Arnold Kling  

Foreclosure Mess

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Megan McArdle asks,

why aren't libertarians proposing solutions for the foreclosure crisis?

Actually, I have written,

What has emerged in recent weeks as "the foreclosure scandal" represents the collision of this 21st-century computerized, global financial system with an 18th-century legal process for obtaining ownership rights to buildings and land. Indeed, the United States has one of the most backward land-title systems in the industrial world.

So my solution going forward would be to modernize the land-title system. My hope is that would achieve a libertarian's goal of clarifying property rights and reducing the costs involved with the transfer of property.

For the current situation, however, the issues are quite difficult. When I was in Boston, I used to joke about why they needed no-fault auto insurance. The way they drive up there, a typical accident is going to have both parties at fault. When a guy going the wrong way down a one-way street hits a guy making an illegal left turn, who do you blame?

Now, you have borrowers who may have committed fraud to obtain a mortgage and are no longer paying the mortgage. You have servicers who did not properly file documents with the record office to update the noteholder of record. Which side deserves the right to the property?

When it comes to law, I am a big believer in common law and somewhat of a skeptic about strict letter-of-the-law. I think that with the foreclosure mess, judges (and juries, where applicable) should do their best to adapt precedents to the current situation in the most sensible way. I am not a lawyer or a legal scholar. I know that my proposed approach to the law will drive some people nuts, but that is the best I can come up with.

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COMMENTS (4 to date)
Michael writes:

Arnold, the problem is messier than you describe. There are borrowers who have committed fraud, and servicers who have committed fraud, but that does not mean that all the problem cases involve two fraudulent parties. The messy cases are the ones where there is one honest party and one dishonest (or mistaken) party.

mark writes:

"Which side deserves the right to the property? "

In MA and in many other places, including NY, if both parties are involved in intentional wrongdoing, the rule of "in pari delicto" is imposed which means the courts will not intervene to help either one. In turn, that means that, if the lender requires a court to conduct a foreclosure or to bless a foreclosure in advance, the borrower wins. If the borrower requires the court to stop the lender from a nonjudicial foreclosure, the lender wins. Where the lender is merely negligent, I am not sure if this applies. The issue in MA however seems to be proving that one is in fact the lender.

volatility bounded writes:

The problem is that the banks devised a system to circumvent state and local taxes on transfers of property, and to cut administrative costs associated with transfers, but did not devise a system to actually trace title. And furthermore, devised instruments where no creditor has the power to unilaterally force workouts, undercutting policies of debtor/creditor law. And the banks changed the rules on debtor at the tail-end of a credit binge with anti-consumer revisions to the bankruptcy laws in 2005, after a credit binge that started in 1980.

Since the banks created this system by engaging in regulatory avoidance at best (or evasion at worst), the way to deal with this is impose the costs upon them in order to deter regulatory avoidance (or evasion) by them. One could do this by revising the bankruptcy code to allow debtors to have their mortgages on primary residences modified in bankruptcy just as can be done with mortgages on secondary residences, and repeal the banks' anti-consumer 2005 changes to the bankruptcy laws.

Hyena writes:

The issue with that system is that it will introduce a serious amount of arbitrariness in property settlements.

The problem I have with this is that it seems weird to me that we should advocate the use of state power to enforce agreements on people. Conceptually, we should claim a second agreement, implicit in the structure of the loan contract, between the borrower, lender and the court. The former sides agree to uphold the standards of the latter, which in turn agrees to bring state power to bear in a dispute.

In this system, the scandal is not between borrowers and lenders. You're absolutely right and the borrowers are absolutely wrong. However, the lenders have failed to uphold their bargain with the courts and so aren't entitled to state power in enforcement.

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