Tuesday, March 31, 2009

When Banks Won't Foreclose

You know that Lewis Carrol has been writing your economic rules when lenders can't be bothered to foreclose on delinquent mortgages. They hold the mortgage, the borrower is in default, the property is theirs for the taking - but they just walk away.

Two problems. A collapse in housing prices. A considerable surplus in housing stocks. The two combine and, at the very bottom, you have houses that are worth so little in today's economy that it's not worth even foreclosing on them. It's cheaper to just walk away. From The New York Times:

City officials and housing advocates here [South Bend, Indiana] and in cities as varied as Buffalo, Kansas City, Mo., and Jacksonville, Fla., say they are seeing an unsettling development: Banks are quietly declining to take possession of properties at the end of the foreclosure process, most often because the cost of the ordeal — from legal fees to maintenance — exceeds the diminishing value of the real estate.
The so-called bank walkaways rarely mean relief for the property owners, caught unaware months after the fact, and often mean additional financial burdens and bureaucratic headaches. Technically, they still owe on the mortgage, but as a practicality, rarely would a mortgage holder receive any more payments on the loan. The way mortgages are bundled and resold, it can be enormously time-consuming just trying to determine what company holds the loan on a property thought to be in foreclosure.

In Ms. [Mercy] James’s case, the company that was most recently servicing her loan is now defunct. Its parent company filed for bankruptcy and dissolved. And the original bank that sold her the loan said it could not find a record of it.

In a city like Detroit, with the automakers on the ropes, and layoffs in the tens of thousands rippling through the economy, bottom-end houses have been selling for less than $10,000. It's a contagious problem. When property prices begin to be set by delinquent mortgagors, homeowners who keep their mortgages in good standing see their equity go into the negative column which can kill their ability to refinance when the mortgage term ends. In that way, the bad mortgage debt can trigger the default in an otherwise good mortgage debt.

America's surplus housing stocks remains an unaddressed problem. With subprime mortgages and "liar loans" fueling Bush's ridiculous "Ownership Society" a lot of people whose income wasn't adequate for home ownership did in fact acquire houses. It moved on right up the chain. People who ought to have had modest houses instead got finer houses than their incomes could support. Others got several houses, sometimes on "interest only" mortgages, hoping that soaring house prices would let them rake in enough profits to let them wind up with one clear-title dream home and a fat bank account to boot. Thus the housing sector, construction and finance, became the engine of America's economy. It became, as Paul Krugman noted years earlier, a fictional land of wealth based on people selling their homes to each other.

Like so many of his initiatives, Bush's Ownership Society proved to be a toxic blessing, an 8-year binge that cemented America's decline. I'd bet that, twenty years from now, the Ownership Society will trump the War on Terror as the greatest scam Bush/Cheney inflicted on their countrymen.

And so America finds itself with far more houses than eligible homeowners. CBC's Neil MacDonald did a feature piece recently that trolled through what were just a year or two back burgeoning Florida subdivisions where most of the homes now sit empty, abandoned. They've been so neglected for so long that these really nice little houses are now being ravaged by the elements as once verdant neighbourhoods come to resemble 21st century ghost towns.

Will this end? Sure, of course it will. What's unsettling everyone today is that nobody knows where the bottom lies and that uncertainty is a plague of its own. Prices will plummet to levels considerably lower than their natural floor and then, as they begin to firm up, confidence will return along with suitable buyers. Maybe there'll even be another bubble but I doubt it. Rash lenders have taken a huge, yet well-deserved hit and the scars will last for decades at least.


Fish said...

As an interesting side note, we learned in my mortgage law class last year that foreclosure is already rare in Canada. Some jurisdicitions have even completely done away with it. Instead banks use their "power of sale".

The difference is that instead of simply taking over title to the house and then selling it to recover the value, they can simply sell it out from under the defaulting owner (first they have to provide notice of course).

If memory serves me, the biggest difference is that if they forclose, all they get is the value of the house. If they exercise their power of sale and do not recover the entire debt, the indebted party is still on the hook for the balance (subject only to the bank's obligation to seek a fair value for the property. No wonder the banks are not interested in foreclosure!

What strikes me as surprising here is that foreclosure was supposed to be useful during times of economic stress. It allows the bank to take over the property and make what money they can with it. I guess the bank is not interested in getting into the landlord business.

The Mound of Sound said...

That's been a common feature of Land Titles jurisdictions. PoS was commonly preferred if you wanted to pursue the mortgagor for the deficiency. I think Alberta is the exception where the law doesn't allow personal covenants on mortgages. There were plenty of stories of Calgary homeowners simply going into the bank and putting the keys on the manager's desk and then being on their way.

In the case where the mortgagor was a marginal borrower in the first place and the bank doesn't stand a snowball's chance of recovering on the deficiency, it's usually more expedient to simply foreclose.

What seems to be putting banks off is that, after in-house costs plus legal, court and realtor fees, they risk winding up with title to a property that's all but unsaleable yet they're subject to municipal requirements that they maintain the house and property in any event.