Foreclosure not end of the pain
Despite acres of trees and barrels of ink spent to cover the foreclosure crisis, an under-story exists to haunt people. A decade after they threw their keys in the dirt and walked away from their dream houses, future financial pain is in store for many former homeowners.
Foreclosure or a short sale does not end financial vulnerability.
Make no mistake: Southwest Florida is where it all started, and by all measures, this region remains the American poster child of a home ownership system gone rancid.
This is not a normal news story. It is more akin to a briefing from somebody who’s visited a very ugly land and comes back to tell you of the horrors. There are no “quotes,” for example. No sad story of Mr. and Ms. X to personify the pain. Mr. and Ms. X may not know how agonizing it will get after they have turned over the keys.
Like a killer cancer or a red-light-runner, this mortal danger, too, has a name – deficiency judgment. It’s a legal term meaning you still owe the money. Even if you’ve been foreclosed on, or the bank agreed to a short sale, you owe the difference between the sale price and the mortgage – plus all the legal fees.
Banks do not have to seek a deficiency judgment immediately. They have five years from the date of a foreclosure or short sale to do so. The judgment itself is valid for five years, and it can be extended another five years. There appears to be virtually no legal defense against it.
A book in the local law library – “Florida Jurisprudence,” Second Volume, No. 37, Page 480 – lays it out: “The grant of a deficiency judgment is the rule, rather than the exception, unless there are facts and circumstances creating equitable circumstances justifying the court’s denial of the deficiency.” In other words, unless you can prove “equitable circumstances,” the bank wins.
Waiting a few years for property values to rebound doesn’t work, either. The same book says on Page 482: “Existence of the deficiency is determined as of the date of the foreclosure sale.”
A few of the early short sale contracts contained a provision to waive the “deficiency judgment,” because banks were in unknown territory, groping their way through a virtually unheard-of jungle of “loans gone bad.” But today, the waiver of “deficiency judgments” is rare. Banks got smart, as the law has allowed.
“Florida Jurisprudence,” again, says on Page 489: “The mere fact that a deficiency could have been obtained in the original foreclosure proceeding does not preclude a separate action seeking damages for a deficiency after a repossession and sale.”
It gets worse. Should “the bank” seek a deficiency judgment after foreclosure, a judge – not a jury – will decide the outcome. Charles Holcombe’s “Florida Mortgage Foreclosure Practice Guide” (also in the law library) says, “The mortgager does not have the right to a jury trial in a deficiency proceeding.” Also in Chapter Six, Holcombe writes, “A separate suit at law does not usually allow the mortgager equitable defenses. This fact may enhance the plaintiff’s chances for a deficiency judgment.”
Such a tidal wave of foreclosures and short sales has not been seen since the Great Depression of the 1930s. The smart lawyers from those days are all dead, but they left behind a legacy of laws and legal decisions, such as the “deficiency judgment,” that dictate judicial action in 2010,
In other words, thanks to law based in the Great Depression, the deck is stacked. No jury trial, no “equitable defenses.” In Holcombe’s words, “The relief sought is a personal money judgment.”
I spoke with a large number of people in confidence to be able to understand the dimensions of this story. In Washington, D.C., parlance, we were “on deep background.” In other words, I would be the source. Everybody had real issues with being quoted – lawyers with cases before judges; mortgage brokers who had assembled bad loans; Realtors who had pressured appraisers; judges wrestling with these issues on “rocket dockets”; public officials and staffers standing by with their hands up, trying without much success to soften the blows falling on their constituents; and people in foreclosure who never had heard the term “deficiency judgment.”
I must add another codicil to this discussion. When I say “banks,” I do not mean the institutions providing homeowners their loans. The banks sold the loans. They belong to … who knows? Another bank? An investment fund? A foreign government? For our purposes, the owner of the mortgage is called “the bank.” But who really owns your mortgage? It could be the People’s Republic of China that owns the “bale” with your sweet alfalfa stalk inside, surrounded by rotting weeds. “The bank” in this story isn’t the friendly neighborhood institution that gave you a mortgage. That bank ditched it – and you – long ago.
So what is this “personal money judgment?” It means five years after foreclosure, “the bank” can go to court and demand you pay the difference between your mortgage (the money it gave you) and the foreclosure sale price (the money it got eventually) – plus legal fees, of course.
