Non-Recourse Mortgages – A Fresh Start

Abstract

In about a quarter of US states, all residential mortgages are essentially non-recourse, meaning that in case of default, the lender can only repossess the house but cannot collect on the private assets and future income of the borrower. This American innovation is now beginning to attract extensive interest abroad, but ironically in the US itself is getting a bad name. The law has been blamed for exacerbating the financial crisis, while stricken homeowners who take advantage of it have been scolded by lenders and even by the Secretary of the Treasury. We propose a fresh and more balanced look at mandatory non-recourse. Contrary to the view that non-recourse regimes lead to a vicious cycle of defaults, we point out that overall default rates have not in fact been meaningfully higher in non-recourse states. Contrary to the view that non-recourse is merely a populist response to over-indebtedness, we present a number of cogent policy justifications for it. Non-recourse can encourage fresh start with less impact on the credit market than bankruptcy; research shows that stricken homeowners are more likely to declare bankruptcy in recourse states. Non-recourse can enhance the accountability of lenders for mortgages. It can provide homeowners with a measure of insurance against loss of home value in cases where this protection would not be provided in the unregulated market due to market failure. We conclude that non-recourse legislation deserves serious, research-based consideration.

Keywords: mortgage, non-recourse, foreclosure, fresh start, insolvency, death spiral, adverse selection

JEL Classification: D82, G21, G28