Why Government Shouldn't Block Home Foreclosures
If one word best summarizes the current housing market, "foreclosure" would be it. Despite record-low interest rates, American homeowners are losing their properties with greater frequency than at any time since the Great Depression. Yet banks and other financial institutions, until very recently on track to seize 1.2 million homes this year, are facing growing pressure to impose "voluntary" nationwide moratoria on foreclosure repossessions and sales. If they don't do the job themselves, say critics, government should do it. Several major lenders in fact have ceased property seizures in the wake of widespread revelations of foreclosures lacking proper documentation. The calls for action are understandable. Yet a moratorium, rather than restore integrity to our financial system, would further imperil it.
Few would deny that the foreclosure crisis is real and getting worse. Monthly data released last Thursday by the Irvine, Calif.-based RealtyTrac indicates that 102,134 bank repossessions of residential properties took place in September. This was the first time in which seizures exceeded 100,000, capping a Third Quarter that saw 288,345 repos. Overall foreclosure filings for the three-month period - repossessions, default notices and sale notices - were 930,437, up 4 percent from the Second Quarter. Put another way, 1 in 139 homeowners nationwide received a foreclosure filing notice during the Third Quarter; in Nevada, the national leader, the figure was 1 in 29. And this is in spite of a $75 billion federal initiative, Home Affordable Modification Program (HAMP), launched a year and a half ago by the Obama administration to prevent such an outcome.
Granted, this trend has natural limits. Barring a sharp rise in the unemployment rate - not out of the question - foreclosures eventually will drop to historic patterns. But this particular cycle presents a new challenge: Many foreclosed homes lack a marketable title. In other words, nobody knows for certain who owns them. It's a by-product of massive securitization, with now-collapsed secondary mortgage giants Fannie Mae and Freddie Mac serving as conduits between lenders and investors. Court documents in a number of states show that much of the paperwork transferring ownership of individual mortgages to investor-controlled financial pools has been lost, ignored or even forged. Of the nearly $11 trillion in outstanding mortgage debt in this country, about two-thirds has been transformed into tradable securities. Mortgage securitization is a global phenomenon. Yet even if the problem were fully contained within the U.S., it still could prove overwhelming if title issues aren't resolved. "If the basic principles of property law have been violated here...it may be extremely difficult to fix," remarked an anonymous source connected to financial industry regulation.
This logjam of broken chains of title could prove calamitous for the housing market because distressed properties now account for roughly one in four home sales. Huge numbers of potential bank-owned homes for sale could be thrown into limbo. Roughly 5 million homes in this country currently are in some stage of the foreclosure process. Fully 600,000 seized homes haven't been placed up for sale yet, notes RealtyTrac. Even a temporary foreclosure freeze would cut deeply into sales next spring, the prime home buying season. And lenders would stand to lose tens of billions, if not hundreds of billions of dollars, over the long run. Banks, already having seen their stock prices sink, are preparing for the worst. JPMorgan Chase announced last Wednesday that it had set aside $1.3 billion in reserves for litigation.
Because foreclosure is a legal as well as financial process, it is time-consuming, especially in states requiring a court order for a lender to take possession. The mortgage meltdown merely has added to substantial waiting times. Whereas the process nationwide took on average 302 days to complete in 2005, it now takes 478 days. In Florida, a state requiring a court order, the average current waiting time is 573 days. It's almost axiomatic that the longer the wait, the more troubled homeowners will have an incentive to give the lender the keys or remain in their dwelling without making payments. This is especially true if the home is "underwater" i.e.; the outstanding mortgage balance exceeds the market value. Deutsche Bank this August released data projecting that 20 million U.S. homeowners will be in this situation by the end of 2011, up from around 14 million. Steep declines in house prices are a good indicator of the concentration of underwater homes. In Florida and California, the two leading foreclosure states in volume, average home prices dropped by more than 50 percent during 2007-09. Very few recent buyers in such states can expect to come out ahead if they are looking to sell today.
Mortgage lenders/servicers, aware time is money, know that the faster they can take possession of distressed properties, the faster they can place them on the market. Overeager lenders, by various accounts, unfortunately have taken legal shortcuts, rubber-stamping documents (‘robo-signatures') without bothering to review them. In states requiring court action, such as Florida, foreclosure cases are known colloquially as the 'rocket docket.' Lenders' outsourced legal help have dispensed with cases in almost assembly-line fashion. The Plantation, Fla.-based law firm of David J. Stern, for example, assigned a team of employees to handle 12,000 foreclosures for Fannie Mae, Freddie Mac and Citigroup, receiving $1,300 per unchallenged action. The firm is now under investigation by Florida authorities for potential fraud. Tammy Lou Kapusta, the senior paralegal in charge of the operation, admitted in a September 22 deposition: "The girls would come out on the floor not knowing what they were doing. Mortgages would get placed in different files. They would get thrown out. There was no real organization when it came to the original documents." Some employees of various Florida mortgage processors have admitted in testimony that they did not know what a mortgage was, couldn't define "affidavit," and knew they were lying when they signed foreclosure-related documents.
