Times: Homes at risk as banks seek more security for credit card debt



Hmmmm. Liver Default Swaps anyone? Their price could vary with someone's alcohol intake of a given night.

I'm guessing they really did keep them in safes. There is a story from (I think) Charles Mackay's "Popular Delusions and the Madness of Crowds in which a sailor mistakes a very expensive tulip bulb being imported to Amsterdam for a small onion and uses it to garnish a meal. He got six months in jail.
I suppose those who had particularly valuable bulbs had to post guards on their plots when trying to bud them.
They also had to invent Tulip Bulb Futures so that people could buy buds from a bulb of known pedigree which would be grown by the next season. Of course there was a certain risk in buying any bulb because nobody knew whether it would "crack" or not and produce the much-desired colour and flame effects (we know now that this was a virus infection). Undoubtedly futures prices varied with the estmated skill of the grower to achieve this.
Bulb traders would be recognised by many of the players of credit and housing markets today. Of course they had importers who would bring fresh bulbs from the wilds of Turkey. They had futures dealers who acted as agents for contracts between growers and prospective buyers or speculators. They had what we'd call "flippers" who would option to buy a bulb but planned to sell before its production. They had wholesale dealers and dealers who specialised only the the rare and expensive bulbs. Many simply loaned money at interest for others to buy and speculate.
All were for a time acting rationally (even the man who sold a house, brewery and multiple acres of land for a single bulb) because for a while demand for the bulbs was huge in western Europe and anyone might get lucky with any bulb and produce flowers of just the colours needed to become rich (by budding the bulb). After all, prices could only go up...
Naturally when the bubble collapsed, too much credit had to be squeezed into too little cash and not all could recover their money. A mad scramble for cash began and of course lending stopped dead. The country was buried in lawsuits as people tried to sue creditors into paying what they had no means, or willingness, to pay. The fact that there was a British, rather than Dutch naval empire may owe not a little to the damage this did to the Dutch economy. Our turn wasn't to come until the South Seas Bubble.
What's interesting is that there were four subsequent, though smaller, flower bulb bubbles in Holland. Unfortunately I've been unale to find any further information on these.
FoFP
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They're all there in black and white.

Clearly attaching the debt to the borrower's house is already inside the limit. That seems reasonable to me. Surely if a debtor has assets then the lender should be able to claim a defaulted debt against those assets?

Nope. The banks are run by twits only marginally less hapless than the borrowers themselves. How else to explain the fact that between them they've probably scattered trillions of Dollars to the four winds?

They have all the protection they need: they can disinvest in the company.

Which is why having a plan B is necessary when the original plan doesn't work out. If only the board of Northern Rock had understood that.

Is this possibility hidden, or is it there for anyone who cares to read of it? After all, we know about it and we (well I anyway) don't have any borrowings riding on the issue.

It's reasonable however to expect them to research a product to a degree commensurate with the cost of what they're buying. Reading the blurb on the back of a paperback is sufficient research. However taking a mechanic friend to a car auction is advised because a car costs more than a book and a faulty one can cost lives. When someone is buying a house, it is for most the most expensive purchase they'll ever make in their lives. Some serious research is needed. Moreover, doing so on borrowed money vastly increases the financial risk involved, and so anyone doing this should understand the product they contract into and the general risks surrounding such products.

It seems the very definition of fairness that if someone borrows money from someone else, they should pay it back.

If they borrow money at all (and to be honest I think by and large people shouldn't) then they should know that if they have any assets at all, they'll be at risk if they don't pay their debts.

Whereas we have the current mess of a bursting credit bubble to indicate why people should have a very much greater fear of debt and the risk it entails. We've gone a great deal too far the other way from the debtor's prison. Your kind of thinking is a big part of why.
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M Holmes wrote:

Not so clear. Some forms of debt are not inside this limit. I do not know which forms are and which forms are not.
You may take an interest in this subject but most people do not.

And yet they still make huge amounts of money and are certainly the financial power house of London which subsidises the rest of the country.

