Flexible Mortgage Contracts

The most regrettable feature of the 2008 recession was the contagion of  foreclosures that swept through vulnerable neighborhoods, impoverishing a whole generation of beginning homeowners, many of them descendants of oppressed ancestors.  I anticipated this well in advance, having witnessed risky lending practises during the previous decade, responsive to many years of uninterrupted home-price inflation and the promise of economic stabilization by the Fed.  This dynamic affected blacks disproportionally, owing to 1990s legislation forcing home lending in redlined neighborhoods.

During the years leading to the 2008 recession, mortgage brokers maximized their commissions by encouraging buyers to take loans for the full appraised value and more.  Thus, buyers were almost ‘under water’ on day one, or following the slightest unfavorable event.  Second mortgages up to 115% of value were encouraged, tempting borrowers to treat them income streams – all on the assumption that the upward home-price trajectory would continue.  Brokers pushed adjustable-rate mortgages on the most vulnerable, least sophisticated buyers.

During the recession, home deflation became epidemic.  That is, one defaulted/abandoned home in a neighborhood caused devaluation of neighboring homes, which were consequently abandoned hence intensifying and spreading failure like a forest fire.

Interested parties just watched as this epidemic destroyed wealth of aspiring homeowners.  A broker has no interest in a completed loan once it's sold off to a bank or investor group.  Our government bailed the institutions out.  There was a government home-refinancing program that helped stronger homeowners, provided they held on through the recession.

Back in 2006 and 2007, I contemplated a flexible mortgage contract, one where the lenders and buyers would share the burden of changing externalities, so the buyer could weather a recession without losing his/her home.  Accordingly, interest and principle would be adjusted temporarily to relieve homeowners of most of the shock but eventually altered to make lenders whole after a recession subsides.  Preventing the abandonment epidemic would mollify, possibly prevent a recession.

Flexible loan contracts should have been implemented in response to the 2008 recession but weren’t.  Instead, the Dodd-Frank legislation required banks to hold more capital.  There was no legislation to protect borrowers early in a downturn.  Lawmakers, lawyers, politicians, economists and bankers, are binary thinkers, ill prepared to design loans for an economic downturn.  That work might need some engineers, the kind who guided Voyager and New Horizons near our most distant planets.