The Great Credit Contraction: Who, What, When, Where and Why

• Publication year: 2010

Georgia State University Law Review

Volume 26 . „

Article 7

Issue 4 Summer 2010

3-21-2012

The Great Credit Contraction: Who, What, When, Where and Why

Alvin C. Harrell

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Recommended Citation

Harrell, Alvin C. (2009) "The Great Credit Contraction: Who, What, When, Where and Why," Georgia State University Law Review: Vol. 26: Iss. 4, Article 7.

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THE GREAT CREDIT CONTRACTION: WHO, WHAT, WHEN, WHERE AND WHY

Alvin C. Harrell*

Introduction

By now nearly everyone knows that the heart of the current problems in our economy is too little credit, not too much.¹ A salient feature of our current economic crisis is the transition from the credit boom years of 1993-2006, to the credit bust beginning in roughly 2007 and continuing to the present, a period referred to here as the "Great Credit Contraction."² This stands in contrast to much of the

* Professor of Law, Oklahoma City University School of Law. Professor Harrell is the Editor of the Consumer Finance Law Quarterly Report.

1. See Michael R. Crittenden & Marshall Eckblad, Lending Falls at Epic Pace, Wall St. J., Feb. 24, 2010 at Al; S. Mitra Kalita, Beyond the Bubble: The 'Democratization of Credit'Is Over—Now It's Payback Time, wall St. J., Oct. 10, 2009, at Al; David Streitfeld, Rates Are Low, But Banks Balk at Refinancing, N.Y. times, Dec. 13, 2009; Nick Timiraos, Borrowers Pass Up Mortgage Windfall, wall St. J., Mar. 3, 2010, at Al. Importantly, this has not prevented the advancement of legislation and regulation designed to reduce credit availability even further. See, e.g., Alvin c. Harrell, Commentary, The Proposed Consumer Financial Protection Agency Act, 63 consumer FrN. L.Q. REP. 140 (2009); infra Parts II and III.

2. See Kalita, supra note 1. Some have referred to it as The Great Recession. See Justin Lahart, Currents, The Great Recession: A Downturn Sized Up—Unemployment Lines Have Been Long Before, but No Prior Slump Since World War II Has Hurt So Much on So Many Fronts, wall ST. J., July 28, 2009, at A12; Mortimer Zuckerman, The Great Recession Continues, Wall St. J., Jan. 22, 2010, at A19. At this point, some have also declared the recession over, but to others that seems overly optimistic. See Associated Press, At Last the Recession Is Over—What Now?, oklahoman, Oct. 30, 2009, at 3B; Associated Press, Higher Jobless Rates Could Be New Normal, oklahoman, Oct. 20, 2009, at Bl; Stephanie Armour, Foreclosures Break Record, USA Today, July 16,2009, at 3B; Alan S. Blinder, The Economy Has Hit Bottom, wall ST. J., July 24, 2009, at A15 (noting that the bottom of a recession is not the same as a recovery); Jon Hilsenrath & Deborah Solomon, Job Cuts Outpace GDP Fall—Break from Historical Pattern Suggests That Unemployment Could Weigh on Recovery, wall ST. J., July 23, 2009, at A3; Jim Kuhnhenn, Jobless Rate Becomes Obama's New Reality, oklahoman, Nov. 7, 2009, at 3C ("At 10.2 percent. . . unemployment [has] climbed to chart-topping heights unseen in more than a quarter century .... [M]ore than 15 million Americans are out of work and 3.5 million lost their jobs while Obama was president."); Amy Merrick & Conor Dougherty, Plunging Revenue Squeezes State Budgets Further, wall St. J., July 17, 2009, at A3; Sudeep Reddy, Bemanke Sees Slow Recovery as Skittish Consumers Cut Back, wall ST. J., July 23, 2009, at A2; see also Ruth Simon, Foreclosure Rescue Still Bogged Down, wall St. J., Dec. 11, 2009, at A9; The Year in Foreclosures, N.Y. Times, Feb. 15, 2010, at A20 (noting that the foreclosure crisis continues "[e]ven with broad government support for housing . . ."). Clearly, something has gone awry. See, e.g., Associated Press, Stimulus-Related Jobs Don't Add Up in Report, Oklahoman, Oct. 29, 2009, at 3B; Liam Denning, U.S.'s Grossly Distorted Product, Wall ST. J., Oct. 30,2009, at C10; David Enrich & Dan Fitzpatrick,

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academic commentary and public policy initiatives of recent years, which often have focused on the need to restrain credit availability.³ The result is a disconnect between public policy and economic needs that is contributing to the crisis. This article explores this disconnect in the context of the Great Credit Contraction, including the relation between consumer protection law, credit availability, and economic growth (or recession), with consideration given to the ways that misguided legal initiatives may have unintended consequences which contribute to economic volatility and distress.