They have the protection now. But a standard bank investor is looking for a safe low risk environment, it would be uneconomic for them to investigate a bank's finances. The failure of Northern Rock was because the regulation failed and needs to be looked at. Confidence in the banking system is required for commerce.

I was actually referring to small borrowers.

Financial contracts are very difficult to understand. My experience tends to suggest that a tiny percentage of financial customers would be aware of the terms or implications of the financial deals they enter into. You may want everyone to spend their time researching this particular issue, but we could say the same about many issues. It really is a waste of time. Much better to have fair contracts with important terms clearly expressed.

This again isn't true if I put 100k in a bank account I expect it to be safe, I don't expect to have to research it. I expect to get the rate quoted and for the bank not to default.
If I put 100k on a horse or a DotCom company I know I need to do my research, but it is a different thing.
Not having to research banks it vital for an efficient economy.

Not to me, or it seems large multi nationals.

You don't believe in finance? A little difficult as it has become the UK's principal industry.

Do you not think it is the lenders who should be expected to have taken a more sophisticated view not the little man.
Particularly as the UK consumer's credit bubble doesn't seem to have burst yet.
I actually share your view that credit has been too easily available however I take the view that it is easier to control the pushers rather than the addicts.
It figures that you would hate my way of thinking but I'm not sure if you realise quite how much.

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People are interested in all sorts of different things and are free to ignore others. What I'm saying is that people who want to ignore knowing about mortgages and debt finance would be best advised to steer clear of borrowing.

Do they? My suspicion is that if the US banks didn't have the ability to lodge their dodgy mortgage-backs and CDOs at the Fed in exchange for real cash, they all already be bankrupt. The Fed's own numbers tend to indicate this.

Let's wait and see whether their earnings were greater than the amount they threw away.

They could always disinvest in the company.

Perhaps. If they invest more than the protected limit without doing so though, they expose themselves to the risk of capital loss.

It wasn't just the regulation that failed. The board borrowed short on the markets to lend long and didn't put in place a Plan B for when they couldn't renew their debts.

Perhaps then it would be better to let poorly performing banks fail so that we could have confidence in the ones left standing?
The BofE and the Fed witter about how what's needed is price discovery so that the various financial entities can mark their assets to market and write down what's lost. What they do in practice though seems aimed at preventing price discovery taking place. If Bear Stearns and Northern Rock hadn't been bailed out, we'd know the prices of quite a number of assets by now.

It behoves everyone who borrows money to have a Plan B for its repayment lest their original plan go awry.

Then that's a large part of the problem. It would bet best to encourage people to use cash if they can't understand the implications of borrowing money.

Not what I said. People should feel free to ignore the whole issue, but they'd also be advised to refrain from borrowing. What's been worn away through this quarter-century credit bubble is a knowledge held by our parents and grandparents: debt is a fickle ally and extremely dangerous when permitted to run amok. Think of it like nuclear power: folks can feel free to throw the switch and enjoy the electricity, but if they don't want to know about the details, best not have them make their own.
Our grandparents learned the hard way during the last credit bubble and most refused debt for the rest of their lives and raised our parents to regard it in the same way. It's only during the latest bubble that I even noticed the previous generation being seduced by debt, and many of them would eschew it other than for mortgages and they were pretty damn careful with them. Our generation though misssed the lesson and accepted 125% loand with teaser rates; endowment mortgages; negative amortisation mortgages (in the US at least) and even thought it normal to buy a chinese meal on credit and pay interest on it for decades.
The end result is that our generation will have to learn the lesson our grandparents did, the same way that our grandparents did.

Of course I'm in favour of that too, but it's no substitute for having the customers either know what they're doing or do something else.

Do you? I don't put more than 30K into any one bank because I know that above that it isn't safe if the bank goes down. I also know it's crucial at this time because more banks go down after a credit bubble bust than at any other time.

So despite the fact that you do know that banks sometimes go down, you take no cognizance of it?

It's different in level of risk, not in principle.

That's why folks pay for ratings companies. Only they've screwed up too. Sometimes there just ain't no substitute for due diligence. It may be less efficient than something else you can imagine, but what's happening as a result of folks not troubling themselves with the research isn't looking so efficient right noww either.

