Fast Foreclosures, Slow Foreclosures

At the onset of the current foreclosure crisis, banks bemoaned their inability to get homeowners in default to respond to their generous offers of loan modifications and other foreclosure alternatives. Homeowners, it seemed, were like ostriches with their heads in the sand. Outreach efforts were launched to bring the homeowners in from the cold. Foreclosure sales, banks told us, were the worst possible outcome, and everything should be done to avoid them.

Fast forward a few years, and we no longer hear about those unresponsive homeowners. In fact, the mortgage servicing industry, starting around 2009, was rapidly overwhelmed with homeowners seeking loan modifications and other workouts. Soon homeowners were the ones complaining about getting no responses from servicers. Diligent homeowner attorneys uncovered the robosigning scandal, courts and regulators demanded that servicers clean up their act, and foreclosure cases languished while servicers gave homeowners applying for loan modifications and short sales the runaround. Today the banking industry complains of spending too much time talking to homeowners, claiming that long foreclosure delays resulting from homeowners massively coming in from the cold are just wasting everyone’s time and money.

This policy debate mirrors a long-standing academic debate: do states using a slower judicial foreclosure process impose unnecessary costs compared with states using the more rapid nonjudicial foreclosure sale process?  Clearly taking the “judicial foreclosures are unnecessarily costly” side is a recent paper by Philadelphia Fed economists Larry Cordell and Lauren Ambie-Hanson.

The paper’s thesis is that the judicial foreclosure process, by extending foreclosure timelines, imposes significant costs and has few if any benefits. The evidence marshaled, however, falls considerably short of proving this thesis. In brief, the cause of long foreclosure times is misattributed to the judicial/nonjudicial foreclosure variable, while the benefits of foreclosure delays, due to judicial foreclosure or not, are given a cursory and misleading treatment.

On the cost side, there is no doubt that delaying an inevitable foreclosure sale will increase the mortgage investor’s loss, by adding more unpaid interest, legal fees and other carrying costs. The first analytical problem is laying the blame for these delays on the use of judicial, as opposed to nonjudicial, foreclosure. There are important state-related variables, apart from the choice of judicial foreclosure, that account for long timelines between foreclosure referral and REO liquidation in some states.

The study period includes the extremely anomalous robosigning period (roughly 2010 to 2014). The courts in a number of high-volume judicial foreclosure states (notably New York and New Jersey) responded to robosigning by demanding that lenders halt foreclosures until all the false affidavits were replaced with good ones. On the other hand, most nonjudicial foreclosure states, e.g. Arizona and California, took no steps to require correction of loan documentation errors (missing assignments, foreclosures of loans in pending modifications). So a state’s choice to require retrospective remediation of robosigning is associated with judicial foreclosure but is a different cause of delays in this period.

The second state-level variable is the presence or absence of foreclosure diversion and mediation programs. While a few nonjudicial foreclosure states adopted these programs, nearly all are in judicial foreclosure states. Foreclosure mediators often insist that mortgage servicers fully evaluate modifications, short sales, and other loss mitigation alternatives before allowing them to go forward. The 2014 Connecticut State Justice Initiative study of that state’s program found that mediation extended the foreclosure process by 254 days, but that when servicers complied with program rules and responded promptly, mediated cases took only 30 days more than non-mediated cases. The study also found that most of the delays were caused by the nonresponsiveness of just two large servicers.

In other words, the combination of programs to force servicers to come to the table and fully explore loss mitigation, and servicer capacity and competence issues, are dragging out foreclosures.  These factors happen to be associated with judicial foreclosure, a legal option that exists mostly in the Northeast and Midwest. The delays experienced from 2010 to 2014 have been extreme, due to the combined impact of robosigning remediation and very slow servicer loss mitigation response time. A final factor adding to the mix is the abandoned foreclosure problem, i.e. homes sitting in foreclosure or REO inventory and not being sold or moved by servicers, a phenomenon that may also disproportionately affect judicial foreclosure states. Drawing conclusions about the causes and effects of foreclosure delays from this time period is problematic.

More importantly, the Philadelphia Fed paper gives the benefits of slow foreclosures inadequate treatment. The authors’ approach is simply to count loan modifications (using a proxy since their dataset doesn’t report actual modifications) in judicial foreclosure states and nonjudicial foreclosure states. Of course modifications are not the real outcome of interest when we look at the benefits of foreclosure delays; they are a means to an end. The real variable of interest is the outcome of a defaulted loan. If the home is sold at foreclosure sale, that is a bad outcome. If the loan payments are cured, or the loan is prepaid voluntarily, those are good outcomes. If the loan is still delinquent and active, that is an ambiguous outcome.

The Philadelphia Fed paper does not report cure and prepayment rates (or completed foreclosure sale rates) for judicial and nonjudicial states. I don’t have access to the McDash dataset they use, but  my tallies from the CTS data for subprime and alt-A mortgages show that completed foreclosure sale rates are much higher in nonjudicial states like Nevada, California and Michigan, while cure rates are much higher in judicial foreclosure states like New York and Connecticut. There are also judicial states with poor outcomes and nonjudicial states with somewhat better outcomes, but in my view, the data show that slow foreclosures, particularly in states with good mediation programs, can result in more cures and fewer completed sales.

But you don’t have to rely on my inexpert data analysis. Three empirical studies (Collins & Urban, The Reinvestment Fund, Connecticut State Justice Initiative) using sound modeling techniques have found that mediation programs in Connecticut, Pennsylvania and Florida significantly increased the rate of loan modification and cures, and even reduced redefault rates after cures.

A single successful loan modification, or even short sale, avoids investor losses that average $100,000 or more. A single avoided foreclosure sale, in other words, produces savings that outweigh the costs of many delayed foreclosures. Moreover, the spillover benefits of a successful workout include the direct benefits to the family of preserving their housing tenure, and benefit of not depressing area housing markets with more unsold foreclosed homes. If foreclosure delays are resulting from mediation and interventions that increase cures, even slightly, the benefits are obvious and substantial. Any model that purports to compare costs and benefits needs to fully account for these benefits.

Nor is the broader macroeconomic impact of foreclosure speeds self-evident. For example, the recovery in housing starts, and current unemployment rates, are worse in fast foreclosure states like Nevada, California and Arizona, than in slow foreclosure states like New York, New Jersey and Connecticut.

It has been neoclassical economist dogma for many years that judicial foreclosure is inefficient, and should be done away with. The recent foreclosure crisis is rich with data from which we can evaluate different legal regimes and interventions, but we need to approach the data without preconceived notions. Legal structures, including judicial foreclosure rules and redemption periods, should be evaluated and improved. While the extreme foreclosure delays of recent years are far from optimal, some of the causes of delays, particularly the better mediation programs, are saving investors money, saving family homes, and saving neighborhoods.