The Ethics of Loan Modification

I was reading an interesting piece about loan modification on one of the AOL discussion sites the other day, and it struck me that while the authors were framing it as a question of economics, there is also a significant question of ethics involved. One of the problems with recommending fantastical fixes for a national problem – like a stalled economy – is that most of the suggestions are going to involve other people’s money, and however rational those ideas might seem to the person suggesting them, they’re going to look very different from the point of view of the people being asked to give up millions of dollars to achieve this social aim. Or, in the case of loan modification proposals regarding the current real estate slump, $71 million USD or thereabouts…

In case you haven’t run across this idea before, the basic concept is that if the various banks were to lower the amount of all of the “underwater” mortgages (ones where the amount owed exceeds the amount the property is actually worth) down to the amount those properties are currently worth, people would be able to start obtaining loans, buying and selling houses, and constructing new one. This would create somewhere between 500,000 and 2,000,000 jobs (it depends on who you ask) and could potentially result in hundreds of billions of dollars in profits for the banks alone, and considerably more than that for the country as a whole. And the best guess as to what it would cost is around $71 billion as of this week – or roughly half of what the American banking industry paid out in annual bonuses to its employees in fiscal 2010…

It sounds simple, doesn’t it? All the banks have to do is pay their super-wealthy executives half of last year’s bonuses this time around, and they can jumpstart the economy, rescue millions of people from bankruptcy, create millions of jobs, and benefit their own self-interest down the line by raking in billions of dollars in future mortgages. In fact, considering that many of our major banks are still in business only because of government bailouts made using our tax money, you could argue that they owe it to the country that saved their bacon to return the favor. Unfortunately, as usual, the actual situation is not nearly that simple…

Consider for a moment that most of these financial institutions are publicly-traded companies, which means that they are owned by individual investors – people just like you. If you had invested your money in a bank, how would you feel if people started calling for that company to drop half of its available funds down a rat hole in order to save the economy? Would you be okay with that, or would you start thinking that maybe other industries (like oil, or insurance, for example) that are recording record profits and have also benefited from government support over the years should chip in their share, too?

Then there’s the question of how many of the people holding underwater mortgages actually deserve to be rescued. Certainly, no one is disputing that there are a lot of innocent people who have been hurt by the situation, but we know that there are a certain number of real estate speculators in that number who were just trying to get rich quickly using other people’s money – effectively yours, if you’re a U.S. taxpayer. Should all of the people who were just trying to make a lot of money by buying and reselling houses without knowing what they were doing (a practice I have compared unfavorably to juggling lit chainsaws) have their fortunes repaired at the expense of bank personnel and investors who haven’t actually done anything wrong?

One could argue (as several commentators have) that the Federal government could impose such a program, or if that’s too onerous, just pay off the difference in the mortgages using governmental funds, but here again, that’s your money they’d be giving away (assuming you pay taxes), and a lot of people who don’t deserve it would benefit from their doing so. Given all of these problems, are loan modification programs actually a viable way of restarting the U.S. economy, or are they just a pie-in-the-sky scheme with no more connection to reality than mice belling a cat?

It’s worth thinking about…