Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

03 April 2008

Anti-Deficiency Laws and our Mortgage Crisis


A Representative Homeowner’s Plight
A Way Out: Anti-Deficiency Legislation
Deficiency States
Leverage, Fairness and Moral Hazard
Conclusion

Economics is a quantitative science. Clear thinking about any economic problem requires numbers. There is no getting around that fact of life. You can come to some pretty wrong conclusions about economic problems if you rely solely on verbal reasoning, normal human intuition and “common sense.” If we take that risk now, we might turn a serious financial crisis into a replay of the Great Depression.

There is a simple and natural focus for economic thinking about our current crisis: the individual homeowner. All four components of our current crises revolve around her. The housing bubble affects the value of her home and therefore the collateral for her home loan. The collateral’s value and interest rates affect her ability to repay the loan, which in turn determines the loan’s value to investors, and therefore the value of the mortgage-backed security in which her loan is “packaged.” The loan’s value also affects the liquidity of credit: the lower and more uncertain that value is, the less likely anyone is to buy the loan or the security containing it, i.e., the less likely credit is to remain liquid. Finally, the homeowner is at the center of the humanitarian side of the economic crisis: what we do about the crisis will determine whether she can stay in her home and how much debt she will bear for the next decade or so.

Therefore the best way to get a handle on the meaning of the current crisis—and possible solutions for it—is to look carefully at the individual homeowner. What follows is a quantitative analysis of a typical homeowner’s plight and the conclusions that we can draw from it.

A Representative Homeowner’s Plight

Consider Mary, 29 years old and the head of her household. She makes $50,000 a year. A year ago she took advantage of the subprime credit bonanza and bought a $300,000 home with no money down.

Mary’s initial “promotional” interest rate on her subprime loan was 5%. To make her payments seem lower, the lender made the loan “interest only,” with no amortization, for the entire two-year introductory period.

To make the numbers simpler, we ignore compounding, which would raise Mary’s payments only slightly. So her introductory payments are simply 5% x $300,000, or $15,000 per year, $1,250 per month. That’s about 30% of her monthly gross income of $4,167 ($50,000/12).

Two points are worth noting at the outset. First, the absence of a down payment gives the lender absolutely no “cushion.” The lender is banking on an increase in the value of the home to provide some equity, or on Mary’s ability to repay the loan according to its terms.

The second preliminary point is more interesting. The fraction (30%) of Mary’s monthly gross income represented by the introductory interest-only payment (at an artificially low introductory interest rate) is precisely the minimum fraction that mortgage lenders used to require for lending before the subprime silliness began. For about three decades beforehand, the mortgage industry observed a 30% or rough “one-third” rule of thumb: it required mortgage payments not to exceed a third of the borrower’s gross income.

Now let’s see what happens when the loan’s promotional, introductory period expires in another year. Then Mary’s rate will go up to 7%. In addition, the rate will now include amortization, since Mary must eventually pay the mortgage off. We can find Mary’s monthly payment for a 30-year fixed-rate mortgage on $300,000 at 7% from any standard mortgage calculator. The result is $1,996.

This number includes only principal and interest. Since Mary put no money down, her actual payment would also have to include mortgage insurance (to protect the lender) and various other fees. The total would be about $2,150.

So at the end of the second year, when Mary’s payment hits this amount, it will increase 72%. It will go from a comfortable (and, before the subprime madness, customary) less than one-third of her gross income to more than half of her gross income.

Unfortunately for Mary, that’s not all. There’s still the housing bubble. In what most economists expect to be the worst case, the market value of her house will decrease by 30% over the next year or so as the housing bubble pops and normal market values resume. After that happens, Mary’s house will be worth only 70% of $300,000, or $210,000. But Mary will still be on the hook to pay the mortgage note for the full $300,000 price at which she bought the house.

That’s Mary’s plight in a nutshell. When her introductory payment period ends, her payments will increase by 72%. They will gobble up over half her gross income (before taxes and expenses) for the foreseeable future. In addition Mary will have $90,000 in new debt, not covered by collateral. Mary will have lost the equivalent of almost two years’ worth of her gross salary simply by buying the house and agreeing to the subprime loan.

