Saturday, November 29, 2008

Prediction 2: The Coming Debt Moratorium

During the recent presidential election both sides of the federal aisle, and their candidates for the presidency, tried to outdo each other in wailing about, and promising relief to, the supposed “victims” of “predatory” lending practices by banks and other lenders.

Then, in a confounding of reason, a nearly a trillion dollars was gifted to the Treasury Secretary to bail out the predators themselves, necessarily creating a horde of other supplicants holding out their beggars’ bowls to catch some of the taxpayer-supplied manna from heaven.

Let’s put aside for the time being the several fascinating issues (e.g., inflation, national debt) that arise from the tulip-craze credit swindles and real estate buying binge of the past several years—caused by democrat-induced fraudulent applications, blind-eye lending decisions, indefensible leverage, and the true definitions of “victim” and “predatory”—and focus instead on what may come next, after the government’s jawboning and arm-twisting of mortgage holders proves unavailing, home foreclosures continue unabated, credit remains frozen, banks continue to fail, debt of all kinds cascades into default, and even commercial mortgages start to tank.

That focus takes us to August 1, 1928.

Mr. and Mrs. John H. Blaisdell sat down with the Home Building & Loan Association and mortgaged a two-story residential building in Minneapolis, Minnesota.

A mortgage is simply another name for a certain kind of contract. The owner (or would-be) owner of real property (the “mortgagor”) pledges it to a lender (the “mortgagee”) as security for a loan. Usually, the proceeds of the loan are used to purchase the property. A common example is the financing arrangement for the purchase of a home. (There can be “chattel” mortgages in personal property, as with financed purchases of automobiles.)

The Blaisdell’s mortgage (i.e., contract) with their lender contained customary, rather simple terms.

In return for putting up their property as collateral, the lender loaned the Blaisdells money. The Blaisdells agreed to repay it in regular monthly installments of principal and interest.

If the Blaisdells didn’t make the payments—if they defaulted on their contractual agreement—the lender could protect its creditor position by foreclosing on the property and selling it at auction.

This is exactly what’s happening today across the country: loan contracts are being breached because of non-payment, and lenders are availing themselves of the legal remedy of foreclosure in order to protect, at least to some extent, the money they loaned.

Back to the Blasidells and the bank.

If the foreclosure sale netted more than the amount Home Building & Loan Association was owed, the excess proceeds would go to the Blaisdells. If it netted less, the borrowing Blaisdells would owe the lender the difference (a “deficiency”).

Another provision of the mortgage contract—automatically inserted there as a requirement of Minnesota law—was a one-year redemption period following a foreclosure sale, during which the Blaisdells could reacquire the property for the price at which it had been sold.

The buyer at the foreclosure sale could get good title only when the one-year redemption period had expired without the Blaisdells having exercised their statutory right of redemption. (Let’s also put aside for now a consideration of by what right the Minnesota legislature could enact a law requiring private contracts to include a right of redemption—a power whose source is far from clear or defensible.)

For a few years the Blaisdells made their regular mortgage payments. Then they stopped.

A foreclosure sale followed, and the lender “bought” the property for exactly the amount then owed on the mortgage. The sale yielded no excess proceeds for the Blaisdells, and no deficiency was owed by them to Home Building & Loan Association which now owned the property subject to the Blaisdell’s one-year statutory right of redemption.

Because the foreclosure sale had occurred on May 2, 1932 the Blaisdells would have had until May 2, 1933 to redeem the property.

But then, a few weeks before that date, providence, in the guise of the State of Minnesota Legislature, intervened. On April 18, 1933, a mere fourteen days before the one-year redemption period was set to expire, the state enacted the “Minnesota Mortgage Moratorium Law”.

The State of Minnesota—not the parties, the Blaisdells and Home Building & Loan Association—had rewritten their mortgage contract.

Why?

