Tuesday, October 7, 2008

Free Enterprise Works: When Australia Shows the Way

This article in the Wall Street Journal talks about one of the main incentive problems built into the American mortgage system: nonrecourse loans. The same problem does not exist in Australia (HT Shikida):

... Australian banks are "light years away from what's happening in other banking systems around the world." Australia's four major banks sit amongst the 20 AA rated banks around the globe. And as the Sept. 23 International Monetary Fund Country Report on Australia concluded, Australia's banking sector "is sound with stable profit, high capitalization and few non-performing loans."

The reasons go directly to regulatory differences that should interest Americans. Take nonrecourse mortgage loans. When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn't cover the debt, they will be responsible for the shortfall. And the lender will chase them for it. It's a neat way of reminding Australians to borrow responsibly.

In America, where populist post-Depression laws in many states have mandated loans be nonrecourse, the opposite is true. Americans can take out a mortgage more or less as a one-way bet. If you can't afford the repayments and can't refinance, you just send the keys back to the bank. Borrowers wipe their hands of liability. So, naturally, an American in financial strife will pay off debts that carry personal liability -- such as credit cards -- before they pay off their mortgage. ...

Now, Australians -- and others -- place a high value on homeownership too. But they are aghast at the dumb things America has tolerated in pursuit of that goal. Even more dumbfounding is that nobody in Washington seems to be talking about fixing it.

In other words, the mortgage system that we have in America is recipe for creating financial dominoes. The Australian system on the other hand has a better chance at avoiding excessive leverage and indebtedness, or scams like this one.

PS: Mankiw also thinks the article gives good advice.

No comments: