One in seven home loans in the United States is now past due or in foreclosure, and about 60% of California mortgages in default end up foreclosed. In an attempt to stabilize the residential real estate market, during the last two years Congress and the California Legislature have enacted laws that extend the time for foreclosure proceedings and encourage lenders to restructure loans to make them more affordable. During this same period, state or local governments in at least 20 states have set up foreclosure mediation programs or, in California’s case, require that before initiating formal foreclosure proceedings on certain owner-occupied residential loans, the lender must first try to contact the borrowers to assess their financial situation and explore options for avoiding foreclosure.
This article places in historical perspective the depths of the current real estate crisis and summarizes the federal and state efforts to stem the foreclosure meltdown it has created. More importantly, it addresses the limited range and other flaws in the current governmental initiatives and suggests why mediation may offer a better alternative – an alternative which can offer a wider range of more economically viable, long-term options for both residential and commercial properties.
The Perfect Storm and the Current Real Estate Crisis
Looking back, the view in 2007 was one of almost unalloyed exuberance. Easy credit and seemingly endless supplies of capital raised the median Orange County home price from $315,730 in 2000 to $630,000 in July 2007 and $729,900 for a single-family, detached home; the annual unemployment rate in California was 5.4%; and, on October 9, 2007, the Dow Jones Industrial Average closed at an all-time high of 14,164.53.
In 2008, the perfect storm arrived. By the end of that year, the median price for a single-family detached home in Orange County had plummeted to $432,110 – a 41% decline from its peak in the previous year. On March 9, 2009, the Dow closed at 6,547.05, having lost 54% of its market value. By September 2009, statewide unemployment had more than doubled to 12.2%, and 5.6 million square feet of office and industrial space lay vacant in Orange County.
In the first quarter of 2007, there were 1,902 completed foreclosure sales in California. By the third quarter of 2008, that number had skyrocketed to 61,705 – a thirty-two-fold increase in just 18 months. By the end of the third quarter of 2009, a staggering 455,130 foreclosure properties were on the market.
Nationally, the Congressional Oversight Panel monitoring the use of federal bailout money observed: “From July 2007 through August 2009, 1.8 million homes were lost to foreclosure and 5.2 million more foreclosures were started. One in eight mortgages is currently in foreclosure or default. Each month, an additional 250,000 foreclosures are initiated, resulting in direct investor losses that average more than $125,000.” (CONGRESSIONAL OVERSIGHT PANEL, OCTOBER OVERSIGHT REPORT: AN ASSESSMENT OF FORECLOSURE MITIGATION EFFORTS AFTER SIX MONTHS 3 (Oct. 9, 2009)(the “COP Report”), available at http://cop.senate.gov/documents/cop-100909-report.pdf.) It is within this context that in 2008 both the federal and state legislatures jumped into the fray in an attempt to stop the hemorrhaging.
An Overview of the Federal and State Initiatives Aimed at Stabilizing the Housing Market
MHA, HARP, HAMP and the Rest of the Alphabet Soup of Federal Programs
Taking direct aim at the steadily worsening mortgage foreclosure crisis, in February 2009, the Obama Administration announced the Making Home Affordable Program (“MHA”). MHA offers two potential solutions for borrowers: (1) the Home Affordable Refinance Program (“HARP”): and (2) the Home Affordable Modification Program (“HAMP”). HARP allows borrowers who are current on their mortgages the opportunity to refinance them at today’s lower interest rates. HAMP infuses $75 billion of federal financial incentives in a shared effort with mortgage servicers, investors and borrowers to reduce interest payments down to a 31% debt-to-income ratio for the borrowers, requires participating servicers to evaluate all borrowers who are more than 60 days in default to see if they are eligible for a loan modification under the program and stays foreclosure sales pending that review. In addition, “Treasury currently estimates it will spend $42.5 billion of the $50 billion in Troubled Asset Relief Program (TARP) funding for HAMP, which will support about 2 to 2.6 million modifications.” (COP Report at 3.) In the words of former Illinois Senator Everett Dirksen: “A billion here, a billion there, and pretty soon you're talking about real money.”