In short, the present crisis has two distinct components, both of which are important. First, interest-rate step-ups threaten to put millions of homeowners into default on their mortgages. Second, if homes are foreclosed, the vast depreciation of home values (with more expected) resulting from the housing bubble’s burst will force homeowners, lenders or both to bear enormous financial losses.

A Way Out: Anti-Deficiency Legislation

Is there any way out for Mary? Her options depend mostly on the state in which her home is located.

A minority of states still has legislation that prevents lenders from holding homeowners liable for more than the value of their homes. These state statutes—a holdover from the Great Depression— are called “anti-deficiency” statutes because they prohibit mortgage lenders from seeking to recover a deficiency in the home’s value (below the loan value) from the homeowner. (Some of these statutes have exceptions for things like second homes and refinancings, but most cover mortgages taken for the purchase of a principal residence.)

These statutes give Mary a real out. She can give the lender the keys to the home and walk way, debt free, even when the home’s value is less than the amount of outstanding debt. The lender can look only to the home to recover the full amount of the loan. California—a state at the epicenter of both the subprime crisis and the housing bubble—is an anti-deficiency state. (See California Code of Civil Procedure § 580(b))

If Mary lives in California or another anti-deficiency state, she therefore has an attractive economic option. She can walk away from her home, giving the lender the keys, and by that act alone relieve herself of $90,000 worth of debt, nearly twice her annual salary. At the same time, she can substantially reduce her monthly housing expense, simply by renting, rather than buying, a home.

For several years now, renting has been a bargain compared to owing a home. Average rents have been far lower than the full cost of home ownership, including mortgage, maintenance, insurance, and depreciation. Therefore Mary can probably rent an apartment with size and amenities comparable to those of her abandoned home for even less than her $1,250 per month introductory mortgage payment. She might even rent a comparable home, as lenders seek to accrue some income from their foreclosed and unsellable properties by renting them out at bargain rates. With these low out-of-pocket housing payments, Mary can begin to save money for a down payment on her next home, hoping to buy later, at a market low rather than a market high.

By law, Mary’s default on her current loan will stay on her credit records for seven years. During that time, it is unlikely that any lender would make her a new home loan—although that risk might change in the future due to new legislation or changes in lending practices as a result of this crisis. So if Mary takes the default option, she should reconcile herself to foregoing home ownership for seven years.

Mary’s other option is to tighten her belt, live on less than half her gross income (with the other half going toward her mortgage), and stay in the house. She might do so if her chief personal goal is to own her own home.

After seven years of payments, the balance on Mary’s loan would be $273,442, and she would have paid $141,098 in additional interest (not counting the interest paid during her two year “introductory” period). Because mortgage interest is tax deductible, Mary would save about 15% of that total, so her net payment for housing would be 85% of that amount, or $119,933. Over seven years that works out to $1,428 per month.

Now let’s assume that, in the interim, Mary could have rented comparable housing for $1,250 per month. Then her “extra” payment over the seven years, to stay in the home rather than default and rent, would be 7 x 12 x ($1,428 - 1,250 = 178) = $14,952. After paying that “extra amount” for housing, Mary would still owe $273,442 on the house. If the house did not appreciate, but were still worth only $210,000, she would be $63,442 in the hole. In total, she would be $78,394 less well off than had she rented during the same seven years.

Mary might recoup this amount—or even make money—if the house appreciated in value during the interim. But it would have to appreciate $78,394 just for Mary to break even. As compared to the initial value of $210,000 (after the housing bubble burst), that’s a total appreciation of 37 % over seven years, or about 4.6% per year compounded.

That sort of appreciation is not impossible; it’s about the national average during the five years before the housing bubble. But Mary would have to take a big downside risk. Even if appreciation of about 5% per year is “normal” for housing in the United States, no one knows how long the housing market will take to return to “normal” conditions. The Japanese real-estate bubble, for example, took twenty years to work itself out. So if Mary stays in the home, there’s a big risk that she might still be in debt more than her annual salary after seven years of belt-tightening.

