Moral Hazard and the Foreclosure Crisis

An important fact has been omitted from the ongoing discussion of the widespread failure to follow legal procedure not only in foreclosures, but also in forming and managing mortgage backed securities:  This is just another example of the consequences of moral hazard that is deeply engrained in the way our financial markets work.  The financial industry functions on the assumption that contracts and activities that are either illegal or unenforceable under current law will – as long as they involve significant bank losses or liabilities – always be made legal retroactively.

Over the past half century the financial industry has not treated the law as a bedrock institution that constrains the nature of its activities, but rather as a set of rules that can be forced to adapt to the industry’s needs and desires.  Thus, the industry knowingly and deliberately creates standardized contracts that are either designed to circumvent the law or in some cases flatly illegal under current interpretations of the law, and then when a case involving the contract arises (which in many instances happens only long after the standardized contract has become an institution), the financial industry tells the court that the dubious or illegal contract is so widespread that the court would create systemic risk by enforcing the law.  (This idea was established by Kenneth Kettering in “Securitization and its Discontents” and the next two paragraphs draw very heavily from Kettering’s article and perhaps form little more than an opinionated summary of several of his sections.)

Standby letters of credit are a clear example of this phenomenon.  In the 1950s banks started issuing “standby” letters of credit, which unlike traditional letters of credit (which were a form of secured loan) are nothing more than guarantees of the debt of bank clients.  As banking law in the United States has prohibited banks from issuing rendered bank guarantees of client debt unenforceable since at least the early years of the 20th century, the “standby” letter of credit was just an effort to repackage a product that was clearly unenforceable by making use of the name of a bank product of long-standing.  This effort was successful.  By the time that a bank failure led the FDIC to challenge the validity of the standby letter of credit in 1973, the market was so big that the FDIC was not willing to put forth its strongest argument – that as a guarantee, the product was unenforceable – because of the consequences of annulling such a large quantity of bank liabilities.  The consequence of this timidity was to grant the standby letter of credit the same standing in an FDIC resolution as a bank deposit.

Repurchase agreements are another example.  The UCC since 1972 has stated that its provisions on secured transactions apply “to any transaction (regardless of its form) which is intended to create a security interest …”  To argue that repurchase agreements did not fall under UCC §9-102 (now §9-109) because they took the form of a sale and repurchase is to engage in sophistry with the clear purpose of subverting the intent of the law.  And yet in the early 1980s – after the market for repurchase agreements had grown to exceed 5% of US GDP – this is precisely the argument that banks were making to judges in an effort to keep repurchase agreements out of bankruptcy court.  Because there were in fact judges who viewed it as their duty to protect the rule of law from the sophistry of the financiers despite – possibly genuine – claims of systemic risk, the industry did an end-run around the Bankruptcy Code by convincing Congress in 1984 to exempt from the Code those categories of repurchase agreements that were actually traded.

The whole over the counter derivatives market also falls into this category.  In 1936 the Commodities Exchange Act (CEA) codified the common law rules (pp. 722 – 23 in link) that had developed over the previous century by making contracts for future delivery (i.e. derivatives and forwards) legal if either (i) they were traded on an exchange or (ii) the intent of the parties was to settle the contract by transferring the underlying asset.  In 1974 the CEA was amended to explicitly include financial contracts under the provisions above and creating the CFTC as an agency enforcing the CEA.  In short, under the CEA the whole over the counter derivatives market as it developed through the 80s and early 90s was plainly illegal – until in 1993 Congress amended  the CEA to allow the CFTC to exempt certain contracts from the law.  (The CFTC under Wendy Gramm promptly exempted swaps and the controversy over Brooksley Born’s stymied attempts to oversee the over-the-counter derivatives market revolved around the wisdom of this exemption – see especially the comments in this link.  In the second comment, note the securities lawyer’s observation that there was not a single law firm in New York at the time willing to support Rubin/Treasury’s so-called claim that the CFTC did not have jurisdiction over swaps.  The Rubin/Treasury view is here and a more objective view here.)

