Commentary

Be Judicial in Your Compassion

What ever happened to the sanctity of private contracts? Consider the bill now pending in Congress that would essentially wipe out existing mortgages — allowing their terms to be rewritten for the benefit of troubled homeowners.

In some cases, unscrupulous lenders loaded billions of dollars in sub-prime debt on families that couldn’t afford it. But if those acts were fraudulent, appropriate legal remedies are readily available to bring the wrongdoers to justice. What is more likely, however, is the flip side of that equation: Borrowers simply got in over their heads or misrepresented their finances in order to grab loans requiring little or no down payment. Yet if the Democrats in Congress get their way, those borrowers will be rewarded for their irresponsibility — not to mention the losses imposed on lenders who were pushed by Congress to provide mortgage capital to poor credit risks.

James Madison saw this mess coming centuries earlier when he penned the following in Federalist 44: “Laws impairing the obligation of contracts, are contrary to the first principles of the social compact, and to every principle of sound legislation.” Ditto, wrote Chief Justice John Marshall in Ogden v. Saunders (1827), lamenting the tendency of states to rewrite contracts under the Articles of Confederation: “The power of changing the relative situation of debtor and creditor, of interfering with contracts … had been used to such an excess by the State legislatures, as to break in upon the ordinary intercourse of society, and destroy all confidence between man and man. The mischief had become so great, so alarming, as not only to impair commercial intercourse, and threaten the existence of credit, but to sap the morals of the people, and destroy the sanctity of private faith.”

That’s why a clause barring states from “impairing the Obligation of Contracts” was added to the Constitution. Madison recognized that each “legislative interference is but the first link of a long chain of repetitions, every subsequent interference being naturally produced by the effects of the preceding laws.” Those words, also from Federalist 44, were prophetic. The “long chain of repetitions” began in 1933 with that year’s passage of the Minnesota Mortgage Moratorium Law. Mindful of the problems facing farmers during the Great Depression, the Minnesota legislature authorized a state court to exempt property from foreclosure even though the debtor had defaulted on his contractual mortgage obligations. In Home Building & Loan Association v. Blaisdel, the U.S. Supreme Court by a 5-to-4 vote condoned Minnesota’s misbehavior. That appalling 1934 decision was the precursor to today’s fiasco involving subprime mortgages.

The resultant moral and legal dilemmas were crystallized pithily by Marcus Tullius Cicero 2,000 years ago. What is the meaning, Cicero had asked, of an “abolition of debts, except that you buy a farm with my money; that you have the farm, and I have not my money?” He might have added that so-called compassionate laws suspending private debt collections and delaying legal proceedings have predictable consequences: a loss of confidence in government, diminished trust in the good faith of contracting parties, and a reluctance to extend credit.

That logic was evidently lost on Chief Justice Charles Hughes, who had little sympathy for the Minnesota lender, Home Building & Loan. Hughes explained that “official reports” showed that lenders “are predominantly corporations, such as insurance companies, banks, and investment and mortgage companies. [They] are not seeking homes or the opportunity to engage in farming. Their chief concern is the reasonable protection of their investment security.” There you have it, a new hierarchy of rights, based on class, found nowhere in the Constitution: Corporate shareholders and employees are second-class citizens, whose rights can be sacrificed to protect homeowners and farmers.

The loan in the Blaisdell case was legal when made, and such loans continued to be legal after enactment of the Minnesota Mortgage Moratorium Law. Mortgages were encouraged by the state for the benefit of homeowners and farmers. Minnesota’s policy was to promote mortgages, and, absent fraud, fulfillment of mortgage contracts entailed no illegal act by either creditor or debtor. The parallels to today’s subprime loans are unmistakable.

There you have it, a new hierarchy of rights, based on class, found nowhere in the Constitution…”

Blaisdell and its progeny essentially excised the contracts clause from the Constitution. States and the federal government now have broad leeway to alter private contractual arrangements with little regard for the disfavored parties whose rights have been extinguished. Never mind that the retroactive impairment of private contracts flouts three of the central premises underlying a free society.

