Almost all Canadian mortgages are “full recourse” loans, meaning that the borrower remains fully responsible for the mortgage even in the case of foreclosure. If a bank in Canada forecloses on a home with negative equity, it can file a deficiency judgment against the borrower, which allows it to attach the borrower’s other assets and even take legal action to garnish the borrower’s future wages. In the United States, we have a mix of recourse and non-recourse laws that vary by state, but even in recourse states, the use of deficiency judgments to attach assets and garnish wages is infrequent. The full recourse feature of Canadian mortgages results in more responsible borrowing, fewer delinquencies, and significantly fewer foreclosures than in the United States.
This is weird in so many ways that it is hard to know where to begin, but grant him his general proposition: There is indeed something problematic about the asymmetric heads-I-win, tails-you-lose structure of non-recourse finance.The trouble is, once you start looking for it, you find "non-recourse" under almost every rock in the capitalist garden. I'm sure Perry would be happy to show you how the same problem underlies the bankruptcy discharge, where the debtor gets to walk away from his just debts. I'll bet (although I do not know) that he feels the same way about bank insurance, like the free-handed taxpayer guarantees that allowed the mischief-makers to bring down the Savings & Loan industry in the 80s/90s.
But it doesn't stop there. When I buy a call option on LittleCo stock, I acquire the right to take the stock or throw it away--analytically no different from my right when I buy my home on a nonrecourse mortgage. I have not heard Perry howling for the abolition of the conditional claims market, and I am not holding my breath.
Or consider the corporate limited liability form itself, the greatest social invention, so Bertrand Russell is supposed to have said, of the 19th Century. Restated: the equity stake in a leveraged company is a call option on the assets--you can take or walk away, just as with stock options, just as with the nonrecourse mortgage.
Probably nobody ever understood this better than the bankers. Look at that picture above of Mr. Banker Himself, J.P. Morgan Jr. Why does he look like he is ready to explode? Because it's his own skin in the game. He was a general partner. If the deals went sour, he stood to lose every penny. No wonder he was a prudent lender. No lwonder he staked so much on personal character.
Sadly, his successors appear at last to have grasped the full implications of his insight. What caused the late meltdown? Of course you can't bring it down to one cause, but if you had to name just one, I'd say--incorporation of investment banks, the great tectonic shift from unlimited to limited liability.* That's when the bankers stopped having skin in the game: when they shifted to heads-I-win, tails-you-lose. They bankers didn't worry about taking lunatic risks because they knew the downside was yours, or rather ours (indeed, any first semester MBA student can show you, the greater your capacity to shift he losses, the greater the inducement to take a risk and the more lunatic the risks you take).
I grant, there is a great puzzle here: why do shareholders get bankers get away with it--or more generally, why does anybody ever buy stock in a bank? But the same specter haunts Perry's argument: if banks operate in a regime of nonrecourse finance, you'd think it would make them more cautious in their lending, more prudent in protecting against risks that they couldn't offload. I don't know the answer to that, but Perry doesn't even seem to notice that it is a problem.
Final Jibe: I think it's pretty rich to see an endorsement of Canadian banking from a crowd who have spent the last dozen years or more telling us about the evils of Canadian health care.
Afterthought: and how could I have forgotten the biggest nonrecourse of them all?
--
*I first grasped this point in reading Barry Ritholtz' Bailout Nation, though I am not sure he would press it quite as far as I do.
Update: This piece got picked up at DeLong, where there is an interesting comment thread. It is also cross-posted at the new UC Davis faculty blog.
Update: Returning visitors will note the much improved glower on the face of JPM. And what is it with the knife?
1 comment:
The reason he wouldn't press it so far as you might is that the transition largely occurs before the beginning of the Second Great U.S. Depression in 2001.
And he would note—with some accuracy—that the need to become a public company was a direct result of the Commercial Banks having eviscerated their local competition (S&Ls) and spent the final two decades of the 20th century moving into both traditional IB areas and the insurance markets.
Turning Commercial Banks into "financial services institutions"—all with the FDIC guarantee, let alone the Greenspan Put—means that they have more capital than a privately-held IB. And Gresham's Law still abides: having a lot more money means you win even with inferior ideas.
The official repeal of G-S in 1999 had virtually no effect: it made it easier for Citi to buy Traveler's, but there are few, if any, other post-1999 transactions that required the 1999 change itself to be permissible.
No question that playing with Other People's Money makes it easier to ignore possible systemic risk--but the transition itself was largely collateral to the landscape changes.
Post a Comment