On the other hand, if Mary rented in the interim and banked the savings on her monthly housing payments, she would have that $14,952 to put up as the down payment for a new home. At ten percent down, she could afford about a $150,000 home. She might even get a loan with only five percent down, for a $300,000 home. And at the outset she would have some equity in her new home, rather than a large net debt.

Most of us are risk averse. We don’t like to take big risks with our financial future. So a rational person in Mary’s position would likely would walk away from her home and take a fresh start as a renter, with no debt. I certainly would. Only if Mary were less risk averse, more self-restrained (i.e., willing to tolerate using only half of her gross income for non-housing expenditures in the interim) or more optimistic about future appreciation than most of us would she stay in the house.

Deficiency States

The result is different in states with no anti-deficiency legislation, which we’ll call “deficiency states.” There, homeowners with mortgages remain liable to pay the full value of their mortgages even after foreclosure. They cannot escape this obligation by filing for bankruptcy, because current bankruptcy law requires mortgages on principal residences to be paid in full.

Thus, if Mary lives in a deficiency state, her best option is to tighten her belt and stay in the house. If she defaults and suffers foreclosure, she will have no home and still have to pay the difference between the home’s value ($210,000, presumed to be the foreclosure sale price) and her $300,000. In other words, she will be homeless and have a debt of nearly $90,000 (nearly equal to twice her annual salary), which she can’t discharge in bankruptcy. She has no choice but to stay and pay.

Leverage, Fairness and Moral Hazard

As this brief discussion shows, homeowners in anti-deficiency and deficiency states live in entirely different economic universes. A homeowner in an anti-deficiency state can walk away from a home that is financially “under water,” leaving the lender to suffer the deficiency. A homeowner in a deficiency state can lose the home in foreclosure and still owe the difference between its market value and the debt. Since the deficiency (as in our example) can be several times a homeowner’s annual salary, the practical difference among states is enormous.

The difference also has three other aspects. The first is leverage. By virtue of her ability walk away free of debt, a homeowner in an anti-deficiency state has the whip hand. If she defaults, the lender will lose the amount by which the home has depreciated since her purchase. Throughout the United States, homes have been depreciating over the last year—about ten percent on the average, so far. Economists predict they will continue to depreciate by another ten or twenty percent. A well-informed homeowner in an anti-deficiency state therefore has a “cushion” of up to thirty percent of the purchase price over which to bargain with the lender.

In contrast, a homeowner in a deficiency state has little, if any, leverage over the lender. The lender has the right to collect the full mortgage debt even after foreclosure. So the lender has little incentive to bargain to avoid foreclosure. The homeowner’s only leverage comes from her ability and incentive to pay. A practical lender will know that an individual in Mary’s position has only a limited ability to pay. It will also understand that a debtor paying for a home she doesn’t own will use every excuse—and every legal trick—to avoid paying. So the lender may bargain to avoid the annoyance and expense of repeated legal proceedings to enforce and collect the debt. But that is all.

The big second difference between anti-deficiency and deficiency states is a matter of fairness. Why should homeowners in different states suffer such different fates just because their legislatures responded differently to the Great Depression eighty years ago? From the perspective of economics and public policy, the enormous difference in economic outcome for homeowners is fortuitous.

When you consider the nature of some states involved, the enormous difference can seem capricious. California’s housing is some of the most expensive in the nation; yet California is an anti-deficiency state. So a person in California who rashly incurred the expense of a million-dollar home without any ability to pay for it can walk away from a million-dollar loan when the home’s value declines to $700,000, saving $300,000. Yet a no-down-payment purchaser of a $200,000 home in a rural deficiency state must pay every penny of the $60,000 by which the home’s valued is expected to decline, while the lender walks away with nary a penny of loss.

The final big difference between states is moral hazard. Much ink has been spilt about the moral fault of both subprime lenders and those who purchased homes from them. But one thing is clear. Lenders in anti-deficiency states like California knew exactly what they were getting into, or they should have.

