Bacon's Rebellion

Democracy Thrives in Sunlight

A price of being the best state for business

—

by

James A. Bacon
in

Beware the Boomerang

Through all the talk of the financial crisis, the housing crisis and various other crises I’ve developed a real misconception. Ok, some of you would say a whole host of misconceptions. However, for the sake of brevity, let’s focus on one of my misconceptions. I thought that once a homeowner had their home foreclosed that was that. I figured the unlucky homeowner would have to move out, they would be traumatised by the whole episode, their credit would suffer but … the bad decision to take out the mortgage would be behind them. Not so fast. Like a lot of things, it seems to depend on the state where you live. And “the best state for business” isn’t always the best state for consumers.

Vanessa Corey seems like a good egg. Ms. Corey built an attractive house with her husband in Fredricksburg back in 2004. Then a couple of bad things happened. The housing bust put a crimp in Ms. Corey’s finances and she and the hubby split. She took her lumps, negotiated a short sale of the house and assumed the $65,000 deficiency was negotiated away. Ooops. Last November, Ms. Corey got a letter from a lawyer demanding that she repay the $65,000. She couldn’t make that payment and had to file bankruptcy.

Here story can be found here.

I’ve done a bit of informal research and it seems that some states are non-recourse states. In California, for example, a combination of state laws allows a mortgage holder to walk away from their house (and loan) and leave the bank holding the bag.

However, about 30 states (apparently including Virginia) allow a lender to legally pursue a deficiency after a foreclosure. In some states the bank can wait up to 5 years to even sue you for the deficiency. During that 5 year interregnum you may have put your financial house back in order … only to see it torn down again.

My question is this – in an era where banks are being “loaned” taxpayer money to “de-leverage” their balance sheets, at a time when the Obama Administration is considering some form of mortgage assistance – do Virginia’s laws make sense? Why shouldn’t Virginia join California in letting borrowers walk away from loans they can’t repay without the dark cloud of potential future financial ruin over their head?

Is it because Virginia is the “best state for business”? Or is it because of the massive campaign contributions handed out to our politicians by the construction, real estate, banking, etc lobbies?

Note: I spent quite a bit of time looking into this matter but it is a very arcane and confused area. I am happy to hear about any factual errors in my post. They will be researched and, if true, corrected.

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37 responses to “A price of being the best state for business”

  1. Larry G Avatar
    Larry G

    Your last two posts are very good Grovteon. Congrats.

    The lady in question had to have a lawyer – right?

    and she was a professional real estate agent – right?

    I don't know about you but her lack of knowledge about how real estate is done in Va sounds a bit fishy.

    But you turned up something interesting.

    Despite numerous stories in the local Free Lance Start – about foreclosures and short sales, I never saw the no-recourse issue discussed.

    My question beyond Groveton's is which party the D's or R's do you think support's Virginia's way of doing it and which party supports California's way of doing it?

  2. Gooze Views Avatar
    Gooze Views

    Groveton,
    You raise excellent questions about the short sales implication in mortgages.
    I am not an expert on the Virginia law relevant to this but in general I think it is reprehensible that financial institutions such as AIG, Merrill, Wachovia and others get a big bailout for deliberately taking huge risks while hardworking homeowners get screwed for reasons beyond them.
    I personally was stunned when the very same credit institutions that couldn't wait to sign me up for three or four more cards in 2005 were ready to dun me if my payment arrived at 5:05 p.m.on the due date.
    Anyway, keep up the good work.
    Peter Galuszka

  3. James A. Bacon Avatar
    James A. Bacon

    Groveton, Here's my observation / question. States that have non-recourse loans require lenders to assume greater risk. In theory, lenders in those states should charge a risk premium on their mortgages. In other words, in theory at least, mortgage rates should be higher in those states than they are in Virginia.

    Does the theory match up with the data? I don't know. But it's worth pursuing.

    If my theory is correct, and if Virginia homeowners enjoy lower mortgage rates than homeowners in non-recourse states, then it becomes a very different story. It's not a matter of evil banks screwing innocent homeowners. It's a matter of different states making different trade-offs. Which good do you prefer: Easier treatment for a defaulting homeowners, a minority, or lower interest rates for all homeowners?

