Legal/Legislative Update – April 16, 2015

Published on: April 16, 2015

GETTING OFF THE POT ENFORCEMENT FENCE. As more states move to legalize marijuana or consider those measures, federal law enforcement officials are feeling increasing pressure to get off the fence they have been straddling and either enforce federal laws prohibiting marijuana use or make the live-and-let-live approach the Justice Department has been pursuing an official government policy. Another middle-of-the-road option: Have Congress enact legislation eliminating the federal proscription against marijuana in states that have legalized it, but leave in place existing laws making marijuana use illegal elsewhere.

Four states (Colorado, Oregon, Washington state and Alaska) have enacted laws legalizing recreational use of pot; legalization measures are on the 2016 ballot in Massachusetts and four other states (Arizona, California, Maine and Nevada), and under consideration in three others ―Missouri, Montana and Florida.

The current situation, with marijuana possession legal in some states but illegal under federal law, “has resulted in a legally murky situation where no one is completely sure what states can or can’t do,” an article in Politico observed recently. Many condo associations are already struggling with whether and how to regulate the use of medical marijuana, which is already legal in many states, including Massachusetts. (See related article.)

STRATEGIC DEFAULTS. When the Obama administration introduced the Home Affordable Mortgage Program (HAMP) during the financial ‘troubles,’ critics warned that the loan modification program, designed to help underwater borrowers avoid foreclosure, would have unintended, negative consequences. A recent study suggests they may have been right.

The negative result critics foresaw was “strategic defaults” — borrowers who could afford to make their payments choosing to default instead in order to qualify for a modification that would reduce their interest rate, their principal balance, or both. Economists at New York University and Kent State found that more than one-third of the loans they studied that were modified through HAMP and other modification programs had payments past due in the month or two immediately preceding the modification announcement.

The study has implications not just for mortgage modification programs, the authors say, but for similar rescue programs targeting student loans and credit cards. “A thorough analysis of modification-induced defaults bears tremendous implications for banking practice and public policy decisions in general,” the authors conclude.

One obvious concern, an article in The MReport suggests: Strategic defaulters with marred credit histories will have difficulty qualifying for future credit. “With a crush of applicants with poor credit and a history of defaulting on loans will have to modify their lending practices or risk turning away an awful lot of potential customers,” the article notes.

KEEPING SCORE. Incorporating rental history in a borrower’s credit score, as the major credit reporting agencies have begun to do, will significantly increase the number of borrowers able to qualify for loan, a study by Experian has found. The survey of almost 20,000 renters with good payment histories found that 11 percent currently had to credit file; including rental history produced prime credit scores for 59 percent and “non-prime” scores for another 38 percent. Only 3 percent of these renters ended up with sub-prime scores.

“Adding on-time rental payments to credit files may help those who operate primarily on a cash basis to integrate into the banking system and establish a credit history that they can leverage to receive more affordable credit and improve their economic well-being,” Brannan Johnston, vice president and managing director of Experian RentBureau), said in a press statement.

Although mortgage lenders have not traditionally considered rental payment history, many are expected to adjust their policies to expand the pool of eligible borrowers and boost loan origination volume, which has remained sluggish even as the economy has recovered.

WAITING FOR MILLENIALS. An improving economy and a strengthening labor market could draw more first-time buyers into the housing market. But it is not at all clear that millennials, who represent the lion’s share of this homebuyer pool, will behave like past generations of homebuyers or trigger the home buying surge on which industry analysts are counting.

The statistics look promising on their face. Millenials will soon replace baby boomers as the largest population segment, with more than 75.3 million members between the ages of 25 and 34.

The employment rate for this group topped 76 percent in January ― its highest level in almost seven years — and their wages have been increasing faster than for any other age group. Household formation rates, which had been declining, have begun rising again — indicating that young adults who have been living with family or friends are renting their own apartments, a key first step toward buying their own homes.

But that next step may not come any time soon. More than 30 percent of millennials responding to a recent survey said that while they want to own a home, that isn’t a priority for them now. Another 30 percent said they either have no near-term plans to purchase a home or never intend to do so.

FORECLOSURE REPEATS. Although foreclosure rates continue to fall, repeat foreclosures are increasing, casting a shadow of ambiguity over the housing market recovery. Approximately 1.5 percent of all homes with mortgages were in some stage of foreclosure in the fourth quarter of last year, according to a CoreLogic report. That represents the lowest foreclosure rate in seven years.  CoreLogic estimates that approximately 5.6 million homes have been lost to foreclosure since the financial crisis struck in September of 2008.

“At [the current rate], we expect to see the foreclosure inventory in the U.S drop below 500,000 homes sometime in the first quarter of 2015 which would be another milestone in the healing of the housing market,” Anand Nallathambi, president and CEO of CoreLogic, said in a press statement.

Repeat foreclosures are moving in the opposite direction, however. According to the January Mortgage Monitor Report, repeat foreclosures increased by 11 percent in January compared with December, representing 51 percent of all foreclosure starts for the month. January’s second-time foreclosure total was also higher than in January 2014 – the first time in more than two years the year-over-year comparison has ticked higher.

