Bring Out Your Deadbeats!

Megan McArdle:

I am afraid that I am one of those people who have no patience for people who refuse to pay their debts.  People who can’t pay their debts?  All the sympathy in the world, even if they accumulated those debts through a series of stupid decisions.  Easy bankruptcy is a good thing precisely because it helps us sort out those sorts of situations quickly, allowing the unhappy bankruptee to get a fresh start.  Yes, some of them go on to make even more stupid decisions.  But most people who declare bankruptcy do so only once, which means they don’t make that sort of mistake–or at least, that magnitude of mistake–again.

On the other hand, while I was mostly against the 2005 bankruptcy reform, I was happy to see that it tightened up the rules on the small minority of people who were unequivocally using bankruptcy to game the system–filing and then vacating serial Chapter 13 petitions in order to keep from being evicted or foreclosed out of houses where they’d never intended making the monthly payments.  Those people were few in number, but they were really morally appalling (and before you get your progressive outrage on, they tended to be affluent and well educated, which is why they were able to game the system.  They really had no redeeming excuses).

I am very sure that most people getting their houses foreclosed upon are simply folks who made a stupid decision and took on more house than they could really afford–or who got hit with a crippling job loss and didn’t have quite enough of a cushion to see them through


Maybe the reporter made them sound worse than they are . . . but it sure sounds like they just decided that once the price of their property fell, they shouldn’t have to pay back the money they’d borrowed.

There is a sizable school of thought that says why shouldn’t they?  They made a contract with the bank under known rules, and as long as they’re willing to pay the penalties, why shouldn’t they just walk away, the way a corporation would?  Well, for one thing, companies don’t always behave like this, and those who get a reputation for stiffing their suppliers run into trouble.  But for another, because society doesn’t really work on such clean logic.  The reason we can have easy bankruptcy and a pretty robust credit market (usually) is that most people act like debts are obligations which should always be paid off if possible.  I’m not saying you should live on Kraft dinner and water for twenty years to slave at an impossible mountain of debt.  But I think before you walk away from three different mortgages, you should explore life options that do not include $1,800 worth of new furniture.

More McArdle:

I find the reaction to my post last week about undeserving deadbeats rather . . . odd.  Odd, because it came mostly from the left, who seemed to think that refusing to pay your mortgage so that you could spend more time and money on cruises and Disney furniture was not merely rational, but admirable.

I thought that the left had cast the rigid view of the rational value maximizer aside, but if not, let me hurl it away with great force.  Institutionally, people may be rational value maximizers in the context of many markets.  But markets work on deep social infrastructure, norms that permit trust to develop.  And one of the norms we have developed is that you make a reasonable effort to repay money you have borrowed.

This is obviously not perfectly observed, and I do not much like the European systems that encourage judges to make value judgements about who “deserves” bankruptcy–whether they deserve it or not, people who are insolvent can’t, er, pay their debts, so we might as well do an orderly liquidation of their assets and liabilities.  But it’s a pretty broad and strong social norm.  If a friend borrowed $10,000 from you to buy a car that turned out to be a piece of junk, you wouldn’t think it was okay for him to stick you with the car and walk away, simply because it was legally possible.

Should we treat corporations differently from friends?  In many ways, yes.  I owe my friends loyalty and effort that I decline to give to any corporation except the one that I work for.  But moral norms don’t change just because we’re dealing with stockholders.  It isn’t okay to shoplift from CVS even if they have crappy customer service and overcharged you for your prescription.  It isn’t okay even if the security cameras are busted and no one will catch you.  It isn’t okay even if the mayor has announced that the city will no longer prosecute shoplifters.  And if one of your colleagues announced that he was planning to lift several hundred dollars worth of condoms, you wouldn’t think “Bravo!”

Now, if I was desperate to feed myself or my kids, I might shoplift, and I’d give a moral pass to someone who did it in a moment of that kind of desperation.  But not to someone who did it because they’d really prefer to spend their paycheck on a new television.