This article seeks to avoid two analytical weaknesses that seem prevalent in the literature on these issues. One is essentially a lack of analysis—a tendency to describe what happened without explaining how or why. More than one presentation and article have been billed

Loans Shrink as Fear Lingers—Portfolios at Big Banks Fall 2.8% in Last Quarter, wall St. J., July 27, 2009, at Al; Edward P. Lazear, Stimulus and the Jobless Recovery, wall ST. J., Nov. 2, 2009, at A19; Don Mecoy, Economist Calls Recovery 'Half-Baked,'¹ Oklahoman, Feb. 24, 2010, at 4B; Sara Murray, As Retail Sales Climb, Consumers Stay Glum, Wall St. J., Feb. 13, 2010, at A2 (noting decline in the consumer-sentiment index); Peggy Noonan, Declarations, We 're Governed by Callous Children, wall St. J., Oct. 31,2009, at A19 ("[N]o one has any faith in [the government] numbers."); Liz Rappaport & Serena Ng, Lending Squeeze Drags On, wall ST. J., Dec. 8, 2009, at Al; see also Mortimer Zuckerman, Op-Ed., The Economy Is Even Worse Than You Think, Wall St. J., July 14, 2009, at A13; Streitfeld, supra note 1. As noted in this article, among the reasons for these problems is the Great Credit Contraction.

3. See Kurt Eggert, The Great Collapse: How Securitization Caused the Subprime Meltdown, 41 Conn. L. Rev. 1257 (2009). Compare Harrell, supra note 1, with Todd Zyuicki, Complex Loans Didn't Cause the Financial Crisis, Wall St. J., Feb. 19, 2010, at A15. For examples of recent legislation and regulatory initiatives that discourage the availability of consumer credit, see id.; Richard E. Gottlieb & Andrew J. McGuinness, Subprime Lending as a Public Nuisance: Casting Blame Mortgage on Lenders and Wall Street for Inner City Blight, 62 consumer FIN. L.Q. rep. 4 (2008); Stephen F.J. Omstein et al., The Current Residential Mortgage Market Landscape in the United States, 61 consumer fin. L.Q. rep. 891 (2007); Janet Frank, Summary of Banking Regulatory Guidelines for Home Mortgage Lending, 61 Consumer Fin. L.Q. Rep. 154 (2007); infra Part I.B.7. See also Gary Fields, Vermont Mortgage Laws Shut the Door on Bust and Boom, Wall St. J, Aug. 18,2009, at Al (noting that Vermont's strict consumer protection laws "[keep] some Vermonters ... from buying homes."). The restraints on private credit have continued to increase even as direct federal credit subsidies have increased, creating a split personality in credit policy that discourages private credit availability even as public funding has increased. See infra Parts II—III; Editorial, The Fannie Mae Dice Roll Continues, wall ST. J., Nov. 11, 2009, at A20 (describing federal subsidies for residential mortgage credit); Henry Kaufman, The Real Threat to Fed Independence, wall St. J., Nov. 11, 2009, at A21 (noting the recent increase in the Federal Reserve Board's balance sheet to $2.2 trillion, including more than $1 trillion of long-term mortgage-related securities). Not surprisingly, this has resulted in the effective nationalization of the mortgage finance industry, with roughly 90% of mortgage lending being funded by the federal government and the private mortgage market "all but erased." The Fannie Mae Dice Roll Continues, supra; see also, Peter Eavis, Uncle Sam Bets the House on Mortgages, wall St. J., Sept. 18, 2009, at C2; infra Parts n—III.

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in essence as explaining how and why the current credit crisis happened, only to present a factual recitation of the relevant events (Lehman Brothers failed, private credit declined, housing values collapsed, foreclosures soared, etc.) without any explanation of the cause and effect relationships responsible for those events. Yet, absent an understanding of these causes and effects, the analysis is obviously incomplete, and any policy recommendations and responses may be merely band-aids that describe the symptoms without addressing needed reforms.

Another analytical weakness, hopefully avoided here, is the tendency to blame the messenger: to blame contract law for bad economic decisions. Contract law merely allows parties to enter into voluntary economic transactions. Given that voluntary transactions are based on individual assessments of needs and wants, and expectations about the future, which may prove wrong, it is inevitable that some such transactions will go awry. This is even more likely in periods of economic volatility, for example, when an economic boom turns to bust. But contract law does not encourage parties to make bad decisions (that honor belongs elsewhere, as noted below). It is an over-simplification—and an inadequate explanation—to say that the parties made a bad deal because contract law allowed them to do so. This is not to say that contract law should be outside the analysis;⁴ but, if this is where the analysis stops, it will be decidedly incomplete and may lead to a preordained conclusion that is inconsistent with party autonomy and American legal traditions. Because contract law is both the mechanism for and the measure of wealth creation,⁵ the

4. The...