One year after the mortgage mess morphed from crisis to nightmare, like a car far past its prime, the foreclosure system still sputters and fires, but rarely on all cylinders. Bankers have hit the brakes on filings, as the legal jam rendered the process essentially a freeway without an exit ramp.
One year ago this week, the mortgage mess morphed from crisis to nightmare. On Oct. 1, 2010, the Office of the Comptroller of the Currency announced it had moved examiners into seven leading mortgage servicers — giant institutions like JP Morgan Chase, Wells Fargo and Citibank — to determine whether their foreclosure paperwork passed legal muster.
That same day, the Federal National Mortgage Association, already under fire for lax oversight and reeling from giant losses, demanded that hundreds of companies servicing its mortgages undertake internal audits.
The drumbeat of scandal reached a crescendo Oct. 8 when Bank of America, which had already stopped foreclosures in nearly half the country, extended the moratorium to the entire nation.
Americans were assured the country’s foreclosure machinery would be quickly tuned and soon restarted. Bank of America’s chief executive officer Brian Moynihan predicted it would be a few weeks.
He was wrong.
In fact, one year later, like a car far past its prime, the foreclosure system still sputters and fires, but rarely on all cylinders. Bankers have hit the brakes on filings,as the legal jam rendered the process essentially a freeway without an exit ramp. Yet, it’s pretty clear that so-called shadow inventory — or homes that are either repossessed or in default — has accelerated in an economy that is, at best, stuck in idle.
It isn’t clear when things will resume. To continue the analogy, the foreclosure process at the moment is like a traffic-clogged freeway that has no exit ramp.
“We’re hitting the one-year anniversary of the robo-signing crisis,” noted Roy Oppenheim, a Broward foreclosure defense attorney. “The banks said it would take 60 days to fix. It didn’t take 60 days. It’s been over a year.”
There have been previous cases that could rival the mortgage meltdown in terms of scope. One of the most often mentioned were the Big Tobacco litigations of the 1980s and 1990s. Another comparable case might be the savings and loan crisis of the early 1990s, which also precipitated a major government bailout effort.
The foreclosure fiasco has characteristics that suggest it could prove even more intractable, and few Americans would be shielded from the fallout. With Big Tobacco, for instance, the damages were largely borne by the private sector, whereas the banking industry is backed by the full faith of the U.S. government.
And though the S&L crisis effectively mothballed the thrift industry, it wasn’t vital to the national economy the way the commercial banking industry is. Although that crisis resulted in billions of dollars in property going into receivership, it was largely commercial real estate, averting the politically explosive subject of families losing their homes.
The country’s major banks have remained resolutely tight-lipped about their legal reasons for scaling back foreclosures for so long. But foreclosure experts and legal analysts say what appears to be happening is a convergence of factors that ultimately makes it not in the banks’ interest to go full steam ahead.
Economically, they may be better served by waiting, in the hopes that unemployment drops and housing prices recover. This strategy has a couple of nicknames: “Delay and pray” and “Extend and pretend.”
Financially, there are persistent worries that the industry simply doesn’t have the money to mop up moribund mortgages. Warren Buffett’s $5 billion capital injection into Bank of America in August, initially viewed as a positive, later sparked debate about the health of BofA’s balance sheet.
And perhaps most significantly, it isn’t at all clear that foreclosure is the smartest legal strategy banks might deploy.
Why? The crisis appears certain to spill into other areas of law.
There are several potential avenues: Major banks are negotiating with the 50 state attorneys general for some type of master settlement. Class action cases by borrowers are being debated. And there have been reports that BofA would consider bankruptcy for its scandal-plagued Countrywide Financial unit if litigation endangers the corporate parent.
The rumors and lack of foreclosure filings speak to a lack of leadership from Washington, said Scott MacDonald, an expert on banking finance at Southern Methodist University in Dallas.
“We need to quit asking, ‘Are you too big too fail?’ and start asking ‘Are you too big to exist?’ ” he said of the bailouts that kept various financial institutions afloat. “We’re taking a very different approach than in the 1980s,” when the government shut hundreds of savings institutions.
As for distressed homeowners, he sees the foreclosure slowdown as simply delaying the inevitable. “We’ve tried to hold up and prop up home values,” MacDonald said. “The problem is, that’s not going to work.”
There is no denying the numbers. In South Florida, one of the centers of the national real estate meltdown, foreclosure filings are off by 66 percent in Miami-Dade County year to date. In Broward County the drop off is 60 percent and it’s 50 percent in Palm Beach County.
That wouldn’t be bad news if it were because there were fewer distressed homeowners. But the reality is far darker. And in terms of real estate law, the issues are much murkier.
Oppenheim said the slowdown is partly because the clock was effectively reset when the crisis erupted. Large foreclosure practices such as the one operated by the Law Office of David J. Stern have exited the scene. Banks have had to summon new counsel, leading inevitably to delays.
