The rule of law

The Georgia Legislature was engaged in an interesting debate last week.  At issue was a bill that would prevent the successor creditor of a debt - specifically intended to to mean the buyers of loan portfolios from the FDIC when it works out a failed bank - from pursuing the guarantor on such loans - specifically intended in this case to benefit developers whose projects were stalled or killed by the Great Real Estate Debacle of 2008 - for any more money than the buyer paid for the loan itself.  In other words, if the debt was purchased at 40 cents on the dollar, the guarantor's liability would be limited to that 40 percent of the loan.  


As is frequently the case in the world, for every problem there is a solution which is easy to understand, simple to implement and dead wrong.  This was another example.  The proponents argued that the bill is about fairness - a simple concept.  The bill would prevent some vulture from sweeping in and making a substantial profit from the individual guarantor.  


And it would be easy to implement - if you are the buyer, you give up the right to more than your purchase price against the guarantor.  End of story.  Nobody is forcing you to buy the distressed loans of a failed bank.


(I will not pursue one line of objections to the bill - that the developers made millions in the decade leading up to the debacle and many of them pocketed the development loans.  Rule #1 still applies and I will not imply malice while stupidity is still available as an explanation - we will presume that the developers who benefit from this bill were just hopelessly over-extended and got crushed when the economy tanked.  Greedy is different than evil; and in this case, greedy is enough.)


Except in classic fashion, the bill didn't just say if you buy distressed loans from a failed bank you give up the right to collect more than the purchase price from the guarantor.  Instead it said that all successor creditors were barred from pursuing guarantors on any debt beyond the purchase price.  That sweeping generalization led to a storm of protest from all sorts of places that the bill's author had never thought about - car notes, equipment lessors, and lots and lots of small banks with weak loan portfolios who didn't appreciate being told that the market to sell those loans in was going to dry up.


To flip to the end of the game, eventually all of the objections to the sweeping nature of the bill caused the final product to be amended to really say what the tool of developers who originally introduced the bill meant to say - buyers of loan portfolios from FDIC asset sales are limited in their ability to pursue guarantors to the purchase price of the loan.  The final version is so narrow that they almost could have named the company that they were trying to inflict this on - except that is unconstitutional.


(The whole thing may very well be unconstitutional.  I'll not bore you with a lot of legal argument.  It's just that legislatures aren't allowed to pass laws that change the terms of existing contracts.  That, by the way, is why the Democratic congress of 2009 couldn't actually just re-write everyone's mortgage to a lower interest rate so that fewer people would default.  They might have wanted too, but that pesky Constitution got in the way again.)


But the final bill, which is yet to come to a vote in the Georgia House, still has a major flaw.  The problem is that the Georgia legislature (and not only Georgia's, because this state is almost never on the cutting edge of anything, so the same lobbyists who got this introduced in Georgia are doing the same elsewhere) has declared that promises don't mean anything.  In certain, very limited, situations, a promise to pay is malleable.  And I bet that 99 out of 100 people promoting this bill - legislators and beneficiaries - have at some point said their word is their bond.  


One of the least appealing features of democracy is how the governing bodies have a tendency to forget what was important six months ago.  One of the biggest arguments against the bank bailouts was that it created a situation where banks could be wildly reckless with their assets - investing ludicrous sums of money (mostly other people's money) in virtually-bogus financial instruments because there were massive profits to be made when the next chump bought them from the bank.  There is no moral hazard - it was I win, you lose.


This "spend like a drunken sailor, we'll take care of you when it goes south" message was a great talking point.  Unless we make sure banks don't do this again, we're just encouraging risky behavior.  It was all the rage.  But nothing came of it, banks are back in the black, probably investing our money in ways that defy explanation, and there is no more regulation than there was in 2007.


And now, the Georgia legislature, taking a cold-eyed look at the amount of money developers poured into their campaigns, has done exactly the same thing.  "It doesn't matter that your company actually got the money; it doesn't matter that you made a promise to pay the money back if the company couldn't; if the bank that loaned you the money goes under (in part because your loan and bunch of others are secured by 400 acres of worthless red clay), you can sleep easier knowing that your exposure is limited to the steep discount someone pays for a bunch of bad loans."


A disclaimer.  When I put on the glasses and suit and kiss Lois Lane goodbye each morning, I become a lawyer who represents creditors. Not the creditors involved in this particular transaction, but creditors nonetheless - ones that rely upon the basic truths that when you buy something you are supposed to pay for it, and when you promise to pay for something, your promise is enforceable.


It is called the rule of law.  It is an essential cornerstone of capitalism.  If your promise to pay cannot be enforced then why should I sell to you?  Countries where there is uncertainty have a hell of time getting investment money.


For now, the Lege decided not to publicly declare that Georgia was a backward economy operating by crony capitalism - who you know determines what the rules are.  But they've cracked open the door.