Due-On-Sale Propriety When Banks Ruin The Economy

[Bryan Hancock]

Now that our banks have all but devolved into GSE conduits I was wondering what the consensus is for the fairness of selling homes with loans on them when interest rates drop.

It is just for the banks to deploy the capital to efficient use based on market rates according to Garn-St. Germain rulings if rates rise appreciably. The servicer and/or lender must retain that call option in the event rates tick up to meet their fiduciary duties with their shareholders. The borrower also retains an implicit call option using distorted government-guaranteed money because they can refinance when rates drop. All is well with the world an equitable. At least this is the case in theory.

What is equitable when the government’s loan model allows banks to bring the economy to its knees such that a large proportion of credit-worthy borrowers can’t obtain loans? Should the rules of engagement change from those based on statutes that are 30 years out of date? If the banks are no longer willing to issue new loans isn’t there a compelling case that the old loans are fine as long as the new borrower presents as good or better credit risk as the original borrower at the time of sale? Wouldn’t the whole system function better without these bank call options in this scenario?

Couldn’t the whole system be designed better to begin with? Couldn’t the lender simply state the conditions necessary to transfer the security interest and sign off on such a transaction when the original loan is issued instead of using this ridiculous system? Wouldn’t the whole system be more efficient and rational absent this large distortion from GSEs purchasing the bulk of loan product? Lenders get call options if the collateral changes hands. Borrowers get call options at any time that rates drop and they can afford the fees to refinance. Is this still tit for tat if lenders blow up the whole system and fail to live up to their end of the bargain by issuing new loans?