10/17/2011 08:34 am ET | Updated Dec 17, 2011

Why Are We Punishing Ourselves? Thoughts on the Foreclosure "Settlement"

Amidst all of the handwringing about the economy and what needs to change to get it back on track, we read of the bureaucratic mentality of "same old same old" impeding such consideration and efforts. Specifically, when one sees articles on the so-called foreclosure settlement, discussions between major lenders and various states and the Department of Justice, it is hard to be optimistic about recovery prospects.

This discussion is about how to discipline lenders who sought to foreclose on defaulting mortgagees, but used so-called "robo-signers" who falsely attested to having reviewed files in connection with foreclosure litigation proceedings. There is no question that anyone who falsely attests to anything in legal proceedings should be subject to legal sanctions, up to and including perjury prosecution.

However, the current talks involve having lenders write down mortgage principal and pay large sums of cash to governments and or borrowers as a result of the false attestation. However, these efforts are totally counterproductive and damaging to the economy for several reasons:

• They are completely unrelated to the merits of foreclosure cases. If someone fails to make payments when due, loan documentation and common sense permit lenders to take action. I am aware of no case in which the false attestations facilitated a foreclosure that was not based upon a failure to pay.

• Allowing principal writedowns to delinquent borrowers simply because of misconduct on the part of lenders turns the mortgage finance system into a lottery and encourages defaults in the hope that borrowers may be absolved of responsibility as a result of lender behavior.

• By the same token, introducing this level of uncertainty into the system drastically reduces the incentive for lenders to lend, by making repayment contingent upon assorted unpredictable subjective factors having nothing to do with loan performance. Under current circumstances, the last thing we need for economic recovery is an impediment to lending.

To add insult to injury, one of the major outstanding issues in the discussions is whether the lenders will be "released" from liability for legal claims once they make payments and other concessions in the $25-30 billion range. While it may seem "just" to refuse such a release -- anyone who has ever been involved in litigation as a litigant or attorney knows that settlement payments are made only to "buy peace" i.e., to terminate a proceeding in order to spare both parties the time and expense associated with its continuation -- and that without such assurance, it is senseless to make the payments, and any payments which are made are more akin to extortion proceeds than a bona fide settlement of differences.

It appears that the efforts of the government officials associated with this effort are simply an effort to punish lenders for real and imagined transgressions and not an effort to obtain redress for the actual losses resulting from these actions. Gerald Seib also notes that such punitive measures appear to be in vogue, but are likely to be economically detrimental. These efforts reflect at best an unfamiliarity with basic legal and economic concepts and at worst a cynical willingness to drag down the economy to pursue individual political objectives.

We must also keep in mind that the private sector actions which led to the Great Recession -- the ill-advised lending and borrowing -- were not in any way unlawful. While the robo-signing may well have been unlawful and should be dealt with as such, it had nothing to do with the existence of the foreclosure crisis or any particular foreclosure proceeding.

In the face of such efforts, it is easy to see why businesspeople are so reluctant to hire and/or invest. Certainly, many bad decisions by the private sector contributed greatly to the Great Recession. However, a continued focus on punishment of private actors will do nothing constructive and must be resisted if we are to have a real recovery.