You Should Care About The Bank Exactly As Much As It Cares About You

David Graeber’s book Debt: The First 5,000 Years opens with the story of a conversation he had with a wealthy Londoner ostensibly interested in social justice. Graeber tells the Londoner about his work trying to ease the insane debt loads and anti-democratic restrictions that the masters of global finance use to control so-called developing countries and their governments. The Londoner’s response catches him off-guard: “Surely one has to pay one’s debts.”

Doesn’t one? Isn’t repaying your debts, i.e., fulfilling your promises, a basic moral principle? Well, no, not really. Graeber does a thorough takedown of this idea in the arena of sovereign debts, where the debt is often (literally) “owed” by a previously-colonized nation for the privilege of having been colonized. But Graeber shouldn’t have been surprised to hear this, even from someone well-versed in social causes. The idea that we are morally required to pay our debts is ubiquitous. People convicted of crimes have to pay a debt to society. We “owe” people “debts of gratitude.” Sometimes we even “owe” people our lives. Hell, even the Lannisters repay their debts.

And we’ve been judging people for failing to pay their debts probably since debts existed. We have specific words for people who don’t pay: they’re “deadbeats” or they’re “loafers.” Even the word “debtor” feels judgmental. What’s more, debtors’ prisons have a long and storied history, including in the U.S. And despite debtors’ prisons having been abolished, you can still find people going to jail just because they can’t pay back debt (including student loans). In short, lots of people firmly believe that paying back one’s debts is a moral requirement, and many people who can’t pay back their debts feel like bad people because of it.

We need to cut this out. It’s certainly not a moral failing to be unable to pay back your debts, nor is it a moral failing to choose not to pay back your debts. The people and institutions most responsible for pushing the idea that one must pay back one’s debts are, unsurprisingly, the lenders. And while the lenders are out moralizing about how their customers must pay or else they’re irresponsible deadbeats, corporations, including the lenders themselves, frequently refuse to pay money they owe even when they can afford to do so. That is, they really only fulfill their promises (debts and other contractual promises) when the benefits of doing so outweigh the costs. If it will cost them more to fulfill a promise than they will get out of it, they just don’t. This is common enough for there to be a term for it: strategic default. (Default is a fancy term for failing to fulfill your end of a contract. It usually applies to loans but really can be any contract.)

This double standard is infuriating, but we can find real harm living behind this hypocrisy. Lots of people feel really bad when they can’t afford to pay back debts even though it is in no way their fault. And the shame and anguish associated with finding yourself trapped in debt doesn’t only prevent people from taking actions that are best for them as an individual, it also serves as a barrier to collective action against abusive creditors.

To understand strategic defaults, you need just a little bit of contract theory. I will try to make this painless. (What follows, all of it, is very much not legal advice. That should be obvious.)

The basic principle behind a contract is that some number of people decide to exchange promises. I promise to paint a portrait of your dog in a military uniform and you promise to pay me an exorbitant amount of money. You promise to give me enough money to buy a house and I promise to pay that money back to you over time, plus interest. Quid pro quo. This for that.

If you and I are very close friends and we trust each other then we probably won’t bother writing this down or even thinking about it as a “contract.” Instead, we make contracts because we’re not friends with and don’t trust everyone. Contracts are for if/when we disagree about something. And when we do disagree, what happens will depend on the contract itself, but also on the law surrounding it. No contract is an island. To understand just one contract you have to swallow the world, or at least the world of contract law. Like with laws in general, what’s written down in a contract only means something in the context of contract enforcement. If I don’t live up to my end of the deal, what are you going to do about it? If you go to court, what is the court going to do? This is what the contract is actually about. It’s the agreement, but it’s mostly how we interpret the agreement and what happens when things don’t go as planned. When things go awry, what can you take from me or what can I take from you?

