The Feudal Mistake

In recent years, mortgages have been carved up into so many pieces that the re-working of mortgages -- and the saving of homes from foreclosure -- is not happening even when there are responsible homeowners who are willing and able to make reasonable payments. Regulators and politicians have done nothing yet to compel the re-working of mortgages, in part because they fear that they will be labeled as trampling upon the constitutional rights to property of the investors who own parts of these troubled mortgages.

That is a huge mistake. Foreclosures are rising, and destroying families and communities. And forcing investors to cooperate in re-working excessively cut-up mortgages is completely consistent with the English and American tradition of property law and property rights.

In feudal England, trade in land was burdened by a legal system that recognized a myriad of current and future interests that could lay claim to any parcel. Underinvestment and illiquidity in the land market was the result. English and American judges created and used legal doctrines to undo the excessive fragmentation of ownership interests in land. Judges read and sometimes simply re-wrote contracts and bequests to promote the holding of land in a "fee simple" -- that is, by a single person or entity with full rights to decide how best to use the land.

In the United States, in the nineteenth century and early twentieth century, oil production was stymied by the fact that the multiple surface land owners of each large underground oil field destructively competed to suck up and "steal" the underground oil from one another. State legislatures responded with tough statutes that compelled surface land owners to hold the underground oil field in a unitary legal structure with centralized management.

In both the feudal and oil field examples, efficient decisions about property could not be made because too many people with different interests had a say over what should be done with the property. Fast forward hundreds of years later, and we see the same basic problem in the American housing market. The structure for mortgage-backed securities that has been used in recent years makes re-working of mortgages a near impossibility. Some mortgage-backed securities holders benefit more if the mortgages do not go into default and the properties do not enter foreclosure, while others benefit more if the mortgages do go into default and the properties do enters into foreclosure. Because many mortgages are pooled in each security, hundreds or even thousands of investors may gain a tiny advantage from any single mortgage not going into default or instead going into default. Under these circumstances, it is not feasible to obtain the consent for a re-working of a mortgage from of all the investors who may have some kind of financial stake.

Congress should draw inspiration from the judges and legislators of the past who tackled feudal land and oil field inefficiencies, and, by statute, eliminate any requirement that all investors in a mortgage consent to the re-working of the mortgage. Instead, government-appointed trustees should be authorized to employ the same criteria for re-working that a community bank traditionally would use when it holds a 100% stake in the mortgage. Mortgages that can be saved by writing down principal to current housing values will be saved, and the housing market will stabilize. Our property law and property rights tradition simply does not require, or even allow, our lawmakers to sit back while the ill-advised chopping up of property into competing interest creates a gridlock that undermines national prosperity. As Abraham Lincoln famously remarked, the Constitution is not a suicide pact.

David Dana, professor of law and associate dean for academic affairs at Northwestern University School of Law, is a leading scholar in the fields of environmental, property, intellectual property and professional responsibility law.

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