By Kenneth Eade
In 2007, the U.S. began to experience its worse housing and foreclosure crisis since the Great Depression. The economic crisis we are currently experiencing had its origin in an economic “bubble”; a distortion in the economy that occurs whenever a major commodity or service (in this case housing) becomes such an object of speculation that its perceived value inflates far beyond its actual value. One of the characteristics of such an economic bubble is that it often sets off a chain reaction throughout the economy, causing unusual expansion while it is still growing, and massive losses when it implodes. According to the Federal Reserve Board, the continued weakness of the housing market presents a significant barrier to a vigorous economic recovery.
At the heart of this crisis is mortgage fraud. The economic bubble that caused the real estate crisis can be attributed to the mortgage banking industry which operated a fraudulent and systemic lending scheme that allowed unwarranted speculation in home prices. This speculation created “phantom equity” where the perceived value of the home, fueled by unsustainable mortgages, far outpaced the home’s true value. When the bubble burst, that phantom equity instantly evaporated leaving the homeowner with a home worth less than was owed. This negative equity, coupled with substantially increased mortgage payments forced homeowners into foreclosure.
Many people have lost their homes to foreclosure, had their credit rating ruined, and suffered unspeakable damage at the hands of predatory lenders. Four million U.S. homeowners have lost their homes to foreclosure since June 2009, when the 19-month U.S. recession ended, according to RealtyTrac Inc. Robo-signing, falsification of mortgage documents and affidavits, and the failure to follow Pooling Service Agreements in loan securitization and the issuance of mortgage backed securities has cast doubt on the ownership of many mortgages and whether the servicing lender even has the right to foreclose or collect on them. Lenders have duped homeowners into mortgage loan workouts or due date extensions or even advised them to go into default to be eligible to apply for a workout or the federal HAMP program, only to end up foreclosing on them after receiving hefty payments.
The mortgage fraud problem is much more far-reaching than just being a major cause of the 2008 crisis, which cost the economy an estimated $100 billion in losses by the end of 2009. The Government Accountability Office predicts that “elevated levels of default and foreclosure will persist” due in large part to declining home prices.
For most American households the family home is by far the largest tangible asset, a buffer against misfortune, and often a significant savings vehicle to fund retirement. By eroding household wealth, the decline in housing prices has contributed to greater weakness in consumption, which further weakens the economy and threatens a recovery. The extraordinary strict mortgage lending standards that prevail in the aftermath of the crisis have stagnated recovery, by limiting or preventing lending to creditworthy buyers. The excess of REO properties in real estate inventory depress the real estate market and, since most people’s homes are their only significant asset, it reduces their buying power not only for consumption, but for higher education, which causes a generational ripple effect. The loss of property tax revenues as a result of depressed property values and the reduction of the property taxpayer base is also a contributing factor to another rare phenomenon of this crisis-municipal bankruptcy.
The U.S. government bailed out the banks by printing extra dollars, bypassing the individual homeowners who are victims of the fraud, who were the intended beneficiaries of the bailout, and instead, subsidizing the banks. The result was that the perpetrators of the fraud were enriched, the foreclosures continued, wealth was redistributed away from the middle class to the top tiers of society, and the economy continued its meltdown, leaving the bill for the bailout to the victims of the crisis and their descendants for generations to come.
In California, as in many other states, it is against the law to collect a deficiency balance on a purchase money loan after the property subject to the loan has been foreclosed upon. Such statutes were enacted to balance the equities between the consumer and the banks; to protect the consumer and give him power against the banks, some of which have been deemed “too big to fail.” The state Legislature enacted the anti-deficiency statutes in light of the foreclosures and abusive deficiency judgments obtained by lenders during the Great Depression. [Spangler v. Memel], 7 Cal. 3d 603 (1972).
A common practice of major real estate lenders leading up to the 2008 Financial Crisis in closing a loan for a borrower who was otherwise unable to qualify for a first mortgage for the entire amount of the indebtedness was to combine a HELOC with a purchase money first mortgage to enable the borrower to purchase the property. Of course, it makes no sense to offer an equity loan on a property that has not yet been purchased by the borrower, but that didn’t seem to bother the major banks.
Several class actions have popped up around the country complaining of banks and collection agencies who attempt to collect deficiency balances on these “uncollectible” second loans and who report the loans as bad debts on the borrower’s consumer credit profiles. This attempt to take a second bite at the apple, after having overvalued the real estate for the first and second mortgages, and having already foreclosed on the property, throws people who have already been thrown out of their homes into “financial homelessness.”
Home equity loans are normally excluded from the application of the California deficiency statutes, but if the home equity loan is masquerading as a purchase money loan, it fits the definition of a purchase money loan as a mortgage or deed of trust given by the purchaser at the time of the conveyance of land to secure the unpaid balance for the price. Loans masquerading as something different have long been deemed to be purchase money loans by state Courts of Appeal. For example, in [Allstate Savings and Loan Association v. Murphy], 98 Cal. App. 3d 761 (1979) the court held that a construction loan was the equivalent of a purchase money loan and was entitled to the protection of section 580(b). In [Brown v. Jensen], 41 Cal 2d 193 (1953), the state Supreme Court held that a second mortgage taken out at the time of sale and used as a purchase money loan is a non-recourse loan to which 580(b) applies.
Attorneys should consider taking action under two federal acts which have been found to be effective in consumer cases. Action can be taken under the Fair Debt Collection Practices Act (FDCPA) to enjoin the collection of these illegal loans, which are contrary to public policy. The FDCPA prohibits debt collectors from using abusive, unfair or deceptive practices to collect debts. Lenders who hide behind bank takeovers and business combinations but still continue to service a fraudulent loan cannot avoid the reach of the act, if the claims are based solely on the collection and servicing practices of the lender as the owner and servicer of a loan that is presently uncollectible under California law not any past torts of the original lender.
The reporting of the uncollectible mortgage can be enjoined by a private action under the Fair Credit Reporting Act (FCRA), which was enacted by Congress to provide fairness to the consumer in the banking system, which is dependent upon fair and accurate credit reporting and unfair credit reporting methods undermine the confidence of the public in that system. The importance of fairness to the consumer is a vital element of the legislative history of the FCRA. In cases where creditors are able to exercise non judicial remedies to recover their collateral to loans and then seek deficiencies, it is essential that consumers have a remedy for creditors who break the law.
Kenneth Eade is an international business lawyer, based in Los Angeles.