Cochrane Sees Moral Hazard Only in One Direction.

Several people have been writing about John Cochrane’s post on Federal Reserve independence, but few have mentioned what is actually making Cochrane mad.  Why does Cochrane feel something has gone terribly wrong?  Here’s a quick scan:

Led by the White House, the state Attorneys General announced their “settlement” with banks….There are also costs.  This money comes from somewhere…To say nothing of the blatant unfairness, and moral hazard…or the larger moral hazard of using the threat of prosecution for procedural errors to force anyone to cough up money towards unrelated policy goals…

Heavens, what a scandal…Documents not properly notarized! Notice it does not even “allege” that anyone was actually kicked out of a house who was paying their mortgage.

I once got into a disagreement with someone over whether or not libertarians care about fraud. I alleged they didn’t, and their real concerns would always run downhill, usually towards debtors.  They have no language for fraud other than a reactionary posture that going after fraud unfairly benefits those on the other end, who have gotten what they deserved.

Look at Cochrane’s post – the robosigning and subsequent scandals are viewed as nothing of significance.  Not only are these acts against the law, but not breaking these laws are essential to the whole securitization chain.  Following the proper legal steps in creating and executing these financial instruments is necessary for the whole thing to work.  From REMIC to trust to property law to bankruptcy remoteness to everything else, unless you are actually following these steps you are causing huge problems for the securitization later on.  The same goes for foreclosures.  Like all property, they are legal creations.  And for a particularly complex piece of property like a security composed of many home mortgages, following the law is essential.

Allowing financial firms to get away with not following the laws we created to handle securitization, property and foreclosure would, in any sensible sense of the phrase, cause “moral hazard.”  But the only moral hazard Cochrane is concerned about is ones that might benefit mortgage debtors, who need to be constantly disciplined.  Two sets of rules – one for the 1%, one for everyone else.

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17 Responses to Cochrane Sees Moral Hazard Only in One Direction.

  1. Philip says:

    Your claims are not actually responsive to Cochrane. You claim: “Following the proper legal step in creating and executing these financial instruments is necessary for the whole thing to work.” Well, is that true? Is securitization failing because of procedural irregularities? That is an empirical, not a deductive, question. As best I can see, the answer is “no.” Technological changes often stress existing forms in the law, and the law is not generally so brittle that it cannot adapt. (This is a point that those on the left generally celebrate rather than lament.)

    In addition, even supposing that all the irregularities have caused big problems, who has been hurt by those problems? You don’t seem to actually be saying that it was the homeowners. Certainly, the MBS-holders aren’t benefiting from the settlement–or am I missing that somehow? Cochrane’s point is that the threat of hugely expensive litigation is being used to subsidize a group of people who weren’t actually harmed by the misconduct. Do you actually think that’s not true?

    • Mike says:

      Should people being foreclosed on have the people foreclosing on them be forced to follow the law? Yes.

      The law surrounding New York trust law and REMIC is pretty brittle by design. Also there’s plenty of empirical work showing that lack of well-kept documentation leads to botched numbers and more than a decade of angry bankruptcy judges. Also what sheenyglass said.

      That said you aren’t responding to my claim: does fraud matter? And is there moral hazard in letting banks robosign?

      • Philip says:

        Your answer still completely neglects the question of “who was actually harmed, and will they be helped by the settlement?” I can understand why you ignore this, because the answer is not good for your position.

        Putting that aside, I can be responsive to you: “does fraud matter? And is there moral hazard in letting banks robosign?” Yes, sure, generically speaking fraud is bad. Rule of law is good, and a scrupulously formal version of the rule of law is a useful social asset in very many contexts. Is there moral hazard in letting banks robosign? I’m not so sure–what really created the moral hazard was a bunch of people willing to buy up mortgages without meaningfully scrutinizing them. If someone is going to buy garbage from the banks, it isn’t really so surprising that they found increasingly efficient ways of churning out garbage. Post-crisis, the willingness to treat offal like gold has ebbed, and the incentive to robosign has correspondingly diminished, because now if banks manufacture garbage, they are far more likely to end up holding the bag.

        So… Does the fraud matter in this case, and matter in a way that is constructively addressed through this settlement? Well, it seems to me that the people who would have the strongest case that the fraud actually cost them money–the purchasers of robo-signed mortgages–aren’t the ones clamoring to punish the banks. And they certainly aren’t the ones being helped by the settlement. If you want to think of it as a sort of punitive damages for bad behavior, being distributed to normal joes who got caught up in the housing crisis, well, OK, but that runs into exactly the problems that Cochrane indicated.

