Mayor Koch Makes a Couple of Good Points

Former Mayor Ed Koch doesn't blog, but he does send out from an email list maintained by his law office an occasional letter with his opinion of movies he has seen recently and sometimes he provides some comments on local or national political issues. He has taken positions on individuals in the news, such as candidates for public office.

Today, on the eve of President Obama's much-awaited speech with new proposals for job creation, the Mayor proposes that the President include the proposal that "the bankruptcy laws be amended immediately to empower bankruptcy judges to reduce principal as well as interest."

This would help clear the sticky foreclosure process. Houses lose value when banks push forward their claims slowly. Some banks do not want to reveal too quickly how many mortgages they signed on to are substandard and are being foreclosed on.

The usual argument against allowing bankruptcy courts to write down the principal owed is “moral hazard”. (This is an insurance term referring to the hazard that insurance can remove the incentive for insured owners to look after their property. Over-insurance, for example, creates a moral hazard because the insured gets more from the property when it is destroyed than the property is worth. Someone who is not moral might torch their own property.)

The argument against allowing bankruptcy courts to write down principal is that it would, in the Mayor's words, "encourage future borrowers to borrow more than they could repay."

Then the Mayor delivers his zinger, addressed to the President:

If “moral hazard” were the standard, why were the banks, which made decisions that were financially devastating to this country, bailed out to the tune of billions of dollars by laws enacted by Congress and signed by you, as well as actions taken by the Federal Reserve?  Remember, Mr. President, that banks were given those billions to provide liquidity to businesses, but instead used the taxpayers’ monies to buy U.S. Treasury bonds to enhance their balance sheets with the interest received.

Something needs to be done to finish "marking to market" in the housing industry. Borrowers have received a lot less help from the government than the lenders. The Mayor's proposal would redress the balance for the remaining borrowers. This would be a good addition to the President's proposals.