In times like these, it’s the little things that mean a lot. For example, a mere 2 pages of the 1279-page Wall Street Reform and Consumer Protection Act of 2009 (HR 4173; Title IV, Section 4105(c)) – if it survives the Senate gauntlet - will create a functional research unit in a new Federal Consumer Financial Protection Agency. The research unit will have a mandate to, among other things, conduct research on consumer financial counseling and education in the areas of debt, credit, savings, financial product usage, and financial planning; to identify ways to incorporate new technology for the delivery and evaluation of financial counseling and education efforts; to research, analyze, and report on multiple aspects of consumer behavior with respect to financial products or services, including consumer awareness and understanding of disclosures, communications, costs, risks and benefits, and current and prospective developments in existing and alternative markets for consumer financial products and services.

Though the federal research mandate presently focuses only on consumers, and ignores Wall Street as a subject of empirical inquiry, it is a good start. Theoretical and empirical work in behavioral economics of Wall Street and consumers began before the watershed bailout of 2008, defined some of the questions Congress now asks, and framed broader questions that may help us understand how we got into this mess, make empirically informed decisions to help us get out of it, and prevent a recurrence. Whether a federal research mandate becomes law or not, this research is likely to continue.

For example, Harvard’s Joint Center for Housing Studies reported in 2007 that the increase in mortgage defaults and foreclosure was caused by several factors, including borrowers taking out loans they did not understand or that were not suitable for their needs; borrowers having limited ability to evaluate complex mortgage products and often making choices they regretted after the fact; and some mortgage marketing and sales efforts that were designed to exploit consumer ignorance and decision-making weaknesses and encourage consumers to select inappropriate mortgage products that could not be repaid and in fact worsened the consumers’ economic circumstances. Essene & Apgar, Understanding Mortgage Market Behavior: Creating Good Mortgage Options for All Americans, Joint Center for Housing Studies, Harvard University (2007). The authors noted that the field of behavioral economics sheds some light on consumer behavior in the mortgage marketplace. They reported, for example, that consumer preferences are malleable, not fixed, and depend on how their choices are framed and the context and order in which information is presented; and that consumers choose mortgage products without being fully informed about them, due to the products’ complexity, the lack of transparency in the price of the loan, and the timing of disclosures (at the closing table). Further, consumers struggle with choices that involve risks and payments over time. They recommended that consumers be provided with a network of “trusted advisors” to advise them of the risks and benefits of mortgage products, that they should be steered toward beneficial loans, that the mortgage industry should increase self-regulation and improve transparency, and should establish minimum standards for mortgage brokers, loan originators, and lenders.

After the historic bailout of 2008, one of several analyses of the behavioral economics of subprime mortgages suggests that subprime mortgage products were in fact designed, in part, to allow the true costs of the mortgages to be hidden in complex, non-salient features of the loans, and to reach consumers who were not able or inclined to study those non-salient features, and therefore did not comprehend the true cost of these “deferred cost” loans. Bar-Gill, The Law, Economics, and Psychology of Subprime Mortgage Contracts, 94 Cornell L. Rev. 1073 (2009). The author acknowledges that there were cases in which unscrupulous lenders pushed high-risk loans onto borrowers who were incapable of repaying them, and of irresponsible borrowers lying on loan applications or taking out loans they could not repay, but the more common scenario was not one in which the lenders were evil or the borrowers were fraudulent or irresponsible. Rather, Bar-Gill suggests that borrowers - being human - were “imperfectly rational” in that they were “myopic” (placing excessive weight on short-term benefits and insufficient weight on long-term costs of high-risk loans) and overly optimistic about future income, cost of credit, and increases in real estate values. Concurrently, lenders and loan originators - exercising business judgment in the frenzied market for mortgage-backed securities - exploited and reinforced the market demand for financing driven by borrowers’ myopia and optimism. The “main culprit” in this scenario was securitization, in Bar-Gill’s view, which incentivized the intermediaries between the investors and the borrowers with immediate compensation based on quantity, rather than quality, of the underlying loans, in a manner in which their interests were not aligned with either the investors or the borrowers.

