Unconventional Economic Wisdom
Justice for Some
Joseph E. Stiglitz
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NEW YORK – 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 sub-prime mortgage crisis, it has done neither.
Part of the rule of law is security of property rights – if you owe money on your house, for example, the bank can’t simply take it away without following the prescribed legal process. But in recent weeks and months, Americans have seen several instances in which individuals have been dispossessed of their houses even when they have no debts.
To some banks, this is just collateral damage: millions of Americans – in addition to the estimated four million in 2008 and 2009 – still have to be thrown out of their homes. Indeed, the pace of foreclosures would be set to increase – were it not for government intervention. 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.
To many bankers, these are just details to be overlooked. Most people evicted from their homes have not been paying their mortgages, and, in most cases, those who are throwing them out have rightful claims. But Americans are not supposed to believe in justice on average. We don’t say that most people imprisoned for life committed a crime worthy of that sentence. The US justice system demands more, and we have imposed procedural safeguards to meet these demands.
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 that are bought, but the laws themselves, through campaign contributions and lobbying, in what has come to be called “corruption, American-style.”
It was widely known that banks and mortgage companies were engaged in predatory lending practices, taking advantage of the least educated and most financially uninformed to make loans that maximized fees and imposed enormous risks on the borrowers. (To be fair, the banks tried to take advantage of the more financially sophisticated as well, as with securities created by Goldman Sachs that were designed to fail.) But banks used all their political muscle to stop states from enacting laws to curtail predatory lending.
When it became clear that people could not pay back what was owed, the rules of the game changed. Bankruptcy laws were amended to introduce a system of “partial indentured servitude.” An individual with, say, debts equal to 100% of his income could be forced to hand over to the bank 25% of his gross, pre-tax income for the rest of his life, because, the bank could add on, say, 30% interest each year to what a person owed. In the end, a mortgage holder would owe far more than the bank ever received, even though the debtor had worked, in effect, one-quarter time for the bank.
When this new bankruptcy law was passed, no one complained that it interfered with the sanctity of contracts: at the time borrowers incurred their debt, a more humane – and economically rational – bankruptcy law gave them a chance for a fresh start if the burden of debt repayment became too onerous.
That knowledge should have given lenders incentives to make loans only to those who could repay. But lenders perhaps knew that, with the Republicans in control of government, they could make bad loans and then change the law to ensure that they could squeeze the poor.
With one out of four mortgages in the US under water – more owed than the house is worth – there is a growing consensus that the only way to deal with the mess is to write down the value of the principal (what is owed). America has a special procedure for corporate bankruptcy, called Chapter 11, which allows a speedy restructuring by writing down debt, and converting some of it to equity.
It is important to keep enterprises alive as going concerns, in order to preserve jobs and growth. But it is also important to keep families and communities intact. So America needs a “homeowners’ Chapter 11.”
Lenders complain that such a law would violate their property rights. But almost all changes in laws and regulations benefit some at the expense of others. When the 2005 bankruptcy law was passed, lenders were the beneficiaries; they didn’t worry about how the law affected the rights of debtors.
Growing inequality, combined with a flawed system of campaign finance, risks turning America’s legal system into a travesty of justice. Some may still call it the “rule of law,” but it would not be a rule of law that protects the weak against the powerful. Rather, it would enable the powerful to exploit the weak.
In today’s America, the proud claim of “justice for all” is being replaced by the more modest claim of “justice for those who can afford it.” And the number of people who can afford it is rapidly diminishing.
Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University. The paperback version of his latest book, Freefall: Free Markets and the Sinking of the Global Economy, with a new afterword, was published in October.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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hughsansom 03:26 14 Nov 10
A two-tiered structure of American justice is becoming institutionalized. Set aside the American cultural standard of attaching virtue to wealth and fame (that is, people are 'better' merely by dint of being wealthy or famous). The American legal structure is rapidly approaching the point where the wealthy are formally accorded privileged status, much as they were before formal democracy (in feudal Europe, for example).
