Last spring I had the opportunity to hear a speech by Martin Feldstein (seen at left), a Harvard economics professor. He spoke at an investment company education day, and he mentioned something that I (and several others I shared a table with) was shocked by. On Tuesday, in an interview with Bloomberg Radio, he explained how these problems created much of the mess in the US housing market and the spillover into the whole global economy.
He stated "The cycle of falling prices and rising defaults needs to be broken by restructuring U.S. mortgages to make them similar to others throughout the world", Feldstein said. "Owners should be at risk of losing a portion of their incomes or assets other than their houses during foreclosure", he said.
Right now, “there is a very strong incentive to walk away,” said Feldstein. “If you have a substantial gap between what you owe and what the property is worth, you have a very strong incentive to default. That doesn’t happen in other countries around the world.”
Feldstein advocates the use of so called “recourse loans” that allow banks to garnishee wages or repossess personal property like automobiles or furniture in the event of a default.
Say what? You mean you can buy a home in the US, and then if the deal goes sour and you owe more than it's worth, you can just walk away? Try doing that in Canada. Other than a reverse mortgage (where you cannot finance 90% of your home value), these beasts are essentially not allowed in Canada. I did some digging on the Internet and found the following explanation of the differences.
I have developed the following flow chart (humour definitely intended but also a dose of reality) that explains the entire mess we find ourselves in.
From lendors who gave out loans like the government gives out bailouts
Lenders then sold the "mortgages" as great "investments" to investment dealers
People in the US then used their homes as giant ATM's
People in the US spent more than their homes were worth
The sub prime meltdown made mortgage default rates increase
This then led to the mortgage "investments" going sour
Which led to the financial crisis we find ourselves in
Which led to the bailouts by governments around the world
Which leads us back to government telling consumers to "spend money" to help support the economy, which means you now go back to the top of the flow chart and repeat the process until our children's children's children can pay for it.