Forgive, or Foreclose?

11/07/2008 05:12 am ET | Updated May 25, 2011

As schoolchildren know, the Liberty Bell is inscribed with the words "Proclaim liberty throughout all the land unto all the inhabitants thereof."

Liberty in America is often equated with economic freedom. Constrain one's freedom to make a deal -- even a bad deal -- some argue, and liberty is diminished. In an era when rampant personal debt has led to widespread ruin, the efficacy of this view of liberty is thrown into sharp relief. Should some people who have made bad deals be forgiven their debts, or are we all better off if instead they face up to foreclosure and the dire circumstances that come with it?

Millions of Americans already have lost their homes through foreclosure in the last several years. With house prices plunging in the worst downturn in forty years, tens of millions of homeowners have lost trillions in personal wealth, and the problems are far from having run their course. Many who fancy themselves conservative free marketers argue that these borrowers made choices, took calculated risks, borrowed beyond their means, and now should live with the consequences. Emblematic of this view was the Report of the President's Economic Advisers last February:

"Policies that attempt to protect market participants from the discipline of the market risk delaying necessary adjustments and creating a potential moral hazard problem by giving lenders and borrowers less incentive to make prudent financial decisions in the future. Markets naturally self-correct, rewarding good strategies and punishing bad ones. In addition, any government actions mitigating the outcomes of risky behavior may create perverse incentives for reckless decisions by borrowers and investors who may come to rely on government interventions."

It is prudent to avoid moral hazard. But perhaps the real moral hazard is abandoning borrowers who are drowning in the current subprime debacle. Some portray them as irresponsible. They made bad deals; let them face the consequences. But is someone who was spending 40 percent of her earnings for a mediocre apartment really "reckless" if she decides to opt instead for monthly tax-deductible mortgage interest payments, even taking advantage of "teaser" rates? How could these borrowers have known in 2005 that when adjustable interest rates reset in 2008 they would not be better off paying mortgages rather than facing unpredictable rent increases? Consider the backdrop: More than 90 million Americans pay more than 30 percent of their income for housing. By 2005, roughly 17 million households were spending more than half of their income on housing, a 3.2 million jump from 2001.

When virtually unregulated, fiercely marketed subprime mortgage products flooded the market several years ago, it was little wonder that millions of nurses, firefighters, teachers, secretaries, tellers, and janitors felt they were ready to become homeowners. Today, they hardly need the "discipline of the market" to teach them lessons about making better choices next time -- if there is a next time. Even if they avoid foreclosure, default and damaged credit mean many won't get a second chance.

It is true that some borrowers gambled on getting a raise before the teaser interest rate evaporated. Some applicants even lied. But with more than 5 million borrowing households overextended to the point of default or foreclosure, the situation has reached systemic proportions devastating to the broader economy.

Failing to offer debt relief assistance while debating whether sub-prime borrowers or unregulated mortgage companies are most at fault is no more productive than arguing about whether negligent campers or neglected forest clearance practices contributed more to a rapidly spreading wild­fire -- the first order of business is putting out the fire before it consumes more homes.

Moreover, when invoking that portentous term "moral hazard," many look solely at borrowing behavior. But isn't market discipline even more effectively applied to the lenders who promoted high-cost loans to low-capacity borrowers, yet now expect the government (through the foreclosure and debt collection process) to aid them in recovering every dollar possible from their borrowers' assets? Meaningful debt forgiveness for borrowers might best instill greater discipline in lenders and other Wall Street players, some of whom are perhaps already contemplating the next clever "innovation" to sell to consumers.

A purely economic perspective on this crisis, however, does not show us which policies advance our total well-being, spiritual as well as material. Market systems are human creations that should enhance our humanity; human beings should not instead be made to serve an ideal of the perfect market.

Those who claim that pure free-market policies are the only way to preserve and promote liberty would do well to consider the rest of the Leviticus verse that completes the Liberty Bell inscription: "It shall be a jubilee unto you; and ye shall return every man unto his possession, and ye shall return every man unto his family."

The biblical Jubilee addressed the relationship between economic prosperity and human dignity. Land had been distributed equitably among the original Israelites -- each household had received land of roughly equivalent value. Over time, as market transactions occurred, some families became better at commerce and had more wealth with which to buy land. Eventually distribution would become unequal. The Jubilee mandated that every fifty years, regardless of what the market had produced, land was returned to its original distribution. In this conception, human beings were more stewards than absolute owners. Overturning the consequences of bad bargains freely made during the course of time advanced ethical goals more than strict adherence to contract enforcement. And in this spirit, promoting massive foreclosures rather than encouraging a policy of forgiving is a morally hazardous course for our society.

The Old Testament custom of the sabbatical (the "shmittah") -- which required that personal debts be forgiven every seven years -- is also relevant today. Time and again, the Jubilee, Sabbatical and other biblical precepts portray property as encumbered by a social obligation that competes with, and usually prevails over, pure economic efficiency.

For example, witness the obligation regarding the farmer to leave the corners of fields "for the poor and stranger," un-harvested, to be picked for free by those in need (Leviticus 19:9-10). It can hardly be ethical to view property as fully under the dominion of individuals (and by extension, corporations) while also finding fault for failing to share some portion of property with those unable to pay the market rate. The Leviticus approach to property is imbued with the notion that people deserve a second chance. The idea that economic affairs should be arranged to afford this second chance -- including recovery from bad deals -- is not limited to biblical precepts. Unfortunately, however, we see too little evidence of these wise values in our economic policies today.

Bankruptcy, a right enshrined in the Constitution, for centuries has provided an orderly process of reducing or forgiving debts. A path to a fresh start is not only beneficial to a vital and dynamic economy, but also stands in sharp contrast to the debtors' prisons rampant in England and elsewhere into the nineteenth century.

Under the current bankruptcy rules, however, Donald Trump can file for bankruptcy for large real estate ventures that have freely borrowed money and then force lenders to write down the debt through the "cramdown" (which affords an opportunity to reorganize). Dana Trump, on the other hand, who buys a house and gets into trouble, cannot modify or write down her personal home mortgage debt.

If we accept that collectively we are better off morally and economically with speeding recovery from the current crisis through avenues of forgiveness, many practical actions are possible. The recently enacted housing legislation contains some important features -- such as offering borrowers a long-term fixed rate federally insured mortgage refinancing option if the lender agrees to a partial loan write-down. (Yet even this program is voluntary for lenders.)

A change in bankruptcy laws to even the playing field for borrowers, or a change in the tax laws that benefit the large pools of mortgages (known as Real Estate Mortgage Investment Conduits) to penalize them for failing to move defaulted loans off their books after some period of time, may be necessary to spur widespread alternatives to foreclosures.

The wisdom of centuries, that our society does better when it provides a path to a second chance and a new start, is profound. What better time to see its embrace of forgiveness as a path that benefits all of us applied than in today's economic earthquake, before the aftershocks do still more damage?

David M. Abromowitz is a Senior Fellow at the Center for American Progress, focusing on housing policy and related federal and state programs and issues. He is partner in the law firm Goulston & Storrs. This article originally appeared in the Fall issue of In Character Magazine,