Anyone who enters the mortgage lending business without competent legal advice is an idiot. There are few idiots in the industry: all have detailed and voluminous forms carefully drafted by lawyers. All who lend in anti-deficiency states had to know that—in any loan involving no or a small down payment—the law puts the full downside risk of depreciation on them. They knowingly took the full risk of depreciation. Homeowners, protected by the anti-deficiency legislation, did not.

At first glance, this observation seems to argue for harsher treatment of predatory lenders in anti-deficiency states. But wait a minute. Most predatory lenders operate nationwide or in a region containing both anti-deficiency and deficiency states. If the lenders themselves did not, then the investment banks that “packaged” their loans and sold them as securities certainly operated in these broader fields. No news reports I have seen suggest that they treated borrowers in anti-deficiency and deficiency states any differently. While the housing market was seeming to defy gravity, they were quite willing to ignore the risk of depreciation wherever they operated.

If you think it unfair to charge these sophisticated folk more than simple borrowers for a risk that affects both, try this little experiment. Ask friends and acquaintances (who are not lawyers or in the financial industry) what anti-deficiency legislation is and whether their state has it. If you get a coherent answer from more than one out of ten, then maybe you have a point.

Conclusion

In order to be fair, effective and egalitarian, any federal law to address the mortgage crisis must take account of two undeniable facts. First, the economic consequences of the subprime lending crisis and the housing bubble’s collapse vary enormously between anti-deficiency and deficiency states. Second, the collapse will cause enormous losses to lenders, borrowers, or both.

We can estimate the magnitude of the losses as follows. Multiply the estimated number homeowners facing possible foreclosure (2 million) by the mean home price ($200,000) and take the loss of value to be 30% of that (the worst-case depreciation that economists predict). The result is $120 billion.

That’s a lot of money, but it’s not particularly enormous these days. It’s less than one-eighth of the minimum estimate of the full cost of our war in Iraq. It’s less than three times Exxon’s profit for the last fiscal year. Yet how we handle that amount, and how we divide the pain between industry and homeowners, will determine what our society and our middle class look like for decades to come.

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12 Comments:

  • At Sat Apr 05, 12:24:00 PM EDT, Anonymous Anonymous said…

    Message to Google Support Staff: Backlink Bug

    With apologies to general readers, this comment is for Google support staff. I could find no other way to send a message anonymously. I have reason to believe Google staff may find this comment, as they seem to have helped cure HMTL problems on this blog previously.

    As explained in detail elsewhere, this blog is anonymous. After spending some time browsing Goodle’s Blogger pages, I could not determine whether I could keep it anonymous and (1) join a user support group or (2) participate in your Adsense program. There seems to be no privacy policy for either support groups or Adsense, at least none that I could find. I’ve maintained my anonymity for several years and don’t want to risk losing it to participate in either of these programs.

    I have a bug to report, which I could not find addressed in the Blogger Support Group. Several of the snippets in reports of backlinks to this post are gibberish, apparently because the excerpt snipper works indiscriminately across separate frames or tables. The resulting gibberish makes it hard to decide whether to retain or remove a backlink, or even to understand what the linking site has to say.

    Separately, it would be nice to have a forward link to each linking site, so I could check each backlink and snippet in context. In some cases, I might want to recognize the linker with a link of my own.

    I realize that a forward link might create privacy issues. I also sense a technological battle going on, with linking sites trying to keep their links secret and nonremovable, and linked sites trying to counter. My site meter allows me to traces backlinks in many cases, but it seems not to have picked up the links that Google reports to this post, several of which appear to be from commercial real-estate sites.

    My own view is that transparency of links is the best policy, and that every blogger (as author with creative control) should have the power to reject links to his/her site or blog. I once had to disclaim a link from a site I found to be of low quality and objectionable.

    I hope Google staff find this comment and would appreciate a reply in kind, preserving my anonymity.

    Jay

     
  • At Wed Oct 22, 03:09:00 PM EDT, Anonymous Anonymous said…

    Jay -

    You are underestimating the economic impact. It has been reported that 1 in 6 homeowners are under water - that is they owe more than their home is worth. About 30% of homeowners have no mortgage at all. Assuming those reports are accurate (and it would be no surprise if the reporters missed some important details) 1 in 4 mortgages are under water and diving as prices continue to decline.

