MARCH 28, 2020 – The full financial fallout from Corvid-19 is currently unknowable. What’s foreseeable, however, is a tsunami of mortgage defaults. Depending on when the contagion dissipates, the blowout of real estate values will keep us in a major post-corvid-19 recession.
In addition to other pressing concerns of responsible governance, governors and legislators must give due consideration to foreclosure law. Much of the remedy here is at the state level and beyond the legal control of the feds, though in the case of federally guaranteed mortgages, that’s worth re-examination.
I’ve spent much of my professional life dealing with real estate remedies during downturns. “Remedies” include tenant evictions, mortgage foreclosures, and deficiency collections. Across our great land, remedies are governed by state law, though the (national) Bankruptcy Code has some critical delay provisions. In my experience, I’ve observed a predictable pattern—and the key to amelioration in the future real estate recession. But memories are short, and the old way of doing things is impervious to meaningful change.
Invariably, state law prescribes the procedure by which a landlord can evict a defaulting tenant or a mortgage holder can foreclose a mortgage and recover property from a defaulting borrower. Procedures vary significantly from state to state, but from a macro-economic perspective, they are strictly legal remedies. Some pretend to incorporate financial remedies (i.e. extra notice requirements designed to “protect” consumers), but despite efforts by consumer advocates, “pretend” features fail to address macro-economic considerations. In large part the conceptual framework of highly technical procedures hasn’t changed in many generations.
The legal framework has never caught up with modern real estate finance. In the vast majority of properties, the mortgage is not held by your friendly or not-so-friendly local banker. It’s owned by a trust established for the sole purpose of holding legal title to a raft of mortgages and issuing bonds to investors (see your own 401(k) or pension fund). To complicate matters, the physical mortgage is held by an independent outfit called a “custodian,” while yet another outfit, a “servicer,” handles collection of payments from borrowers and remittances to the trustee (usually a big bank with a large trust department that charges a fee for serving as “trustee” but has zero financial interest in the mortgage; the trustee sends payments to the investors (bondholders hither and yon—again, think “bond fund” among your retirement investments).
What’s disastrous in a “blowout” economy is that the foregoing structure dissipates authority. No entity has the practical legal ability to make an economically rational decision. The sole course of action is foreclosure under state law (administered by the “servicer”). And remember, as regards apartments and commercial buildings, the owner/borrower uses rents to pay the mortgage—rent defaults = mortgage default.
Foreclosures become epidemic because that’s the only route available to mortgage holders (i.e. trustees/servicers/investors). As a result, values plummet, making a bad situation worse—for everyone. The answer: legislatively-sanctioned and executive ordered moratoria on foreclosures during economic crisis. The time to act: now.
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© 2020 by Eric Nilsson