Some analyst attribute the increase to seasonal factors, but Guy Cecala, CEO and publisher of Inside Mortgage Finance, thinks more fundamental and more disturbing factors are at work. “So much tinkering was done with defaulted borrowers over the last five or six years,” he told CNBC, “it’s not surprising they’re running into problems again.”

THE SECOND TIME AROUND. An old song says “love is lovelier the second time around.” Some housing industry executives are hoping lenders will view homeownership the same way when they consider mortgage applications from borrowers who have defaulted on previous home mortgages.

Industry estimates peg the number of “boomerang buyers” at close to 5 million – a tempting prospect for lenders trying to boost loan revenues.

“We have a large number of people who were affected by foreclosure and have been sitting in the penalty box,” Mike Orr, director of the Center for Real Estate Theory and Practice at the W.P. Carey School of Business at Arizona State University, told the Wall Street Journal. “This ‘boomerang buyer’ group is a pretty substantial potential demand,” he added.

Not all lenders are comfortable about giving borrowers who have defaulted in the past a second chance at home ownership. Massive losses on loans that went south defaulted during the financial crisis and the huge penalties many paid for shoddy lending practices have made some lenders─ especially the largest ones ― skittish and unwilling to consider borrowers who don’t have a pristine credit history. Contributing to that skittishness, many analysts are warning that past defaults are a good indicator of future ones.

But some lenders, encouraged by a strengthening economy, improving credit scores, and federal policies aimed at strengthening the housing market, are accepting and beginning to seek buyers who want a second chance. Smaller, regional banks in particular are moving to increase their market share by filling the gaps ultra-conservative underwriting policies are creating.

Some industry executives are beginning to see the results. Foreclosed borrowers, who have tried unsuccessfully to obtain mortgages in the recent past, are trying again. The difference, one lender told the Journal: “They can actually get approved now.


COVERAGE CLASH. The residual impacts of last winter’s ice dams and the damage they caused condo associations throughout New England, have focused intense interest on insurance coverage and claims. Within that context, a recent dispute between a Louisiana condo association and its insurer may be particularly interesting.
The dispute in Houston Specialty Insurance Company v. Meadows West Condo Association centered on whether the ordinance or law provision in the community’s master insurance policy should cover the replacement of equipment implicated in a fire but not damaged by it.

A fire originating in the HVAC duct of one unit in the Meadows West Condominiums damaged two units in one building, causing approximately $50,000 in damage. The insurer, Houston Specialty Insurance Company, paid that claim, but balked at a separate claim for the cost of replacing the HVAC duct work in all buildings, which a building inspector had ordered the association to do. The inspector had determined that the accumulation of combustible materials in a section of the duct was the likely source of the heat that had caused the fire.

The community had suffered five fires in identical areas over the past 15 years. A previous inspection had suggested that the HVAC design might be faulty, but had not determined whether the design complied with building code requirements in place when the condo buildings were constructed in the 1970s.

Complying with the building inspector’s order – and his threat to take legal action if the association failed to comply – the condo board replaced the HVAC ducts in all 18 buildings and filed a $316,489 claim for the work, which Houston refused to pay.

In the ensuing litigation, the insurer argued that the policy did not cover the duct replacement, because that equipment wasn’t damaged in the fire; and that the ordinance or law provision in the insurance policy did not apply because:

  • The building code provision cited by the inspector did not authorize him to dictate how a building should be repaired or reconstructed; and
  • The inspector did not cite a specific ordinance requiring the design changes he mandated.

The association contended, and the federal district court agreed, that the provision applied because a local official had determined that the changes were needed to comply with code requirements in place when the fire occurred.

The court also rejected the insurer’s argument that a policy exclusion denied coverage for any loss resulting from the association’s failure to comply with building code requirements. Houston argued that an inspector’s conclusion that the duct work may have contributed to an earlier fire, in 2010, put the association on notice of the problem and required corrective action at that time. But the court concluded that the inspector’s earlier observation was not conclusive and did not include a directive to repair or replace the ductwork. The court also pointed out that the code requiring the redesign was not enacted until after the 2010 fire, and that there was no evidence that Meadows West violated any requirement in place before the 2012 fire.

Houston’s effort to asset an exclusion for damage caused by faulty design also fell short with this court, which noted that that the inspectors who found that the ductwork was or may have been implicated in the fire weren’t qualified to determine whether the design or maintenance was faulty. Correspondence the insurer cited to support its argument actually proved the opposite point, the court said, demonstrating that the officials’ opinions “were limited to the cause of the fires as opposed to design, construction and/or maintenance issues…Most telling,” the court said was a letter in which one inspector stated, “I cannot design a repair,” and then directed the association to hire professionals qualified to do so.


“We’ll look at every option that brings housing opportunities within reach of more Americans.” ― HUD Secretary Julian Castro referring favorably to recent proposals to modify traditional credit scoring models to incorporate “nontraditional factors” that would enable more borrowers to qualify for loans.