Radical, popular and right
About a year ago a good friend of mine came up with an excellent policy idea. I said it was unworkable. After several months of reflection, I realised I was wrong. The idea is in fact excellent – it makes economic sense, political sense and seems morally correct. I only wish I could claim the credit.
So here it is: let’s make negative equity illegal.
Or, more formally, let’s legislate to make mortgages in the UK non-recourse. I.e. if a mortgage is taken out against a property and the borrower defaults, then the borrower is only responsible for handing over the property, not any other sum.
So if I borrow £250,000 to buy a flat (and just typing that makes me remember how silly London property prices are) and then fall into difficulties (say if I lose my job), it doesn’t matter if the flat is now only worth £220,000. I just hand back the keys and the bank takes the £30k hit.
In other words, negative equity is not possible. At any time I want I can simply hand back the keys and the debt is gone.
This is already the case in multiple jurisdictions, including about half the US.
The rational is simple – a bank employs a legion of economists, statisticians, loan officers etc, who should be better able to work out the direction of house prices and the ability of a borrower to meet payments than any individual. So they should carry the risk.
What would be the side effect (other than the gratitude of thousands saved from negative equity and the threat of bankruptcy)? Obviously banks would have to be far more cautious in their lending. Loan to value ratios of over around 85% would become much harder to get. This would not only make bank loan books safer going forward, but also put a break on house prices. Both good things.
I argued that this would make it much harder for first time buyers to get on the ladder. I now see that if house prices were lower this would be less of an issue.