Looking beyond the causes to some of the effects of the mortgage meltdown, a recent discussion paper summarizes behavioral economic aspects of homeowner perceptions of default and foreclosure, psychological factors that affect homeowner decisions to not “walk away” from homes with negative equity even though it may be financially prudent to do so, and behavior of loan servicers in making decisions concerning modification of mortgage loans. White, Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis, Arizona Legal Studies Discussion Paper No. 09-35 (December 2009). Research shows that humans are easily overwhelmed by the mathematical calculations involved in evaluating the financial benefits and costs of “strategically defaulting” on a mortgage, have cognitive biases that impair their ability to grasp the long-term benefits of default, suffer from selective perception that causes them to fail to see evidence that their homes are suffering steep declines in value that may not be recovered in their lifetimes, tend toward “optimistic overconfidence” that home prices will “bounce back” and their homes will soon be worth more than they paid, and make decisions based on emotional biases that prevent them from accepting that their homes are worth tens- or hundreds-of-thousands of dollars less than they owe for them. White points out that risk analysts have studied the relationships between default and such factors as loan-to-value ratio, current equity, affordability, credit scores, geography, and unemployment – but have not extensively studied the relationship between default and psychological factors such as guilt, shame, embarrassment, and fear. White argues that lenders, loan servicers, government, credit reporting services, non-profits, and other cultural forces reinforce the latter, and act amorally in asymmetrically imposing shame, fear, and guilt on homeowners who may be financially better off defaulting on their mortgages, and should not be stigmatized because they can no longer afford to make a financially imprudent mortgage payment. He concludes:

Regardless of the precise policy prescription, it is time to put to rest the assumption that a borrower who exercises the option to default is somehow immoral or irresponsible.  To the contrary, walking away may be the most financially responsible choice if it allows one to meet one’s unsecured credit obligations or provide for the future economic stability of one’s family.  Individuals should not be artificially discouraged on the basis of “morality” from making financially prudent decisions, particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices.  The current housing bust should be viewed for what it is: a market failure – not a moral failure on the part of American homeowners.  White, supra, p. 52

Future directions for influencing public policy with behavioral science research are suggested by Amir and Lobel, Stumble, Predict, Nudge: How Behavioral Economics Informs Law and Policy, 108 Colum. L. Rev. 2098 (2009). The authors review two recent behavioral economics books by leading scholars in the field (Thaler & Sunstein, Nudge: Improving Decisions about Health, Wealth & Happiness (New Haven: Yale University Press, 2008); Ariely, Predictably Irrational: The Hidden Forces that Shape Our Decisions (New York: HarperCollins, 2008)), and suggest that – in order to more effectively influence public policy and law – the field should include multidisciplinary research in economics, psychology, sociology, and organizational behavior, and field studies on salient policy questions, in addition to traditional laboratory experiments. They propose that law and multidisciplinary behavioral studies explore “. . . contexts and spheres of action in which individuals behave irrationally and those in which experience, expertise, information and incentives have elevated market actors close to the status of true ‘Econs’. . .,” and suggest that the research complement an emerging “new governance” model to enhance problem-solving, self-regulation, and government-industry cooperation.

The time is ripe for a multidisciplinary effort to provide theoretical and empirical foundations for law and policy governing economic relations among consumers, loan originators, loan servicers, underwriters and issuers of mortgage-backed securities, and investors in mortgage-backed securities. The foregoing small sample of recent scholarship in the field provides some indication of what we know, and some guidance as to where we may go from here.

In Goodwin v District Court, 779 P.2d 837 (Colo. 1989), the Colorado Supreme Court vacated an Order that authorized sale of a home in a foreclosure proceeding, where the evidence showed that the party who had foreclosed on the property had, in fact, assigned its interest in the promissory note secured by the deed of trust.  The Court ruled that a party trying to foreclose has the burden of proving that it is the real party in interest.   In order to prove that it is the real party in interest, it must show that it holds legal title to the promissory note.  Platte Valley Savings & Loan v Crall, 821 P.2d 305 (Colo. App. 1991); American Surety Co. v Scott, 63 F.2d 961 (10th Cir. 1933).   If the party is not the original beneficiary on the note, and claims that the note was assigned to it, it must prove a full and complete assignment from the assignor - i.e., from the party who held legal title to the note - to convince the Court that the homeowner will not be subject to other foreclosure actions by other parties who actually hold legal title to the note.  Alpine Associates, Inc. v. KP & R, Inc., 802 P.2d 1119 (Colo. App. 1990).