So while I think that most people who declare bankruptcy or give up their houses are deserving of empathy, not shame, I think that the small minority who abuse the system should be made to feel shame. Not because they’re being mean to big fat banks.  But because they’re hurting the rest of us, by doing things that we clearly recognize aren’t right if they are done to us.

Steve Waldman at Seeking Alpha:

I would like to agree with her. I think that if we structured the economy so that I could agree with her, we’d have both a better world and a more prosperous economy.

But, in the world as it is, in this mess as we’ve made it, her position is beyond unfair. Businesses walk away from contracts all the time, whenever the benefits of doing so exceed the costs under the terms by which they are bound. McArdle is certainly right to point out that companies frequently honor costly bargains they could get away with breaking, because their reputations would be harmed by walking away. But, reputational costs are economic costs. They are a part of the cost/benefit analysis that firms use in making decisions. It is not virtue that binds them to keep their word, but medium-term self-interest. Similarly, homeowners consider the hit to their credit rating and potential loss of social standing prior to walking away.

The question is whether debtors should keep paying off loans simply because it is the “right thing to do”, even when, taking all financial and non-financial costs into account, they would be better off reneging. A human being can choose to be “upright” in this way, if she wants. But under the prevailing norms of business, managers of all but the smallest firms can not so choose. To do so would be unethical.


ndividuals must operate in a competitive economic environment dominated by entities constitutionally incapable of overriding self-interest to “do the right thing”. Virtuous individuals can expect no reciprocity from the firms with which they contract. They have two choices: live nobly and get screwed, or adopt the amoral norms of their counterparties. It has taken some time, but we are all coming around to the only supportable view. “It’s just business,” we shrug, even if we never wanted to be businessmen.

At this moment, the amorality of the transactional, profit-maximizing firm has seeped into most of our commercial relationships. This contributed grievously to the financial crisis: employees of Wall Street firms do not view themselves as morally bound to the fate of their employers, but as atoms negotiating the best terms that they can for themselves. When they found themselves able to enter into arrangements that offered irrevocable cash payments against uncertain accounting profits, they did so eagerly. When flippers discovered they could borrow huge sums of non-recourse money for real estate, and capture huge gains with little personal wealth at risk, they did that too. Asking flippers not to put back underwater property is precisely analogous to asking Wall Street whizzes to give back their exorbitant pre-crisis earnings. The latter won’t happen, so the former should not. Given where we are, every underwater homeowner should absolutely act ruthlessly in her self-interest. If that leads to further turmoil and collapse at the banks, so be it. I see no reason why deeply flawed institutions should be sustained on the backs of the virtuous, via a kind of stupidity tax.

It didn’t have to be this way, and going forward, perhaps we can find a way out. As I said at the start of this essay, I’d prefer to live in a world where I could agree with Ms. McArdle. It was not inevitable that we conceive of the firm as a nexus of contracts without agency for moral action except via implausible relegatation to shareholders. That is just one of many possible ideologies, and a rather idiotic one. The core notion that shareholders “own” the firms they fund is, in my view, a poor definitional choice.

But so long as the “social responsibility of business is to increase its profits”, the social responsibility of customers is to look to their own self interest. Even if that means dropping their house keys in the mail and renting the place next door.

Razib Khan:

