Foreclosure and Property Rights

The housing crisis and financial crisis has had a huge effect on my economics classes. Formerly obscure concepts, such as credit default swaps, and mundane points, such as the limits of Fed power, have come to the forefront as important issues that students need to know to fully understand the crisis.

The foreclosure problem is quickly turning into a new teachable moment on the importance of property rights. Quite simply, the announcements by major banks to suspend foreclosures across the country due to problems with the paperwork (due to missing and fraudulent documents) has the potential to cloud the property rights to foreclosed houses across the country. While the legal issues involved are interesting and maddening, from an economics point of view, the confusion over property rights will make it harder for the housing market to function and recover from the crisis. Simply put, who will buy a foreclosed house when the title to it is suspect (title insurance companies are pulling back from issuing new policies on foreclosed properties).

Any solution to this problem will create more problems. If people fighting foreclosure can win either monetary payments from banks not to fight or possibly win title, and lose the mortgage obligations in the in the process because the banks cannot show ownership, than the result is moral hazard to default and more people will challenge the banks. This will have the knock on effect of further weakening the financial positions (and stock values) of the banks. Ignoring the problems with these mortgages will make it easier to foreclose (which has been tried in some states such as Florida), will result in more abuses by banks, such as foreclosing on people who never had a mortgage with the banks. This new part of the crisis stems from attempts to speed up the process, which brought the issue of bank abuse to the light of day.

There is no good solution to this problem. However, there is a good teachable moment.

The core of the teachable moment is this: basic economics teaches that secure property rights are crucial to the functioning of any market. The failure of property rights will cause market failure - in this case, it will prevent the recovery of the housing market. Only governments can enforce property rights.

A good description of how this new part of the crisis has emerged is covered by Mike Konczal at the blog Rortybomb.