If the original note has been sold to one or more other parties - as may well be the case where the note has been sold to a “Trust” under the terms of a “Pooling and Service Agreement,” and the Trust has, in turn, created and sold several classes of securities to investors in “Mortgage Backed Securities” - it may be necessary for the Trust or the Investors to initiate the foreclosure action, if they can prove they hold legal title to the note.  Or, a representative of those parties may proceed with a foreclosure if the representative is able to prove full and complete assignments from the owner or owners of the note.

Each case is unique, and a homeowner facing a foreclosure should seek legal counsel to review all documentation related to the property and the foreclosure in order to make an informed decision as to how or whether to oppose a foreclosure.  The question of “who is suing you” is the first question to ask in defense of a foreclosure these days.  It is only the first of many questions that may arise, but it is definitely a wise place to start.

If you would like some informative reading on these issues, check out the Foreclosure Defense Group.  And call your lawyer if you have any questions.

                                    Dorothy

If the financial crisis has taken you on a wild ride and left you feeling like you’re wandering on a winding road in a strange land, hang in there.  You may find your way home with some help from the great and powerful Prez. 

President Obama announced his Homeowner Affordability and Stability Plan today, with the intent to “. . . help up to 7 to 9 million families restructure or refinance their mortgages to avoid foreclosure.”   The plan provides for refinancing of loans owned or guaranteed by Fannie Mae or Freddie Mac, to make mortgage payments more affordable for those who have made their payments on time but have not been able to refinance due to declining home values, and those at risk of default.  The plan will be implemented under guidelines to be developed by the Department of Treasury, provides incentives for loan servicers and borrowers to refinance the loans and stay current, and requires all financial institutions receiving Financial Stability Plan assistance to implement loan modification plans consistent with the Treasury guidelines.  Though the plan presently applies only to Fannie Mae and Freddie Mac loans, the Administration intends to work with federal and state agencies to implement the upcoming Treasury Guidelines across the entire mortgage market, when permissible and appropriate, including loans owned or guaranteed by Ginnie Mae, the Federal Housing Administration, Treasury, the Federal Reserve, the FDIC, Veterans’ Affairs, the Department of Agriculture, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration. 

The program applies only to homeowners who want to stay in their homes - not to “speculators or house flippers” - and is available to homeowners whose house is worth less than the mortgage balance, or who have a high combined mortgage debt compared to income, even if the homeowner is not in default on the mortgage payments.  Lenders are required to reduce interest rates so the borrower’s monthly payment is no more than 38% of the borrower’s income, the fed would match further reductions in interest rates dollar-for-dollar with the lender, down to a 31% debt-to-income ratio, and lenders will be required to keep the modified payments in place for five years - after which the interest rate may be gradually stepped up to the conforming loan rate in place at the time of the modification.

President Obama also announced upcoming measures to allow judicial modifications of home mortgages during bankruptcy for borrowers who have run out of options, and to provide relocation and other forms of assistance for renters displaced by foreclosure.  The bankruptcy provisions would require homeowners to first ask their servicers/lenders for a modification, and certify compliance with reasonable requests from the servicer to provide essential information.  This provision would apply only to existing mortgages under Fannie Mae and Freddie Mac conforming loan limits, “. . . so that millionaire homes don’t clog the bankruptcy courts.”

The guidelines for the program are scheduled to be announced on March 4, 2009, after which homeowners whose loans are owned or securitized by Fannie Mae or Freddie Mac may apply to their mortgage lender or servicer for refinancing under the program.  Homeowners whose loans are already scheduled for foreclosure may contact the loan servicer to see if the loan may qualify under the program when it becomes available.  The lender is not required to postpone the foreclosure, but many lenders have expressed an intent to postpone foreclosure sales on mortgages that may qualify for a modification under the program. 

Meanwhile, homeowners who believe they may qualify for the program are advised by the Administration to gather information they will need when the program begins on March 4, including documentation of monthly gross income, most recent income tax return, information about any second mortgage, payments on credit cars on which balances are carried, and payments on other loans, such as student or car loans. 

