Strategic Default (banks do it, why can't you?)

[whylaff]

The morality component of contracts has its origins in the notion that they are an individual right. The reality is that there is no morality with contracts. It’s just a very convenient way to keep people doing something when they stop and ask – “why?” Contracts should be treated like any other business transaction, in that you need to look out for what is in your best interest.

 

[StageLeft]

I absolutely think people should default/go BK if it makes strategic sense for them to do it. Morally speaking, in these matters if you are legal I think you are morally satisfying. Others may disagree of course.

I say this because the law already has plenty of allowances for not paying. Your credit hit, house taken away. That is the cost you have and agree to when you sign the loan so if you're willing to take that hit and it seems to make sense I think you should do it with a clean conscience.

Many people, and certainly many libertarian-types would agree that a contractual obligation is a moral obligation.

To me it is UNLESS it specifies, clearly, reasonable penalties, in which case if you can withstand those and want to, go for it. Would anybody say it's immoral to cancel a phone contract after 6 months instead of 2 years and why not? Because you pay the penalty and that's that.

Byzantine borrowers who merely trade their word for cash results in an overall decline in society.

People are not trading their words merely for cash, they are trading also their financial history and respect. So beyond those words they can lose additional assets and have a blown credit history. This is worth more than words. If it was only that banks would not lend, they would ensure you had more, like collateral or 20% down so that they don't take a hit. Hey, that is a novel idea

 

[PokerGuy]

Nothing wrong with walking away from the house if it makes financial sense. It's a simple contractual obligation, including provisions for handling defaults etc. It's a contract, nothing more, nothing less. There is no additional "obligation" outside of what's in the contract, just like the bank certainly would not feel any "moral obligation" to do anything for you if it wasn't mandated in the contract.

 

[Modelworks]

Morality has little to do with finance now. In the past when a mans word was worth something there was morality in things like borrowing money. The difference is then the person loaning you the money wasn't trying to screw you over every way they could. You borrowed the money, agreed to pay it back on simple terms like , give me $100 , I will give you back $110 in a year and that was all there was to it.

Now they have made it so complicated that you almost need a lawyer to keep from getting screwed.

 

[Modelworks]

People are not trading their words merely for cash, they are trading also their financial history and respect. So beyond those words they can lose additional assets and have a blown credit history.

This is something else I think the financial system has gotten wrong. It should not be based on the best credit score gets you the best interest rate. The reason I say this is because it penalizes people to the point that some can never get fair loans. They are stuck paying high interest rates that only lead to them defaulting on loans over and over because the terms of the loan are so hard to pay back.

Instead I think a system based on amount borrowed with a preset standard interest rate would work better. The way something like that would work is every bank would loan money at a set rate to all customers regardless of history. The credit history would decide the amount to be borrowed and not the rate to loan it. So your history would look like:

borrowed $100 paid back
borrowed $200 paid back
borrowed $500 paid back
borrowed $1000 paid back

And so on. The more you borrow and the more you pay back the higher your limit becomes. If you don't pay a loan then your credit would drop back a notch or two. You could still get credit at fair rates which allows people to recover from bad decisions but also not to be frivolous. It also would stop things like people buying homes they could not afford, since if they were trying to buy a $500k home and the most they had ever borrowed was $1000 then they clearly are out of their league. The system now is set up where I can borrow and pay back a bunch of $50 loans and have a great score to get a $500K home.

 

[LegendKiller]

People are not trading their words merely for cash, they are trading also their financial history and respect. So beyond those words they can lose additional assets and have a blown credit history. This is worth more than words. If it was only that banks would not lend, they would ensure you had more, like collateral or 20% down so that they don't take a hit. Hey, that is a novel idea

As a lender myself, any borrower who defaults automatically goes into the shitcan, this not only affects that borrower, but also ALL borrowers, as now the lender knows that you can't depend on common statistics to determine the actual ability of a borrower to pay, but you now must suspect ALL borrowers, since default now does not depend on if the borrower CAN pay, but if the borrower WILL pay.

This is the fundamental breakdown in logic for strategic borrower supporters. Pricing of all lending is based upon measurable risk on common statistics. Most of those statistics are measured by FICO scores and income. However, if you add in just general risk of default form people who will do so because they just don't feel like honoring a contract anymore, those costs are distributed across ALL of society, since you can't narrow down WHAT THE PROFILE OF A DEFAULTER IS.

