Thursday, January 22, 2009

The problem of the American non-recourse mortgage

In Britain (and most of the world), all mortgages are "recourse mortgages". That is, the borrower is personally liable for all debts, whether secured or non-secured. Therefore, if a borrower gets into difficulty and their home is repossessed and then sold, if the sale of the property yields less than the loan, the borrower is still liable for the difference, and the courts can attach their future earnings. This is one of the main reasons the UK has a low repossession rate. It makes sense to try to meet your mortgage payments instead of having to pay rent plus repay outstanding debt on your repossessed property. Even strict banks such as Northern Rock only repossessd 0.56% of the loans on their books in 2008 - and their rate was three times that of the other banks.

In the USA though, uniquely in the world, they operate non-recourse mortgages in 27 states, including California and Florida. With a non-recourse mortgage, you only need to return the keys to your home, and you are no longer liable for the debt. While property prices are rising and there is equity in the home, it's rational to continue paying the mortgage. But if your home is "underwater" as the Americans like to call negative equity, and you are struggling with the payments, it is rational to simply return the keys and let the lender deal with the problem. The lender then has to sell the house - but increasing supply of homes for sale into a falling market simply depresses house prices even more, and increases the losses the lenders incur on that property. Hence the reason why US house prices have been falling continuously since 2006. In non-recourse states such as Nevada, 7.3% of all it's housing units received a foreclosure notice in 2008.

No wonder the American lenders were so keen to sell on their mortgage portfolios to guillible European banks! And this is why the losses are mounting up.

The Obama administration is likely to take drastic action to solve the problem and simply legislate to reduce the homeowners mortgage to below the market price so that they are no longer "underwater" and no longer have an incentive to default. A write down figure of 20% has been bandied about together with a clause making the new loan a "recourse" one, so that is the limit on the losses. American banks are worried about this as they will lose on the mortgages that haven't yet defaulted. But the upside is that there won't be this glut of foreclosed homes coming onto the market to depress prices and house prices should stabalise. Those holding the liabilities (mainly our silly banks) will take a hit, but reducing the foreclosures should mean that those losses are confined to the 20% or so write down in the loans. Given that the banks are currently suffering from uncertainty about how big their losses could get, stating now that their losses will be about 20% and writing it all down in one hit should mean that the banks should stabalise too.

The true solution for the future of course is to end all non-recourse mortgages - but there are so many vested interests in America who want to keep them that this is unlikely to happen.

19 comments:

Anonymous said...

Look, it does not matter how you spin it, our financial institutions were willing and able participents in this whole sorry episode of greed and dishonesty.

The idiotic middle classes have spent the last twenty five years voting for property bubbles, cheap credit and cheap imports, our economic performance is today judged on how much we spend on foreign crap in the high street, not on the the balance of trade.

The pot is now empty,the masters of the universe turned out to be pension theives, asset strippers and troughers.

Some richly deserved pain is on the way, and when it gets here we can rethink the way we want to do bussiness, ie make things, grow things or fix things.

Time to throw all the waste paper in the bin once and for all.

Anonymous said...

The principle of the non-recourse mortgage is a good one - it transfers the risk from the inexperienced customer onto the experienced and wise bank. Most progressives should support this kind of thing.

In a rational world, non-recourse mortgages cause banks to lend much more sensibly, as they will pay heavily for making stupid loans. However, in the US, banks just didnt give a shit, and they didnt give a shit on such a grand scale that they not only broke the bank, but the broke the whole system.

Dont give the banks the fig-leaf they dont deserve. The problems were caused by irresponsible lending, not non-recourse mortgages.

snowflake5 said...

To the first anonymous comment - yes if our financial institutions had stuck to lending to domestic households and business they wouldn't be in this mess. BUT, I wouldn't go as far as claiming that it's wrong to want to buy your own home (actually it's the prudent thing to do, as you don't want to face retirement on a fixed income and rents rising each year).