Paperwork shoddiness has triggered a wave of litigation nationwide. Various individual and class-action homeowner suits are claiming that mortgage lenders and servicing firms have used phony documents to execute foreclosures. In December 2009, an employee of GMAC Mortgage (Ally Financial Inc.) stated in a deposition that his team signed about 10,000 documents a month without determining their accuracy. And a lawsuit filed in Louisville federal court on behalf of Kentucky homeowners alleges that the Mortgage Electronic Registration Systems (MERS), a Reston, Va.-based intra-bank mortgage transfer service, conspired to create false documentation.
The clouding of title to properties could clog the courts for years to come. "This is going to become a hydra," said Peter Henning, a professor at Wayne State Law School in Detroit. "You've got so many potential avenues of liability. You don't even know the parameters of this yet." Likewise, Richard Kessler, a Sarasota, Fla. attorney, states: "Defective documentation has created millions of blighted titles that will plague the nation for the next decade." Kessler conducted his own survey revealing errors committed in about three-fourths of all foreclosure-related court filings. Global securitization of mortgage finance has muddied the chain of title to possibly millions of American homes. The resultant lawsuits could involve countless homeowners, investors, title insurers, lenders and government agencies.
In the face of such a scenario, some lending institutions have backtracked. Bank of America early this month suspended tens of thousands of foreclosure sales in the 23 states requiring court approval. Ally Financial and JPMorgan Chase soon imposed foreclosure suspensions of their own in these states. On October 8, Bank of America extended its moratorium to all 50 states and the District of Columbia; Ally Financial, JPMorgan Chase and PNC Financial Services soon joined. But on Monday, October 18, Bank of America, servicer for about one in five U.S. home mortgages, reversed course, announcing it would resume foreclosures in the 23 states requiring judicial approval after finding no cases of proceedings brought forth in error. Company CEO Brian Moynihan earlier had tried to calm nerves: "We haven't found any foreclosure problems. What we're trying to do is clear the air and say we'll go back and check our work one more time."
He hasn't found much sympathy among government officials. Senate Majority Leader Harry Reid, D-Nev., and House Speaker Nancy Pelosi, D-Calif., each have called upon lenders to freeze foreclosure actions in all 50 states until they can sort things out. Rep. Edolphus Towns, D-N.Y., chairman of the House Committee on Oversight and Government Reform, has made a similar demand. Senate Banking Committee Chairman Christopher Dodd, D-Conn., has announced he will hold hearings starting on November 16. President Obama on October 7 vetoed a bill sponsored by Robert Aderholt, R-Ala., requiring local courts to accept notarized interstate foreclosure documents. Federal Housing Administration (FHA) Commissioner David Stevens has asked agency-approved mortgage servicers to conduct immediate audits of all foreclosure operations. Attorneys general from all 50 states, though stopping short of calling for a moratorium, have launched a joint investigation into document fraud. And the Federal Housing Finance Agency, regulator for Fannie Mae, Freddie Mac and Federal Home Loan Banks, while announcing foreclosures can continue, are calling upon lenders to fix the document morass immediately.
Several nonprofit organizations also are pressing for a moratorium. Representatives from the NAACP, the National Council of La Raza and other civil rights groups joined union spokesmen at an October 7 press conference to demand action. "If we don't take drastic measures now, we can expect millions of additional foreclosures in the coming years, with a disproportionate number of them involving Latino and African-American families," said Wade Henderson, president of the Leadership Conference on Civil and Human Rights. There is a certain irony in such words. It was aggressive pressure by organizations such as his that proved instrumental in persuading lenders to expand mortgage credit availability to minority borrowers who couldn't afford it.
There can be little doubt that millions of homeowners are in way over their heads or that many mortgage lenders, inundated by paperwork, have valued speed over accuracy during the foreclosure process. The calls for a moratorium are understandable. Defective title chains serve to depress the entire housing market. Buyers may well pull out of ongoing deals. "All the buyers are scared to buy," recently observed Fort Myers, Fla. real estate agent George Messeha. But a moratorium would create far more problems than it would solve. This approach should be avoided for several reasons.
First, a foreclosure ban effectively would sever legal obligations between borrower and lender, providing distressed borrowers with the equivalent of amnesty. Borrowers, realizing the lack of negative consequences, would have more reason than ever to avoid making payments. A moratorium thus would constitute a huge subsidy from the honest to the dishonest - and expand the ranks of the latter. Even if "temporary," such a move would diminish the sanctity of contracts. Pending business deals, housing-related or not, could be shelved. A moratorium would undermine the integrity of rule of law, without which markets cannot function.
