I remember a school assembly when I was a kid. A man was brought in who’d had a tracheotomy. He had a hole cut in the front of his throat. When he talked it came out as an unpleasant croaking sound, which he made, he explained, through some sort of burping action that approximated speech.
The point of the assembly was plain enough: This man had been a smoker. If you want to end up like him, smoke. I never did.
The image of the Croaking Smoker returned to me a few months ago when I sat in on Notre Dame Professor Tonia Hap Murphy’s business law class. I was curious about a topic they were covering that day. Professor Murphy was talking about remedies for breach of contract and the difference between legal and moral obligations.
This brought us to what the PowerPoint slide on screen labeled as the “Current issue”: people choosing to walk away from their mortgages.
Since the recession that began in late 2007, we’ve all heard about homes being foreclosed upon. A homeowner loses their job and can’t pay the mortgage. The lender seizes the property. The residents are evicted.
“Walking away” is different. It’s when homeowners voluntarily abandon their property, leaving the house to the lender and skipping out on the remaining debt.
Under normal circumstances the bank may do fine. It can sell the house, and the combination of the sale proceeds, the buyer’s forfeited down payment, and all the interest and principal the homeowner has paid over months or years may more than recoup the original loan amount.
But when housing values drop sharply, as they have the past four years, a homeowner can end up owning a house that is worth less than even the remaining balance on the loan. This is known as being “underwater.” Millions of Americans today are in this situation.
I was one of them, I admitted to this room full of 18- to 22-year-olds — and wondered if they were looking at me as I had looked at the Croaking Smoker. Don’t end up like him.
Except I hadn’t come to class to plead “Don’t do what I did.” I tried to do the right thing. You can decide if I did.
A new home
It all started in early 2006 when I resigned my position of 10 years as associate editor of Notre Dame Magazine to become director of university communications and publications at the University of Nevada in Reno. The newly created position offered more money and more responsibility, along with the opportunity to live in one of the most beautiful places in the country.
Reno is situated along the Sierra Nevada mountain range in northern Nevada, less than an hour from Lake Tahoe. Incidentally, it’s nowhere near Las Vegas, about 450 miles to the south.
One of the drawbacks of moving to Reno was the cost of housing, about triple that of dirt-cheap South Bend. But prices were considerably less than in the San Francisco Bay area, about a three-and-a-half-hour drive to the west. That comparatively low cost of living and the fact that Nevada has no state income tax had led many Californians to buy homes in Reno. Some bought for future retirement, some bought on speculation.
We were lucky, a real estate agent told us when we arrived in early 2006. Six months before, she said, it would have been hard to find anything to buy. Houses were being sold a few hours after listing. In dozens of new subdivisions with names like Granite Ridge and Mountaincrest, people were queuing up at dawn for the right to pay the asking price in the next “release” of homes.
I’d never witnessed anything like this. But it was easy to see why people were flocking here: the breathtaking mountain scenery, sunshine 300+ days a year, fresh new homes and shopping areas going up everywhere, no potholes, humidity, mosquitoes or traffic.
We ended up buying a relatively compact house in a tiny upscale subdivision called Talon Pointe. It was in the heart of a valley-size planned community called Somersett with an elegant fitness center and championship golf course.
I almost couldn’t believe our luck. I’d looked at model homes in Talon Pointe several weeks earlier and had fallen in love with one of them. But the prices were well beyond our means.
When my wife, Sue, an elementary school teacher, joined me from South Bend some weeks after my relocation, I took her by the models at Talon Pointe just for fun. As it turned out, the sale of one nearly completed home of the model I loved had fallen through. It was now being offered for tens of thousands of dollars less. The builder also was offering cut-rate financing and would pay all closing costs.
The price was still at the outer limits of our preapproved range, but I figured I was bound to get some kind of raise in a year. Sue, too. To keep pace with the state’s population explosion, Nevada schools were paying modest “signing bonuses” to teachers relocating from out of state.
We also figured that if we felt squeezed financially we could always sell the house in a couple of years at a profit — possibly a large one, considering the bargain we were getting.
As I weighed the decision I kept hearing the words of a local resident I’d met at a charity dinner some weeks earlier: “You should always buy a new house because you’re never going to be able to buy that house at that price again.”
It was true, I thought, I’d never heard of a new house going down in value.
You can guess the rest of the story.
