Walking Away From Bad Debts.

Two gigantic real estate companies, Tishman Speyer Properties and BlackRock Realty, that bought the last sizable chunk of middle-class housing in Manhattan are walking away from the failed project and turning the properties over to their creditors:

The surrender of the properties, first reported by the Wall Street Journal, ends a tortured real estate saga that saw the partnership make expensive improvements to the complex and then try to rent the apartments at higher market rates in a real estate boom. But a real estate downturn and the city’s strong rent protections hindered those efforts, leaving the buyers scrambling to make payments on loans due for the properties, which have been a comfortable harbor for the city’s middle class since they opened in the late 1940s.

“We have spent the last few weeks negotiating in good faith to restructure the debt and ownership of Stuyvesant Town/Peter Cooper Village,” said the statement by the partnership. “Over the last few days, however, it has become clear to us through this process that the only viable alternative to bankruptcy would be to transfer control and operation of the property, in an orderly manner, to the lenders and their representatives.”

In one respect, it's a triumph for affordable rental housing, especially in Manhattan, where the middle-class has been squeezed out. The inability of the working class to maintain a foothold in much of New York City was a big downside of the boom, and the possibility that they could come back could be an upside to the bust. The inability to convert these rental units to market-rate ones may also be the wake-up call many New Yorkers have been waiting for: You can't rely on a high-end market alone.

But this story also serves as a reminder that sometimes it makes the most sense to walk away. As many commentators have pointed out, we tend to assign immorality when families who own homes decide, after crunching the numbers, that paying their mortgage is no longer worth it, but have no such qualms when businesses make the same decision:

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a “norm asymmetry.” In other words, they think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It’s as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical.

That norm might have been appropriate when the lender was the local banker. More commonly these days, however, the loan was initiated by an aggressive mortgage broker who maximized his fees at the expense of the borrower’s costs, while the debt was packaged and sold to investors who bought mortgage-backed securities in the hope of earning high returns, using models that predicted possible default rates.

After all, as Daniel Gross points out, you are living up to the terms of the deal if you walk away from the home you've decided not to pay for. Urging homeowners to continue to pay their mortgage is more about the big picture -- all of those foreclosures would be bad for the banks. But it's pretty easy to argue that we've worried about the banks enough.

-- Monica Potts

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