The Morality of Strategic Default

Professor Curtis Bridgeman (FSU College of Law) has an article on The Morality of Jingle Mail:  Moral Myths About Strategic Default.  I have a fundamental philosophical disagreement with the article, but it's got a lot of very good, clear analysis of arguments about strategic default, including a very useful typology of argument.  

Professor Bridgeman's article claims not to be a moral case against strategic default.  Instead, he argues (somewhat artificially, I think) that it is merely a critical examination of the claim that strategic default is not morally blameworthy, either because of the borrower's situation, the behavior of the lender, or the put-option nature of the mortgage contract.  

Bridgeman generally presents the arguments for strategic default fairly.  The major exception is when he assumes that the argument for strategic default is that the mortgage contract "gives parties the right to choose between performance and simply forfeiting the house without paying any additional damages." Bridgeman points out that this is hardly true in nonrecourse mortgages, and that most mortgages are technically nonrecourse. I think this overstates the argument. A fairer statement is that the mortgage contract gives parties the right to choose between performance and forfeiting the house and risking paying additional damages. Strategic default on a formally recourse mortgage is about a gamble that the lender won't pursue the deficiency because it's too darn hard to collect unsecured debt. And presumably that's been priced into the mortgage itself and the risk spread over a large pool of loans (contract law consistently fails to internalize underwriting in its analysis because it sees only the individual contract, not the contract ecosystem). 

My major argument with Bridgeman, however, is a philosophical one about what contracts are. He sees contracts as promises. I don't. I see them as economic bargains that have implicit optionality. 

To put this piece in perspective for Credit Slips readers who don't get their kicks out of contract theory, there is a branch of contract law scholarship that waxes philosophical and takes the promissory nature of contracts very seriously. Under this view of contract law, contract is not merely an economic bargain, but it is a moral undertaking, and violation of the contract is therefore a serious failing. This branch of contract theory is at war with what might be called an economic view of contracts, perhaps best represented by Oliver Wendell Holmes, Jr., and his famous dictum, 

“The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it,—and nothing else.”

Perhaps it's not surprising that few if any true adherents to the contract as moral undertaking view are bankruptcy scholars. Bankruptcy law adds an asterisk to Holmes' famous dictum (from 1897, when there was no bankruptcy law in the US) that a contract is an undertaking to carry out a promised exchange or pay damages. As Professor John Witt has noted, that asterisk say that the damages can be paid in little tiny bankruptcy dollars. But even without bankruptcy, except in the rare case where specific performance is permitted as a remedy, a party to a contract may always choose whether or not to perform or pay damages.  As Holmes observed,

"The only universal consequence of a legally binding promise is, that the law makes the promisor pay damages if the promised event does not come to pass. In every case it leaves him free from interference until the time for fulfilment has gone by, and therefore free to break his contract if he chooses."

Bridgeman presents some rather weak doctrinal arguments in his favor (does the UCC article 2 commentary really carry much weight? It's not the law, and the results under the UCC aren't those that which obtain if contract were promise) that he seems to recognize are not compelling as he couples it with the perfectly fine observation that the legal treatment of an act is distinct from its morality. 

Where Bridgeman loses me, however, is when he next assumes (but never quite comes out and argues directly) that there is any moral content to a mortgage contract. I don't see a compelling case there. I don't see why there's necessarily any more moral content to the mortgage contract than there is to my typing or changing the toner cartridge.

Moreover, contracts can be done be humans as well as by corporate forms, and there is "one law to rule them all." The idea of there being a moral obligation assumed by an LLC is absurd, so why is there one assumed by a sole proprietor who enters the same contract? Or how about a homeowner whose contract is with a bank (a corporation)? Is there only a moral obligation running one way there?

Indeed, can one owe a moral duty to a corporate entity or any other nonsentient object? There might be fiduciary duties, but that's a legal status, not a moral one per se.  (The closest exceptions that come to mind are the Seinfeld episode where Tony the psycho mechanic absconds with Jerry's car because Jerry isn't taking proper care of it or veneration of religious objects, such as doing pennance after dropping a Torah scroll or tefillin, but in both cases, the objects are ascribed anthropomorphic qualities). 

I can't disprove the notion that contracts can never be moral undertakings any more than Bridgeman can prove it. I just don't see any need to go there, and there are plenty of cases where there's no moral quality whatsoever. If banks wanted to ensure specific performance of contracts, they could easily draft them differently--just lend at lower LTVs and force a forfeiture upon default, for example.

But certainly some people see contracts as moral undertakings, and that affects their willingness to strategically default, just as it affects their willingness to file for bankruptcy, and I am not one to deny the deeply held convictions about the morality of contract that these people hold. But I don't think that one can assert there to be a universal morality governing mortgage contracts. It's an optional morality, and I'm not sure what it really gets a person other than locked into a bad bargain and a good sense of self, whatever that's worth. I don't think this is the same kind of morality as "you shall not murder." It's personal, not universal. 

Bridgeman's argument makes me grind my teeth because of my philosophical differences, but I think the article does a really nice job of laying out contract as promise for strategic default, to the point that I'm thinking I might assign it to my contract students next year--it should make for a good classroom discussion.