We have a financial industry that views as normal the practice of deliberately creating systemic risk by developing financial instruments that will cause our largest banks to collapse, if the law in its current form is in fact enforced.  The end result of this process is that we have a legal system that – at least when it comes to financial transactions – is composed of laws written by and for the benefit of financial institutions themselves.

While I have a lot of sympathy for Paul Jackson’s point that these procedural matters don’t really matter to those who have defaulted on their mortgages, because in the vast majority of cases their default means they don’t have much of a legal claim to the house, the complete failure by a financial industry full to the gills with well-paid lawyers and real estate experts to comply with the laws governing mortgages and the transfer of real property is a big issue.  (And I see that Paul Jackson agrees with me on that last point.)  It is a big issue precisely because it demonstrates in very plain terms the financial industry’s utter contempt for the rule of law and for the tax-paying public that is counted on to open its wallet every time a bank sneezes.

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25 comments so far

  1. Multi Medium » Moral Hazard Pays on

    [...] sounds like a pretty correct assessment to me.  In a nutshell: [The financial] industry knowingly and deliberately creates standardized [...]

  2. Frank McGillicuddy, Boston MA on

    banks/financiers have higher standing w legislators since the former issue the egregious amounts of govt debt that the latter need to sustain (at least federally) massive budget deficits – absent the deficits, the debt would be much smaller and the bank/financier’s heft wrt pols would be similarly reduced – y’all made this structure and it’s rhythms over the last 60yrs, don’t surprised if you cannot kick the habit in less than 30yrs (somewhat akin to diets/fitness, perhaps drug addiction)

  3. Frank McGillicuddy, Boston MA on

    and another aspect to consider – the leniency wrt banks that was born/continued 60yrs ago was done so within the ColdWar dynamic – budget deficits were an aid for defense/space spending, and the econ performance of the G7 during that time was very much compared to that of the soviet union and the warsaw pact satellites – today ofcourse, that dog don’t hunt, but inertia carries on…..

  4. [...] government could allow banks to do is to fail and go out of business when they do a lousy job. This post from Synthetic Assets (HT Macroresilience) suggests that the perverse effects of government [...]

  5. Recomendaciones « intelib on

    [...] Moral Hazard and the Foreclosure Crisis [...]

  6. [...] And create it [...]

  7. [...] reasonable enough assumption. After all, they’ve gotten away with so much already. As “Synthetic Assets” points out: “over the past half century the financial industry has not treated the law [...]

  8. [...] on education and health care, and the rule of law has been supplanted by political expedience and corporate moral hazard terrorism.  And why is that?  Because Republicans and conservadems attack progressive ideas as [...]

  9. Sonic Charmer on

    The charge of moral hazard is certainly apt but is slightly at odds with the (implicit) conclusion that finance is somehow uniquely full of a special sort of bad person that has contempt for the rule of law. If the latter were really the issue, or a helpful diagnosis, the answer would seem to involve just getting better people into finance. Which, I don’t think would help. The problem (as with all moral hazard) is the incentives, not the (predictable) reaction of (mostly) normal people to those incentives.

    I am reminded (of all things to analogize this to) of the situation with drug laws. Drug laws nominally (and arguably, somewhat arbitrarily) ban certain sorts of drugs, with harsh penalties etc., but alas many many people do not obey these laws. And if we were to enforce all such laws to the letter in such a way as to reduce violations to near-zero, we’d have to police the populace to an (even more) Orwellian degree and throw (yet more) huge numbers of people in jail.

    So who to blame? You might say that the problem with drug laws is: too many people with contempt for the law; we have a bad populace. Or you might say: we’re not enforcing the law well enough; how could we have allowed this situation to arise?

    But it’s also possible, and should be on the table, to say: perhaps there was something wrong with the laws themselves. And indeed people have and do say exactly that, and then agitate for the laws to be changed, and then they can be changed, and are changed, and probably will change more. Is this because Congress has been captured by druggies? Or is this a natural and healthy process of (written) law evolving closer to natural law?

    Standby letters of credit, bankruptcy-remote SPVs, repos, and the like (none of which I am necessarily a huge fan of or wedded to, mind you, and likewise for CDS, CDOs, etc) all were developed in response to certain demands. Prominent among those demands, obviously, were bankers’ demands for fat paychecks. But they also clearly met the demands of the whoever used them, or the opportunity would not have been there to fatten those paychecks in the first place.

