Most people don't have problems with their bank , sure they are greedy but not as greedy as the alternatives .
I fear your proposals will provide protection for the Gamblers .

Thats one way of making a profit at the banks expense.

Er, barley, Garum Masala and 579. Weren't the banks the big gamblers? i.e. Lending into a bubble-inflated residential market without employing proper risk management practices? Tom sixpack should pay up and shut up, thereby indemnifying banks from their negligence?

That is a very thoughtful article Gavin.

You have identified quite a few little rorts that the banks are into. On second thought maybe you have identified some big rorts.

I don't agree completely with everything in the article, but rather than quibble I just want to say well done. Don't be deterred by the thoughtless drivel that gets posted here as comments. There are intelligent people out there who appreciate your work.

Why should you be liable for the shortfall!
Get a grip of yourself, you are saying ,because values have fallen the contract you signed is void. Look at it the other way, if values have risen, and you default, as it is now, the bank sells and you get the overpayment. Be realistic. A contract is a contract, If you borrow when the market is up, that is your decision.

The author’s proposal that banks shouldn't be able to claim more than their collateral when a borrower can't repay their loan is superficially appealing but would lead to some perverse outcomes. This form of loan has contributed to the magnitude of both the boom and the bust in the US housing market.

Tt exacerbates the boom-bust housing cycle by introducing asymmetrical risks for borrowers - if house prices rise, borrowers win; if prices fall, they don’t lose. So borrowers do not carry the consequences of their bad decisions, and are encouraged to make risky investments. This will make price booms longer and stronger.

It would also prolong and deepen the downturn in sales and prices during the subsequent bust, because it encourages mortgage holders to walk away from loans that exceed their houses’ prices. This would lead to a flood of properties on the market at exactly the worst time in the housing cycle, when prices and demand are falling.

Both of these have contributed to the housing crisis in the USA.

Banks, of course, would be well aware of this. They would impose stricter conditions and demand higher interest rates of borrowers to compensate for and offset the additional risks they would have to carry. They would be more risk averse in who they lent to. In the USA, the government attempted to offset these problems by setting up Fanny Mae and Freddie Mac to lend to high-risk borrowers the mainstream banks would not touch. This of course, further exacerbated the downturn.

There are a host of other probable perverse incentives that would flow from the proposal, from under-insurance to poor maintenance

Australian housing is vastly, dramatically overpriced, by all reasonable measures. The recent analysis by The Economist is right on the money, and you can see from the chart gallery below (including two charts from The Economist house price web tool) just how overvalued Australian housing really is.....

http://australianpropertyforum.com/pages/gallery/

12 months ago there was complete denial that real estate was in trouble, but now the realization is beginning to dawn on many that something terribly serious is about to occur in Australia. The spruikers maintain faith in a soft landing, but they're straight out of luck this time. As 2011 unfolds the spruikers will come to understand that real estate in Australia is dead for generations. For anyone who's interested in reading some excellent blogs about the Australian property bubble I highly recommend the blogs hosted on the Australian Property Forum.....

http://australianpropertyforum.com/pages/blogs/

During the next two years we can expect to see vacancy rates and inventory levels surge to unprecedented levels as house prices collapse by up to 40 or 50% in most parts of Australia. This might sound extreme, over the top. But how over the top were the 200% to 300% rises in house prices we saw over the past decades. A 50% fall is nothing in the scheme of things, it just brings prices back to a fair level. House prices always revert to the mean and Australia is no different. All the nonsense dreamed up by spruikers about shortages and population growth, it's all just hot air, designed to breath more life into the bubble. A vain attempt to blow new life into a dying bubble justifying more unsustainable price increases to already exorbitant asset prices. But the air has run out. Consumers are tapped out. There is no more money left. The bubble is dead. Long live the new new paradigm, where an average family can finally afford a decent home in Australia. It's been a long time coming, but soon it will be time for the bears to party. Bring it on!

The borrower , whether borrowing from a bank or the person next door , should repay a loan , as required by the conditions to which the borrower agreed , even if the lender did not obtain sufficient security [ not "collateral " . Collateral means additional security obtained by the lender to support the main form of security , usually a mortgage ] . Banks may be unwise in some lending practices, but that does not excuse the borrower from a moral and legal obligation to repay . Encouraging borrowers to avoid such an obligation will only make it necessary for banks to require more stringent repayment obligations and better security from responsible borrowers .

Great ideas, I also think the idea where if a mortgagee defaults when they have negative equity then they should just be able to hand the keys back and the bank gets stuck with the debt. Yes this reduces the pressure on the borrower to get a sensible mortgage but on the other hand it massively increases the responsibility on the bank. This means that the banks should require higher deposits and greater ability from the borrowers to service their mortgage debt. This then should depress any housing bubble.

579 wrote: "you are saying, because values have fallen the contract you signed is void." No, I'm expressing a view on what should be in the contract in the first place. "If you borrow when the market is up, that is your decision." True. And if you lend when the market is up, that is also your decision. The difference is that the lender has more power and better information than the borrower.

Rhian complains that non-recourse loans encourage borrowers to "make risky investments" and "walk away from loans that exceed their houses’ prices." Yes, and full-recourse loans encourage lenders to make risky loans and foreclose on them.

Yes, Fanny Mae and Freddie Mac exacerbated the burst -- because they first exacerbated the bubble.

The lender can make adequate insurance a condition of the loan. If the resale price of a repossessed home is impaired because the borrower has neglected maintenance, then negligence is a tort for which the lender can recover damages, most likely as an out-of-court settlement. It is quite another thing to suggest that the lender should get damages for a burst bubble at the borrower's expense.

jaylex takes me to task for using the term "collateral" in the American sense instead of the British sense (my intended meaning is clear from the context), and makes the startling observation that non-recourse loans make lenders more conservative (yep, that's the idea).

jaylex further pontificates that borrowers should honour the conditions to which they agreed. Amen. That means the full-recourse terms of existing mortgages should be honoured if those terms were actually written into the contracts. It doesn't mean such terms should be allowed in future contracts. It doesn't even mean that if some existing mortgages have full-recourse terms resting on the governing law rather than written into the contracts, then those mortgages should be grandfathered from a change in the governing law. The legislators have the power to grant such grandfathering. But the lenders don't have a right to it. If the lenders didn't have the foresight to write the full-recourse conditions into the contracts, that's their problem.

many thanks gavin. i learn a lot from your articles - and am glad to see that you're writing more in plain english for non-economists like me.