Tuesday, January 18, 2011

Mortgage Questions

This post had a very perceptive take on a question from Megan McArdle:

McArdle: “Let’s turn it around,” I asked. “What if the bank decided that it wanted to exercise the same sort of option?…What if the bank foreclosed on your house, even though you made the payments, because it figured it could make more money taking the house and selling it?” (Not a likely scenario, I know, but a useful thought experiment.).

Banks exercise the same sort of option all the time when they resell mortgages (and hopefully notes!) from one entity to another entity. That’s the problem we have right now, that this reselling option banks use was so sloppy it’s tearing up the economy.

This is why if you are the type of person who thinks markets self-regulate through consumer demand and reputation there’s a major problem, as consumers have no choice over their mortgage servicer. If you don’t like your servicer, and refinance your mortgage with another bank, that bank can still sell off your mortgage and you can still end up serviced by the same institution.

I never quite thought of the decision to resell mortgages in this light, but this is a remarkably good point. It's not quite the same scenario as "seize the house" (which I think was the actual tactic that McArdle had in mind) but it certainly does put the decision to resell mortgages in perspective.

In a more pragmatic light, the decision to try and do regulation by reputation (long a bad idea) has even less relevance in the modern world. First of all, job tenures at banks may be quite short so the people making decisions that undermine a firms reputation may be elsewhere at the end of this period. Second, firms themselves often vanish or are absorbed by other firms (consider Washington Mutual as an example). These features of the modern corporate environment make it difficult to use a reputation based system as the primary check on the system.

This is not to say that homeowners who are in default should be given free houses (I'd think that was obviously an incorrect conclusion) but rather that we should give the regulatory structure of banks some serious thought.


  1. And why do we need to turn it around in the first place? Financial services companies engage in strategic default all the time. Apparently it's only wrong when you do it.

  2. I think the question is whether there is a social norm that is being violated (a moral imperative to pay your debts if possible). I do kind of like that ideal but agree that corporations have long since left it behind.

  3. I too have mixed feelings about Jingle-mail. Barring an unexpected catastrophe like a job loss, you shouldn't buy something you can't pay for and if you can pay for it, you should.

    That said, over the past few decades, we've made it much harder for individuals to be protected from creditors and more socially acceptable for corporations to default on their debts.

  4. This is why I liked the issue of creditors being able to sell mortgage notes, as it brings the differences of obligations to the forefront.

    In Canada you can't pre-pay your mortgage (or only in a limited form) making the instrument more valuable (less risk of refinancing if interest rates drop) which has led to a lot less securitization. I am reluctant to recommend this as a reform but it does seem to solve some of the issues at play.