"The Foreclosure Flap"

Sydney M. Williams

Thought of the Day

“The Foreclosure Flap”

October 11, 2010

A root cause of the global financial crisis was a failure on the part of banks to maintain stringent underwriting standards, allowing them to grant mortgages to potential homeowners with insufficient capital and income. Government, as has been well documented, not only encouraged but mandated such profligate behavior. Questionable practices by mortgage brokers and consumer greed played important roles. Nevertheless, banks violated an inherent obligation to their owners – the shareholders.

It now appears there has been sloppiness on the part of some banks when it came to the process of foreclosing on homes where the mortgagor fell behind in his payments and violated the terms of his contract. Last Wednesday, four major banks decided to suspend foreclosures in twenty-three states where the process must be approved by a judge. The decision was prompted by the disclosure that the wrong person at the bank may have been signing off on the intended foreclosure notice.

That decision has drawn attention to the foreclosure process and Congress is now determined to convert what is a sensible decision on the part of the banks – to temporarily suspend foreclosures pending internal investigations as to the cause and to make corrections – into a political football. Not allowing a crisis to go to waste, on Thursday Democratic Representative Edolphus Towns of New York demanded a national foreclosure moratorium. On Friday, Senator Harry Reid of Nevada inserted his oar, endorsing the recommendation. Keep in mind, according to an article in today’s Wall Street Journal, the process has never been expedient. Today the process takes 478 days, versus 302 days in 2005. It should also be remembered that currently about one third of all home sales are foreclosure sales.

Ironically, and almost comically, the Senate, in the waning days of the 111th Congress, passed in September, and sent to the President the Interstate Recognition of Notarization Act of 2010, a bill designed to smooth the foreclosure process for lenders. While the bill’s sponsor was a Republican, it sailed through both houses of the Democratically-controlled bodies of Congress. Last Thursday, the President pocket vetoed the bill – a decision to not sign a bill when Congress is not in session.

Donning populist colors, a few Democrats jumped to the defense of [allegedly] disenfranchised homeowners, portraying them as defenseless persons, ejected from their houses into the dark and chill of the night by unfeeling bankers. However, as the Journal reports in today article, most foreclosures occur after “borrowers have already turned over the keys to the home and walked away from their loans.” No one has suggested that banks were foreclosing on those current on their payments.

Nevertheless, millions of homeowners have negative equity – 21.5% of all mortgaged homes at the end of the second quarter, according to Credit.Com. The temptation to walk is strong, yet most owners continue to respect the contract they signed.

There is no question that a large number of people are caught in a terrible bind. They willingly bought a house, in many cases beyond their means, enticed by rising prices and easy mortgage terms, requiring little documentation. They took out a mortgage equal to the value of the house. Instead of rising, home prices began to decline; the economy went into recession; the financial crisis struck; they lost their job; whatever savings they had were gone. With no assets, these people had no choice but to vacate their home, or to continue to live there but not paying their mortgage. Banks repossessed the house and the foreclosure process began. The foreclosure process has always been time consuming. Five years ago the process averaged 302 days; today it is 478 days.

Should the government intercede in these proceedings? Several state attorneys general, as well as members of Congress, as mentioned above, have urged a nationwide moratorium. On the other hand, White House advisor David Axelrod on CBS’s “Face the Nation” questioned the need for such action. A moratorium would have consequences. First, it would have the effect of diminishing the ability of poorer people to obtain credit and will raise their interest costs. Young, aspiring homeowners would essentially be barricaded (or severely curtailed) from the housing market. Secondly, prices for houses must be allowed to find a natural level; the market must be allowed to “clear”. Artificially supporting a price, by restricting supply, forestalls the inevitable day of reckoning. The experiences in California and Florida are instructional. Both saw prices drop 50% between 2007 and 2008. California, which does not require the approval of a judge for a repossessed house to be sold, foreclosures have begun to decline and prices have been rising nominally. However, in Florida, a state in which the process must go through the courts, foreclosures continue to rise and prices continue to fall.

Politicians helped get us into the current mess. Those who have adopted the mantle of Populism, while vouchsafing empathy, are making things worse. Sensitivity and personal feelings are worthy characteristics, but a democratic society can only function and thrive under rules of law. Blame for financial crisis and the housing debacle has many fathers – bankers, builders, brokers, politicians and consumers. Aggravating the problem by permitting those who have violated the terms of their contracts to stay in their homes will not help. The consequences are too important.

Thus far Congress has been eager to lay all the blame for the crisis on bankers, brokers and builders; they have absolved themselves and consumers from any complicity. You will sooner see Elvis return to the stage than hear Senator Chris Dodd or Representative Barney Frank (or any other politician, for that matter) admit culpability for their role in the process. Foreclosures are an unpleasant aspect of capitalism. As politically tempting as it may be to place a temporary ban on them, it is a bad idea. In fact, speeding up the process of foreclosures will do more to hasten an ultimate and inevitable recovery.