Bankruptcy

Congress' Response to the Mortgage Mess

By James White

Eric Sevareid once remarked that a "chief cause of problems is solutions."

From a libertarian perspective at least, I suspect that we will find "problems" in the "solutions" that Congress will enact to solve the sub prime mortgage mess. At this point it seems inevitable that the current Congress (and, even more so, the one that will likely sit in 2009) will be moved by heartrending stories of foreclosure of citizens? residences at the hands of mortgagees who have charged excessive rates, misrepresented the terms of the loan and induced the debtors to take on too much debt.

It seems certain that Congress will allow stripping down of mortgage liens in bankruptcy. Doubtless Congress will try to shackle mortgage brokers with expensive certification and criminal liability. It may also go beyond abolition of holder in due course status for mortgage note holders to force persons in the chain of title of the notes to bear some of the credit loss that occurs when the debtor defaults. If Congress can find a way to do it constitutionally, Congress may also mandate some form mortgage modification. Congress might even take up my friend John's foolish idea that lending too generously be a tort. Congress will justify the legislation by anecdotal testimony in televised hearings from pitiful wretches who knew not what they were doing.

If my lugubrious predictions prove true, there will be a measurable--possibly quite large--impact on the market. Such rules will make mortgage lending less profitable to everyone in the system-so the number of mortgages written will decline and those that are written will be marginally more expensive. It will winnow the number of mortgage brokers and so remove some who have committed fraud in writing mortgages. It will make investors upstream think twice about buying a debt that carries not only a fraud claim but also the possibility of tort liability for too generous lending, and even a lasting stain (for debt liability) that cannot be removed by assignment to another.

I am quite clear about what Congressman Paul would do to solve this crisis- nothing. He would note that the interest rate on 30 year mortgages in late January 2008 was lower than any time since mid 2005. He would point out that many mortgage brokers have gone into bankruptcy and that the gushing market for mortgaged backed securities has gone dry. He would point out that Countrywide rewrote more than 83,000 mortgages to alleviate pressure on its debtors in 2007 and that it expects to modify even larger numbers of mortgages this year. In short he would argue that Darwin's rules are already at work and that, left to itself, the market will cure the excesses that we have observed. In his view adding harsh legislation on top of the market's Darwinian response would cause the number of home loans to decline well below the optimum number.

By now you will have understood that I am sympathetic to the libertarian position, and I wonder whether the debtors' friends in Congress have a covert agenda, namely to keep those with poor credit from taking on debt even when these debtors are fully informed of the risks and costs and quite willing to bear them. To protect consumers from fraud is worthy, but is it worthy to bar an informed consumer from economic behavior that Congress thinks too risky? What do you think?

Full post as published by Credit Slips on January 21, 2008 (boomark / email).