    So, evidently, certain institutions need and have a use for these LOCs. You claim banking law prohibited this (reading the PDF at the link link, it appears the situation is a bit more subtle). But in any event, why should that be so and can it not change? And what do we expect lawyers to do in this context if not attempt to navigate the letter as close to the margin as possible?

    Maybe a more direct comparison worth thinking about is usury (by which I mean here not merely excessive interest but collecting interest altogether). Interest used to be illegal in various Western societies (obviously still is in some places), and then it wasn’t. Is that because interest-collectors had contempt for the law and then captured government. We all tend to view interest as fairly innocuous and unobjectionable nowadays. So is it possible to acknowledge that the law itself was a bit unnatural and unrealistic. Indeed today in places which still nominally ban usury we find a completely analogous response springing up to the one you complain about – ‘Islamic finance’ – another instance of financial ‘innovation’ being created specifically in order to circumvent (however well-intentioned) regulations that are in conflict with market actors’ demands.

    This all suggests another angle one could come at all this from: maybe finance itself is nothing more/less than business of navigating the nominal letter of the law (while ignoring/circumventing its spirit) in order to squeeze maximum value. Do we expect that nobody will engage in doing this. Surely someone will. So, whichever groups/institutions engage in this activity, they are what one can call the ‘financial sector’. And it’s certainly important to identify when (especially) government policy has set up perverse incentives for them, leading to moral hazard – as I think we have. But let’s not be surprised that they do what they do or expect otherwise.

    Instead, I would prefer an approach based on identifying what needs are being unmet (or arbitrages being exploited) that led to such ‘innovations’. In some cases, perhaps those needs are unmet due to misguided government regulation that could painlessly be changed anyway; similarly, perhaps the whole reason for the existence of the arbitrage being exploited (as, I’d argue, is the case with rated securitization) was government regulation.

    If one doesn’t like the fruit being created by institutions working under clear, straightforward motives in predictable response to some given regulatory structure, it’s at least possible that a good remedy could involve changing that regulatory structure. Complaining about the financial sector being inherently anti-rule-of-law etc., however accurate, could mean missing this remedy altogether.

    • csissoko on

      I’ll try to get to a more thorough reply tomorrow. But the big conceptual issue that I’m seeing right now is that you and I have a very different understanding of what it means to be a member of civil society. Most people try to deal respectfully with each other and to contribute positively to each other’s well being. People who are trying to “squeeze maximum value” out of their fellows are the one’s the law is supposed to sideline and in serious cases imprison.

      I don’t understand how a commercial environment is supposed to function if it isn’t founded on respect for ethical behavior.

      • Sonic Charmer on

        Indeed, I don’t agree that the law should “sideline and imprison” those who maximize finances…within the letter of the law (and I find such a sentiment counter to, not a defense of, the rule of law). On a (mostly) smaller scale, many people arrange their finances consciously in order to minimize their tax bill – which is an example of the same thing. I don’t think this is unethical, let alone merits jail time.

        One may always seek to close loopholes, clarify the law etc. in order to remove the usefulness and/or prevalence of some of the resulting ‘innovations’ – especially if they are seen to cause problems – and that is perfectly fair. But it’s not clear how a response based on castigation and reproach for a supposed lack of ‘ethics’ or integration into civil society will help any. These are all, at their core, rather dry legalistic arguments over fine boundaries and definitions, i.e. whether activity X qualifies/fits the definition of banned/regulated activity Y. I fail to see a significant moral or ethical dimension to whether (say) banks can issue Letters of Credit or Letters of Credit-like things. They either can or they can’t, according to the letter of the law. (It sure sounds like they can.) The more interesting question might be what are the bad effects (if any) if they do, and how can those effects be remedied, or the activity disincentivized.

        What a commercial environment needs are clear property rights and rules enforcement, not ‘respect for ethical behavior’ per se. Or, to put it another way, ‘ethical behavior’ needs to be clearly defined, in the letter of the law – not retroactively, in a heated blog post. Again, that’s what rule of law connotes.