“We’re seeing a lot of ‘start from scratch,'” Oppenheim said. “Servicer B needs an affidavit from Servicer A, but Servicer A is gone. So you have a problem; there is no solution.”
Stephen Morrell, an economist at Barry University in Miami Shores, concurred. “There were a lot of legal issues that arose with robo-signing,” he said. “So banks had to go back and re-examine their processes.”
He said that in the last year, “it appears banks have intensified efforts to negotiate with mortgage holders, to slow down and stop foreclosures.”
Homeowners Stay Put
Others say there’s another reason foreclosures have ground to a near-halt.
Simply put, a defaulted — but not foreclosed — homeowner is better than none at all. At some point, foreclosures reach a critical mass. They begin driving down the value of properties banks are repossessing, magnifying their losses.
Secondly, although a mortgage in default is costly, it’s cheaper than securing an empty home. As one saying goes, the second you foreclose, the pool turns green. “It reduces the value of the holding,” said Charles R. Gallagher III, a foreclosure defense attorney in St. Petersburg.
“Banks want to avoid paying all that money to secure and maintain,” Gallagher said. “They’re getting free property management.”
In theory, banks should have plenty of money to tackle the problem. Many big lenders have been reporting record profits. But Sheila Bair, the recently departed head of the FDIC, told Congress in June that “the main driver of earnings improvement continues to be reduced provisions for loan losses.” In other words, profits are largely an accounting maneuver, where reserves put away previously are returned and reported as income.
‘Profits Are A Mirage’
“The big banks are basically going back into the reserve cookie jar,” says Ken Thomas, an independent economist and bank analyst in Miami. “A lot of their profits are a mirage.” In fact, recent FDIC statistics show industry loan loss provisions at the end of June were 17 percent below a year earlier.
From a legal perspective, another issue is that the sheer scope of the scandal is rewriting the legal rules of the foreclosure game.
Historically, foreclosures were relatively rare and legally simple. The plaintiff was the lender and the defendant was the defaulted homeowner.
However, controversy over robo-signing and other practices turned that legal model on its head. Now, it’s often borrowers, even those clearly in default, claiming they are the aggrieved parties, victims of predatory lending and unscrupulous business practices.
At this point, litigation is advancing on several fronts. So moving forward with foreclosures may undermine lenders’ positions in other areas.
A case in point: The ongoing talks between the 50 state attorneys general and the five leading mortgage servicers could produce a settlement of — reportedly — $20 billion or more for homeowners. But banks at this point don’t know what kind of legal protections the settlement would provide them, or what form of relief it might provide to homeowners currently in default.
Class Action Hurdles
With so many distressed homeowners making essentially the same complaints, there is widespread speculation that class actions — where thousands of foreclosure cases are bundled together — could begin to sprout.
Sergio Campos, a University of Miami law professor, said potential classes might seek relief through statutes such as the Truth in Lending Act. Another option might be the Real Estate Settlement Procedures Act, a consumer protection law passed in 1974, he said.
But he added that the hurdles are high for such cases. To certify a class, a judge must find a common harm or a common question of law. The problem is, the mortgage market is essentially millions of individual contracts. And households fall into foreclosure for different reasons — everything from unemployment to strategic default.
“It’s hard for me to see what’s tying them together,” Campos said.
The bar for certifying class actions appears to have been raised more this summer by the U.S. Supreme Court. In a discrimination case involving female Wal-Mart employees, the court denied class action status to potentially 1.5 million plaintiffs.
Why? Justice Antonin Scalia, writing for the majority, found that any discriminatory activity resulted from “literally millions of employment decisions” made by individual managers. The case needed evidence of systemic discrimination, or as Scalia wrote, “some glue holding the alleged reasons for all those decisions together.
“Taken to its logical extreme, it could make it very difficult to certify classes like this,” Campos said of the Wal-Mart decision.
With either the AGs or a potential class action, a problem will be determining who’s in and who’s out, Campos added.. “How they define the class is crucial,” he said. “I’m sure the banks will definitely want to get rid of as much liability as possible.” However, large settlement pools have been known for creating what’s nicknamed “the Field of Dreams” syndrome. Translation: “If you build it they will come,” Campos said. “People come out of the woodwork” saying they belong to the class.
Another legal option that could be holding back foreclosure activity is the U.S. Judicial Panel on Multidistrict Litigation. Created in 1968, the panel determines if civil actions in different federal districts involve enough common questions of fact that they can be transferred to one court for pretrial proceedings. The goal is to conserve resources by avoiding things like duplicate discovery. Even then, “it’s not uncommon for these cases to last seven or eight years,” Campos said.
And it may take longer. In that regard, the foreclosure slowdown is reflective of a leadership — public and private — that has never fully grasped the scale of the problem, said Thomas, the banking analyst.
“Ben Bernanke and everyone else underestimated how bad this crisis is,” he said of the Federal Reserve chairman. “They kept giving projections that it would be over by 2010, then 2011. And now it’s almost 2012.”