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Borrowers and Lenders

Mark Howard
Mark Howard,
Executive Editor
Whatever you may think about Gov. Rick Scott's desire to duplicate Texas' strategy for creating jobs ["Hold Your Horses, Rick"], one Texas success Florida wishes it could have emulated was that state's avoidance of the worst of the real estate bust.

Texas has plenty of cheap land, is home to several big home builders and generally has lax controls on zoning and development. Nevertheless, it came through the real estate boom-bust relatively unscathed. Texas experienced neither a grotesque run-up in home prices nor massive foreclosure rates — particularly compared to the experience of most big states. According to Alyssa Katz, author of "Our Lot: How Real Estate Came to Own Us," even subprime borrowers in Texas did "especially well compared with their counterparts elsewhere." As of July, according to RealtyTrac, the rate of foreclosure filings in Texas was less than half that in Florida.

Reasons given are various. Some point to Texas' experience with a real estate bubble in the 1980s, when the oil sector collapsed and home prices cratered along with the state's economy. The argument is that Texas bankers were so chastened by their experience in the 1980s that they avoided overextending credit during the recent bubble. Nice, but it ignores the national nature of the banking industry — Texas, like Florida, is a banking colony with most deposits held by out-of-state institutions.

Others say Texas property taxes — on average, twice the rate of Florida's — created a disincentive for speculation by making it more expensive. Those high taxes may have played a role by helping keep a lid on home prices.

Still others point to consumer protection measures in the Texas Finance Code. In 2001, the state banned prepayment penalties; other parts of the law outlaw various kinds of exotic mortgage financing, including negative amortization loans and balloon repayments. But those measures only applied to a small slice of overall loans and were easily dodged, according to Katz and other writers.

Katz nailed the best explanation in an article published last year in The Big Money, part of Slate.com. She believes the main reason Texas escaped was because the state's constitution outlaws "cash-out" refinancings — mortgage loans in which the homeowner borrows more than the previous loan amount based on his home's appreciated value and then uses the proceeds to pay off other debts or simply as found money.

Texas doesn't allow the total amount of debt on a home — whether from a mortgage or home equity loan — to exceed 80% of the home's appraised value. And it's illegal to use proceeds from a refinancing to pay off other debts.

The law effectively kept Texas homeowners from using their homes as ATMs, precluding the overleverage that led many in Florida and elsewhere to such grief. In her

article, Katz wrote that for every percentage point increase in a state's share of subprime mortgages that are cash-out refinances, the likelihood of foreclosure in that state goes up by one-third of a percent.

She also cited a study by Alan Greenspan in which the former Fed chairman estimated that 80% of the mortgage debt in America between 1990 and 2006 involved refinancings in which people converted home equity to cash.

There are a couple of ways to view the Texas laws. Liberal commentators — forever seeing consumers as victims and lenders as predators — tend to wax poetic about the "consumer protection" measures that shielded Texas homeowners from evil lenders.

A different view is that the laws, whose roots go back to the mid-1800s, according to Katz and others, are the deeply rooted expression of a value — a fundamentally conservative Texas attitude toward debt and leverage — that serves both banks and consumers well. If the laws were effective at protecting consumers from lenders, they were just as effective at protecting consumers from themselves and at protecting banks from themselves.

I'll confess to being conflicted at whether Florida should consider copying the Texas laws. Post-bubble, I had enough equity in my home, and the home was still worth enough, for me to do a cash-out refinance. Staying within the 80-20 framework, I was still able to borrow enough to pay off the previous loan and finance my daughter's first two years of college. Via the mortgage loan, I essentially ended up borrowing college money for less than 5%, with an additional discount in the form of the tax deduction for mortgage interest.

Great deal, but that was luck, not craft. Had my daughter graduated from high school a year or two earlier, a cash-out refinancing might have left me upside down.

So if Florida is looking for things to copy from Texas, it could do a lot worse than creating a Texas-style ban on cash-out refinancings. Given Florida's history of boom and bust real estate cycles, anything that helps foster a little more economic stability sounds like a very good idea.

Once upon a time, 80-20 loans were the standard. As several have wisely observed in the wake of the recession, all the efforts to loosen credit restrictions led to more home buyership, but a lot less real homeownership in terms of the equity owned by the people in those homes. We'll be living with the consequences for a while yet.


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