 Go all right. We're ready My name is Doug French It is 1430 And I'm here to talk about the Ethics of default Thank you for showing up after lunch. I know there's a lot of things to do On a sunny afternoon in Bo drones. I'm honored that you're here Honored to be asked to speak It's one of my two or three speaking parts this weekend This will be longer than my other speaking parts The ethics of default come from this most most of this is from a little book Very thin book You know my girl wishes I had thicker books She wishes I had bigger books But maybe that'll happen one of these days, but for now Just this tiny little book called walk away, which I didn't bring any copies of I didn't realize we were peddling books this weekend, but you know where to get it It's online at mises.org and you can either get it for free or you can buy it And I believe we charge eight bucks for this or something like that So anyway strategic default Is really the bedrock what I'm going to talk about and strategic default is when a homeowner Stops paying on their mortgages when in fact they can afford to pay But they choose not to pay because the collateral value supporting that loan Has fallen Way below the loan balance Now I'm not talking about people who take out a loan and never make a payment I'm talking about people who borrowed in good faith to buy an asset or maybe they refinanced in good faith During the bubble the housing bubble of the mid-2000s, and they made their payments until they realized That it made no sense to feed a mortgage that On a house that was worth but a fraction of what they have and you have a number of people around the United States that this is the situation They are thousands of dollars underwater In some cases hundreds of thousands of dollars underwater some cases million dollars Underwater and these people can pay But they'd be paying for a liability that will never never ever be an asset so This is this is good money after bad on stilts But for some and for some libertarians this issue is a no-brainer CPA Karen DeCosta wrote on on the rockwell calm She said walk away free yourself from the unnecessary Bondage and let the giant banks sort out the mess that they help perpetuate perpetrate as well But other libertarians would say a contract a contract right To not pay a stealing the lender fulfilled their end of the bargain They they lent you the money to buy or refinance the house the note doesn't give you an out There's nowhere in any promissory note on a house. It says, you know if the house goes down in value go ahead and walk away No note ever says that and Conversely a lot of people will say well listen if the house soars in value you borrow 200 to buy a two hundred thousand dollar house it goes up to three hundred thousand you sell it you pocket the 100,000 and the lender of the poor lender only gets the interest that they contracted to get so This isn't a partnership. It's a straight contract deal and you know private contracts are the bedrock of a free society and Thus we have this issue with with libertarians. I mean what would happen if people were just allowed to walk away on their obligations I mean it'd be chaos But the question is is America a free society There are property rights for all in America and So I got under this issue because of some various fights During email exchanges which some people in this room were a part of and Started thinking about You know, what should people do if they're thousands and thousands of dollars Underwater under mortgage should they sacrifice for the rest of their life To make sure that Fannie Mae Freddie Mac B of a and The city corpse of the world Get some money now I Start this with the idea that let's say you bought your house as a corporation and you're the you're the CEO of that corporation and let's say This is a million dollar house And you borrow nine hundred thousand and you put a little bit of money down and Then the market gets cut in half You know nine hundred thousand and the house is only worth half But the house is only worth half a million dollars now if you're the president of a corporation And the corporation owned that asset and and the company has plenty of money to Fund that What would do what would they do? Well? time and time again Big real estate companies Have walked away and It's viewed as the best thing to do in fact It's viewed if they don't do that as a violation of their fiduciary duty Now fiduciary duty Being a principle of natural law That has been incorporated in the Anglo-American legal tradition and this principle Underlies the duties of good faith loyalty and care that apply to corporate officers Directors now fiduciary duty of company supervisor is the prudent management of the company And the assets on behalf of shareholders It's not on behalf of the company's creditors or anyone else In terms of fiduciary duty to a person to company shareholders So in the case of that I just laid out where the property is hopelessly under water it would be the fiduciary duty of the company to walk away to hand the keys to the lender and And Just let it have them back and in fact Morgan Stanley did this on five buildings in San Francisco Where they bought it at the height of the boom? Morgan Stanley being a lender themselves, but did they go ahead and pay on this underwater property? Of course, they did it was in the best fiduciary duty of the company and the shareholders that they just mailed in the keys and Believe me Morgan Stanley had the cash to make the payments so and this is many real estate trusts did this and It's it You know there was this quote in the Wall Street Journal these companies all have piles of cash to make the payments They are simply opting to default because they believe it makes good business sense Now at the same time you may remember a guy named Hank Paulson and Hank Paulson is He was former secretary treasury now best-selling author, I believe and He said at the same time that these big companies were walking away and handing in the keys Hank Paulson was saying any homeowner who can afford his mortgage payment That chooses to walk away from an underwater property is simply a speculator and One who is not honoring his or her obligations So while we have this savvy Commercial property owners doing their fiduciary duty We have the Hank Paulson's of the world and other high-minded folks saying if you're the average person Who bought their house in California somewhere for half a million dollars? It's now worth 250 you still owe 400 You'll never dig out of this equity hole. Those people are morally wrong while the Titans of the real estate industry Do the right thing and walk away Now of