The Foreclosure Crisis—Where We Have Been, Where We Are Now and What Lies Ahead
The Foreclosure Crisis—Where We Have Been, Where We Are Now and What Lies Ahead
By Charles P. Castellon, Esq.
© 2015, All Rights ReservedAs we endure the historical foreclosure crisis resulting from the great real estate boom and bust, it’s worth evaluating where we stand, how we got here and what lies ahead. This legal, economic and real estate crisis began in earnest around 2008 when the economy collapsed and real estate market went crashing down. A tsunami of borrowers began defaulting on their mortgages as they lost income and their plummeting property values put them deeply “upside down.”
Now the economists tell us foreclosure rates are at their lowest levels since 2006 (near the peak of the real estate rise). Florida, however, carries the dubious honor of being number one in the nation in foreclosure filings. According to Realty Trac ®, one in seventy four Florida homes had foreclosures filed in 2015. Though we’re far from the lowest depths of the crisis, there is much continued and new danger for borrowers in Florida. The economy has rebounded at a painfully slow pace and many will continue to struggle through the foreseeable future.
On the frontlines of the foreclosure crisis—the courts—it has been a wild ride. The legal system was completely unprepared for the onslaught of cases that flooded court houses statewide. Unprecedented backlogs resulted and a virtual state of paralysis set in. Though slow to respond, the judiciary made efforts to better handle the cases. Retired judges stepped back in to preside over hearings. With many unjust results, “rocket dockets” emerged to push through in rubber stamp fashion cases toward court auctions with the entire judicial review taking merely minutes to complete. The courts ordered mediation conferences for primary homeowners to work out terms with their lenders and avoid foreclosure. This effort has been far more sizzle than steak, as very few borrowers walked out of mediation with a deal in hand and nobody has ever forced a lender to offer relief it did not want to extend.
We have seen the “robo-signing” scandal among many other examples of lender fraud, often perpetuated by their own legal counsel. The infamous David Stern, king of the foreclosure legal empire representing lenders and owner of the yacht called “Tu Casa Es Mi Casa” went down in flames while running a criminal enterprise. Though no high-level banking or Wall Street executive has faced criminal prosecution for the massive fraud leading up to and during this crisis, there have been numerous class action lawsuits and government civil cases leading in hundreds of millions of dollars in penalties. Very recently, Sun Trust settled a government action resulting from its failure to process loan modification applications as required by law and their acceptance of government funds.
In 2013, after repeated efforts, the banking lobby successfully pushed through the Florida Legislature a foreclosure reform law with much hype. Though it contains no radical provisions (such as the earlier effort to convert Florida into a non-judicial foreclosure state that would have essentially handed the hen house to the foxes without court oversight) it brought some significant changes.
Among the changes to the foreclosure law were provisions limiting wrongfully-foreclosed homeowners to money damages rather than the ability to regain title to their homes. Similarly, a competing “lender” claiming to hold the rights to a previously-foreclosed mortgage would only be able to seek financial compensation instead of title. If you’re wondering how this could be an issue, trust me, it is a huge byproduct of the fraud banks and their Wall Street partners committed by selling the rights to the same individual mortgages to multiple investors in mortgage-backed securities.
At our law firm, we’ve handled more than one case involving two separate lenders each claiming to own the rights to the same mortgage and promissory note. As Mark Knopfler of the band Dire Straights wrote, “two men say they’re Jesus, one of them must be wrong.” The provision of the new law getting the most attention is perhaps the “expedited foreclosure” section. This is supposed to ease the judicial backlog by providing lenders a quicker path to a foreclosure judgment and court sale. It basically turns the tables on the burden of proof by requiring the borrower to raise legal issues and defenses at an “order to show cause” hearing to convince a judge why the lender shouldn’t win on the spot. We have seen some lenders and their aggressive counsel use this provision and it has made our foreclosure defense work more challenging. Oddly, as long as I can remember, there has already been a version of a “fast track” foreclosure on the books, but lenders’ attorneys have almost never used it in residential cases prior to the enactment of this new law.
WHERE WE ARE HEADEDWe have discussed where the foreclosure crisis has been. This brings us to the questions of where are we now and where is the crisis headed? One major issue for borrowers involves the expiration of the Mortgage Debt Relief Act (MDRA). Passed during the infancy of the crisis in 2007, this federal law protected primary homeowners in foreclosure from tax liability flowing from forgiven mortgage debt. In the view of the IRS, when a lender forgives all or part of the borrower’s debt, this is a taxable event creating phantom income for which the borrower needs to pay taxes at their ordinary income rate. The law conferred a great protection by preventing a big tax bill. This law has expired and the tax relief that came from it is over.
