Sunday, October 2, 2011

The Illusion of Walking Away From Mortgages: Banks and Vultures Will Go After Owners

Something that investors outside the U.S. were always wondering is how come mortgage owners who were in default could seemingly walk away in the U.S. if they coud not pay. For a few years now it had seemed that if a house owner could not they just left the house and that was the end of the story.

Now the lawsuits are starting to show up. It is not so much the banks that are going gater the owners, but vulture firms who buy the defaulted mortgages and don't really care about an public image. Afterall, it looks bad for banks to sue the delinquent owners, when they themselves were deliquent - but were bailed out.

The WSJ reports for the case of  Joseph Reilly lost his vacation home after stopping paying his mortgage. The bank repossessed the house and sold it and Mr. Reilly thought that was the end of it. Howeverm in June a phone call informed him of a court judgment against him for $192,576.71. In the foreclosure sale his former house fetched less than a quarter of what was owed. His bank sued him for the rest.

The result: deficiency judgments. According to the WSJ, forty-one states plus District of Columbia allow lenders to sue borrowers for mortgage debt.

"Lenders still sue for loan shortfalls in only a small minority of cases where they legally could. Public relations is a limiting factor, some debt-buyers believe. Banks are reluctant to discuss their strategies, but some lenders say they are more likely to seek a deficiency judgment if they perceive the borrower to be a "strategic defaulter" who chose to stop paying because the property lost so much value. "

"Some close observers of the housing scene are convinced this is just the beginning of a surge in deficiency judgments. Sharon Bock, clerk and comptroller of Palm Beach County, Fla., expects "a massive wave of these cases as banks start selling the judgments to debt collectors."

In a paradox of the battered housing industry, trying to squeeze more money out of distressed borrowers contrasts with other initiatives that aim instead to help struggling homeowners, including by reducing what they owe."

There is now  a growing secondary market for these bad mortgages (or is that terciary or 'n-ary by now?, remember the packaging or prime and sub-prime martgages?). Sophisticated investors are "ravenous for this debt and ramping up their purchases,". Deficiency judgments will eventually be also bundled into packages that resemble mortgage-backed securities.

The judgments sell for only about two cents on the dollar, versus seven cents for credit-card debt.
"Silverleaf Advisors LLC, a Miami private-equity firm, is one investor in battered mortgage debt. Instead of buying ready-made deficiency judgments, it buys banks' soured mortgages and goes to court itself to get judgments for debt that remains after foreclosure sales. "

This will get very ugly.

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