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“There are more instances of the abridgement of the freedom of the people by the gradual and silent encroachment of those in power, than by violent and sudden usurpation.”     James Madison

December 7, 2007

Subprime Restructure Resistance – How Much Is Punishment-Driven?

by Brad Warbiany

It’s clear to everyone with reasoning ability that our subprime mess is, well, a colossal mess. We’re talking about a credit bubble that’s enormous, and the fallout of a big-time POP will put our nation into the question of major recession vs. hyper-inflation.

This is not a good thing. This is not good for the American people, this is not good for homeowners, this is not good for lenders, this is not good for economy in general, and this is not good for the government. Investors and lenders are already feeling the effects, as you see major mortgage companies writing off billions of dollars of losses. This is not good for homeowners, as many are facing foreclosure as their payments reset to rates that they can no longer afford. And it’s not good for the economy, because a major credit crunch will shut down the engine that allows us to escape the effects of this downturn (albeit only temporarily, but that’s a factor of our screwed-up monetary system in general).

I personally believe that while this is a bad situation, there are things we can do to minimize the downturn. One of those things is for lenders to take a pro-active approach to people who took on bad loans and are facing foreclosure, in order to find a way to restructure the loan to terms that are acceptable. This is obviously a good thing for the borrower, as they can meet their current payments and a restructuring allows them to keep their home in their possession and keep their credit rating intact. This is also a good thing for the lenders, because in a stagnant or downward housing market, foreclosures are a losing-money proposition for the lender. Foreclosing on a house, holding the property for several months or taking a huge loss on the sale, and then also forgoing the future interest on the loan is a pretty big downside for them. For investors, a restructure is a bad thing, but potentially a less-bad thing than the lenders failing and their investments becoming worthless.

Yet there has been a lot of resistance to such an idea. And while I hate to say it, that restructuring appears to have some desire for punishment, rather than a desire to help people work things out, which I find troubling. A few examples:

Second, in part because of the housing bubble and in part because of simple bad decision making, people were buying houses they really couldn’t afford and entering into loan transactions that were not in their best interest.

Two parties are involved here and both deserve what they have coming to them.

essentially, the government is trying to ruin everybody’s credit for the benefit of a few morons. Great!!!

these Bush socialists want to rewrite real estate contracts, effectively reward people for being greedy idiots, punishing those who chose higher interest, fixed loans.

so the politicians can appear to be “sensitive” to poor people who are apparently too stupid to read the documentation when buying their house or can’t handle their own finances.

Now, all of those quotes came from one post and one comment thread. Taken individually, none are really all that noteworthy. But taken together, there’s an underlying thread of anger and scorn there that is rather troubling.

Don’t get me wrong, I’m very worried about the aspect that government brings into this mess. I think the term “bailout” is still premature, but I worry that if lenders don’t follow the government’s “suggestion” here, that they’ll quickly move to a more active role. There are definite problems with the government getting involved in this mess.

However, the negative reaction to a restructuring of loans is something that I’ve noticed for at least the last month or two, even before the government aspect came into the picture. There seems to be an underlying punitive aspect, as if these borrowers and lenders should simply have to feel pain due to their decisions, even if there are reasonable ways to avoid the pain.

In this deal, there were a lot of culpable parties. Borrowers were buying houses that were going up in value, so they had some (perhaps bad) belief that they could sell and get out if things got bad. They were buying the loans from brokers, many of whom were getting paid more to funnel borrowers into these “creative” loans, and who also were selling those same loans on the back end, so they had no incentive to make sure the borrowers were creditworthy. The lenders did relax standards for loans they were buying, but at the same time they were simply slicing-and-dicing those loans into CDO’s and SIV’s and selling them on a secondary market, spreading the risk out to people who were willing to take it. And this was all underwritten by loose monetary policy borne of a government that was searching for anything that might take it out of the post-9/11 slump.

Lenders and borrowers have a potential way out of this mess. And if they are able to stabilize the situation long enough to turn a sharp housing crisis into a long housing stagnation, the wider economy might at least avoid some major unpleasant shocks. But it seems like some individuals are SO focused on the punitive aspect that they would rather watch the whole mess come crashing down than support individual lenders and borrowers do what they can to avoid it.

Again, I’m somewhat conflicted on this issue. Since selling my house for a whopping three-figure profit earlier this year in order to move to California, I’m stuck in a tiny apartment with a wife and baby, hoping that there is a major housing crash so I can afford to buy a condo. I want there to be enough pain that prices come to a point that allow me to get into the market, which is something I cannot do right now. To do this, we need a serious correction, not just a protracted stagnation.