On October 8, 2009, the Treasury Department claimed a significant milestone by helping half a million troubled homeowners to lower their home payments. The following day, however, the Congressional Oversight Panel expressed three strong concerns about HAMP’s effectiveness:
First is the problem of scope....The program is limited to certain mortgage configurations. Many of the coming foreclosures are likely to be payment option adjustable rate mortgage (ARM) and interest-only loan resets, many of which will exceed the HAMP eligibility limits. HAMP was not designed to address foreclosures caused by unemployment, which now appears to be a central cause of nonpayment, further limiting the scope of the program....
The second problem is scale....Treasury’s own projections would mean that, in the best case, fewer than half of the predicted foreclosures would be avoided.
The third problem is permanence. It is unclear whether the modifications actually put homeowners into long-term stable situations. Though still early in the HAMP program, only a very small proportion of trial modifications that were begun three or more months ago have converted into longer-term modifications. In addition, HAMP modifications are often not permanent; for many homeowners, payments will rise after five years, which means that affordability can decline over time....The result for many homeowners could be that foreclosure is delayed, not avoided. (COP Report at 4.)
From an Orange County perspective, scope may be the most glaring of these problems. Both HARP and HAMP apply only to “conforming” loans that are eligible for FHA, VA or USDA loans owned, securitized or guaranteed by Fannie Mae or Freddie Mac. Each of these loan programs has a present “conforming limit” of no more than $729,750 for a single family home – a limit which will revert back to $625,500 on April 1, 2010 unless further extended by Executive Order.
A significant portion of Orange County homeowners have “jumbo” loans, which exceed the conforming limit. They are effectively excluded under MHA, as are many entrepreneurs and business owners who don’t hold down a “steady job” and have fluctuating incomes. They are similarly ineligible under the Foreclosure Alternatives and Home Price Decline Protection programs. It provides incentives for both servicers and borrowers to pursue short sales and deeds in lieu of foreclosure where a borrower is eligible for a MHA modification but unable to complete the modification process.
There are several other gaps and deficiencies in the current MHA program. First, HAMP applies only to first trust deed owner-occupied residential borrowers. (There is also, however, a complementary Second Lien Modification Program (“2MP”).) With a few minor exceptions, commercial, second home and real estate investment loans are simply not affected. Second, like many governmental initiatives, MHA is beset by a confusing mélange of statutes, regulations, Guidelines and, in HAMP’s case, “Supplemental Directives.” Imagine how laypersons (both borrowers and servicer representatives alike) must feel in trying to move through the loan modification and foreclosure maze.
Third, so far, HAMP has offered temporary bandages, not long-term solutions. As the Congressional Oversight Panel observes: “HAMP modifications begin with a three month trial modification period for eligible borrowers. After three months of successful payments at the modified rate and provision of full supporting documentation, the modification becomes permanent.” However, as of September 1, 2009, “only 1.26 percent of HAMP modifications had become permanent after the anticipated three-month trial. . . .[T]his does not mean that the other 98.74% of HAMP trial modifications have failed, merely that they have not yet become permanent.” (COP Report at 48.) Meanwhile, foreclosure starts outpace HAMP trial modifications at a rate of more than 2 to 1. While “Treasury officials have stated that the goal is to modify 25,000 to 30,000 loans per week[,] Treasury’s own projections would mean that, in the best case, fewer than half of the predicted foreclosures would be avoided.” (Id. at 4.)
For loan servicers and lenders, the magnet of the MHA program is the financial incentives it provides. However, about 20% of the nation’s servicers have not been sufficiently attracted to enter into participation agreements with the government thereby leaving a significant gap in the program’s coverage. Moreover, in order to qualify for these financial incentives, servicers must carefully adhere to the Treasury’s Guideline, Supplemental Directives and other administrative procedures. In the short term, such slavish adherence will result in cash in the lenders’ and servicers’ pockets; but it may also hamstring them from crafting longer-range solutions.
