Legal/Legislative Update – February, 2013

Published on: February 10, 2013

NOT IMMINENT

San Bernardino Country, which attracted national attention last year when lawmakers said they were considering using eminent domain as a tool to deal with underwater mortgages have attracted attention anew with their decision not to pursue that plan.

Members of the Joint Powers Authority ― a commission appointed to consider the idea on behalf of the county and two of its cities ― unanimously rejected the proposal, which called for seizing delinquent loans and reducing the principal balance so borrowers could avoid foreclosure.

Commission members cited lack of public support and concerns about threatened litigation and the potential harm to the housing and mortgage markets as the primary reasons for their decision.

“It introduced risk into the market that we couldn’t quantify,” Greg Devereaux, who chaired the five-member commission, told the Los Angeles Times. “It wasn’t a decision that a board like this should make unless there was overwhelming support in the community for going forward with that solution, and assuming that risk; that support never materialized.”

Chicago Mayor Rahm EmAanuel has also publicly rejected the idea, which is being floated nationally by Mortgage Resolution Partners (MRP), a California investment firm that has proposed eminent domain as a tool that can help local communities deal with the economic damage foreclosures inflict on neighborhoods and municipalities. The company would serve as an intermediary, collecting fees for syndicating the loans local governments seize.

MRP officials said they were disappointed by the San Bernardino decision but continue to explore the idea with more than 30 other jurisdictions nationwide.

Mortgage industry executives, on the other hand, were relieved by the outcome of the San Bernardino deliberations, which they had been monitoring closely, fearful that the idea, once implemented, may spread.

“We are encouraged” by the no vote, Timothy Cameron, managing director and head of the Asset Management Group of the Securities Industry and Financial Markets Association. “The unprecedented, potential use of eminent domain would cause severe damage to struggling housing markets and is likely unconstitutional on its face,” Cameron told the LA Times.

ABILITY TO REPAY

The Consumer Financial Protection Bureau (CFPB) has finalized the “ability to repay” regulations requiring lenders to verify that home buyers can afford the mortgages they receive. There was a time when this would have sounded like common underwriting sense to lenders and borrowers. But in the wake of the financial implosion – caused in no small part by reckless and abusive mortgage lending ― it sounds almost revolutionary.

“I firmly believe that if the ability-to-repay rule we are announcing today had existed a decade ago, many people…could have been spared the anguish of losing their homes and having their credit destroyed,” Richard Cordray, director of the CFPB, said in announcing the new rules.

The Dodd-Frank Financial Reform legislation mandated the ability to repay requirement, directing regulators to define a category of “qualified mortgages” that would be deemed to comply. The CFPB has defined as plain vanilla”lower-priced loans that are typically made to borrowers who pose fewer risks.” This definition excludes loans with points and fees exceeding 3 percent, no- and low-documentation loans (known less than affectionately as “liar loans”) as well as mortgages with risky characteristics balloon payments, interest-only payments, negative amortization and terms longer than 30 years.

The rules specifically require lenders to base underwriting decisions on the actual principal and interest payments over the life of the loan (not on “teaser” rates in effect during a limited introductory period) and to consider eight specific underwriting criteria:

  • Debt-to-income ratio (which can’t exceed 43 percent)
  • Current income or assets;
  • Employment status
  • Current and expected earnings;
  • Credit history;
  • Monthly payments on the mortgage
  • Other mortgage-related obligations and loans associated with the property
  • Other debt obligations and
  • Borrower’s ability to assume more debt

Responding to concerns about the potential impact on credit availability, the CFPB decided to phase-in the debt-to-income limit over 7 years or until Congress restructures Fannie Mae and Freddie Mac. Until then, loans with higher ratios will be deemed “qualified mortgages” as long as they meet the secondary market underwriting requirements established by Fannie Mae or Freddie Mac.

The Community Associations Institute (CAI) is still assessing the impact of the QM regulations on condominium loans. In a preliminary statement, CAI Executive Officer Thomas Skiba noted with approval that common area fees are included in the calculation of the borrower’s ability to pay. That standard “will ensure home buyers are able to fulfill all financial obligations related to owning their home—including their association assessments,” Skiba said, adding, “this will create a greater degree of financial stability for community associations, while helping to ensure fairness and equity for all owners in a community.”

THE UNCONVINCED

Housing industry executives and analysts have been cheering the housing market recovery, proclaiming it strong and sustainable. But not everyone is convinced. The main problem, Quinn Eddins, director of research a Radar Logic, believes, is that it is investors, not homebuyers, who are driving the positive numbers, and those investors aren’t buying from home builders or home owners; they are buying from financial institutions selling foreclosed properties and from other investors who are selling distressed properties they’ve acquired.

