On November 1, 2012, a little talked-about Massachusetts law will go into effect that gives judges in the Bay State the power to determine whether a bank can foreclose on a home or must modify the mortgage. Signed on August 3 by Gov. Deval Patrick, the “Act Preventing Unlawful and Unnecessary Foreclosures” creates a series of new hoops for banks and other mortgage creditors to jump through in order to foreclose on borrowers who aren’t making their payments.
Under the new law, lenders will have to demonstrate to a Massachusetts court that they made “a good faith effort” to work with delinquent borrowers, and that they took “reasonable steps” to avoid foreclosing. Such “steps” would include considering whether the borrower could make a lower, “affordable monthly payment” relative to their current delinquent loan.
These terms are ridiculously arbitrary: “reasonable steps” and “affordability” will be defined very differently by a bank trying to get its shareholder’s money back, versus a homeowner desperately clinging to a roof over his head. Furthermore, they will be interpreted differently by different judges.
Beyond the risk of arbitrary judicial rulings, the vagueness of the law will likely make financial institutions even more cautious, which will in turn raise mortgage costs and hurt future homeowners. In fact, price data from Zillow.com is already showing a correlated (though not necessarily caused) increase in the cost of a 30-year fixed rate mortgage for Massachusetts borrowers most likely to default (those with a 5 percent or less down payment). The price has jumped from 3.4 percent to 3.8 percent since the law was passed. Who knows how much the price will jump once the law is enacted?
The law also requires lenders to prove that they will reap more revenue from foreclosing on the home and selling it in a distressed sale than from modifying the mortgage. At first glance, this provision seems redundant. Presumably a bank would modify a mortgage if they thought they would take fewer losses relative to a foreclosure, even without the government telling them to do so. But the point of the law isn’t to encourage banks to figure out how to profit the most from delinquent homeowners, it is to empower judges to tell banks that their estimates on value are wrong.
And though judges will soon have that power, they will be far less qualified to determe value than the banks. For instance, implicit in any assessment of whether a foreclosure will be more valuable than a mortgage modification is an estimate of how much selling the home as a bank-owned property would generate. Banks then compare that to the value of a mortgage modification. Not only will a bank and the court likely have different estimations, but from bank to bank there is rarely a concurrence of opinion on housing market futures. This is just the tip of the iceberg in terms of complicating factors for judges and regulators getting into the mortgage value assessment game.
There are still more problematic hoops in the Massachusetts law, such as the requirement that lenders sell homes to special non-profits in short sales, and the extension of the period--from 90 days to 150--that lenders must wait before they can foreclose on a deadbeat borrower.
But the underlying problem with this new law is that it focuses very intensely on the near-term, while willfully ignoring long-term costs.
For instance: If a bank is making erroneous estimates on the value of foreclosures, and taking more losses than it needs to, then judicial intervention will keep a firm in business that should (and prior to this law, would) be allowed to fail. This hurts future businesses that would out-compete the bad banks of today, and means poorer quality service for the local areas those banks serve. (This might seem like a needless focus on unseen costs, but that was the push back on concerns about the build up of the housing bubble during the mid-2000s.)
Foreclosure is a terrible thing for families, and no fun for financial institutions swallowing the loss. However, without foreclosure there would be little lending in the first place. It is an important recourse that keeps the financial system rolling forward. Ultimately, the new Massachusetts law puts too much authority into the hands of the court, does little to help the housing market, and is potentially creating problems down the road.