  4. Anonymous Avatar
    Anonymous

    Virginia v. California – anecdotal evidence. Just looked up 30 and 15 year fixed rates for both states from Bank of America.

    VA 30 year 4.750% APR 4.919%
    VA 15 year 4.125% APR 4.395%

    CA 30 year 4.750% APR 4.930%
    CA 15 year 4.125% APR 4.414%

    California rates are higher. But are they higher because of the higher risk on foreclosure?

    TMT

  5. Groveton Avatar
    Groveton

    Jim asks a very good question. That question is only further complicated as organizations like Fannie Mae or Freddie Mac bundle those mortgages from different states and turn them into securities.

    One final point. Obama may direct Fannie and Freddie to start forgiving the portions of mortgages which are underwater for some homeowners. This is being rumored as a possible "August surprise" in the run up to the fall elections. If so, how do Virginia's laws look? I guess our consumers who held on to their houses by their fingernails do better than the Californians who skeedadled. Of course, none of that will help Ms. Corey.

  6. Darrell -- Chesapeake Avatar
    Darrell — Chesapeake

    Now in this environment of Tea Parties and the citizenry p!$$ed off the most they have ever been, do you really think threatening defaulting homeowners with jail is going to have any effect? Try and garnish the wages of people who would rather quit than give the leeches another penny. Go ahead, put grandma in jail. But you better leave room for all those protesting outside the seats of power and banks.

  7. Hydra Avatar
    Hydra

    Two stories. A hard working black man is a graduate of VA segregated schools. He Eventally saves enough to buy a townhome. Since he does not read or write well his wife manages the finances. She becomes mentally ill and stops paying the mortgage. He gets foreclosed on with 25k in the bank. First he knows of any of this is when he comes home to find himself evicted. No amount of legal or political pressure can convince the new owner to give up all or even part of his ill-gotten gains. Five years later the supreme court overturns a similar foreclosure, saying the bank had not made a sufficient attempt to notify the owner in person.

    2. Most HOAs are administered by a few large management firms. In some states they are allowed to foreclose on a home for nonpayment of HOA fees. A sargeant deployed in Iraq lost a paid for $400k home when his pregnant wife overlooked $200 in fees.

  8. Anonymous Avatar
    Anonymous

    The foreclosure on the service man by the HOA might have have been preventable by operation of the Soldiers & Sailors Civil Relief Act. The Act permits service personnel to request a delay/deferral in court proceedings.

    TMT

  9. Hydra Avatar
    Hydra

    The foreclosure went forward. In Texas it is an administrative proceeding that can take as little as 20 days.

    Texas has some kind of homestead act that prorltects servicemen. Supposedly.

    Meantime he is out of his home and his case does not come up until Jan. If he wins he will still have to unwind at least two subsequent sales of the home.

    Apparently the HOA management companies have learned that this is big business. A far cry from an organization that is supposed to protect home values.

  10. Hydra Avatar
    Hydra

    Anyway, why would this be less egregious for a non serviceman?

    Why does one get more protection than another?

    BTW, when the home was auctioned at the courthouse steps, it was purchased by an HOA officer for a few thousand. He subsequently flipped it.

    How the HOA management Co profited isn't clear, except they got paid their HOA fees.

    There must be more to the story, and it can't be good for a marriage.

  11. Larry G Avatar
    Larry G

    From a moral point of view, I was taught that when you signed they paper, you were promising to pay back a loan and it was your duty so I always thought that if they repossessed the property and you still owed money on it that they had the right to go after your other assets.

    It was only later than I learned that not all loans worked this way.

    I also don't think that if you lose your job or other bad stuff happens to you that you are then entitled to not pay your debts

    Your debts are your debts and when you sign for them – you're making a commitment to find the money even if you lose your job or run into other financial issues.

    That's why it was important to not sign up for too much debt even if, in theory your credit rating would allow you to.

    That was the reason why you should always start out with 20% equity in your home so that if really bad stuff did happen, that the value of the home would be sufficient to satisfy the liens.

    Somewhere .. we had a bunch of people grow up who don't subscribe to any of these values and it becomes a game of how one can evade paying legitimate debts that you promised to pay.

    You are not entitled to a home..

    Your are not entitle to a job..

