Contract Law and Distributive Justice
In 1980, Anthony Kronman wrote a brilliant article on “Contract Law and Distributive Justice,” in which he basically argued that a rigorous adherence to core libertarian principles regarding just transactions — there should be no force or fraud involved in a truly voluntary transaction — would move one in the direction of paying careful attention to the distribution of economic power between the individuals entering into a contractual arrangement, and thus to the distribution of economic resources in society as a whole. It’s an interesting idea, and I thought of it as I read Matt’s take on irresponsible borrowers.
There really is plenty of blame to go around here. But I just don’t see how more than a tiny fraction of it could possible adhere to our electrician or teacher or secretary who’s decided, basically, that the financial services professionals and government regulators know what they’re doing. Now could she have known better? Sure. She could have been reading Dean Baker and Paul Krugman and others. The idea that this lending was all being undertaken on a false premise that a nationwide housing bust was impossible wasn’t a highly guarded secret. I was, for example, familiar with the chart above and with the analysis suggesting that a bust was, in fact, likely. And I believed that analysis. But at the same time, I write about U.S. public policy debates for a living. If there’s a dissident line of thinking that, despite its general unpopularity, is popular among left-of-center economists—well, that’s the kind of thing I know a lot about. But our nurse? Why would she know?
Though I’m sympathetic to Kronman’s analysis, Matt’s take gives me pause. I was thinking to myself, “down this road lies ruin.” But that’s too strong. Let’s extend the logic a little further and caveat emptor vanishes entirely. I’m reminded of Keith Joseph’s notion of the “pocket-money society.” And you have to wonder about Megan McArdle’s renter/owner distinction: what do we do about those who were, in Matt’s case, reading Baker and Krugman, or who were just cautious about taking on heavy obligations? We’re tilting the economic balance in important, perceptible ways that will disadvantage people on the basis of their time-preferences.
Because lots of ordinary people were suspicious of ‘it looks too good to be true’ lending and didn’t borrow at those prices. Yglesias’ argument is false to facts.
— Adam Greenwood · Feb 24, 11:27 PM · #
Here’s the question to ask Matt: if you didn’t do a cash-out refi, and your neighbor did, and spent the money on a boat, and now he’s underwater and eligible for government assistance and you’re not, and he still has the boat and you don’t, wouldn’t you be pissed off?
On the other hand: if your wife happened to get pregnant with her second child in early 2006, so that you really felt you needed a bigger place, and the nice man from the mortgage company assured you that with zero downpayment, an interest-only loan and a 2-year ARM you’d be easily able to shoulder a $600,000 mortgage on that 1800 square-footer with the postage-stamp yard, and then the value of that house dropped 40% and you went and got laid off, why should you be “punished” with foreclosure?
And, of course, we’re throwing money at bankers who deserve even less sympathy, because we think we need to to avert a more serious recession.
All of which is to say: nobody is proposing helping homeowners because the homeowners “deserve” help. There’s no way the government can accurately distinguish “deserving” from “undeserving” recipients of assistance, assuming they could even define what would make one “deserving” in some abstract sense. We’re doing this to prevent further implosion of the housing market.
Personally, I think a better approach would be: create some kind of structure akin to bankruptcy that turns underwater homeowners into renters with a 2- or 3-year lease and, if necessary, have the government buy the houses. That’ll crystallize the loss on the mortgage debt, thereby revealing the “true” value of the mortgage securitizations, while preventing whole neighborhoods from becoming ghost towns through mass foreclosures. The government can sell off its enormous chunk of the nation’s housing stock at the appropriate point in the future.
— Noah Millman · Feb 24, 11:42 PM · #
My mortgage has a 20% LTV ratio with a low 30 year fixed rate, and I bought my sloop with cash. What do I get?
Of course the answer is nothing; not even the opportunity to profit from further implosion.
— Tony Comstock · Feb 24, 11:52 PM · #
Obama needs to keep in front of this message. I was surprised at how much the mortgage leg of the recovery plan doesn’t bail out those underwater. It’s mostly targeted at people 80-105% LTV. If you are at 95% LTV right now , it is likely you put 20% down two years ago and watched half your savings get wiped out. The reckless leveragers are way over 105% LTV right now.
Kicking these ‘lucky duckies’ 1% doesn’t strike me as that bad of a deal if it helps stabilizes the number of defaults.
— Rortybomb · Feb 25, 12:45 AM · #
This does bring up a good point though – housing decisions are some of the most violate and emotional decisions people make, and it is wise to tread lightly (which I think Obama has). One can talk forever about the ins and outs of guassian copula formulas, which probably did more than anything to bring on the current downturn, but people will just stare at you oddly.
Housing however; everyone’s daily decisions there are incredibly visceral, both on the bullish and bearish ends. Every statement is going to have half the population very upset.
