these challenges from the get-go and, early in the 1990s, developed categories of “right versus right” decision-making — ways to frame a question in realistic, everyday terms — with the realization that there may be compelling arguments on both sides of the issue. Dr. Kidder further codified four paradigms for weighing such dilemmas: justice versus mercy, individual versus community, long term versus short term, and truth versus justice.

I was reminded of these paradigms as I read the top stories in last week’s financial press and came across a dilemma that might be classified as “principle versus principal.”

Here’s the story: A U.S. government agency called the Federal Housing Finance Agency has declined to allow permanent reductions in principal on “underwater” mortgages (i.e., those in danger of or in default) that are backed by Fannie Mae and Freddie Mac, the giant quasi-governmental enterprises that prop up home loans.

Here’s the translation: The president and many in Congress want the federal government to provide bailout money for financially troubled homeowners who owe more than their houses are worth.

Treasury secretary Tim Geithner backs a bailout, arguing that the White House plan would “provide much needed help to a significant number of troubled homeowners, help repair the nation’s housing market and result in a net benefit to taxpayers,” reports NBC News.

But Edward DeMarco, the Federal Housing Finance Agency head, won’t budge, insisting that there’s no evidence that the plan would stop enough foreclosures to be a plus on the balance sheet and arguing further that the program would encourage people who have taken on more mortgage than they can handle to default in order to reap the benefits of principal reduction.

The last part of the argument not only has an ethical base but is grounded in ethics terminology, invoking the phrase “moral hazard” — effectively rewarding reckless behavior by offering a backstop to those who get in too deep.

Moreover, the question of default itself has become part of a new ethics controversy because many underwater homeowners are engaging in what’s known as “strategic default,” failing to pay the mortgage even though they can do so, betting that the damage to their credit ratings will be less expensive in the long run than will the continued burden of a mortgage on a property now worth much less than the purchase price.

These ethical questions are part of a larger scenario: the unraveling of the global economy, partly due to the collapse in the housing market and the subsequent implosion of securities and other financial vehicles pegged to housing. And, again, it’s a scene that might be viewed as a morality play of sorts as we face a variety of right-versus-right scenarios. Here are just a few examples:

• Justice versus Mercy: Do we extend a hand to homeowners in financial quicksand even though a justice-based view holds that they knew what they were getting into and gave their word — the most important commodity in a financial system that is glued together by trust?

• Individual versus Community: In the case of strategic default, is it right to walk away from a debt because the calculus shows it will benefit you individually, even though widespread default is clearly corrosive to the climate of trust that undergirds the entire credit industry? Along the same lines, is it fair to shift individual financial burdens from those who can’t or won’t pay to the broader community of people who can?

• Long Term versus Short Term: Some would argue that avoiding bailouts and backstops is a matter of a painful treatment for the economy out of concern for its long-term survival. While it is tempting to help those in need now, the argument goes, bailouts only delay the inevitable, allowing the problem fester and grow until it’s incurable.

• Truth versus Loyalty: While not a perfect corollary, note that the entire concept of bailouts of financial institutions is as much a political issue as a fiscal one. In the early days of the crisis, as documented in journalist Andrew Ross Sorkin’s excellent book Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System — and Themselves, Treasury officials found themselves weighing the choice of whether to pursue a no-bailout philosophy baked into their political stances or confront what they (in some cases) presumed to be the truth: Letting giant investment banks and related firms fail would produce an economic crisis that would trigger pandemic fiscal catastrophe.

So here we have an ethical case study that is neither theory nor abstract. The decision will in all likelihood affect anyone who owns a home, wants to own a home, pays taxes, or wants to avail themselves of consumer credit.

And while it’s clearly a fiscal issue based on complex projections and assumptions, it’s also an ethical issue because, for one factor, trust in the other party’s good intent is the commodity that keeps the financial system alive and the lubricant that allows its gears to grind.

So, what do you think? Given the current mortgage situation (explained in more detail in the news articles cited below) do you believe the government should offer a bailout to underwater mortgage holders in danger of default? Or should we stand on principle and refuse to reduce principal for those who knowingly incurred the financial obligations that got them in over their heads?

©2012 Institute for Global Ethics

 

Ethics Newsline® editor Carl Hausman is a journalism professor who has written three books on ethics and specializes in explanatory journalism.

For more information, see: American Banker, Aug. 3 — Bloomberg, Aug. 2 — NBC News, Aug. 1 — San Francisco Chronicle, July 31 — Forbes, July 31.

Questions or comments? Write to newsline@globalethics.org.