“Some commentators suggest that investor-driven home price appreciation could spur demand among housing consumers, which will in turn bring about a broad-based and sustainable recovery in the nation’s housing markets,” Eddins wrote in a recent market report. And that may be the case, he said, “but we are skeptical of this theory.”

Because “traditional” homebuyers are still pretty much sidelined by conservative underwriting guidelines, Eddins argues, “it is hard to see a direct connection between the current increase in institutional demand and future gains in household demand.” Equally problematic, he suggests, the strategy investors are using – buying foreclosed properties and renting them – will eventually kill that business model, because it will push prices up to the point at which “the economics of buy-to-rent strategies no longer work.”

Rather than the sustainable recovery other analysts see, Eddins anticipates another negative cycle, with falling demand from investors increasing the REO inventories of banks and pushing prices down again, until investor demand recovers, starting the current trend over again – invests will dominate the market, pushing sales and prices upward. This cycle will continue, Eddins predicts, “until consumer demand recovers and drives a real recovery in housing values.”

GETTING BIGGER

Purchasers of new homes, who had embraced a ‘smaller is better’ philosophy during the housing downturn, have apparently decided that bigger is better again. After declining for five years, the average size of newly built homes increased by 3.7 percent in 2011 compared with the previous year, according to data compiled by the Census Bureau.

A recent survey by PulteGroup confirmed that trend, finding homebuyers in all age groups expressing a preference for larger homes. That includes baby boomers, now at an age and stage where conventional wisdom suggests they should be thinking about down-sizing. Only 28 percent of respondents 55 and older said they expect their next home to be smaller.

“Across all demographics…respondents] said they want their next house to be the same size or larger,” Valerie Dolenga, a spokesman for PulteGroup, told DS News. “An overwhelming majority – 84 percent – said they don’t intend to downsize. I don’t think the McMansion is dead,” she added. “People want that square footage.”

Younger households need space to accommodate growing families; for baby boomers, Dolenga said, the issue is “stuff.”

“They have a lot of stuff …they don’t want to let go of…and stuff has to have a place to go.”

LEGAL BRIEFS:

HOLD OR FOLD

The Massachusetts Supreme Judicial Court has ruled that financial institutions must either hold the mortgage and note or be acting on behalf of the note holder in order to initiate a proceeding to determine if a borrower is entitled to foreclosure protections under the Service Members Civil Relief Act. “Because non-mortgagees are not, by law, in a position to foreclose on a mortgage,” the court ruled, “they could not suffer the loss that the service member proceeding redresses.”

That ruling, in HSBC Bank USA, N.A., Trustee v. Jodi B. Matt, is consistent with SJC’s landmark decision last year in Eaton v. Federal National Mortgage Association, concluding that possession of the note and mortgage is required to establish standing to foreclose.

The court eased the impact of that ruling considerably by deciding it would not be retroactive. The Eaton decision also made it clear that while “unity” (possession of both the mortgage and the note) is required in a foreclosure action, the foreclosing entity need not physically possess the note; it need only document that it represents the note’s holder. A footnote in the decision said lenders could meet that requirement by filing a statutory affidavit with the registry of deeds affirming that they either hold the note or represent the entity that does. A footnote in HSBC indicates that a similar process may be acceptable to establish standing in SCRA actions.

 

DEBT COLLECTORS?

In another foreclosure-related decision outside of Massachusetts, the U.S. Court of Appeals for the Sixth Circuit has held that attorneys who handle foreclosure actions may meet the definition of “debt collectors” under the federal Fair Debt Collection practices Act. The court made it clear, however, that the definition applies only to attorneys whose primary business is mortgage foreclosure.

A lower court had ruled that attorneys are not covered by the FDCPA, which requires debt collectors to comply with a laundry list of consumer protections and establishes huge civil penalties for failure to do so. The lower court in this case concluded that foreclosure actions involve the protection of a security interest and so are not “debts as defined by the FDCPA. But the Sixth Circuit rejected that view.

Any activity whose purpose is to obtain payment of a debt “is properly considered debt collection,” the court held, and “every mortgage foreclosure, judicial or otherwise, is undertaken for the very purpose of obtaining payment on the underlying debt.”

The Second, Third, Fourth and Eleventh Circuits have reached the same conclusion.

 

WORTH QUOTING:

“If the FHA were a private financial institution, likely somebody would be fired, somebody would be fined and the institution would find itself in receivership….It is merely and merrily on its way to becoming the recipient of the next great taxpayer bailout.” –Jeb Hensarling (R-TX), chair of the House Financial Services Committee, during a recent hearing on the financial condition of the Federal Housing Administration.