Foreclosure prevention laws extended the slump, experts agree

Our real property system functioned well for centuries with very little change. Prior to the housing bubble, it was widely accepted that people borrowed money to buy houses and if they didn’t pay it back according to the terms of the promissory note, the mortgage agreement allowed the lender to call an auction to get their money back. Housing was an earned reward, not an entitlement.

The basic dilemma is simple, most people don’t have the cash to buy a house, and it would take them most of their adult lives to save for one, so lenders designed loan programs to allow people to occupy and “own” a house while they were working and earning to pay for it. Without modern lending, demand for housing, as measured by actual dollars and not mere desire, would be far too small to accommodate population growth and household formation. The result would be either government owned housing or privately funded rental units and extremely low home ownership rates. Houses would be far less expensive, probably hovering around replacement costs, but ownership would be available only to the very few with the cash to pay the construction cost of a house.

In modern politics, Progressives want to make every human want and need an entitlement, and Conservatives want people to earn everything. Progressives want a compassionate society whereas Conservatives want an industrious one. There is a relentless push by Progressives and Conservatives fight an ongoing but losing battle to hold back the tide. The latest battle lines between Progressives and Conservatives relates to housing. Shelter is a basic human need, and Progressives have sound arguments why this should be an entitlement; however, shelter comes in many forms, and fee-simple ownership of a private dwelling unit is a form of shelter Conservatives argue should not be an entitlement, and I for one, agree with Conservatives on this point.

Home ownership requires vast sums of money. As this is generally borrowed money, we need a functioning system where private lenders can earn a profit commensurate with the risk they assume when they make the loan. In the pre-bubble system, lenders could easily limit and evaluate their risk because they had certainty regarding the contingencies if the borrower defaulted on their loan. That certainty which existed for hundreds of years is gone. Private lenders face little or no certainty on what rules they will face and what costs they will incur to recover their capital if a borrower defaults. When investors or lenders are uncertain, they become conservative and demand either higher interest rates or they stop lending. Only the backing of the US government is sustaining the housing market due to this uncertainty.

Further, providing certainty is not the final resolution. If legislators create onerous waiting periods and excessive costs for lenders to recover their capital, lenders will factor this into the price they demand for their money. In other words, expensive foreclosure processes will drive up interest rates, cause down payment requirements to rise, and curtail lending. Right now, lenders operate in a void of uncertainty, and they face the real prospect of increasing costs as loan owners gain entitlement status. If we are to return to a private lending market, these uncertainties must be resolved, and lenders must reevaluate the cost of their capital. As a nation dependent upon borrowing to sustain the housing market, we face a stark choice: either we nationalize housing finance, or we will face higher borrowing costs in the future.

Insight: Evidence suggests anti-foreclosure laws may backfire

By Tim Reid — Wed Jun 27, 2012 4:45pm EDT

(Reuters) – State and federal laws enacted to protect homeowners from eviction in the wake of the 2008 housing crash may be extending the slump, according to a growing number of economists and industry experts.

Foreclosures have all but ground to a halt in Nevada, which passed one of the stiffest borrower-protection laws in the country last year. Yet the housing market is further than ever from recovery, local real estate agents say, with a lack of inventory feeding a “mini-bubble” in prices that few believe is sustainable.

The bulls, realtors and those who recently bought homes, assure us the recovery is solid, but the shadow inventory bulls want to ignore foretells another story. The dramatic spikes some markets like Phoenix have witnessed can only be sustained if shadow inventories never come to the market. Perhaps these future sales can be metered out at a rate which doesn’t push prices below previous lows, but perhaps not. Either way, it’s unlikely current gains will be sustained and rapid appreciation is forthcoming.

A recent U.S. Federal Reserve study found that in states requiring a judicial review for foreclosure, delays associated with the process had no measurable long-term benefits and often prolonged the problems with the housing market.

Delinquency is not part of a healthy housing market.

Until we return to normal, small delinquency rates, the problems with housing are not resolved, and since cure rates through loan modification are dismal, the only way these delinquencies are going to be cured is through short sale and foreclosure. And since short sales require a willing participant who isn’t planning on living free until a foreclosure, lenders are either going to have to increase short sale incentives or ramp up foreclosures again to clear out the trash.

Data from housing market researchers points to similar conclusions.

“Many state laws that stretch out the period for legitimate foreclosures result in no added benefit for the homeowner and produce harm to the housing finance system and to neighborhoods,” said Alfred Pollard, general counsel to the Federal Housing Finance Agency, at a House of Representatives oversight hearing in March.

Some people who have been able to stay in their homes despite failing to pay their mortgages may disagree,

You think?

but it may be a different matter for the neighborhoods where they live.

An overhang of properties that the banks want to foreclose, but have not dared to, not only can hold back a sustainable recovery in prices but also might encourage blight as the defaulting borrower has less incentive to keep the property in good condition.

“Folks with negative equity can’t sell their home and are less likely to invest in improvements or repairs, or pay their property taxes,” said Sean O’Toole, chief executive officer of ForeclosureRadar.com, which tracks foreclosures.

