Market risk was present back when home prices were increasing rapidly, but historical market trends minimized this risk in the minds of the purchasers. Buying a home is an investment, just like buying stocks or commodities. The bank is not responsible if the value of the property goes down, and would not be rewarded if the value of the property goes up. The borrower is responsible for the value of the underlying asset.
If a bank loans a teenager the funds to buy a new Hummer and gas prices suddenly go to $10/gallon, is the bank responsible for the decreased value of the Hummer? Market conditions changed during the life of the loan in this case. The teenager would not have anticipated the decreased value of his asset before initiating the loan. Should the teenager be allowed to walk away from the loan because the value of his asset decreased?
If an individual purchases 100 shares of GM stock with borrowed funds, is it the lender’s fault when the price of those shares fall considerably? Did the bank’s responsibility increase because many people lost money when the price of GM stock fell? If the price of GM stock had doubled rather than fallen, the bank would not have been given additional compensation/reward for making the loan. If the bank offered very generous rates and terms when providing the loan, did they become more responsible for the loss or gain associated with the underlying asset? In this case the bank made a loan to the borrower in good faith, and the loss of the borrower’s value on the asset used with the proceeds of the loan is not the lender’s fault or responsibility. The fact that this loss also affected many other people does not make the lender any more responsible for the value of the underlying asset. The lender did not require the borrower to initiate the loan; the lender agreed to make the loan to the borrower on mutually agreed terms.
It’s hard for some people to separate the emotional aspects of the home purchase, because of their close personal daily interaction with their investment. They let irrelevancies cloud their judgment when considering the situation. The bank making the home loan did not require the homeowner to make the purchase; they agreed to make the loan the homeowner requested on mutually agreed terms. The bank is not responsible for the change in value of the property, and would not have shared in the increase if the market value of the property had increased.
The anger of underwater homeowners is misdirected. Instead of blaming the bank that made the loan on mutually agreed terms, they should blame those responsible for the overinflated prices.
* The Federal Reserve played a major part in reducing and maintaining interest rates at very low levels, which caused unrealistic market price increases. More people could afford loans, which lead to more demand, and higher prices.
* The Fair Housing Act pressured banks to make loans to un-creditworthy borrowers, which increased demand and raised prices. People who could not otherwise buy homes were now capable.. this increased demand and raised prices.
* In order to meet the demands of the Fair Credit Housing act, new loan instruments such as interest-only loans and aggressively adjustable rate mortgages made larger mortgages more affordable, which increased demand and raised prices.
* Congress created and expanded the Secondary Mortgage Enhancement Act, the Tax Reform Act of 1986, and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 — These enhanced and expanded the creation of Mortgage Backed Securities which further encouraged loan origination.
All of this resulted in an overheated/overpriced housing market and unrealistic expectations of future price expansion in the home market.
In states and contracts where the owner has recourse to return the home in lieu of payment, the homeowner is well within their rights to return the home if they choose. No moral issue exists — the bank accepted the risk that the home might be returned when they accepted the loan. Any bank that would make a loan under these conditions deserves the consequences of their actions.
When the homeowner does not have recourse to return the home under the terms of regulation or their mortgage contract, they have the legal and moral obligation to conform to the terms of their agreement. The bank does not have any greater responsibility because housing prices fell, or the value of the stock went down, or the value of the Hummer tanked. The emotional attachment to the asset associated with the loan doesn’t increase the bank’s obligation.
In other words, it’s time to stop blaming the banks, and using that blame as an excuse to avoid legal obligations.
You are absolutely correct. I am more interested in how even I fell for what appears to be a sucker's bet. The bank making the home loan is not only getting paid for the loan (through interest, front loaded), but is also entitled to seize the property (at any value) if the borrower defaults, and can pursue a negative variance (in the event of decreased value) through seizure of other personal assets.
The borrower has a very easily defined upside and downside. The lender, on the other hand, will either break even (through asset seizure) or make a tidy profit in interest. A simplification, sure, but definitely in the lender's favor.