If we have a contract for a commissioned dog portrait (complete with old-timey military uniform and regalia), and I fail to paint the portrait, you might be able to make me refund your money and pay however much more it will cost to have someone else do it. But you probably can’t force me to paint the portrait if I don’t want to do it—that looks like slavery and American courts frown on slavery (except for people convicted of crimes, extracting slave labor from them is a-okay). Or if you loan me money to buy a house and I don’t pay the money back, you might be able to take the house. But you probably can’t come in the day after I miss a payment and change the locks. We have generally decided that’s not an acceptable way to collect on a mortgage. There’s some process, established through a statute or through court decisions, for enforcing the contract through foreclosure. You have to follow that process if you think I’m in default.

Defaults can happen for all sorts of reasons. Sometimes they can’t be helped. If you give me a mortgage but I lose my job and can’t afford the payment, I will probably default. I don’t want to default, but I can’t really help it.

Sometimes, though, defaults are strategic. That is, sometimes I might decide that I’ll be better off by defaulting than I would be by doing what I agreed to do. This is the gist of strategic default, both the totally fine corporate kind and the shockingly immoral individual kind: even considering the worst thing that you can do to me if I default, I’m still better off defaulting.

For example, imagine I am a naïve print publication (ahem) and you are a bank. I decide to do some vertical integration and purchase my own printing press. You think that’s a worthwhile idea and agree to loan me the cost of the printing press, $100,000, in return for a security interest in the printing press. (That’s like having a mortgage on the printing press. If I don’t pay you back, you get to take the press for yourself.) So you’re betting that my business will succeed and/or that the printing press will remain worth at least as much as I owe on it. And I’m betting that having my own printing press will save me more money than I have to pay you for the loan.

But then let’s say that I belatedly realize that print is dead. I need to pivot to video, possibly on the blockchain, quickly. This printing press was a bad purchase, and, since print is dead, the thing isn’t worth nearly what I paid for it. It’s now only worth $20,000. But here I have a contract where I agreed to pay you $100,000 plus interest for it. I can still afford to pay you (thanks to all my wonderful subscribers), but I don’t really want to. What am I to do?

Well, if I’m a shrewd and economically rational magazine, I might think of the costs and benefits of each of my options. I could continue to pay on the loan. That would maintain my relationship with you and keep my credit rating high, but it would cost a lot of money. Or I could stop paying the loan. That would tank my relationship with you, hurt my credit, and allow you to confiscate the printing press, but it would save me a lot of money. If all you had was your security interest (i.e., mortgage) in the printing press, then strategically defaulting might be my best option. Our agreement was that I would pay you or you could take the press. Paying you means I lose a lot of money and not paying you means I lose the press—a useless piece of machinery. I might decide, as a matter of strategy, to just stop paying.

This is a simple example, but companies do this all the time. A particularly Byzantine (but fun!) recent example is the Hovnanian strategic default. Basically, a company called GSO made a bet that another company called Hovnanian would default on some of its debt (the bet took the form of credit default swaps). Rather than waiting around for this to happen, GSO decided to essentially pay Hovnanian to default on that debt. Goldman Sachs, who made the bet with GSO and is now down a lot of money on the deal, is very unhappy about this and of course there’s a lawsuit about it. It’s similar to another strategic default from a few years ago (also involving credit default swaps).

But, again, this is more complicated than it has to be. Companies often have incentives to default on their agreements. Economists think a lot about strategic defaults because economists think a lot about incentives and costs/benefits and effects on behavior. You can find some basically incomprehensible finance papers worrying that strategic defaults are making credit more expensive, and others worrying that companies need to strategically default more than they currently do. (Here’s Bloomberg’s Matt Levine making that latter paper at least a little bit more understandable.) The point is that corporate finance is complicated and everyone is always thinking about how they can squeeze a little more money out of a deal. Sometimes they do that by defaulting on an agreement. It’s just shrewd business, like corporate bankruptcy and tax avoidance.

You might think of individual people in the same way. Economists and finance experts are always berating us for our irrationality and lack of financial understanding. So they might encourage us to be more rational and find advantages—maybe save some money or maybe get some leverage—by strategically defaulting on our contracts. Not so. The idea that failing to pay back a debt makes you a bad person is deeply ingrained into our society, so much so that trouble repaying debt is causally linked to clinical depression, and lenders often weaponize this shame as a collection tactic. Plus, the amount of moral approbation heaped upon people who default on their contracts sometimes depends on those people’s race.