    If you lose your job – even if it is not your fault, you still owe the money because you signed a piece of paper that said you would pay it back.

    in my view this is what is wrong with the country right now.

  12. Hydra Avatar
    Hydra

    From a moral point of view, you are only obligated to the terms of your contract. If your contract is for a non-recourse loan and you default on that loan, then your moral obligation is over once the contract is terminated through repossession of the collateral.

    The bank has a moral obligation, also. Having signed and agreed to a non-recourse loan then their obligation is not to attempt recourse outside the terms of the agreement.

    The bank has a further moral obligation to not make so many non-recourse loans that they put their investors and depositors at risk.

    You have no moral obligation to pay back the money if the bank agreed to share the risk through non-recourse lending.

    Even if you have a loan that you are obligated to pay back, your first moral obligation is food clothing and shelter for your family. the lenders can get paid back later, with interest. Your moral obligation to pay them does not extend to exonerating them for overstanding their own moral obligation not to overextend.

  13. Hydra Avatar
    Hydra

    20% equity might not have been enough in some places.

    If you designed airplanes with 20% margin on everything, you would never get one off the ground. 20% down payment on everything would bring the economy to a halt.The losses from that would be a lot more than the losses from an occasional loan default.

    If the bnk wants to demand 20% equity and they can stay in business that way, then fine, but why is it MY moral obligation to protect a bank that is willing to lend to me with 15% down?

    it is really a simple trade off, common to all businesses: if you do not borrow enough money, you do not have the facilities to serve as many customers and make as much money as you might. You give those customers up to your competitors and they may never come back. However, if you borrow too much money you put your enterprise at risk.

  14. Larry G Avatar
    Larry G

    when you borrow money from someone else – no matter whether it's a family member, or a friend or a bank – it's not your money – it's theirs – and you have a moral obligation to give it back

    or else you're stealing it.

    that's what I was taught.

    you're not entitled to the loan to start with.

    just like you are not entitled to own a home or even have a job.

    If you incur debts – then you owe the people who lent you the money whether it's the bank, or the credit card or a friend.

    We've turned into a nation of excuse makers and blamers of others in my view.

    personal responsibility has become a joke.

  15. Hydra Avatar
    Hydra

    "you're not entitled to the loan to start with."

    ==================================

    The bank is not entitled to have me as a customer, either.

    If the bank wants to be in the lending business they have to agree to terms with me. If the bank agrees to take on part of the risk (non-recourse loan) then I have no obligation to go overboard to relieve them of that risk.

    Suppose you lose your job and cannot make your mortgage payment. you go to the laon officer and explain to him that he will get paid because you have high moral standards.

    Good luck with that.

    Suppose you exppalin that he will get paid because you have a CD sufficient to pay, but it does not mature ofr eight more months.

    Good luck with that, too.

    Bottom line, you are not any more morally obligated to the bank, than the bank is to you.

  16. Larry G Avatar
    Larry G

    the "bank" is little more than a depositor/investor who offers loans on THEIR terms – not yours….

    you are free to not ask for the loan.

    but once you "apply" for the loan and get the money – the money is not yours – that's why it is literally called a "loan".

    you owe that money and you owe it according to the terms that the loaner of the money required – and you signed for – indicating that you would repay it according to what you signed.

    I'm surprised at you. You're the guy that is always talking about "stealing" what you don't own.

  17. Groveton Avatar
    Groveton

    After thinking about this matter a bit more … I am begining to see it more Larry's way. Walking away from your mortgage without recourse is a kind of pseudo-bankruptcy. You extinguish your biggest debt without having to actually go through personal bankruptcy. In fact, people in California can walk away from horrible personal decisions on housing with no liability in the future. This creates a moral hazard in the consumer.

    In addition, there is a huge moral hazard for the bank executives as well. Most compensation plans pay out pretty quickly. The sins of 2004 weren't really visible in 2007. So, the bank stock prices looked good and all those stock options being cashed by the bank executives pushed a pretty penny into the bankers' hands. Unfortunately, the stock prices were based on false assumptions regarding bad loans. The bankers had a moral hazard too. The fix is to defer the compensation out far enough to ensure that the results are really going to materialize. Maybe a minimum of 5 years? Maybe a minimum of 7 years?

