Wednesday, October 12, 2011
Right out of college a few years back, my son was doing mortgage restructuring for M & I. He worked with a lot of debtors in Florida who would typically say that the bank should reduce the principal on their loan because their house was now worth half what they paid for it. Chris wondered whether they would agree that the bank could increase the principal if the house had appreciated in value.
It's easy to make fun of the young lady in the picture. Both she and her bank entered into a bad transaction. That she apparently does not understand that the bank is going to lose more than she will is probably a product of frustration rather than ignorance. She is stuck in a bad place and even though she put herself there, it is also a product of market developments that no one expected. It hurts and I can understand why she wants to blame someone else and get someone else to bail her out.
But to say that her plight is the simple product of someone else's greed and can be solved by making that someone else pay is incoherent. A commenter on this blog can't understand why it would be "destructive" to just forgive her debt and let her stay in her house. The comment is illustrative of the problem with many calls for state intervention to achieve "economic justice." It ignores the consequences of intervantion.
The problem with a broad standing debt forgiveness is that it would further seize - if it wouldn't destroy - credit markets. She might be happy until it came time to sell the home or to buy another and credit would be unavailable.
But what about the banks, weren't they bailed out? They sure were although much of that money was paid back. For me, the jury is still out on whether that was a good idea. The best thing would normally be to allow them to take their losses and move on. Maybe the threat of a panic in the fall of 2008 was such that there was no choice. Investors were shocked by the decision to let Lehman Brothers fail but that reaction was itself a product of a bubble and expectations that were themselves largely fed by government policy. Peter Wallison explains some of it (but not all of it) in today's Wall Street Journal.
Having said that, there are solutions for her. In all probablility, she won't have to pay anything in excess of the value of her house because, even in states where deficiency judgments are permitted, she can seek the protection of the bankruptcy courts.
H/T: Dan Sebring