Stop here for a second. It bears repeating: nothing in this article is legal advice. I am not your lawyer and it’s probably not a good idea to get legal advice from magazines, especially ones full of delightful comics and quizzes and fake ads. If you’re in default or approaching default or thinking about default, talk to a lawyer. If you don’t have much money, call legal aid. What your lender can do if you default will depend on your state and your contract and your individual circumstances and you probably need professional help thinking through these things. Defaulting is probably not very strategic if it lands you in jail.

You may recognize the term “strategic default” from the foreclosure crisis. Back then, important, credentialed, and wealthy people were worried about underwater homeowners strategically defaulting, i.e., walking away from their mortgages and their homes. (As it turns out, people generally didn’t walk away even when it might have made financial sense to do so.) But these important people were saying things like underwater borrowers have a “moral responsibility” to keep paying their loans and worrying about “the message [defaulters] will send to their families and their kids and their friends.” Why? Because “[y]ou promised to repay the loan when you took out the mortgage, and it’s your responsibility to do everything possible to honor that commitment.”

The foreclosure crisis was a stark example of this sort of moralizing, but it’s far from the only example. Anyone who has been unlucky enough to interact with a debt collector knows this. Debt collectors apply moral pressure with an impressive zeal. They turn on a dime from encouraging you to be an upstanding and responsible person by paying your debts to admonishing you for failing to set a good example for your kids by falling behind. (Even as a legal services attorney I had multiple debt collectors tell me I was being irresponsible and/or unethical by helping my clients with their debt problems.)

This is only one weapon in their arsenal of ways to make people feel guilty and powerless. It’s weaponized morality selectively applied. The selective application is highly ironic—the debt collector you’re talking to is not the entity you “promised” to pay. In fact, they probably bought your debt for a few cents on the dollar, if that. And yet they’re calling you irresponsible for failing to give them the money you borrowed from someone else so that they can keep the vast majority of it as profit. Another irony: the debt collector that is lecturing you about being a responsible person operates in an industry based largely on grift, where debt collectors constantly rip each other off, sell fake account lists, refuse to pay each other, etc.

Any discussion on debt and morality also needs to touch on bankruptcy. The idea behind bankruptcy is that people should be able to get a fresh start under some circumstances—that they shouldn’t have to spend their whole lives burdened by debts they can’t pay. It’s part of the broader context of contract law that we talked about above. Every lender making a loan understands that the borrower might declare bankruptcy and that they, the lender, might not get paid. This risk is generally accounted for in the price of the loan—that’s what risk-based pricing is. The formal bankruptcy process as it now exists is a relatively recent innovation, but the idea has roots going back to colonial times and beyond. The first federal law on voluntary bankruptcy in the United States was enacted in 1841. When Georgia was established in 1732 it was intended to be a safe haven for debtors. Even the Old Testament recognizes that people shouldn’t be trapped in debt forever. Both Exodus and Deuteronomy mark seven years as the time limit for indebtedness. (“At the end of every seven years you shall grant a release. And this is the manner of the release: every creditor shall release what he has lent to his neighbor or his brother, because the Lord’s release has been proclaimed.” It is probably no coincidence that the Fair Credit Reporting Act only lets your creditors report negative information about you for—you guessed it—seven years.) Nonetheless, people feel very guilty about bankruptcy and often avoid it for as long as possible, inflicting massive financial harm on themselves in the process.

This morality vs. strategy double standard makes its race preferences particularly clear in bankruptcy. Recent journalism and academic studies show that whether a person gets the benefit of a post-bankruptcy fresh start largely depends on their race. Put simply, many bankruptcy attorneys—the people who are supposed to help their clients get a fresh start—steer black clients into more expensive bankruptcy plans that force them to pay more money to their lenders. ProPublica revealed this trend in a fantastic series on bankruptcy in the south.

