February 3, 2014
Foreclosure Prevention: The Real McCoy
Patricia McCoy has posted Barriers to Foreclosure Prevention During the Financial Crisis (also on SSRN). In the early 2000s, Pat was one of the first legal scholars to identify predatory behaviors in the secondary mortgage market. These behaviors resulted in homeowners being saddled with expensive loans that they had trouble paying off. As many unaffordable mortgages work themselves through the system, Pat has now turned her attention to the other end of the life cycle of many an abusive mortgage — foreclosure.
The article opens,
Since housing prices fell nationwide in 2007, triggering the financial crisis, the U.S. housing market has struggled to dispose of the huge ensuing inventory of foreclosed homes. In January 2013, 1.47 million homes were listed for sale. Another 2.3 million homes that were not yet on the market—the so-called “shadow inventory”—were in foreclosure, held as real estate owned or encumbered by seriously delinquent loans. Discouragingly, the size of the shadow inventory has not changed significantly since January 2009.
Reducing the shadow inventory is key to stabilizing home prices. One way to trim it is to accelerate the sale of foreclosed homes, thereby increasing the outflow on the back-end. Another way is to prevent homes from entering the shadow inventory to begin with, through loss mitigation methods designed to keep struggling borrowers in their homes. Not all distressed borrowers can avoid losing their homes, but in appropriate cases—where modifications can increase investors’ return compared to foreclosure and the borrowers can afford the new payments—loan modifications can be a winning proposition for all. (725)
The article then evaluates the various theories that are meant to explain the barriers to the loan modification and determines “that servicer compensation together with the high cost of loan workouts, accounting standards, and junior liens are the biggest impediments to efficient levels of loan modifications.” (726) It identifies “three pressing reasons to care about what the real barriers to foreclosure prevention are. First, foreclosures that could have been avoided inflict enormous, needless losses on borrowers, investors, and society at large. Second, overcoming artificial barriers to foreclosure prevention will result in loan modifications with higher rates of success. Finally, knowing what to fix is necessary to identify the right policy solution.” (726)
It seems to me that the federal government dealt with foreclosures much more effectively in the Great Depression, with the creation of the Home Owners’ Loan Corporation. In our crisis, we have muddled through and have failed to systematically deal with the foreclosure crisis. McCoy’s article does a real service in identifying what we have done wrong this time around. No doubt, we will have another foreclosure crisis at some point in our future. It is worth our while to identify the impediments to effective foreclosure prevention strategies so we can act more effectively when the time comes.
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