Yet I still don’t understand the desire that some people have to watch people get thrown out of their homes and their credit ruined. I understand if they made bad decisions so egregious that there is no recourse, but these are mostly people who are making their current payments and just looking for a way to avoid watching their whole world come crashing down. And the lenders are absolutely hoping that they don’t have to foreclose on wide swaths of property, because they know that they’ll lose their shirts in that sort of market.

It’s not a good situation. But why do so many people want to see punishment, rather than see voluntary agreements between borrowers and lenders that might allow lenders to stay afloat and families remain in their homes? I realize that we are conservatives, and we don’t want to see people insulated from the consequences of their actions by government action, but so much of the reaction that I see seems to be a desire for punishment, rather than understanding. America is a land that values fairness, but it is also a land that values compassion. Why have we swung so far away in this case?

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  1. Brad,

    My comment was meant to be harsh towards people who default on their loans…but I don’t consider it a punishment for them not to receive a government bailout. They’re simply being held accountable for their actions, the same way I would be held accountable if I signed a contract without bothering to consider the long-term effects of it then failed to live up to the terms. I bought a house a few months ago, and I took the time to read everything I signed, to understand the terms of my mortgage before I entered into it, to find an investment that made sense for me and that I’d be able to pay for. What entitles any of these defaulters to be exempt from that standard? What entitles them to basically bail out of their contract without the other person’s consent by essentially holding up their hands and crying “I’m poor and I didn’t understand what I was getting into, so I shouldn’t have to pay”? The only thing these people are victims of is their own bad choices, the same as people who choose to use drugs, or drive drunk, or blow their money in casinos are victims of their own bad choices. If you feel bad for them, that’s understandable, donate to a charity that helps people in need…those are designed to help give people second chances and participation is voluntary. If the lenders feel bad and want to help restructure the loans, that’s fine…they’re the ones best able to assess their own level of risk and determine the amount of help they can offer.

    What the defaulters aren’t entitled to, however, is a government bailout on the taxpayers dime where the government forces the lenders they just screwed to comply…because that is a punishment. It’s a punishment for the lenders who took a chance on giving somebody the funds to buy a new house. It’s a punishment for the shareholders and investors in the banks and the companies that made those loans possible. It’s a punishment for all those employees who got laid off from places like Countrywide Financial because the government has made it more difficult for those companies to recoup their investment. It’s a punishment for investors who wisely stayed out of the housing market until property prices dropped. It’s a punishment for people who might now be able to afford a new home (and not default on it) by buying one of the foreclosures. It’s a punishment for everyone who tried to do what they’re supposed to do in a free society, act prudently in their own best interests through voluntary cooperation. It’s a punishment for everybody except the person who should be punished…the original investor who defaulted on his responsibility to live up to the obligations of the contract he signed. And no, I don’t have a lot of sympathy for the people who can’t honor their obligations…same as I don’t have sympathy for anyone who thinks that fraud and theft are acceptable ways to do business in this world. My sympathy lies with the people who lived up to their word…same as it does with the victim of any crime.

    Comment by UCrawford — December 7, 2007 @ 6:50 am
  2. UC,

    We agree on one point. There should not be a government bailout on the taxpayers dime, and the government should not coerce (even if implied) the mortgage industry into accepting these terms.

    But I think you’re missing something when it comes to the contract these people signed. They agreed to that contract, and if the lenders want to hold their feet to the fire and foreclose, the lender can do so. But the lenders don’t want that! The lenders would prefer to avoid foreclosure, as long as they’re working with someone who they reasonably believe will keep paying every month (even if less than originally specified).

    What they’re basically offering is a re-negotiation. Renegotiating contracts is an entirely normal affair, done when both parties realize that the current contract doesn’t serve their needs. I agree that the borrowers shouldn’t be “bailed out”, but why should we not support a renegotiated contract that is mutually beneficial to the borrower and the lender? As long as that contract is freely negotiated and not through government force (we’re on a very fine line in this case), what’s the problem?

    Comment by Brad Warbiany — December 7, 2007 @ 8:17 am
  3. Brad,

    Actually we were in agreement about voluntary renegotiation too (see the last sentence of the first paragraph on my last comment)…if the lenders want to renegotiate, that’s fine, I’ve got no problem with it. My only disagreement with your post was in portraying people who are getting foreclosed on as some kind of victims here, which they are not, and taking commenters to task for believing that people should be held accountable for their actions and for the contracts that they signed.