    Its likely that the total real estate losses from the peak of the bubble are already several trillion dollars, more than the entire assets of the banking system. This is the real reason banks won't loan to one another, they understand that they have huge amounts of potential losses over the next few years. Enough potential losses to overwhelm even the strongest financial institutions.

     
  • At Fri Oct 24, 08:38:00 PM EDT, Blogger jay said…

    Dear Anonymous,

    My wife sometimes calls me Mr. Gloom and Doom, but you outdo me. For several reasons, things are not as bad as you think.

    While the total loss in value of all homes nationwide may indeed be in the trillions, that number has no practical significance. All homeowners are not going to sell their homes at once, far less in a down market. People need places to live.

    The same is true of the number of homes “under water,” i.e., with outstanding loan balances that exceed the homes’ market value. Whether one-sixth or one-fourth of all homes (your comment is unclear), that number, too, doesn’t matter.

    As long as people are living in their homes, are happy with the homes and their neighborhoods, and are able and willing to continue their loan payments, low home values have little practical significance. All the low values mean is that the owners have less net worth to brag about, can’t sell their homes easily, and can’t take out new home-equity lines of credit. If they stay in their homes and continue to make payments (and their neighbors do the same), eventually the home values will rise and exceed the amounts outstanding on the loans, and the owners will have positive equity. That’s what most people probably will do.

    Problems arise only when homeowners can’t make their loan payments or have to sell their homes. Then the “paper” losses becomes real, and the owners have the difficult choices I’ve outlined in my post. While every case of this kind is a personal tragedy, the estimate so far is two million homes—a small fraction of the nation’s housing stock.

    As for the 30% (your number) who have no mortgage, that’s good. Having no mortgage means you own your home outright, so whatever value it may have is positive net worth. If you sell the home, you receive the entire sales price (less commissions and costs) as cash. Many retired people are in this category. They’ll be fine as long as they have enough income to live on and don’t fall for predatory mortgage, home equity, or home improvement loans.

    That said, there is a real problem, with three aspects. First is the human and neighborhood tragedy. Massive foreclosures destroy lives, ruin neighborhoods, and further tank home values. Second is the demographic problem. High gas prices, coupled with urban sprawl, may ultimately make whole neighborhoods unsustainable. Many neighborhoods far from work places already have a high foreclosure rate. Some of them may never recover and may become abandoned—a permanent exurban blight.

    The worst problem is the macroeconomic one. As home values and home sales decline, many bad things begin to happen. Home construction stops. Real-estate brokers lose their livelihoods. Sales of appliances and home furnishings decline. So the home bust becomes a large part of what’s pushing our entire economy into recession. As the recession deepens, more people lose their jobs and can’t afford their house payments, and more foreclosures ensue. And the economic situation gets worse. It’s a vicious cycle.

    Fortunately, the vicious cycle works in slow motion. It’s nowhere near as rapid as the stock market crash. So we have some months, maybe even a year, to begin to solve it. For some solutions, see this post.

    As for the dollar amount of the problem, it indeed is growing. I’ve increased my $120 billion estimate in the above post to about $310 billion, as explained in this post. But the price of a solution is nowhere near a trillion. Yet.

    That’s why this election is so important. If we elect someone who understands economics and puts people first, we’ll never get to the real disaster scenarios. If you’ve been reading this blog, you probably know whom I have in mind.

    Jay

     
  • At Sat Jan 08, 04:47:00 PM EST, Anonymous Anonymous said…

    What are the politics (arguments for and against) a state like California having an anti-deficiency law?

     
  • At Sat Jan 08, 09:12:00 PM EST, Blogger jay said…

    Dear Anonymous,

    I’m glad you asked. Because of Google’s comment-length limitations, I’m publishing my reply in two parts. This is Part A.

    The basic arguments for and against anti-deficiency legislation are simple and straightforward.

    When a man or woman takes an unsecured loan (one without a mortgage), the lender has to rely on the borrower’s income and assets alone. Legally, there is no other means to repay the loan.