If you think you qualify for this program, follow the instructions on the links of this post, contact your lender, and get started.  There will be an onslaught of calls to lenders and servicers, so thorough preparation will help to expedite your application and make sure you’re ready, when the time comes, to click the heels of your ruby slippers.

Inspired by the possibility of a “Middle Class of Artists” on Web 2.0, a stellar panel discusses a range of legal and policy issues that will be addressed in coming months and years - and will set a course for the telecommunications industry for generations to come - in areas including radio, broadband, copyright, creative commons, and others affected by the ongoing transformation of music industry business models.  There’s no guaranty you’ll make any money, of course, but at least you will be better-informed in your approach to the business of music.  Segments of the sessions, held February 11, 2009, are available via webcast on the FMC Blog and on web.illish.us.  A few tip-of-the-iceberg highlights:

• The FCC authorized low power FM (LPFM) local radio stations in 1999.  Commercial broadcasters, which had consolidated many stations in the 1990s, raised various objections to the LPFM Platform, but an FCC study was completed in 2003 that addressed those objections.  The new political climate in DC provides a forum to create local LPFM radio, and allow local non-profit and commercial broadcasters to recapture radio’s place as the voice for local culture, including - of course - local music.  The challenge for Congress and the FCC will be to balance public and private rights, duties and responsibilities in the airwaves, and create regulatory structures that allow local commercial LPFM radio the opportunity to compete in commercial markets, and non-profit LPFM radio opportunities and support in serving local culture.  The future of local radio will be determined largely by - you guessed it - you!  Drop a line to your representatives in DC and tell them where you stand on local radio.  While you’re at it, make sure to tell them you want each LPFM station to broadcast on the web.

• The regulatory framework for telecommunications - including such things as broadband deployment, network neutrality, and spectrum reform - has been identified as a priority for the Obama administration.  FMC panelists seemed to agree that broadband is the “key enabling application” for independent artists, and it has the potential to create an artist middle class of indies with successful business models.  Panelists saw centralized control over spectrum allocation to be a real threat to use of the internet as a creative and business medium for indie artists, and argued that regulatory models created 75 years ago - that hampered open access to radio in the 1920s, television in the 1950s, and cable in the 1980s - should be changed to promote both social and economic interests, and to prevent disenfranchisement of users of the internet.  There is a lot of activity in this area, and now is a good time to get involved in policy discussions if you want to have an impact.

• The transition documents of the Obama administration state an intent to “. . . update and reform our copyright and patent systems to promote civic discourse, innovation, and investment while ensuring that intellectual property owners are fairly treated. . . .”.   Most of the media attention given to the decline of record labels, artists going out on their own, P2P file sharers being prosecuted by the RIAA, Facebook being sued for copyright infringement, etc., etc., etc., arises from conflicts between content creators (e.g., songwriters) and users (listeners), and everyone in between (e.g., performers, publishers, record labels, performing rights societies, etc.).  There is a lot of litigation going on these days as established music industry business models and laws are challenged by rapid advances of the internet, and by an expanding global apprehension that music on the internet is free.  Legal and policy issues are being actively defined in both the Courts and the Congress, as new technologies are typically applied and adopted so rapidly (e.g., P2P, YouTube) that the law governing rights of content owners and their representatives under former technologies and applications is under constant challenge and revision.  Future posts will address copyright, copyleft, creative commons, and related matters.  For now, if you’re an indie artist, why not protect your ownership interests in your work so you will be free to either make money on it or give it away, as you choose?  Learn as much as you can, protect your rights, and become involved however you choose in ongoing legal and policy debates.

• Imagine you’re sitting on a planter on a downtown street corner in your home town, playing your guitar, and your old brass spittoon is on the sidewalk in front of you, and maybe 100 people walk by while you’re playing and maybe one-of-every-ten of them drops a buck in the spittoon, so when you pack up you have 10 bucks.  Now imagine your buddy, who has a (part-time) day job at a local Web 2.0 start-up, drops by and sets you up on a live webcast, and your audience is now, let’s say, 6 billion, and you ask your buddy if he knows how to set you up so one-of-every-ten of the 6 billion (i.e., 600 million) can drop a buck in your spittoon, and your buddy says, “Done deal, dude,” then disappears.  Now imagine you go to the FMC panel on the Digital Music Marketplace and you hear how the web is an awesome opportunity for indies, and you hear some great ideas, some of which worked and some of which didn’t, and you hear there’s no single proven solution for making money with your music on the web, so you have to be creative, maybe even give free downloads so you can sell Ts, etc., etc. - and you wish you could find your buddy because he made it sound so simple and he seemed so sure . . . .

