Let Us Learn from the US Mortgage Chaos

Arruñada, Benito (2010), “Let Us Learn from the US Mortgage Chaos” Expansión, October 26.

The mortgage foreclosure crisis in the US offers several lessons for Spain. It warns us of the risk involved if the debtor responds only with the property, and it shows the value of our institutions. First, US mortgages are a primitive form of setting a guarantee whereby the debtor sells the property to the lender, who is obliged to sell it back when the former pays off the loan. Many US mortgage loans are therefore “without recourse”, so the debtor can be released from the debt by giving up the property.

Those who support adopting a similar solution here are forgetting that with such non-recourse mortgages, lenders bear greater risks, both financial (because default is more likely) and for the real estate (if the price of the property falls below the value of the debt). Downward price spirals worsen and credit likely becomes more expensive, making it more difficult for the poor to buy homes.

Second, US property registers keep deeds of sale, but do not check that transactions respect property rights. There may be contradictory rights in the register, with several owners or several mortgages of equal status. The only way parties can fully clarify ownership is in the courts.

Moreover, registers show widely diverse performance. In many counties, their effectiveness is as low as that of the departments that organize elections. Both offices report to the Secretary of State, and are often assigned as a political prize. So insurance companies maintain “title plants” which allow them to determine the legal status of properties and to issue policies guaranteeing ownership for purchasers and lenders. More recently, the banks have created another register (the Mortgage Electronic Registration System, or MERS, covering 65 million mortgages) to record any assignment transactions resulting from the securitization of mortgage loan portfolios, and to carry out any necessary paperwork, without involving the public registers and standing in as nominees for lenders.

This process is behind the current mortgage foreclosure debacle in the US. Systematic failings have been discovered: in many cases, no-one knows who the mortgage-holder is, debtors have litigated using these mistakes to escape foreclosure, and a growing number of judges have questioned the right of MERS to initiate foreclosures. Main lenders, such as GMAC, JPMorgan Chase, and Bank of America, even paralyzed their foreclosures in order to review their processes. And, even more seriously, title insurance companies have stopped insuring the titles of properties coming up for sale after repossession. There is therefore the risk that not just the mortgage market will collapse but also the property market.

Speed of the registration system

It is true that the US registration system works fast. According to the latest Doing Business report, property can be purchased and registered in just 12 days, involving just four formalities and placing the US in 12th position on a global ranking. Spain is not far behind. Registration in Spain takes 18 days, with just four formalities, better than the OECD average of 25 days and 4.7 formalities.

But what is most important are not the initial costs. Figures such as those given by Doing Business hide the fact that in the US both the value of the formalities and the security they offer are minimal, as shown by the foreclosure chaos. Such chaos would never have arisen if, as in Spain, foreclosure were based on entitlements that had been unequivocally established by an impartial, public register. Spain stands alongside Denmark and Holland as having the lowest mortgage costs in Europe, according to the European Mortgage Federation. The efficiency of our guarantee system keeps mortgage costs down, and competition ensures that such low costs result in low interest rates.

It is therefore important to pay attention not only to initial costs but also to the value of our institutions. Some of the proposals included in the Bill of Law on Sustainable Economy, however, insist on minimizing formalities without considering their usefulness, and on reducing fees below the cost of the services involved. We have a good system, but will not be able to maintain it if the regulators do not understand how it works.

Finally, we should show more respect for our markets when they are as competitive as the mortgage market. This was not done by the Seville judge who has just found that the “floor” clause which establishes a minimum interest rate on variable-rate mortgage loans is abusive, considering that floor clauses should be equivalent in value to “ceiling” clauses.

This is by no means the case. The two clauses cover different future risks, and there is no reason why their value should be the same. It is the price (the interest rate spread) that adjusts the value of services for the two parties, with the inclusion of these and many other clauses. And it is competition amongst lenders (which is much higher in Spain than in other neighboring countries) that ensures that the price is set at the point of equilibrium, that is, the “fair price”.

We used to have a judicial system that aimed to convert judges into automata, following Montesquieu’s bouche de la loi. Our 1978 Constitution changed that, granting judges a degree of discretion that is more in line with common law. Cases like this one suggest that enforcing the law responsibly requires better knowledge of the subjects being judged.