Tucson Land Use Law Blog : Tucson Land Use Lawyer & Attorney : Fleishman Law Firm : Tax Liens, Foreclosures, Zoning

University of Arizona College of Law Professor Brent T. White has stirred quite a bit of controversy over his recent article in the Arizona Legal Studies entitled "Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis."  

His basic thesis is that despite the increasing number of homeowners walking away from their underwater mortgages, most homeowners continue to try and hold on to their homes even when it does not make economic sense to do so.  He suggests that homeowners choose to try and hold on to their homes to avoid the shame and guilt of foreclosure and because of the  "exaggerated anxiety" over the perceived consequences of a foreclosure created by "social control agents."  In short, he believes that underwater homeowners (in Arizona and California) are not knowingly making bad choices, they just can not "cognitively grasp" that they would be better off financially by simply walking away.  At the end of the day, argues White, many more underwater homeowners should be walking away from their mortgage obligations. 

As a justification for his thesis, White suggests that the "norms governing homeowner behavior stand in sharp contrast to norms governing lenders, who seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility. This norm asymmetry leads to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse."  

White argues that there are costs associated with walking away, but they are not outweighed by the financial benefits of a "strategic default."  While White's thesis is controversial, as it applies to Arizona borrowers, he is correct.  Arizona's anti-deficiency laws are incredibly broad and protect the large majority of borrowers who are now trying to keep pace with a subdivision home that is severely underwater.  Arizona's anti-deficiency statute (A.R.S. Section 33-814(G)) prevents lenders from pursuing a deficiency (the difference between the amount owed by the borrower and the price bid at a trustee's sale) against the borrower.  While a borrower's credit rating will undoubtedly take a severe beating from a foreclosure and the borrower may have to wait several years to obtain a federally guaranteed loan, for many underwater borrowers, the calculus leads to the undeniable conclusion that walking away makes the most financial sense. 

As for the moral aspect of walking away, White reasons that the overriding message to borrowers is that they have a moral responsibility to pay off their obligation.  White counters this message by pointing out that lenders are operating amorally according to market norms and could have acted to protect themselves by following prudent underwriting practices.  White's final point is that  "it is time to take morals out of the picture and search for an equitable solution to the negative equity problem."  While White is correct in many respects, had lenders and borrowers employed a stronger sense of morals when it came to underwriting and borrowing, we might not have experienced such a severe market bubble and attendant bust. 

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It seems that the small glimmer of hope that everyone is hoping for in the housing market is not likely to come anytime soon.  Mathew Padilla has posted an excellent blog article discussing that the discussion of another wave of foreclosure implies that the current wave has already receded.  Sam Khater, a senior economist with First American CoreLogic has stated: “To say there is a second wave implies the (current) wave has receded . . . I don’t see that the wave has receded.”

Call it what you will, the next foreclosure wave to hit will largely involve Pay Option ARMs.  Pay Option ARMs are adjustable rate mortgages on which the interest rate adjusts monthly and the payment adjusts annually, with borrowers offered options on how large a payment they will make. The options include interest-only, and a "minimum" payment that is usually less than the interest-only payment. The minimum payment option results in a growing loan balance, termed "negative amortization."  As Long and Foster's Ron Sitrin recently commented: because these loans "had negative amortization for so long, they can't refinance out of them and they cannot sell them because the loans are worth more than the properties themselves."

For the most part the expensive gated communities have avoided the impact of the current foreclosure wave, but its job loss consequences are coming home to roost in the upper income brackets.  This graph puts the Pay Option ARM problem in stark terms: 

As a recent post on Dr. Housing Bubble stated: "The Pay Option ARM is one of the most poorly construed mortgage product ever to face this planet. It was a pathetic attempt to allow a larger majority of Americans to have a piece of the great American credit ponzi scheme."  How's that for upbeat? 

