The Feudal Mistake
In recent years, mortgages have been carved up into so many pieces that the re-working of mortgages -- and the saving of homes from foreclosure -- is not happening even when there are responsible homeowners who are willing and able to make reasonable payments. Regulators and politicians have done nothing yet to compel the re-working of mortgages, in part because they fear that they will be labeled as trampling upon the constitutional rights to property of the investors who own parts of these troubled mortgages.
That is a huge mistake. Foreclosures are rising, and destroying families and communities. And forcing investors to cooperate in re-working excessively cut-up mortgages is completely consistent with the English and American tradition of property law and property rights.
In feudal England, trade in land was burdened by a legal system that recognized a myriad of current and future interests that could lay claim to any parcel. Underinvestment and illiquidity in the land market was the result. English and American judges created and used legal doctrines to undo the excessive fragmentation of ownership interests in land. Judges read and sometimes simply re-wrote contracts and bequests to promote the holding of land in a "fee simple" -- that is, by a single person or entity with full rights to decide how best to use the land.
In the United States, in the nineteenth century and early twentieth century, oil production was stymied by the fact that the multiple surface land owners of each large underground oil field destructively competed to suck up and "steal" the underground oil from one another. State legislatures responded with tough statutes that compelled surface land owners to hold the underground oil field in a unitary legal structure with centralized management.
In both the feudal and oil field examples, efficient decisions about property could not be made because too many people with different interests had a say over what should be done with the property. Fast forward hundreds of years later, and we see the same basic problem in the American housing market. The structure for mortgage-backed securities that has been used in recent years makes re-working of mortgages a near impossibility. Some mortgage-backed securities holders benefit more if the mortgages do not go into default and the properties do not enter foreclosure, while others benefit more if the mortgages do go into default and the properties do enters into foreclosure. Because many mortgages are pooled in each security, hundreds or even thousands of investors may gain a tiny advantage from any single mortgage not going into default or instead going into default. Under these circumstances, it is not feasible to obtain the consent for a re-working of a mortgage from of all the investors who may have some kind of financial stake.
Congress should draw inspiration from the judges and legislators of the past who tackled feudal land and oil field inefficiencies, and, by statute, eliminate any requirement that all investors in a mortgage consent to the re-working of the mortgage. Instead, government-appointed trustees should be authorized to employ the same criteria for re-working that a community bank traditionally would use when it holds a 100% stake in the mortgage. Mortgages that can be saved by writing down principal to current housing values will be saved, and the housing market will stabilize. Our property law and property rights tradition simply does not require, or even allow, our lawmakers to sit back while the ill-advised chopping up of property into competing interest creates a gridlock that undermines national prosperity. As Abraham Lincoln famously remarked, the Constitution is not a suicide pact.
David Dana, professor of law and associate dean for academic affairs at Northwestern University School of Law, is a leading scholar in the fields of environmental, property, intellectual property and professional responsibility law.
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Excellent piece, Dr. Dana.
We would all do well to remember that "we have all been here before." Bubbles have come and gone, securities have been written and their supposed rights fought-over on the decks while the boat slipped into the water. In this instance, it is in the best interests of more than 300 million people (just in -this- country...
I think that we cannot argue the fact that the numbers on those pieces of paper consist mostly now of empty air. So, we do have a choice: is the paper to be "worth less," or "worthless?"
The bottom-line here rests in the hands of a family that has nothing to do with that security, and also everything to do with it: the Homeowner. They've got a house that "a willing buyer would pay a willing seller" only a fraction of the number printed on that piece of paper they hold. They're GOING TO WALK: they will not live in debtor's prison. They'll burn it to the ground if they have to. But... they do want the house.
So, strike a bargain. Reduce the number. Yes, the security will have lost its "value," but it will actually HAVE the value that remains.
Debt-forgiveness is not new. Many societies have a "Day of Jubilee." Perhaps they knew what they were about . . . . .
Whole countries have used debt forgiveness and emerged the stronger for it.
Who in their right mind believes the free market system works, and must protect investors? Why, of course, Paulson demanded entitlement for Bush's $1 trillion dollar going away present for his cronies on September 19, 2008. Yes, the same day the RNC admitted they are, in fact, the Party of Corporate Welfare. We must protect investors, even if we have to foreclose on millions of homeowners. That's how the free market works. Well, America does not tolerate corporate welfare. It's time to slap a moratorium on foreclosures, stop the bleeding, and if the investors want to squeal and scream, they can meet the judge, and explain how their free market works.
We should all fax a summary of this article to our congressmen.
