In its first regulatory response to the sub-prime lending crisis, the Federal Reserve has recently passed rules that would prohibit lenders from making non-income verification loans. But these rules ignore the fact that the issuance of bogus mortgage loans, in which other people’s money was used to fund loans to unqualified borrowers were often facilitated by inflated property appraisals which made it appear that the home to be mortgaged was worth more than the loan. All this is being done in the name of protecting unsophisticated borrowers who are now facing foreclosure and personal financial ruin.
Does this remedy really attack the underlying problem? I think not. What it does do, is to impose another regulatory layer on the already over regulated, and therefore expensive, process of obtaining a mortgage. Each layer requires another professional to be involved in the home buying process and makes the process more costly.
Wouldn’t it be simpler, and far more effective if the Federal Reserve required all non-income verification loans to be non-recourse loans? By requiring these loans to be non-recourse, the lender would bear the financial responsibility (and risk) that the appraisal which supports the loan is accurate, and if it's not accurate, it's the lender who bears the risk. This would surely encourage lenders act more responsibly when engaging the property appraiser and would permit the market to regulate the supply and demand of this type of financing. A lender, which understood that its only recourse in the event that its borrower fell behind in his payments would be to repossess the property, would look more closely at the purported value of that property. And although no home mortgage borrower welcomes the possibility that he would be dispossessed, in the event of foreclosure, the borrower would have no personal liability for any difference between the amount due on the loan and the value of the property on the date of foreclosure. Borrowers would be shielded from the negative consequences of incurring additional debt, which they are unable to repay.
In addition, if the lender could only look to the value of the property to recoup its loan, the foreclosure sale process might become more equitable. Presently, the lender has every incentive to “dump” the foreclosed property and look to the borrower for the difference. If the loan were non-recourse, the lender might act more prudently to realize the maximum value from the foreclosed property, perhaps re-marketing it instead of placing it at auction. The inventory of foreclosed properties might then also be better managed to mitigate the collateral downward pressures imposed upon the housing market under the current scheme.