You also talk about the "balance of trade" but the surplus countries like Germany and China are suffering badly, as they depended on anglo-saxon consumption not domestic consumption. There is a lot of rubbish talked about trade - the best thing is to have a zero trade balance, where you import the stuff you are no good at making and export the goods and services that you are good at. Surpluses cause over-production just as much as deficits cause over-consumption.

To the second anonymous contributor - if non-recouse mortgages were such a good idea why is it that the entire world shuns them (and in the US, 23 states have recourse mortgages and are experiencing lower defaults than the non-recourse states). People won't lend if they think people are incentivised to default, unless they can pass the liability onto someone else who doesn't realise what is at stake. You mention irresponsible lending, but in many of the non-recourse states, part of the lending spiel was "it's ok to borrow as if the house price drops you can just return the keys and it's the lender who suffers..."

Anonymous said...

Snowflake, is your argument seriously that it is a bad idea because not many places do it? It's illogical for a progressive to use that argument, since progressive policy is by definition to advance niche ideas into orthodoxy.

Paternity leave and gay equal-rights dont exist in most places. Are they a bad idea too?

Re "it's ok to borrow as if the house price drops you can just return the keys and it's the lender who suffers..." - yes it was nuts for a company to say that it was happy for people to default on the cash it was lending. No sane person would ever do that. They were insane.

Rick said...

There was a time on our country when borrowers who defaulted on loans went to prison. Perhaps that was not such a bad idea.

It is wrong to say that people who default on a mortgage are victims of financial institutions. Americans are not that stupid. They know exactly what they are doing when the take out a mortgage, and who they are screwing by walking away from one.

broncodelsey said...

'No more boom and bust'

'Britain is best placed to face the recession'

'British jobs for British workers'

Is there anyone left in the country that believes or indeed listens to anything that comes out of our great leader's mouth?

snowflake5 said...

Anonymous - any system where a borrower feels it's in their interests to default in certain circumstances, and indeed they they take out loans on the basis of "heads I win, tails you lose" is bad.

The point of the UK recourse mortgage is that borrowers know they have to repay debts even when house prices fall - so they make the effort to do so, and defaults are thus lower than in America.

Can you just imagine if we had non-recourse mortgages in the UK? People would be defaulting like crazy and then we really would see a property price plunge as a glut of homes came onto the market. I can't believe you are defending the Amrican system.

Anonymous said...

I agree with anon and would go further to state that recourse loans are unethical. Recourse loans encourage a bank to lend even when all the information available internally to the institution points towards a future of sustained declines in prices. They will simply increase deposit payments and relax in the knowledge the borrower is legally bound to repay the loan whether they have a house or not. Institutions aren't interested in building your personal equity and as long they are guaranteed loan repayments they couldn't care less if you have to go sell at a loss and live with your mum for the rest of your life in order to pay off the loan.

Aligning the goals of homeowners and lenders more closely and punishing banks for not doing so is more appropriate. The information available to banks is either not available, or not available in a timely manner to many home buyers, some of whom who are financially illiterate.

Financial literacy does not seem to have been a educational priority in any country including here in Australia.

Imagine if all of the loans in the US were recourse. Uscrupulous lenders would have continued just as before, but the difference being that the financially illiterate borrowers banks took advantage of would be in poverty for life.

snowflake5 said...

Anonymous - if recourse loans truly "encourage a bank to lend", then why is it that the worst of the lending took place in non-recourse states like California, Nevada and Florida?

There are two parties to a loan, the borrower and the lender. Both are responsible. A non-recourse situation allows a borrower to be reckless knowing that they can walk away from their situation, that they can borrow money and not pay it back. Sorry, but that is a form of fraud, theft.

Yes the banks need to be reined in through greater capital requirements, so they make fewer loans. But borrowers need also to take their commitment seriously. All those defaults that these non-recourse borrowers are making, where they took the money and are refusing to pay it back - it's not only ruined the American economy but the world one, and it's taxpayers who are suffering.