There are two types of bankruptcy for most people: Chapter 7 and Chapter 13. Chapter 7 is faster and cheaper and wipes away most debts quickly, but doesn’t help when people have lots of assets or have problems with their mortgage. Chapter 13 takes three or five years and involves paying your lenders on payment plans over time. Chapter 13 only gets you out from under debt if you manage to make your payments for three or five years. Many people fail on these extended payment plans and end up worse off than they were before they filed bankruptcy. Chapter 13 also costs more in attorney fees.

ProPublica found that bankruptcy attorneys nationwide, but especially in the south, were far more likely to put their black clients into Chapter 13 plans and their white clients into Chapter 7 plans. One attorney, who filed mostly Chapter 13 for his mostly black clients but was twice as likely to file Chapter 7 for a white client than for a black client, explained: “A Chapter 13 shows people how to live without buying things for that 60-month plan,” and “[w]ith a Chapter 7, wham bam it’s over, and they’re back to the same old thing, the bad habits that got them in trouble to begin with,” and “[t]hey need to learn how to live not buying things on credit.”

These attitudes from a bankruptcy attorney are not anomalous. A study recounted in a disturbing 2012 paper sent surveys to bankruptcy attorneys across the country. The survey had short descriptions of client situations and asked the attorneys to recommend Chapter 7 or Chapter 13 based on the facts given. The surveys had identical facts, except that some clients were named Todd and Allison and went to United Methodist church (implicit signals that Todd and Allison are white), while others were named Reggie and Latisha and went to African Methodist Episcopal Church (implicit signals that Reggie and Latisha are African American). Despite having identical facts, bankruptcy attorneys recommended Chapter 13 to Reggie and Latisha around half the time (47%), and recommended Chapter 13 to Todd and Allison less than a third of the time (32%). Not only that, the attorneys considered Todd and Allison more competent if they wanted Chapter 7, but considered Reggie and Latisha more competent if they wanted Chapter 13. These results show that even bankruptcy attorneys, who are supposed to help people get the best financial results through a process set up to eliminate debt, nonetheless have implicit or explicit biases that black people ought to pay back more of their debt than white people—that black people should “learn how to live not buying things on credit” while white people should do what’s in their financial best interests.

So we have a double standard. Companies are expected to act within their legal rights to their full financial self-interest, and individuals (but especially poor and black individuals) are expected to honor their commitments no matter the consequences. But what is the right answer? Is it that corporations are being immorally selfish by strategically defaulting and we should hold them to stricter moral standards? Or is it that moralizing about debt is a cynical weapon deployed by creditors to increase their revenue, and we should all default when it’s strategic to do so? The moralistic view has some appeal. I generally think that removing moral considerations from finance and economics makes for a deluded and miserable economic system and world. Plus, there’s some intuitive weight behind the morality of repaying debts, at least when you can. If I borrow $10 from a friend and promise to pay them back, but then refuse to pay them back even though I have $10 on hand, that seems wrong. We should generally do things we promise to do.

But there are a lot of differences between borrowing money from a friend and borrowing money from a lender. For one, my friend probably won’t charge me interest. The lender will not only charge me interest, it will try to calculate the likelihood that I will refuse to pay it back and charge me more interest if it thinks I am unlikely to pay. This seems sort of like a concession that maybe in some circumstances I shouldn’t pay.

Another more important difference is that I make my friend a very simple one-sided promise. There’s no sophisticated contract that has taken into account all the different possibilities and both parties’ enforcement rights. But a loan is just that kind of contract. It lives in the world of contract law where everyone’s enforcement abilities are carried into the agreement. In other words, it’s more like an either/or. My promise to my friend is just a promise to do something—my promise to the bank is a promise to do something and an agreement about what the bank can do if I don’t. Either I will pay this loan back or you can sue me for whatever I haven’t paid plus interest and collection costs. If it’s a mortgage, either I will pay this mortgage back or you can foreclose on my house. The lender and I (theoretically) understand those options at the outset, so it’s strange to say it’s immoral for me to exercise whatever my options are.

I think it’s helpful to imagine a friend transaction more like a contract to see if it still feels immoral to break the promise. Imagine I promise to pick my friend up from the vintage clothing store at 4. But, if I’m not there at 4, I agree they can use my credit card to get a stretch limousine to take them home. Either I will pick them up or I will pay for a luxurious ride home. In this situation it feels much less immoral for me to fail on the promised ride. They have another option! They understood and agreed to these options. They might prefer for me to pick them up, but they understand that maybe I won’t be able to and in that case they’ll settle for the limo. If the limo option wasn’t acceptable then they would have made other arrangements altogether.

