The Road To Hell

They say the road to Hell is paved with good intentions. It is also littered with unintended consequences.

As an example, take a look at the recent "well-intentioned" action by our NY State Legislature and Governor Spitzer. Everyone knows that there is a mortgage crisis and that foreclosures are on the rise. Our lawmakers in Albany decided that they had to do something about it.

They also apparently concluded that the crisis stemmed from the unfair practices of greedy mortgage bankers who foisted bad loans upon innocent borrowers, aided and abetted in this scheme by heartless foreclosure attorneys (full disclosure: I would be one of those attorneys). Thus they passed a law to "help" those innocent borrowers to avoid losing their homes. The law requires the bank's attorney to add a notice to foreclosure papers which warns the borrower that failure to submit an Answer to the papers could result in a default judgment and it encourages them to get an attorney.

Gee, isn't our Legislature caring and considerate? They should really feel good about themselves, shouldn't they? Well, let's look a little closer.

First, despite popular belief to the contrary, banks do not want to foreclose. They lose money on virtually every foreclosure. Banks are in the business of lending money, not the real estate business. They do not wish to own scores of foreclosed houses.

As a result, banks have elaborate loss mitigation programs for borrowers with financial difficulty. They offer payment plans, loan modifications, payment deferrals, etc., all intended to allow the borrower to be able to pay their mortgage (this is not lender altruism; the bank only makes a profit if the borrower can repay the loan). Generally, the borrowers who get to foreclosure have exhausted those loss mitigation opportunities and are relatively unlikely to be able to avoid loss of their house.

After a foreclosure lawsuit is commenced, it becomes more costly for borrowers to cure their default because they are then required to add whatever legal fees and costs have been incurred on top of the mortgage arrears. Still, about 20% of the defendants we deal with in foreclosure manage to scrape together the money they need to redeem their loan.

So, how does the "feel-good" action by the Legislature affect this scenario? In fact, it will make it less likely that that 20% will avoid the worst case. The new notice encourages getting a lawyer and putting in an Answer. When foreclosure defendants serve an Answer, the bank's attorneys must make a Motion for Summary Judgment. That motion raises the legal fees and costs of the foreclosure. Guess who has to pay those fees? You're correct if you said the borrower.

Encouraging submission of Answers would only make sense if a large percentage of defaulting borrowers had a true defense to foreclosure. As usual, the governmental solution ignores the reality of the market. In addition to evil foreclosure lawyers, there are quite a number of "good" borrower's attorneys out there. They find the borrowers who have real defenses and they represent them (and if their defense is valid, things are worked out). The vast majority of borrowers with valid defenses find attorneys now without Albany's assistance.

So in the end, the Legislature's action was worse than ineffective. It could not help the 80% of borrowers who simply did not have the resources to save their house and it will hurt the chances of the 20% who might have done so. The main beneficiaries of this law? Those evil foreclosure attorneys. Now, rather than getting our minimum fees on default cases, we will be collecting additional litigation fees responding to the Answers encouraged by this new law.

Some may say, thank goodness, our government "did something" about this problem. I'd say that by rushing in and acting on half-baked assumptions, they made it worse.