Get involved.  Change your world.

, , , not only be the right thing to do to keep American families in their homes, but we believe it would allow OTS-regulated thrifts to avoid the costs of foreclosures in cases where modifications might be feasible under the Plan.

“. . . decided to discard the assumption of  market rationality that underlies most economics and to embrace the psychological insights of what’s known as ‘behavioral economics.’ . . .” and that Roubini “. . . and other prominent economics are paying more attention to behavioral economics, which starts from the premise that economic decisions, like other aspects of human behavior, are influenced by irrational psychological factors.”

This statement, standing alone, may appear superfluous, intuitively obvious, and just another ex post facto remark inspired by 20-20 hindsight.  Of course, we’re irrational.  We’re human.  But there is more to it than that - there is a reservoir of theoretical and empirical knowledge in the field of behavioral economics that, as suggested in a recent post, may guide systematic empirical research to inform emerging economic policy in the U. S. and the world.  I am not suggesting that behavioral economics has all the answers to all the questions, but I am saying it provides a context within which significant questions may be asked.  And I offer a forum to begin asking these questions.

I was recently reappointed to chair the Behavioral Science Committee of the ABA Section of Science and Technology, and am considering how best to approach a discussion of how behavioral economics may assist in formulation of economic policy and law.  Please share any thought you may have on this.

Finally, a word about the title of this post.  First, I recently shared a distinction among Econs, Mecons and Wecons, as heuristic extension of Thaler’s distinction between Econs and Humans.  I would like to add the term “Becons” to this list, as a shorthand version of “behavioral economist.”  I sincerely hope the behavioral economists of the world will not be offended by my poetic propensities.  Second, the reference to crystal balls is both a tip of the hat to those Becons who predicted the financial meltdown, and a challenge to Becons whose theoretical and empirical work may guide us into the future of economics.

Starting simply - as I am inclined to do when faced with new complexity - one of the founders of behavioral economics, Richard Thaler, makes a fundamental distinction between Econs and Humans.   Econs are economic agents in standard economic models who always choose rationally, but Humans make choices with bounded rationality, bounded willpower, and bounded selfishness.  Econs, he says, are like Mr. Spock, and Humans are like Homer Simpson.  I have found a slight extension of this distinction to be helpful in navigating the shallows of the sea change in global economics, a distinction between two hypothetical types of human - Mecons and Wecons.  In this heuristic, a Mecon is a human motivated primarily by economic self-interest; a Wecon is a human moved by a consciousness that we are all in this together.  If an Econ is Mr. Spock, then a Mecon is Mr. Scrooge before the spirits visited, and a Wecon is Mr. Scrooge the morning after.

It may be convenient, in these early days of the transformation of global economic consciousness, to place blame and search for saviors.  It would be easy to characterize unregulated free market capitalists who put Alan Greenspan in a “state of shocked disbelief,” or fee-inspired mortgage brokers who put people into homes they couldn’t afford, as pure Mecons, and to characterize proponents of various alternatives to free market capitalism, or the emerging Generation G, as pure Wecons. But no human is pure Mecon or Wecon, just as no human is pure Econ.   Some capitalist entrepreneurs have long considered corporate profits a means to social ends, many investors routinely integrate social and environmental priorities with economic concerns in their investment decisions, many international corporations were implementing policies and practices of corporate social responsibility, protection of economic, social, environmental and cultural rights, long before the current crisis, and most who worked in the financial industry did not cause the meltdown.  Certainly, eligible Mecons should be brought to justice, drunken money changers may need support groups to sober up now that the party’s over, and some may become more contrite, spiritual, and philanthropic.  Most importantly, the millions who lose jobs, homes, and faith in themselves or their society will need help facing the potentially overwhelming circumstances that now challenge humanity.

