Richard Thaler, of Libertarian Paternalism fame, has a generally sensible piece in the New York Times, Will More Borrowers Walk Away From Their Mortgages.
Two points however bear refuting:
[The] norm [to keep paying a mortgage even on underwater property] might have been appropriate when the lender was the local banker. More commonly these days, however, the loan was initiated by an aggressive mortgage broker who maximized his fees at the expense of the borrower’s costs, while the debt was packaged and sold to investors who bought mortgage-backed securities in the hope of earning high returns, using models that predicted possible default rates.
That is in equal parts sentimental and pernicious. If it is ok to exercise the put option to Morgan Stanley, it is also ok to do it with the local banker. You, I, Morgan Stanley, and the local banker are all equally responsible under the law for our promises and the contracts we enter. That there should be one law for favored in-groups, like the local banker you may run across in the grocery store, and another, lesser law for outsiders and strangers, like Morgan Stanley, is profoundly subversive to continued existence of the liberal order. That we have largely overcome such distinctions in the law is a fundamental pillar of a commercial republic. Throwing it overboard would be dangerous and wrong.
Eric Posner, a law professor, and Luigi Zingales, an economist, both from the University of Chicago, have made an interesting suggestion: Any homeowner whose mortgage is underwater and who lives in a ZIP code where home prices have fallen at least 20 percent should be eligible for a loan modification. The bank would be required to reduce the mortgage by the average price reduction of homes in the neighborhood. In return, it would get 50 percent of the average gain in neighborhood prices—if there is one—when the house is eventually sold.
This is equally ruinous to the rule of law. If such a modification was to the advantage of both sides, there should be nothing to prevent it from happening now. That this is not happening shows that it is not in the interest of at least one side. That it is eagerly embraced by the politically attuned suggests that the large and politically powerful group—homeowners—who would benefit at the expense of a small and despised minority—Wall Street banks and their investors.
So, shorn of rhetorical pretense, the Posner/Zingales proposal is no more than a expropriation of property held by the politically powerless for the benefit of the politically powerful. It is disappointing that distinguished economists such as they should need to be reminded that such proposals—even if they are not enacted!—undermine the rule of law and push nations along the road to ruin.
