Should Mortgage Giants Pursue Borrowers Who Walked Away?
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The Fiscal Times
January 21, 2014

If any company captures the zeitgeist of the housing collapse, it might be YouWalkAway.com. Started in 2007, the California-based firm helps underwater homeowners — those whose houses are worth less than what they owe on their mortgage — decide whether they should stop paying on their loans. If borrowers choose to default, the company’s advisors then walk them through the foreclosure process.

Co-founder Jon Maddux says that when the firm launched in 2007, real estate professionals told him it might last two or three years. But the steady stream of clients kept coming, and Maddux says he’s shocked the company is still in business.

Now, some of Maddux’s clients could be the target of renewed efforts by government-backed mortgage companies Fannie Mae and Freddie Mac to pursue money the borrowers owed on their foreclosed homes. The focus follows two inspector general’s reports last September that chastised both firms for failing to go after people who could have paid on their mortgages but chose to walk away. Doing so could recoup more of the $187.5 billion in taxpayer bailouts that Fannie and Freddie have gotten since 2008, the reports said.

It’s worth noting that nearly all of that money — $185 billion — has already been paid back. With the rebound in the housing market, the two government-run providers of housing finance have returned to profitability. They sent $39 billion in dividends to the Treasury last month, meaning that taxpayers could soon start profiting from the investments that saved the mortgage giants from insolvency.

In most states, after Fannie and Freddie foreclose on a home and then sell it, they can pursue the former owner for the difference between the sale price and what the borrower owed on the loan. But the inspector general concluded that the companies failed to do so in more than 100,000 cases that together represented at least $6 billion. The FHFA is developing plans by the end of this month to ensure that the Fannie and Freddie do a better job of pursuing those who defaulted but could have kept paying.

The inspector general noted that going after those borrowers for the deficits could help deter future strategic defaulters. Barry Habib, CEO of mortgage market intelligence company MBS Highway, says that defaulting, once considered “shameful,” is now widely acceptable.

An October 2012 national survey commissioned by consumer risk management firm ID Analytics found that a third of those polled said homeowners should be able to strategically default on their mortgages without facing any consequences. Thirteen percent said they’d likely strategically default on a mortgage, and 17 percent said they know someone who has. Strategic defaulting has led to higher interest rates for other borrowers, says Edward Pinto, a resident fellow at the American Enterprise Institute and former executive vice president at Fannie Mae.

Even if the inspectors think Fannie and Freddie should go after more strategic defaulters, actually doing so may be another story. One reason is state law: 12 states bar lenders from suing foreclosed owners for the deficits, and 10 others have very short statutes of limitations for doing so — between 30 to 180 days, depending on the state.

Related: 7 Reasons Rentals Are Rocking the Housing Market

Another problem is figuring out who had the ability to pay and who didn’t. “If you have to install a new computer system or spend hundreds of thousands of dollars to do this, it might not be worth it,” says Robert Pozen, senior fellow in economic studies at the Brookings Institution.

Fannie and Freddie told the inspector general that they are capable of determining who could have paid, but an FHFA response to a previous inspector general’s report admitted that assessing borrowers’ finances isn’t easy or cheap. An FHFA spokeswoman declined to answer a question about how Fannie and Freddie assess whether borrowers can pay, directing inquiries to the inspector general’s office, which didn’t respond to a request for details. 

The case of 41-year-old Dave Astle shows how hard it may be to suss out those who could have paid. In 2005, Astle and his wife bought a 3,100-square-foot house in Temecula, California for $500,000 with no money down. By 2009, they were getting a divorce and needed to sell the home, since they couldn’t continue to live together. By then value of the house had dropped to $300,000, so they’d be on the hook for $200,000 — enough to wipe out their savings — if they sold. 

The couple stopped paying their mortgage, and the bank foreclosed the following year. Actually proving they had the means to pay would require collecting reams of financial documents going back five years and then making a determination--possibly in consultation with a judge--about whether their decision was reasonable.

Even if Fannie and Freddie can identify voluntary defaulters, the inspector’s reports admit that actually collecting can take months or years. “Trying to get a billion dollars out of a bank is one thing. Trying to get $20,000 out of 50,000 homeowners is an entirely different story,” says Pinto. “You have to go down a torturous road to do it.” 

Real Estate Red Alert: Where Have All the Houses Gone 

Maybe most important, Pinto doesn’t think pursuing defaulters will be a priority for new FHFA director Mel Watt, the former Democratic Representative from North Carolina who started on Jan. 7. Pinto believes Watt will be focused on expanding Fannie and Freddie’s footprint in the housing market, increasing access to loans through policies like enforcing affordable housing mandates, and even offering principal reductions to borrowers who are upside down on their loans, which previous director Edward DeMarco declined to do. FHFA’s press office said that it couldn’t comment on Watt’s priorities at this early stage.

In any case, the changing market already has cut into the pool of strategic defaulters. No one keeps statistics on their number, but Habib thinks it’s quickly falling as home values rise and improve homeowners’ equity. Already the proportion of those who are upside down on their mortgages has shrunk from a third to under 15 percent, he says. A likely factor in the reduction is the FHFA’s Home Affordable Finance Program, which lets many underwater and near-underwater homeowners refinance, minimizing their motivation to default. 

Jon Maddux offers the best clue about where trends are headed. YouWalkAway’s business has shrunken dramatically, with virtually no new clients coming in the door seeking help with strategic defaults. So he’s resigned to launch a new venture called AfterForeclosure.com. It will help “boomerang buyers”—people who have been through foreclosure who want to try home ownership again.

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STEVE YODER writes about business, real estate and other domestic policy issues. His work has appeared in print and online at Salon, The American Prospect, Men's Health, The Crime Report, and elsewhere.