The gist of this court case is that the banks / owners of Mortgage Backed Securities are likely to take another round of losses, while businesses and homeowners who are delinquent on their mortgage payments will now be able to remain in their properties / houses 'rent free' until lengthy and expensive ( for the bank / MBS owner ) litigation is completed ...
(snip)"CMBS default rates ballooned by almost 500% in 2009, up from 1.21% in the beginning of 2009 to over 6% by the end of the year. According to Trepp, this is highest default rate since CMBS deals were first marketed. Jefferies & Co estimates that the CMBS default rate could reach 9-14% by the end of 2010.
So the last thing a special servicer would want to hear is that a Federal District Court in California has opened the door to a novel new foreclosure defense related to constitutional law. While this case deals specifically with single family residential loans, the RMBS market is much larger than the CMBS market, and at least one far-reaching rule change - the IRS's 2009 modification of the REMIC provisions - can be traced to controversy that first arose in the RMBS market.
The case involves non-judicial foreclosure proceedings on a single family home in Ramona, California. The borrower defaulted on the mortgage in November 2007. In February 2008, a notice of default was recorded and served. And in December 2008, a notice of sale was recorded and served, setting a date for the public auction of borrower's home. The borrower has alleged that their Fifth Ammendment rights to due process have been violated, and a federal court has refused to dismiss the case.
California is a non-judicial foreclosure state, which means that Newport Beach property flippers are generally not entitled to their day in court in the event of a mortgage default. However, this case challenges that notion (although it is limited in scope), and the court has agreed to postpone the sale of the lender's collateral until the case is resolved. Translation: the defaulting borrower gets to live in their 2 bedroom, 1.5 bath bungalow with carport until whenever forever the case is decided.
The most interesting aspect of the case is that the borrower alleges that the lender violated their Fifth Amendment procedural due process rights, even though the Fifth Amendment only applies to governmental actions, not those of private corporations. The court, in refusing to dismiss the complaint, agreed that in some circumstances the Fifth Amendment does apply to private entities, so long as there is sufficient nexus between the government and the private entity.
There are four different tests used to determine whether private action can be attributed to the state: (1) public function; (2) joint action; (3) governmental compulsion or coercion; and (4) governmental nexus. The court said that "satisfaction of any one test is sufficient to find state action, so long as no countervailing factor exists."
The court also said that the mere fact that a business is subject to extensive regulation is not sufficient to find joint action, but that because the case involves the Home Affordable Modification Program ("HAMP"), which is a federally funded program, there could be a nexus over and above just extensive regulation."(snip)
deeper analysis of the issues comes from
(snip)"The plaintiffs filed suit in federal court to stop the foreclosure, naming as defendants Timothy Geithner, the FHFA the lender and the servicer. The plaintiffs were allegedly denied a HAMP modification, and they claim the government and the bank violated the plaintiffs' right to "due process under the Fifth Amendment for failing to create rules implementing HAMP that comport with due process."(snip)
(snip)"The judge refused to dismiss the case because the plaintiffs might be able to prove the government has "insinuated itself into a position of interdependence" with the bank. The phrase seems apt, felicitous even, and perchance in the fulness of time may prove to be widely applicable. But this is only a very preliminary decision, and the court will need to take a look at the relationship between this particular bank and the government.
The court may also need to consider whether the plaintiffs have any constitutionally protectable interest. The Fifth Amendment says, among other things, that no person may be "deprived of life, liberty, or property, without due process of law." A deeply underwater homedebtor facing a lawful non-judicial foreclosure process may not have much property interest in the home. It is possible to have a property interest in certain types of government benefits if the benefits are an entitlement explicitly created by law. It is not clear whether HAMP creates such an entitlement, and that may end up being the main issue in the case."(snip)
Depending on how quickly this legal issue is resolved, the implication is that would-be lenders now have an even stronger reason to deny new loans to any individual or business whose future ability to service the loan is the least bit 'shaky'. The problem for the would-be lenders is that, in a worst case scenario, rather than being able to 'quickly' recover 40-60-80 cents on their loaned dollars via foreclosure and auction sale ( with 'quickly' now meaning a year), or rather than being able to generate some sort of alternative cash flow ( via property rental for example ) the lender may now be looking at ZERO cents on the dollar recovery and zero cash flow for years while every foreclosure attempt can be contested such that the case must now wind its way through the US court system before the delinquent homeowner can be displaced and the property 'recovered'. And this of course doesn't count the vastly higher litigation costs eating into whatever eventual recovery is actually possible once the foreclosure cases are concluded and the delinquent homeowners are displaced.
The other possibility of course is that the lender will be forced to offer the delinquent homeowner a significant reduction in outstanding loan principal / interest rate ( i.e. taking an immediate loss of loan principal and an ongoing loss of cash flow ) via a HAMP modification, with the possibility / probability that the homeowner will again default on on the HAMP modified mortgage the future ... which will again start another cycle of attempted foreclosure / litigation, providing the delinquent homeowner with yet more months / years worth of 'free rent' at the expense of the lender !
This is very likely to depress real estate prices even further, since would-be lenders are going to be extremely reluctant to expose themselves to making new loans that potentially mean having to provide 'free rent' for additional home buyers who could have the legal option of ceasing mortgage payments while continuing to occupy the property for 2-3-5 years beyond the point where their mortgage payments stop being made.
And while not dealt with specifically in this court case, a possible eventual decision that HAMP based mortgage principal foregiveness / below market mortgage interest rates constitute an ENTITLEMENT right for certain US residents could open a proverbial Pandora's Box full of new economic / tax issues ! The possible situation is actually summed up pretty well by a popular bumper sticker ...
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