    • Who has been hurt?
      Jason Grodensky: http://www.sun-sentinel.com/business/fl-wrongful-foreclosure-0922-20100921,0,36776.story
      Angela Ianelli: http://theweek.com/article/index/201027/_Bank_repossesses_wrong_home_
      Denroy Bell: http://www.wftv.com/news/15523844/detail.html
      Gerald Thitchener: http://www.oginski-law.com/news/vegas-jury-awards-couple-34-million-for-mistaken-foreclosure-20051003.cfm

      These cases came from just a quick google search – each one a case where a homeowner was either making their payments or did not even *have* a mortgage with the bank in question – but because the banks had not followed the procedures, they assumed they had a right to foreclose.

      This isn’t even counting the hundreds (potentially thousands) of illegal foreclosures on active-duty servicemembers.

      • Philip says:

        But these are not apt examples at all. Wrongful foreclosure creates a very clear and effective cause of action for the homeowner–in your last link, to the tune of $3.4 million! If our legal system was indifferent to that kind of behavior, that would indeed be very troubling, but there is no sign that it is. I suppose if you could show that this sort blundering never happened in the past, in the golden days of proper notarization, and you wanted to argue that the settlement will have a prophylactic effect, that could make some sense, but without further evidence both of those claims strike me as rather flimsy.

        Meanwhile, you clearly like to be like Mike, inasmuch as you completely neglect the question of whether the kinds of people who were really hurt by the sloppy documentation practices are actually the ones helped by the settlement.

    • Charlie says:

      “Post-crisis, the willingness to treat offal like gold has ebbed, and the incentive to robosign has correspondingly diminished…”

      Robo-signing is not in granting the mortgage. Robo-signing is a term used to describe when a bank employee signs an affidavit to a judge saying that he or she has carefully reviewed the documents that show that a borrower indeed has been delinquent in a loan and that the loan is owned or serviced by the bank and that the bank has a right to foreclose.

      It turns out many of the bank employees were signing these affidavits (that are sworn statements to judges) without reviewing any of the required documents. Further, it appears that they were hired for this purpose. Lastly, there are several allegations that documents have been fabricated.

  2. Tom says:

    This is really big: enforcement of property rights is usually one of the few functions that libertarians say is important for government to do (along with defense and police.) Is Cochrane really saying that isn’t important either?

  3. sheenyglass says:

    “Is securitization failing because of procedural irregularities? That is an empirical, not a deductive, question. ”

    Whether the law is actually being enforced is empirical, but whether a valid perfected security interest has been 1) taken in a property and 2) conveyed is a legal (deductive) question. A failure take these steps in the transfer are not “procedural irregularities.” Rather, they fundamental failures of the transaction itself. There are clear rules for both of these steps not just to protect debtors/homeowners, but to protect subsequent holders of negotiable instruments (who need to be certain their are no other claims to payments on the note), subsequent secured creditors (who need to be aware of priority liens in order to make informed lending decisions) and subsequent purchasers of the property (who need to be able to rely on the county title records in order to be certain that the grantor has valid title to convey).

    • Procopius says:

      “Is securitization failing because of procedural irregularities? That is an empirical, not a deductive, question. ”I think the question here is really, “Are people able to buy pieces of paper which say they are secured by property liens and promise to pay a certain amount of money, and then receive the money the pieces of paper promised?” And the answer to that seems to be “Yes.” If $6 trillion of MBS have been issued since 2009 the investors must not be seeing a problem arising from the lack of proper legal procedures. Granted, the law is being violated and various governments are not getting a lot of money they are entitled to, but we haven’t worried about rule of law in this country for at least 15 years now. So I think the question really being asked is

      • EMichael says:

        Strangely enough, the investors will end up paying more in this whitewash of a settlement than the perpetrators. And if the states pursue suits outside of the bounds of the settlement, the investors will probably take another hit.

  4. David Kaib says:

    Another term for procedural regularities is ‘due process’, or if you prefer, the ‘rule of law’.

  5. AlanDownunder says:

    If you care too much about self enrichment, rather than too little, at least your heart’s in the right place.

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  10. Barry says:

    “Is there moral hazard in letting banks robosign? ”

    J*s*s f*ing Ch*st – robosigning is fraud. They ain’t doing it just for kicks; they’re doing it to defraud somebody.

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