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On May 20, 2009, President Obama signed into law Senate Bill 896, also known as the "Helping Families Save Their Homes Act of 2009."  Section 702 of that Act - the "Protecting Tenants at Foreclosure Act" is very broad in scope and affects the ability of the new owner of certain foreclosure property (including Section 8 properties) to take immediate possession of that property. 

The new Act has effectively mandated a tenant-friendly "non-disturbance clause", common in commercial leases, into the residential landlord-tenant world.  The Act now requires landlords to provide tenants residing in foreclosed residential properties to be provided 90 days advance notice to vacate the property.  However, except where the purchaser intends to occupy a given property as the primary residence, the terms of any bona fide lease remains in effect.

A lease or tenancy must meet the following requirements to be a bona fide lease: (1) The tenant cannot be the mortgagor or the child, spouse, or parent of the mortgagor; (2) The lease or tenancy must be the result of an arms-length transaction, and; (3) The rent required under the lease cannot be substantially less than fair market rent for the property or the rent is subsidized by a Federal, State or local subsidy. 

This is a watershed change in the law and now provides residential tenants protections that, though common in commercial leases, rarely have been seen in the residential context.  It also brings the law a small step closer to the long-past English feudal system of attornment, whereby a a new landlord had to obtain the consent of the tenant before becoming the new landlord.  Such a system was abolished in 1705, but it is clear that the pendulum is swinging towards tenant protections.  In light of the massive foreclosure wave that has swept this country, it is not surprising to see such a change.  A lot of unsuspecting tenants were left holding the bag after their landlord lost the property to foreclosure.  For what it is worth though, such a change is temporary.  The Act sunsets at the end of 2012. 
 

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When I hear the term "cram down" authority in the bankruptcy context, I keep picturing some poor mortgage lender warily stepping into a bankruptcy judge's chambers only to have a long metal pipe shoved down his throat until the lender is willing to give in on a loan modification.  Only a month ago it appeared that bankruptcy judges were on their way to wielding such foie gras power. 

While a "cram down" bill made it through the House of Representatives in March, Senate Bill 61 met fierce resistance and failed to muster the necessary votes to pass.  Brett Weiss, a bankruptcy attorney in Maryland, provides some excellent insight in his article as to why Senate Bill 61 bill could not pass despite President Obama's apparent 100-day mandate clout and a Democratically controlled Congress.  One is left to wonder why President Obama, who supported such "cram down" authority was unwilling to use some of his political capital to see this one through.

Senate Republican Leader Mitch McConnell of Kentucky seemed to echo the standard line being floated by the likes of J.P. Morgan Chase & Co., Bank of America Corp., and Wells Fargo & Co, namely that the vote was "a bipartisan rejection of an interest-rate hike, which is exactly the wrong solution for jobs, homeowners and the economy." 

However, as Brett Weiss notes in his article, mortgage insurance was the real issue.  Mortgage insurance gives lenders a very strong incentive not to write down principal, and gives them more money if they foreclose, even where the property is sold at a significant loss, than to work to make the loan performing.  In the end it seems that saving the likes of the stronger financial institutions was more practical than forcing the likely failure of MGIC, RMIC and Genworth, mortgage insurers already on the ropes.

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As the foreclosure wave has grown into a tsunami-like crisis, advocacy groups such as the Association of Community Organizations for Reform Now (ACORN) have taken to the streets in campaigns to lobby legislators about implementing new regulations that will help stem the foreclosure crisis and curtail predatory lending.  When I left the Pima County courthouse yesterday, there was an ACORN protest taking place at the same time that a Trustee's Sale was going on.  An interesting contrast between ACORN's bullhorn calls to action and the trustee calling out bids. 

Unquestionably, the foreclosure epidemic has resulted in some very impassioned debate as to whether and how the government should act.  Rick Santelli's recent rant highlights just how impassioned this debate has become.  While Santelli's rant has garnered much of the media hype, Stuart Varney's recent interview with ACORN's Bertha Lewis demonstrates just how zealous some people have become at the prospect of the government aiding struggling homeowners, who many view as irresponsible.  Varney was incredulous at ACORN's suggestion that people on the verge of foreclosure should stay in their homes.