        Finally, the implication that finance is somehow uniquely implicated in this sort optimized legal/fiscal navigation is also a bit narrow. You can cite (as the paper does) bankruptcy-remote, off-balance-sheet vehicles as instances of circumventing bankruptcy law; I can cite the GSEs (Fannie Mae and Freddie Mac) as larger, more egregious, and earlier examples of the same basic trick, perpetrated not by unethical ‘finance’ but by the U.S. Government. Was that unethical? If not why not? Or if so how does pointing it out help anything?

      • Sonic Charmer on

        P.S. As widely reported recently, many individuals who took out mortgages – i.e. borrowed money – and couldn’t pay them back are now heading to the courts trying to forestall foreclosure of their home – i.e. stay in a home they haven’t paid for – based on the argument that (in securitization) the legal holder of their mortgage may not have been recorded properly. And they may have a legal case, which might have the practical effect of delaying or even derailing their foreclosure, and/or letting them live rent-free in a house they didn’t pay for.

        So one might say, then, that such defaulted borrowers are trying to maximize value within the letter of the law.

        Is this unethical? Are such people in violation of the norms of civil society, and should they cease and desist all legal challenges immediately and surrender the homes they (plainly) don’t own? If not, why not?

    • csissoko on

      I certainly have never claimed that finance is “full of a special sort of bad person”. I think it’s far more likely that financiers are surrounded by a culture where so-called innovation is considered the pre-eminent goal and that the norms in this environment do not require innovation to meet existing legal criteria but instead financial industry employees are encouraged to “push the boundaries” of the law and do whatever the regulators will let them get away with. In my view such a culture shows contempt for the rule of law. However, this does not take place because the culture is full of bad people, but because it is full of people who are not trained and required to value the rule of law. In short, I don’t see the problem as one of “getting better people into finance”, but as one of completely changing the cultural environment in the financial industry. A combination of large bank resolution and a new regime of punishment (i.e. fines, firing, disbarment) for individual actions that show disrespect for the rule of law would be useful steps.

      I can certainly apply this argument to cultural environments where illegal drug use is the norm, and observe that cultural change would be a good thing there too – but it really has nothing to do with my post.

      It is, of course, a platitude to say that some laws, like usury laws, are wrong and due for a change, but that can hardly justify the financial industry’s modus operandi of creating systemic risk and then demanding change in a law that was not obviously flawed. (In fact that fact that systemic risk was successfully created is a pretty strong indicator that regulators should have been on the ball and enforcing the law in the first place – since it served to forestall systemic risk.) If financial firms want a legal change they should be forced to lobby for it ex ante like the rest of us, not demand that it be implemented after violating it for years.

      Thank you for pointing out that I was careless in stating that standby letters of credit were prohibited. I have edited the text to make it clear that they were simply unenforceable.

      I don’t see the point you’re trying to make in saying that there is a demand for these products. It’s abundantly obvious that the law that makes certain contracts unenforceable developed in an environment where there was a demand for those contracts. Afterall, most of these rules developed out of case law where the judges were evaluating whether or not existing claims should be enforced. In the case of repos, the relevant statute explicitly recognizes that there will be efforts to avoid it. Are you trying to argue that every law that someone has an interest in avoiding should be eliminated? I really don’t understand.

      You continue by claiming that because there a demand for circumvention of the law, “what do we expect lawyers to do in this context if not attempt to navigate the letter as close to the margin as possible”. Do you honestly believe that the only job of lawyers in this environment is to help their clients find a way to circumvent the law? If so, I’d hazard a guess that you’ve spent too much time in an environment where there is little respect for the rule of law. Afterall, remember that we live in a common law country where the law is not just a set of rules, but a set of principles governs too – so the law, itself, properly conceived is really not that easy to circumvent (even if your client can successfully avoid court cases and thus get away with infringements for a very long time). The financiers have for decades gotten away with outrageous behavior because regulators and courts were willing to cater to their “systemic risk” excuse, but the vapidity of this claim was laid bare in 2008. In 2008 we saw the natural consequences of stripping the economy of the legal rules that had been developed over centuries to protect it from system risk, and so I think the game is up. The financiers had a nice few decades of orgiastic excess and it’s time for them to learn that society simply cannot afford their decadent habits.

