Ethical Banking

[Nigel]

Joe takes out an adjustable rate mortgage. Joe had planned on refinancing the home before the interest rate become excessively high. Due to an economic downturn, Joe can no longer refinance and cannot afford his mortgage payments at their current 10% interest rate. Joe, knowing his situation, goes to the bank and explains his financial situation. He tells the bank that he could afford his payments if the interest rate were 5% (the initial interest rate on the loan was 4%). Joe states that if the interest rate is not lowered the home will most likely be foreclosed on since he cannot afford the current payments. Joe also brings relevant financial documents to show his situation to the bank.

The bank denies Joe's request and eventually the house is foreclosed. The bank knew in advance that by foreclosing on Joe's home would most likely result in the bank not being able to fully recover the amount owed on the mortgage. Despite this impending loss, the bank denies Joe's request and eats the loss. The reality of this transaction is that the loss will be passed on to other bank costumers who will be charged higher fees and receive less money on investments.

Joe is requesting that a contract be broken, the bank will not void the contract since it is a valid contract. Is the bank's decision moral?

While Joe's intentions in signing the mortgage, planning to refinance are questionable; does the bank's choice to offer Joe this adjustable rate mortgage mitigate these questionable intentions since the bank knows that the vast majority of adjustable rate mortgages will be refinanced as interest rates increase? Both Joe and the bank were aware of the possible outcomes when signing this mortgage.

[softwareNerd]

It makes sense for a bank to maximize its long term income. This can mean renegotiating a loan rather than foreclosing. However, there are two issues that banks face that are not addressed by your example:

Firstly, the facts are never so clear-cut. Joe might show the bank documents to prove that he cannot afford to pay. However, there is really no way for the bank to know if the assets Joe shows them are all he really has. There are many ways to hide assets. Also, the amount that Joe can afford going forward is open to debate. The bank may think Joe should cut back on his other expenses far more than Joe thinks he ought to. The bank may think Joe should get a second job, that his wife should get a second job, and so on.

Secondly, it is important that the borrower suffers when he cannot pay back his loan. It is in the interest of lenders for borrowers to think of default as a serious blow to their lives. So, it is actually worthwhile to the bank to take some loss on particular loans in order to ensure that "moral hazard" does not increase for all their future loans.

Edited August 2, 2011 by softwareNerd

[FeatherFall]

Also, after forclosure the bank can try to find someone who is capable of paying higher interest rates. It's not necessarily a complete loss and could result in an even more profitable mortgage.

[BradN]

Joe is requesting that a contract be broken, the bank will not void the contract since it is a valid contract. Is the bank's decision moral?

The only immoral decision the bank could make is one that broke the contract WITHOUT booth parties in agreement. A possibly dumb decision is not immoral. Joe is the one acting immoral in your example. Asking another to sacrifice for his dumb decisions is immoral. Expecting another to sacrifice for his dumb decisions is EVIL.

And yes banks do make more money off the foreclosure, Loans are set up to pay interest first. As long has Joe is paying, the bank is making money. When he forecloses, even in a quick sale, the bank can come out ahead.