Tuesday, October 19, 2010

The Foreclosure Mess and justice

In the blog "The big picture", David Kotok has a very interesting article on the foreclosure mess. In the context of that article I would like to make a few comments. 

Before the comments, I must state that the issue, like all other in this crisis, straddles the political, legal, social and financial sectors. As a preamble, we must look out for the interest of individual as that is the primary responsibility of the courts and the governance mechanism. We must, like I say in my book, differentiate between real living citizens and firms that have acquired citizenship. It is time for the congress, government and legal apparatus to stand behind the interest of individual. Here are my comments:

First, both the defaulting lender (genuine defaults) and the institutions that misplaced the promisory note are at fault. However, the court has to evaluate the gravity of the situation and that depends on the relative bargaining power of the two parties. The question of relative bargaining power is very important as I discuss in my book Subverting Capitalism and Democracy. The bargaining power equations are clearly favoring the institute. The responsibility of the court is, therefore, to protect the interest of the weak i.e. the individual. Even if it means, in some cases, rewarding the mistakes of individual. Further, the individual will obviously pay for the mistake through higher taxes and loss of jobs. In all fairness, she will pay no matter what the outcome of the foreclosure.

Second, if the chain of title is broken, the person who can defend the title should have the right to initiate foreclosure. However, the person must show unequivocal demonstration of the title. In all probability, an institution within the chain of title cannot establish this without dispute for those downstream will challenge their claim either as fraud or will stake their claim to title. In the light of this claim, it is unreasonable to ask the individual to make a payment.

Third, if it was a matter of making payments, courts could have ordered payments into an escrow account to be allotted to those who can establish rightful ownership. The interest rate or size of payments should be in accordance with the agreement, or if the agreement fails to establish clear rate of interest, it should be at the interest rate set by the Fed. Similarly, courts can initiate a suo-moto foreclosure in cases where it is clear that borrower willfully defaulted and recover the money through auction of the property. The recovered money can then be transferred to escrow account waiting to be claimed by rightful owner.

Fourth, in all fairness, courts must set out limitation date for the title to be clarified. Without a limitation, the process can drag along for years. It is unjust to the individual.

Finally, in all the situations the outcome for banks, mortgage brokers and investors in mortgages are grim. Either way, we have a problem on our hand. It clearly means that banks and other intermediaries will need a bigger capital buffer than what they are currently carrying. Further, approximate estimates peg the capital requirement to be much higher than during 2008 Lehman episode.

It appears that the financial institutions may have realized this and initiated a global pull-back of capital. It is possible the recent correction in global equity markets are a result of this problem.