In Philadelphia, Baltimore, and their respective suburbs, some homeowners still
pay "ground rents." The term, which dates from the eighteenth
century, is a misnomer as the payments represent interest on renewable 99-year
or perpetual mortgages. Although the creation of new ground rents fell out of
favor before World War II, ground rents and other types of long-term,
interest-only mortgages have much to recommend them and are widely credited
with making Philadelphia the "city of homes" and Baltimore the
"city of home owners."

In the eighteenth and nineteenth centuries, lenders found in ground rents a
secure, readily salable (liquid) long-term asset that generally yielded between
five and six percent. Defaults were rare because loan to value ratios (LTV) were
conservative, typically in the neighborhood of 50 percent, and the interest due
any given quarter or year was negligible compared to the value of the real
estate, providing borrowers with strong incentives to make payments. Moreover,
in case of default, lenders could lawfully enter the home and seize and sell
any personal property found at the address. Rarely was it necessary to
repossess the real estate to keep an account current.

Homeowners liked ground rents because the contracts kept their housing payments
relatively low and eliminated the refinancing risks that periodically crushed
those whose mortgages fell due when interest rates were high, mortgage renewals
were unavailable, or housing prices were plummeting, as during the Great
Depression. Ground rents were extinguished when a homeowner bought his contract
from the investor holding it. When market interest rates were relatively high,
the contracts could be purchased cheaply. When they were relatively low, the
contracts were dear. The key was that homeowners could decide if and when to
purchase the contract, allowing them to ride out financial storms rather than
be sunk by them. "It is worthwhile noting," wrote legal scholar Frank
Kaufman in 1940, "that relatively few ground rent defaults occurred during
the recent depression. In fact," he continued, "Baltimore has seen
less of the foreclosure evil than have other large cities in which only
ordinary mortgages are used."

That raises the question of whether widespread use of ground rents could have mitigated
the crisis of 2007-8. They might have, even if the average ground rent LTV had
increased to 100 percent and the contracts were securitized as mortgages were.
Ground rents would have decreased borrower opportunism (moral hazard) by making
it easier for lenders to force homeowners who continued to reside in their
houses to keep their accounts current and, in the case of walkaways, to
foreclose on the property. In addition, as interest rates fell following the
crisis, the value of ground rents would have increased, offsetting to some
degree losses realized on the sale of foreclosed properties. The vicious cycle
witnessed since 2007 -- decreased home prices and liquidity leading to defaults
that decrease home prices and housing market liquidity yet further, triggering
yet more defaults -- may have been stopped sooner or even prevented in the
first place. We will never know for sure, of course, but regulators should
consider allowing some modern experimentation with these hoary instruments of
home finance.


Popular posts from this blog

vision board: off to Paris!

a brief trip to (smelly) Manila Zoo

ang huwarang pamilya