There seems to be an idea that defaulting on a loan is a victimless crime, that it's only the "faceless bankers" who lose money suffer and supposedly they "deserve" to lose money for being so reckless as to lend it. It's not victimless at all - all of us are paying. As for the sob story about people having to "live with their mum" because they have to repay a recourse mortgage - well no-one forced them to borrow, did they. They did it freely.

If the USA had recourse mortgages the way they do in the rest of the world, we wouldn't be in this mess, because the defaults that triggered this crisis wouldn't have occured.

Anonymous said...

Walking away from your family home, neighbours and community is something you would do willingly given half a chance? You think these people are thieves?

How can it be a form of theft when banks value the property, keep the deeds, effectively own the house and rent it to you and get the house back if you don’t pay - as agreed in the contract?

Recourse or non-recourse, we have been living off future earnings to a point where debt is too high. Life seemed good and Governments want to go back to the good times.

Here in Australia our govt is desperately trying to prop up unsustainable growth in house prices which are the most expensive in the world (relative to income). Most of the population cannot be suckered into more debt as they are up to their eyeballs now. Most are attempting to deleverage. The best targets are the newbies.

An Aussie govt minister said to first home buyers last week “now is the time to buy”. Recently I read about a 21 year old being offered tens of thousands of dollars if they spend it before June. Up to $42,000 in grants and stamp duty subsidy are given to first time buyers to encourage them. Naturally as a result of this, first home buyers are quickly making up 26% of all home loans and growing, and the houses they buy have gone up 10% in a matter of weeks.

Interest rates are a low point and hyperinflation and potential interest rates of 20%+ are not something the youngsters could even believe possible. Most of them are unaware that Oz imports inflation or that Japan, Switzerland, UK and USA are busily printing money right now, just as they sign their shiny new recourse home loan contracts. Most of them don’t know that Australia runs a large current account deficit and that our banks are reliant on overseas borrowing to sustain the domestic debt levels - right in the middle of a worldwide credit crunch.

The banks here lend freely whilst knowing and modelling all of the above, secure in the knowledge that the loan will follow the individual (not the asset) throughout their lifetime - and can be particularly reassured by the fact that young people have a lot of lifetime ahead of them.

According to your theory if the youngsters default down the track we should castigate them - as they entered the contract freely. They should consider the "faceless bankers" who lose money and suffer.

Everything is not the fault of the USA. Sub-prime did not cause this problem, but is a natural first symptom. Non- recourse mortgages are not the cause of the problem. Recourse mortgages would not have prevented this mess. The causes are complex, but include unsustainable debt levels. The issue now is the state of the household balance sheet. One of the reasons this will take longer to get through is that households cannot react quickly to recession in the same way as business. Families can’t sack the children etc.

snowflake5 said...

Anonymous - buying a home is a risk. Everyone knows that, you don't even need that high an IQ to realise that . Adults shouldn't go into it thinking they should be allowed to default. It's no good trying to say, I'm an imbecile, I didn't know what I was doing, it the bankers fault for lending. The genuinely ill are protected by law (no court would rule against someone mentally ill who took out a mortgage in a state of confusion for instance). As for those who are well - if they really thought they could borrow and default, I'm afraid they are fraudsters.

As for the question, did US sub-prime cause the global problem - yes it did, because American lenders sold on their risk to everyone else. European and other banks assumed that American mortgages were recourse (as is standard throughout the world), they didn't do due diligence and realise that the reason American lenders were so keen to offload the risk is that the non-recourse mortgages are a fraudsters dream come true. The bankers too are adults, and should be prosecuted on behalf of their shareholders for not checking things they should have.

Anonymous said...

http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/0318_at.shtml

Anonymous said...

Hey snowflake5, could you please indicate where you got the information of the non-recourse mortgages from? Thank you in advance!

Anonymous said...