There is, of course, the treatment of the Wall Street robber bankers. There is, similarly, the exemption granted the entire Bush administration for some of the most heinous crimes (war crimes) in the world in the past 30 years. On a smaller scale, Colorado District Attorney Mark Hurlbert accepted an extraordinarily lenient plea bargain in the case of Martin Erzinger on the grounds that prosecution might threaten Erzinger's wealth. (Erzinger is an executive at Morgan Stanley in Denver.)
Politicalthinker 06:08 17 Nov 10
'In today’s America, the proud claim of “justice for all” is being replaced by the more modest claim of “justice for those who can afford it.” And the number of people who can afford it is rapidly diminishing'
Who defends the poor in America? Justice has been thrown to the dogs.
bluebear 10:32 18 Nov 10
Both thumbs down!
This article made an inferential argument generalizing foreclosure anecdotes to blame US justice system in an illogical manner; then it further articulated a not very resourceful analogous proposal about Chapter 11.
The issues discussed are not about “justice for all” versus “justice for those who can afford it,” but about whether it is injustice to mark prices to market to force those who turned stonewalls by making bad bets face the facts and realize the losses, just to let economic activities move on.
Any foreclosure procedural weakness belongs to the executive side of the justice system and is not manifestation of unfairness in any legislative doctrine and hence is not in line with the inferential argument leading to the suggestion for Chapter 11 on homeownership.
The proposed homeowner’s Chapter 11 would establish a loophole in the form of a risk-free ratchet speculation mechanism through which real estate investment gains would still be private but losses would be public. It would create a run-away counter solution to the present problem as it would cause moral hazard and more housing bubbles.
Chapter 11 on businesses, quite the opposite, has been a means to settle the realization of unrecoverable private losses for public gains. An enterprise may be heavily in debt but as long as its operations generate sustainable cash flows then while it shows neither accounting profit (i.e. has no money to pay interest expenses) nor economic profit (as compared to the scenarios had its financial resources been unimpaired and used in other investments), still it can have significant public value. The value shows in its socioeconomic profit as it creates jobs, is a consumer for its upper supply chains, and is participating in market competition to enhance consumer surpluses for its customers. And thus a legal detachment of the present operating strengths from the historical financing weaknesses is favorable.
farfetched 10:24 19 Nov 10
When Nations and Systems Forget the Real Game
One can assume the Power Elite can affect a nation or a single retirement fund to become squeezed and somewhat oppressed in this current Austerity Environment. They say, market forces cleanse wasteful investments, innovative business models make existing ones obsolete, and the economy roars forward all the stronger for it--or do the Magicians of the Oligarchy running the show from behind the curtains blind us?
rbarthjr 11:28 22 Nov 10
Those interested should read Matt Taibbi's piece in the latest Rolling Stone at http://www.rollingstone.com/politics/news/17390/232611
tradewithdave 03:57 05 Nov 10
Reprinted from the article titled "Stickin' It To Stiglitz" on the website www.tradewithdave.com http://tradewithdave.com/?p=3238
If the American Dream is nothing more than a balance sheet that can be restructured, then why do we send our young men to die in defense of it when we could simply have a bankruptcy judge supply a cram down order of convenience claims and issue a fresh balance sheet of your debt to, or equity from America. Assuming you had a son or husband or father who died for their country the account would be reconciled based on the net present value of a human life based on the calculations included within the recently passed Health Care Reform Bill. This is nothing more than Isaiah Berlin’s Two Concepts of Liberty applied to the Wall Street Bailout of 2007 – 2008. Don’t fall for it. Dave Harrison www.tradewithdave.com
Renowned economist and university professor Joseph Stiglitz wrote a piece for www.project-syndicate.org. I posted a link to the entire article below. As the discussion about the fraudclosure scandal continues to rise in the consciousness, it is increasingly shining the spotlight on the role that property rights play in the extracting of what Adam Smith referred to as the Wealth of Nations. Many folks of the libertarian persuasion are able to offer a very compelling argument that once our rights are boiled down it is evident that all rights are essentially property rights.
My primary issue with Professor Stiglitz position is that the main justification for his version of Homeowner Chapter 11 Bankruptcy is due to the unjust nature of the bankruptcy laws which were passed just prior to the credit crisis and in defense of the predatory lending practices of banks. Rather than building another flawed model on top of our weak foundation, Dave’s position is that the foundation must be strengthened at its core, or rebuilt entirely. The solution is not to add, but rather the solution is to take away.
