Sunday, November 07, 2010

Foreclosures and the Rule of Law

Frank Pasquale

Is the US becoming a third world nation? Arianna Huffington's recent book makes the case, arguing that crumbling infrastructure and vast inequality herald a new era of unaccountable elites. She argues that "our financial system [has] become a bad carnival game where the rich always get the grand prize and the average American walks away empty-handed."

Matt Taibbi directly connects financialization with the decline of common infrastructure in his new book, Griftopia. He describes a litany of roads and bridges "already leased or set to be leased for fifty or seventy-five years or more in exchange for one-off lump sum payments of a few billion bucks at best, usually just to help patch a hole or two in a single budget year." Taibbi says the process is "stripping wealth out of the heart of the country," reminiscent of the extractive industries of Nigeria or Equatorial Guinea. Even the New York Times's moderates are finding the US uncomfortably close to a "banana republic," with Nicholas Kristof concluding that "You no longer need to travel to distant and dangerous countries to observe . . . rapacious inequality. We now have it right here at home."

Attorneys have a difficult time coming to grips with this new political economy. Many wholeheartedly believe that today's chief executives deserve to make four or five hundred times the average worker's wages (rather than the roughly fifty-fold multiple prevalent in 1980 America, and elsewhere in the world today). Perhaps the nation's richest 1 percent in some sense deserves to have captured 80% of the increase in income from 1980 to 2005. These are moral claims that cannot be conclusively proven or disproven.

But we as attorneys can at least insist on a common rule of law for all. And that's what our legal system has grievously failed to provide during the foreclosure crisis. As the indisputably pro-market Jonathan Macey notes, "the banks have created significant legal exposure for themselves 'by committing fraud upon the courts.'" And yet the first thing our Congress could think to do was to endorse legal cover for them, as eagerly as it retroactively immunized warrantless wiretapping.

Was that merely a case where the grandeur of "democracy" deserved to trump punctilious formalism? Had it occurred in isolation, perhaps. But coming after a long line of bailouts, megabonuses, and the refusal of big banks to play even their basic utility role in our economy, it is inexcusable. As Joseph Stiglitz explains,

The mortgage debacle in the United States has raised deep questions about "the rule of law," the universally accepted hallmark of an advanced, civilized society. The rule of law is supposed to protect the weak against the strong, and ensure that everyone is treated fairly. In America in the wake of the subprime mortgage crisis, it has done neither.

[I]n recent weeks and months, Americans have seen several instances in which individuals have been dispossessed of their houses even when they have no debts. . . . The procedural shortcuts, incomplete documentation, and rampant fraud that accompanied banks' rush to generate millions of bad loans during the housing bubble has, however, complicated the process of cleaning up the ensuing mess. . . .

But banks want to short-circuit these procedural safeguards. They should not be allowed to do so. To some, all of this is reminiscent of what happened in Russia, where the rule of law—bankruptcy legislation in particular—was used as a legal mechanism to replace one group of owners with another. Courts were bought, documents forged, and the process went smoothly. In America, the venality is at a higher level. It is not particular judges who are bought, but the laws themselves, through campaign contributions and lobbying, in what has come to be called "corruption, American-style."

When Businessweek looked for guidance on implications of the US crisis, it turned to property rights expert Hernando de Soto. Having crusaded for years to modernize the Peruvian land titling system, he is apparently now ready to offer guidance to America.

Stiglitz calls for a "Homeowners' Chapter 11," in order "to keep families and communities intact" as efficiently as business bankruptcies "allow a speedy restructuring by writing down debt, and converting some of it to equity." I will leave it to the bankruptcy experts to comment on the plausibility of that particular proposal. But the current crisis convinces me that Andrew G Haldane, Executive Director for Financial Stability at the Bank of England, is correct to make the following points:

During this century, restrictions have been placed on poisonous emissions from cars – in others words, prohibition. This is recognition of the social costs of exhaust pollution. Initially, car producers were in uproar. The banking industry is also a pollutant. Systemic risk is a noxious by-product. Banking benefits those producing and consuming financial services . . . .But it also risks endangering innocent bystanders within the wider economy – the social costs to the general public from banking crises.

If we continue to subordinate the rule of law to the whim of banks, what former IMF Chief Economist Simon Johnson described as the "quiet coup" will be complete. Liquidation of the rule of law in foreclosures will be one more "social cost" of banking crises.

X-Posted: Concurring Opinions.

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