course a person can't have a fiduciary duty to themselves It's defies the explanation fiduciary duty means Doing the best thing for others in this case shareholders But surely if CEOs have a fiduciary duty to shareholders then a mortgage payer has some sort of fiduciary duty to his or her family I Mean is a family supposed to sacrifice their entire lives Kids not going to college Maybe not being able to go to Boulder on vacation Just so city bank B of a Fannie Mae can get their payments. I mean is a family supposed supposed to exhaust all savings essentially be financially Improved in order to satisfy this losing contract if you're running a company You would certainly be kicked out you might even be you know Prosecuted in some way from a falling fiduciary duty, but if you're an individual your browbeat into making These bad financial decisions Now Aristotle explained that man is a rational being and men learn man learns that Work that learns what works in the world natural laws to achieve this desired ends survival and prosperity and Murray Rothbard explained and In the ethics of liberty that he said the very fact that the knowledge needed for man's survival and progress Is not innately given to him and determined by external events Shows that man has the free will to either employ reason or not and that They act and an act set against his life and health Would objectively be called in more So the idea here is if if you act against your financial health, you're actually not being more or you're actually being immoral in Rothbard's words however In the same book Rothbard writes the proper the perfectly proper thesis that private persons or Institutions should keep their contracts and pay their debts So Rothbard says if you have a private debt Private persons and institutions you should keep those contracts and pay the debts But the issue here is that the mortgage market is anything but private in fact 97% of the mortgages today are either guaranteed by FHA or they were bought in secondary market by Fannie Mae and Freddie Mac Now during the boom It was not 97% it was about 50% but the 50% that didn't That wasn't guaranteed by the government or purchased by Fannie Mae and Freddie Mac Those deals in the private market were dictated by terms set by the government lenders So everybody tried to compete with government lenders and they set the pace for for what an mortgage would look like So to me it's very hard to imagine that Rothbard Would insist that a private individual be poorer and less prosperous In an effort to pay Fannie Mae and Freddie Mac and B of A and J P Morgan Chase Because these are entities that are only in business Because the government has kept them in business and that's one of the reasons that Fannie Mae Freddie Mac and these others don't negotiate with people who are underwater Unless they're down on their payments. There's no reason for them to negotiate. Why don't they negotiate? It's Washington that keeps them in business not borrowers that keep them in business Now 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 and Since government-sponsored entities which are Fannie Mae and Freddie Mac Is now considered Government debt since they've been bailed out. There's no it's always been government debt. There's always been this Implicit guarantee that's always been placed so Since Fannie Mae Freddie Mac debt The payment on this debt is by taxpayers it is coercion So the funding of GSEs the the funds that they use To buy these mortgages in the first place is obtained in Rothbard's view through Coercion and aggression against private property and in no way is that ever listen Such coercion can never be less it from a libertarian point of view putting wrong and Rothbard if you remember Always advocated that government debt should be repudiated The entire government outright he said let the chips fall where they may just let government bonds be Just repudiate the debt and whoever's whole then will take the loss and In the same article Rothbard ridicules the Social Security Administration because it quote has government bonds in its portfolio and collects interest and payment from the American taxpayer Allowing it to masquerade as a legitimate insurance business So when you think about it in that terms the Social Security Administration Acting as of insurance company, but they're not they're just this phony Ponzi scheme then if To me it would be hard to imagine that Rothbard would view Fannie Mae and Freddie Mac as a legitimate mortgage business And he went on to write that if the idea of Repudiating that the debt was too harsh Then he said at least but the federal government in bankruptcy He said first we have to rid ourselves of the fallacious mindset that conflates public and private And that treats government debt as if it were a productive contract between two legitimate property owners Now if Fannie and Freddie and the rest were allowed to go bankrupt The mortgages would be assets in a bankruptcy Handled by a trustee and they would be auctioned to buyers The highest bidder Underwater mortgages would be trade at pennies on the dollar very very just deep discounts and the buyers of those notes Who would buy? $200,000 mortgage they might buy it for $80,000 the first thing they would do is go to borrowers And make a deal with them because they know the borrower Probably wants to stay in their house, but it's hopeless And so they would quickly renegotiate the debt down in terms of the principal payment We're not talking about these phony lowering interest rate payment She can't lower the interest any lower than already is So the issue here is the principal amount If somebody buys a mortgage at 30 cents on the dollar They would probably quickly turn around and rewrite that mortgage of 50 cents on the dollar And everybody would go on about their business And in fact, this is being done by a gentleman named Lewis Renneri And he actually started this curatization of mortgages way back when for Solomon Brothers Anybody who's read the book Liars Poker Has heard of Lewis Renneri and he has a company right now that is doing that Very thankful buying mortgages at a deep discount Turning around contacting the borrowers saying listen, we didn't praise along your house your way underwater We've noticed you pay and we'll make a Deal that'll work for both of us But a bailed out institution has no incentive to negotiate with anybody. Why should they're keeping them They're keeping these mortgages on their books at a hundred percent a hundred cents on the dollar And they were able to do this with accounting changes made in March of 2009 These are specifically changes to FASB 157 115 and 124 