"We expect you to repay your debts."
Those seven words could save America. Let me tell you why.
Heads, I win ...
Surely you've heard of the onslaught of people walking away from their homes because their property is worth less than the mortgage balance. Even borrowers who can afford their monthly mortgage payment are stopping, simply because it doesn't benefit them anymore.
This is entirely legal in many states. After the house is forfeited, "non-recourse" laws prevent lenders from going after these borrowers' assets or garnishing wages in an attempt to be made whole. It's a one-way ticket: If the housing market works in your favor, enjoy the ride. If it doesn't, that's the lenders' problem. Better luck next time.
Individual homeowners aren't the only ones walking out. In December, Morgan Stanley (NYSE: MS) abandoned ship on five San Francisco office buildings, turning the properties over to its lender. A Morgan Stanley spokesman got right to the point, saying, "This isn't a default or foreclosure situation. We are going to give them the properties to get out of the loan obligation." Not a bad deal -- for Morgan Stanley.
I support these walkers wholeheartedly. Why? Because they're following the law, and laws that help you shouldn't be ignored, even if you think they're outrageous. When someone offers you money, take it. And when the law allows you to walk away from a debt, do it. That's rational behavior.
But it's interesting to ask what the economy would look like if this weren't the law. For one thing, other debts like credit cards and student loans have at least some recourse. As anyone on the naughty list at Bank of America (NYSE: BAC), Citigroup (NYSE: C), or American Express (NYSE: AXP) can attest, banks will shake you upside down for every penny you're worth if you default on these debts.
Second, non-recourse mortgages are unique to the U.S. Most industrialized nations have laws allowing lenders to garnish wages and seize assets when borrowers default and the mortgaged property doesn't cover the loan balance. You borrow, you pay. Tellingly, many of these countries didn't end up with a Chernobyl-style housing meltdown like we did.
Take Canada. Its housing problems look practically nonexistent compared with ours. One reason for this is that nearly every Canadian mortgage is full-recourse. As one recent article put it:
If a bank in Canada forecloses on a home with negative equity, it can file a deficiency judgment against the borrower, which allows it to attach the borrower's other assets and even take legal action to garnish the borrower's future wages ... The full recourse feature of Canadian mortgages results in more responsible borrowing, fewer delinquencies, and significantly fewer foreclosures than in the United States.
It's hard to know exactly how big a difference this makes. But take a look at this chart comparing Canadian mortgage delinquencies with those in the States. Enough said.
Ditto for Australia. As one Australian journalist wrote in The Wall Street Journal in 2008:
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.
Not surprisingly, Australia currently has one of the healthiest real estate markets in the world, with 11% growth last year after a barely noticeable 4% drop in 2008. Come hell or high water, Aussies find a way to pay their debts.
Still not sold?
Changing recourse laws would probably be about as popular as ending Social Security. You'd hurt a lot of people. Admittedly, I doubt it will ever happen. But anyone who actually supports the non-recourse system should have to explain the advantages it brings. Other than supercharging homebuyers' ability to speculate like frat brothers in Las Vegas, I can't think of many.
Do non-recourse home loans promote growth? Maybe the growth of mortgage brokers and derivative traders, but the real drivers of our economy -- the Microsofts (Nasdaq: MSFT), Googles (Nasdaq: GOOG), and Boeings (NYSE: BA) of the world -- gain nothing.
Does it encourage entrepreneurship? Maybe in the business of flipping condos, but that isn't much to be proud of. Does it promote capitalism? If you believe that trust and a strong system of contract laws are two of capitalism's tenets, then no.
Surely, though, it protects those who are down on their luck, right? Not really. Even with a full-recourse system, bankruptcy laws protect those in over their heads.
So could "we expect you to repay your debts" be the seven words that save America? They won't solve all of our problems, but they're certainly worth a shot.