"Re-working mortgages" is a little bit ambiguous. We need a simple tag, something the public can understand, even if it is more words.
Maybe something like "allow government authority over sliced default mortgages" .
Great article. Indeed, the property rights framework is completely inapposite here -- one of the big problems with deregulation is that it essentially legalized gambling over mortgages in the form of so-called "shares" relating to mortgages. So it makes little more sense to say that a holder of some tiny piece of (or prediction regarding) a mortgage has a "property right" in it than it would to say that I have a property right on some horse on which I placed a bet at the track.
As a society, I don't give a tinker's dam about some "bets at the track."
(1) I want to prevent people from needlessly becoming H-O-M-E-L-E-S-S.
(2) I want to keep homes from being abandoned, looted, and burned.
(3) I don't want bankruptcy, where the supposed "asset" that I hold becomes W-O-R-T-H-L-E-S-S.
(4) A loan that shrinks to one-third its inflated size, but remains a performing loan, continues to be a viable security. The homeowner lives in the home, maintains it, and has equity in it.
The leprechaun has come and gone. The "gold coins" he had were merely straw. Let us take inventory of what remains ... we shall find that it is still "much." Where financial crimes have been committed, let them be tried and punished. But we should not permit this leprechaun to turn people out into the streets in the dead of wintertime.
Redistribution of wealth is the key issue here. For it is out of the question that renegotiation of mortgage-debt is far from a liberal do-goodism.
Plenty of intermediaries would actually profit in one way or another from enlarged options to renegotiate. Others would suffer. But it is clear that the problem is not one of preferences towards saving home-owners. It goes far beyond that.
One doesn't have to be an adherent to Rawls' views to find that property rights are two things at the same time: the foundation of a stable free market democracy and an incomplete kind of contract.
There has been much talk in the campaign about 'spreading the wealth around', and it was painful to witness how the notion of taxation has been twisted, with transparent political aims. To deny the incompleteness of property rights is another, albeit much more subtle move in the same direction.
Obama has proposed the need and feasibility of a rethinking of the options to renegotiate mortgage-debt before he ran. This counts among his biggest achievements as a senator, and that it played a minor role in the campaign is due to complexity more than to irrelevance.
The subject is, however, very hard to gauge and to limit in its unintended consequences. Sanctity of contracts is a core need, but it has to be weighed against the consequences of the abuses that have already taken place. Here's a simple way to make explicit the level of sublety: to discuss the ethics of stealing from thieves is a slippery slope.
But it's impossible to deny the moral hazard implications of bailouts for banking while at the same time insisting on sanctity of contracts when it comes to non-systemically relevant entities. There is a necessity to consider future legitimacy of contracts and drivers of trust to be faced here.
There is a time and there is a place for "the sanctity of contracts," Diogenes, and I submit that "this is not 'it.' "
The reality that we face is that massive, unpunished frauds have been committed ... at the highest halls of finance and by the highest Civil Officers of our government. One must hope that we will have the good common sense to realize that such things cannot be "off the table," but meanwhile, this reality makes our "sacred" contracts "impossibl
Leprechaun gold.
We must first accept that we have no choice here. The persons who are ultimately to "perform" these "sacred" contracts are the mortgagees themselves ... and they're not going to do it. The more we try to put their hands to the fire, the more wooden structures will explode into flames. All that will remain of our "sacred things" are two tail-lights fading off into the distance, and it will be a cold day in a hot place before they ever buy another mortgage from us again.
This is business, in the aftermath of high crime and fraud. The money is not "lost." The money never existed at all.
There is a time and a place for ledger books. But there is also a time and a place to close those books, to forget those precious figures, and to look instead at the reality that surrounds us.
Maybe you read too much determinate assertiveness into my post, which was really only musing and pondering: I only restated the obvious, namely that there is a trade-off between the details of the current situation and what's commonly the point of view on contracts. I didn't claim to have an answer, and I don't have one.
By the way, 'sanctity' does not really have a religious meaning here, as far as I know. It's just a manner of speech roughly translating into 'untouchable'.
About fraud in the subprime crisis: this is very difficult to tell, and certainly none of my personal business (I don't live in the US). From what I hear, there was fraud - at various levels and stages. But it may be equally important or even more important to note that fraud is not needed as an essential element in the explanation of this crisis. It is first and foremost a market failure. Of course there is also a wider sense of 'fraud', where it encompasses any transaction at blindly inflated prices, detached from fundamentals. In that sense, the crisis may well be the biggest fraud in history.
Like feudalism, the government has been working for the benefit of the aristocracy. None of this is by accident.
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