Taking Bubbles Seriously in Contract Law
71 Pages Posted: 4 May 2011 Last revised: 27 Jul 2012
Date Written: March 30, 2011
Abstract
If bubbles reflect social outbreaks of poor judgment, then even those who adhere to individualistic notions of contract should recognize that there is a basis for denying enforcement of bubble contracts.
This article outlines the argument that bubbles -- defined as outbreaks of poor judgment -- exist and can be recognized, at least after the fact. It then argues that declining to enforce bubble contracts is consistent with libertarian and utilitarian approaches to contract. Finally, it considers the merits of rescission versus equitable adjustment as a way of handling unenforceable bubble contracts.
The article argues that an approach to modifying or rescinding bubble contracts -- perhaps including mortgages entered into during the recent housing bubble -- that is grounded in contract theory may be preferable to approaches that are based on the state's power to react to emergencies.
Keywords: bubbles, contracts, mortgage modification
JEL Classification: K12, G14, G38
Suggested Citation: Suggested Citation