Academic

Over a year ago, I began thinking of the 2008 financial crisis in terms of a Contract Crisis, analogous to the perceived Torts Crisis.  At some point, society looks at existing contract law and expectations and sees that if contracts are enforced as required, negative things may happen.  Because this may happen over and over to certain repeat players or have external effects, we would like to step in and reform contract law, even if it affects current contracts.  (So, reform mortgages, or credit default swaps, or bonds, etc.)  One example is working itself out in California.

One aspect of the Contract Crisis that galls many people is the fact that mortgage borrowers have a "put" in their mortgage that allows them to default and give the property over to the mortgage lender, thus reflecting that both the borrower and the lender are shouldering the risk of property value decline.  No one seemed to mind this until now, when the impact of hundreds of thousands of borrowers "putting" their properties to their lenders could have negative consequences to financial institutions, neighborhoods, the real estate market, and the lending market as a whole.  In California, statutes also prevent lenders from continuing to pursue mortgage borrowers for the deficiency, or the amount of the loan owed over the current value of the property, thus ensuring that the mortgage borrower accept risk of property decline.  (This didn't seem to have much ex-ante affect on willingness to originate loans, but not a topic for today.)

However, state legislators in California are considering a bill that might change existing mortgage law, even with respect of current mortgages, originated under prior law.  Some legislators want to increase mortgage borrower protection by making clear that lenders cannot look to borrowers for the deficiency, even if the gap between loan principal and FMV is the result of refinancing or home equity loans.  Some want to protect the borrower, but only if the home equity loans was used for home improvements.  Others aren't quite so sure any amount above the original principal amount should be protected.  The current statute was enacted during the Great Depression, presumably before the home equity loan and cash-out refinancing became popular. 

And some critics have concerns about any new protections to old loans.  Contracts in crisis.