I am back from a trip to Norway and Denmark. The impetus for the trip was an invitation to speak to a group of alumni of the Business Institute in Oslo. My topic was property bubbles.
The morning of my talk, I took a walk along the beautiful path next to the Akers River. My mind wandered, and at one point I tried to recall the steps to this dance, which I had learned recently and only done a few times. My mind also wandered to my talk, and so when I gave it I used the opening 25 seconds of the dance while singing (details below the fold).
Anyway, a lot of the questions were good ones. My favorite was when a guy asked if Norway would be less subject to a bubble because its mortgage loans come with recourse. In most states in the U.S., you can default on your mortgage and owe the bank nothing other than the keys to the house. With recourse loans, after the foreclosure sale, you still owe the bank any deficiency between the sale price of the home and the outstanding balance on the loan. I agreed with the thrust of the question, because recourse loans make people think twice about making speculative home purchases. I certainly think that recourse loans change the dynamics of the housing market. Canada has recourse loans, and that may be one reason that they did not suffer the bubble-and-crash that we did.
In my answer, I also pointed out that the underwriting criteria shift when you have recourse loans. You can be a bit less concerned about the property itself as security for the loan and a bit more concerned with the borrower’s capacity to repay the loan (income and assets) and with the borrower’s conscientiousness (as typically measured by a credit score).
For all the Dodd-Frank legislation and all the mumbo-jumbo about shadow banking, it really would have been simple to prevent the financial crisis of 2008. Recourse on mortgage loans would have done it. In effect, recourse loans give mortgage borrowers more “skin in the game.” Instead, Dodd-Frank tried to envision giving mortgage brokers more skin in the game.
And, of course, removing government support for investor loans probably would have done it as well.
I’m not (meanwhile, I did right, left, cha-cha-cha)
An expert on bubbles (left, right, behind-side-cross)
There is (right turn center, cha-cha-cha)
No such thing (left turn out, behind-side-cross)
Cause if there were (right, cross, Yemenite right)
An expert on bubbles (left, touch-right, right-back Yemenite)
He’d be (left turn)
Rich as a king (left Yemenite)
If I were an expert I would be a rich man (left shoulder in, two quick Mayim steps to the center)
Da-da-da-da-da (in place, cross right, left-right, left-right-left with a left turn)
And you wouldn’t hear me telling you about it (left shoulder out, two quick Mayim steps)
Da-da-da-da-da (in place, cross right, left-right, left-right-left with a left turn)
I was told afterward that several in the audience wish they had taken videos. Perhaps they were sorry about missing an opportunity for blackmail.
You write: “Recourse on mortgage loans would have done it.”
But I’m not so sure. E.g., a CNBC article reports on some research and says: “First, it’s not true that the U.S. is uniformally nonrecourse. Two states with among the highest foreclosure rates, Florida and Nevada, are full recourse. In fact, the Federal Reserve classifies most states as full recourse. Ireland has full recourse mortgages and some of the harshest bankruptcy laws in the developed world. But as of December 2012, 11.9 percent of Irish mortgages were delinquent by 90 days or more.”
Also, what about student debt? Student loans are full recourse but it hasn’t prevented what looks like a bubble.
I used to live in a recourse state, near the state line of a non-recourse state. Seemed to me the housing markets behaved mostly the same way, mildly bubbly. When the prices were going up and at least some folks I know we’re acting like ‘momentum investors’ with dreams of flipping houses, no one even seemed to know what the state law was and ‘recourse’ / ‘non-recourse’ wasn’t yet part of their vocabulary. That only came later when things started to go south.
And, as it happens, the ‘recourse’ proceedings in my state were so time consuming and burdensome, with endless delays, ad hoc, (and ex post facto) legislative, extensions, and continuances issued by sympathetic (and democratically elected) county judges, that most of the time the banks didn’t bother and picked the ‘quick process’ method of settling for the collateral. Lots of people got lots of ‘free rent’ waiting for eviction, often over a year, and most of them took a huge hit to the credit record but only rarely did most of them have to pay much back.