As always, the foreclosure epidemic is far more nuanced than many of the talking heads are willing to discuss.  Predatory lending certainly was in force and many people were not informed of what they were getting into.  Likewise, many, many people bought far more home than they could ever afford.  Only time will tell whether massive government intervention or the force of the market will prevail. 

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It is clear that that lending industry has been slow to confront the ever-widening foreclosure crisis that began to pick up steam in 2007.  Indeed, Sandor E. Samuels, the former chief legal officer of Countrywide Financial was quoted as saying "We are going to keep making these loans [subprime teaser loans] until the last second they are legal."  Samuels' comments seem to reflect some of the general industry denial about the problem.  Despite such denial, many have been advocating changes that will help address the crisis. 

Last month, Arizona Attorney General Terry Goddard, along with twenty one other Attorneys General sent a letter to the U.S. House and Senate leadership urging an amendment to the bankruptcy code that would permit federal bankruptcy courts to order loan modifications, also known as "cramdown authority" in Chapter 13 bankruptcies.  The Attorneys General are advocating broader authority in the bankruptcy courts to stem the foreclosure tide. 

However, the lending industry has been actively lobbying against granting such cramdown authority, which they argue would reward irresponsible borrowers and result in higher borrowing costs.  The general intransigence is perhaps better explained by the accounting nuances involved in allowing wide-scale modifications.  Aubrey Cohen has a good blog post that describes how the securitization of loans has complicated the process. 

Nonetheless, Citi recently dropped its opposition to cramdown authority, but has stood alone among the lending industry.  One is left to wonder whether Citi was pressured into such a stance given that it has come to the Treasury trough twice in recent months for bailout funds.  Meanwhile, the Mortgage Bankers Association recently launched a "Stop the Bankruptcy Cram Down Resource Center" to try and ward off any further attempts to empower the bankruptcy courts to force modifications.  Time will tell whether the banks are able to ward off continued congressional pressure to force modifications.  No small task. 

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RealtyTrac just released its 2008 U.S. Foreclosure Market Report, which reported that there were a total of 3,157,806 foreclosure filings (default notices, auction sale notices, and bank repossessions) on 2,330,483 properties during 2008.  That was an 81 percent increase over 2007 and a 225 percent increase over 2006.  To get a feel for the breadth and scope of just how serious the foreclosure Juggernaut is, take a look at this map to see just how hard hit certain parts of the country were in 2008.

Arizona reported the third highest foreclosure rate of all states in 2008.  4.49 percent of all housing units in Arizona received at least one foreclosure filing during the year.  Indeed, 116,911 properties in Arizona received a foreclosure filing, which also put Arizona third for total foreclosure filings.  Amazingly, foreclosure activity in Arizona during 2008 increased 203 percent from 2007 and 665 percent from 2006.  That last percentage far surpasses the two top foreclosure activity states - California (412 percent increase since 2006) and Florida (412 percent increase since 2006).  

Not surprisingly, Pinal and Maricopa County were particularly hard hit.  The Phoenix metropolitan area reported 97,684 foreclosure filings in 2008, an increase of 220.77 percent from 2007.  That put the Phoenix metropolitan area fifth on the top 100 metropolitan areas, which is fairly consistent with its metropolitan population ranking.  The Tucson metropolitan area reported 9,043 foreclosure filings in 2008, an increase of 113.33 percent.  The Tucson metropolitan area ranked 37th on the top 100 metropolitan areas, which is again fairly close to the Tucson metropolitan population ranking. 

The burn-off of the Arizona housing bubble seems to be gaining momentum faster than the meteoric rise in real estate prices.  For example, take a look at the graph of median home prices in Phoenix between 1989 and 2009.  Look at the incredible bell curve between about 2005 and 2008.  The scary thing that some commentators are noting, is that while the bell curve has basically been erased and median prices are near 2004 levels, the current inventory of homes is far greater than 2004 levels, not to mention, it is much more difficult to qualify now.  Looks like we may not hit a bottom for a while yet.  The bubbly hangover may be more painful than the euphoria of the upswing, eh? 

