I have been asked several times ‘what would you change’ in the mortgage market in order to prevent serious financial melt-down in the future, the truth is there is no single thing that will ever do it, our issues are a perplexing intertwining of regulation failure, greed, banking errors, mismanaged risk, fundamental misunderstanding of money markets and national failure. There are key players within this, first and foremost is our government, after that is our central bank/ regulator, and finally financial institutions.
Anyway, the one thing I would change if I could would be the security on asset lending, in a nutshell I would just change one rule, therefore removing the need to revamp the entire system, the rule would mean that asset lending is non-recourse beyond the asset upon which the loan was secured.
In plain English, if you got a mortgage then the only recourse a bank would have wouldn’t be to you (currently you are on the hook for 12yrs and more) it would be to the property itself and after that the financial institution could go and hang if it didn’t work out. The positive benefits to this would be impressive.
1. Banks wouldn’t EVER offer 100% mortgages or other products where financial risk was high to the institution if the client didn’t repay.
2. Securitization would be evidence of a quality book being sold for future cash-flows rather than as a means to get risk off the balance sheet and over to somebody else, the due diligence would be much stricter and buyers wouldn’t step up if LTV’s were not in line with expected incomes.
3. Banks would charge higher margins, this would lead to a less leveraged institution – the old method (2000 to 2008) was to go out and borrow as much as you could at low margins so as to amplify results on lending, but when the interbank market went out of kilter it nearly caused the closure of banks across the world. Higher margins are a good thing and it removes the need for turning commercial banking into a den of gambling.
4. Borrowers would be more thoroughly vetted and loan to value offerings would come down, forever, this would mean that only people with a decent deposit and the correct lending profile would have access to lending, lending to ‘everybody’ isn’t about fairness, it isn’t evidence of a world where equality reigns supreme, because it’s not meant to, access to lines of credit should be based upon the worthiness of the individual, that’s how it used to be, that is how it should be, what happened at the end of the bubble was that anybody with a pulse who was willing to sign their name to a loan offer could get finance, that can’t be repeated.
5. Banks would know their contingent risks at any time, they couldn’t securitize easily and therefore loans would sit on their own book for longer periods, there would also be a deeper understanding of the ongoing performance of loans for the same reason, the system would be steady.
6. Only a foolish bank would explode lending if they had no recourse beyond the asset – that would help prevent property bubbles to a great degree.
Obviously this wouldn’t solve everything, it would likely lock huge swathes of the population out of home ownership, it would likely drive down property prices, but lower prices are not a bad thing, I don’t hear people complaining when there is a sale on LCD televisions! And carrying large debt is not necessarily a good thing for every person, home ownership does have a host of positive societal benefits, but when it is done at any cost, and to the detriment of the borrower then these benefits can rapidly be negated.
And of course, the objective of this post was to name just one thing, naturally a host of changes would be better, but if there was only one button that I could press and create a rule on the basis of it then it would be the one making mortgages non-recourse.