Oct 122008

For reasons I never could quite understand, mortgages are heavily tested on the bar exam, usually constituting at least a third of the property questions on the MBE. While I did learn the rules sufficiently to pass the test, my eyes always glazed over at the thought of them. I just couldn’t care about the technicalities of financial instruments; I cared about people.

Even in this current crisis, my view is the same. The technicalities of financial instruments still strike me as mind-numbingly arcane, but to the extent to they affect real people, real lives, and real homes, well, in that respect they are incredibly relevant.

However, it’s this dichotomy about mortgages that seems to be at the root of our current problem. And standing away of its solution.

On the one hand, mortgages are technical and often complicated financial instruments. Bought and sold, underwritten and recalled, mortgages are entirely pecuniary in character and exclusively of the realm of banking and finance experts.

But as long as they are regarded merely as mechanisms of investment, they will fail as mechanisms of investment. For doing so ignores their other dimension: as necessary tools to get people into homes.

In fact, it frustrates me to hear people blame the crisis on subprime mortgages. Yes, they were riskier loans, sold to less-wealthy people who necessarily had lower credit ratings. But remember that these so-called “subprime” borrowers were often sold usuriously unaffordable mortgage products that even the better-healed wouldn’t be able to pay. In many instances it’s not a defect in the borrower causing the default as much as a defect in the loan itself. I fear that the lesson of this crisis will be that no future loans will be extended to underserved strata of society, a decision that’s both unnecessary and unfortunate. Getting people of all levels of income into stable housing is a good thing for society and ultimately economically advantageous for everyone. Recognition of this reality is not only helpful for the future but key to how we negotiate the problems of the present.

Especially as the world-wide economy sputters, risking the instability of entire sections of society would be a very bad call. Forcing people out of their homes will force them to be both economically unproductive and potentially also dependant on an already-stretched public fisc. Keeping them in their homes must be a priority.

But doing so is hardly an act of charity on behalf of banks. In fact, it could be key to their solvency. The idea behind a mortgage is that if a borrower stops paying his loan, the bank can take the property as collateral in order to cover its loss. But what’s happening now is that banks are finding themselves encumbered with properties that cannot be sold for anywhere near the balance of the loan; that require further money for upkeep and taxes; that devalue the entire neighborhood and deflate the real estate sector generally; and that are no longer able to be revenue-producing assets. Clearly, simply foreclosing on properties and evicting the residents is not working out for anyone.

In the debates Senator McCain has proposed the government buy bad mortgages. I don’t think such a proposal is a good plan. It’s too simple, and too unnecessary. It is not necessary that mortgages become public; there’s still a place for private banks here too. In fact, in the long run, we’d rather have them return to stability than leave us bank-less. So a more appropriate action for the government to take would be to alter the legal terrain such that it will help them — and society generally — get back on their feet. Towards that end, here are some legal changes that should be imposed instead:
(1) Bankruptcy courts should be allowed to adjust the interest and principle on their defaulting mortgages, at least for properties that are primary residences. (I believe something along these lines was proposed in the bailout bill, but I’m not sure if this provision ultimately made it into it.) Doing so addresses both parts of the problem: people are not uprooted, and the banks get liquidity, income, and smaller losses — or potentially even profit, just perhaps less than originally anticipated. The last thing anyone should want is for a bank to recover an empty property. Courts should be authorized to ensure that doesn’t happen if at all possible. In exchange, perhaps banks could obtain some sort of conditional lien on the property, so if a borrower is ever able to sell the property for more than the amount of the adjusted loan, or circumstances change to allow the borrower to afford a greater amount, the bank could be first in line to recoup the value it conceded during the bankruptcy.

(2) Where necessary state laws should be changed so that any property recovered in a foreclosure or sold at auction would be taken subject to any current tenancy. (In other words, someone renting the property would get to stay.) This week came news that the sheriff in Cook County, Illinois, is refusing to evict tenants from their foreclosed-upon homes. There are obviously some questions about whether such refusal is consistent with his duties to uphold the law (although given the concern he raised that the evictions were not being properly executed it’s possible the answer is yes). But his actions point to an additional problem with the current mortgage crisis: that innocent tenants are being displaced. Thus even more people are losing their homes and being destabilized, and banks are ending up with even more abandoned properties and their incumbent costs. Whereas if the tenants could be kept, properties would not be abandoned, they would remain maintained, the occupancies would reduce the oversupply problem and increase property values generally, and banks would have access to the income stream from the rent. Perhaps banks could then even negotiate a lease-to-own arrangement with the tenant, but without changing the law to require tenants to be kept during a foreclosure I don’t think banks will have the freedom to negotiate these alternate arrangements.

Such proposals are win-win for everyone — or at least “lose-less” than the current situation. But what’s important about them is that they are not overly-technical solutions directed entirely at the financial sector. Rather, they are reasonable, human-understandable solutions that focus on the people involved, which is exactly how it needs to be.

 Posted by at 9:19 am

  One Response to “Thoughts on the economy – mortgages”

  1. In exchange, perhaps banks could obtain some sort of conditional lien on the property, so if a borrower is ever able to sell the property for more than the amount of the adjusted loan, or circumstances change to allow the borrower to afford a greater amount, the bank could be first in line to recoup the value it conceded during the bankruptcy.
    That is the provision that has been missing from most of the proposals, and the one that also causes some of the problems, in that many borrowers, who were expecting to profit on their purchases, greatly resist the thought that they will not be able to do so.
    Your analysis is spot on though, all the way through.

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