The most recent effort to shore up home prices by managing inventories of foreclosed homes involves Fannie Mae's Deed-for-Lease Program ("D4L"). Under this initiative, qualified homeowners who are facing foreclosure may agree to reconvey the property through a deed in lieu of foreclosure but then remain in their homes for up to a year. This mirrors an effort by Freddie Mac which offers month-to-month leases to people who have lost their homes to foreclosure. However, like HAMP, there are a number of limitations which may prevent homeowners from taking advantage of the D4L program. Most notably, the borrower must convey title subject only to the Fannie Mae loan (in other words, no home equity lines of credit or other junior encumbrances on the property are permitted), and documented proof of income sufficient to pay market rent on the home is required.
California’s Legislative Response: Providing Sufficient Time to Negotiate or Merely Delaying the Inevitable?
On July 8, 2008, the Governor signed into law Senate Bill No. 1137 (2007–2008 Reg. Sess.)(“S.B. 1137"). S.B. 1137 applies to residential mortgage loans made from January 1, 2003 to December 31, 2007 that are owner-occupied residences. It requires a trustee or authorized agent to “contact the borrower. . . in order to assess the borrower’s financial situation and explore options for the borrower to avoid foreclosure” and gives the borrower the right to request a meeting within 14 days to further discuss the situation. (Cal. Civ. Code § 2923.5(a)(2).) The servicer may not file a notice of default until 30 days after the initial contact is made. With respect to all rental housing units, S.B. 1137 also extends to 60 days the time in which a tenant must remove himself or herself from the property following a foreclosure sale. (The federal Protecting Tenants at Foreclosure Act, Publ. L. No. 111-29, §§ 701-04, 123 Stat. 1660-62 (2009), applies to any “federally-related mortgage loan or. . . residential real property” and provides for even longer notice – a notice to vacate must be given “at least 90 days before the effective date of such notice.” (Id. at §702.) Presumptively, this federal law preempts S.B. 1137).
In the current session, the state legislature enacted the California Foreclosure Prevention Act. (Assembly Bill No. ABX2 7 & SBX2 7 (2009-2010 2nd Ex. Sess.).) A.B. 7 further extends the time it takes for a lender to foreclose on residential first trust deeds originating in 2003-07 by imposing an additional 90-day moratorium. However, a lender or mortgage loan servicer may qualify for an exemption under the act by implementing a comprehensive loan modification program, which meets specified criteria in conformance with the HAMP program. Most of the major banks with California branches and each of the five largest home mortgage servicers have qualified for this exemption. However, for those who have not qualified for exemption, the time frame for nonjudicial foreclosures has risen from roughly four months on June 30, 2008 to a statutory minimum of 231 days now. Day 1: Lender Contacts Borrower; Day 31: Filing of Notice of Default; Day 121: 90 Day Moratorium on Serving Notice of Sale; Day 211: Filing of Notice of Trustee’s Sale; and Day 231: Trustee’s Sale. Moreover, since most lenders will wait until an account has been delinquent for five months before initiating foreclosure proceedings, as a practical matter, it now takes at least one full year and usually longer to complete a foreclosure.
From the borrowers’ perspective, the present laws are essentially toothless since they lack sanctions or accountability for lenders, and mortgage loan servicers are not required to consider alternatives to foreclosure, such as short sales and government assisted programs.
From the lenders’ perspective, some properties are so far underwater or the borrowers’ income so insufficient that there is no reasonable prospect of a successful loan modification. To forestall the inevitable and effectively provide a defaulting homeowner with a year’s “free rent” is simply unconscionable (albeit probably not illegal under the rationale of Home Building & Loan Association v. Blaisdell, 290 U.S. 398 (1934)(rejecting challenges to a Minnesota foreclosure moratorium during the Depression)).
From a mediator’s perspective, the present mortgage foreclosure programs have proven to be ineffective because so few homeowners have actually received any lasting benefits from them. As of September 1, 2009, HAMP has only facilitated 1,711 permanent mortgage modifications. All the other modifications are still in a three-month “trial stage.” (COP Report at 3.) That most HAMP workouts have not resulted in a “lasting peace” is further reflected in the troubling recidivism rate in mortgage defaults. At the Orange County Bar Association’s Real Estate Law Section meeting on September 22, 2009, the California Commissioner of Real Estate, Jeff Davi, opined that between 50% and 75% of the borrowers who enter into loan modifications default under the modified loan agreement within six months.
