Balancing the rights and responsibilities of borrowers and lenders isn’t easy, but it is important that a society do it well. This not only involves issues of fairness but also of economic efficiency. Get it wrong and not only will injustices occur, but an economy will be less productive than it might be.
This balance issue arose in the recent request by Minnesota Attorney General Lori Swanson that the Legislature pass a law specifying steps creditors must take before courts grant them default judgments. This effort targets collection companies that specialize in buying unpaid bills from banks and credit card firms at deep discounts from their nominal values and then using all legal means to collect.
Swanson’s proposed measures include a requirement that creditors verify the current address of the debtor rather than using what may be a years-old address on the original documentation. It is not uncommon for creditors to get summary court judgments in their favor because the debtor apparently made no response to earlier duns — but only because the paperwork never got to them.
The same balance issue also lays at the heart of the recent $8.5 million agreement between 10 banks and the U.S. Office of the Comptroller of the Currency to settle charges of their illegal practices in foreclosing on homes with mortgages in default or in processing requests for loan modifications. The practices included violations of the Service members Civil Relief Act, or SCRA, that gives specific protections to members of the military on active duty. The OCC is the primary regulator for banks with federal charters.
Balancing the rights and responsibilities of debtors and creditors is not easy. Make it too hard to collect debts and you deprive lenders of their property unjustly. Make it too easy and some borrowers will suffer from abusive collection practices. These are questions of fairness or justice or “equity,” as economists use the term.
But there also are efficiency issues. Make it hard for creditors to collect, and potential lenders would be less willing to venture their financial capital for others to put to productive use. Tilt the scales against borrowers and people will be deterred from seeking funds that, prudently used, would make their lives better or their businesses more productive.
The question goes far back in history. The Old Testament is full of passages that deal with circumstances, such as the Year of Jubilee, in which debts must be forgiven and bonded servants freed. Condemnation of creditors who abused debtors is a feature of the minor prophets. And secular philosophers in Greece and Rome examined the same themes.
Some of my students at a conservative Christian college where I once taught thought Jehovah was way too easy on deadbeats and noted that modern economic theory would predict that it would become harder to borrow anywhere as one approached the Jubilee.
Theoretically there is some “sweet spot,” balancing the rights of both parties to credit transactions than optimizes the flow of savings into productive uses and thus produces the greatest output of goods and services to meet the needs of society. Borrowers and lenders should both take on some, but not too much, risk. Unfortunately, it is impossible to say exactly what would constitute this balance.
Ronald Coase, the 1991 Nobel laureate, argued that one could achieve economic efficiency as long as the rules of the game were precisely defined and understood by all parties. This clear definition is more important than the actual rule.
For example, with regard to the attorney general’s beef about debt collectors, Coase might respond that one could pass a law like the one the Swanson wants that requires the creditor to verify current address before a judgment can be issued. But he might also say it is the responsibility of the debtor to inform the creditor of any address changes if they want to avoid being liable for a summary judgment. One’s views on which approach is more just could vary, he might say, but you can get an economically efficient outcome either way.
Of course, enforcement is necessary. The SCRA is pretty clear about what lenders to servicemembers may and may not do, but some of the nation’s largest banks ignored this clear law. Clear laws requiring that banks seeking foreclosure had to review all of the facts and documents about a mortgage did not prevent the banks from hiring third-party contractors who robo-signed as many as 400 files a day, attesting that they personally had carefully reviewed each file.
I don’t know whether the legislation sought by Swanson will pass, but it seems reasonable. The federal government is belatedly enforcing the law, but like the banks it regulates, it does not have enough resources to clean up the mess that we engineered over the 10 years running up to 2008. The new Consumer Financial Protection Bureau set up in the Dodd-Frank act and loathed by many Republicans in Congress certainly marks a move in favor of borrowers and against lenders. It remains to be seen whether it will fly or survive the next period in which the GOP controls the White House and Congress.
Critics of the bureau correctly point out that tilting in favor of borrowers will decrease the availability of loans. But, given the fact that, in the past, many loans were made to people who should not have gotten one, fewer risky loans may be good for society. But the new rules may also raise borrowing costs for the rest of us, too.