As the Minnesota legislature explained,

“Whereas, the severe financial and economic depression existing for several years past has resulted in extremely low prices for the products of the farms and the factories, a great amount of unemployment, an almost complete lack of credit for farmers, business men and property owners and a general and extreme stagnation of business, agriculture and industry, and

“Whereas, many owners of real property, by reason of said conditions, are unable, and it is believed, will for some time be unable to meet all payments as they come due of taxes, interest and principal of mortgages on their properties and are, therefore, threatened with loss of such properties through mortgage foreclosure and judicial sales thereof, and

“Whereas, many such properties have been and are being bid in at mortgage foreclosure . . . sales for prices much below what is believed to be their real values and often for much less than the mortgage or . . . indebtedness, thus entailing deficienc[ies] . . . against the mortgage[es] . . . and

“Whereas, it is believed, and the Legislature of Minnesota hereby declares its belief, that the conditions existing as hereinbefore set forth has created an emergency of such nature that justifies and validates legislation for the extension of the time of redemption from mortgage foreclosure and execution sales and other relief of a like character; and

“Whereas, The State of Minnesota possesses the right under its police power to declare a state of emergency to exist, and

“Whereas, the inherent and fundamental purposes of our government is to safeguard the public and promote the general welfare of the people; and

“Whereas, Under existing conditions the foreclosure of many real estate mortgages by advertisement would prevent fair, open and competitive bidding . . . and

“Whereas, it is believed, and the Legislature of Minnesota hereby declares its belief, that the conditions existing as hereinbefore set forth have created an emergency of such a nature that justifies and validates changes in legislation providing for the temporary manner, method, terms and conditions upon which mortgage foreclosure sales may be had or postponed and jurisdiction to administer equitable relief in connection therewith may be conferred upon the District Court,

* * *
“Section 1. Emergency Declared to Exist. In view of the situation . . . the Legislature of the State of Minnesota hereby declares that a public economic emergency does exist in the State of Minnesota.” (My emphasis throughout.)

Sound familiar?

Just substitute for the “Minnesota Legislature” the “Congress (and President) of the United States,” and these words, and the rationale behind them, could have been written today.

In order to implement the state’s newly declared mortgagor/debtor-relief policy, the Minnesota Mortgage Moratorium Law mandated that foreclosure sales could be postponed, and the redemption period extended until May 1, 1935—two years after the Blaisdells could have redeemed their mortgaged property under the law that existed when they made their contract with the bank .

Taking advantage of the Moratorium Act, the Blaisdells asked a Minnesota court to enter an order extending their redemption period.

The court—apparently recognizing that Article I, Section 10, of the federal Constitution expressly prohibits a state from enacting any law “impairing the obligation of contracts,” and realizing that the Moratorium Act did just that—refused to grant the extension.

So the Blaisdells appealed.

The Minnesota Supreme Court reversed the lower court and granted the two year extension (conditioned on the Blaisdells paying $40.00 “rent” each month).

Consider what had happened.

The Blaisdells had put up their real estate as security for a loan from Home Building & Loan Association. The loan had been defaulted. The lender had to repurchase the property, and then wait almost a year until the statutory redemption period expired before it could have clear title.

Near the end of that period, the Minnesota Legislature rewrote the Blaisdell-Home Building & Loan mortgage contract, the net result being that the lender would have to wait a minimum of another two years before obtaining the property—all the while receiving “rent” instead of the contractually-agreed mortgage payments.

We know why the Minnesota legislature enacted the Moratorium Act.

What was the Supreme Court of Minnesota’s rationale for upholding it?

According to the later Supreme Court of the United States opinion, which we will get to in a moment, the Minnesota court upheld the moratorium law because it was . . . . . .

“ . . . an emergency measure. Although conceding that the obligations of the mortgage contract were impaired [despite the prohibition of Article 1, Section 10], the [Minnesota Supreme Court] decided that what it thus described as an impairment was, notwithstanding the contract clause of the federal Constitution, within the police power of the state as that power was called into execution by the public economic emergency which the Legislature had found to exist.” (My emphasis.)

Actually, the Supreme Court of Minnesota had been even more explicit, and arrogant, about what motivated its decision:

“In addition to the weight to be given the determination of the Legislature that an economic emergency exists which demands relief, the court must take notice of other considerations. The members of the Legislature come from every community of the state and from all the walks of life. They are familiar with conditions generally in every calling, occupation, profession, and business in the state. Not only they, but the courts must be guided by what is common knowledge. It is common knowledge that in the last few years land values have shrunk enormously. Loans made a few years ago upon the basis of the then going values cannot possibly be replaced on the basis of present values.” (My emphasis.)

