More foreclosure fallout

The big national lenders that halted foreclosure activities two weeks ago have now resumed after their self-scrutiny of the documentation related to mortgages that are to be foreclosed. The efficacy of this review is questionable; if it’s anything like the degree of care these same companies brought to granting the loans, servicing them and then foreclosing on them, this whole effort was more public relations stunt than useful review. Besides this shoddy paperwork, however, there are other consequences of the current wave of foreclosures.

A front-page story in today’s New York Times examined foreclosure practices in Spain where the borrower is responsible for the entire amount borrowed plus interest and penalties even if that amount exceeds what is realized from the sale of the real estate covered by the mortgage. The article contrasts that with the practice “in most of the United States” where the borrower’s liability is limited to the amount realized on the auction of the house. That’s not the case in Massachusetts. We’re like Spain. Let’s say you borrow $250,000 and grant a mortgage on your home to the lender as security. You default on your payments so the lender holds a foreclosure auction. Home values have declined, so the high bid at the auction is only $175,000. That amount is applied to your debt but it doesn’t wipe it out – you still owe another $75,000 (plus accumulated interest, late fees, attorney fees and costs of collection). Most likely, the lender will file a suit against you for the deficiency and obtain a judgment that will be good for another twenty years. The point is that the foreclosure is not the end of your troubles.

Now many might say “if they had any money they wouldn’t have lost their house so what’s the point of the lawsuit?” While that might be the case, the lender may have no choice but to pursue collection efforts because of the transformation of the home mortgage business from a two party transaction (lender and borrower) to a three party transaction (lender, borrower, and investor). Remember, throughout this decade, lenders shipped their mortgages off to Wall Street were they were pooled and then fractionally divided into bonds that were sold to investors. The lender-investor relationship was a complex one with many duties, responsibilities and liabilities. Anytime the lender (i.e., the person servicing the mortgage) makes a decision regarding the mortgage – whether to modify it, allow a short sale, or to pursue a post-foreclosure deficiency lawsuit – the lender must always look over its shoulder towards the investor. Anything done by the lender that lessens the likelihood of the investor receiving a full return would likely result in a legal claim by the investor against the lender.

Property law has been around for hundreds of years and is pretty well settled. What is far from settled is the consequences of this Twenty-First Century home mortgage securitization process. The uncertainty that engulfs the fallout from the bursting of the housing bubble will continue to depress the real estate market for years to come.