In story after story about the foreclosure crisis, you will find the implicit idea that borrowers who can afford to pay their mortgage should keep on paying it no matter how much their house sinks in value because they have made a promise to pay and to do otherwise would be an abuse of the system.Propagating this idea is good for lenders and probably good for taxpayers, but basically, it's nonsense. Most states--California being the most relevant example--make it very difficult for a lender to go after borrowers for more money after they have foreclosed on a house. In California, lenders can foreclose in two ways. One way, the non-judicial foreclosure, lets the lender take back the deed with a 60 day notice after the first missed payment. In practice, this means that lenders can take the house in a matter of about four months. If they do that, however, they cannot get any more money. The other way lets lenders go to court to get the full amount due on the mortgage. This can take years. If the lender wins in court, then the borrower still has 366 days to pay off the mortgage and take back the house, which means that for all practical purposes it can't be sold. Thanks to California's "one act" rule, a lender cannot pursue both options: the bank must choose one.In practice, this means that a bank that doesn't want to get bogged down in a two year long morass has little option but to take back the keys, accept a huge loss, and call it even. Is this an "abuse" of the system? I don't see how. The loss was something that lenders could have anticipated at least as easily as borrowers. The reality is that ordinary people are lousy at figuring out the ins and outs of real estate transactions. Relying on the one act rule to get out of a mortgage is not to abuse the system--it is to use the system in precisely the way it was intended to be used. The reason that the one act rule exists is that lenders and developers have through the years shown a great deal of ability to maneuver unsophisticated buyers into crummy real estate deals. The reason that the one act rule exists is to put the risk of these deals on the lender, not the buyer. The purpose is to discourage bad underwriting, dishonest marketing, and unjustified price inflation by making it very, very hard for a lender to get back the money if they lent more on a mortgage than a house was worth...invariably stories that mention the prospect of foreclosure talk about the hit that this causes to a borrowers' credit rating. Obviously, there is a hit. However, journalists are mistaken when they imagine that a credit score is a judgment on the character of borrowers. It's not. It's a judgment about the likelihood of someone repaying a loan. Bad marks like a foreclosure affect this. But being overextended on credit affects this even more
This gets back to the original spur for Felix Salmon's post: The instant hysteria that poured from CNBC's weirdly tan financial soothsayers when they were faced with the prospect of homeowners learning and exploiting real estate law. They're trying to preserve a financial system they know and understand, and as each major piece falls away -- first all the banks cease to understand risk, then the investment banks go insolvent, then the insurance giants, then the commercial banks, then the homeowners begin ruthlessly learning the rules of the system -- it becomes a little bit clearer that whatever emerges next will have to account for these new rules, and will thus be rather different. A network that understood its niche in the financial sector of 2005 has little interest in starting anew in 2010. They're the last folks that the financial system still works for. Indeed, CNBC is coming in for a lot of hits lately, but that's because the financial sector, as we've known it, has virtually no defenders left but them. They want everything to get back to normal. But if ordinary Americans -- if Felix and Santelli's loser homeowners and all the rest -- cease respecting the old rules and begin a ruthless endgame with lenders, then there's nothing for the banks to come home to. There wll have to be a new normal. And where will CNBC be then?