  18. Larry G Avatar
    Larry G

    moral hazard is an interesting concept….. when applied to sub-prime loans, securitization, derivatives and credit default swaps.

    The reason they are called sub-prime loans is that the folks they're making the loans to have bad credit – and folks – they don't have bad credit because they have dandruff or bad breath.

    they have bad credit because they have already demonstrated that they don't take debt seriously.

    So on of the dumbest mistakes made by Wall Street, Fannie/Freddie and anyone connected with the cockamamie idea that …some how.. folks who had earned sub-prime status …..

    would act like folks with good credit – and not walk away from a debt ….either

    … well.. those folks need a brain transplant….

    So everyone from the local loan originator, to Fannie/Freddie, to the big Wall Street banking firms based their risk levels on the idea that folks with sub-prime credit would not walk away from those loans in any greater number than those with good credit.

    … And we wonder why this country is so screwed up.

  19. Groveton Avatar
    Groveton

    LarryG –

    It was a great big game of musical chairs. Somebody initiates a dubious loan and gets it approved. Then, the loan gets bundled into a package and the package is sold as a collateralized security. Then, the package is insured by a risk insurance company. Everybody guesses that almost everybody is "too big to fail" and will ultimately be indemnified by the government (i.e. the taxpayers). The whole sordid game is played on skids greased by a Federal Reserve which artifically kept interest rates way, way too low.

    Nobody knew how long the music would play. So, the trick was to get your nibbles before the music stopped.

    I have no problem with executives getting paid lots of money. I'd just like to see that money deferred for quite a while and be redeemable only if the company has long term financial success.

    Frankly, the big question I have in all this is where the various boards of directors were during this fiasco. Aren't they supposed to be the conscience of the shareholder over the long term?

  20. Larry G Avatar
    Larry G

    " Nobody knew how long the music would play. So, the trick was to get your nibbles before the music stopped."

    this sort of implies that the folks participating in it knew that it ultimately could bring the country to it's knees economically but didn't care as long as they personally benefited.

  21. Larry G Avatar
    Larry G

    and this brings up a pretty fundamental issue.

    If the private sector has figured out how to make enormous profits doing something that ultimately will bring the country to it's economic knees….

    is it up to the govt to regulate such that this won't happen?

    Fannie/Freddie clearly facilitated this mess and it looks to me – more and more that the phrase – Government Sponsored Enterprise

    means this –

    that private investors get to decide what government policies get created to benefit their activities …..

    … a safety "net" for speculation…..

    but my question is – what if Frannie/Freddie were dissolved and/or became a govt-only entity with no influence from the private sector?

    see: " Fannie and Freddie must die"

    http://articles.moneycentral.msn.com/Investing/JubaksJournal/fannie-and-freddie-must-die.aspx?pgnew=true

  22. Hydra Avatar
    Hydra

    The governments attention is finally turning to the ratings agencies, which, in my opinion were the primary facilitators.

  23. Larry G Avatar
    Larry G

    It's hard to believe that no one knew that the rating agencies were doing what they were doing especially when people were paying them to do it.

    This is sort of like blaming a policeman for taking a bribe while ignoring who is paying the bribe and why they are paying it.

  24. Hydra Avatar
    Hydra

    the "bank" is little more than a depositor/investor who offers loans on THEIR terms – not yours….

    you are free to not ask for the loan.

    ==================================

    You are also free to negotiate the terms of the loan.

    It is not the banks terms, it is the terms that both agree to.

    Under your view, the bank can never go wrong: they get paid regardless.

    In my view, the lender and borrower are partners (both having signed an agreement) and each take certain risks.

    Say you put donw $20k on a $100k home, and over twenty years it appreciates at the average rate of 1%. It is now worth $121,000 and you have doubled your original investment, and maybe made fifty percent on your total investment.

    Meanwhile the bank has taken in about 63k (just in interest) on its investment of $80k, and it got most of that front-loaded so its risk goes down over time, and your risk goes up as you pay back principal and give the bank interest.

    Both parties stand to make money, if things go well and both parties take a risk if things go bad. You both make a bet, and you both take a risk. One would have to be crazy or stupid to sign a note that says heads you win, tails I lose.