But again, practically no ordinary person really predicted, knew, or understood any of this beforehand. The contract law system relies heavily on the legal fiction that people give informed consent, but mostly they leap before they look.
And most of failing homeowners don’t have the savings to make the suing the homeowner worth while. The bank could win $100K from former homeowner and they only had $10,000 in the bank then they have to wait forever to collect. (I believe Arnold is exaggerating the number of investment/rental properties which is probably 5 – 10% of the home foreclosures.)
Buyers thought about the details of ‘recourse’ and other negative consequences and downside risks the way criminals think about the length of sentences for their crimes. That is, they don’t. They don’t calculate some kind of mental expected value or run a cost benefit analysis. That’s not the incentive to rich they respond. They mostly have some gut feeling about whether they are going to get caught (i.e that the bad thing would happen to them.) Below some psychological threshold, if the answer is perceived as ‘most probably not’, then the details and magnitudes of the consequences cease to be psychologically salient, one hits saturation pretty quickly, and throttling the same type of penalties slightly up or down doesn’t have much impact on behavior.
Yes, it looks like the states are all over the map on this with only about 10, the largest being California, being non-recourse states.
https://www.cga.ct.gov/2010/rpt/2010-R-0327.htm
In Spain we have recourse loan mortgages and we had the biggest housing bubble in all the world. So it is not the only factor.
Dr. Michael Burry DID become a rich man — because he knew the MBS/ CDO junk backing the 1995-2005 housing bubble increases were a bubble.(He pushed to create, and profit from, The Big Short on such “financial instruments”) But the Fed didn’t want to talk to him, tho he was willing to give a Stanford graduation speech a few years ago.
I think full recourse helps, but won’t solve the problem of speculators in a seller’s market.
A better change to dropping the interest rate deduction would be converting it to a 30% tax credit on the whole house payment — with a lifetime limit of 10 times the median taxable income (~$50k last year; ~$500k total maximum credit). What was really needed was more long term equity. There would have been more if there had been less use of the home equity loans which suck out equity but increase the interest payment and thus increase the deduction.
I believe helping working middle class folk live in better homes is one of the biggest give-backs to those who receive so few other direct gov’t benefits, and even if it’s less economically sensible than lower taxes and no subsidy for home ownership, the support for ownership is close to support for the American Dream. And it’s economically good for society to support working folk dreaming of earning a better life. Economists against home ownership subsidies are missing something.
It’s not only NOT economically sensible, it’s economically harmful to those you are trying to help. You could simply let those working middle class folk keep more of their own earnings to do with as they wish, but you prefer taking tax money from them, washing it through the very costly D.C. bureaucracy & thereby losing a portion to mere administration, and returning to the taxpayer far less than what you confiscated from him. All in an effort to convince him that he’s getting SUCH a deal from his government. Bah humbug.
Oh, the dance video was GREAT. Reminds me of many fine college Folk Dance classes.
Considering that I believe the banks are responsible for inflating and then deflating, going after bad debt means trying to collect money that doesn’t exist anymore in large part caused by the banks themselves. If the incentive doesn’t work for you then this aspect could be a big problem.
It also seems like enforcement is hit and miss. I’d be interested to see an analysis of the effect “stochastic enforcement” would have. Maybe you don’t think about it or assume it won’t be enforced while buying on the runup, but then it could be deflationary during the bust even if it isn’t enforced at all as defaultors must assume some non-zero probability of enforcement.
I knew that some statesin the U.S. had recourse, but I am surprised that there are so many.
But what is the common law here, as opposed to the formal legislation? It is hard enough in this country to get a foreclosure processed. I have never heard of any bank going after an individual borrower for a deficiency. If it is rarely done, then for all practical purposes all mortgage loans in this country are non-recourse.
On the other hand, the Spanish counter-example, with recourse loans and a housing bubble-crash, seems to be a strong point.