A 2010 change in foreclosure laws is helping bring some pricing sanity back into the market.
Published May 31, 2011 by J.R. Lind
What’s the market value of something when the market isn’t functioning? If there are no buyers — no matter the price — figuring that value can be as impossible as dividing by zero.
When the housing market was hopping along, there was no shortage of buyers when a bank needed to sale a property at foreclosure and any difference between the sale at public outcry and the outstanding amount of the loan could be sought through the court system. If a home with a $500,000 mortgage sold for $400,000, a bank could easily come for the remaining $100,000.
That worked just fine when there are plenty of buyers. But what if, as has happened during this housing crisis, the buyers disappear and the banks are stuck buying back the foreclosed tracts?
The logical answer is that if there is only one bidder — in this case, the banks themselves — the rational choice would be to bid as low as possible and, again, seek the deficiency in the courts.
"When the economy hit the skids, foreclosure sales for a while were getting prices at 20 percent of the loan value — crazy low — and I don’t think that was a function of the real value being 20 percent. We just stopped having a functioning market," said Bob Mendes, a member at MGLaw. "If you are a bank, you have to make a decision: Would you rather bid in at 20 percent and be able to sue for $400,000 deficiency or bid in at 80 percent and sue for $100,000 deficiency?"
In an effort — spearheaded by a reeling development community — to keep bankers from systemically underbidding, the state legislature last year enacted a change in the foreclosure law that has given legal recourse to the borrower. Under a handful of appellate cases, borrowers already had a right to sue if the market value was too low, but as is often the case from court decisions, there were lots of gray areas.
And while the legislature sought to protect the borrowers through legislation, the law may have actually had the opposite effect, said Bone McAllester Norton attorney David Anthony.
"The clarity of the new statute provides an obstacle for attacks on the foreclosure bid price," he said. "In the past, the standard was unclear. Now, it’s a clear test and easier to overcome… The burden is clearly on the debtor to prove by a preponderance of the evidence that the property sold for an amount materially less than the fair market value… That’s not an easy standard to meet."
So in a way, the law managed to both benefit and hinder each side in the creditor/defaulted borrower battle.
"Before the law changed, our advice to lenders was, ‘Start the bidding on the low end of the range of market value,’" Mendes said. "Post the law changing, there’s a little more art, because there’s not as many bidders. But under the statute, if you have successfully predicted something in the range of market, you have defended yourself… If we’ve seen any impact, it’s that banks are back to bidding into a price where the market is."
In a recent sale, Mendes said, the bank put up a property for outcry that held a $2.1 million debt. Eventually, the lender bought back the property at $1.5 million, a hefty tag that still left a $600,000 deficiency for the borrower to overcome. A year ago, Mendes said, the bid could have come in "hundreds of thousands of dollars lower."
Anthony said most bankers already were careful to make fair bids, even in the tough economy, in large part because a too-large deficiency might trigger a bankruptcy for the borrower, in which case they would likely not see the money anyway.
What he sees as the major change is the tightening of the statutory window, the time lenders have to seek those deficiencies, from six years to two.
"Bankers are getting tired of these legal fees, so they’d do these foreclosures … and then sit on them. Some banks would even sell the deficiency on the note," Anthony said. "Now you only have two years to sweat it out. Six years is a long time to kick the tires. I think banks are desensitized to chasing down deficiencies, but now they don’t have forever."
Anthony said he wasn’t sure the law was a "gut reaction" to the rash of foreclosures that beset most parts of the country when the housing bubble burst. That affliction has inspired a slew of proposed changes to Tennessee’s foreclosure procedures, the most widely debated of which has been a plan to no longer require that foreclosure notices be printed in newspapers of record.
SouthComm, the parent company of Post, is one of a number of media companies that have hired lobbyists to oppose the change. But, Mendes said, in a normal market, these things become less of a hot-button issue.
"This statute only matters in a historically ridiculous time. As soon as we get back to a functioning economy, bidders will set the price, but in the absence of bidders, banks are," he said. "It’s just brought everybody back to what the norm has always been: Foreclosures should be priced at market value."
Click here for the entire story in the Nashville Post.