Thursday, July 01, 2010

The Promissory Note

When one buys a house that he finances with a bank, he signs a promissory note. He also signs a mortgage, which "secures" the obligation he undertakes to pay back what he borrows. (I would shorten the phrase "promissory note" to simply "note," but it would not be useful in this discussion to drop the word "promissory.")

The promissory note contains the promise of the borrower to pay back what he borrows, together with the interest, according to a time schedule described in the note. There is a mortgage, as I mentioned, but the core of the transaction is the borrower's promise which resides in the promissory note.

If the borrower were to break his promise (i.e. "default" on the promissory note) , the creditor could simply sue the borrower. There is no obligation that the creditor foreclose on the mortgage first. The creditor could simply sue and get a judgment.

However, in practice the creditor will foreclose, because the house will not run away and disappear, as the borrower might. Furthermore, in the course of the foreclosure proceedings, the creditor will get a judgment against the borrower anyway, if the proceeds of the foreclosure proceedings do not cover the borrower's indebtedness and the expenses of the foreclosure. The judgement is the "deficiency judgment" that I discussed in an earlier post.

Again, at the center of the mortgage foreclosure proceedings is the borrower's promise. There is nothing in the promissory note that states that "I promise, provided everything works out." It is simply "I promise."

It is important to point out that, if the foreclosure proceedings happen to yield more than the sum of what borrower owes and the expenses, (that is, the house sells for more than the mortgage balance) the creditor doesn't get to keep the profit. It goes to the borrower. Of course, in such a case the borrower porbably won't let his house go into foreclosure, because it has equity in it. After all, the creditor only agreed (promised) to take back what he lent, plus the interest. The creditor can't take the profit. We will hold the creditor to that promise.

The idea that the borrower can walk away, because the creditor has his remedies at law, and that there is, therfore, nothing immoral is nothing new, of course. It reflects the school of "legal realism," whose most famous advocate was Oliver Wendell Holmes, Jr. It pretty much reflected the philosophy at the University of Chicago when I attended the law school there, and I would say it reflected the philosophy of the other major law schools in the country. That philosophy is fraying at the edges, because its basis in Social Darwinism worries the Statists. Government, after all, needs to step into the economic jungle and impose "fairness."

But Christians don't take their cues from the pagan culture, regardless of how refined and sensible it seems to be (at least in a given case). We have to take a second look at these difficult questions. To coin a phrase, What would Jesus do?

What about Jesus? (By the way, he did not own a house here on earth but owned many of them elsewhere. Actually, here he did not have a place to lay his head. That's a little troubling when we worry about our houses here on earth.)

Maybe this question about keeping your promises in the financial context is a Caesar vs. God thing. Maybe Jesus refers to two worlds when he had answered the Pharisee's question and that Christians can walk back and forth between them when it makes economic sense to do so.

Maybe not.


Carol said...

It reminds me of something that occurs these days sometimes with elderly parents who may be facing rather costly living expenses in some type of elder care facility in the future. I'm not sure I have all the details exactly right, but this is how I think it works, more or less. Let's say we have a parent who may need to leave their home and move into some kind of facility where they can receive more care and supervision than they have at home. Let's also assume that parent has some financial resources which could cover the cost of the facility for a period of time, but if the parent lives for many additional years they may outlive their financial resources. (Here's where my knowledge of the details gets a little fuzzy.) I believe the government has made some provision for continuing care for the elderly who have no money by putting them into certain federal programs, and that elder care facilities may be mandated to accept a certain number of these patients.

Getting back to our hypothetical parent, suppose they move into such a facility, live there a few years, use up their financial resources, and then the government begins to contribute money for their care. When the parent dies, there will be no financial "estate" left for their children.

But suppose the children had been advised, in prior years, to transfer the parent's assets to the children's control so that they could then oversee the parent's needs and arrange for the parent's care. "Coincidentally", this would also make the parent eligible to receive those federal dollars for their care, since they would have no assets in their name. And, when the parent died, possibly there would still be financial assets of the parent remaining that the children would have "inherited". This would be legal to do, and I think people do it quite a bit. But does that make it "right" to do? Especially for a Christian?

Macon said...

Interesting to know about the Promisory Note. I'll need to think on it.

I do see a couple of rhetorical trailheads, though:
- is there a Christian obligation to a Corporation? There clearly is one to an actual person, to a neighbor. But the Corporation, it's legal 'personhood' notwithstanding, has un-neighbored itself in its very incorporation. (And, by this logic, Partnerships have not.) So there may be no neighbor obligation here.
- is there a proper and allowable civil-disobedience approach to this where we can call for a peaceful financial revolution by punishing these institutions and the govt in this way?

Mom, your story is provocative and instructive, but I don't think it applies to the promisory/mortgage issue. The story is a very clear case of fraud, even if legal,. The strategic default becomes fraud (and no longer strategic default) if the person does have the equity to repay the loan.

Paul Stokes said...

I'm not sure I would call "strategic default" a fraud, in the legal sense - unless at the outset the borrower lied on the loan application. In that case, as I mentioned, he is not a strategic defaulter, he is a criminal; there is no question about his immorality. The question is about the morality of the true strategic defaulter. As to whether it makes a difference if we have a corporation, it is important to note that corporations are owned by stockholders. As we know with BP, some of those shareholders depend on a pension that has BP stock in it. Don't ask for whom the corporation tolls, it tolls for thee.