      You go on: “maybe finance itself is nothing more/less than business of navigating the nominal letter of the law (while ignoring/circumventing its spirit) in order to squeeze maximum value. Do we expect that nobody will engage in doing this. Surely someone will. So, whichever groups/institutions engage in this activity, they are what one can call the ‘financial sector’.” Have you never heard that the job of the financial sector is to support the real economy by directing the resources of savers to their most valuable use? Do you honestly believe that the real economy doesn’t matter anymore and that the whole purpose of finance is to find laws that restrain profitability and circumvent them – independent of the fact that many of these laws were carefully tailored to protect the economy from systemic risk? Once again you seem to have spent too much time in an environment where the rule of law (and the wisdom of centuries past that it embodies) gets short shrift.

      I think we all need to recognize that wise financial policy will necessarily create incentives to subvert that policy – in the same sense that allowing banks to exist creates a strong incentive for owners of banks to give themselves interest-free loans. This does not mean that we should stop imprisoning bank CEOs who defraud the bank through self-dealing. The one thing that’s certain in a credit-based economy is that there will always be a demand for bank assets, like guarantees and commitments on derivative contracts, because these are effectively free (or at least underpriced) forms of money. That fact is not an argument for why these assets should exist. On the contrary, it’s argument for why they should be at a minimum carefully regulated – if not prevented from existing by voiding them under contract law.

      When laws have been developed over the centuries to ensure that finance serves the public policy goal of supporting the real economy, it is extremely short-sighted to claim that the “demand” for circumvention of those goals is evidence of the wisdom of circumventing them. If you want to change certain rules and regulations, that’s fine, but the financiers need to demonstrate the value of changing those rules before they violate them, not after.

      (Sorry for the delayed reply.)

    • csissoko on

      When I refer the the law as “sidelining” those who try to take advantage of their fellow citizens, I was referring to things like the “duty of care” in tort law and the necessity for two parties to a contract to have a similar understanding of what the contract meant (“meeting of minds”). That is, the law imposes clear limits on one person’s ability to take advantage of another — and this is a good thing.

      You seem to envision the law as a set of rules, rather than of principles. The “loopholes” you speak of are frequently violations of the law that are simply meant to test the quality of enforcement (i.e. many tax shelters that make it into the press).

      I can enjoy a little hyperbole now and then, but for the most part what you are calling “castigation” is really just a blunt statement of what the actions look like to me. My kids don’t like it when I tell them they’re making up excuses to justify misconduct either — but that doesn’t mean it’s not my job to call them on their nonsense.

      I think the reason you don’t see a moral aspect to the widespread use of legally unenforceable standby letters of credit in an environment where the FDIC (and indirectly the taxpayer, c.f. the FSLIC) may end up bearing their costs is that you are choosing not to recognize the public policy purpose behind the unenforceability of these contracts. As I noted in my previous comment, in my view it is in the nature of a credit-based financial system to create demand for new bank liabilities (because they are free or underpriced means of expanding the money supply) and thus the creation of incentives for fraud-like behavior is inevitable. The best way to “disincentivize” them is to strictly limit the banking system’s ability to create new forms of liabilities (which was the purpose of each of the common law rules referenced in my original post).

      The way you discuss the “letter of the law” makes it pretty clear that you don’t have a very good understanding of the nature of the law. To quote from Fuller and Eisenberg’s intro Contracts text (which in turn is quoting an 1880 legal tract) “We are constrained then always to leave a considerable part of our meaning to be found out by interpretation, which, in many cases must necessarily cause greater or less obscurity with regard to the exact meaning which our words were intended to convey.” In short, the law is composed of words and words are inherently imprecise, so the “letter of the law” is in many ways a meaningless concept – in a way that the phrase “the law” is not. An important principle underlying the concept of law is that “ethical behavior” cannot be explicitly defined even though most of the time we all know what we mean by the phrase.

      It was precisely because I don’t have a good enough understanding of Kettering’s discussion of the legal status of securitization that I didn’t raise it in my post. I’m also not sure that bankruptcy-remoteness applies to GSE MBS, since they are explicit GSE liabilities, but I go well beyond my knowledge base in mentioning this.