As these programs are presently being administered, both borrowers and mortgage loan servicers alike tend to find the entire modification process dehumanizing. Many workout and loss mitigation departments maintain very little continuity. When homeowners call, they may speak with a different person each time or cannot find a person who has any authority to negotiate. Conversely, many servicers are simply overwhelmed. They may honestly strive to reach an agreement with borrowers; but their agents are frequently inadequately trained and have no real power to address the borrowers’ needs. Rarely, if ever, do the two sides actually engage in face-to-face dialogue. The almost inevitable result is formulaic responses by the lender and bewilderment and frustration by the borrowers. There are few opportunities afforded for the parties to sit down and honestly analyze the alternatives to foreclosure or devise a workout strategy that will result in a long-term solution to the problem.
Rights and Remedies Under California Foreclosure Law
An ever-increasing number of commercial and non-HAMP eligible homeowners also have properties in foreclosure. In the currently depressed real estate market, it is likely that the number of judicial foreclosures will increase. However, while a judicial foreclosure raises at least the possibility that a lender may recover a deficiency judgment against a commercial borrower, such proceedings rarely happen. Judicial foreclosures are almost always far costlier and take longer than nonjudicial foreclosures (more commonly referred to as “trustee sales”); and the judgment debtors’ statutory rights of redemption and to possession of the property for up to a year following the foreclosure sale have a substantially adverse effect on bid prices.
Under California’s “security-first” rule, a creditor cannot recover directly on the underlying obligation until it first forecloses on and sells the real estate securing the loan. Only then may it obtain a judgment for any deficiency. (See generally 1 ROGER BERNHARDT, CALIFORNIA MORTGAGES, DEEDS OF TRUST, & FORECLOSURE LITIGATION §§ 4.3-.12 (4th ed. 2009).) During the Great Depression, California further enacted legislation that a secured lender cannot obtain a deficiency judgment after a trustee sale (Cal. Civ. Proc. Code § 580d), or obtain any deficiency regardless of which foreclosure method is used if the sale related to an owner-occupied residence securing a purchase money loan. (Id. at § 580b.)
As a result of California’s security-first and anti-deficiency rules, the overwhelming majority of both residential and commercial foreclosures in Orange County are trustee sales. At least in a declining market, they usually involve the secured creditor making somewhat less than a “full credit bid” (thereby preserving its right to pursue an action for waste in the event that the foreclosed owners “trash” the property) but with virtually no hope of any other relief.
It’s Time to Think Outside the Box
Several critics, including the Democratic controlled Congressional Oversight Panel, have started seriously to question whether HAMP’s trial modification period does anything other than hold the loan in a suspended state for 90 days before most secured properties continue winding their way inexorably towards foreclosure. (See also Matthew Padilla, Obama Program Mostly Delays Foreclosures, Firm Says, ORANGE COUNTY REGISTER (Oct. 15, 2009).) In the case of many California residential properties sold between 2003 and 2007, that delay now stretches to over a year between the time that the borrowers first timely failed to make a mortgage payment and the secured creditor obtains possession of the foreclosed property. There has got to be a better way! There is: it’s called mediation.
The two principal advantages that mediation offers are its flexibility and its intensity. For both MHA and non-MHA eligible properties, mediation presents a range of available options that are typically given scant attention by overworked loan modification departments. These include principal reductions, extending the term of loans, transfers to relatives or other third parties or having them act as additional guarantors, staged or plateaued restructurings, blended equity mortgages, forbearance until the borrowers can obtain new employment or other steady source of income, refinancing with a different lender, and a transition strategy where borrowers who can’t afford one home swap it for another property in the lender’s REO portfolio.
In cases where the borrowers simply cannot afford to keep their homes or a successful restructuring doesn’t appear to be in the cards, a mediation can also arrange for what the Center for American Progress, the influential think tank founded by John Podesta, President Clinton’s former Chief of Staff , refers to as a “graceful exit.” ANDREW JAKOBOVIC & ALON COHEN, IT’S TIME WE TALKED: MANDATORY MEDIATION IN THE FORECLOSURE PROCESS 10 (June 2009)(“American Progress Report”).
