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Friday, October 8, 2010

National Foreclosure Moratorium On The Way

Bank of America announced earlier today that it is suspending foreclosures in all 50 states.

This development is the latest in a series of events over the last week which have seen one major bank after another suspend its foreclosure efforts because of processing or paperwork errors.  When the paperwork is in the course of litigation, it becomes a serious matter and can raise entirely valid questions as to the presence of fraud, forged or false notarizations and other irregularities that go to the issue of whether homeowners received adequate due process. 

The banks' failures -- whatever the cause -- are inexcusable, particularly given their receipt of ample taxpayer bailout funding and record profits in the last year.  The banks had the money -- the wherewithal -- to hire the people and create, implement and maintain the processes to ensure that foreclosures would be processed correctly and fairly, and to hire lawyers to do the same. The banks may have been very negligent should these errors prove to be widespread and systematic, as opposed to one-off mistakes or other anomalies contained to specific offices or supervisors.

As for the effect on the national residential housing market, an effective national foreclosure moratorium (which legislators like New York's Congressman Edolphus Towns already have proposed) will have several effects:

(1)  More strategic defaults.  A moratorium of indefinite duration will embolden homeowners otherwise able to pay their mortgages to consider defaulting, using strategic defaults to cut their losses, live rent-free for an extended period of time (the average time between default and eviction being estimated at over 18 months) and pocket the savings for an excellent, risk-free and tax-free return on investment.  This moral hazard should not be surprising given the combined presence of a financial benefit from defaulting with the lack of enforcement of any penalty for defaulting.

(2)  Appraised values will plummet.  A house already in foreclosure will be unsaleable at any price, at least for the short term.  (Here is my theory, published last Saturday, October 2, 2010, speculating why.)  Appraisals work on comparable sales and often account for extenuating factors to adjust estimated values up or down.  A foreclosed, unsaleable home may have an effective current price of zero -- as it cannot be sold at any price if the buyer requires a mortgage and cannot get the requisite title insurance to satisfy a mortgage underwriter.  The appraisal may not necessarily use the implied zero price, but will likely have every reason to apply a steep discount to all other data that would have been used previously.  How much of a decline in appraised values do you expect?  10%?  20%?  50%?

(3)  A new capital crisis.  What happens when banks finally mark to market  the value of the mortgages they hold on all of these underwater -- and now, going to be much more underwater-- homes?  This will drive down the banks' balance sheets (reducing assets) and put pressure on them to raise real capital.  Think the banks were hoarding cash before?  Think it was tough getting a loan before?  You ain't seen nothing yet.

Eric Dixon is the president of Eric Dixon LLC, headquartered in New York City.  Mr. Dixon has been a New York lawyer since graduating in 1994 from Yale Law School.  Mr. Dixon handles litigation counseling and litigation stress management for those who are the subject of lawsuits, have been threatened or expect to be sued or investigated.  Mr. Dixon has extensive knowledge of corporate governance, the federal securities laws (including the many anti-fraud provisions and related issues) and election law, and significant experience in representing businesses and their owners and managers in litigation, government investigations, settlement negotiations, complex due diligence investigations and business formations.  Mr. Dixon has also represented over two dozen political campaign committees and candidates for public office, including presidential and gubernatorial campaigns, on ballot access issues.  Mr. Dixon may be reached for a confidential consultation and case assessment at 917-696-2442 or via e-mail at

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