More Punishment Less Revenge

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 7 August 2008, 7.50 am and 7.20 pm)

One year after the subprime crisis began and even after massive losses have been registered, global financial markets remain fragile. It’s anyone’s guess when this will end.

One thing is certain though. The legal battles are beginning. In the US, investment banks and ratings companies are being sued by investors bent on recovering their losses. Investors are also suing to take revenge. This is because they can’t accept that their investment bankers get to keep their fat bonuses and salaries.

As the legal battles step up, we will hear contrasting accounts of who is responsible. Angry investors will surely say that the crisis could be avoided if ratings companies and investment banks had been less greedy and more vigilant.

In their defense, the investment banks will surely say that they were only responding to investors’ greed. They will also argue that US policy makers were at fault.

In the end, no one will be wiser. It would be like listening to the two contrasting versions of the quarrel between a husband and a wife. There is “her” version. There is “his” version. And there is the truth. Unless we share the same bed as the divorcing couple, we will never know precisely who did what to whom.

Even if the culprits of the credit crisis can be identified, American mortgage borrowers will continue to bear the losses on their homes. Many say they are the real victims. But these victims are striking back.

Because more and more US borrowers are walking away from their homes after returning their keys to the lenders. All the lender can do is to try and sell the house and recover some money. But he can’t go after the borrower for the outstanding loss.

This is because a legal quirk originating in the Great Depression of the 1930s makes it almost impossible for lenders to pursue the borrowers. If all US mortgage borrowers walked away at today’s prices, the losses for the lenders would go up by another US$1 trillion. This will upset global markets again.

Certainly, by walking away from his home, the American borrower will have his credit record sullied. But unlike his Singapore counterpart, who will be made a bankrupt, the American can still keep his job and carry on a normal life. In five years’ time, his bad credit record will be erased.

Since the 1930s, not many Americans have walked away from their homes like this because of the social stigma attached. But this is changing because the stakes are high. It all boils down to one factor. The punishments for defaulting in the US are not strong enough.

Economists have always believed that strong state punishment is essential for both parties to stick to a contract. Strong state punishment also helps to create trust. And when trust exists, it’s easy to develop an efficient market economy.

Last month, a paper published by economist Naci Mocan of the Louisiana State University demonstrates this connection. Mr Mocan’s research looked into the types of situations whereby revenge is most likely.

He found that revenge was very strong in countries with low levels of income, low levels of education, a weak rule of law, and where people have experienced war and racial disruptions.

Mr Mocan’s research reinforces the belief that when state punishment is strong, individuals’ revenge will be weak, and vice versa.

Because US mortgage borrowers feel that the US legal system will not punish those who have cheated them, they are probably taking their revenge by walking out of their homes.

There was a time when buying a house in the US was like entering into a marriage. It was a commitment for life. Now that state punishments are weaker for both loan default and divorce, the new attitude must be: “if something better comes along, just get out and make the switch”.

By the way, if you are mediating for a divorcing couple in a country where state punishment is weak, tell the husband this. Mr Mocan’s research also found that among groups of people, the most vengeful are women.