Don't Let Judges Tear Up Mortgage Contracts

[5711-Marine]

While I wouldn't classify myself a Libertarian (there are several areas I disagree with) this proved to be an interesting read.

I completely disagree with allowing a judge to modify a mortgage contract. People must be held accountable for their actions. If you plan on spending tens or hundreds of thousands to purchase a house, but don't want to spend a few hundred to have an attorney look over the contract, when you feel wronged, complain to some one who cares.

Like we said in the Marine Corps "if you're looking for sympathy it is between shit and syphilis in the dictionary"

Don't Let Judges Tear Up Mortgage Contracts: Amidst the so-called "credit crisis," there is much talk about how libertarianism is dead, or at least how libertarian first principles are irrelevant. One appeal of libertarianism is that its basic principles are simple and easy to understand. Private property, freedom of contract, self-defense, restitution for rights violations, etc. While some libertarians hold these principle as ends in themselves, all libertarians also believe they lead to good consequences. And the general public is concerned with consequences along with its views of morality. When a public policy debate arises, however, it is not persuasive simply to invoke libertarian general principles. One must know something about the subject at hand to explain how violating these principles is likely to turn out badly.

Libertarian first principles can be analogized to having a cheat sheet of answers to a multiple choice test. While you might know the right answer--which is certainly useful--you won't know exactly why the answer is right, which is needed to truly understand the subject being tested. And without such an understanding, one cannot explain the "right answer" to others and why it is right.

One of the basic libertarian principles is that persons have a right to enter into contracts of their choosing, and that the government should not intervene to hold such a contract unenforceable. But contract law recognizes valid defenses to a contract that are needed to protect contractual freedom. And contract law has long co-existed with bankruptcy laws. (For a libertarian analysis of bankruptcy laws see here.)

While libertarians today might instinctively object to letting bankruptcy judges modify existing mortgages, to be persuasive, one needs to know something about both the mortgage market and how bankruptcy proceedings work to know exactly why this is a bad idea. Co-conspirator Todd Zywicki has an op-ed in today's Wall Street Journal opposing giving bankruptcy judges the power to modify existing mortgages. His essay well illustrates why libertarian principles alone are not enough to enter into a public policy debate. One also needs knowledge of the subject at hand. You should read the whole thing, but here is an excerpt:

In the first place, mortgage costs will rise. If bankruptcy judges can rewrite mortgage loans after they are made, it will increase the risk of mortgage lending at the time they are made. Increased risk increases the overall cost of lending, which in turn will require future borrowers to pay higher interest rates and upfront costs, such as higher down payments and points. This is illustrated by a recent example: In 2005, Congress eliminated the power of bankruptcy judges to modify auto loans. A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform.

Allowing mortgage modification in bankruptcy also could unleash a torrent of bankruptcies. To gain a sense of the potential size of the problem, consider that about 800,000 American families filed for bankruptcy in 2007. Rising unemployment and the weakening economy pushed the number near one million in 2008. But by recent count, some five million homeowners are currently delinquent on their mortgages and some 12 million to 15 million homeowners owe more on their mortgages than the home is worth. If even a fraction of those homeowners file for bankruptcy to reduce their interest rates or strip down their principle amounts to the value of their homes, we could see an unprecedented surge in filings, overwhelming the bankruptcy system.

Finally, a bankruptcy proceeding sweeps in all of the filer's other debts, including credit cards, car loans, unpaid medical bills, etc. This means that a surge in new bankruptcy filings, brought about by a judge's power to modify mortgages, could destabilize the market for all other types of consumer credit.

There are other problems. A bankruptcy judge's power to reset interest rates and strip down principal to the value of the property sets up a dynamic that will fail to help many needy homeowners, and also reward bankruptcy abuse.

Consider that the pending legislation requires the judge to set the interest rate at the prime rate plus "a reasonable premium for risk." Question: What is a reasonable risk premium for an already risky subprime borrower who has filed for bankruptcy and is getting the equivalent of a new loan with nothing down?

In a competitive market, such a mortgage would likely fetch a double-digit interest rate -- comparable to the rate they already have. Thus, the bankruptcy plan would offer either no relief at all to a subprime borrower, or the bankruptcy judge would set the interest rate at a submarket rate, apparently violating the premise of the statute and piling further harm on the lender.

More worrisome is the opportunity for abuse. [snip]

If Congress wants to deal with the rising number of foreclosures, it should not create a new mess by converting the mortgage crisis into a bankruptcy crisis. Doing so will open the door to a host of unintended consequences that will further freeze credit markets, raise interest rates for new home buyers, and spread the mortgage contagion to other types of consumer credit. Congress needs to reject this plan and look for better solutions.

Read the whole thing here.

[Morel42]

I'd actually like to see some version of this implemented in a limited fashion..

Such as, Single family homes of a combined income of <blank> with 1 or more children be able to refinance to a lower fixed interest rate.

At least billions would be spend keep families in their homes.

You have some points about dumb people getting what they deserve. However, children aren't responcible for their idiot parents signing things they shouldn't.. And there are a few cases of genuine fraud in morgage contracts.. Not very common I'll grant, but it does happen.

[Exbiker]

Judges should have nothing to do with mortgage contracts unless some kind of fraud is proved. Reality is stupidity on the buyers part is not fraud.
The banks how ever can do what they decide because it`s their right to write down a loan or ease the terms of the contract only if they choose.
Stupid people that over bought deserve to lose their home. They will just have to rent for a while until they grow some brain cells.

[Carnes]

You have some points about dumb people getting what they deserve. However, children aren't responcible for their idiot parents signing things they shouldn't.

I just want to say real quick that when the government supports people who make bad decisions for the sake of protecting their innocent children, it ultimately makes things worse. It is a terrible shame that innocent kids get hurt when parents make bad decisions, but it is the responsibility of the parents alone for that bad situation. When government steps in, it is called 'enabling' which only serves to make the situation worse for the children.

Government should not, under any circumstances, support poor decision making. I am all for local and larger charity organizations helping people when they are down, but that is not the business of government.

[5711-Marine]

I just want to say real quick that when the government supports people who make bad decisions for the sake of protecting their innocent children, it ultimately makes things worse. It is a terrible shame that innocent kids get hurt when parents make bad decisions, but it is the responsibility of the parents alone for that bad situation. When government steps in, it is called 'enabling' which only serves to make the situation worse for the children.

Government should not, under any circumstances, support poor decision making. I am all for local and larger charity organizations helping people when they are down, but that is not the business of government.

+1 on all your last.