Recourse mortgages with significant down payments will stabilize the housing market, prevent speculative bubbles from forming, and limit taxpayer risk.
In the late 1980s, housing finance regulation focused on avoiding a repeat of what took place during the Savings and Loan crisis: government bailouts of institutions that had become insolvent by taking on too much interest-rate risk. Unfortunately, the new system, dominated by securitization, succumbed to the other major risk in mortgage lending, namely, house price risk.
Mortgage default risk is closely tied to the behavior of house prices. As long as house prices are not declining, mortgage defaults will be rare. If a borrower whose house has increased in value runs into financial difficulty and cannot pay the mortgage, it makes more sense for the borrower to sell the house and pocket the profit than it does to default on the mortgage.
Defaults on appreciated homes almost never happen. Thus, in an environment of rising home prices, underwriting standards tend to become lax, and other risk-management measures tend to be loose. When house prices are rising, lenders are not punished for poor judgment, mistakes, or even for making loans based on fraudulent claims by borrowers regarding their income and financial situation. As long as house prices continue to rise, borrowers either keep up with their payments or sell their homes and use the proceeds to pay off their mortgages.
When house prices are rising, the only real risk to the lender is from lending more than the value of the house to begin with. During the housing bubble, one observed ads for mortgage loans for 125 percent of the value of the home. Clearly, any lender who does this is asking for trouble. Also, any lender that is careless about appraising the value of a house for a refinance transaction where the borrower increases the loan amount is asking for trouble.