Planet Money had a very interesting podcast about a month ago, titled "Discipline and Forgiveness". The basic gist is that some mortgages are what is known as recourse mortgages -- if you fail to pay, the lender can take everything you have (their recourse). Others are non-recourse mortgages -- if you fail to pay, the lender can take your house, but that's it. The rest of your assets are protected. What you get depends on where you live and (I assume) other factors.
The podcast compared the two on a number of dimensions. Normally, Planet Money is extremely good. I recommend it highly. However, on this one I think they totally dropped the ball, failing to address the following three critical points:
First, they assumed that people, in particular borrowers of mortgage loans, are essentially rational beings and make rational (i.e., mathematically optimal) economic choices. This is a common (really, a foundational) assumption of traditional economics. Unfortunately, it is completely false. Humans are not rational in their decision making, and there's nothing we can do about; it's simply human nature. We should organize our economic system around the way people are rather than the way we wish they were. (For more on this topic, I highly recommend Dan Ariely's Predictably Irrational.)
Anyway, in the case case of mortgage borrowers, two cognitive biases are relevant. People overweight the present (we get a house!) when comparing to the future (the bank might come after us). And, they underweight the probability of bad things happening (the kind of bad things that might lead to a default on one's mortgage). Both of these factors make people more likely to accept loans that are more risky than is prudent (i.e., than they would accept if they were perfectly rational).
Second, where is the onus of greater sophistication in risk analysis? In a recourse mortgage, it's the customer: in case of default, the bank can much more easily be made whole, because they can simply destroy the customer by taking more and more assets until the loan is repaid. In a non-recourse mortgage, it's the bank, because in case of default, all the bank gets is the house; thus, the bank must carefully analyze the situation to ensure there will be sufficient equity in the house to repay the loan in cause of default.
Of these two players, who is the more financially sophisticated? Banks, by far, because bankers have much training and deep expertise in finance and because they have access to sophisticated computer tools. Thus, they should be the party with more risk assessment responsibility.
Finally, the entire point of collateral is that the lender can take it if a loan is not repaid. Also, there is a common financial instrument useful for protecting one against loss: it's called insurance. If the value of the collateral is insufficient to pay back a loan, buy some insurance. You could even make the borrower pay for it! And this is exactly what is done for non-recourse mortgages; if one doesn't make a large enough down payment, one is required to buy mortgage insurance until the loan is paid down a sufficient amount.
The bottom line is, there's absolutely no need for recourse mortgages in a civilized society, and any state or country which permits them should be embarrassed to do so.
No comments:
Post a Comment