THE BURNED OVER DISTRICT

Last week, William K Black and L Randall Wray put forth the first part of their solution to the Great Foreclosure Fraud that is keeping the economy tied down in knots. Today in the second part they provide more detail and the most efficient way to apply the law to the wrong doers. All the details are important, but it really boils down to two simple solutions.

What to do? We suggest an immediate moratorium on foreclosures and a requirement that all notes be produced by purported holders of mortgages within a reasonable length of time. If they cannot be found, the mortgages -- as well as the securities that pool them -- are no longer valid. That means that the homeowners are not indebted, and that the homes are owned free and clear. And that, dear bankers, is a big, big problem. It is also the law -- without evidence of debt, there is no debtor and no creditor.

As they note, this would reward some individuals who engaged in fraudulent behavior, but they argue that letting the small fish go is the price for effectively tackling the big fish. They also argue that no fish is too big to catch.

The assertion that the SDIs cannot be resolved because of their size is unsupported. Very large institutions have already been resolved both in this country and abroad. The "too big to fail" (TBTF) doctrine has always been unproven, dangerous, and counter to the law. An institution that is not permitted to fail faces obvious adverse incentive problems. It also destroys healthy competition with institutions that are not considered TBTF. It encourages risk-taking and fraud. And it subverts the law, which requires that insolvent institutions must be resolved.

As we write this piece, the markets are taking it upon themselves to begin to close down the control frauds -- with homeowners fighting the foreclosures and investors demanding that the banks take back the toxic waste. Unfortunately, following the market solution will be a long-drawn-out and costly process -- both in terms of tying up the judicial system but also in terms of the uncertainty and despair that will persist. At the end of that process, the banks will have to be resolved. No matter how much the politicians dislike it, they will end up with the banks in their hands -- either now or later. Taking them now is the right thing to do.

Time is money in dealing with this problem and the lack of leadership in Washington is probably going to double the cost to us and our children.