May 21, 2010
Harris on Recourse and Non-Recourse Mortgages
Ron Harris (Tel Aviv) has posted Recourse and Non-Recourse Mortgages: Foreclosure, Bankruptcy, Policy on SSRN. Here's the abstract:
The recourse-non-recourse dimension is fundamental in any loan as it deals most directly with the pool of assets out of which lender can collect at delinquency and default. This paper calls attention to an exceptional feature of the American home mortgage market, compared to mortgage markets elsewhere in the world, the prevalence of non-recourse mortgages as created by foreclosure rules in leading states such as California and Arizona and federal bankruptcy law. It explains how the legal impediments on recourse to personal assets and future income, together with the recent drop in home prices, led to a dramatic rise in strategic foreclosures (ones that resulted from negative equity rather than from cash-flow problems). No less than 588,000 strategic walk-away mortgage defaults took place, representing nearly 20% of all foreclosures in 2008. Most of these were not likely to happen in a recourse regime.
The paper then deals with policy. It uses a few theoretical frameworks: put option, default insurance, asset partitioning and screening. It examines the pros and cons of recourse regime and of non-recourse regime. It concludes that there is no compelling justification for prohibiting either recourse or non-recourse loans. The benefits and pitfalls of a dual regime are then examined. The question relating to why we don't observe a dual regime in the real world is addressed. The paper recommends that jurisdictions that prohibit recourse loans lift this prohibition. It concludes that both recourse and non-recourse should be on the table, on the levels of regulation policy and lending practices.
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Thanks for posting this Ben.
As a factual matter, do we know whether the "recourse" provision ever bargained for in states where it is available?
Posted by: Dennis Crouch | May 21, 2010 8:40:38 AM
The question as I understand it is whether in jurisdictions that allow the enforcement of recourse mortgages, jurisdictions that permit deficiency judgments, say Texas or Florida, in fact both types of mortgages are being offered. This is an issue that bothered me a lot. My theoretical analysis suggests that both should be offered but in fact I did not find significant evidence for the offering of non-recourse primary residential mortgages is such jurisdictions. Commercial mortgages of both types are being offered for reasons discussed in the paper.
In p. 38-41 of the paper I addressed this puzzle. I rejected specialization, securitization and default insurance as good explanations for the absence of non-recourse mortgages in these jurisdictions. I believe that lenders do not want to make this dimension of the agreement more salient, as saliency may reduce demand for loans, and thus do not compete over it. I also think that the ability to discharge the deficiency in chapter 7 bankruptcy, which apply to all jurisdictions, diminishes the distinction between recourse and non-recourse loans.
I'll be delighted to learn of empirical indication for the availability of both types of loans in dual regime jurisdictions or of additional explanations for the absence of non-recourse loans.
Posted by: Ron Harris | May 25, 2010 12:54:05 PM