Justice Olsen of the Minnesota Supreme Court, in a concurring opinion, added the following:

“The present nation wide and world wide business and financial crisis has the same results as if it were caused by flood, earthquake, or disturbance in nature. It has deprived millions of persons in this nation of their employment and means of earning a living for themselves and their families; it has destroyed the value of and the income from all property on which thousands of people depended for a living; it actually has resulted in the loss of their homes by a number of our people, and threatens to result in the loss of their homes by many other people in this state; it has resulted in such widespread want and suffering among our people that private, state and municipal agencies are unable to adequately relieve the want and suffering, and Congress has found it necessary to step in and attempt to remedy the situation by federal aid. Millions of the people’s money were and are yet tied up in closed banks and in business enterprises.” (My emphasis.)

In other words, by “common knowledge” things were rough for depression-era borrowers—just as they are today for some, especially those who tried to game the system by purchasing homes without adequate means to pay for them in the expectation that the bubble would everlastingly get bigger and bigger and never burst—let alone for the wheelers and dealers on Wall Street whose voracious appetite for “investment” vehicles could be satisfied only by more and more rotten paper debt.

But times were tough for Home Building & Loan Association (and other lenders) too, so it appealed the case to the Supreme Court of the United States to protect itself and its depositors.

There, Chief Justice Charles Evans Hughes authored the Court’s majority opinion upholding the constitutionality of the Minnesota Mortgage Moratorium Law.

A significant portion of his opinion consists of a survey of some of the Court’s previous cases, on the basis of which Hughes enunciated a startlingly candid conclusion:

“It is manifest from this review of our decisions that there has been a growing appreciation of public needs and of the necessity of finding ground for a rational compromise between individual rights and public welfare. The settlement and consequent contraction of the public domain, the pressure of a constantly increasing density of population, the interrelation of the activities of our people and the complexity of our economic interests, have inevitably led to an increased use of the organization of society in order to protect the very bases of individual opportunity. Where, in earlier days, it was thought that only the concerns of individuals or of classes were involved, and that those of the state itself were touched only remotely, it has later been found that the fundamental interests of the state are directly affected; and that the question is no longer merely that of one party to a contract as against another, but of the use of reasonable means to safeguard the economic structure upon which the good of all depends.” (My emphasis.)

What Chief Justice Hughes was saying couldn’t be clearer.

Postulating an ever-increasingly complicated social environment in which “the good of all” was the standard of value, Hughes held that “public needs,” “public welfare” and “fundamental interests of the state” trumped, and had to be protected from, something perniciously antithetical: “individual rights.” Necessary, according to Hughes and the Court’s majority, was a “rational compromise between individual rights and public welfare.”

Since the nature of a compromise is “a settlement in which each side gives up some demands or makes concessions,” the concept can have no application to individual rights, which are either absolute or nonexistent.

Indeed the majority’s idea of a compromise—between the sanctity of contracts supposedly guaranteed against government impairment by a specific provision of the Constitution (Article I, Section 10), and the “public welfare” that allegedly required a two-year mortgage moratorium—was to allow Minnesota to rewrite the central provision of the Blaisdells’s contract with their lender (repayment of the loan).

So much for compromise—and contracts, and, for that matter, individual rights.

Although since the Blaisdell decision in 1934 there has been some amelioration of states’ power to nullify the Constitution’s Contract Clause, the precedent still stands. Thus, if the real estate situation worsens and the government’s jawboning and arm-twisting of lenders proves inadequate to forestall foreclosures, no one should be surprised if Congress enacts a federal mortgage moratorium act, or Obama decrees one by Executive Order.

But now of course mortgages are only a relatively small part of the financial meltdown problem. Now, the financial undertow caused by oceans of toxic debt paper is sucking under banks, credit cards providers, the auto industry, and God knows who else. Now, it appears that the world financial and economic structure is drowning.

And what life preserver may Congress and Obama, in their infinite stupidity and disdain for the free market, throw into the churning debt waters? Using the Minnesota Mortgage Moratorium Act as a template and the Supreme Court’s decision in Blaisdell v. Home Building & Loan Association as precedent, it will be a Federal Debt Relief Act. In effect, bankruptcy without bankruptcy.

Or, better put, more of the poison that caused the disease.