The courts, under these Depression-era laws, have little leeway but to enforce a judgment authorizing the legal seizure of your bank accounts, automobile, personal property, stocks and bonds, even your television and other personal goods inside your new abode, to satisfy the difference. – years and years after your default on the mortgage.
You might have spent 10 years trying to get back on your feet after you threw the keys in the dirt; yet, everything you’ve earned or bought subsequently is forfeit. “The bank” can claim every dime with the force of law.
Tens of thousands of homeowners in Sarasota County are “under water,” owing more on their mortgages than their homes are worth.
One of every eight workers is unemployed. Many are walking away from their mortgages, throwing their house keys in the dirt. Nationwide, a quarter of homeowners are under water. Locally the number is vastly higher.
Most don’t realize Florida law allows “the bank” not only to foreclose on their homes if they stop paying, but – with a legal instrument called a default judgment – chase them for decades to reap the difference between the foreclosure sale price and the amount of the mortgage.
We are in a collision between Great Depression-era law and ultra-modern finance. I need to simplify something complex at this point. Think of a field of alfalfa, each individual plant representing one specific mortgage. Thanks to enormous deregulation and incentives offered by presidents of both political parties, these alfalfa plants could be reaped, baled (i.e., consolidated) and sold in bulk. This created an entirely new financial product for sale. Since the new product was backed by real property, it became a hot commodity.
Unfortunately, these new products were not created in a methodical or regulated manner. As any alfalfa farmer knows, some parts of a field grow superior crops and other parts grow weeds. But the bankers bundled the good and the bad together in “bales” and sold them. One simple change made this possible.
To make the “bale machine” work, bankers needed to eliminate historical paperwork. Florida mortgages for 150 years were registered by local officials. The clerks of court offices did the work, and they charged a fee.
To avoid the registration and processing fees at local courthouses to record sales of mortgages (saving hundreds of dollars per property) and then reselling them to a “bailer,” a private company was created to keep an electronic record of each mortgage in the “bale.” It is called MERS – the Mortgage Electronic Registration System. The effort is so electronically efficient, it employs fewer than 100 people.
Local mortgage originators – real local banks – were delighted with this secondary market. They resold many of their mortgages, especially the shaky ones. Now “the bank” could be anybody. The bank no longer is “the bank.” Instead, it can be an investor, an investment group or even a foreign government.
Some homeowners fighting foreclosure have asked “the bank” for proof of indebtedness. All “the bank” could come up with was a MERS record, not a piece of paper with stamps, seals and signatures. When judges asked for documents attesting to the ownership of mortgages, fraudulent documents began to appear in courtrooms. Some lawyers representing “the banks” produced signatures and notary stamps that – upon further investigation – were revealed as frauds. MERS itself came under attack.
But if the MERS concept is upheld – billions are at stake, so that seems inescapable – the last real systemic block to widespread foreclosures is gone. A congressional oversight panel on Nov. 16 released a report after looking into these “automatic processors.” The report said they “may have concealed much deeper problems in the mortgage industry.”
Reverse triage
Now the bundles are going bad – the weeds turning sour – and the holders of these “bales” possess increasingly smelly products. Today these owners are conducting triage – separating the “dead” from the “injured” from the “walking wounded.” But unlike military surgeons, their priorities are reversed.
First priority is the “dead” – properties involving cases in which people threw the keys in the dirt and walked away. Looters on the Florida West Coast quickly followed, stripping the homes of anything valuable, down to the copper wires in the walls.
In the opposite of military triage, these properties have become the prime focus of the banks. Here foreclosures fly through the legal process in “rocket dockets,” as judges called from retirement spend less than one minute per property to give “the banks” possession.
After gaining possession, “the banks” hold a fire sale, crushing neighborhood property values. Contamination with “death” spreads like a miasma over the community. North Port would have preferred a cholera epidemic to the “rocket docket.” The impact on a community is an incentive for other property owners to throw their keys in the dirt.
However, former owners have no idea they are still on the hook for the difference between the foreclosure sale price and the mortgage amount: the deficiency judgment.