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So a borrower defaults under a promissory note and the deed of trust.  Normally, the lender in that circumstance will exercise the power of sale clause in the deed of trust and begin the foreclosure process by noticing a trustee's sale.  However, the lender may also choose to call the note due and accelerate the entire amount and proceed with a judicial foreclosure.  Most lenders choose to go the trustee's sale route because it is faster and cheaper than a judicial foreclosure. 

What I recently discovered, is that many attorneys do not know about a borrower's statutory right of reinstatement and how that right applies in the context of both a trustee's sale and a judicial foreclosure.  Under Arizona Revised Statute Section 33-813(A), the trustor under a deed of trust (borrower) may reinstate (or cure the default under the promissory note) by paying the lender "the entire amount then due . . ., other than the portion of the principal as would not then be due had no default occurred . . ."  In other words, the borrower only needs to come up with the amount he or she is in default, not the entire amount due under the promissory note.  Nonetheless, many lenders' attorneys seem to believe that if the lender calls the promissory note due and exercises its right to accelerate the promissory note, the borrower must immediately pay the entire amount owed under the promissory note in order to cure the default, not just the defaulted amount. 

However, in Chapparral Development v. RMED Intern, 170 Ariz. 309, 823 P.2d 1317 (App. 1991), the Arizona Court of Appeals ruled that under A.R.S. Section 33-813(A), a trustor has an absolute right to reinstatement whether a lender chooses to foreclose by means of trustee's sale or a judicial foreclosure.  The difference being, if a lender chooses to pursue judicial foreclosure, a borrower's statutory right of reinstatement is cut off once the lender files the judicial foreclosure action and the borrower will have to pay the entire amount owed on the promissory note.  On the other hand, in the context of a trustee's sale, the borrower can reinstate up until 5:00 p.m. the day before the date of the trustee's sale.  But once the trustee's sale has been held, that right of reinstatement is extinguished.

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It has been interesting to watch the transition in the State Land Department, whose long-standing mission has been "to enhance value and optimize economic return" for the State Land Trust.  In practice, the Department has simply sold trust land to the highest bidder at public auction, which historically have been developers.  Despite ongoing attempts at State Land Trust reform through the initiative process, it seems that the State Land Department has slowly begun to internalize changes as to how state trust lands are to be managed.

The Town of Oro Valley's proposed annexation of nearly 9,000 acres of State Trust Land known as "Arroyo Grande" is a case in point.  On November 19, 2008,the Town of Oro Valley voted 6-1 to adopt a general plan amendment, which will allow the process to begin for the possible annexation of Arroyo Grande.

Arroyo Grande will likely be a proving ground for the future of how the State Land Department manages the state trust lands.  Various stakeholders already have been very active in the process.  Interestingly, while Oro Valley initiated the annexation discussion with the Department, Pima County has effectively dictated much of the development of the conceptual plan.  Pima County, who has been the prime orchestrator of the Sonoran Desert Conservation Plan, has been openly critical of Oro Valley's commitment to preserving open space.  Pima County Administrator Chuck Huckelberry recently sent a memo to Oro Valley Town Manager David Andrews expressing concern over the absence of wording in the general plan ensuring that open space in Arroyo Grande and a wildlife corridor are sold for below-market value for conservation purposes.  Despite Pima County's desire to purchase some 6,000 acres of the Arroyo Grande, it recently abandoned such efforts.

Oro Valley's Andrews recently responded to such criticism by stating that "The preservation of open space in perpetuity is a deal breaker for the town."  The next phase - the pre-annexation development agreement - will prove the most interesting as the stakeholders hammer out what actually will be included in the final annexation agreement.  Whether Oro Valley is truly committed to the same goals as Pima County remains to be seen.  Nothing better than watching jurisdictions joust. 

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