Rising Foreclosure Rates in the Wake of Sub-Prime Mortgages: An Interview with Chuck Hansen

We’ve all heard about rising foreclosure rates in the wake of sub-prime mortgages reaching the end of their honeymoon period. Has the foreclosure hammer fallen and if so, in what areas of California or the US is it being felt the most?
Hansen: I think the hammer has fallen. I've not really studied the data, but my sense is that it's worse in some of the "urban overflow" counties where land was cheaper but where it has taken more of a hit. California seems to be leading the pack.

Is retail/commercial or residential being hit harder?
Hansen: Residential, quite certainly.

How long do you think this increased rate of foreclosures will last?
Hansen: That is more a function of the market and how long it stays down. Given the recent stock market issues, credit may get tighter. If so, the foreclosure epidemic could last for 3 to 5 years; if the market improves, foreclosure may be on the rise for only 1-2 years.

Will the economy be affected?
Hansen: Because of antideficiency laws — some of which were designed in the 1930s as a means of avoiding the aggravation of market downturns — and the changes in the bankruptcy laws, the impact will be somewhat muted in California. Essentially, the impact will slow and retard the anticipated recovery in home prices. I don't subscribe to the direst predictions. Land in California is too desirable and population pressures are too great for the sub prime bubble to make a huge impact on the entire California real estate economy for a sustained period. Unfortunately, the workers affected are some of the less skilled and more economically vulnerable. Paradoxically, holding down home prices might even help some aspects of the California economy.

Are there any self help methods available to those facing foreclosure?
Hansen: There aren’t many self help remedies available to sub-prime mortgagors. Injunctions are typically beyond their reach financially and difficult to get on their merits absent unusual circumstances. Some consumers file bankruptcies, but those proceedings don't stave off the foreclosure for anywhere nearly as long as used to be the case. Some borrowers opt for workouts, but the dollars are often too small to create “debtor’s leverage” or warrant major lender concessions.

Do you think the governement will get involved to prevent a further onslaught of foreclosures?
Hansen: Not really. There's not a lot government can do. And we already have in place foreclosure and antideficiency laws created for the much greater crisis of the Great Depression. At the end of the day, if someone borrowed money secured by a trust deed and the lender’s conduct was lawful and non-deceptive, the legal system ultimately has to permit that lender to foreclose. If you don’t, you are seriously impairing credit markets and the obligations of contracts. General depressions beget things like foreclosure moratoria, but that phenomenon would occur only in a very severe economic crisis, such as occurred during the Great Depression.

Any practical advice for property owners with sub prime mortgages realizing that soon they might be unable to meet their mortgage payments?
Hansen: Be open with your lender. Try to discuss the problem with them before default — although, unfortunately, they often won't talk if you're not yet in default — or shortly after default. Don't wait until the last minute to try to persuade them of the virtues of a workout if that's what you're going to have to do. Deal with the problem early and openly. If you indulge in denial and act flaky after defaulting, how can you expect the lender to expect different conduct if the loan is worked, modified, and a foreclosure averted this time? And know that you don't face massive personal liability if you're foreclosed.

What are the financial consequences of foreclosure? What liability does the property owner face?
Hansen: If the foreclosure is nonjudicial, no personal liability can follow in California. If the loan is “purchase money” (meaning, in this context, made for assisting in the acquisition of an owner-occupied one-to-four family dwelling) no liability is possible regardless of method of foreclosure. So, basically, there is no realistic risk of personal liability in this kind of lending. Credit is harmed and shelter and any equity are lost, but that’s the extent of it. Personal liability can follow the judicial foreclosure (through court proceedings) of a recourse, non-purchase money loan, but this pattern is rare in low and middle tier residential lending.

How long, typically, does a homeowner have between notice of default and the day the house goes up for foreclosure sale?
Hansen: Legally, the process can be completed in 3 months and 3 weeks after default, if the lender hits every mark perfectly. More realistically, however, four plus months. See CCP Section 2924, et seq., generally known as California’s “foreclosure law.”

