Tuesday, October 5, 2010

Why Halting Foreclosures is a Bad Idea-- Part I

Just when we thought that the housing market could not get into a bigger mess, the major banks started announcing that they are putting a hold on pending foreclosures.  To many commentators this appears to be a good idea--over the weekend commentators on Fox News remarked that this would give troubled homeowners more opportunity to straighten out their problems and keep their homes.  But does it really?

Apparently the foreclosure process has created about as many villains as the origination process.  Many people outside of the industry are blaming the MERS system which allows lenders to sell home notes without re-recording the deed of trust.  I read the comments' section today of a website called 4closurefraud.org which urges distressed homeowners who are about to be foreclosed on to find an attorney to argue that they do not have a legal obligation to pay anyone but their original lender.  If the note has been sold to a new lender, and the original lender has been paid off, they do not have any obligation to make payments under the note. 

This argument is nothing short of insanity.  I wonder if the people who advocate using technical loopholes like MERS and the presence of a new lender to avoid foreclosure realize that the secondary market (which allows lenders to buy and sell home loans and therefore creates more capital for originating new mortgages) is the very reason that they were able to buy a home in the first place.  If you dismantle the secondary market by claiming that the current note holder does not have a legal right to foreclose on the property, you effectively destroy the very system that has allowed the U.S. to become a nation of homeowners.

Then there are complaints about "foreclosure mills."  A letter signed by Barney Frank, Alan Grayson and Corrine Brown dated September 24,  2010, addressed to Michael Williams, CEO of Fannie Mae, complains that Fannie Mae servicers in Florida are employing law firms that specialize in speeding up the foreclosure process, "without regard to process, substance, or legal propriety.  According to the New York Times, four of these mills are both among the busiest of the firms and are under investigation by the Attorney General of Florida for fraud...Several of the busiest of these mills show up as members of Fannie Mae's Retained Attorney Network."  The letter complains that pressure to foreclose upon properties is leading Fannie Mae and its servicers to rely on attorneys who "specialize in kicking people out of their homes" noting that this same network of attorneys is retained to do pre-filing mediation between troubled homeowners and banks.

I do not know whether Williams responded to the letter or in what fashion he did so, but I do know this week, one wholesale lender suspended its operations in Florida.  If foreclosures are going to be under the scrutiny of Congress, why lend there at all?

In the meantime, Bank of America, Ally and Chase are putting a hold on foreclosures in 23 states requiring court ordered foreclosures.  According to an October 1, article in the Washington Post, Bank of America executive Renee Hertzler admitted in a deposition that she signed up to 8,000 foreclosure documents a month without reviewing them.  The attorney general of California has ordered that Ally Financial stop foreclosures in the state--California does not have judicial foreclosure--and Connecticut attorney general Richard Blumenthal has announced a 60 day moratorium on all foreclosures by all lenders in the state.

So where is all of this headed?  The elephant in the room in this situation is, that legal maneuvering aside, the homeowners being foreclosed on cannot afford the houses.  The reason that the HAMP program--Making Home Affordable--has been such an ongoing failure is that even if the loans are modified into more affordable terms, the homeowners still cannot afford them.  We currently have homeowners living in their homes over 400 days after foreclosure while they wait for the bank to sell the house.  Is a person who has been living in his or her home without making a payment for 400 days going to want to start making payments on that home again if the loan can be modified?  I don't think so.  After not making a house payment for over a year, those homeowners are not going to be happy with anything less than have the lien invalidated so that they can own the house free and clear--a move which would cause a financial crash that would make the one two years ago look like a minor hiccup.

And then there is the issue of the title companies who insured title on the sale of foreclosed properties.  If the foreclosures themselves are ruled illegal, they will face claims on the title they insured.  In the worst case scenario, the new buyers could potentially forfeit the property as it is returned to its original owners.  If the title company is responsible, will they have to reimburse all of the costs to the individual who purchased one of these homes in good faith and is now going to be homeless himself?  Apparently, the title companies are getting nervous, as Old Republic Title has stopped issuing title insurance on foreclosed properties owned by Ally.

Frustrated homeowners who feel embattled by the banks may be cheering these moratoriums on, but they do not understand the full consequences of what is happening right now.  And while the individual homeowners may not understand this reality, I believe that the major players in the housing industry such as Barney Frank certainly do understand it.

Is this all just political appeasement ahead of an important midterm election?  Maybe partially, but I think this issue of stalling foreclosures on technicalities is a much more important issue than merely scoring brownie points with angry voters.  A court ruling that a note holder who purchased a home note on the secondary market does not have a legal claim to foreclose on that property could fundamentally and radically change housing finance in the United States.  If a judge were actually to rule that the lien holder does not have legitimate claim to the property the secondary market would effectively end, which would mean that banks and lenders would be able to make significantly fewer home loans at significantly shorter terms knowing that they were not going to be able to sell the notes.  This new halting of foreclosures is much more than just a political move for voters, or a stall tactic for unhappy homeowners--it is a power play to restructure homeownership in this country as the government moves us from a society of homeowners to a society of renters.

Some of you may remember a few years ago, before the market crash and the murderous drug war in Mexico--when there was a lot of interest in providing housing finance in Mexico.  Stewart Title even opened a title office in Mexico City.  At that time, the idea was that so many Americans wanted to retire to Mexico that if the proper mechanisms were in place, they could buy houses with mortgage loans and title insurance similar to what they enjoyed in the U.S.

Efforts to duplicate the mortgage system were unsuccessful though.   Living here on the U.S.-Mexico border, I used to get phone calls from people wanting to buy both commercial and residential properties in Mexico and wanting to get them financed.  Financing was almost impossible to obtain, and after a few years I asked one lender why that was true.  They answered that Mexican law made it almost impossible to foreclose on a property owner, and for that reason, lending was very scarce.

As we work through the process of foreclosures, we need to remember as a society that what makes mortgage debt an attractive financial instrument is that unlike credit card debt or auto loans, mortgage debt is secured against an immovable piece of collateral which under normal circumstances usually appreciates in value.  A homeowner in trouble cannot run away with his house.  So the debt is a good risk because the collateral is the lender's security.  But when we make foreclosures impossible, we take away the collateral, and without the collateral, the entire system crashes.

Tomorrow:  Whose fault is the foreclosure mess anyway?


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