— Rortybomb · Feb 25, 12:53 AM · #
Two things:
1. In the middle of the housing/credit boom, my parents bought a house with a standard, old-school, 30-year fixed mortgage with a large down payment. They expect that they will continue to be able to make the payments with no problem. They could have borrowed 3 times as much money as they did, but they knew that it would be crazy, since they’d never be able to make the payments. If we’re talking about who “deserves” help from the feds, it’s people like them who were smart enough not to screw themselves over to begin with.
If, instead, we’re talking about who “needs” help, then we’re talking about a whole different class of folks, defined according to a whole different system of metrics. As Noah, says, the government can’t decide who deserves help, only who needs help.
2. On the other hand, I still fail to see why we need to have a federal solution at all. Surely, if restructuring mortgages, even into a radical new form such as a 2-3 year lease, were economically viable — i.e., it would be worth more than simply foreclosing — then the mortgage owners could do it themselves. If it’s not economically viable, then we’re still asking folks like my parents to foot the bill to keep their dumber neighbors from being punished for their mistakes. Just foreclose, resell the houses under sane mortgages, and get on with things.
— Ethan C. · Feb 25, 02:56 AM · #
Maybe we should look at those sub-prime mortgages as either fraud or malpractice. The people with the expertise were the ones makeing the loans. They had to know that someone making $20k a year can’t afford a $220k mortgage, yet they made the loan anyway. The broker made it because he gets paid toarrange mortgages and thebanks made it becasue they thought they thought that when the homeowner defaulted in a couple years they would get a house back whose value had increase 20% which they would then resell. Whose the most culpable here, if your are concerned with culpability?
— cw · Feb 25, 04:32 AM · #
I see that I just restated Yglesias’ argument. But look how many fewer words it took me.
— cw · Feb 25, 04:44 AM · #
Noah:
What if your neighbor really felt he needed that new boat? What if the nice man at the boat yard assured him he could afford it?
You don’t need a graduate degree to ask “How much do I pay per month if I take this mortgage?” and compare that to your after-tax income. It is not, in my opinion, asking super-human awareness of the future to recognize that as an at-will employee, you might be laid off and have to pay your mortgage while looking for a job. If the guy had done those things, then it wouldn’t be essential that the value of the house declined (though obviously it would suck, just like it sucks that many 401K accounts have lost 40% of their value) – he would be able to stay in his house because he could make the payments. The guy has to move out because he was speculating on the change in value of the house.
In the end, I think that Ethan C. is correct – the guy that was more prudent has to give up future consumption in order to transfer consumption to the guy who took a risk and lost the bet, or maybe more precisely, future prudent guys will have to transfer consumption to him, as we are financing all of this with government debt.
I get the argument that we are doing this not to help this guy out, but because it’s in our own interest (I’ve made exactly this argument for the original TARP program). But there need to be some severe limits to that idea, or it socializes all risk. That is, in analogy to your example, why should a guy who listened when that nice guidance counselor assured him that GM was a great place to work, and then worked hard for 20 years now be punished by the fact that he has implicit counterparty risk for the funding of his pension? Isn’t it in all of our interest that we not crater the Detroit auto sector?
It’s a very non-theoretical slippery slope that plays exactly to natural human political biases. As Rehian put it, “down this road lies ruin”.
Of course, the Republicans have very little standing to make this kind of argument credibly, hence this is all carping – Obama, Pelosi and reid and going to get what they want, and I guess we’ll all have to see how it works out.
— Jim Manzi · Feb 25, 06:52 PM · #
“ the guy that was more prudent has to give up future consumption in order to transfer consumption to the guy who took a risk and lost the bet, or maybe more precisely, future prudent guys will have to transfer consumption to him, as we are financing all of this with government debt.”
Or maybe we will have to change our military role in the future and halve our defense budget for ten years, as you more or less suggested. Or maybe we have to speculate on the prudent guy losing his job and thus his house becasue we didn’t bail out the imprudent guy (if we actually are bailing out imprudent guys rather than people who we prudent but are now underwater anyway, or who got sick or whatever).
I understand the point about socializing risk but we spend have socialized the risk of big corporations like the airlines for years. If we really want to talk about socilaizing risk let’s really talk about it in all aspects. How about flood insurance for instance? Or how about reregulating how big banks can get?
— cw · Feb 25, 08:05 PM · #
“Of course, the Republicans have very little standing to make this kind of argument credibly, hence this is all carping – Obama, Pelosi and reid and going to get what they want, and I guess we’ll all have to see how it works out.”
To my mind, this may be the very worse aspect of the last 8 years. Call me crazy, but I think it’s actually helpful to have a credible opposition party. I feel not unlike how I felt on the eve of the invasion of Iraq…
RE: Future Prudent Guy
I’ve worked in just the sort of downbeat neighborhoods that government flood insurance was supposed to provide a with a safetynet, on that basis I have a hard time being “conservative” about the idea. But I’ve also seen how it’s transformed the coastline of the Eastern United States, which makes me feel down right hawkish.
Life is complicated.
— Tony Comstock · Feb 25, 08:17 PM · #