Judicial Reports: Foreclosure Courts: Fix or Fake?

By Leah Nelson
lnelson@judicialstudies.com 
Posted 06-25-08

The State Legislature has asked judges to help solve the homeowner loan crisis. Problem is, judges don't have the authority to suspend the laws of economics or the ability to make invisible litigants appear out of thin air.

Editor's Note: This story was updated June 25 at 1 PM.

While Chief Judge Judith S. Kaye announced a pilot project last week to test measures designed to make the court system friendlier for homeowners facing foreclosure, the Legislature jumped the gun, passing on their last day in session a new law intended to ease the same homeowners' plight.

Among other things, it mandates settlement conferences on foreclosures that involve certain subprime loans. 

Two huge issues threaten to make the exercise an empty gesture.

Problem one: Almost 90 percent of homeowners notified of foreclosure lose by default because they never respond.

Problem two: Even if the new system can improve that response rate, the brave new world of securitized home loans often makes it impossible to find a human being who has the authority to renegotiate with the beleaguered borrower on the plaintiff’s behalf.

According to a press release from the Governor's office, the law's purpose is to "protect people from losing their homes." It will also expedite the process when foreclosure is the only option.

Currently, proceedings take up to 18 months in New York City and the surrounding counties, and about 8 months elsewhere in New York State.

Settlements could come in several forms, such as modified rates or payment schedules that would allow residents to keep their homes. Or they might involve deed transfer without formal foreclosure (which would save lenders approximately $60,000 in court costs and keep a serious black mark off defendants’ credit scores.)

Early conferences between plaintiff and defendant are a central feature of the reforms. But as Judicial Reports noted in this story, only 10 percent of borrowers facing foreclosure challenge the action in court. Observers attribute this high default rate to a combination of factors, including inadequate notice by lenders, homeowners’ ignorance of their rights and confusion about how to proceed, and the hopelessness of people swamped by debt to multiple creditors.

Turnout is low even in Brooklyn, where the Supreme Court Civil Term has arguably the State’s most homeowner-friendly foreclosure part (read more about it here).

Under the new law, lenders are required to send a notice to homeowners at least 90 days before commencing legal actions against them, along with a list of local providers from whom they can seek legal advice.

The law also specifies that plaintiffs must be represented at conferences by people "with authority to settle the matter:" those who have the power to modify loan terms or amounts.

But old-fashioned mortgages were held by a single bank that also serviced them and dealt one-on-one with borrowers. By contrast, many loans during the past several years — especially the subprime variety underlying many current foreclosures — were securitized: chopped up and resold to any number of shareholders.

The contractors to whom many investment banks farmed out the task of servicing mortgages have limited powers.

They can collect payments, and they can foreclose. But unlike representatives from banks that own mortgages in their entirety, their authority to modify the terms of the loans they service or accept a title transfer in lieu of court proceedings is restricted — sometimes by the terms of their contract with the lenders they represent and always by their obligation to act in accord with the best interests of the investors who bought shares of the securitized mortgage debt.

Bruce Berkman, a prominent plaintiff’s attorney at Garden City’s Bergman, Henoch, Peterson & Peddy, scoffed at the idea: “To just say that the courts will help because they’ll have [defendants] give a deed to the lender, it just won’t work.”

He continued, “Do you think something is going to happen where by fiat they can do that? [Not] when you’ve got trustees and all kinds of layers of authority that make [loans] difficult or cumbersome to modify.”

Experts at the Securities Industry and Financial Markets Association (SIFMA), a financial trade association, said that the matter of finding lender representatives empowered to change loans’ terms at court conferences is the least of their concerns about the legislation.

More problematic, said Sean Davy and Chris Killian of SIFMA’s Mortgage-Backed Securities (MBS) and Securitized Products Division, is the potential conflict between a policy response to the housing crisis and the enduring need to preserve the sanctity of contracts.

The law's failure to delimit judges’ role at foreclosure conferences is a problem for plaintiff representatives, who, Davy and Killian said, might hesitate to agree to modifications if they’re unsure that the cards they hold today won’t be taken from them tomorrow.

The law is to supposed to prevent avoidable foreclosures. But, as SIFMA’s spokesmen point out, almost anything is avoidable if you're willing to be flexible. When it comes to keeping people in their homes, how flexible will judges expect lenders and the investors they represent to be?

Also, they wonder, in foreclosure conferences, will judges be moderators only, or will they make decisions that, at a typical settlement conference, would be left to the parties?

In a market where houses lose value with each passing day, even granting the defendant an extension could negatively affect investors if modification negotiations fail despite the extra time.

Davy and Killian are also uneasy about the long-term effect of agreeing to modifications.

If the changes are permanent, decreased revenue from loan repayments means that investors could lose more earnings in the long run than they would on an immediate foreclosure. But if modifications are a temporary reprieve, there is no reason to believe that people who bought more house than they could afford when credit was loose wouldn’t default on payments again once the old rate kicks back in — meaning that lenders would lose revenue in the short term and still have to foreclose later.

If all of this is so, isn’t the new law simply a case of the government building a Potemkin village?

Court leadership, which, in testimony before a state senate committee a few weeks ago, strenuously opposed the role the legislation assigned judges, was taciturn. "We are now evaluating the implications of the bill," said court spokesperson Kali Holloway.

The new legislation in unambiguously intended to benefit homeowners. But Chief Administrative Judge Anne Pfau publicly rejected the idea of using the courts to implement such an agenda, reminding the other two branches that judges may not serve as advocates.

Absent explicit legislative intervention of a type that has not seriously been proposed, they cannot modify the terms of a contract in order to make it more favorable to one party or the other.

Unlike proposals from the State’s Executive and Legislative branches, the court’s plan promoted “greater efficiency in case resolution and better outcomes for both homeowners and lenders” [emphasis added]. This would seem to address plaintiffs’ concern that judges overseeing settlement conferences would make decisions forcing a contractual change without due process.

Paul Lewis, Judge Pfau’s top aide, acknowledged that the courts are not sure what authority they have to deal with the plaintiffs who have the power to foreclose but not to modify loans’ terms — potentially a serious problem if lender’s lawyers chose to fight.

With its pilot project, the court wasn't promising miracles. But judging by the contents of this new law, the state government may be expecting them anyway.

“We don’t expect to go from a 90 percent default rate to a 10 percent rate,” said Lewis. “We’ve never seen anything like this before. We don’t know yet whether the default rate will drop. The lenders will lose enthusiasm if they show up and there’s no one on the other side of the table.”

There are other unknowns.

Depending on demand, legal services might be hard-pressed to give defendants the help they need in the time-frame the court desires. No one knows what percentage of foreclosures stem from securitized loans.

Even the meaning of "subprime" - the operative word in determining which borrowers would benefit from the law - is hazy. "It's a total nightmare. I don't know how it is going to be implemented. The definitions of subprime loans are completely Greek to me," said Steven Baum, a prominent Buffalo-based plaintiff's lawyer with two decades of experience in his pocket.

And the court system doesn’t know how much more time-consuming the new system will be for judges and clerks overseeing foreclosures who, if all goes to plan, will have to fit conferences and follow-ups into their schedules.

Too bad for them. The Legislature has spoken, and now, having offloaded the burden of resolving a market-generated crisis in the hands of a judiciary that has explicitly stated its inability to do so, it's time for the Senate and Assembly's summer vacations. 

Posted by Dirk on June 25, 2008 01:23 AM to Judicial Reports