      Finally, I’m more interested in the macro implications of the financial industry’s failure to follow the rule of law. Since most if not all of the banks involved have in-house lawyers who should have been able to set them on the right path and most if not all of the big banks should know that their actions have macroeconomic implications, I hold them more responsible than the individual homeowner who has less understanding of the law and less ability to have an effect on the macro economy.

      • Sonic Charmer on

        Appreciate the substantive & good response(s)! A bit much to chew on & don’t want to (further) hijack your comments section, so I’ll try (& probably fail) to keep it brief while addressing:

        1. IANAL (I am not a lawyer) so you’re right that my understanding of the law is less complete than, for example, yours.

        2. “Circumvent” was a poor/lazy choice of words on my part. “Navigate” was better for what I was trying to describe. I should think it almost tautological that part of what in-house lawyers (of any firm) are meant to do is to help that firm navigate, i.e. stay inside of, the law. I don’t think this is actually the locus of our disagreement anyway though; I can’t imagine you could genuinely dispute this.

        3. To clarify my example of GSEs, in the analogy it was the government which (nominally) removed loans from its (so to speak) ‘balance sheet’ via the maneuver, not the GSEs themselves of course.

        4. I still maintain that rule of law’ is not served by an attitude that people at times ought to be thrown in jail for violating ‘the law’ where ‘the law’ connotes something not fully and objectively encapsulated by the way laws are actually written. This opens the door to enforcement that is arbitrary, politicized, corrupt, etc. I’m sure you understand the nature of this concern (even if you think it misplaced here, or that I have misunderstood you).

        Part of my take-away from you is that the law ought to be enforced more aggressively, more finance people thrown in jail, regulations interpreted expansively and maximally, etc. You base this on a stated concern for the rule of law. But the notion that the world of finance somehow lacks a sufficient critical mass of rules, laws, regulations, oversight, prosecutions, etc. does not jibe with my experience and indeed strikes me as patently absurd. As you probably know: finance is regulated up the wazoo. No single person could possibly comprehend the entirety of (sometimes conflicting) regulations that could or might be brought to bear in situations involving financial transactions/structures. And people in finance basically sign over their lives and privacy to the government. Indeed, it’s my sincere belief that virtually everyone in finance (at least in a position of any kind of sensitivity/decisionmaking) could be prosecuted tomorrow, under some tickytack infraction or another, should the government so decide, including people who think they’re following the law (I’ll use the phrase again as a layperson would; again, IANAL) to the letter.

        Correct me if I’m wrong but you seem to want more of this, and for the law to be interpreted more broadly and less literally (i.e. ‘to the letter’ is not enough for you), under the guise of concern for the rule of law. You give the example that ‘ethical behavior’ cannot be explicitly defined. I totally agree, which is precisely why I am against the idea that such considerations can or should form the basis for laws. If one can’t define the law, one can’t possibly know whether one is in violation of it (in someone else’s eyes) – and, therefore, whether the government can toss them in jail. Again, that is not the rule of law as I recognize the concept.

        We have already seen this with the politicized charges against Goldman Sachs over their Abacus deal earlier in the year. The government proved nothing against them and it has not been sensibly articulated by anyone I have what exactly they did that was illegal; yet, they paid a fine for the obvious and understandable reason of getting the bad publicity behind them. My sense is that this sort of thing could pretty much be done by the government at any time, to any financial actor. That is not well characterized as rule of law, and I don’t think more of it would help – not help stave off crises, nor anything else.

        5. I see that in part our different takes probably stem from our perceptions of what caused/contributed to the crisis and prescriptions for how to avoid same. For example, I see the crisis as having stemmed in no small part from entirely predictable responses to misguided government actions and regulations. This factor is absent from your diagnosis. But if I, too, believed that the crisis was caused by ‘systemic risk’, and that ‘systemic risk’ was caused/instigated by banks developing all these (in some cases possibly dubiously-legal) structures, I might share your opinion about them.