Second, a moratorium will disrupt financial markets, maintaining the imbalance between supply and demand. As mortgages more than ever are packaged into marketable securities - that's what triggered the financial meltdown in the first place - there will be a capital flight from housing, making funds for purchase, construction and renovation more difficult to obtain. Institutional investors such as pension, insurance, equity and hedge funds may avoid the housing market altogether. Any number of them may demand compensation for losses. Some already have taken action. A group of institutional bond holders this Monday wrote a letter to Bank of New York Mellon Corp. and Bank of America, citing BoA's "failure to observe and perform, in material respects" its role as servicer for 115 separate bond transactions. The group holds a combined $16.5 billion of the $47 billion generated by these deals. And last Friday, JPMorgan Chase bond analysts estimated that future losses from loan repurchases (or "buybacks") failing to meet seller promises could reach anywhere from $55 billion to $120 billion. Preventing primary lenders from foreclosing will exacerbate this problem in the future because it would fail to address the fact that people would continue to live in homes they can't afford. These bonds are based on an assumption of repayment.
Third, a foreclosure ban would hasten the decline of neighborhoods wracked by foreclosure. Housing industry columnist Kenneth Harney recently explained: "(A)lthough you might not be delinquent on your mortgage, the bank-owned house down the street that hasn't gone to foreclosure sale - and for months - might not be resold for an extended period to new owners who would make needed repairs and capital improvements. If the house becomes a long-term eyesore, it could negatively affect neighborhood property values." Now foreclosures do adversely affect surrounding property values. Research by Dan Immergluck (Georgia Tech) and Geoff Smith (Woodstock Institute); Robert Cotterman (U.S. Department of Housing and Urban Development); and University of Texas at Dallas economists Tammy Leonard and James Murdoch has demonstrated as much. But taking no action would be a far worse alternative. Foreclosure is a formality. It is an effect as well as a cause of local decay. And large numbers of people moving in who can't afford even to pay off a mortgage, much maintain their properties up to housing code standards, is the catalyst for decay. Property value declines, while almost inevitable, at least can be contained where foreclosure is swift and certain.
Fourth, a ban would invite greater federal intrusion in the housing market -as if enough intrusion hasn't taken place already. For the first half of 2010, 89 percent of all new home mortgages were federally-guaranteed in some way, notes industry periodical Inside Mortgage Finance. That's up from 30 percent in 2006. Several months ago the Federal Reserve System completed a first-ever purchase of mortgage-backed securities - $1.25 trillion worth - to prop up house prices. Government displacement of the market may well be the unstated purpose of a foreclosure freeze. Advocates of such a strategy know that if properties can't be put back on the market, they are unlikely to generate mortgage payments, even if occupied. That gives lenders an extra incentive to dump this inventory onto public agencies, especially Fannie Mae and Freddie Mac, which were placed under federal conservatorship two years ago and have received nearly $150 billion (so far) in taxpayer bailout funds. What do Fannie Mae and Freddie Mac have to lose by buying properties? If they lose money, they can be compensated, if not by the lenders, then by the government. They have been virtually the only companies willing to buy distressed mortgages from lenders during the current crisis.
The foreclosure meltdown is a product of excessive enthusiasm for promoting homeownership and securitizing high-risk mortgages. The underlying source of the crisis is the false idea that Americans have a right to become homeowners, even if lacking in creditworthiness. Get set for a replication of the crisis, too, once the provisions of the Dodd-Frank financial reform legislation fully kick in. The law's new Consumer Financial Protection Bureau, informally headed by Harvard law professor-turned-populist warrior Elizabeth Warren, is not likely to be impressed by mortgage industry pleading. And the law contains a host of affirmative action mandates for mortgage lending. Since blacks and Hispanics long have exhibited significantly higher rates of default and foreclosure than whites, civil rights groups will seize upon any racial disparities as a pretext to step up pressure on lenders, Congress and regulatory agencies to keep the money flowing to favored constituencies.
The federal government and the states by all means should investigate foreclosure fraud, recklessness and incompetence. There is ample evidence that mortgage lenders, deluged by paperwork, have been conducting foreclosures without due diligence. And if individual homeowners have been falsely evicted from their homes, they should have full recourse to sue. The real estate title industry, mired in practices dating back more than a century, could use some updating. But barring foreclosures would produce far more harm than good. It would remove millions of homes currently or potentially in foreclosure from market transactions, drive up market prices generally, and enable people who haven't made a mortgage payment in months, even years, to continue living as freeloaders. A mortgage, in the end, is a contract. Eliminating liability for upholding a contract is the antithesis of sound law and sound economics.