To help elaborate on my debate with Professor Stiglitz, I have excerpted his article below and added my own text in color.
“It is important to keep enterprises alive as going concerns, in order to preserve jobs and growth. But it is also important to keep families and communities intact. So America needs a “homeowners’ Chapter 11.” Since when is it important to keep enterprises alive? The whole idea behind a free market economy is to let businesses that no longer provide value in the marketplace to be replaced by those that do. It is exactly this type of thinking that leads to bailouts and bonuses for the undeserving few. Am I saying that we shouldn’t have bailed out GM? Indeed I am. Just take a look at Germany if you want to see an example of what happens when you let business do business. If GM had disappeared, within weeks, entrepreneurs would have put together new and vibrant business models and it wouldn’t have taken three years to get around to an IPO and the leaders wouldn’t be checking in with the White House for permission to fly somewhere and the approved transportation method.
“Lenders complain that such a law would violate their property rights. But almost all changes in laws and regulations benefit some at the expense of others.” Are you serious? Do you believe that’s a valid justification for the rule of law… it’s not perfect so let’s just add another law that’s not perfect… and so on… and so on. Ask the Dean at Columbia Law School how he feels about that comment and get back with me. The opposite is true. Yes, laws are flawed but that’s no justification for the justice system or adding yet another administrative layer. “When the 2005 bankruptcy law was passed, lenders were the beneficiaries; they didn’t worry about how the law affected the rights of debtors.” We agree on that? So what’s your point? My point is bulls make money, bears make money and pigs get slaughtered… that is unless they get a bailout, then they just become bigger pigs. If the slaughterhouse of free market capitalism had been left to function as designed, we’d already be through this downturn and there would have been a slight shift in the ratio of homeownership to rental properties back towards its historical equilibrium. If the American Dream is more about owning a home than protecting the rule of law, habeas corpus and distraint, then I’m going to need to see your papers… starting with your constitution.
“Growing inequality, combined with a flawed system of campaign finance, risks turning America’s legal system into a travesty of justice. Some may still call it the “rule of law,” but it would not be a rule of law that protects the weak against the powerful. Rather, it would enable the powerful to exploit the weak.” Last time I looked the system was a republic and we just witnessed first hand the impact of the Citizens United v. FEC decision has had on the election process. Maybe Koch Industries support of the Tea Party bought the outcomes, or maybe the average small business owner was fed up with higher taxes. I don’t know, I’m not a pollster. The whole idea behind the rule of law is not that it is just or unjust, but rather that it is a system of justice that moves ever closer towards the truth although it can never fully achieve the goal due to the inherent flaws within the people who administer the system. The key is that it is a system based on laws, not a system based on the arbitrary nature of the decisions of men. As soon as a corporation can don an American Military Uniform and go into battle and lose its life for its country, then corporations will be something to be honored. Until then, they are simply a tool of the commercial enterprise to manage business risk, not sovereign risk. As far as campaign finance reform and term limits. Well, you might want to give Meg Whitman a call and see how spending all those millions worked for her. I know her media buyer probably is probably not having any problem making the mortgage payment and if the newest group being sworn in inside the beltway doesn’t get it right, term limits are headed their way soon. It’s tough to get the fox to install protection for the hens… that’s the farmer’s responsiblity… Dave’s a farmer.
“In today’s America, the proud claim of “justice for all” is being replaced by the more modest claim of “justice for those who can afford it.” And the number of people who can afford it is rapidly diminishing.” All the more reason that the number of Americans who will be able to afford to go to Columbia University will be falling precipitously while the number of people from Singapore will continue to increase. In our effort to spread the democratic message of freedom and liberty across the globe, we’ve lost sight that without the law of the land in place, the bargian is a Faustian one and the only thing that is gained is a trading partner while what is lost is the life and potential of our most valuable asset – our young men and women in uniform. When will it be too late to turn back? It will never be too late as long as at least one courageous individual remains to declare the truth. Property rights or not, God created man to be free. Don’t tread on me, and for now thanks to the law of the land, don’t tread on my property.