Rule of Law: Why We Need to Freeze Foreclosures

Last Updated Oct 14, 2010 1:08 PM EDT

To halt foreclosures across the land, or not? That's the question we face now that lenders' "robo-signers" have ceased, if only temporarily, their frantic clickety-clack.

To answer it, as usual in matters of national significance, you have to unpick its intertwining strands:
  • Legal -- are banks breaking the law in seizing people's homes?
  • Economic -- would a government-imposed foreclosure moratorium cripple the housing market and hurt investors?
  • Psychological -- would a freeze increase or decrease consumer confidence?
  • Ethical -- can the same banks that created the problem be trusted to fix it?
  • Political -- what do our elected leaders gain by endorsing or opposing a freeze?
Politics comes last in this list of questions because it naturally comes first among the people most directly in charge of answering them. That's not a knock on our political class so much as a truism, like noticing the leaves turning brown this time of year. Also note that this represents but one set of considerations; there are many others, depending on how close you want to draw near to the problem.
At peak altitude, by contrast, such issues usually come down to, as sociologist G. William Domhoff has written, who benefits, who rules and who wins. Or, hovering even higher, who gets what?

What the Obama administration gets in deciding whether to halt foreclosures is a political quandary -- a choice between appearing to side with Wall Street and taking actions the White House says could slow the nation's economic recovery (not to mention denting Obama's reelection hopes).
A moratorium on foreclosures may provide short-term political satisfaction in an overheated election climate, but the administration fears it will only delay the inevitable and necessary process of forcing many Americans out of homes they cannot afford.
There's some truth to that. Nearly a quarter of homes sold in the second quarter consisted of foreclosures. Freezing such sales would delay what many consider a necessary, and inevitable, reckoning for homeowners, potentially leaving the housing market to fester for years.

In fact, though, the foreclosure pipeline is already certain to back up as hard-up borrowers seize on the latest allegations to fight mortgage servicers in court. And more broadly, someone -- borrowers, financial firms, investors, taxpayers -- must eventually eat the massive mortgage-related losses that continue to afflict bank balance sheets. What remains to be decided is when, and in what measure. In opposing a moratorium, the White House appears to be shying away from forcing banks to confront this reality. Notes economist Dean Baker:
[I]t could be discovered that the [foreclosure] fraud and procedural abuses are widespread. It would likely be very costly for many servicers to construct the proper paperwork to carry through foreclosures. The administration may not want to force banks to incur these costs.
What do banks and investors get? An unmitigated disaster, they contend. Said Tim Ryan, head of the Securities Industry and Financial Markets Association, an industry trade group:
It would be catastrophic to impose a system-wide moratorium on all foreclosures, and such actions could do damage to the housing market and the economy. It must be recognized that the mortgage market, investors and the health of the economy are all interrelated. Investors in the housing market -- including American workers with pension funds, 401k plans, and mutual funds -- would unjustly suffer losses in their savings from these actions. Increased uncertainty in the securitization market would further constrain consumer credit and spending, dampening our already unhealthy economic situation.
Stripped of the obligatory populist flourishes (all hail the American worker!), this is an argument for throwing homeowners facing illegal foreclosure under the bus. The interests of a few hapless borrowers must give way to the greater financial good, according to this line of thinking. It's also a thinly veiled threat -- beware your 401k! -- and a bluff.

That's because flagging home prices and slow economic growth means the market for residential mortgage-backed securities already is uncertain, while lending has been on a drip-feed for two years now. So I'm not sure how "increased uncertainty" stemming from a foreclosure freeze would make things significantly worse. Writes Felix Salmon:
[I]t's far from clear that a foreclosure moratorium would hurt house prices -- or even RMBS prices -- at all; indeed, it's pretty hard to see exactly what Ryan and Sifma are worried about.
What is clear, by contrast, is that the Street faces potentially staggering legal and financial liabilities regardless of whether foreclosures are stopped. Investors are suing the big banks that sold them oceans of mortgage-backed securities in order to force the firms to repurchase the loans. If these mortgages turn out to be invalid because loan servicers can't document who owns them, then such firms could be on the hook for billions of dollars. (For taxpayers, of course, that raises another nauseating possibility -- TARP II.)

And what do average Americans get in all this, beyond agita? That, too, remains to be decided. But as we weigh up the likely costs, it's worth remembering that there are good reasons why the rule of law -- in this case the legitimacy of property rights -- trumps other interests, including a bank's natural wish to limit its losses and a politician's duty to heal the economy. Ownership should mean something. So should the "technical" procedures mortgage servicers are legally required to follow to respect that principle.

Here's how Cleveland federal District Court judge Chrisopher Boyko put it in barring Deutsche Bank in 2007 from foreclosing on homeowners because of inadequate documentation:
This Court acknowledges the right of banks, holding valid mortgages, to receive timely payments. And, if they do not receive timely payments, banks have the right to properly file actions on the defaulted notes -- seeking foreclosure on the property securingthe notes.
Yet, this Court possesses the independent obligations to preserve the judicial integrity of the federal court and to jealously guard federal jurisdiction. Neither the fluidity of the secondary mortgage market, nor monetary or economic considerations of the parties, nor the convenience of the litigants supersede those obligations.
Stopping foreclosures would hurt, perhaps badly. In the long run, not stopping them would hurt immeasurably more.

Image from MorgueFile
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    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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