    There is no moral hazard when both parties recognize the risk and both parties sign the note.

    Why would you sign a note that guarantees the bank gets its money but there is no guarantee you get your house?

    It would be a fraudulent gurantee anyway, since you cannot squeeze blood out of a stone. You could lose half of your income and be saddled with payments you can't make against a principal amount that increases with interest. you would be in debtors prison forever with no hope of escape.

    Now, THAT, is a moral hazard.

    Banks are already well protected in this transaction, provided they don't do something stupid. It used to be that you still had to pay the bank the bulk of its interest, even if you paid off the note early (pre-payment penalty). Talk about 110% guarantee for the bank and none for the customer.

    It is true that the loaned money is not your money, but it is also true that you only own that portion of the house covered by your equity. The bank is not loaning you money so much as they are buying part of your house, and you agree to buy a piece of ti back from them every month, therfore the bank shares the risk of ownership.

    Suppose you go bust due to job loss Inthe face of a 15% housing decline, but your house is 99% paid for. Even after fees and an auction sale there should be enough to pay off the banks legitimate interest, and you would get the rest. It is yours, you paid for it. The bank doesn;t get the whole house because you missed the last $1600 payment, but it does get paid for what it owns, first, plus collection fees.

  25. Hydra Avatar
    Hydra

    That is why there is no moral hazard: the bank gets paid first. But, no moral hazard is not the same as saying the bank has no risk. Their risk of ownership is the same as yours: you might not get all your money back.

    If things go well, the bank gets their money front loaded. If things go badly the bank gets their money first. And if that isn't slanted far enough to the bank side, you thinkt the bank should be paid, regardless.

    Well, fine, but if that's going to be the agreement, then you should get the house, regardless. And that would mean no foreclosure. The bank would continue to own whatever its share was, and that portion might be increasing, if you cannot make sufficient payments. The loan would automatically be renegotiated just as the government is trying to force the banks to renegotiate now, to keep the borrowers in their homes.

    Unless there is no hope the borrower can resume payments, this is probably a better deal for the bank than foreclosure into a market where nothing is selling. However, it does make their reserves situation interesting.

    Loan products like this already exist in the form of reverse mortgages and interest only loans.

    In an interest only loan, you bet the value fo the house will go up, and the bank bets that it won't go down more than the value of your down payment. The amount of the down payment is the "spread" between bid and asked, just like in the stock market or the sports bar.

    As long as all of this is understood and agreed to, there is no moral hazard. The moral hazard is more likely to be on the bank or brokers side, because they are the experts and have more knowledge.

    That's when it is called predatory lending.

  26. Hydra Avatar
    Hydra

    Some people knew. Some even resigned from the agencies because of it.

  27. Larry G Avatar
    Larry G

    I think you're confused Ray.

    Getting a loan is not a partnership.

    It's not recognized as a partnership legally nor by the IRS.

    A partnership is defined explicitly as that.

    The bank fully intends to make a profit off of lending money to you and the paper you sign requires you to pay back the loan no matter how things worked out for you on the use of the loan.

    You're arguing that if you, for instance, bought some property with your loan and it did not work out for you that the bank should help take the loss.

    not normally. The bank requires collateral and usually an appraisal to verify it's value – and you agree that they will take the collateral – when you sign for the loan.

    The bank IS taking a risk but usually charges higher interests rates to give them increased profits – to help build a fund to pay or the default loans – a cost of business.

    When you use your credit card – you are getting a loan.

    You are not engaging in a partnership with the credit card company to share in the benefits and risks for the money they loaned you.

    Credit card companies also don't have collateral so their primary leverage against you is to ruin your credit rating making it difficult for you to get other credit.

    There is no "partnership".

  28. Hydra Avatar
    Hydra

    Getting a loan is not a partnership.

    =================================

    Go read your Contract law.

    It is not a partnership in the legal definition of partnerships as a form of business organization.

    However, BOTH parties have to sign the document or it does not go forward. In that sense it is absolutely a partnership.

  29. Hydra Avatar
    Hydra

    and you agree that they will take the collateral – when you sign for the loan.

    ===============================

    Right, but you do not agree that they will take more than the collateral.