All that has happened, and all that is yet to come, raise multitudes of empirical questions.   We face more than an economic crisis - we face a psycho-socio-political-economic-ecologic-legal crisis of unprecedented proportions.  Stated more optimistically, we face an unprecedented opportunity to transform humanity’s relationship to itself and the planet in all of these arenas.  Systematic empirical research into the human dimensions of causes and possible solutions to the crisis/transformation will serve us well.  It is no longer a political question whether law and policy should be informed by scientific research.  The White House has re-opened the doors of government to science, the Chief Economic Advisor to the President is a behavioral economist, and “We the People” - we Econs, Mecons and Wecons who are all in this together - deserve no less than economic law and policy informed by behavioral science.

Myth #1: Everyone Already Knows the Miranda Warnings. In fact, the authors report, 28% of college undergraduates in one study were not aware of the right to silence, and believed that failure to cooperate when placed under arrest may be used as incriminating evidence; 34% believed the police can continue an interrogation after an attorney has been requested; and 24% believed that a Miranda waiver had to be signed in order to be valid. The authors wonder how a “garden-variety detainee” could understand the warning, if college students fare so poorly.

Myth #2: Miranda Warnings Are the Same Wherever You Go. In fact, analysis of 945 federal, state, and county jurisdictions revealed 886 “unique” variations of the warning, ranging from 21 to 408 words in length, and even found four variations of the warning in one county in Pennsylvania – one each used by the local police, the sheriff, the university, and the railroad. Only 80% of the warnings studied advised of the continuing right to silence and counsel, despite the requirement that the “opportunity to exercise these rights must be afforded . . . throughout the interrogation.” Miranda v. Arizona, 384 U.S. 436, 479 (1966).

Myth #3: “Smart Enough to Do the Crime” Means Smart Enough to Understand Miranda Warnings. In fact, one study compared the lowest and highest functioning defendants and found the lowest comprehended only 24% of the warning, and the highest only 66% of the warning.

Myth #4: Oral and Written Miranda Warnings Have the Same Effect. In fact, one study found that persons who receive an oral warning fail to comprehend at least half of the warning three times more frequently than those who receive a written warning. A survey of 631 police investigators found that 67% of Miranda warnings were given orally, and the rest were given either in writing or by audio recording.

Myth #5: While Miranda Warnings Are Easy to Understand, Juvenile Warnings Are Very Easy to Understand. A study of 122 juvenile Miranda warnings from across the country found the juvenile warnings to be more than 50 words longer than the general warnings intended for all age groups, and reading levels required for comprehension slightly higher than the reading levels for the general warning. Though some states attempt to protect juveniles by, for example, required a parent or guardian to be present during the Miranda advisement and any interrogation, the authors questioned whether the parents could comprehend the warning sufficiently to counsel their children about the consequences of waiving constitutional rights. Further, one study found that 55% of parents wanted their children to confess, 33% of parents wanted them to tell the truth in a manner that might amount to a confession, and no parents advised their children about Miranda rights.

Myth #6: Miranda Warnings Delivered in Spanish Are the Same as Those Delivered in English. Studies have shown various mistranslations of the warning into Spanish, omissions of the right to “free” legal counsel, and failure to advise concerning the continuing right to silence and counsel three times more frequently than in English versions of the warning. One court has thrown out a Spanish translation of the warning because it did not communicate an unambiguous right to counsel, and instead advised that “you have the right to solicit the court for an attorney.” State v. Ortez, 631 S. E. 2d 188 (N. C. App. 2006).

Myth #7: Suspects Understand that Heeding Miranda Warnings Isn’t Harmful. In fact, a study of college students showed that one-third believed their silence could be used as incriminating evidence in a future trial, and preferred to give their own versions of the facts rather than allowing investigators to “assume the worst.” The study also revealed the 24% of the Miranda warnings in the U. S. erroneously advise suspects that they have the right to remain silent only “. . . until counsel is available.”

Social science research into the Miranda warning is in its infancy, but is beginning to make its way into consciousness of courts and lawyers. Challenges to Miranda warnings are likely to increase as deficiencies in warnings across jurisdictions come to light.