    There’s nothing to be conflicted about in the housing crisis. The people losing their homes are doing so because they made financially unsound decisions and tried to live beyond their means…if they get foreclosed on it’s because they put themselves in that position by failing to plan or to honor their agreements. And if the lender chooses to renegotiate their mortgage with them to help them keep their home they should be damned grateful for the charity that they were extended because the bank’s under no moral obligation to help them at all.

    Comment by UCrawford — December 7, 2007 @ 8:37 am
  4. [...] at The Liberty Papers, Brad Warbiany explores this same issue and asks a question: It’s not a good situation. But why do so many people want to see punishment, rather than see [...]

    Pingback by Below The Beltway » Blog Archive » Bush’s Mortgage Bailout Creates Resentment — December 7, 2007 @ 8:43 am
  5. I’m not portraying them as victims. When I bought my home in 2005 (selling in 2007), I already saw the writing on the wall and wasn’t about to get into any sort of “creative” loan. I knew rates were going up, and I was planning for it. Obviously I think the people who were buying option ARMs and interest-only mortgages were idiots (and called them such in April 2005).

    Again, I’m not saying these people should get a free pass, nor that they should ever feel entitled to a restructuring of their loan. What I object to is the characterization that these people shouldn’t get their loans renegotiated because they need to be taught a lesson.

    It’s like saying to someone who’s married to a controlling, manipulative bitch that he can’t get a divorce, even though both he and his wife want one. Yes, it wasn’t smart of him to marry her, but that doesn’t mean it’s a decision that they both shouldn’t be able to get out of.

    Comment by Brad Warbiany — December 7, 2007 @ 9:10 am
  6. Brad,

    They do need to learn a lesson about prudence especially when there is a ton of speculation going on. Yet the purchase of a house is usually a life-altering decision, so the mortgage writers are wise to restructure the loan for the benefit of all parties involved. I’m really ambivalent about the new law. It doesn’t really do all that much and forces some investors to get paid very little for a high risk proposition.

    Prudence is essential in preventing the next one from happening, again. In a way, that requires a measure of pain to be exacted upon those that lacked prudence in purchasing the house. If only they would be so wise to apply prudence to all purchases rather than the ones that they’ve learned a lesson on. People have lost millions in the stock market.

    Comment by TanGeng — December 7, 2007 @ 10:49 am
  7. Brad,

    I wasn’t claiming that they shouldn’t get their loans renegotiated with my original quote…simply that the government has no business getting involved and forcing renegotiation, mainly because the politicians aren’t so much interested in helping people out with what they’re doing as they’re interested in pandering for votes by rewarding irresponsible people at the expense of the lenders (who are the victims in this situation).

    Comment by UCrawford — December 7, 2007 @ 11:07 am
  8. TanGeng,

    The question I have is how much pain the rest of us must endure in the form of a cratered housing market and credit crunch in order to ensure we exact enough punishment against these borrowers?


    Why do you say the lenders are the victims here? It takes two to tango, and they were just as irresponsible as the borrowers. Yes, it was the borrowers who are defaulting, but lenders who don’t take an active role in determining creditworthiness of the people they loan money to are asking to lose their shirts. Lenders made bad business decisions with their investors’ money, and many lenders are now paying the price for that. They’re not victims, they’re just as much idiots as the borrowers who overextended themselves.

    Comment by Brad Warbiany — December 7, 2007 @ 11:39 am
  9. Brad,

    What about the argument that the market should be allowed to work this out without government intervention ?

    If that means a lot more foreclosures, then that’s what it means. The market will adjust, and so will people’s behavior.

    If it means that some, or most, lenders, renegotiate the terms of mortgages with borrowers, then I’m fine with that too.

    The problem I have with what Bush announced yesterday is that it essentially involved the government telling all sides that they better work it out on their own or the state would impose a solution on them.

    Comment by Doug Mataconis — December 7, 2007 @ 11:55 am
  10. Brad,

    The lenders are the victims because they didn’t violate their end of the contract. They lived up to the terms they set in the contract, whereas the defaulters didn’t. Were the credit risks fairly high? Sure, but that’s why the adjustable rates were in place…because they realized that the payoff down the road was going to be greater, which offset the risk. Had the borrowers read their contract they would have realized this too…but that’s not the fault of the lenders that the borrowers didn’t bother to understand the obligations they signed up for.

