David R. Henderson  

Good for Michael Vick--or Incentives

Los Angeles Unions' Two-fer on... Markets describe reality; mode...
"What Michael did was the exception, not the rule," Luzinski said. "He didn't have to do this. The law allows you to skate by and pay your creditors 10 or 20 cents on the dollar, but he thought this was the right thing to do."

Vick said he could have filed for Chapter 7 bankruptcy instead of Chapter 11, which he ultimately chose. The former would have meant most of his debts would have been forgiven.

"I didn't want to stiff people who never stiffed me," Vick said.

This is from Darren Rovell, "Michael Vick pays down his debt," at ESPN.com. The article details how Michael Vick, who lost his football career at his peak performance by being imprisoned at Leavenworth, paid back his creditors in full--or at least will be close to doing so.

It's heartening to see someone take such responsibility when the incentives go the other way. Of course, you could say that the incentive was to take responsibility in order to get his football career back, as reporter Darren Rovell points out in the linked interview. Ok, then. Good for incentives. So this story is either a feel-good story about Michael Vick or a feel-good story about incentives. My guess is that it's a bit of both.

HT2 Joseph T. Salerno.

By the way, I think Joe Salerno goes way too far in calling Vick a "hero." But Vick did do something admirable. That doesn't speak at all to the horrible things he did that landed him in prison. But I'm a "glass 30 percent full" person, as regular readers of this blog know.

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COMMENTS (7 to date)
Brent writes:

Torture canines --> prison.

Torture people --> meh...

BC writes:

I have a sincere question about the ethical aspects of debt default. My question applies most directly to mortgages and collateralized loans, but could apply to Vick's situation as well.

When lenders lend, they assess the risk of default, and the borrower pays a premium over treasury rates to compensate the lender for such risk. The risk premium on a mortgage, for example, might include in part the value of a put option on the home since, if the home value drops below the value of the debt, the borrower has the option to allow the lender to foreclose. Now, if someone owned an explicit put option, then no one would call them irresponsible or unethical for exercising that option. When the option is embedded in a loan, however, then some people would consider such "strategic default" to be unethical, even though the interest they pay might already include the price of that option. Why is that?

It seems to me that the ethical thing to do is to behave consistently with the market expectations that went into pricing the loan, i.e., default under the circumstances that market participants would have expected default at the time the loan occurred. That's hard to figure out though when the default options are implicit rather than explicit. (Also, most likely, the market expectation was that x% of borrowers will default under circumstance y, and one can't always default on only x% of the loan.)

One more consideration: if a corporation doesn't default strategically on debt, are they behaving ethically and responsibly? From the lenders perspective, one might say yes. However, the corporation's managers have a fiduciary duty to act in the best interests of its shareholders. If they don't default strategically whenever the opportunity arises, one could argue that they are behaving irresponsibly.

In Michael Vick's case, the article says that an investment firm actually bought some of his debt from the Atlanta Falcons, presumably at some sort of discount. Presumably, the discount reflected the investment firm's and Falcons' expectations about the circumstances under which Vick might default. Does Michael Vick have some ethical respsonsibility to provide a windfall to the investment firm by paying back debt under circumstances that the investment firm didn't necessarily expect him to? The ethics seem ambiguous to me.

There would be fewer ethical ambiguities if loans contained more explicit default options. For example, mortgages could explicitly allow borrowers the option to "hand over the keys" if the home value dropped below a certain level. Other loans could automatically decrease or eliminate the value of the loan if the borrower's income or net worth fell below a certain threshold. Most loans don't work that way, however. So, some borrowers pay for options that they never exercise while other borrowers exercise options that they didn't really fully pay for.

David R. Henderson writes:

Good questions and analysis. I’ve thought a lot about this myself. I have a friend--call him John--who, in the 1990s, was living at a fairly low standard of living so that he could pay off his credit cards. He had about $40-$50K in credit card debt and a car worth about $5K. That was the extent of his marketable assets. I said, “John, you should declare bankruptcy.” He said “No, I think that’s wrong.” I said, “Did you ever lie about income, assets, or debts when you filled out credit card applications?” “No,” he said. “Well, then,” I said, “the credit card companies went into this with their eyes open and they’ve already taken account of the risk.” “I know,” he said (he’s an economist), “but I still think it’s wrong.”

I admired him for this. I don’t think it would have been wrong for him to default but I admired him more for not doing so.

I slept on this for a few days and you know what I did? I offered to lend him $2K at an interest rate 2 percentage points below the highest rate he was paying. I knew this was a good risk. It was.

Dan Meyer writes:

Perhaps the felt 'wrongness' of defaulting depends partially on how exogenous it feels like the debtors' circumstances were. Defaulted because you gambled it away or bought lots of caviar? Feels like you should pay it back. Defaulted because of a fluke storm, or because of a downturn in your industry? Feels OK to default.

In Michael Vick's case, you could argue his circumstances were endogenous: he did bad things and, predictably, lost a few years of earnings when he was punished. I expect that many/most people would agree with that view, so, regardless of how Michael Vick feels, this means that (as you mention, David) paying everything back could be a good strategic move.

I personally think Vick's punishment was unreasonable, so, under this model, I would view the loss-of-earnings as mostly morally-exogenous and therefore think that Vick should default.

Dan Meyer writes:

To better-connect my post to BC's:

The market expects defaults for two types of reasons:
1) random/exogenous bad things happen
2) fraud or other bad behavior happens

It feels moral to, as part of a debt contract, pay a premium to insure against #1. It feels icky to let people insure against #2.

One's appraisal of Michael Vick's actions could depend on whether you think he's in situation #1 or #2.

Ray Lopez writes:

"That doesn't speak at all to the horrible things he did that landed him in prison" - dog fighting? I thought Vick's sentence was disproportionate to the crime. They literally beat dogs by hanging them on trees, while they are alive, to soften the meat in South Korea. In the Philippines, where I live now, cock fighting is a sport; in the USA this will land you in prison.

In short, Vick's crime--and it was a crime by US standards--should have landed him a hefty fine and a month in jail, not 23 months in the peak of his earning capacity. Remember, these athletes have to compress a lifetime of earnings is less than a decade.

David R. Henderson writes:

@Ray Lopez,
I thought Vick's sentence was disproportionate to the crime.
I agree.
In short, Vick's crime--and it was a crime by US standards--should have landed him a hefty fine and a month in jail, not 23 months in the peak of his earning capacity. Remember, these athletes have to compress a lifetime of earnings is less than a decade.
I agree.

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