Pipeline

Foreclosure Tax

California State Assemblyman Bob Blumenfield has hit upon a novel way to offset the costs to communities suffering from foreclosure fallout.

On Feb. 18, Blumenfield introduced a bill that would require banks to pay communities $20,000 for each foreclosure they conduct. According to an April 19 press release, the rationale behind Blumenfield's bill, which is supported by the Service Employees International Union and the Alliance of Californians for Community Empowerment, is that foreclosures cost local governments an average of $20,000. The press release cites a litany of expenses that communities incur when banks foreclose, including public safety calls, arrests, unpaid property taxes, trash removal, lawn maintenance, water usage, building inspections and vacancy intake.

"It is the next step," says Mike Konczal, a fellow at Roosevelt Institute, a liberal think tank, who recently testified before the California State Assembly Banking and Finance Committee about the proposed legislation. "We are not going to prevent a lot of foreclosures," Konczal said. "Even if the baddest person is being foreclosed upon, a lot of the costs are absorbed by the communities."

The California Bankers Association is strongly opposed to the proposed legislation. "Some proponents like to call this a fine or a penalty," said Beth Mills, a spokeswoman for the association. "But it is a tax and as with all taxes this will get passed onto the consumer — future homebuyers. And it will be a cost that bankers will have to factor into future mortgages."

Blumenfield represents Los Angeles County, which has more foreclosures than any other county in California. He says that his proposed foreclosure fee should provide a financial incentive for banks to modify or refinance loans. However, "If lenders can't or won't modify a home loan, then my bill makes them pay for some hidden foreclosure costs now borne by communities," Blumenfield said in the April press release. "In the Valley, our local law enforcement is dealing with an abundance of squatting issues, underground raves, vandalism and burglaries — all because of foreclosures."

Mortgage Morals

Walking away from a mortgage you can afford to pay may be a financially rational decision, but is it a moral one? In an essay published this month in Wake Forest Law Review, Curtis Bridgeman, a law professor at Florida State University, argued that strategic default is immoral, and rebuts several arguments that have been made to the contrary.

For example, Bridgeman wrote, some say that "mortgage contracts include an implied 'put' option. That is, the homeowner is said to have a contractual 'right' to walk away so long as she is willing to suffer the consequences of doing so" — losing the home and having a foreclosure on her credit record.

The problem with that line of thinking, Bridgeman said, is that it "fails to distinguish between a contract that lays out the consequences of one party's failure to perform its duty and a contract that gives one party a right to cancel. Contracting parties often find it worthwhile to negotiate the consequences of default in the contract itself, but such terms should not be confused with termination clauses." He granted that "it is possible for a borrower and lender to negotiate such a put option (which may explain some of the high-profile and supposedly strategic corporate defaults)." (The italics are Bridgeman's.) In reality, this is a rare occurrence in single-family residential lending. Termination clauses (common in cellphone contracts) are "a bargained-for right," Bridgeman said, but "terminating is not breaching."

If we excuse homeowners who walk away on the grounds that they are willingly paying the price, "one might as well argue that one has an 'option' or 'right' to steal or commit murder so long as one is willing to go to prison. The question of which behavior is permissible or forbidden is a different question from that of how we respond to such wrongdoing."

Interestingly, Bridgeman also wrote that recourse — a mortgage lender's right to chase after borrowers for the portion of debt not covered by a foreclosure sale — is allowed in more states than is commonly thought.

"Most of the states that are often listed as nonrecourse actually do allow deficiency judgments so long as the lender is willing to foreclose through the court system," he said. Only six states are "true nonrecourse," according to Bridgeman. "The vast majority of home mortgages in America are recourse loans." Yet even when mortgages are nonrecourse under state law, that still does not excuse walking away from a contractual obligation, Bridgeman said.

"Some states have statutory limitations on the amount of compensatory damages that tort victims may collect," but "no one in his right mind thinks that these limitations create a right to injure so long as he pays up to the maximum statutory damages."

Quotable …

"Then there's this economic downturn and now I'm holding a 300K house in a 10K neighborhood. My accountant just wants me to walk away from it. But I'm like, I can't do that. Just because I'm evil doesn't mean I don't care about my credit rating."

"Dr. Doofenshmirtz," the not-very-menacing villain of the Disney Channel cartoon "Phineas & Ferb," in a recent episode.