What are the legal consequences for the tenants in a foreclosed commercial property?
Hansen: The lease is wiped out if it is subordinate to the foreclosing trust deed. If this occurs, the tenants are relieved of their obligations to the landlord, and covenant of quiet enjoyment is breached. The landlord/borrower looses the property but faces no personal liability unless — and this is rare — loan is both recourse and the lender forecloses judicially — which is also rare. These issues are often dealt with in the commercial context by way of agreements typically called “SNDA’s” — short for Subordination, Non-disturbance and Attornment Agreement — which often provide that the tenancies survive the foreclosure — even if technically otherwise subordinate to the foreclosing loan — and that, following foreclosure, the tenants and the new post-foreclosure owner will form a new landlord/tenant relationship on some stated basis.

American Home Mortgage Company, not a sub prime lender, recently filed for Chapter 11. Several major national lenders may follow suit. How will this affect would-be borrowers? If the trend of mortgagor bankruptcies continues and the real estate market continues to bottom out, what’s in store for the average homebuyer?
Hansen: Generally, lender bankruptcy filings should have little impact on the borrowers on the lenders’ loans. The mortgage paper will be purchased out of bankruptcy or administered from within bankruptcy. The key things that borrowers need to watch are that they correct their records if they find that their loan has been transferred, so that they don't pay the wrong lender. Having said this, the demise through bankruptcy of too many lenders certainly could have some impact on competition within the mortgage market and how long one would have to wait to fund a new loan, and it could cause a diversion of capital to fund investments other than California residential mortgage lending.

With the exception of a few Bay Area counties, home price increase percentages are falling, and houses are on the market for longer periods. Price reductions seem to becoming increasingly common. This would seem to be an ideal time for investment buyers to snap up distressed properties. Any comment?
Hansen: What an amazing market the California real estate market is that we can get excited about — to use your phrase — “falling home price increases” rather the absolute and substantial price declines. The very phrase reflects our assumption that sooner or later land in California will appreciate.

But the fact that a market is down is not necessarily a signal to invest. One might have said that about buying stocks in 1931. It all depends on how long the down cycle lasts and how deep the decline goes. The economics depends on at least several economic layers. The current sub prime speed bump will, if one looks only at the sub-prime phenomenon, be reasonably temporary as the market adjusts — the ability to correct irrational economic conduct and to adjust accordingly is the central genius of a free market. But who knows what other changes will occur? For example, what will happen to credit in the longer run? When the rest of the world stops keeping us liquid and sending us easy money despite our failure to save, you could see a bursting of the bubble on an epochal scale.

Does it make sense for sub prime lenders to renegotiate the terms of mortgages with borrowers who are facing foreclosure, when the lenders are also in financial distress? Why isn't renegotiation a better strategy than foreclosure?
Hansen: Any foreclosing lender might find negotiation preferable to immediate foreclosure. For one thing, after a trustee's sale the borrower is off the hook — if the loan was ever recourse. And, in a significantly impaired market, the lender's going to lose too, especially after holding and resale costs. But regulatory restrictions and economic realities don't really allow lenders to sustain too many concessions on too many loans over too long a time. In some ways, it's harder to work out loans in a down market than in a generally up market where the problem is more unique to the borrower or the particular property.

Who is making money in the real estate market right now?
Hansen: The contrarians and the bottom fishers. Frankly, you didn’t have to be a real estate genius to see the current crisis looming. The real surprise for me was how long the bubble expanded before the “pop.”

Judging from how busy we are at Wendel — we specialize in real property litigation and transactions — there's still a lot of economic activity, and people still need leases and facilities. There are still smart investors who are able to buy so low that even impaired values and incomes can leave room for them to a good profit. Litigators and well positioned transactional types — with a mixed set of skills — do well in steep markets, going up or down. What kills litigation is a flat market.

You didn’t really ask me this, but I would like to add a word of advice for those dealing with real estate investments and mortgages. It’s the oldest bit of advice in the world but only rarely heeded: If it’s too good to be true, it’s too good to be true. There are no “magic” deals in real estate. Sure, even incautious and impulsive investors and borrowers can sometimes do well in a real estate deal. But in the long run, the people who do well are those who do their homework — due diligence — and understand that the market will always be cyclical.