I think this is the nub of where we differ. You have some sort of leftie bias destroying rational thinking.

Seems so. At least we both see *that* as unfair.

For business, but not for consumption.

I'm hoping to see that cured quite soon.

I think the little man should have lived within his means and that the lenders should have lived with the consequences of their folly. The first will soon again become the norm. The latter will probably have to wait for someone too big to bail to go down, but the way the central banks are behaving, that may happen sooner than we all imagine.

Oh, I think I've seen some leaks, but I agree, there's much more to come.

The thing is that there's been no attempt whatsoever to control either. History shows that in such a circumstance, control is re-enabled by the disappearance of the product.

I'm not sure what you mean here. I think the basic issue is that it greatly offends my sense of justice for someone to borrow money from someone else promising to pay it back, and then reneging. As far as I'm concerned "I didn't understand I'd have to pay it back!" just doesn't cut it.
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M Holmes wrote:

I'm not interested in cars I guess you think I shouldn't drive. I'm not interested in cooking I guess I shouldn't eat?

A few small US banks might be bankrupt. I thought a lot of the CDO business was handled in the UK, most of the companies I've seen so far have come out relatively unscathed.

What you mean last years earnings? One bad year, a lot of the banks seem to have come through the initial stage ok. The worrying thing was the secondary effects that seem to be affecting companies like CS who I think posted a loss for the last quarter.
[snip]

What does borrowed short mean? Borrowed on the short term markets and lent on the long term markets? Yes we know the board messed up but the regulators are there to ensure they do not take an inappropriate level of risk. When gambling with other peoples money there is a distinct personal advantage to taking on more risk (I assume you understand why) this is why we need regulation.

Better still they should close banks down before they fail. The regulator should ensure a bank is not allowed to get to the stage of a Northern Rock.

I don't know what you mean. You would prefer a price collapse even if it destabilised the economy? I suppose you would argue a small shock would lead to more stability. I think you are right but the regulators let the situation get to a dangerous stage where a failure may have had a catastrophic knock on effect.

Things go wrong, plan B or plan C life is a gamble.

I actually agree some use of credit is bad. But a system without credit would be stagnant. Our system is based on the entrepreneurial ethic and it has served us well.

Yes I'm not arguing that excessive credit is wrong. I'm arguing that lenders need to be more careful and more carefully regulated.

Why the customer. It is the lenders that should know better?

When did the last major uk high street bank go down and default on its standard accounts?

Due diligence? I'm supposed to do my own research which is better than the rating agencies? How?

I'm not a leftie.

No multinationals clearly define their liability when they enter into loans. I do not think this is unfair.

How would people obtain houses? I guess you would favour renting?

Well as we don't seem to have a whole bunch of alternative money makers in the uk I guess you are hoping for a mega depression in the uk.

Or maybe not. I think the markets will recover quite quickly. My worry is that business will go to Hong Kong and Singapore.

If the banking industry collapses in the uk, sure. If it the banking system survives it is quite possible it will just be a readjustment.

Of course there has been an effort to control it. Haven't we just had all tha Basel II stuff. It is just a very rapid and complicated industry and is difficult to control.

I'm not a leftie, most would consider me economically right wing. I work in derivatives. My only saving grace is that I normally work in interest rate products rather than credit.
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Feel free. However, if you have someone else fix your car or cook your food, you know you run the risk of crashing or being poisoned if they didn't do it right. You'd best know enough to make a judgement on that so that if the brakes make a funny noise or the meat looks raw, you can demur.
Same goes for dealing with debt. Ever heard the phrase "TANSTAAFL"?

I have the suspicion that things are worse than that, though of course it depends what we mean by "bankrupt". For certain values of "Mark to make-believe", their assets probably do exceed their obligations. The question is whether true values will be discovered...

It's the folks who end up with it who are in trouble. So far the brokers are surviving. No doubt they'll end up in a blizzard of lawsuits though as those who didn't do due diligence decide to blame their dealer.
Perhaps you'd say that folks buying a CDO should just know that it's OK and needn't know anything about them?

