Former baseball player Jose Canseco had a problem: His $2.5 million home was losing value, and he didn't like it. Real estate is only fun when it, you know, goes up.
So he handed the keys back to the bank and walked away. He played the housing game. It didn't treat him well. So he called it quits. "It didn't make financial sense for me to keep paying a mortgage on a home that was basically owned by someone else," he said. "I decided to just let it (the house) go …"
That "someone else" was, of course, the bank.
This walk is actually a foul
It's called walking away, and it's becoming a big problem. In general, mortgages in the United States are non-recourse loans (although laws vary state by state). This means the collateral backing the mortgage is limited to the house. In short, when a borrower like Canseco walks away from his home, the bank often can't go after his other assets if the house is worth less than the loan. It can't garnish his wages or take his savings, car, boat, watch, or firstborn. The bank gets the house, and nothing else.
Interestingly, this little loophole is almost exclusively an American tradition. As Harvard economist Martin Feldstein put it:
The 'no recourse' mortgage is virtually unique to the United States … Officials and investors in other countries are amazed to learn that U.S. mortgages are no recourse loans. It is indeed surprising that this rule in the U.S. applies to home mortgages but not to any other type of loan.
In most countries, banks can shake you down for all you're worth if you stop paying your mortgage. Australia is one of those countries. If you can't pay your mortgage in the Land Down Under, banks will hold you accountable. An op-ed in the Wall Street Journal elaborated on this last year:
When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn't cover the debt, they will be responsible for the shortfall. And the lender will chase them for it. It's a neat way of reminding Australians to borrow responsibly.
Yeah, that is neat!
With this in mind, it makes sense to look at differences between real estate markets in Australia and the U.S.
Australia has had an epic real estate boom that started in the mid-'90s. What it has not had -- at least not yet -- is an epic real estate bust. Here's how changes in home values compare:
|
Year |
Australia |
United States |
|---|---|---|
|
2003 |
18.9% |
11.0% |
|
2004 |
2.7% |
15.3% |
|
2005 |
2.3% |
14.5% |
|
2006 |
8.3% |
0.4% |
|
2007 |
12.3% |
(8.6%) |
|
2008 |
(3.3%) |
(16.7%) |
Source: Australian Bureau of Statistics (weighted average of eight capital cities), S&P Case-Shiller 20-City Composite Index.
Australian home prices's failure to plunge isn't entirely attributable to the country's full-recourse loan system. It's just one variable in a big, burly economic system. Prices could also drop like a stone any day -- we just don't know.
But the greater stability of its housing market is definitely encouraging. Could it be that full-recourse loans encourage homeowners to:
- Not act like Canseco, walking away from your home just because you can?
- Think real hard before taking out a mortgage, knowing the bank will hound you if you fail to pay? And maybe keep a sizable rainy day fund handy, just in case the bank comes a-knockin'?
- Jump through hoops to pay your mortgage, even if it means severe sacrifices?
Crikey! Yes!
We've quibbled about how to prevent another financial collapse. The ideas at hand mainly include throwing rotten eggs at Bank of America (NYSE:BAC), Citigroup (NYSE:C), and AIG (NYSE:AIG). But what if we acknowledged that a burden of responsibility lies with homeowners as well? What if, rather than treating banks as pure villains and homeowners as pure victims, we spread the responsibility more equitably? Would full-recourse mortgages promote responsible borrowing, and thus a more stable housing market, financial system, and economy? I'm tempted to say they would.
The downside of full-recourse mortgages
Some might argue that such an approach could backfire. After all, our economy's growth lies in its acceptance, if not encouragement, of failure. That's capitalism. Lenient recourse laws and bankruptcy protection encourage the risk and innovation that create the Googles (NASDAQ:GOOG), Microsofts (NASDAQ:MSFT), and Boeings (NYSE:BA) of the world. Full-recourse mortgages would therefore divert dollars away from housing investment, stifling advancement.
But that is actually what's crazy about a non-recourse mortgage system. For the past decade, we treated housing like it was something capable of innovation, somehow worthy of investment dollars because it was destined to achieve great things. We believed that housing could change your life. That it could make you rich. That it was the new "new" thing -- an Internet we'd never discovered before.
But that was all a sham. A thousand years ago, a home was a place to sleep. A thousand years from now, it'll be the same. A house is not an investment -- it's a place to live, and nothing more. Artificially supporting a degree of risk that encourages failure is kinda nuts, since homes are incapable of innovating into anything beyond what they've always been.
I know this is a touchy issue that'll draw a wide range of opinions. So I'm handing this article over to you. What do you think? Should the U.S. follow the rest of the world and move toward a full-recourse mortgage system, making homeowners liable for unpaid balances? Let us know in the comment section below.
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