THE BLOG

How Do We Judge the Homeowner?

10/18/2010 06:19 pm ET | Updated May 25, 2011

In the rush to foreclosure, the banks and even government officials have been taking the position that the borrower/homeowners are fully to blame for the situations they find themselves in and that the paperwork technicalities just need to be worked out in order for there to be a just outcome, which is to say, a foreclosure.

Industry executives note that few, if any, borrowers in the foreclosure process dispute the fact that they're not paying their mortgages. "We're not evicting people who deserve to stay in their house," James Dimon, J.P. Morgan chief executive, told analysts Wednesday.

Okay. This seems simple enough. The contract between the bank and the borrower says that the borrower will make their payments and that if they don't, the bank can foreclose. Assuming the bank did everything right, it can.

We live under the free market paradigm and that is simple free market -- and contract law -- cause and effect.

But, what if the borrower was defrauded in either a legal sense or a moral sense at the inception of the contract? That may not make the contract unenforceable, but does it make the enforcement inequitable? Does it erode this moral high ground that lenders are claiming?

Perhaps we need to be more discriminating here.  Some time ago I posted on asymmetrical information in regard to one type of transaction. But suppose that there was asymmetrical information at the time the mortgage was originated? According to Dealbroker, Jamie decided on October 2006 to get J.P. Morgan out of Subprime. According to the article, the JPM team decided that quality control had slipped at the originator level. What might this mean? I suspect "quality control" is a euphemism for rampant fraud. So lets just say that October, 2006 is "Day Zero."

It used to be said that a business person needed a good banker, a good accountant, and a good lawyer. (Now it might be said that a banker needs a good lawyer.) Implied in this is that there is a professional relationship and that the customer depends on the advice of these professionals. Bankers have until recently seen themselves as professionals. In the less heady days of local banking, the President and senior officers of the bank made the loan decisions. One of them generally had a relationship with the borrower. They knew the borrower and had their interest in mind along with the interest of the bank. There was a certain implied fairness at work. The judgment of the banker often accrued to the benefit of the borrower. If the banker thought something was a bad deal, they said so. If they thought the borrower was making a bad investment either in general or in relation to their specific circumstances (knowledge, skills, income, liquidity, time horizons...) they would tell them that.

The mechanistic finance models took that away.

So is there any difference in the way we should look at someone who purchased a house on Day Zero minus One versus Day Zero Plus One?  Perhaps before Day Zero, the general conditions in the market were that everyone was wrong. Everyone thought prices would continue to rise. Everyone thought the rising prices would mitigate the imprudent loan processes and structures, the no-doc loans, the 97% loans or 120% home equity loans. At Day Zero plus One, that changed. The caution light should have come on and the relationship of the professional banker to the client should have included caveats about the investments that were being made. This is idealistic, I admit.

But, someone should investigate when JP Morgan and every other bank changed their policies in regard to loan to value, income verification, product recommendations to customers, instructions to bankers, incentives to bankers, etc. If banks knew in the executive suite or the research department that the fundamentals were turning ugly, and still kept making loans and shoving them into government guarantee programs or selling them to investors, then there is no moral high ground. The information asymmetry was used to make more money. In a moral sensibility, the contract should be looked at what it was, a gamble by both parties. If at this point in time the stupidity of the lender has allowed the contract to become unenforceable, then that is the lender's problem. Too bad, so sad.

Now, none of this absolves the borrower of responsibility for their decision. It just puts the borrower and the lender on a level moral ground and perhaps they find themselves on level legal grounds. If that is the case, the lenders should get off their high horse and negotiate modifications that share the losses between two equally culpable parties.