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The More Short Sales Done in Mortgage Settlement, the Better

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The recently issued report from the court appointed monitor of the settlement agreement between the five leading mortgage loan servicers and the 49 state attorneys general contained some very interesting information.

Many observers have complained that the servicers have taken too much advantage of being able to get some credit against the settlement funds for eliminating second mortgages which, in reality, had no value anyway, calling this the "second mortgage loophole." But with the credit for eliminating or reducing second mortgages only 10% of the loan amount, is this something we really need to worry about?

More importantly, consumer groups are howling over the widespread encouragement of "short sales" under which lenders receive 45% credit for the amount by which the first mortgage is forgiven pursuant to such a short sale. A spokesperson for the Center for Responsible Lending was quoted as saying "It's shameful. A short sale is a kissing cousin to a foreclosure; it depresses property values and kicks people out of their homes. Haven't the banks done enough damage?"

I have written frequently in BankThink about the desirability of encouraging a massive increase in short sales as the best way to accelerate our progress in moving through the foreclosure crisis and restoring normalcy to the housing market. I have cited several reasons for this position. First of all, there is simply no fair or equitable way to selectively reduce the principal amount of one person's mortgage and not another. Furthermore, to do so would only encourage bad behavior with other obligations in the future. But as I have repeatedly shown, a short sale by which the home is sold for less than the first mortgage amount does not invoke these issues of "moral hazard" precisely because the homeowner is giving up ownership of the property. Thus, a short sale is the only way in which "principal reduction" can be accomplished fairly and equitably.

Secondly, short sales provide a free market opportunity for the over stressed borrower to dispose of a property in an orderly way. Because the property is sold by a contract between a willing seller and a willing buyer, the price obtained is inevitably higher than the amount which the property would bring in a foreclosure.  Short sales also generally avoid the damage to neighborhood property values caused by a foreclosure which is often followed by a contentious eviction.

A third point which is often overlooked by consumer advocates is that a high proportion of the troubled mortgages still in place throughout the country were obtained under false pretenses. In applying for "low-documentation" or "no-documentation" mortgages (also known as alternative-Aloans) borrowers typically inflated their income, assets, or employment background in order to qualify for a larger loan than they reasonably knew they could afford. Surely one cannot defend reducing the principal balance of such a loan and still allowing the borrower to remain in the property.

All of this leads one to believe that the fact that the bulk of the relief, pursuant to the negotiated mortgage loan settlement agreement, is going to short sales is a huge victory for the agreement and the economy. It offers strong evidence that short sales are the correct way of administering a market determined principal reduction without any risk of "moral hazard" consequences. Banking regulators should take notice and do everything possible to encourage lenders and loan servicers to expedite short sales for the millions of homeowners still "underwater" on their mortgages. 

Alexander R. M. Boyle is the retired vice chairman of Chevy Chase Bank. He has worked in mortgage lending and consumer banking for 30 years.

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Comments (2)
Basically a thumbs up on this article. Clearing inventory, whether title is with the banks and mortgage companies or still with the defaulted borrower, is critical to establishing a 'balanced" market somewhere near an equilibrium. To get there requires incentives for all parties, which most often is present in a short sale. Policy makers applying their own view on morality to the mortgage market do seem to be slanted to the position that the lenders are all bad, and the borrowers where naive manipulated victems. Nah...it takes two to tango.
Posted by BuckW | Thursday, February 28 2013 at 3:46PM ET
Mortgage Note Holders should be required to pre-qualify the existing homeowner(s) to enable the current homeowner to buy back their home in a short sale or to bid up to a certain amount at auction.

It is ridiculous that the current homeowner does not have any resonable chance to get their home back at the lower purchase. Many were intentionally set up with loans destined to fail, but insurance made that ok. Outrageous ARMs, balloons, and the sort with the tiering of loans when it was not needed.

Shame on all the greedy ones which caused this externally imposed hardship on both the trusting and the naive. They were laughing all the way to the bank. No more.

As a CPA who has reviewed many of these outlandish mortgage notes, I am somewhere between a speechless financial and systems professional, a rabid homeowner advocate, and a compassionate human being simply crying for those who lost everything trying to save a home which was intentionally destined for loan failure.

The real crime, though, was the banks never wanted anyone to keep their home. It was far more profitable to foreclose, keep collecting insurance for the face value of the note, charge off the debt, take a loss for tax purposes, and then to sell the debt. Unjust enrichment if you ask me.
Posted by sjnewport | Saturday, March 09 2013 at 4:53AM ET
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