There are plenty of Monday morning quarterbacks poking at the reasons for the housing bubble. Certainly one of the major reasons for the rise in foreclosures and short sales was unprepared buyers. These unqualified buyers were given mortgages for more than they could afford and adjustable rate mortgages often meant that what started off bearable suddenly ballooned out of control once the rate rose. Some have tended to blame the buyers for not knowing better and for buying outside their means.
Blaming the consumer however shifts the responsibility to those least equipped to handle it. It also presumes that the way to prevent a future bubble is two-fold: to prevent these potential buyers from getting these mortgages, and to educate the potential buyers about the risks of a mortgage. This has been the strategy in the years following the housing bubble.
The creation of the Consumer Finance Protection Bureau aims to make sure that mortgages, credit cards, and other financial products work well for Americans purchasing them. It’s a noble goal and a worthwhile organization. However, fundamentally it still implies that the consumer bears all responsibility for the purchase. Mortgage providers, urged on the by the government, have tightened their restrictions. This has had two major deleterious effects: it has prevented many first-time buyers from entering the market and it has discouraged many from seeking loans at all.
The difficulty in dealing with mortgage companies has also led to a strong preference for cash buyers. Currently it is very hard for a buyer with a mortgage to compete against an all-cash offer. The seller generally choses cash to avoid the potential difficulty of dealing with a buyer whose financing could disappear.
What if there were another way to prevent a future bubble? Two professors, Atif Mian and Amir Sufi, propose a new economic model: the shared responsibility mortgage. In their new book, House of Debt, they discuss debt forgiveness as well as new mortgages that share the risk between the consumer and the mortgage provider. Businessweek provides a good explanation of something like this could work. It’s essentially a form of price protection, not dissimilar to the types of price protections offered by department stores that offer to match or beat a competitor’s price.
In the shared responsibility model, a buyer buys at a price and if the value of the home goes down, the principal owed falls as well. If the value of the home rises, the value of the principal does not go up but there could be some contingencies built in that when the owner sells the home the mortgage provider also receives some smaller share of potential profits. Shared risk and shared reward. I’m oversimplifying the specifics but the concept is basic and makes a certain sense, uniting the borrower and lender as partners in the home.
When the housing bust happened the government first saved the institutions before considering the individual borrowers. By the time the issues of borrowers were addressed it was too late for many. Those experiences carry scars not easily forgotten as those who short sold or foreclosed work their way back. Many would like to buy again but others are afraid to take the risk.
This is an interesting model to look at especially as we are already in the midst of another crisis—the student loan crisis. Once again, the borrower is alone, forced to find a way to pay off a huge debt. These borrowers are delaying household creation, marriage, and children while they struggle to pay off six-figure student debt. They often delay saving for retirement and the creation of a rainy-day fund, leaving them more at risk if calamity strike. Imagine a shared responsibility model for student loans. It would truly change the discussion on the intrinsic value of an education.
Shared responsibility is a radical concept in some ways. It changes the relationship between the purchaser and the seller but it may be the only thing that can prevent these types of debt-driven cataclysms from happening over and over again. It may not work, but given the alternative, it’s certainly worth a shot.