This is why contracts have more than a legal relationship but also a moral one. If you lend money to your friend, you do it because you know him. If you thought he was going to fuck you, or if you didn't know he WOULDN'T fuck you, then you wouldn't lend, or you would increase the interest rate for compensation of the risk. This not only affects that one friend, but all friends.

Modelworks. You're actually increasing the risk in lending, in that by rewarding people with higher balances, you're actually allowing those who may not pay in the future gather more money, and more risk. This does not work on a portfolio basis as you'll get a negative bias in those who ultimately cannot pay in the end (especially if they accumulate more debt than they can pay for).

The correlation between FICO scores and default rates is VERY high. I know this because I worked for a 3bn consumer loan lender. I analyzed almost 1M loans over 10 years, creating annual and quarterly originated pools. I then tracked those pools over their lives (static pool default curves).

I then stratified those loans by FICO score, term, whether it was a refinancing/upgrade or new origination...etc. The FICO score stratifications were striking. Obligors who had FICO scores of 700+ defaulted maybe 1/10th as much as those with a FICO below 600, banded.

Sure, there is a negative bias with FICO scores, but do keep in mind that FICO scores will eventually raise with payment history, allowing lower rates, lower debt service, and, as a result, higher loan balances, which is your end-goal anyway.

 

[LegendKiller]

I do love how "banks" keep being bandied about, yet not a single person has mentioned evil pension, bond, mutual, or 401k funds.

------------
This is BS. I love how you pretend to be worried about some old lady on a pension ignoring place like Goldman or Morgan Stanly typically bonuses out roughly half of their gross profits, with only a minuscule piece being paid in dividends to shareholders. Not to mention their ridiculous cost of doing business e.g. private jets, $300K country club memberships, parties etc.

Ahh yes, applying the broad brush of bonuses to every single banker, painting them all as "evil" people who deserve nothing.

I do vilify those who have problems and I despise those who caused this latest problem. However, I do not generalize.

Although, overall, I do think that general executive pay is out of hand.

 

[Hayabusa Rider]

The banking industry had decided to hit up consumers with ungodly increases in interest rates, regardless of credit history. I know it was done to me.

Someone bail me out.

 

[Zebo]

Ahh yes, applying the broad brush of bonuses to every single banker, painting them all as "evil" people who deserve nothing.

I do vilify those who have problems and I despise those who caused this latest problem. However, I do not generalize.

Although, overall, I do think that general executive pay is out of hand.

My point was it's not shareholders or pensioners benefiting from their get rich quick schemes so to place blame on them as if they are somehow pressuring investment bankers to do these things is ridiculous. In fact pension funds are generally getting poorer by investing with them look a Citis stock or how Pension guarantee corp is bankrupt with now the feds shoring it up.

Belive it or not I don't have a problem with high executive pay *if* they perform for their investors - Taxes are another matter though.

 

[Zebo]

The banking industry had decided to hit up consumers with ungodly increases in interest rates, regardless of credit history. I know it was done to me.

Someone bail me out.

I have 833 FICO and one CC canceled (advanta business) and all rates raised and credit lines slashed, This goes along with my point in another thread that capital is not going to those deserving and productive building a false economy.

 

[Hayabusa Rider]

I have 833 FICO and one CC canceled (advanta business) and all rates raised and credit lines slashed, This goes along with my point in another thread that capital is not going to those deserving and productive building a false economy.

If anyone really cared about the general population, part of the bailout legislation would have stipulated how financial institutions may punish consumers for things which aren't the fault of the latter. For example it could have limited increases in interest rates, allowed people to keep accounts without having to cancel them, only triggering higher rates under certain conditions.

Nope.

We don't contribute to their war chests, and therefore are of no consequence.

The whole concept of a representative Democracy is a farce. There are no real choices, and when that's the case participation is pointless. Sad, but that's how I see it.

 

[ElFenix]

Agreed. Don't preach "morality" if you yourself aren't going to be "moral."

which banks are preaching morality? so far i've got a radio talk show how and a business ethics professor who was contacted by the reporter (so hardly preaching). neither of whom are banks.

 

[Zebo]

If anyone really cared about the general population, part of the bailout legislation would have stipulated how financial institutions may punish consumers for things which aren't the fault of the latter. For example it could have limited increases in interest rates, allowed people to keep accounts without having to cancel them, only triggering higher rates under certain conditions.

