Monday, February 23, 2009

Recourse and Judicial versus Non-Judicial Foreclosure

Many are firmly fixed on the idea that making a loan recourse reduces default risk. Here is Greg Mankiw, for example:

How might the feds ensure repayment of these mortgages? One possibility is to make them recourse mortgages (that is, the lender would have recourse to the borrower's other assets, if the borrower defaults and the house value falls below the mortgage principal).

In my experience this is not the case; I've talked about why here. In a nutshell, there are factors far more influential than potential loss of other assets that drive borrower behavior (for example, ability to pay).

Another reason recourse is rarely pursued by lenders is because it is invariably a judicial process. Non-judicial foreclosures through trustee sales are just that – non-judicial, with a fixed time frames, no hearings, and precisely known fees. Once you get attorneys, judges, and even juries involved in a process, both costs and uncertainty escalate dramatically.

This is especially true when judges are on unfamiliar territory. Back in the early 1990’s while working for an income property lender we were in court many times every week getting receivers appointed. Ordinarily this kind of work is allocated within a county to one or two judges, and given any kind of volume the attorneys and judge quickly get on the same page as to what’s expected and what the results would be. However, when the judge normally handling receiverships was on vacation, results were all over the map, because the substitute judge was not familiar with receiverships.

Processes and results also vary wildly between jurisdictions. Receiverships were routine in California, but almost impossible to obtain in Florida. A bankruptcy case which would have been resolved in 6 months in San Diego took 4 years and an appeal to the U.S. Supreme Court to resolve because it started out in Shreveport, Louisiana.

Finally, it is often the case that a lender’s effort to strip the borrower of their assets in addition to seizing the collateral gets a cool reception from judges and juries. From a recent MBA Newslink article:

Terry Hutchens, president of Hutchens, Senter & Britton, Fayetteville, N.C., told participants yesterday at the Mortgage Bankers Association's National Mortgage Servicing Conference and Expo that while lenders or mortgage servicing firms in the past might be given the benefit of the doubt in the event a home foreclosure case went to court, juries and judges in the current unfriendly judicial environment do not feel as inclined to cut mortgage firms or their attorneys any slack whatsoever.

"There has been a climate change," Hutchens said. "The pendulum has swung too far and we are not being treated fairly."

Recourse lending is not a panacea.