Wednesday, October 5, 2011

Introducing The New No-Recourse Mortgage

Phil:    What if there were no tomorrow?
Gus:    No tomorrow? That would mean there would be no consequences, there would be no hangovers. We could do whatever we wanted!
Phil:    That's true. We could do . . . whatever we wanted.
—Bill Murray as Phil Connor and Ric Ducommun as Gus in Groundhog Day

For some three weeks now we’ve had protesters staging some kind of sit-in down on Wall Street.  It’s never been clear what, exactly, it is they’re protesting or what it is that they want, although they’ve garnered support from the likes of Susan Sarandon and Michael Moore, so you know it must be a good idea.  

From what I gather, at least part of the complaint has to do with banks foreclosing on houses.  Similar complaints have been raised by state attorneys general, all 50 of whom have for months been engaged in an investigation of and settlement negotiations with five major banks—Bank of America, JP Morgan Chase, Wells Fargo, Citigroup, and Ally Financial—over foreclosure practices.  To be fair, to the extent the complaint is over illegitimate foreclosures—foreclosures where the borrower is not in default—they may have a point. 

The problem is the complaint isn’t limited to illegitimate foreclosures, but extends to ALL foreclosures.  The mindset here is that foreclosure in and of itself is evil and bad, and that those who are the subject of a foreclosure are victims.  California Attorney General Kamala Harris has gone so far as to withdraw from the 50 state negotiations because they don’t hit the banks hard enough; she believes the banks actually should be forced to reduce principal balances. 

As I discussed a couple of weeks ago, the spate of foreclosures isn’t really the spawn of an evil banking plot, but actually has its roots in federal regulations that forced banks into a high-risk loan market they didn’t want to be in in the first place.  In the interest of having everyone own their own home, Congress and the Fed compelled the banking industry to begin making loans to people who could not afford them, and it was only a matter of time before the mathematics caught up and the defaults began.  The foreclosures followed. 

Of course, the reality of that history doesn’t matter to the Left, for whom everyone is a victim.  And this “victimhood” also conveniently forgets what a mortgage is, and why a foreclosure happens.  A mortgage is a contract through which A borrows money from B in order to buy a house.  B lends A the money, and A buys the house.  For the Left, this is where the agreement stops.  But there’s more to the story.   

You see, a contract requires mutual obligations.  In exchange for B lending A the money to buy the house, A agrees to pay that money back over time, with interest, pursuant to an agreed schedule of payments.  But because the very nature of a mortgage assumes that the borrower likely doesn’t have the amount of money borrowed, B needs some security to ensure A actually pays the money back.  So the house itself is tied to the mortgage contract as “collateral”;  in the event A fails to pay the money back according to the agreed schedule, B is entitled to take the house and sell it in order to recover the money he lent to A.  This is what a “foreclosure” is. 

For the Leftist, the borrower is somehow a victim.  But the borrower made an agreement with the lender.  If there’s a legitimate foreclosure happening, it’s because the borrower breached that agreement.  You can complain all you want about fairness, and how it’s not the borrower’s fault that he lost his job, but that’s the deal he made.  Contracts are all about allocating risk.  When you sign a mortgage, part of the risk you assume is that you will at some point become unable to make the payments to which you agreed.  The bank didn’t assume that risk—that’s what collateral insures against—you did. 

So who’s the victim here?  Nobody held a gun to these people’s head and made them sign these mortgages.  Nobody forced them to borrow tens or hundreds of thousands of dollars and pledge their houses as collateral.  If they didn’t want to assume those risks, they were free not to take out a mortgage.   

Not quite so for the banks, who if they wanted to be in the business of making home loans, were compelled by federal regulation to make more loans to riskier borrowers than they otherwise would have on their own.  And having now made the loans and handed over their money to these borrowers, what these protesters and attorneys general are now saying is the banks can’t rely on the only protection they had built into these mortgage contracts; and for those like Kamala Harris, they should be forced to surrender their claim to part of the money they loaned in the first instance.  The borrowers get to keep the house and not pay back the money.  This totally reverses the risk allocation to which the parties agreed in their mortgage contract. 

I guess we’ll just forget about Article I, Section 10 of the Constitution forbidding the government from enacting any ex post facto (retroactive) law, or any law impairing the obligation of contracts.  

What the Left really wants is a world with no consequences (or at least with consequences borne and paid for by someone else).  You lost your job and can’t pay your mortgage?  No problem, we’ll just tell the bank it can’t collect.  You built your house in a flood plain or a coastal area and didn’t obtain flood or hurricane insurance?   No problem, we’ll just take money from other taxpayers and pay to fix your house for you.  You’ve made bad investment decisions, or your market’s dried up, or the union has out-negotiated you into an unsustainable long-term CBA?  No problem, we’ll just dip into the magic piggy bank and give you a bailout. 

It is a fact—a hard fact, but a fact, nonetheless—that there are negative outcomes in this world.  People lose jobs.  Businesses fail.  It happens. 

But what do we suppose is going to be the result if we create a business paradigm where banks can no longer rely on the security and risk allocation built into a mortgage contract?  In their zeal to shield a segment of society from loss by unilaterally shifting it to others—in this case, the banks who made the loans—the folks protesting on Wall Street and the attorneys general have lost sight of what that’s going to do to the mortgage market.  If a bank can’t count on the terms of its mortgage to ensure that it either gets paid back or has recourse to foreclose on a collateral asset, it’s going to be much more reluctant to make a loan in the first place.  It may take 50% down and a 25% interest rate before a bank is willing to accept the risk not only that you default but that some government official steps in and prevents the bank from foreclosing on the house and forces the bank to forgive some of the debt.   How many will be able to afford their own home then? 

Sometimes the cure is worse than the disease.

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