Monday, March 16, 2009

Re: Contracts

Aztec, another good post and Friedmanite, good response.

Aztec, your post notwithstanding, I stand by my statement that Obama is undermining contract integrity.

But let me first confess my ignorance about the connection of TARP funds and mortgage restructuring. I didn't realize the policy was restricted to TARP recipients. I would agree that if a bank comes hat in hand to the government, there is a reasonable quid pro quo in making changes at the behest of the government. The only problem is that many of the TARP recipients did not need the money nor want it. Many were essentially strong-armed into taking the money, and now, aware of all the strings attached, are now furiously trying to return it as fast as possible.

Regardless, my complaint is not with bankruptcy law. Unless I'm mistaken (again), Obama's plan for mortgage restructuring is unrelated to whether or not someone declares bankruptcy. That would make sense. For the most part, foreclosures are completely separate from bankruptcies as they are non-recourse loans. Anyone can mail in their keys at any time, and the banks only recourse is to take the property. I would wager that the vast, vast majority of home owners who are facing foreclosure will not declare bankruptcy.

Absent a bankruptcy, as far I know, courts have never rewritten the terms of mortgages. Why would they when the bank can always take the collateral? If Obama wants to change the rules of mortgage lending, as you suggest, that's up for discussion, but it shouldn't be allowed ex post facto. If he wants to screw up the mortgage market going forward, he's welcome to do that, but to unilaterally change existing contracts is disgraceful, and as Friedmanite points out, it will put a massive chill on any future lending. Why would I ever lend money to anyone when all they need is a good sob story for the government to step in, change the rules, and revoke my rights?

To again echo Friedmanite, your point on moral hazard makes no sense. When a bank forecloses, they take the property. If housing prices have dropped, they take the loss. The only loss to a previous homeowner that put zero down is a blotch on their credit record. To the extent that the bank lent "with little or no risk", it is only because they immediately sold the mortgage to another bank or investor. But someone at the end of the transaction is taking the loss, and it is not the homeowner. Banks will be much more cautious in the future without any threat of renegotiation. Adding renegotiation as a risk will just push them from caution into complete inactivity.

Finally, regarding the Big Three, I don't support bankruptcy because I want to punish workers. I support bankruptcy because the Big Three cannot function as profit-making companies under their current structure. The only thing keeping them alive is government help, which means government money is basically being funneled through zombie car companies to workers. This is a waste of money and unsustainable. In the long-run, workers will be better off working for a restructured, profitable company rather than depending on government largesse.

Finally, just to distill the point, bankruptcy is the proper channel to handle an insolvent company. It is also the proper channel to handle an insolvent individual. But it is has nothing to do with home foreclosures, which are a separate, non-recourse transaction. If Obama intends to comingle bankruptcy rules with foreclosure rules, he is making a grave mistake.


friedmanite said...

I believe the homeowners options to just mail in the keys and walk away is based on state law. AZ and CA both have anti-deficiency laws, which allow homeowners to walk away. In other states, the mortgage company can come after you for the remaining balance you owe.

In states with an anti-deficiency law, homebuyers are 2-3 times more likely to walk away from their mortgages.

GammaBoy said...

I stand corrected, Friedmanite. I thought all states were non-recourse.