A “graceful exit” can include such strategies as deeds in lieu of foreclosure; short sales; surrender agreements in which the lender agrees not to disclose the default to credit reporting services; reconveyance of the property with a leaseback to the borrowers (with or without an option to buy); even so-called “cash for keys” to provide the borrowers with moving expenses or other cash in consideration of their reconveying and voluntarily vacating the property. While the last option may sound heretical – pay defaulting borrowers to move? – in the long run, the savings to the lenders in foreclosure costs and the ability to put the home on the market at an earlier date can be considerable.
The Home Affordable Foreclosure Alternatives Program ("HAFA") may further provide incentives to borrowers, servicers and investors alike to encourage such surrender strategies. For example, Supplemental Directive 09-09 provides servicers $1,500 in incentives and fully releases borrowers from any future liability for debts when they utilize a short sale or deed in lieu of foreclosure on a HAMP-eligible loan; however, it requires that all junior liens be paid off in full and, at present, is voluntary and will not be fully implemented until April 5, 2010.
Implementation of a Successful Mediation Program
With each passing month the list of governmental entities joining the mediation bandwagon seems to increase. The 30 current programs run the gamut from mandatory court-supervised “conciliation conferences” in Philadelphia; references to a private mediation center in Miami; various borrower “opt-in” programs – the most popular approach; and to a strictly voluntary on both sides mediation program in Florida’s 19th Judicial Circuit. These programs are extensively analyzed in the American Progress Report and will not be discussed at length here.
Presently, most of these programs are in states where judicial foreclosure is the predominant method of foreclosure. However, there is no legal impediment to adopting such programs in non-judicial foreclosure states, such as California. For example, Nevada established a borrower opt-in program through the simple expedient of forbidding a trustee to exercise a power of sale unless the trustee first provided the borrower with information similar in scope to that required under California’s S.B. 1137 and offered the borrowers an option to mediate.
With estimates of one in six mortgaged homeowners at risk of losing their homes, the clamor for further governmental action continues to swell. If voluntary efforts continue to fail, then mandatory mediations and perhaps more draconian methods may be in the offing on the federal, state and local levels. Among other advocacy groups, the Center for American Progress has called upon the federal government to mandate and fund the nationwide adoption of mandatory mediation programs at the state and local levels. In September 30, 2009, Senator Reed introduced such legislation in Congress. S. 1731, 11th Cong. (2009). Similarly, State Assemblyman Pedro Nava has sponsored emergency legislation to set up such a system through the Monitored Mortgage Workout ("MMW") Program to be administered through the California Housing Finance Agency. (Assem. Bill No. 1588 (2009-2010 Reg. Sess.)).In other words, it is probably not a question of if, but when, the government will institute a mandatory mediation program within California. Conversely, nothing prohibits servicers and lenders from voluntarily encouraging mediation in conjunction with or as an alternative to the MHA and the proposed MMW programs. With perhaps more than a soupçon of enlightened self-interest, that’s certainly the course I advocate.
What the Participants Should Do to Facilitate a Successful Mediation
Having made it to the bargaining table, what then? In Five Steps (and Several Suggestions) That Lead to a Successful Mediation, Vol. 50, No. 10 ORANGE COUNTY LAWYER 34 (Oct. 2008), available at www.merringlaw.com/article.pdf, I explore in greater detail some of my thoughts on the subject. Briefly summarized as they apply to mortgage foreclosures, these five steps are:
1. Be Prepared.
The mediation will run much more smoothly if several days in advance of the conference, the parties exchange all of the information the other side(s) needs to properly assess the situation and resolve the dispute. On the servicer’s side, it should provide the borrowers copies of all the underlying loan documents; its affordable loan modification and net present value computations; its valuation of the property, whether that be an appraisal, broker price opinion or merely its best “guesstimate” based on neighborhood comps; and proof of the mortgage holder’s standing and status as the real party in interest.
On the borrowers’ side, information should include pay stubs, tax returns, bank statements and other evidence of their monthly income and expenses; documents evidencing their present and long-term assets and liabilities (including any home equity loans or other liens on the property); and any other information that could aid the servicer’s analysis as to their creditworthiness and ability to implement a successful loan modification.