One down, and we're less than a year into this. How many of the rest would be under already if the taxpayer weren't being forced to bend over and pay cash against dodgy mortgage-backs?

The thing is that risk wasn't what everyone thought it was. I refer you to the speech by Sir Printsalot where he told the Congressional Banking Committee that these derivatives spread risk around the folks who understood it and could handle it.

It's that old heads-I-win tails-you-lose thing eh?

Hmmmm. There's another, older, Greenspan speech from around 1997 when he was asked whether they oughtn't to go into the business of regulating derivatives. His answer amounted to the same idea that these people were all grownups and knew what they were doing, and that regulation would bring two problems:
a) People would tend to trust the regulators stamp-of-approval rather than do due diligence because it was easier.
and
b) The market involved more money than planetary GDP and if the regulator got it wrong and got sued...
My take is simpler: regulation and a government stamp-of-approval isn't nearly as safe as knowing about the product. Basically Greenspan had the first part right, apart from him believing that the boys in suits really knew what they were about.
Interestingly the fuss came about as a result of the over-the-counter swaps trade being 7 weeks or so behind with their paperwork. Folks like Doug Noland pointed out that the danger was that if the markets hit problems, there'd be no transparency (well, even less than there already isn't in such unregulated markets) regarding who owed who what, and that could turn a drama into a crisis. Boy does that look prescient now.

Such touching faith in government regulation makes me nostalgic for the 70's. The problem, as we've discovered since then, is that the boys in braces get paid more than the boys in the government set to watch them. The evils of capitalism (heh) mean that the boys in braces will therefore be more clever than the government watchdogs and will get around whatever safeguards are put in place.

Yes, because the quicker we get to the bottom, the sooner we can get started up again. In 1930 fed interference turned a four year recession into a fourteen year depression. I'd rather get it done hard and fast and clear out the dead wood rather than long and grinding and spend a fortune bailing them out.

Debt-deflation is self-terminating and will restabilise at a different value of assets and money. The same cannot be said for hyper-inflation, which is where we'll end up if we print enough money to bail out all the idiots out there.

As I said: debt-deflation is the cure. It was the maniacal borrowing in the credit bubble that was the disease.
Sadly, it's going to take some time and a hell of a lot of denial before sufficient numbers of people finally admit this. It's also going to prove rather expensive.

I don't think it appropriate to gamble with other people's money.

It may be that there's some way to encourage use of credit for business without having everyone and their kid sister pay for a cup of coffee oin HP for 30 years. That used to be called "stigma" but having aseemingly abolished this, perhaps we can find another way?

I refer you to my previous answer re regulation. It anyway won't work unless we can regulate the punters too, and require that they know what they're doing. I only need to look at the drivers on the road to understand how well that would work.

*Everyone* should know better. I was emailed by a friend last year to tell me that he knew someone who'd been called into the FSA at the start of the NR crisis. It turned out that the high heid yins at the FSA had no clue whatsoever that Jimmy Stewart wasn't still handing out mortgages and he had to draw them diagrams on his napkin to explain securitisation and CDOs to them (this isn't a big secret as I'm told the same anecdote appeared in a recent TV documentary). Perhaps this might make you a little less confident about the regulators?

When was the last Great Fire of London? Are people still careful with matches there?

Note what I said: either do that, or do something else, like take care not to put more than the protected amount in one bank.
Do you suppose that perhaps a big part of the CDO problem was that people who used to do their own due diligence when buying products (even unto actually analysing them) instead grew to regard the ratings stamped on the envelopes? "Hey, a guy at S&P says it's AAA and that's good enough for me!"
Now *that* regulation has hardly worked out well now has it? It's so screwed up it makes Greenspan look like a genius.

You share a love of government regulation with the lefties I drink with.

Save up for 'em.

I *do* rent.

It's gone beyond hope now don't you think? I've said for years here that we'd all ultimately get a ringside seat at a debt-deflation. Welcome to my nightmare I guess.

