Posted on Friday, September 25, 2009
Proposals pending in Florida, one of the hardest hit states, reflect the problem at the foundation of our crisis, who should be responsible for bad buying and lending decisions? How should we allocate the risk of bad decisions?
The first proposal addresses deficiency judgements and essentailly would prohibit lenders from obtaining a deficiency judgement when the borrowers property is Homestead. The proposal sites deficiency judgements on Homestead property as being agsinst public policy but I beg to differ. Borrower moral hazard is against public policy. And moral hazard is exactly what is created when borrower know they can take whatever risk they want in buying a homestead property because the worst case is the bank will take the home from them but they will not be responsible for any deficiency. There are already states in the US that use this type of non-recourse theory for Homestead property and these laws have had zero impact on keeping the state foreclosures down during the crisis. In fact California, another top foreclosure state, has such a law! The proposal would also give judges discretion in whether to allow deficiency judgments in other cases. The idea that a judge is the best person able to make a decision like this is not sitting well with me. I can see a plethora of abuse here. Imagine a case where the borrower has plenty of money but the bank nonetheless has to eat the loss because the property happens to be Homestead. What about the guy with no money but whose foreclosure happens to be on a rental property he owns and conseqeuntly gets no protection from a deficiency judgment for? Lets be clear, this is a loss that eventually will be shared by all of us in the form of tighter lending standards and higher borrowing costs. I say lets the folks who default on their loans, Homestead or not, pay their own costs, not the rest of us. If the same guy makes a ton of money when he sells his Homestead he gets to keep the profit so essentially this proposal has banks taking the hit but not sharing in any upside. Even without this proposed new law, a borrower with a deficiency judgement from a Homestead foreclosure who really cant afford to pay it can seek bankruptcy protection, s system that has worked sufficiently. The bottom line? Limiting deficiency judgments on Homestead mortgage foreclosures is a bad idea.