How Non-Recourse Mortgages Can Drive Default Rates Up

Tim Worstall leaves an

interesting comment on my Jim Cramer post:

One thing about US mortgages that does surprise a Brit like me. Usually,

(depends upon the State) they are "only" secured by the property,

at least for a first mortgage. So if the mortgage is higher than the value

of the house, the (soon to be ex-) owner can walk away leaving both the house

and the debt with the bank. That’s very different from hte negative equity

we had in the UK in the early 90s, when you might lose the house and "still"

owe the further amount of the mortgage.

Whether there’s a word for this situation I’m not sure, but fungible certainly

isn’t it.

There is a word for this, and it’s "non-recourse". Tim is quite right

that in some states, mortgages can be non-recourse – which means that

Cramer’s strategy of "walking away" from a house with negative equity

can make a certain amount of short-term financial sense.

Let’s take an extreme example: let’s say you’re wealthy, and have a couple

of million dollars floating around in liquid assets. You bought your $1 million

condo at the height of the Miami property boom, with 10% down, and it’s now

worth maybe $750,000 – much less than your $900,000 non-recourse mortgage.

(I have no idea whether non-recourse mortgages exist in Florida; let’s say they

do.)

In this case, you can walk away from your condo – maybe you’ll go to

your summer house in Maine for a couple of months. The bank sells the condo

for whatever it can get for it, and your $900,000 debt is wiped out. Then you

return to Miami, and buy an identical condo – maybe even the exact same

one – for $750,000 in cash. (Having already defaulted on one mortgage,

you’re not going to find it easy to get another.) Presto, you’ve just made $150,000.

In more normal circumstances, things aren’t quite as cut-and-dried. Real people

care a lot about their credit rating, which will get trashed if they default

on their mortgage. Indeed, if you don’t have the cash to buy a new home, it’s

very hard even to rent somewhere if you have atrocious credit. But intuitively

it makes sense that default rates on non-recourse mortgages are going to rise

more than on normal mortgages when people find themselves in a negative equity

situation.

So the multi-billion-dollar question is this: What proportion of ARMs is non-recourse?

My guess is that it’s quite low. But I have no data on this question at all.

Can anybody help me out?