Banks Seeking Short Sale Deficiencies

Published by clickbroker.blogspot.com

A new form of restraint is evolving on future residential real estate bubbles that goes way beyond more stringent lending standards and better due diligence on borrowers. The Wall Street Journal’s “A Short Sale May Not Mean You're Home Free” reports that banks, mortgage servicers and mortgage investors are becoming more aggressive in recovering the remaining loan balances after a short sales and foreclosures. The inclusion of a promissory note might not be directly obvious in the short sale agreement, as the clause might be hidden in the small print.

States vary in their laws for allowing additional recovery after foreclosures, and forcing the borrowers into bankruptcy might or might not benefit the lender. But short of foreclosure and bankruptcy, the lender has complete discretion on the amount of forgiveness to bestow on the borrower. Dept forgiveness by the primary mortgage holder does not imply forgiveness of any secondary leans. The Journal pointed to a former WaMu borrower granted a short sale with forgiveness on the first mortgage only to have JP Morgan (JPM) demand payment on the second mortgage.

Walk away borrowers are starting to be actively pursued if they have a job and any assets. At this point it’s an economic decision based on cost and expected recovery. But as the courts and bankruptcy laws continue to be tested, more standardized out of court settlements should evolve.

The important question is how will an active pursuit of deficiencies effect real estate buyer behavior and their appetite for risk? Will future buyers fully understand that their obligation to repay their loan is independent of the collateral they post? In this case, I hope the states move to a legal framework that obligates borrowers beyond the value of their collateral.

Educating mortgage borrowers to their repayment obligation might put a drag on home sales and lenders might once again become complacent about the value of residential real estate as sufficient collateral. But adding risk to the borrowers, beyond their down payments, would create a more even real estate market. This should fit in well with President Obama’s call for the end of severe bull and bust cycles.

Think about how many times Federal Reserve Chairmen Greenspan and Bernanke adjusted interest rates in the last two decades to try to fine tune the economy. Neither being successful, but in desperation Greenspan proclaimed booms and busts were necessary to promote innovation.

The President is trying to focus consumers on understanding and intelligently using credit, from mortgages to credit cards, and being treated fairly in the process. We cannot depend on a consumer economy to the detriment of the consumers themselves. The new thinking goes against everything both Greenspan and Bernanke stand for. But the pursuit of mortgage deficiencies is certainly one of the primary steps in whipping the consumer back into shape.

Fair lending practices must include consumer responsibility for all their debts and being fully knowledgeable of their obligations before signing. As difficult as it is for the banks to digest, consumers must be told that they may never get out from under a credit card debt with a 30% interest rate.

The consumer economy has relied far too long on disguising the traps of consumer debt. The financial system must first end usury interest rates, and then aggressively pursue all obligations, so that consumers are scared straight. The Fed be damned.

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