2. Choose the Right Guru for Each Case.
Mediation is a process. As a general rule, the mediator’s experience in a particular legal subject matter area is not an overriding concern. Rather, flexibility, patience, perseverance and curiosity are the hallmarks of most successful mediators. Mortgage foreclosures may be one of the exceptions to the rule. This is a very convoluted and rapidly developing area of the law and at least some familiarity with the substantive law is, if not essential, at least desirable.
3. Bring in the “A” Team.
The borrowers and a representative of the loan servicer with substantial settlement authority must be present at the mediation. In stark contrast to most mediations, which typically only involve two sides, however, there are a vast array of other potentially affected parties in foreclosure proceedings who may deserve to be heard. These could include guarantors, junior lienholders, real estate brokers, short-sale purchasers, homeowners’ associations, tenants and anyone else who may have a direct stake in the outcome.
Of course, if any of the participants are represented by counsel, they must be included. But mortgage foreclosure mediations present the special challenge that most property owners will not be represented by an attorney. Who else may be useful in facilitating a successful resolution of the dispute?
Certainly, a HUD-certified housing counselor may be invited to the table; but many of them are simply too busy to attend in person. Many people turn to relatives or clergy in times of stress for comfort and advice. Their potential role in the process should not be ignored. The former, in particular, may be in a position to advance a workable loan modification by loaning money on behalf of the homeowners or offering a guarantee. Even if the borrowers speak some English, might they feel more comfortable if an interpreter were present?
4. Ask Your Clients What They Really Want and Need.
For some people, facing the prospect of losing their home or business location through foreclosure can be a traumatic experience. For others, it’s strictly a business decision and a matter of dollars and cents. As their attorney, it is your duty to determine what their underlying interests really are and how they can best be addressed in the mediation. Sadly, it may also be your duty to guide them into a “graceful exit.” In that context, “As a peacemaker the lawyer has a superior opportunity of being a good man.” (Abraham Lincoln, Notes for a Law Lecture.)
5. Put on Your Dancing Shoes and Be Patient.
Most successful mediations involve a series of continually diminishing steps through which the parties move and countermove. A common metaphor negotiation theorists use to describe this process is the “dance.” It may take several hours or sessions for all of the participants to fully explore various workout scenarios or surrender options. The dance cannot be rushed. The slower you go at first, normally the quicker the matter can be resolved.
What Are the Odds: Does Mediation Offer Better Prospects of Long-Term Solutions in the Present Foreclosure Crisis?
Mortgage foreclosure mediations are only now starting to gain traction, and there is insufficient data to reach any definitive conclusion on this subject. Nevertheless, the preliminary returns look very promising. Nationwide, the Philadelphia and Connecticut mediation initiatives are among the more established programs. “Both programs report that approximately 72 percent of homeowners who participate in mediation reach a resolution, either a modification or arranging for a ‘graceful exit’ through a deed in lieu or similar resolution.” (American Progress Report at 41.)
Connecticut has kept detailed statistics of both the number and outcome of its mediations. Of the 2,233 mortgage foreclosure mediations completed in that state between July 1, 2008 and March 31, 2009, a loan modification, reinstatement or foreclosure plan allowed 59% of the owners to remain in their homes and 14% of the borrowers voluntarily agreed to move. Only 27% of the mediations ended in an impasse. Similar success rates have been reported elsewhere throughout the country.
The jury is still out as to whether a negotiated agreement will result in a lower rate of redefaults. However, in an analogous situation – bankruptcy settlements – statistical analyses show that there is a much greater likelihood that a debt will actually be paid if the debtor agrees to a settlement rather than has a decision imposed on him or her.
Finally, most foreclosure programs require the loan servicer pick up the entire cost of the mediation or for the parties to split them equally. However, there is much to gain – and little to lose – if attempts are made to resolve a foreclosure through formal negotiations: lower foreclosure and administrative costs; improved time management for servicer personnel; a lesser likelihood that foreclosed borrowers will commit waste and, finally, peace of mind.
Resolve to be a peacemaker. Mediate, don’t hesitate.