Nope.

We don't contribute to their war chests, and therefore are of no consequence.

The whole concept of a representative Democracy is a farce. There are no real choices, and when that's the case participation is pointless. Sad, but that's how I see it.

I've been seeing it that way since Clinton. I don't even know why politics interests me as all we can really do is work within parameters given and anything else such as participation, campaigning, reading seems a big waste of time. Glutton for punishment I guess.

 

[werepossum]

I have 833 FICO and one CC canceled (advanta business) and all rates raised and credit lines slashed, This goes along with my point in another thread that capital is not going to those deserving and productive building a false economy.

I haven't had any rate increases, but a couple cards had the limits reduced. As I only use credit cards to order off the Internet and have several, I didn't particularly care either way. Frankly I'd just as soon see personal credit tightened.

My absolute preference would be for credit cards to be limited to 3% above prime. That would make credit cards very difficult to obtain, lower limits, and stop much of the abuse. As it is, before the crash a neighbor had several cards maxed out and even though she earned in the low twenties each time she maxes one out they raise her limit. They earn a fortune in interest and when she inevitably files bankruptcy, they get to write off the outstanding balances as well even though the actual borrowed amounts will likely have been paid off. There is no excuse for allowing credit card companies to make irresponsible loans and charge 30% interest, either don't pretend to regulate them at all or regulate them with some common sense.

 

[Modelworks]

Modelworks. You're actually increasing the risk in lending, in that by rewarding people with higher balances, you're actually allowing those who may not pay in the future gather more money, and more risk. This does not work on a portfolio basis as you'll get a negative bias in those who ultimately cannot pay in the end (especially if they accumulate more debt than they can pay for).

The correlation between FICO scores and default rates is VERY high. I

Getting a loan for $10K would not entitle you to a loan at $20k until you paid off that outstanding debt. Your total limit across all loans would be $10K until you could demonstrate the ability to be debt free before going to the next step up in loans. That keeps people from being able to pay car payments and then use that as a basis that they should be able to now buy a house.

The current system is like you borrowing $20 from me once a month and always paying me back. You get a new high paying job and now want to borrow $5k based on the idea that you always paid me back before.

The current system allows people to get loans for large amounts based on the idea that they paid back much smaller amounts. I think it would work better if people demonstrated the ability to be completely debt free before credit increase on amounts were allowed.

FICO scores and default rates correlate because the terms on poor scores serve to keep scores low. Offering low credit scores a credit card with 29% interest and extra fees makes it very hard for people to recover.

Credit wasn't even needed a century ago for the consumer. It all started when companies found out they could raise prices but keep wages the same.

 

[LegendKiller]

The banking industry had decided to hit up consumers with ungodly increases in interest rates, regardless of credit history. I know it was done to me.

Someone bail me out.

This is one point I do have a problem with.

When I was at a CC issuer in 2006, in their Treasury/Securitization department, I asked one of the head guys what would happen when/if a credit crisis hit, increasing defaults in the portfolio. He said that they'd merely increase the interest rates in the portfolio to make up for the defaults.

I was surprised by the naivete in that statement.

Although, do keep in mind that interest rates on CCs were actually historically low in the last 5 years.

 

[LegendKiller]

My point was it's not shareholders or pensioners benefiting from their get rich quick schemes so to place blame on them as if they are somehow pressuring investment bankers to do these things is ridiculous. In fact pension funds are generally getting poorer by investing with them look a Citis stock or how Pension guarantee corp is bankrupt with now the feds shoring it up.

Belive it or not I don't have a problem with high executive pay *if* they perform for their investors - Taxes are another matter though.

Shareholders and pensioners did benefit from the boom. Have you reviewed share prices of those banks so deeply involved in it?

 

[LegendKiller]

Getting a loan for $10K would not entitle you to a loan at $20k until you paid off that outstanding debt. Your total limit across all loans would be $10K until you could demonstrate the ability to be debt free before going to the next step up in loans. That keeps people from being able to pay car payments and then use that as a basis that they should be able to now buy a house.

The current system is like you borrowing $20 from me once a month and always paying me back. You get a new high paying job and now want to borrow $5k based on the idea that you always paid me back before.

The current system allows people to get loans for large amounts based on the idea that they paid back much smaller amounts. I think it would work better if people demonstrated the ability to be completely debt free before credit increase on amounts were allowed.