    So if the borrower has insufficient income to repay the loan, or if the borrower becomes insolvent, the lender is entitled to go after the borrower’s assets. That makes some sense if the lender has required (as many did and do) the borrower to list assets and has made the loan in reliance on those assets.

    The situation is different when the loan is secured by collateral, such as a mortgage on a house. In that case, the lender, by taking a security interest in the collateral, indicates that, after the borrower’s income or solvency, it is relying primarily on the value of the collateral to repay the loan, and only secondarily on the borrower’s other assets.

    In the case of a home loan, the mortgage is the security, and the house is the collateral. If the borrower can’t repay the loan, the mortgage allows the lender to take possession of and title to the house and resell it to repay the loan.

    Therefore, in a mortgage situation, everyone knows—or should know—that the house as collateral is the lender’s chief means of recovering the loan if the borrower’s income is insufficient to repay it. Anti-deficiency laws merely recognize that financial and factual reality. They force the lender to look only to the value of the mortgaged house if the borrower can’t repay the loan.

    The arguments against anti-deficiency legislation are two. First, a person who borrows money should be responsible for paying it back. Period. If the loan is a home loan and the value of the house is insufficient, then the lender should be entitled to go after the borrower’s other assets, such as bank accounts, stock, cars, etc. Second, if the borrower has listed other assets on the loan application, the lender has a right to go after them to recover the loan. Everything the borrower owns and has listed on the loan application, this argument goes, should be fair game, except (if the borrower declares bankruptcy) assets exempted by the bankruptcy laws.

    These arguments are only the first round. For more, see Part B below.

     
  • At Sat Jan 08, 09:18:00 PM EST, Blogger jay said…

    Dear Anonymous,

    This is Part B of my reply to your comment, asking about arguments for and against anti-deficiency legislation. It continues in Part C below.

    The arguments in Part A above are only the first round. They assume that: (1) the lender has done its homework and has protected itself by requiring the borrower to disclose all income and assets, accurately and completely, in the loan application; (2) the borrower has made that disclosure honestly and completely; and (3) general economic conditions are stable, so that it’s possible for both parties to know what the house was worth at the time the loan was made and reasonably to predict where it would go from there.

    As we now know, every one of the those assumptions turned out to be false in the subprime meltdown of 2008. Many lenders did not require full and complete disclosure of borrowers’ income and assets. Instead, they were happy to make “liar’s loans” based on inadequate, unverified, or obviously false information in the loan application. Borrowers—especially those too ignorant or ill-informed to recognize something too good to be true—were only too happy to comply. And as the whole house of cards collapsed, no one could predict or even keep track of home values as they declined precipitously.

    Both sides were irresponsible. So under these circumstances, the question then becomes: who should bear the greatest responsibility for the utter failure of assumptions (1) -(3)? Should it be the lender, who makes a business of lending money on homes and who has training in that business and access to economists and all the resources of the home mortgage industry, privately and on the Internet? Or should it be the individual borrower who, however ignorant or greedy, takes a home loan and grants a mortgage at most of few times in his or her whole life?

    To me, the answer to these questions is obvious. If you make a business of something and receive money for what you do, you’d better know what you’re doing. Lenders who made loans without any down payment, without getting and verifying complete information about borrowers’ income and assets, and without considering the possibility that home values might go down, were stupid and negligent businesspeople. They should have known better, but they were blinded by their own impatience and greed.

    Many, if not most, did know better. But they were happy to be sloppy and negligent because they could immediately sell the bad loans they made to someone else, who would “package” them and resell them as mortgage-backed securities, and so on down the line. The whole thing was a financial Ponzi scheme in which business people out to make money (without taking responsibility for their actions) ignored real risk because they could always get someone further downstream to take the loss.

    Again, both lenders and borrowers were irresponsible. But who was more irresponsible? I think it was the lenders, who were irresponsible as a business. They knew (or should have known) they were being irresponsible because, if they had any experience in that business, they knew they had never done anything like that before.

    Instead, just a year or three before the crash, they had carefully documented every borrower’s income and assets, checked the results with credit reporting agencies and by other means, taken a down-payment of 10% to 20% of the value of the loan to allow for possible changes in the home’s value, and had the home appraised by professional home valuers to determine its value at the time the loan was made.