This is how we should think about the morality of debt and default, strategic or not. Contracts for loans are both priced for the risk of default and carry with them enforcement powers in case of default. What happens if I don’t pay is built into the transaction. The lender expects me at the beginning to do what’s best for me and prices my loan accordingly. Any future invocation of morality is, I think, hypocritical at best.

If we can get past the shame of stigma of having debt, and the judgment that comes with not paying it back, we might find some powerful options in terms of collective action. Being an individual debtor isn’t unlike being an individual employee or an individual renter. You yourself may be vulnerable and, to an extent, disposable to your employer or landlord or lender. But if you could unite with others and act as a group you would have more leverage.

This is not a secret in finance. There’s an oft-repeated saying: “If you owe the bank $100k, the bank owns you. If you owe the bank $100m, you own the bank.” It’s a variant on too-big-to-fail—the more of a lender’s business is tied up in you, the more the lender depends on your success to survive.

We can’t all go get loans big enough to own the bank, so to speak. But you could imagine a large-scale debt strike forcing loan modifications en masse, just like a job strike can force contract renegotiation and a rent strike can force lease modification. Like with employment and rent, the success of a debt strike would depend on what the lenders could do about it, i.e., the enforcement options. It would also need appropriate scale: a lender that deals with 10,000 non-strike defaults per year will not be especially put out by dealing with an additional 100 strikers.

Both enforcement and scale present problems for the recent attempts at federal student loan debt strikes. Federal student loans are about the most enforceable debts in existence—they have no statute of limitations and the feds can garnish your wages without going to court and you usually can’t escape them through bankruptcy. So defaulting doesn’t create as much leverage as it would with other debts where the lender might need to take you to court within a certain amount of time if they want to collect. And scale is also an obvious challenge. There are more than 40 million people with student loans and more than a million default every year. So a few dozen or even a few thousand victimized students refusing to pay their fraud-induced debt won’t create much actual leverage against the federal government. (That’s not to say these strikes are wholly ineffective. They managed to get decent publicity and called attention to the dual problems of for-profit schools peddling worthless degrees, and the federal government lending money to those schools’ victims and then aggressively collecting on it for decades.)

But you could imagine, for example, an online community of people with debt from deferred-interest credit cards. If a large number of customers of the same deferred-interest card decided that they were deceived about how the cards worked and they were going to refuse to pay, that might force the lender to the table. (This would function somewhat similarly to a class action lawsuit but may avoid the card’s inevitable rip-off clause.) If the lender still attempted to confront people individually, they could share information about tactics and offers. It would also create a source of information for regulators or attorneys or researchers who want to find out how the cards were actually sold and marketed. There would be an already-convened group of people willing to share their experiences. (The CFPB’s consumer complaint database serves as a valuable research tool now, but it doesn’t connect people with each other and doesn’t provide any identifying information so there’s no organizing potential. And the CFPB’s banker-friendly current leadership wants to close it to the public.)

Organizing this sort of strike would be logistically difficult and any platform would need a lot of safeguards, e.g., against informants and also against scammers hoping to dupe strikers they know are desperate. But these are not insurmountable problems. The first and possibly most difficult step would be overcoming the shame people feel about being in debt and the idea that defaulting on debt is irresponsible and wrong.

One of the most frustrating aspects of the strategic default double standard is how effective it has been. A 2009 survey found that 81% of people think it is immoral to refuse to pay a debt. A 2014 poll found that people are more embarrassed about their credit card debt than they are about their age, weight, bank balance, and credit score (though credit score came in second). My guess is that these reactions are based less on a careful consideration of debt and morality, and more on our prevailing culture of shame around debt and poverty—a prevailing culture that, not coincidentally, benefits lenders and costs the rest of us. If we can overcome this shame, we can get better outcomes for ourselves and open opportunities for collective action.

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