The injured
Some homeowners – still believing in a system with a hint of fairness – have tried to reach an agreement with “the bank.” They proposed selling their properties to willing buyers, but for less than the mortgage values. They made the properties immaculate, put them on the market and hoped buyers would recognize the value. This process is called a “short sale.” But the owner of the mortgage – the bank, holding company, risk investor, foreign government, who knows? – must agree to the price.
The news is full of short-sale failures, in which an offer of even $2,000 less than the remaining mortgage is rejected by the bank/holding company/risk investor/foreign government. Why would the holder of the note refuse to negotiate or even communicate?
The answer is “legal fees.” And the corollary is again “deficiency judgment.” Not only can “banks” demand you make them whole (i.e., pay every dime you owe), but they also can assess you every nickel of legal fees in the process. At $200 or $500 per hour, the nickels add up fast.
And property owners cannot rely on PMI – private mortgage insurance – because the companies handling PMI are running away as fast as they can from the crisis. Those $40 or $100 per month premiums you paid for PMI? You’ll need to hire a lawyer to make the company stand behind its promise. In fact, you’ll not only need to hire your own team of lawyers, you’ll also probably end up paying for the bank’s team of lawyers.
It doesn’t make any difference if the property is foreclosed on or sold in a short sale, because the rule of “deficiency judgment” means the bank will get its legal fees covered and eventually reap the difference in sale price vs. mortgage price when it comes back to court for ask for a “deficiency judgment.”
A huge and personal financial time bomb is hovering over each and every foreclosure or short sale in Sarasota County and Florida.
“The banks” have up to five years from the date of foreclosure or short sale to file for the deficiency judgments. They can wait for the smoke to clear, then seek to make their losses good.
Another category of “the injured” includes people who stopped paying the mortgage but continued to live in their property. For the time being, “the bank” is fine with this arrangement. The bank is taking care of “the dead” first, stopping the looters. But “the injured” are next. Don’t think “the bank” forgot you.
The problem is especially acute for people owning nonproductive rental property. A foreclosure or short sale on one puts all of a person’s holdings at risk of seizure to satisfy the deficiency judgment. Only your personal home, your domicile, is exempt.
This threat to rental property owners spreads the pain across a much wider spectrum. We think of foreclosure in terms of family homes. But the collapse of property values, the out-migration of people from the county and the demise of the local construction industry has led to a plunge in rents.
Many local professionals over the past decades “parked” their investment money in rental housing. Today even mansions are renting for peanuts on the Gulf Coast of Florida. It is not just homeowners sweating “deficiency judgments.” Owners of substantial numbers of rental properties see their “empires” at risk. They are the “walking wounded,” people still paying their multiple mortgages by diving into their savings paying “the banks” for the luxury of losing their savings. Partners in law firms all over Florida are sweating.
New business model
Banks are fond of saying, “We’re in the banking business, not the property business.” Banks don’t want to manage property, find tenants for rental homes, collect rent or fix plumbing. It’s not their game. But debt is something they understand very well. And debt – just like those bales of mortgages – can be sold.
In the next five years, as “the banks” obtain deficiency judgments against defaulted borrowers or short-sellers, a new wave of financial paper will be created. Enter the debt collector. One of the country’s biggest “receivables management firms” is located here in Sarasota.
Just as banks are not in the property business, they are also not in the debt collection business. And just like the original mortgages, these judgments can be bought and sold. The buyers this time will be professionals in “receivables management.”
Once a bank wins a deficiency judgment (and it’s hard to present a defense against it), the bank will try to collect it. But it will tire and sell the debt to a collector for pennies on the dollar.
These debt collectors will skim the cream and sell the rest for fewer pennies on the dollar. And so on down the food chain. In other words, if you throw your keys in the dirt, or hold a successful short sale, you’re still liable.
If you’ve already gone through the process with a lawyer, and the lawyer didn’t advise you about the “deficiency judgment,” you may have grounds for a malpractice suit – one more legal proceeding you get to pay for.
Nobody has a clue about what to do. Congress, the Florida Legislature, the Florida Bar Association, local governments, neighborhood associations, scared individuals: We only know Depression-era law rules.
(Editor’s note: the above article written by staff writer Stan Zimmerman appeared in two parts in the Pelican Press)