FICO scores and default rates correlate because the terms on poor scores serve to keep scores low. Offering low credit scores a credit card with 29% interest and extra fees makes it very hard for people to recover.

Credit wasn't even needed a century ago for the consumer. It all started when companies found out they could raise prices but keep wages the same.

Being able to demonstrate the history you ask for is far more difficult than you think and isn't a workable solution. Debt-service coverage ratios are very good indicators of being able to pay. The idea that you have to wait for a 10K loan until you paid off a 5K loan is silly, as then you're stuck with a 5K car, rather than depending on whether or not you can actually pay for the loans.

FICO migration numbers prove otherwise. Terms between subprime and prime borrowers aren't as significant as you'd like to think and are easy to improve in small increments. I'd love for you to prove your contention otherwise with actual data, since I've never seen a single shred that would agree with you.

Yes, consumer credit has increased, but I would hardly say it is new. However, debt is nothing more than consumption pushed forward, provided it isn't overhwelming, it is fine. I firmly believe that, overall, consumer debt is fine at its current levels, as long as there isn't such a huge problem with housing. That CC defaults have not turned as bad as many feared, and they follow unemployment rather than other indicators, tangentially support that conclusion.

 

[Zebo]

I haven't had any rate increases, but a couple cards had the limits reduced. As I only use credit cards to order off the Internet and have several, I didn't particularly care either way. Frankly I'd just as soon see personal credit tightened.

My absolute preference would be for credit cards to be limited to 3% above prime. That would make credit cards very difficult to obtain, lower limits, and stop much of the abuse. As it is, before the crash a neighbor had several cards maxed out and even though she earned in the low twenties each time she maxes one out they raise her limit. They earn a fortune in interest and when she inevitably files bankruptcy, they get to write off the outstanding balances as well even though the actual borrowed amounts will likely have been paid off. There is no excuse for allowing credit card companies to make irresponsible loans and charge 30% interest, either don't pretend to regulate them at all or regulate them with some common sense.

I own a liquor store, buy and oil and gas wells in addition to owning 5% of a gas gathering system in LA. I'm not the operator but as a partner I must share in costs and we needed a new compressor (cost $400,000) and could not get a loan for it as in the past. Similarly, my credit line at jarbos a major liquor distributor was slashed from 100K to 60K and terms from 90 to net 30. I see it up close and personal and it's hurting our growth.

 

[Hayabusa Rider]

This is one point I do have a problem with.

When I was at a CC issuer in 2006, in their Treasury/Securitization department, I asked one of the head guys what would happen when/if a credit crisis hit, increasing defaults in the portfolio. He said that they'd merely increase the interest rates in the portfolio to make up for the defaults.

I was surprised by the naivete in that statement.

Although, do keep in mind that interest rates on CCs were actually historically low in the last 5 years.

What made no sense to me is that I have an outstanding credit history and paid faithfully I've never made a late payment. In many ways I was the ideal customer. I canceled every card but one, and that I pay off every month.

If people who have less secure positions are forced to pay considerably more than they have been prepared for, then they will default. CC companies lose.

If they alienate those who like me can afford to dump them, then we're gone. CC companies suffer again.

It's like they are trying to be the Chrysler of financial industries.

 

[LegendKiller]

What made no sense to me is that I have an outstanding credit history and paid faithfully I've never made a late payment. In many ways I was the ideal customer. I canceled every card but one, and that I pay off every month.

If people who have less secure positions are forced to pay considerably more than they have been prepared for, then they will default. CC companies lose.

If they alienate those who like me can afford to dump them, then we're gone. CC companies suffer again.

It's like they are trying to be the Chrysler of financial industries.

Yeah, I was astounded by the complete lack of logic in the executive's statement. I was also surprised by the mere futility of explaining the problem to him. Many people in my area at this company were equally blind to the eventual credit crisis that unfolded. Most though housing in that area would NEVER decline and that default rates could never hit double digits within 5 years.

It was quite laughable.

However, your post is actually a huge point I'm trying to make. Since people are defaulting at unexpected points (low/high ficos, employed and unemployed, because they WANT to default, not because they can't pay), EVERYBODY in society pays, since systematic risk in credit cards has increased as a result of unmeasurable and unpredictable updates.

Strategic defaulters are making it far more difficult to predict defaulting, thus, dramatically increasing systematic risk.

And you now pay for it. How do you feel about that?