    The lenders are the victims here, they didn’t deserve to get hosed any more than somebody who takes a quick shortcut through an alley deserves to get mugged, or a girl who wears sexy clothing or walks alone at night deserves to get raped The lenders weren’t doing anything wrong by lending money to people. While the people in my hypotheticals may have done things to increase the probability of a bad result, the ultimate responsibility still lies on the perpetrator. The borrowers who defaulted were the perpetrators because they accepted a risk with no thought to the future consequences of those risks. That’s why I’m not sympathetic about losing their houses and why it pisses me off that the government is getting involved. If the lenders want to bail them out, fine, because they shouldn’t have to be penalized twice if they can get a better deal by settling. But if they can get a better deal by throwing the family who defaulted out on the street, even at Christmas, I think they’re entirely justified to do so (both financially and morally) because the lender wasn’t the one who negligently violated the terms of the contract they signed.

    Comment by UCrawford — December 7, 2007 @ 12:08 pm
  11. Brad,

    The pain should be as large as the magnitude of the folly. And a free market solution would help bring that to fruition. If it means an agreement between lender and borrower to reduce interest rates so that the lender can get paid as much as possible while the borrower can stay in the house, so be it. That’s the best solution if the market comes to that conclusion.


    All parties are equally reprehensible for not doing due diligence or inaccurately judging the risks of the marketplace. The borrower is at fault for thinking that the mortgages in question were a good deal and would make out on top through the transaction. The lender is at fault for not accurately judging the risks and giving out loans to people that could not afford them. Investors are at fault for thinking that there is easy money to be made by purchasing CDOs, SIVs, or any other financial instruments that package up these non-conforming loans.

    Yes, the borrowers are the ones violating the terms of the contract if they are missing payments or trying to change the terms. But when these people can’t pay, it’s the lender’s money at risk. You can’t diminish how stupid the lenders were in writing so many non-conforming loans. They threw precaution out the window.

    There are a few different risks involved. In the home purchase transaction, the house is the risk. They’re betting on the housing market to improve and house prices to rise. They’re taking that risk. But borrowers don’t have the cash to buy houses. So in the loan transaction, borrowers are the risk. Lenders assume the risk and are betting that the borrower is right. And they gain in the form of higher interest rates if the borrowers come through. Everyone’s getting hurt now that the borrowers were wrong.

    Comment by TanGeng — December 7, 2007 @ 12:34 pm
  12. My basic point being that while entering into an overly risky contract is certainly not desireable, having one side live up to the obligations of the contract while the other side defaults creates a victim/perpetrator dynamic in which the one who upheld their end of the contract deserves the more favorable result. If renegotiating gives the lender the better result, I’m fine with that. If throwing the defaulter out on the street gives the lender the better result, I’m fine with that too (as anyone else who believes in personal responsibility should be)…I just disagree with the whole idea that both sides (lender and debtor) share equal blame in this fiasco when they clearly do not.

    Comment by UCrawford — December 7, 2007 @ 12:35 pm
  13. TanGeng,

    I agree that the risks the lenders took were too high, and the market has penalized most of them to varying degrees for taking those risks. But again, my point is that they still deserve the better result than the defaulter because the lender chose to live up to their contract. What the government’s doing flies in the face of that…rewarding the defaulters for skipping out on their obligations while punishing the lenders for honoring theirs. That’s why, I believe, the response that Brad took issue with towards the defaulters was so hostile.

    Comment by UCrawford — December 7, 2007 @ 12:40 pm
  14. Doug,

    I have no disagreement with the argument that the government should not have gotten involved.

    Comment by Brad Warbiany — December 7, 2007 @ 12:50 pm
  15. UC,

    I’m not saying blame should be spread equally. However, there’s plenty of blame to go around, and the lenders deserve some of it.

    I’m also not saying these lenders should be forced into anything. I think it is their own choice, as the party with legal rights to the house, whether they try to renegotiate or foreclose.

    What I take issue with is the inherent desire to see the borrowers get punished. It seems to me that people would rather see people tossed from their homes than given the chance to work things out.

    It’s the attitude that bothers me more than anything.

    Comment by Brad Warbiany — December 7, 2007 @ 1:01 pm
  16. Brad,

    I think what most of the people you quoted earlier would prefer to see is for people to be held accountable for their actions. That’s what I was saying. If that means the lender renegotiates so they can recoup their investment, I’m perfectly fine with that because it’s the best possible result for the party that honored their end of the contract (the lender). If that means the defaulter gets chucked out on the street, I’m perfectly fine with that too, again because it’s helping out the party that honored their end of the contract. My hostility was directed at the mindset that the defaulters somehow deserve a break simply because they were stupid enough to enter into a contract that they couldn’t honor…which they don’t. If that comes off as heartless or cruel, it’s only because I’ve worked jobs where I’ve represented the lenders before and I’ve seen the damage it does to businesses when people who default on their obligations are shielded or protected from the consequences of their actions by outside parties. I have sympathy…just not for the people who skip out on their debts.

