The moral ambiguity of default

With the subprime crisis raging, there are many stories of people walking out of their mortgage. It also seems that it is not uncommon among young people to walk out of a mortgage before the first payment thus getting one year of free rent (credit re-building apparently not being an issue at a young age).

In a free and just society, there cannot be compulsory personal bankrupcy law. Maybe debtors buy as an insurance the right to default, maybe they don't and they go to debtor's work camp. In the U.S. the state allows anyone to declare personal bankrupcy.

According to two different analysis of the law I reach two opposite conclusions.

a) Defaulting on a debt is theft, the creditor should be able to sue and settle an agreement where the debtor repay some of all of the debt (through total liquidation of assets, work, etc). This is prevented by the governement, thus creditors charge a higher interest rate, covering default risk as a defence against this agression. The higher rate does not legitimate defaulting, much like the shop raising its prices to account for stolen goods does not justify shoplifting (this is Rothbard's position).

b) The State force creditors to bundle their service with a default insurance. When someone contracts a debt, he his buying the insurance as well through higher interest rates. Defaulting (or walking out of a mortgage) is merely exercising an option that was bought.

This same ambiguity can be applied to many different laws, such as zoning laws. If I bought a house close to a school, is building a peep-show ok because zoning laws are coercive, or is not okay because the State prevented me to buy the right-to-build-a-peep-show from the original owner (who died with no heir thus destroying that right)

So, is walking out of a mortgage a rational arbitrage or a fraudulous theft?

Share this

It's ambiguous

I think it really can be ambiguous. One of the functions of courts is to resolve ambiguities, so in the wake of a government collapse the many ambiguities that arise might be resolved in court.

Certain land regulations might survive as easements. On the matter of peep shows next to schools, a court might decide that the school had an easement over the neighboring property which gave it the right to prevent the neighbor from opening a peep show. Or it might not.

That being said, the decision of a court is not entirely arbitrary. The opposing sides do not always have equally weighty arguments. I think that one important consideration is that minimization of involuntary wealth transfer through a change in the law is generally desirable. If peep shows are not allowed next to a school, then this affects both the school and the neighboring property owner. If a legal change allows peep shows, then this affects the two parties, in effect transferring wealth from the school to the school's neighbors, or at least to any neighbors who opt to open a peep show. The wealth that the school loses is the good of an immediate neighborhood free of peep shows. The wealth that the neighbor gains who wants to open a peep show is the new opportunity to open a peep show.

The end result may be the same with the exception of a cash transfer. If the school initially retains an easement preventing peep shows, it can nevertheless sell this easement back to the neighbors. The end result, then, is no easement and a cash transfer from the neighbors to the school. This would be identical to the alternative (the school does not initially retain the easement) with the exception of a cash transfer.

Ideally, I think, the distribution of rights (e.g. property and easements) in the wake of a governmental collapse should minimize wealth transfer, and in order to do that, it should reproduce as closely as possible the regulations that currently govern us. I am not advocating that we trap ourselves in our current regulations, but only that we start there. We can then buy and sell the rights in any way we see fit.

People who borrow money do so currently on the understanding that they can declare bankruptcy. People who lend money do so on the understanding that their borrowers can declare bankruptcy. This affects things such as the interest charged. If someone has been paying high interest to compensate the lender for the possibility that he might declare bankruptcy, and if he then loses that right, then he has been screwed, because he has been paying for something he does not get. And the lender gets a windfall profit.

one important consideration

one important consideration is that minimization of
involuntary wealth transfer through a change in the law is generally
desirable.

becoase ?

I think it makes a valid utilitarian point, which is needed in such a case of moral dilemna but it's still a bit unsatisfying... instead of zoning law, one could argue about property taxes for example. Do you buy the obligation to pay property taxes along with the house? It is indeed discounted in the price... if so you should keep paying taxes if not shouldn't you pay the previous owner the discount value?

Because

becoase?

Use creates a claim, and this can create property rights (for example, first use, and also, long time use of owned property in the sense of adverse possession). It should, in the same way, have the capacity to create easements - partial property rights, rights in aspects of property. Regulations create patterns of use, so even when the regulations disappear, the fact of the use has been all along creating a claim, and the longer the use over time the stronger the claim, and this claim may in some cases outweigh competing claims.

Do you buy the obligation to pay property taxes along with the house?

No. What I've been saying in the case of the peepshow prohibition is that we can think of a regulation as an easement and that we should try to preserve such easements. Sometimes. If there aren't stronger considerations contrary to this. So to deal with this situation in that same way you need to find an analogy employing property rights.

Here's an analogy. You are a renter. The state is your landlord. The state charges you very low rent (property taxes). Because the rent you pay is so low, you are able to sell your tenancy of that house and get a sizable sum for it. The buyer will pay you a lump sum, and then move in and pay the rent in your place.

So, suppose that someone buys your tenancy - i.e., pays you to leave so that he can replace you as tenant. Then, suppose that the rent goes down or disappears altogether. Does the buyer owe the seller anything? No, not unless they specifically agreed to such a thing.