Do we want systems that are chaotic and messy but where errors will be small, isolated and fixable or do we want systems that are orderly but large, complex and full of systematic errors that result in catastrophic failure? The Contract for Deed, a source of anxiety for many worried that individuals are being taken advantage of, is not the problem. It's the answer.
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Last week, the Minneapolis Star Tribune ran their second story this year on a specific type of transaction known as the Contract for Deed. The first article, which ran last January just as the Minnesota legislature was convening, called contract for deeds a "house of horrors for buyers." The second article was a follow up reporting on legislation inspired by the first. It is a journalist's dream: identify problem, draw attention to it, watch policy makers take action to address it. It has a real feel good vibe to it.
And it completely misses the mark.
It is important to understand what a contract for deed is. When doing a real estate transaction, it is a written contract that spells out the terms under which someone agrees to purchase and someone agrees to sell the property. Here is how the Star Tribune ominously described it:
Unlike a traditional home sale, the transactions typically take place with no bank, no Realtor, no appraisal -- and little government oversight. Instead, the seller finances the sale and then collects monthly payments, much like a landlord.
The undercurrent here is that, without a bank, a Realtor and an appraiser, there is hardly any protection for the little guy making this transaction. (As a side note, why is Realtor a proper noun? That just seems silly.) Here are some of the ills reported in the first article:
Across the Twin Cities, many homes sold through contract for deed have been beset by inflated prices, high interest rates and other terms that almost guarantee the buyer will default, according to a Star Tribune investigation of 1,330 such deals dating back to 2007.
In hundreds of cases, records show, sellers failed to provide mandated home inspections that would have revealed code violations and safety hazards. Some buyers said they were misled about outstanding debts attached to the properties. Others thought they were signing a lease.
Contract for deed sales have become more common as more people have become economically distressed and, after going through a foreclosure, unable to purchase a home the modern way (note I did not say "traditional" way as the "traditional" way would be a contract for deed, something very common here in America for hundreds of years). If you are a high risk buyer, you generally don't get great terms, particularly when you don't qualify for a bank loan. But all that is obvious and somewhat beside the larger point I want to make.
What I want people to pause and see is the difference between small scale and large scale failures.
The former we get all upset about, largely because it is in our capacity to grasp. We understand that, when a poor immigrant family enters into a contract for deed with a dishonest seller, they often get taken advantage of. That offends us, for good reason. We demand that something be done and, when something is done we feel like progress has been made (even when all that is done is to require some people selling property on a contract for deed provide a disclosure form for the buyer to sign -- not sure how that will discourage fraud).
Interestingly, the ones most upset about injustice are those that are the main players in the current system. Realtors, appraisers, closing agents, bankers, title companies and city officials all express outrage that people may be taken advantage of in transactions that take place out of their protective custody. But what happens when they turn on the little guy? Who cries foul then?
That's the large scale failure, the one that is too complex and difficult to fully comprehend. The one where nobody is at fault because everyone is simply doing their job. The one that is not so neat to wrap up into a 40 inch news story that leads to bipartisan legislation.
A couple of years ago I read the book And Then the Roof Caved In by David Faber in which he detailed the systematic fraud in the housing market that began with the Realtors and appraisers and went all the way to the big banks and the ratings agencies. While there were lots of tales of woe, and lots of news stories written, this kind of systematic fraud is less easy to become outraged about. There is no clear villain. No single bad guy we can pin the blame on. Just a corrupt system that we're all part of.
When you're a seller, your Realtor is great when they can get you a higher price for your house than what the market price should be. That the buyer's Realtor makes a little more money on the higher transaction doesn't hurt things either, especially if everyone qualifies. The appraiser is good for ensuring that, making certain that the high end of the price range is achieved, with comparables to justify it. He'll get a call back the next time an appraisal is needed. Of course the closing company is looking out for everyone, making sure there is clear title (head over the Strong Towns Network for some personal stories on that) and all the paperwork is done correctly (not). Then you have the local bankers who, knowing they are not going to keep the loan but simply package it up for the secondary market, are sure to perform all nature of due diligence (again, not).
In short, nobody in the current mainstream real estate transaction system has any direct incentive to look after the little guy. Now I know many good and honest people that work in this industry -- I'm not disparaging them -- but am simply pointing out that they all get paid when transactions take place, largely as a percentage of the transaction cost. That provides a huge incentive to do transactions, the more expensive the better.
So when the little guy gets taken advantage of in this system, what happens? We get more forms to sign (if you've ever been to a closing you have experienced the two inches of worthless CYA disclosures even the closing agents roll their eyes at) and things like Dodd Frank legislation. And when a major real estate transactor like Bank of America gets caught defrauding thousands, their PR department goes to work and, at worst, they may face a slap on the wrist fine.
What we've decided in this country is that we are going to take our fraud on a grand scale instead of an individual scale. In the effort to protect the little guy, we've created systems that are run exclusively by big guys. When those big guys manipulate interest rates, dream up exotic securities that they know will fail and crash the banking system, well....that's just the way things work. We bail them out and then try to reinflate the housing bubble (for the benefit of the little guy, no less).
For me, I'd rather get screwed by another little guy than a handful of big guys. At least with the little guy, I've got options. I can negotiate a different contract; can't do that with Bank of America. I can shop around among thousands of different alternatives, not four or five all colluding with each other. When a transaction goes bad, I have recourse in a court of law, not a roboteller and a team of attorneys that will flood me with fine print.
And maybe I'm not so stupid after all. Maybe if I am expected to negotiate my own contract, I might read it. I might demand that it make sense. I might expect the people working on my behalf to actually work on my behalf. Maybe if I wasn't treated like an idiot, I might be able to buy a home the same way I buy a car, a cell phone or a college education.
Speaking of which....why don't we have a bunch of disclosures when young adults take out a mortgage worth of debt to get a college degree? Shouldn't we disclose what the cumulative future payments will be and correlate that for them as a share of their projected earnings? After all, is their anyone more gullible than a college freshman? Answer that question and you'll understand how we got here.
This is all about Nassim Taleb's Antifragile insights. Do we want a system that is chaotic and messy but where errors will be small, isolated and fixable or do we want a system that is orderly but large, complex and full of systematic errors that result in catastrophic failure?
The Contract for Deed is not the problem. It's the answer.
You can get more of Chuck Marohn's insights by reading his book, Thoughts on Building Strong Towns (Volume 1). It is a primer on the Strong Towns movement and an essential read for those wanting to get up to speed quickly.
You can also chat with Chuck, Nate Hood, Andrew Burleson, Justin Burslie and many others over at the Strong Towns Network. Join the ongoing conversation on how to make yours a strong town.