Which allowed the banks to foreclose on homes without having to recognize a loss until the houses are sold And essentially these new rules which were sought by the american bankers association Not surprisingly allow the banks to increase their reported profits And strengthen their balance sheets allowing them to increase the reported value of their toxic assets So one while one side of this transaction gets bailed out by the government They have uncle sam as their partner underwater homeowners Are Subject to this brow beam by the lights of Henry Paulson and others in the press That they need to do the right and the moral thing by keeping banking their payments Now in the ethics of liberty Rothbard constructs an example of a theater owner Contracting with an actor for a performance On a certain date the actor changes his mind and doesn't appear And he poses the question should the actor be forced to appear And rothbard says no that would be slavery Should the actor be forced to reimburse the theater owner for advertising in other expenses? And rothbard says no They shouldn't be forced to pay um They shouldn't be forced to pay this is the lack of foresight and poor entrepreneurship on the theater owner's part But of course if the actor had been paid and he doesn't perform Should he be forced to return the money rothbard points out the problems like this are solved in a republic In a libertarian society By requiring the actor to put up a performance performance bond In short if the theater owners wish to avoid the risk of non-compliance They could refuse to sign the agreement unless the actor posted such a bond Well in the case of mortgage defaults the collateral Of the loan the homes are essentially that performance bond And when the borrower doesn't perform that collateral is surrendered Yeah, and to dovetail with that the basic part of underwriting risk of a mortgage just in quote This is a guy named guy steward who wrote a book on the mortgage business called discriminating risk sure that the home Lenders need to make sure that the home is sufficient value to cover the amount of the loan That's a key part of underwriting And if it doesn't satisfy the debt in most cases lenders can choose to go after the borrower's assets for any deficiency that that they may have And they can go out after that But any loss they take would be in rothbard's words due to their lack of foresight entrepreneurship Now there's also this hue and cry of people walking away destroying neighborhood values You hear this deal all the time as if we have a duty to our neighbors In the first place nobody has that power denigrating neighbors property can be compared to Smirching their good name in the case of slander and libel Rothbard points out and for a new liberty that what the law of libel and slander does in short Is to argue that a property right Of someone in his own reputation in other words a person has this property right to our Our our reputation but a person does not own a property right to his or her reputation Or the repute and at the same time they don't own the reputed value of their home The reputed value of the home is Purely a function of the subjective feelings and attitudes held by other people Now I lifted that phrase from what rothbard was talking about what other people think of other people in the terms of slander, but you can use it for home valuations as well And the same same thing happens here It's the collective the value of your home is the collective values and feelings of the marketplace And you have no influence over that So you have title your to your property, but you don't have ownership of these collective feelings and valuations Now there's also this idea that defaulters raise the cost of borrowing and And uh, but banks will even likely offer good loan pricing If they're If they're aware that property prices can decrease Good borrowers will even get better terms than they normally would Uh, because they know that Property has the potential To go down And there is also the question of whether Lenders even have taken entrepreneurial risk at all. We talked about they should pay the price for for their entrepreneurial mistakes But the federal government has made whole fanny may freddy mac Bank of america and the others When they do well They're able to just go on and on and do their business and if not then the uh taxpayers are left On the hook if they fail I mean it's heads I win and tails you lose That's essentially the reverse Robinhood system if you will so You might wonder What our host Thinks about all this And i'm not sure what he thinks about it now, but He in an interview with the austrian economics newsletter back in 1998. This was uh Interview with professor hoppe austrians in the private property society They asked him a question And he said in a free market the level of risk people undertake Is prescribed by property rights and strict liability A person is bound by the terms of a contract even if it means giving up everything he owns In bankruptcy law the states permit a certain group to act in violation of the contract They have agreed to these types of laws create legal uncertainty and socialize risk So when he was asked the follow-up question What happens then if a debtor doesn't have the money to pay his creditors? Professor hoppe said it is the obligation of the creditor to see To it that he is protected against these types of contingencies the outcome is dictated by the terms of the contract The borrower may pay out of future income if there is no provision in the contract for the borrowers going belly up That's the lender's tough luck He made a stupid contract and what I would say is We have anything but a free market at the moment But certainly lenders have made many stupid contracts And they should be made to pay for their tough luck You know It's said that libertarians Always believe in self-defense And in a way For some people the best financial self-defense Is for them to walk away to make sure that their family is taken care of Yet many of the same libertarians that believe in self-defense Be unable to protect yourself They side with the henry paulson's of the world The big banking cartels that we've been talking about all morning today They side with them preaching the same Message That you should keep paying and paying and paying till the end of time Till you make your last till your final breath You should do all you can to make fanny and freddy whole But I would say And I finish every talk about this the same way that no obituary will ever read He was a good and ethical man He died broke His family suffered But he never missed a payment To fanny man Thank you