The deflating bubble
When the housing bubble detonated, Nevada was ground zero. Foreclosures and the massive inventory of new houses sent prices into free fall. Real estate experts in Reno estimate that whenever the bottom comes, it will take 18 years for prices recover to their 2005 peak, assuming price appreciation returns to its pre-bubble rate.
My anticipated salary raise never materialized. Worse, 18 months after I started at the university, a new administration eliminated my job and the division in which I worked. I was invited to stay on in a different department, but at a much lower salary. I accepted the extension while I continued to look for something permanent.
We took the precaution of putting our house up for sale at a break-even price, but that didn’t draw any offers. Eventually we lowered the price until we would be losing money — still nothing. The Reno real-estate bubble was leaking value at an accelerating rate.
I could have stayed longer in my temporary position, but I opted to “invest in myself” and apply for admission into a new master’s degree program on management of online communities at the University of Southern California’s famous Annenberg School for Communication & Journalism. I was accepted and enrolled at the beginning of 2008. Sue stayed in Reno teaching while I rented a room near campus in Los Angeles for the duration of the one-year program.
I graduated on schedule at the end of 2008 — right into the worst job market since the Great Depression. I couldn’t find anything, so I returned to Reno. I visited the second department for which I’d worked, and the director asked me to come back. I gratefully accepted while continuing to apply for positions related to my graduate study in online communities.A year went by. I still couldn’t find anything in Reno or elsewhere. After a second contract extension I learned that my temporary position would end June 30, 2010. For the first time in my life I was facing indefinite unemployment.
Throughout all this we dutifully kept paying our $2,000+-per-month mortgage payment. But we knew there was no way we could survive long on just my wife’s modest teacher’s salary and my temporary state unemployment benefits. Plus, now I had student loans to repay.
We looked into the Obama administration’s homeowner-assistance program. But real estate values had fallen so far so fast in Reno that our property was too deep underwater to qualify.
We contacted the lender to whom our mortgage had been sold, EverHome. The Florida-based bank wouldn’t consider any reduction in principal or lowering our already discounted interest rate, which was locked in for five years. We had just completed year four.
Everyone we talked to — Realtors, investment advisers, a lawyer friend specializing in bankruptcy — told us the same thing: Stop paying on your mortgage. As long as money was coming in, the bank was not going to consider modifying any terms, they said. Why would it? Everyone turned out to be correct.
About this same time, early 2010, an influential column appeared in The New York Times Magazine by Roger Lowenstein, an investment expert. Lowenstein said people should walk away from their underwater homes even if they could still afford the payments. They shouldn’t even feel guilty about doing so, he said, because businesses do it all the time.
He cited the investment bank Morgan Stanley, which had decided to stop making payments on five San Francisco office buildings. The company had purchased them at the height of the boom, and their value had plunged.
Another argument I heard went like this:
You’re the victim here. The price you paid for your house wouldn’t have been nearly so high if not for the irresponsible, easy-credit lending practices of the banks. They handed out so much money to so many unqualified buyers that it inflated prices. Your home shouldn’t have cost what it did. Why go on paying money to these companies responsible for that distortion?
We had a lot to think about.
First, it appeared almost certain that Sue and I would have to leave Reno. I couldn’t find any jobs in my field. Nevada’s unemployment rate was, and still is, the highest in the nation. Counting “discouraged workers,” those who have given up looking, the rate was 22.3 percent in the third quarter of 2010, according to the Bureau of Labor Statistics.
We couldn’t rent our house for anything close to our mortgage payment. And if we moved out we’d have to find a short-term rental because, in all likelihood, we were going to be leaving town.
So our choices were these: 1. Stay in the house without paying our mortgage until the bank foreclosed and evicted us. This might not happen for a year or more, we were told, because lenders prefer to have a property occupied and being maintained; or 2. Seek a short sale.
A short sale means the lender agrees to the sale of your house at the current market price, even when that price is less than what you owe on it. You, the homeowner, lose everything — your down payment (in our case it was essentially our life savings, about $70,000) and everything you’ve put into the house. That includes all the accumulated interest and principal you’ve paid so far (for us, about $100,000). The lender gets all of that plus the proceeds from the sale of the house. In return the lender forgives any remaining balance on the loan.
A short sale, we were told, is a bit less damaging to one’s credit than simply walking away and going through foreclosure. You also don’t have to worry about the lender obtaining a default judgment, which is a court order to repay the rest of the debt over time. As Professor Murphy noted in class, default judgments are not available to lenders in 10 states. In those states if a homeowner walks away from a mortgage, all the lender gets is the house. Nevada is not among those walk-away states. California, less than 10 miles from our house, is.