Megan makes the point that our economic and social system does not rely purely on rational self-interest, but also on an accumulated capital of norms which lead to virtuous cycles. My family is from Bangladesh, and I have seen this first hand. Corruption & nepotism in Bangladesh are almost impossible to change because it is stuck in an equilibrium state; if you are the first person to not be corrupt or nepotistic you’re only causing hardship to your family and relatives while others prosper. As an example, I have an uncle who works as a civil servant and has been promoted to a relatively high position because he is known to be someone who refuses to take bribes. The reason my uncle does not take bribes is mostly due to family tradition,* and, I suspect some personality quirks inherited from one of my grandfathers (he was a notoriously guileless individual, and that tendency has passed on to some of his children). Though his clean reputation means that he is in high esteem in the eyes of his colleagues, it is also a running joke that all of his subordinates live in palatial homes while he has a modest apartment! This causes some awkwardness because he simply can not entertain any of his subordinates since his material condition is so inferior to what they are accustomed to. In terms of innate moral character I doubt my uncle is elevated in any particular way from his colleagues and subordinates. Rather, he has an idiosyncratic and plainly irrational set of norms when it comes to maximizing his material wealth.**

Cultural norms can shift through positive feedback loops, and changes are not always reversible. Dan Ariely has reported this from his behavioral economic research; once you turn people into pure utility maximizing rational actors it is often hard to reverse their decision making heuristics so as to take on a softer edge. Anyway who wants to see the canonical shifts from vice to virtue to collapse to virtue repeatedly need only study Chinese history. From a purely utilitarian perspective I think Megan is correct. A sense of personal responsibility and norms which assume that one has a responsibility toward one’s fellow citizen beyond and above the call of the law can help ameliorate collective action problems and increase aggregate utility.

But…as noted by some of Megan’s critics in the comments of her posts, the problem is that we aren’t utility maximizing machines, rather, we have an innate sense of justice and inclination toward spite and retribution. Over the past few years it is clear that at the commanding heights of the American economy a substantial number of individuals were acting their own rational self-interest, within the letter of the law, while at the same time sacrificing the collective interest. Last year when I was reading about the collapse of LTCM in the late 1990s I learned that one of the traders, Eric Rosenfeld, nearly scuttled the bailout which rescued the financial markets from chaos because he was weighing whether it was in his personal interest. Because he was a partner his consent was necessary under the law. The bigger point is that there’s a perception in the American public now that the the elites of finance are corrupt and extract all they can get out of the system with full knowledge that they’re backstopped by the credit of the American government and have access to cheap government money. It’s all legal.

So I guess what I’m saying is that without elites who have a sense of virtue it is going to be really hard to maintain a moral window on personal behavior. This isn’t a matter of judgement, I think it’s a description. The people who are “walking away” are probably leading indicators of the sort of rational behavior which will become the norm as people realize that that sort of selfish behavior is spreading. In some communities with a strong spirit of collective identity and leadership from the top perhaps ostracism will prevent rational behavior on the individual level which might be a liability in the aggregate, but I suspect that more often many average Americans will simply justify their behavior to each other by pointing to the fact that a substantial number of elite Americans have no hesitation of screwing them if they can and it is in their interests. In other words, it has gone from what should you do, to what can you get away with. Of course this is a vicious circle, and not good for anyone.*** But that might not matter.

Reihan Salam:

The principles Razib describes are difficult to “operationalize,” but it’s clear that they are very important. This is one reason why Americans are so lucky. We benefit from what Razib calls an “accumulated capital of norms which lead to virtuous cycles,” and usually through no effort of our own. This is why I’ve always felt that the right kind of nationalism or patriotism is grounded in gratitude and humility, not a sense of superiority.

UPDATE: Megan McArdle

UPDATE #2: Steve Waldman

Kevin Drum

UPDATE #3: Felix Salmon

McArdle responds to Salmon

UPDATE #4: Reihan Salam

UPDATE #5: On a similar note, seven months later… people walking away from the mortgages.

David Streitfeld at NYT

James Joyner

Barry Ritholtz


Daniel Foster at The Corner



Filed under Economics, Go Meta, The Crisis

2 responses to “Bring Out Your Deadbeats!

  1. Pingback: What We’ve Built Today « Around The Sphere

  2. Just thought you’d be interested to know that I have added you to my bookmarks You make valid points in a concise and pertinent fashion, This is a really good read for me, many thanks to the author one of my articles hope u enjoy reading getting paid for surveys

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