Which markets? I doubt the mortgage securities markets will ever return in the same form and am convinced the people waiting for them "returning to normal" are deluded. The Auction Rate markets are in a terminal state. Nobody seems to think that SIVs will even be on life-support much longer.
There will always be some sort of markets of course, and being an optimist, I know there'll be another boom at the end of all this. Much will have changed though and in the next bubble, the speculative token won't be housing. I can't tell you what it will be though.

that the interweb is here.

I know too much about bubbles to have that degree of optimism.

Where? Who couldn't get a loan?

Much yakking and a little moving of deckchairs. There are even some now claiming they should postpone it.

You've been a good sport arguing with one so cynical as I, so I'll declare my interest. I'm a credit bubble junkie. I'm quite fascinated by historical oddities and things related such as financial manias and crashes. Despite the fact that a great many people go mad during them (really: the idea that just anyone could borrow becoming generally accepted will be seen in the future as an outbreak of mass-insanity) they do follow a predictable pattern (if unfortunately unpredictable timing, else I'd be mailing from my luxury spacecraft). This one has been the largest in history, involving the most debt and the most people. The denouement will most likely be spectacular.
What it means though is that you berating the regulators and me berating the idiot "investors" is pretty much beside the point. It's the very nature of these things to skew people's thinking so far as to make them seem caught up in madness to those who come after (we still don't think of the buyers of tulip bulbs as sane even though they were as much purely rational economic actors as your derivatives friends). The majority of people were always going to get caught up in this, just as the regulators were always going to look the other way or get slapdash. History is pretty clear that politicians and their friend who try to stand in the way of a bubble will simply be trampled in the rush. Most see the way the wind is blowing, sip the Kool-Aid and get with the program.
I can't say quite when all this became inevitable. Certainly there was an identifiable credit bubble by the time Labour were elected. I'm thinking though that historians are going to peg this as having started around 1984 with Thatcherite deregulation and that the 1990's recession will be seen as a mere pause for breath.
Anyway, as a derivatives guy, what do yoy reckon to Roubini's stuff?
Cheers
FoFP
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So if we do get hyper-inflation is this a bad thing for people with 100% mortgages or a bad thing for people such as yourself who rent.
I have been following these events since 2001 and often read your comments and your previous views on the impending credit crunch, which is now upon us, made me (along with other reasons) take on more debt to move up the housing ladder in 2006. Only history will determine if this was the correct decision.
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Both.

Can't argue with that.
FoFP
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Last year a colleague was getting married and wanted to buy a house. He had a long chat to me about the advantages of buying then, or waiting out the end of the credit bubble. The thing is that he had no deposit and so even if the credit bubble was about to burst right then and he wouldn't have to wait ages (as it turned out it was, but even I didn't know that in March) he'd have been in no position to take advantage of house price falls because with them would come a requirement for sizeable deposits as credit grew scarce. For him, it was a case of now or never. Only those with cash can wait to take advantage.
Which I suppose reconfirms that what's best depends more on personal circumstances than the pertaining financial environment.
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wrote:

Glad I'm not in his shoes, he might not have timed the market very well yet if he can fund his mortgage he should be ok, however he may have problems climbing the ladder in future.
My reasons for climbing the housing ladder like many others were driven by growing family. My first house cost about 40k in 1999, at the time the type of house I moved to would have cost about 80k. In 2006 I sold my house for about 100k and bought the new one for 160k. So in 7 years the cost to change had increased by 20k. Admittedly we did get it a little cheaper than you would expect as it was a little worn.
What I can remember at the time is you predicting how difficult it will be to obtain credit and someone says during the crash of the 90's that he couldn't sell his house for half he had paid for it. I could have gambled and got a better cost to change deal during a downturn but I didn't want the mega hassle and then I still would have had the credit issue.
Although the house has risen a bit in value, the fact that we are facing a possible housing crash doesn't matter to me. What matters to me is having a decent amount of liquid assets to continue to fund the mortgage in any hard times. I have got to live somewhere and as I see it my paper loss at any time will be the difference between what my new and old house are valued. If all houses crash by 50% then my paper loss at the time will be 10k and this is not factoring in any increase in house and mortgage set up costs.
On the issue of deflation, I think your Austrian need for a proper solution is hindering your judgement. Although I think we have reached the top as regards to the banks irresponsible lending, I have a very bad feeling about the irresponsible lending of the BoE.
Whats your opinion on the possibility of this credit bubble being managed by the central banks for a considerable time, gradually deflating the problem as opposed to the big pop that you so desire.
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His eventual calculation was that the banks cannot come for those who keep paying their mortgage and so if he just concentrated on that, he'd be OK. I reassured him that even in the depths of the US's Great Depression (actually their second of that nomenclature) those folks who kept their jobs and kept up their payments actually did OK. It's the folks who are, or who will fall, outside of that envelope who will do most of the suffering.

