•  
  •  
 

Authors

Dov Solomon

Document Type

Article

Abstract

People tend to attribute the outbreak of the 2008 financial crisis to deregulation. This article challenges this view and presents a unique perspective of the crisis as in fact rooted in the way the residential mortgage market is regulated. Focusing on non-recourse mortgage legislation, which is a unique feature of the US mortgage market dating back to the period following the Great Depression, the article analyzes the contribution of this legislation to the onset of the Great Recession. The discussion shows how regulation that was enacted in response to a major economic crisis not only failed to prevent a large-scale future crisis but also created the conditions for its eventual emergence.

Non-recourse laws prevent lenders from seeking a deficiency judgment after foreclosure and impose no personal liability on borrowers in the event of default. They distort risk allocation in the mortgage market as they allow borrowers to externalize the risk of default to third parties. These laws thus create incentives for excessive borrowing, which ultimately resulted in the housing boom and bust of the 2000s. The analysis in this article has important implications for current reforms in leading foreclosure states, such as California and Nevada, where regulators recently expanded the scope of the existing mandatory non-recourse legislation. The insights from the article regarding non-recourse mortgages should serve as a warning to regulators against adopting such legislation.

 

To view the content in your browser, please download Adobe Reader or, alternately,
you may Download the file to your hard drive.

NOTE: The latest versions of Adobe Reader do not support viewing PDF files within Firefox on Mac OS and if you are using a modern (Intel) Mac, there is no official plugin for viewing PDF files within the browser window.