Editor: David Reiss
Brooklyn Law School

January 30, 2013

Strategies to Improve the Housing Market

By David Reiss

Boston Consulting prepared this Strategies to Improve the Housing Market report on behalf of The Pew Charitable Trusts.  The report focuses “on practical solutions that can readily be implemented by industry, agencies, and regulators working within existing mandates, or by nongovernmental organizations.”  (6)  I highlight three proposals in their report that I find particularly interesting.

1.  Promulgate Consistent Set of Loan Servicing Standards

Mortgage servicing is governed by a number of loan servicing standards—including standards under the DOJ settlement, OCC consent orders, FHFA Servicing Alignment Initiative, CFPB, as well as those of individual states—which vary in scope and individual provisions. A consistent set of loan servicing standards across the servicing life cycle can both ensure a basic standard of service for all homeowners and reduce the operational complexity of complying with multiple, varying standards for servicers.  (8)

This seems to be key to dealing with the misaligned incentives and anticommons problems that have become so apparent during the Subprime Bust.

2.  Streamline The Foreclosure Process in Key States

The long foreclosure process, particularly in judicial states, creates negative impacts on both lenders and communities, particularly when borrowers are “free riding.” While preserving the primacy of states and localities in foreclosure law, experts highlighted the desirability of working with them to develop a “model” foreclosure process based on best practices, to be adopted by states and localities on a voluntary basis. We recommend that an NGO takes the lead on developing such a model, based on best practices across jurisdictions, brings in key states and other relevant stakeholders to build consensus, and advocates for change with state policy makers and legislatures.  (9)

This issue is more complicated than the report (and most other commentators) concedes.  The claim that borrowers are “free riding” is not exactly true.  Lengthy foreclosure periods existed before the mortgages were entered into and were presumably priced into the cost of mortgages.  Indeed, the FHFA is trying to reprice mortgages in jurisdictions with the longest periods.  There are clearly policy choices at issue in the design of a foreclosure process.  For homeowners and lenders alike, the difference between the lengthy judicial process and the relatively rapid non-judicial process is only the most stark example of how process (in this case, length of process) affects substantive rights (that is, post-default occupancy periods).

3.  Rationalize First and Subordinate Lienholder Rights

In the context of continuing demand for home equity loans (second or subordinate liens), there is a need to clarify the rights of first and second lienholders to avoid a repeat of current frictions in the future and to restore investor confidence that first lienholders will have enforceable priority in the event of default. Any new framework put forward should achieve two key objectives:

>  protecting first-lien priority

>  standardizing treatment of seconds in loss mitigation efforts.

Conflicts between first and second lienholders have been a source of controversy and friction since the crisis began. It is unlikely that private investors will want to commit substantial new investment dollars to private securitizations until this issue is resolved. The industry, perhaps through the auspices of one of its trade association, should take the lead on further developing these options, in the first instance, with involvement from the FHFA, Treasury, and FDIC.  (11, emphasis deleted)

This is a very important issue.  I have been struck since the early days of the crisis how non-lawyers in particular (economists are particular offenders!) assume away the legal rights of seconds in their proposals to address the foreclosure epidemic.  Unsurprisingly, the seconds (knowing what happens to those who “ass-u-me”) have successfully asserted their legal rights to protect their financial interests.  Any solution to the problem of misaligned incentives between first and seconds must take the legal rights of these profit-maximizing entities into account.

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