The houses I have taken from long-term squatters in Las Vegas all required numerous small repairs. Every little thing that broke went unfixed because the loan owner had no incentive, and there was no landlord to call to do it for them.

The increasing doubt about the impact of anti-foreclosure laws on the long-term health of the housing market calls into question a basic principle of the Obama Administration’s approach to the housing crisis.

… In the latest expression of this philosophy, the California legislature, at the urging of Attorney General Kamala Harris, is poised to pass a “homeowners bill of rights” that would mean new requirements for lenders looking to foreclose.

But conservative and free market economists have long been passionate in their belief that the foreclosure process should be allowed to work efficiently. Delays in clearing the huge backlog of distressed properties will only push back a meaningful recovery of the housing market, they say.



According to the National Conference of State Legislatures, a bipartisan organization serving the legislators of all 50 states, more than 400 foreclosure laws were enacted across the United States in 2011 alone, and most slowed down the process.

The Nevada law, passed in October, may be the most stringent: It imposes criminal penalties on lenders that try to foreclose without the proper paperwork. That has led to a dramatic drop in foreclosures in a state that was among the hardest-hit by the housing crash.

In September, banks filed nearly 5,000 foreclosure notices in Nevada. By February, just 460 were served, according to online foreclosure property marketplace RealtyTrac.

Many of you may have noticed that I have removed the investment properties tab from the blog. I have no product to sell to cashflow investors. I am struggling to keep my small fund invested in properties because so little inventory is available. My fund has benefited by the increased value of all its holdings, but making profitable flips is difficult when so few properties come to market.

Ricky Beach, a real estate agent in Reno, Nevada, said the new law, AB 284, “has pretty much killed the market here.” The lack of foreclosure activity has led to a dearth of inventory, he said, with the number of homes for sale in the area down to 778 today from more than 1,700 in September.

This has triggered a “mini-bubble” in housing prices because the few properties available are receiving multiple bids. The only problem: No one thinks the gains are sustainable.

“The bill did nothing to solve the crisis – it’s just prolonged it,” Beach said. “Sooner or later the banks will work out how to deal with the law. And then foreclosures will hit the market, and prices will crash back down.

For as much as I would like to celebrate the Las Vegas recovery, I think Mr. Beach is right. There are still tens of thousands of delinquent mortgages in Las Vegas which must be resolved, and for reasons mentioned above, most of these will likely be MLS sales through short sale or foreclosure REO.

Malik Ahmad, a Las Vegas foreclosure defense lawyer who has spent the last six years trying to help vulnerable borrowers deal with unscrupulous banks, said the law had completely changed his view of the nature of the crisis.

“This law has become a mockery,” Ahmad said. “I am now turning down clients every day who I know have no intention of ever trying to pay their mortgage. They just want to stay in their homes for free. And that is a bad situation for everyone, lenders and homeowners.” …

This isn’t news to anyone who has read this blog, but the fact that delinquent loan owners are gaming the system for free housing is not a common meme in the mainstream media. Most reports focus on the supposed victims of the housing bust to promote a bailout agenda. Those of us pointing out the problems with these policies are widely ignored. I hope this news article is the beginning of a new trend. I suspect it will be because lenders are going to have to start foreclosing to force out the committed squatters.


A study by three Federal Reserve economists compared the foreclosure processes and outcomes for borrowers in the 20 “judicial” foreclosure states – where banks must seek court approval before they can foreclose – and the 30 “nonjudicial” ones, where such court oversight is not required.

…Their conclusion? States with judicial protection over the foreclosure process or the arrears system “indiscriminately” slowed down the foreclosure process, but with no measurable benefits. In fact, delinquent borrowers were more likely to make good on their arrears in nonjudicial states than in states where they had more time to do so. These borrowers were also just as likely to be repossessed in a judicial state than in a nonjudicial one – it just took longer.

Progressives have pushed their agenda of bailouts and foreclosure delays without acknowledging the incentive to squat this creates. Rather than resolving delinquency as they hoped, their policies quite predictably created more delinquency because it rewarded borrowers for doing so.

Mitt Romney, the Republican presidential nominee, has expressed a different view. “Don’t try and stop the foreclosure process,” he said while campaigning in Nevada last year. “Let it run its course and hit the bottom.”

Since then, he appears to have moderated his stance, stating that banks should provide more help to borrowers “who have circumstances that would justify renegotiation” of their loans.

Unfortunately, Mitt Romney lacked the courage to stand behind is completely correct and appropriate stance. Perhaps this was a gaffe (a politician inadvertently telling the truth) and telegraphs what he might do if elected.

The bottom line is that however well intentioned foreclosure prevention laws are, the end result is harmful to the housing market. Foreclosure prevention laws promote squatting to game the system for free housing, and they drive up the costs to banks who will ultimately pass those costs on to consumers through higher interest rates and fees. These problems will inhibit lending, delay the recovery, and hurt future pricing. All these laws should be opposed.