Friday, July 09, 2010

Yves Smith on the Default of the Rich

She writes about this morning's story in the New York Times:

Another message here is that high income borrowers aren’t taking the Freddie/Fannie/bank bluster about strategic defaults seriously. Recall that the latest threat was that they would pursue deficiency judgments, as in sue borrowers who defaulted where the proceeds from the sale of the home, net of expenses, did not cover the mortgage debt. Now in some states that is not permitted (purchase money mortgages in many states are non-recourse, but refis never are). But independent of that, it is expensive to pursue defaulting borrowers, and if the borrower really is broke (say he had medical emergency, a business failure, or a costly divorce) litigation is just a costly wild goose chase. The most obvious group to pursue, nevertheless, would be defaulted owners of big ticket homes in affluent areas. They clearly regard the odds of legal action as low.

She slips in an important sentence--that refinanced mortgages lose their non-recourse status. Refinancings swamped purchase money mortgages in 2004 and were a substantial share of the market in 2005-2006. It would be interesting to see an estimate of the share of mortgage debt outstanding in "non-recourse" states that actually now come with recourse--I would imagine it is well over 50 percent. One might think that "sophisticated" investors are more likely to refinance than the general public (I did a paper with Lacour-Little some time ago that suggested that this was true), and so that "strategic" default could be particularly costly for this group. Certainly, if I were a lender and observed a borrower with a $1 million plus loan with recourse, I would go after the borrower for a deficiency judgment.

There is a broader point here as well. I have been reading arguments that America got itself into trouble because it is too borrower friendly, and that countries that avoided trouble, such as Canada and Germany, did so because of recourse. But the fact is that for all intents and purposes, the US is a recourse country too.


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Joe said...

The countries like Canada and Germany have avoided the situation United States and rest of the world is facing today - Recession. If United States is a recourse country too then why the situation has become worse recently?

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