The Volokh Conspiracy - Bubble Update:

Just read that 61% of all new California mortgages this year are interest only, no money down. This is especially important because California (like a few other states, but, unlike, say, D.C. area jurisdictions where about 50% of the new mortgages are interest only) has a law requiring that all mortgages be "non-recourse," i.e., if a mortgagee defaults on his loan, the bank cannot attach any of the mortgagee's other assets, but can only foreclose on the house. If prices drop significantly in the next couple of years, as they likely will (given that only 17% of Californians can now afford the median house), thousands of people are going to walk away from their loans and let the bank foreclose, with no bankruptcy consequences. Sure, it will ruin their credit record, but how much is a good credit record worth? Probably not $120,000 (the negative equity on a $600K loan--median single family home price in California--if prices decline a modest* 20%). Anyway, many of the loans are adjustable with "teaser" rates used to qualify the buyers, who understand that in two years they will have to refinance or sell, because they won't be able to afford the new payments. They are counting on interest rates being lower, or on being able to "flip" the house for more money, and using the proceeds to get "back in the game." And they are likely to lose their homes, and the mortgagers are likely to lose a good chunk of the money they are lending. One thing that stumps me: Fannie Mae (which has been cooking its books for years!) buys the smaller loans (after all, what good would Fannie Mae be if it couldn't help poorer people get mortgages for homes they can't afford?), but who is dumb enough to purchase the larger non-recourse loans at the end of a bubble market? I know that Countrywide Financial and other lenders have been keeping more loans on their own books, assumedly because they are running into resistance from the market. Still, someone is buying many of these loans, often packaged into derivatives. And someone is going to lose a lot of money.

*Yes, modest, given that this would simply take the market back to 2003 prices.

UPDATE: A reader corrects: "I believe that you make a factual error in your Volokh Conspiracy post on the potential housing bubble. California is a "single action" state. That is, a lender secured by a residence has only two options: foreclose or sue the borrowers for the full amount of the loan. This is unlike (virtually?) every other state, where a lender can foreclose and then sue the borrowers for the deficiency, if any. This is in most instances a distinction without a difference, as few borrowers would have sufficient assets (especially in a default) to provide a better repayment result for the lender, but it is a difference."

FURTHER UPDATE: Another reader corrects the correction: I believe you still have it wrong as to California. California Code of Civil Procedure Section 726 (a) provides a single form of action that must be followed to recover a debt owing that is secured by a mortgage or deed of trust on real property. Section 726 requires foreclosure on the property and provides a means to recover the deficiency in the event that what is recovered is not sufficient to pay off the debt. But, Section 726 specifically mentions the exception to deficiency judgments provided by Code of Civil Procedure 580b. Section 580b does not permit a deficiency judgment where the debt is secured by a purchase-money mortgage or deed of trust to residential property. Thus, I don't believe a creditor has an option to "sue the borrowers for the full amount of the loan." A creditor holding a purchase money mortgage or deed of trust on residential property must foreclose on the property, and cannot recover any deficiency.

Any California real estate gurus want to set the record straight?

	[David Bernstein, August 20, 2005 at 12:45am] Trackbacks Bubble Update: Just read that 61% of all new California mortgages this year are interest only, no money down. This is especially important because California (like a few other states, but, unlike, say, D.C. area jurisdictions where about 50% of the new mortgages are interest only) has a law requiring that all mortgages be "non-recourse," i.e., if a mortgagee defaults on his loan, the bank cannot attach any of the mortgagee's other assets, but can only foreclose on the house. If prices drop significantly in the next couple of years, as they likely will (given that only 17% of Californians can now afford the median house), thousands of people are going to walk away from their loans and let the bank foreclose, with no bankruptcy consequences. Sure, it will ruin their credit record, but how much is a good credit record worth? Probably not $120,000 (the negative equity on a $600K loan--median single family home price in California--if prices decline a modest* 20%). Anyway, many of the loans are adjustable with "teaser" rates used to qualify the buyers, who understand that in two years they will have to refinance or sell, because they won't be able to afford the new payments. They are counting on interest rates being lower, or on being able to "flip" the house for more money, and using the proceeds to get "back in the game." And they are likely to lose their homes, and the mortgagers are likely to lose a good chunk of the money they are lending. One thing that stumps me: Fannie Mae (which has been cooking its books for years!) buys the smaller loans (after all, what good would Fannie Mae be if it couldn't help poorer people get mortgages for homes they can't afford?), but who is dumb enough to purchase the larger non-recourse loans at the end of a bubble market? I know that Countrywide Financial and other lenders have been keeping more loans on their own books, assumedly because they are running into resistance from the market. Still, someone is buying many of these loans, often packaged into derivatives. And someone is going to lose a lot of money. *Yes, modest, given that this would simply take the market back to 2003 prices. UPDATE: A reader corrects: "I believe that you make a factual error in your Volokh Conspiracy post on the potential housing bubble. California is a "single action" state. That is, a lender secured by a residence has only two options: foreclose or sue the borrowers for the full amount of the loan. This is unlike (virtually?) every other state, where a lender can foreclose and then sue the borrowers for the deficiency, if any. This is in most instances a distinction without a difference, as few borrowers would have sufficient assets (especially in a default) to provide a better repayment result for the lender, but it is a difference." FURTHER UPDATE: Another reader corrects the correction: I believe you still have it wrong as to California. California Code of Civil Procedure Section 726 (a) provides a single form of action that must be followed to recover a debt owing that is secured by a mortgage or deed of trust on real property. Section 726 requires foreclosure on the property and provides a means to recover the deficiency in the event that what is recovered is not sufficient to pay off the debt. But, Section 726 specifically mentions the exception to deficiency judgments provided by Code of Civil Procedure 580b. Section 580b does not permit a deficiency judgment where the debt is secured by a purchase-money mortgage or deed of trust to residential property. Thus, I don't believe a creditor has an option to "sue the borrowers for the full amount of the loan." A creditor holding a purchase money mortgage or deed of trust on residential property must foreclose on the property, and cannot recover any deficiency. Any California real estate gurus want to set the record straight?