        6. My point re: demand for ‘products’ is not to say that where there’s demand, illegal activity (not that you convinced me that your examples were examples of such) should be legalized. It is simply that such demand and ‘innovation’ tells you what actors’ incentives are and which rules/regulations form a hard boundary for their actions, and that can be important to think about. You may look at the result and think, ‘tough, the regulations are needed’. Valid! But: if you see a predictable sprouting of ‘innovations’ *that you don’t like* and deem harmful (as you have here), it may also be worth asking yourself what regulations incentivized them, and indeed, whether those regulations make sense.

        Again, this is not to say the illegal should be made legal just because someone wants. It is to say, however, don’t complain about the fruit if you yourself planted the tree and won’t chop it down.

        7. As for finance’s job being to ‘direct the resources of savers to their most valuable use’, I guess I agree, but hasten to add that sounds like just a different (I guess, more respectable) way of phrasing what I said. What exactly are finance’s cues/metrics for what is ‘most valuable’ supposed to be, if not: ‘most profitable’?

        Best,

      • csissoko on

        I can certainly understand financiers being frustrated by an excess of regulation and don’t doubt that it may be a problem.

        I don’t really want more regulation. I think there need to be some simple regulatory principles that are actually enforced — and one of the things I think needs to be carefully monitored and restricted are bank liabilities.

        Thanks for a fine discussion!

  10. [...] reasonable enough assumption. After all, they’ve gotten away with so much already. As “Synthetic Assets” points out: “Over the past half century the financial industry has not treated the law [...]

  11. [...] Moral Hazard and the Foreclosure Crisis Synthetic Assets (h/t Richard) [...]

  12. jim on

    CAN SOMEONE ASNWER THIS QUESTION FOR ME PLEASE ….. IS THEIR A LAW CALLED PRIVACY ACT? AND IF THEIR IS WHY DOES’NT THIS COUNTRY ABIDE OR LIVE BY THE RULE OF THE CONSTITUTION.ITS SAD TO THINK THAT YOU SIGNED WITH ONE BANK OR LENDER ONLY TO FIND OUT THAT YOU ARE WITH ANOTHER,AND ANOTHER. WHO GAVE OUR RIGHTS UP TO THE FIANCIAL INSTITUTIONS. SOMEONE PLEASE TELL ME

  13. [...] The problem (as with all moral hazard) is the incentives, not the (predictable) reaction of (mostly) normal people to those incentives. I am reminded (of all things to analogize this to) of the situation with drug laws. … visit. [...]

    • jim on

      WELL BEFORE YOU HAVE MORAL HAZARD YOU HAVE TO HAVE MORALS

  14. [...] there has been a gradual evolution of the creation of a mechanism for systemic economic fraud which will become legal after the fact due to “systemic risk” The financial industry functions on the assumption that contracts and activities that are either [...]

  15. Nathanael on

    Given the massive and blatant criminality, violating not just rules but also principles, which was engaged in by the “servicers” over the past decade, I have no sympathy with Sonic Charmer’s position.

    What we need is something closer to the European “principles-based” accounting regulations. They’re much less specific, but if your behavior seems fishy and contrary to the principles, you get shut down and probably put in jail.

    The uncertainty as to what is illegal promotes caution, and that’s a very good thing. In most areas of law uncertainty about what is illegal would seem bad. But in an industry — finance — with a 5000-year record of running clever scams to cheat people “legally” it’s good to be able to do it.

    • Sonic Charmer on

      uncertainty as to what is illegal

      Is the antithesis of the rule of law. Which the OP has professed an interest in.

  16. leslie on

    SUBJECT: GOLDMAN SACHS EMBEZZLEMENT SCHEME – SECRET SECONDS

    THE LATEST SCAM – DO A TITLE SEARCH ON YOUR PROPERTY – WE DID AND THIS IS WHAT WE FOUND:
    In May 2005 we deposited and invested $200,000 in Real Property, where we recently found out that $118,800 was embezzled out of our property from Mortgage Lenders and Trust Brokerage Companies, namely Goldman Sachs through an escrow Transaction. The $118,800 in funds was paid to these embezzlers from the Investors unbeknownst that the securitization happened by encumbering our property and making up a fraudulent fake Promissory Note and Deed of Trust.

    See the link for further information: https://fdaaccount.box.net/shared/a1pjz9sz5c


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