Hi,

Very interesting column and debate. Would you mind indicating where you found the data on the number of states in which non-recourse loans were available and on the percentage of defaults?Thanks in advance!

Anonymous said...

When I bought my home I had never heard of Recourse or Non-Recourse. The lender didn't tell me about it and I didn't know to ask. The idea that a lender would tell a customer that if they can't repay the loan not to worry, just send back the keys and you're off the hook is insane. And I don't know of anyone that bought a home with the idea that if it suddenly lost value they could just walk away. Buying a home is the largest and costliest purchase that most people will ever make. Most people undertake the purchase of a home as a lifetime investment.

The problem with the Ressession is much larger then just Recourse/Non-Recourse mortgages. People losing their jobs and no longer being able to pay. Banks more then willing to refinance homes as values shot up not thinking or caring that they will someday come back down. Mortgage Brokers getting loans to people that truly couldn't afford them. All driven by greed and profit. I'm not saying that non-Recourse loans haven't contributed to the problem but it's not the only cause.

Snowflake, just to add information to your stats. California, Nevada and Florida also have some of the highest unemployment rates here in the U.S. I think it's safe to say that the majority of people defaulting on loans are not all a bunch of scheming dishonest people going into a mortgage with the idea of "Heads I win, Tails I can't lose". I'm willing to bet that most of them were like me and had never heard about Recourse/Non-Recourse loans until they were about to loose their home.

Conchscooter said...

Non recourse loans should have helped prevent this melt down. If the lenders had taken seriously the threat of borrowers walking away the bankers would have considered more carefully to whom they were lending. As it is the banks here on the US lent money willy nilly to anyone they could persuade to take the loans and they didn't give a dman if the loans were recourse or non. They sold the debt and took the profits. When the crash came we the people bailed them out.
Non recourse loans are the only thing we little people have to protect us. I am considering dumping out of my beloved home because I am sick of funding the banksters even in my small way. I've lost my responsible $140,000 down payment and now I have to keep feeding the bank that took 25 billion dollars in taxpayer bail outs? For what? Retirement? That's a bitter laugh.

Anonymous said...

There's plenty of blame to go around beyond Bankers. Significant blame resides with: the manner of enforcement of the Community Redevelopment Act; Congressional and Administration pressure on banks to fund unworthy applicants; Congressional and Administration pressure placed on GSEs Fannie Mae and Freddie Mac to buy (fund) mortgages of those with no assets, no income, no credit score; and Barney Frank and Chris Dodd who stonewalled the need to initiate regulatory oversight of Freddie and Fannie transactions.

Anonymous said...

Multiple Large Corporations walk away from Commercial Real ventures that are losing Money.

CEO's & Co. boards have a fiduciary duty to their shareholders to make $ and dump losers.

Why is it admirable for them to walk away to save share holder value but terrible for the little guy to do the same.

The banks are screwing the little guy with guilt.

I say throw the keys at them & run, don't walk away!!

If the little guy doesn't watch out for himself, who is going to?

Anonymous said...

Conchscooter we must have the same bank. Government gave the bank a 25 billion incentive to take over my original bank. I am in Nevada --My Homes value has dropped 65%. I made the mistake of putting over 40% down.My home is approximately worth my original deposit. If the house went up 10 % a year (Impossible)_ it would take about 30 years to break even - The banks want you to Foreclosure as the Govt pays them.
People are being forced to walk --Banks are not willing to reduce principles in line with the current market value. What happened to the 25 Billion? Banks hurt the honest man buy allowing people to purchase homes with interest payments only. They lived great for five years and walked(Smart). Did the average guy have control over this ? Basically the Government has stripped the middle class utilizing the banks via bailouts. What choice ? , wait until 90 years of age to break even? Almost have to have non- recourse mortgages with the shady deals Banks and Government have.
Are second mortgages also non recourse? I have been reading that banks (WAMU) were giving higher commissions (3%) on sales of second mortgages if they were variable.
The Baby Boomers are in for a rough road.