The first is the principle of private autonomy: Respect for the rights of each individual means that all persons must be at liberty to dispose of their property and their labor as they wish. By allowing people to order their affairs through contract without government intervention, the Constitution fosters individual self-determination. When government unilaterally does away with private contracts, it intrudes upon personal liberty. That’s why the Framers crafted the contracts clause: To promote personal liberty by grounding economic transactions on the right of free exchange, insulated from legislative pressures and majority whim.

The second is the rule-of-law ideal: Government must announce its rules in advance, avoid applying the rules retroactively, and ensure equal treatment under the law. As a result, individuals will be able to predict with fair certainty how each rule will be implemented, and plan their affairs accordingly. If existing contracts are altered by government edict, planning by private actors will be undermined. If rules are applied selectively or discriminatorily, the potential for abuse is obvious: Legislators will be tempted to use the coercive power of government to advance the interests of those with political muscle, or exact retribution against unpopular groups.

And the third is the separation-of-powers principle: The contracts clause was designed, in part, as a check against concentrated government power. Under our system of government, the legislature’s task is to address broad political issues prospectively, not to examine in specific cases whether the laws have been properly applied and obeyed. The judiciary’s function is to review individual cases after-the-fact, but not to design prospective rules that address questions of policy. In that sense, the contracts clause prevents the legislature from assuming the institutional rule of the courts — reserving to the judiciary the job of resolving individual contractual disputes.

Now, granted, the contracts clause applies to the states, not the federal government, but there are two constitutional amendments that provide an equivalent check on the feds: First, the Tenth Amendment limits the federal government to its enumerated, or specifically listed, powers. Second, the due-process clause of the Fifth Amendment prevents the federal government from retroactively abridging the terms of settled, lawful transactions. Those amendments were cavalierly ignored in 1933 when the New Deal Congress and President Franklin D. Roosevelt abrogated all contractual gold clauses, effectively dissolving numerous long-term leases just as Minnesota had dissolved numerous mortgages.

Instead of a cost-of-living escalator, many lessors had protected themselves against inflation with a gold clause — a common provision at the time — which gave the lessor an option to demand payment in gold rather than dollars. Big mistake. Ostensibly to maintain government reserves of the metal during the economic emergency of the Great Depression, the president and his fellow New Dealers erased existing lease provisions and gutted the rights of property owners as if they never existed. Lessors were not permitted to replace their gold clauses with different escalators; they were not allowed to renegotiate their leases; they received no compensation for the diminished value of their property.

Incredible? Perhaps so. But in 1935, a bitterly divided U.S. Supreme Court rubber-stamped Congress’s 1933 foolishness in three companion cases that became known as the Gold Clause Cases. Chief Justice Hughes, writing for the majority in Norman v. Baltimore & Ohio Railroad Co., the lead case, applied his expansive vision of judicial supremacy: “We are under a Constitution, but the Constitution is what the judges say it is … .” Hughes concluded that Congress could override private contracts to the extent necessary to regulate the value of money — a federal power expressly enumerated in the Constitution. When Congress abrogates contracts and confiscates property, however, even if purportedly executing an enumerated power, “this is Nero at his worst. The Constitution is gone.” Those were the trenchant words spoken extemporaneously when Justice James Clark McReynolds read his dissent from the bench.

Whether it was the canceling of Depression-era mortgage and lease obligations or the compelled waiver of the rights of today’s sub-prime lenders, our leaders in all three branches of government have been all too willing to disregard the constraints imposed on them by the Constitution. Only principled and consistent judicial engagement can restore proper respect for the Constitution as it was written.

Robert A. Levy is senior fellow in constitutional studies at the Cato Institute and co-author of The Dirty Dozen: How Twelve Supreme Court Cases Radically Expanded Government and Eroded Freedom (Sentinel, 2008), from which this article has been extracted.