June 21, 2010

Battles in California Over Mortgages

By DAVID STREITFELD

As the housing market continues to sputter, the real estate industry is increasingly split on the responsibilities of overextended and foreclosed homeowners.
On one side are the bankers, who say borrowers should be liable for what they owe. On the other side are real estate agents, who say those who lost their houses should not be so burdened by debt that they cannot move on.
The differences have real financial consequences: bankers want to collect on billions of dollars in outstanding loans; real estate agents want as many people as possible to return to the housing market.
For the first time, the debate is spilling into the realm of law making, with state legislators in California considering a bill that would redefine the obligations of many defaulting homeowners. The efforts to shape the bill demonstrate how much is at stake — in California and the many other states with distressed real estate markets.
The legislation introduced in the winter by the real estate lobby would have largely shielded foreclosed homeowners from debt collectors. But by the time it passed the state Senate on June 3, the banking lobby had succeeded in scaling it back. Now the bill goes to the state Assembly, where a committee will take it up next week, and bankers intend to continue lobbying.
“We’re concerned this could adversely accelerate strategic defaults,” said Rodney K. Brown, chief executive of the California Bankers Association, referring to instances in which borrowers leave their properties without settling with the lender.
For years, a house in California was a machine for building wealth, and few were the families that could resist temptation. They refinanced their loans to pay for vacations, operations, tuition or, frequently, investments in more houses. Many of these households ended up struggling after the crash.
The lenders were often aggressive in making loans and frequently were predatory. The extent to which this absolves the borrowers of responsibility is at the center of the current debate.
The original legislation said borrowers who took cash out of their houses would be shielded as long as they used the money for home improvements. In its current form, the proposed law is not quite so forgiving.
The bill that passed the Senate by a lopsided vote of 30 to 4 would protect former homeowners up to the amount of their original loan. For instance, a family that took out a $500,000 mortgage to buy a house and then refinanced and took cash out, swelling their loan to $600,000, would be released from claims on the original sum but remain vulnerable on the $100,000.
Ellen M. Corbett, the Democratic state senator from San Leandro, Calif., east of San Francisco, who introduced the measure, said it is a matter of fairness.
During the Depression, she said, California legislators decided that losing your house was punishment enough. They did not want lenders endlessly hounding borrowers for the difference between what they owed and what their former house was worth, an amount called the deficiency.
Seventy-five years later, because of that law, anyone who has an original loan and wants to get rid of the house because it has fallen in value can simply walk away without further legal jeopardy. But a homeowner who refinanced, even for the straightforward reason of getting a lower interest rate, could in theory lose the house and be pursued for the deficiency.
“I don’t believe the original intent was to have a two-tier system, where some were protected and some were not,” Ms. Corbett said.
The agents, too, say this is a fairness issue. But there is also self-interest involved.
“Realtors are very worried about this because they think it will destroy the housing market if people end up with these huge deficiency judgments and are never able to buy a house again,” Ms. Corbett said.
To some extent, this is a fight over something that is not happening, at least not yet.
Lenders in California rarely chase foreclosed borrowers for deficiency judgments. Pursuing such cases in court can be an arduous process, and few of those in foreclosure have the assets or incomes to make it worthwhile.
But the threat of such action can come in handy for lenders, servicers and collection agencies. By raising the possibility of a court fight, they can negotiate favorable terms when agreeing to loan modifications and workouts, surrenders of deeds and sales for less than the full amount owed, also known as short sales.
“Using the threat of a deficiency, full-recourse lenders often prevail upon distressed borrowers to sign new, unsecured obligations in exchange for their assent to a proposed short sale or surrender of a deed,” said William A. Markham, a lawyer with Maldonado & Markham in San Diego. “This practice will nearly vanish overnight if the new measure becomes law.”
About a third of the seven million California households with a mortgage have negative equity, a condition known as being underwater, according to the research firm CoreLogic. Many of these families might be content to wait years for a rebound in real estate but others, if at least partly freed from deficiency worries, might walk away.
“This will lead to a surge in the supply of housing, a corresponding decrease in the price, and a welcome hastening of the end of the foreclosure crisis in California,” Mr. Markham said.
State Senator Mimi Walters, a first-term Republican representing Laguna Niguel, north of San Diego, voted against the measure precisely because it could encourage more defaults.
“I’m very sympathetic to what’s going on in the economy and to people that are losing their homes,” said Ms. Walters, a former executive with two Wall Street firms. “But we have to be careful not to overleverage ourselves and to take responsibility when making investments.”
The banking lobby says it could accept the bill as is, on one condition: that it apply only to new loans. In its current form, it applies to any existing loan.
“We really don’t want the legislature redoing contracts,” said Mr. Brown of the California Bankers Association. “That sends a bad signal to investors, to markets and to those whom we extended the credit.”
Whatever the fate of this particular bill, the issue of responsibility for debt is unlikely to be resolved anytime soon. New government-mandated modification programs that for the first time will reduce borrowers’ debts will go into effect this fall, sparking another round of debate about who gets help and who does not.
“We’re a little in the Wild West here,” said Paul Leonard, California office director of the Center for Responsible Lending. “People are struggling with what it means to uphold the terms of your mortgage contract and what it means to walk away. There are no tried and true rules.”