The trick with debt-deflations is to get through them with as much intact wealth as possible. Folks who manage that OK should do pretty well. One thing to note is that the Magic Money Token is usually different in the next bubble,so "The housing ladder" is more than likely a feature of this bubble and it may well not exists once we're through this. Certainly it'd be a far more sane country if we simply expected houses to depreciate in the same way cars do and used investment money for something more productive.

We run our lives according to personalrequirements, not the whims of the markets. You seem to have your head on straight. I'm sure you'll get through it all OK.

Certainly I'm always on the lookout for that. It'san easy thing to fall into.

I do believe they're the source of future inflation and possibly hyperinflation if they lete their interfering run away from them. I realise the odds of modern central banks submitting to, and alleviating the effects of, debt-deflation are somehwat minimal. My worry is that if they merely delay it, it could be all the worse for that.

History says that many try and pretty much all fail.
Think about it: even normal markets are unable to be managed by soviet-style committees (The USSR ended up so at odds with reality that they'd have got poorer more slowly if they'd all stayd in bed all day). What ae the chances that such a committee would be able to garner information,make correct predictions and pull the right levers a precise amount during the chaos that's going to come out of a credit crash?
Northern Rock was their first turn at bat. Feel confident?
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"M Holmes" wrote

Cars halve in value over a period of a few years; over what sort of time period would you expect a house to halve in value?
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It depends on how well it's looked after I guess. I'd imagine that after a few years of neglect, houses could halve in value quite quickly.
It might also depend where it is. It seems that in Cleveland and Chicago, many foreclosed houses are more than halving in value within a week after the occupants depart. Apparently you could have a four-bedroom house in Chicago for four thousand Pounds if you didn't mind too much who your neighbours were.
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M Holmes wrote:

I take it you mean Ohio, not Teesside.

I imagine the recurrent cost of keeping a private militia to guard it would make the proposition untenable.
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On Mon, 24 Mar 2008 14:02:53 +0000 (UTC), M Holmes

The reason for limited liability is to encourage people to take entrepreunial risks. If I buy shares in a company and it goes belly up, why should I have to cough up to meet its debts especially if I am a mere shareholder and have nothing to do with the management of the company.
Long Live Limited Liability.
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It's in many people's bones. They'll take risks even if held responsible for their consequences.

You own the company. If the company owes someone money, then you do. Limiting that obligation is fraud.
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As I've said, if the banks want to loan money on the basis that defaulting on payments means you must sell your house to repay them that's not a problem. They are secured loans and should be sold as such. The problem lies in the fact that they se4ll loans as being unsecured, on higher interest rates, and then still want them repaid from the sale of people's houses.
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Someone takes a loan. They see the rate they'll pay on the contract. They agree to pay that rate voluntarily. Where's the problem?
FoFP
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I keep pointing out the problem, you just keep ignoring it and repeating the question.
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Mike_B wrote:

That's not the case. Charging orders don't mean you must sell your house to repay them. They mean that a charge gets recorded against your house so that *when* you eventually sell it, they will get their money then.

The higher interest rate in the case of unsecured loans is in effect a kind of insurance in the banks' favour against the risk that the borrower might default on the loan. But the "premium" isn't high enough to cover the loss of the whole debt. It is only high enough to cover the cost of taking action to recover the debt.
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