This tax liability is often confused with deficiency actions described more fully below but they are distinct and separate threats. For years, players in the foreclosure world have been expecting deficiency collection actions to hit foreclosed borrowers. It appears to finally be happening and this may be a major issue for some time to come.
Simply put, a deficiency is the difference between the fair market value of a property in foreclosure and the final debt owed the lender. For more recent cases, the 2013 law provided clarity in terms of the statute of limitations for lenders to pursue a deficiency claim, now two years. For older cases, the allowable time to sue for deficiency is more of a legal grey area but it’s unlikely that motivated lenders will let too much time pass before suing. Now we’re seeing a wave of deficiency claims representing the biggest new threat to distressed homeowners in the foreclosure aftermath.
I have long urged clients seeking an exit strategy to consider a short sale instead of simply allowing the lender to steamroll them through an undefended foreclosure. Though short sales carry many virtues for homeowners not interested in keeping the home and the mortgage debt, a major benefit is the opportunity to negotiate a deficiency waiver.
For the overwhelming majority of our firm’s short-sellers, the lenders have agreed to waive the right to pursue a deficiency action as a condition of the deal. For many “strategic defaulters” lacking great hardship, lenders have granted deficiency waivers in exchange for a borrower’s cash contribution or taking back a much smaller unsecured promissory note to put some “skin in the game.”
When a borrower allows the foreclosure process to take title to the home, there are no promises regarding the deficiency and the lender is free to seek that relief. Who is at risk for a deficiency action? The answer is borrowers who have lost their homes through foreclosure or have reached some kind of settlement, such as a short sale or deed in lieu of foreclosure, without the benefit of a deficiency waiver as part of the deal. Practically speaking, however, lenders are much more likely to pursue a deficiency claim against borrowers they know or suspect to have significant assets to seize. The old cliché, “blood from a stone” comes to mind and it certainly makes sense for lenders to set their sights on targets with the best potential for recovery.
The next question involves what borrowers can do to defend themselves against deficiency claims. Though such legal actions may seem a slam-dunk, there are some steps borrowers can take to contain the damage and fight back. One defense may come from “standing” issues. This relates to the fundamental legal question of who has the right to sue. In defending foreclosures over the years, the standing issue has presented the most common defense. This is because originating lenders sold off the rights to mortgages so frequently (and often illegally, in violation of the terms of mortgage-backed security agreements) that they failed to properly convey the rights to another party attempting to sue. In many cases, the foreclosing lender will file a deficiency action.
In other cases, they will “sell the paper” to collection company sharks buying for pennies on the dollar with an enormous cushion to reap a profit. If such rights are not properly and legally assigned, there will likely be holes in the case. Additionally, the borrower can dispute certain facts in a deficiency action that may not kill the case, but may contain the damage. For example, the issue of the market value of the property is a benchmark in the case from which the amount of damages is measured. Successfully challenging that benchmark can significantly reduce the amount owed.
Also, a borrower may engage in asset protection strategies to shield assets from deficiency claims. This is an ethical and legal minefield that should only be considered very carefully. There is a legal concept known as “fraudulent conveyance” that refers to a debtor moving assets to avoid or hinder creditor claims.
Generally, there is a spectrum of time under which a borrower may transfer or dispose of assets that would be under judicial scrutiny. On one end of that spectrum, moves made before a debt is even delinquent and there is no claim against the debtor are more likely to be upheld. On that other end, moving around assets closer in time to the deficiency claim would more likely be held invalid as a fraudulent conversion. The surrounding circumstances rule when there isn’t much direct evidence of the debtor’s intent regarding these moves. A successful fraudulent conveyance claim would allow the lender to overturn asset transfers to get their paws on some money. Debtors should proceed with extreme caution and seek advice before playing this game. Deficiency actions may push many borrowers toward bankruptcy protection. This option may work well, either as a liquidation of debt through a Chapter 7 or reorganization through Chapter 13 of the Bankruptcy Code. The pros and cons of filing bankruptcy as well as who may qualify for various forms of relief may be complicated and borrowers facing a deficiency claim should consider all the consequences.
It is worth noting that a deficiency action shouldn’t be considered a zero-sum game with a clear winner and loser. Frequently, fighting back and asserting one’s legal rights will lead to a negotiated settlement that can get the plaintiff some money while containing the damage for the defendant to regroup and start rebuilding one’s financial life.
Though we have come a long way in this long, strange trip, the foreclosure crisis remains far from being over. Stay tuned for more reports from the frontlines.
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