    These arguments continue in Part C below.

     
  • At Sat Jan 08, 09:19:00 PM EST, Blogger jay said…

    This comment has been removed by the author.

     
  • At Sat Jan 08, 09:21:00 PM EST, Blogger jay said…

    This comment has been removed by the author.

     
  • At Sat Jan 08, 09:32:00 PM EST, Blogger jay said…

    This comment has been removed by the author.

     
  • At Sat Jan 08, 09:49:00 PM EST, Blogger jay said…

    Dear Anonymous,

    This is Part C of my reply to your comment, asking about arguments for and against anti-deficiency legislation.

    When lenders decided to take few or none of the precautions that had been standard in the mortgage industry, and to pass the risk of not being paid back to others by financial legerdemain that they understood little or not at all, they were being supremely irresponsible, and they were doing so as a business. In my view, blaming it on the borrower—a consumer ignorant of the business, ill-informed about it, and often deluded by unscrupulous mortgage brokers—is just not on.

    As for assumption (3), the assumption of general economic stability, who should take the risk of it being wrong? Should it be the person who makes a business of valuing homes and lending on them, or should it be the consumer who does deals like that only a few times in a lifetime? Again, I think the answer is obvious.

    Indeed, that’s why many states still have anti-deficiency laws on the books. They arose during the Great Depression, when farm and home values plummeted due to a drastic decline in general economic conditions that no one could foresee. The causes of the collapse were, as usual, on Wall Street, among the people who claimed to understand high finance and made a living from it. But no one in the Midwest, California or any of the other anti-deficiency states had any idea what lay ahead when they made and took mortgage loans on farms and homes.

    When the crash came, farmers and homeowners found they couldn’t pay, and lenders found the values of the mortgaged properties, vastly reduced by the Depression, weren’t sufficient to repay the loans. Legislatures in many states decided, that, under those circumstances, the businesses that had made the loans should take the hit, rather than the entirely innocent consumers.

    In those days, both parties could be considered “innocent.” There were no “liar’s loans,” no mortgages made without down payments, and none made without careful documentation and verification of the borrowers’ income and assets.

    In addition, in that far-off time, local bankers made most mortgage loans. They knew their borrowers personally, and they took personal knowledge of borrowers’ character, honesty, diligence, wealth and income into account in deciding whether to make loans. So they were much, much, much less negligent, stupid, greedy, and complicit in the collapse than lenders before 2008’s sup-prime debacle.

    Yet even in those more innocent days, many legislatures decided that people who make it their business to make home loans should suffer an unforeseen and perhaps unforeseeable loss, rather than equally innocent consumers. How much more powerful are the same arguments today, when the businesses that made the loans were so much more negligent, culpable and complicit in the downturn?

     
  • At Mon Apr 16, 03:08:00 AM EDT, Anonymous David said…

    Somehow before having a mortgage loan you have to plan according base with you capacity to pay. You'll not ended up a broke or mortgage crisis.

     
  • At Tue Apr 17, 01:25:00 AM EDT, Blogger Jay Dratler, Jr., Ph.D., J.D. said…

    Dear David,

    Your English betrays your lack of education, or maybe you've been drinking.

    Lenders have primary responsibility for making sure that borrowers can repay their loans.

    They used to do just that, before the subprime crisis. When I refinanced our home in 2004, for example, I had to submit copies of tax returns and statements from all my bank and brokerage accounts, as well as a lengthy application summarizing my income and assets. I took me half a day to collect the information and fill out the application, even with the help of the Internet.

    No one ordered or even asked banks or mortgage brokers to make liars' loans. They did it themselves because they thought securitization would allow them to sell the loans to unsuspecting buyers before the shit hit the fan.

    I leave you to figure out who was at fault---the borrower who thought he might be able to pay, or the bank or mortgage broker that—out of sheer greed and complete disregard for the securities buyer—violated every custom and rule of banking since banking began.

    But please sober up first.

    Best,

    Jay

     

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