Halloween Costumes, Foreclosures, Creditors’ Bargains and how the 1% View Our Laws on Debt

If you haven’t already, you should read Joe Nocera’s column “What the Costumes Reveal.” He includes a slideshow of six photos from a Halloween party last year at the foreclosure mill law firm Steven J. Baum, in which the associates were all dressed as homeless people who were just evicted. Part of the office featured a rundown neighborhood destroyed by mass foreclosures and the sign “Baum Estates” hanging above it. Another picture shows a consumer attorney with her eyes cut out. Baum has recently settled on charges that it was manufacturing and robosigning foreclosure documents for $2 million.

It is easy to dismiss this as a particular kind of awfulness, just jerks run amok. Perhaps they are going through some cognitive dissonance from the misery they are inducing. Maybe they are taking on the roles created by a system of aggressive corner cutting. Maybe. But I think there’s a more powerful ideology behind their actions that gets at how the 1% and elites view the rules governing troubled debt in this country and how they should function.

Let’s look closely at what the signs say. The “Baum Estates” sign hanging over a rundown shantytown shows that the only concern is the ability to collect, without concern for the community. Parts of the procedures necessary for eviction — “I was never served,” “order to show cause” — are held in contempt. They convey the idea that consumers have no valid excuses when it comes to bad debt. They vilify consumer advocates. They mock the idea that consumers should have any legal recourse during foreclosure, that banks and creditors need to follow basic rules, and that any concerns other than creditors’ (rundown neighborhoods, for example) should get consideration.

This notion that those being foreclosed on should be embarrassed about fighting the action and that they, not the banks, are the ones undermining the system has been voiced elsewhere. From last year, Arnold Kling wrote that:

However, the %&*#^ lawyers for the borrower come in and claim standing to challenge the foreclosure on the grounds that the foreclosure notice was sent by someone who has not properly documented that he is the noteholder. Legally, they may have standing to do this. Morally, they do not. The sensible policy would be for the government to step in and legislate that borrowers have no standing to sue unless they are claiming to have complied with the terms of the note.

People calling out banks for not following the rules are immoral, and the government should step in to make sure that the laws governing debts work to protect the maximum return for creditors. And Mark Calabria, director of financial regulation studies at the Cato Institute, wrotes that:

The current efforts by states to use technical mistakes by lenders to allow borrowers to remain in homes without paying could ultimately undermine the very concept of a mortgage.

“Technical mistakes.” Notice the blame in Calabria’s comment. Banks, by not following the trust and REMIC laws that constitute the securitization process, aren’t the ones undermining the process in which banks can legally bring foreclosures to court, and thus the concept of a mortgage. The states, and ultimately the homeowners, are undermining it by pointing out that the banks haven’t followed the rules. This comment is consistent with the idea that the only reason to have laws is to protect creditors from debtors.

This view of the world has its roots in a theory of how the rules governing debt, especially bankruptcy, should function in this country. A heuristic can be used to understand it — it’s called the creditor’s bargain. In this idea, the rules should only exist to the extent that they benefit the creditor’s ability to collect money. It’s simple: if a law, custom, norm, or rule helps creditors collect when things go wrong, it is a good one. If it takes into account concerns other than creditors’ return — say, destroyed neighborhoods, whether banks follow the rules, etc. — they are worthless.

This theory imagines, making a perverse mockery of the egalitarianism of Rawls’ theory, that all the 1% and all the creditors were put behind a veil of ignorance where they did not know what kind of 1% and creditor they’d be. Maybe they’d have collateral that was sensitive to the business cycle; maybe they’d be slow to notice trouble and thus slow to collect. Given the wide variety of problems that could occur, and the way debtors could play them off each either, the creditor class bargains on rules that benefit them all according to the rank of their claims. And benefitting creditors is the only thing that the rules of debt should consider.

In this world, debtors probably could challenge the legality of their foreclosures, making sure proper procedure was followed. But that’s not what the rules are meant to do. The rules are just there to benefit creditors, not debtors. It is in this world that those Halloween costumes make perfect sense. I love pointing out how passionate libertarians like Calabria have been all for the sanctity of contract when it comes to bankruptcy reforms like “cramdown,” but when it comes to the idea that all these mortgages are unsecured debt because of bank-led abuses in the chain of property records, they get angry at debtors, even though they are still holders of contracts. But again, if the law is just there to protect creditors against the difficulty of collecting on debtors, not to provide a level playing field for those with debt, it makes perfect sense.

It also makes perfect sense that creditors and bankers haven’t gone to jail, but debtors who took out a liar’s loan have gone to jail. It makes sense that elites, like former Peterson Institute CEO David Walker, want to see debtors’ prisons on the agenda while no elites talk about jail sentences for the abuses in property law. The law is there to coordinate the best interests of creditors, not provide rules and protection for debtors.

(If you thought classical liberalism/libertarianism was all about how contracts, laws, and markets provide level playing fields and protection from abuses of the powerful — how they take feudal privileges and melt them into air — and not about how they reconfigure the government, customs, and laws to be protectors of capital and hierarchy, first of all that’s adorable, and second you need to get a copy of The Reactionary Mind, pronto.)

Guess which law professor, almost 25 years ago, provided the defining critique of the intellectual theory that debt laws and bankruptcy should only narrowly consider the interests of creditors, and has worked to provide a counter theory? That’s right, Elizabeth Warren. Every time you hear that the banks are afraid of her folksy wisdom and charming accent, also remember that they are afraid of her ability to demolish legal theory that puts the banks and creditors at the center of the law. She noted that the economic value of bankruptcy is only one part, and that our understanding of bankruptcy should have four goals: “(1) to enhance the value of the failing debtor; (2) to distribute value according to multiple normative principles; (3) to internalize the costs of the business failure to the parties dealing with the debtor; and (4) to create reliance on private monitoring.”

Warren also noted that bankruptcy was “an attempt to reckon with a debtor’s multiple defaults and to distribute the consequences among a number of different actors. Bankruptcy encompasses a number of competing — and sometimes conflicting — values in this distribution.” For instance, the costs of a foreclosure to a community are a major externality which should be considered. She continued, “bankruptcy policy also takes into account the distributional impact of a business failure on parties who are not creditors and who have no formal legal rights to the assets of the business.”

Though the Halloween pictures are disgusting, they are a symptom of a larger view of the way the law should work that is even worse — one in which debtor’s protections are mocked, the rule of law is ignored, and shantytowns proudly display their creditor’s name over them. This is the way many elites view the rules when it comes to debt. Thankfully, there is more and more mass opposition to this perversion of the law.