A short sale gave us one other good excuse to stop paying our mortgage. Here’s why:
We were told that lenders typically require a homeowner to contribute thousands of dollars more out of pocket to make a short sale go. The lender wants to see you contributing all you can. Knowing that, the agent with whom we listed our house suggested we stop paying on our mortgage immediately so we could begin saving up those thousands to hand over at closing.
I couldn’t do it. In my mind it would be unethical to live in a house without paying for it. So Sue and I agreed that we would pay on our mortgage, the full monthly amount, for as long as my job lasted. But no longer. This is what we explained in our “hardship letter” to the lender, and that’s what we did.
Our agent and our lawyer friend both said they admired my integrity, but they thought I should put my family’s welfare ahead of my sense of obligation to the lender. We’d mentioned to both of them that our daughter was getting married in a few months. Wouldn’t we rather give her some or all of our monthly mortgage payment than give it to the bank?
When we stopped paying, our formerly disinterested lender began calling, asking what the problem was. We had explained it all in previous calls to them and in our hardship letter. But we were now dealing with a different department, the one concerned with deadbeats.
After a couple of months and several price cuts we finally received an offer on the house — for $249,000, exactly half of what we’d paid for it new four years earlier. The price didn’t matter to us. Unless someone had offered more than $428,000 — the approximate amount we owed — we wouldn’t see a penny of it. So it was the lender’s call on accepting the offer.
As we’d been warned, EverHome demanded we kick in additional money: $10,000 in cash and for us to sign a $25,000 promissory note.
We counter-offered $2,000 cash.
The bank settled for $3,000.
There were more complications and demands and more sacrifices on our part. The sale wouldn’t close for several more months, by which time I’d returned to Notre Dame as a writer with the Mendoza College of Business. As I write this, we are renting a house near campus.
I gave Professor Murphy’s class a condensed version of our housing story and then asked for a show of hands from students. How many of you think that after you graduate and are settled and have a job you’ll want to buy a house?
The class had about 40 students. Four hands went up.
Never smoke, implores the Croaking Smoker. And don’t buy a house either!
Of course I hadn’t come to class to scare people off of homeownership. I was more interested in the ethical dimensions of the mortgage crisis. Such as the argument that we had been the victims of industrywide irresponsible lending practices. Cases are well documented. Maybe the bank shouldn’t have approved us for so large a loan.
But I asked myself, did I know for certain that our particular lender had engaged in those practices? Would it be ethical of me to hold it against this company without knowing for sure? Would it be ethical to play judge and jury?
The broader issue, and the subject of Murphy’s lecture, was promise-keeping. As business analysts like Lowenstein advise, it sometimes makes perfect business sense to cut one’s losses, break a promise, and simply pay the penalty for breach of contract. But what if everyone viewed promises as strategically breakable?
What if you knew that anyone making a promise to you would be perpetually tallying the pluses and minuses of keeping that promise? Whenever the scales tipped so that the foreseeable profits or pleasures outweighed the penalty for reneging, the other party would feel free to break that contract, promise or vow.
Murphy was asking essentially the same question now — what if promises were temporary things? No student raised a hand, so I volunteered.
“If you can no longer rely on promises,” I said, “then the whole system of trust would collapse.”
The U.S. housing industry collapsed under the weight of greed and irresponsible behavior. The decisions my wife and I made as we tried to resolve our mortgage difficulties had no restorative effect on the financial system, I am sure. But a society’s values are constructed of millions of individual actions and decisions. They collectively shape what we consider decent, responsible, respectable, normal. These standards are always in flux. Like the hour hand on a clock, we don’t see them moving, but we see that they have changed over time. Maybe we pushed that trend line a quarter-tick in a positive direction.
We could have made out better financially by taking people’s advice and walking away. I feel like we made out better ethically going our chosen route. I’m not going to fish for a halo by asking which is worth more. It’s a false dichotomy anyway. Most of the time it’s easy to make a business or investment decision while keeping one’s ethics intact. Sometimes it’s not. Don’t be surprised if some day you find yourself on the ethical equivalent of a log in the water, stepping forward and back, searching for that elusive balance over something as mundane as real estate.
Ed Cohen is a writer in Notre Dame’s Mendoza College of Business.