    Comment by UCrawford — December 7, 2007 @ 1:28 pm
  17. Brad,

    Ahh I see. You’re just objecting to the contempt or desire for a wild spectacle in the mortgage business.

    I’m not driven by emotion in saying that I think those stretched too thin by a ridiculous mortgage have to deal with the pain. It’s a little uncaring, but a little bit of tough love and a little bit of charity to help them regain their feet is what is in order. We don’t need the government to prop up an untenable economic position in an effort to delay the consequences five more years.

    Comment by TanGeng — December 7, 2007 @ 1:34 pm
  18. If loan companies and bonds men are so hard up for money, I welcome them to cut a deal with me. 70 cents on the dollar of mortgage debt I owe.

    But what happens instead? They use the government to pick pockets.

    For goodness sake, please remove Pat Henry’s name from this web site.

    Comment by C Bowen — December 7, 2007 @ 1:47 pm
  19. Bowen,

    Did you read what Brad wrote at all ?

    He said that he doesn’t support government involvement in this process. The post was about why some people are so resentful of the very idea that some of these mortgages might be renegotiated voluntarily.

    I oppose the Bush plan precisely because it smacks too much of government compulsion. However, if Countrywide, Wells Fargo, Citibank and the other lenders want to renegotiate with their borrowers to avoid foreclosure (and no bank wants their loans to go into foreclosure in a declining real estate market), then that’s their perogotive.

    Comment by Doug Mataconis — December 7, 2007 @ 1:51 pm
  20. C. Bowen,

    Actually, I think it’s the defaulters who are using the government to pick peoples’ pockets here, not the loan companies.

    Comment by UCrawford — December 7, 2007 @ 1:52 pm
  21. And Brad wasn’t making a case for government intervention at all.

    Comment by UCrawford — December 7, 2007 @ 1:53 pm
  22. All,

    If you get a chance, I recommend you read this post at Calculated Risk.

    I’m beginning to think that this was even less of a “bailout” for borrowers than originally suggested.

    If that post is accurate, the plan is largely just the regulators offering a way within the current legal and contractual obligations of the lenders and investors to go forward. In reality, they haven’t done much at all, although as most politicians are wont to do, they made it seem like they were sweeping in to save us all.

    Comment by Brad Warbiany — December 7, 2007 @ 1:58 pm
  23. Brad,

    “In reality, they haven’t done much at all”

    But they’ve done enough to affect the market by appearing to interfere. Even empty gestures of intervention or superficial government regulation can have detrimental effects on free markets and influence people’s actions by creating either the perception of regulation or the fear of more stringent regulation being tacked on. You should know that, Brad.

    Comment by UCrawford — December 7, 2007 @ 2:46 pm
  24. Brad;

    Thank you for coming clean and acknowledging that the gubmint’s plan is not for the failed credit risk consumer, but a means of giving a value to the paper the bonds men and loan sharks wrote so they can unload it on the open market.

    Modern dupes not withstanding, a brace post.

    Still, it’s best to remove Pat Henry’s name from this moderate (being kind) web site.

    Comment by C Bowen — December 7, 2007 @ 6:27 pm
  25. UC

    You seem to fall for that age old fallacy that the consumer benifits from socialist schemes. If nothingelse, these set of consumers got to live in a house well beyond their means for period of time. They have already had their payoff.

    Comment by C Bowen — December 7, 2007 @ 6:29 pm
  26. C Bowen,

    Nope, if you’ve read my previous comments you’d have realized that you and I are in agreement about the defaulters having lived above their means. But considering Brad’s link, I’ll retract my comment about the bill being used to help the defaulters (although the rhetoric from Bush implied otherwise). I’m just opposed to any government intervention of this sort in the market, superficial or not, since even the threat of government regulation has adverse and unintended consequences…no matter who the bill’s really intended to help.

    Comment by UCrawford — December 8, 2007 @ 8:00 am
  27. C Bowen,

    I basically said that all the government has done is clarify their own tax/regulatory stance. That’s hardly “giving a value to the paper”.

    If I ask a cop “is it legal to do X”, where X is something that will make me money, and he says “yes”, has he given me anything?

    As for whether this blog is “moderate”, one of the contributors to this blog is a declared anarchist, I’d be considered on the fence between anarchy and severe minarchy, and the rest of the contributors are anywhere from where I am to being small-government Republicans. At least for myself, I think that if I were arguing about government in the 1780′s, I’d be firmly in the camp as an anti-Federalist, which is exactly where Patrick Henry was.

    Comment by Brad Warbiany — December 8, 2007 @ 9:53 am

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