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.