  30. Larry G Avatar
    Larry G

    the terms of the loan are not negotiated.

    They offer you the loan on THEIR TERMS and when you sign – you are agreeing to THEIR TERMS.

    re: Collateral

    If you sign a piece of paper than says you owe X dollars – you owe X dollars.

    If the collateral is X dollars, then you're fine – if it does not produce X dollars then if it is a recourse loan – they can go after your other assets.

    When you sign the paper it says whether or not you agree to such terms.

    Again – most of the time – you get told what the terms are – on a take it or leave it basis…

    You can always attempt to negotiate the terms but make no mistake it is not a partnership legally or otherwise.

  31. Hydra Avatar
    Hydra

    "the terms of the loan are not negotiated."

    ===================================

    They offer you the loan on THEIR TERMS and IF you sign – you are agreeing to Your terms and theirs. More than once I've signe a document and simply drawn a line through and initialled things I would not agree with. More than once I have simply walked out because we could not agree on terms.

    It is a mistake to think they have any more control over this than you do.

    I just refinanced my place and they had terms I wouldn't agree with. I offered to take my business someplace else and they agreed to my terms.

    Now here is the funny part.

    Originally, I went to my current lender and asked them for a no documentation re-fi, since they already had all my documentation and a good history on the existing loan. They agreed, but I could not get the rate I wanted, so I went someplace else, where I got better terms and a better rate.

    Within a month, they sold my loan back to my original, previous lender. That lender would have been better off if they had negotiated with me in the first place.

    So don't try to tell me it is their terms. Both parties sign and both parties agree to whatever is on the paper.

  32. Hydra Avatar
    Hydra

    then if it is a recourse loan – they can go after your other assets.

    ================================

    The IF being the negotiable part.

  33. Larry G Avatar
    Larry G

    I'll admit that you can negotiate the terms of the loan – that's true.

    But when you sign the paper – you are agreeing to the terms and if the terms say you owe X dollars, then you owe X dollars and if the terms say that that if the collateral does not cover the X dollars and you owe the balance, then you owe the balance.

    When you sign the paper – you are making a promise to repay according to the terms you agreed to .

    There are lots of ways to evade paying but none really change the fact that you made a promise to pay.

    And that pretty much defines our society these days.

    "Contracts" are no longer considered "contracts" but merely negotiations that can be changed.

  34. Hydra Avatar
    Hydra

    "Nonrecourse debt or a nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the collateral……

    The incentives and motivations for the parties is intermediate between those of a full recourse secured loan and a totally unsecured loan. While the borrower is in first loss position, the lender also assumes significant risk,……."

    End of story. If the lender signs such a document you have no moral obligation that extends beyond the terms stated.

    Here is the fun part. Suppose you owe $100k and the home is sold for $80k. The bank takes a $20k loss, which they write off against taxes as a business expense. But for you, the $20k forgiveness by the bank is equivalent to and counted as income, on which you may owe taxes. (The amount you owe may be offset by depreciation and other BASIS in the home.)

  35. Hydra Avatar
    Hydra

    But when you sign the paper – you are agreeing to the terms and if the terms say you owe X dollars, then you owe X dollars and if the terms say that that if the collateral does not cover the X dollars and you owe the balance, then you owe the balance.

    When you sign the paper – you are making a promise to repay according to the terms you agreed to .

    =================================
    That is a lot of ifs.

    And that is all I said to begin with. The bank also agrees to the terms.

    Normally, when you have a collaterallized loan, the collateral is all you are bound for, and usually the lender makes sure that it is more than sufficient for that reason.

    In the example above, you may owe $100k you cannot pay due to job loss. The bank forecloses and the property still sells for $120k. Your loand might have terms that says the bank keeps the whole $120k, but you would be a fool to sign a document like that.

    On the other hand if the bank sells the place for $120k and pays off the $100k loan balance, you are going to get $20,000 which you have to report as capital gains.

  36. Hydra Avatar
    Hydra

    There are lots of ways to evade paying but none really change the fact that you made a promise to pay.

    ================================

    Not if I signed an agreement, also agreed to by the bank, that I agreeed to pay up to the limit of the collateral.

    There is no eveasion in that, it is the terms agreed to.

  37. kellybrook Avatar
    kellybrook

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