Government Intervention in Foreclosure

This is Part Four of a series of articles on foreclosures.
This article does not constitute legal advice.
Foreclosure laws vary from state to state.
Homeowners in financial distress should always hire legal counsel. Call your local state bar association for a referral.  Reduced or free legal aid may be available in some states. Ask for a referral from your state Bar Association or through a LOCAL HUD-Approved Housing Counseling Agency.

In this article we will address current government intervention as well as discuss possible future intervention programs. For other preventative measures, check out the other parts of this series:

Part one: Foreclosure; Losing the American Dream
Part two: Options for Homeowners Facing Foreclosure
Part three: Loan Modifications
Part four: Government Intervention in Foreclosure
Part five: Foreclosure; Letting Go and Rebuilding

Current government intervention in the foreclosure process has taken many forms. Some states such as California, Florida, New York, New Jersey, Massachusetts, Philadelphia, and Illinois have discussed, proposed, or passed legislation in favor of a foreclosure moratorium.  In order to avoid state mandates, some companies placed a temporary halt on foreclosures over the holidays. These companies include Indymac, Countrywide, WAMU, and loans held in the Fannie/Freddie portfolios.  Recall that during the real estate bubble run-up, government backed loans fell out of favor. Many subprime loans are held by lender/servicers in pools of mortgage backed securities. The foreclosure moratorium didn’t reach those homeowners.

State moratoriums give homeowners more time to possibly refinance into a Hope for Homeowners loan or complete a short sale and the moratorium also gives banks more time to get caught up on all the backlog of foreclosure paperwork

Financial Economics Analyst Edward Vincent Murphy, in his Sept 12, 2008 report “Economic Analysis of a Mortgage Foreclosure Moratorium,

85 thoughts on “Government Intervention in Foreclosure

  1. I’m glad to see the bankruptcy option coming back to life. This is the first I’ve heard of the possible reawakening.

    Just so others understand, most likely any such relief would only be part of Chapter 13 reorganization, sometimes called “wage-earner” reorganization. The power to modify home loans already exists in Chapter 11 (full reorganizations) and probably shouldn’t exist in Chapter 7 (liquidation). The power to modify other loans already exists in Chapter 13. Home loans are an exception, and possibly an exception that lead to the mess we’re in because it made banks more likely to make risky loans. Remember 120% of value seconds? Those were the result of this exception.

    For the modification to be effective in 13 the debtor would likely need to complete a plan that lasts at least 36 months, unless perhaps the property is sold to a third party earlier. The longest a plan can last is 60 months. Thus, this is not quick simple relief for mortgage debtors. They’d have to live under a budget and court supervision for 36-60 months, during which time they’d also deal with their other debt and hopefully learn a few things about living in a financially responsible manner.

  2. At to the quotes Tanta quoted, the banks are full of it. For about the last three years they’ve had the greatest protection ever on auto loans. Does that mean that they are now making auto loans like madmen? No.

    If it doesn’t work one way (increased loans), why would it work the other way (fewer loans)?

    As a practical matter, the people buying mortgage backed securities should be happy with increased bankruptcy powers. The banks are so incompetent servicing loans in default, taking the power away from the loan servicers would improve their situation.

  3. Someone on Twitter just reported that someone jumped off the empire state building 10 to 15 minutes ago. Don’t see confirmation of that yet, but it could be one of those signs we look for regarding recession or depression.

  4. I do have some sympathy for people who were taken advantage of by fraud and are now suffering for it. People however were told lies they wanted to hear – so they mostly blindly believed them.

    I purchased a home in NY toward the end of the price run-up. This was the biggest purchase of my life, so I read every document. I hired a lawyer to go over everything with me. I made sure I could afford the home relatively comfortably. I moved out to Seattle a couple years later, and ended up about breaking even when all is said and done – and I consider myself lucky.

    No one held a gun to my head. My pre-approval was for considerably more than the place I purchased. No one pressured me to buy more than I felt comfortable with spending. Just because a bank will give you more money does not mean you should take it – and you certainly don’t have to take it.

    Many home buyers were greedy.
    Many (most?) mortgage brokers were greedy.
    Many Real Estate Salespeople were greedy.
    Banks were greedy (including shareholders).
    And of course there were those on Wall Street who were greedy.

    So, I can understand why 51% of the people are against government intervention. Why should those of us who handle our money responsibly pay for the greed, feelings of entitlement and excess of others?

    This is NOT a case where there was a natural disaster. This is mostly a case of a rampant consumerism and greed – so let the people who were greedy pay their debts. I’m fine with extending mortgages to make payments more reasonable, but I disagree with forgiving or reducing debts — except in cases where there was actual fraud or some sort of disaster or serious hardship (ie. medical emergency, etc.).

    “Buying too much crap or things one cannot afford” is not a disaster, it is a choice. Poor choices need to have consequences – that is life, and that is how people learn.

  5. I would like to add another fcator that should be known and discussed as we address solutions to the Foreclosure Crisis.

    It is a tragedy when an individual borrower defaults on the mortgage and loses his/her home. The tragedy is magnified when the borrower is a small business owner, employing from 1 to 10 employees. The loss of jobs related to mortgage defaults and the resulting business failures will further weaken our economy and prolong the recession.

    On December 14, 2008, CBS’s “60 Minutes” had a segment on the 2nd Wave of Foreclosures. They indicated that experts were expecting another wave of mortgage defaults on ALT-A and Option ARMs mortgages which will dwarf the Subprime Mortgage Crisis. CBS MISSED A VERY IMPORTANT FACT!

    Many fail to realize that there are millions of self-employed smaller businesses, who employ from 1-10 employees, that are holding the mortgages that are going to reset in 2009 through 2012. These borrowers are Prime and Near-Prime borrowers who hold ALT-A, Option ARMs, Interest-Only mortgages. There are $1 Trillion ALT-As, and $500-600 Billion Option ARMs.

    So, here we have a major problem… Not only will these small business owners lose their homes, but there will be the resulting JOB LOSSES on their business failure. Note, although President-Elect Obama is stressing the need to create 3 million new jobs, we must understand that “JOB RETENTION IS AS IMPORTANT AS JOB CREATION

  6. I’m with Gene. The greed that has consumed this country has everyone in a tough situation. I’m against bailouts and any type of forgivness programs. People who are not smart enough to figure out whether they can afford before they buy shouldn’t get help from taxpayers. Sure, there are cercustances where people loose their jobs and other things but that’s what saving for a rainy day is for. A goverment requirement of 5% down on ANY real estate purchase would solve a lot of problems. A policy like this would teach Americans how to save again and also ensure they had some what of a cushin for depreciation. All these bailouts and not holding people accountable sets a very poor presedent.

  7. Prof. Bornstein, I failed to mention that I am also one of those small business owners and part of the reason I keep my personal finances reasonable is because I feel have a responsibility not only to myself and my family, but to my employees and their families.

    Over the last 15 years I built my business up from nothing to the point where I have no debt and both personal and business reserves to get through this type of economic crisis.

    I understand that drastic measures need to be taken to ensure the economy does not totally collapse, but I personally want to make sure those steps are taken in a sustainable way that help prevent this type of crisis from happening again in the future.

    “Giving” people or organizations money without strings attached or consequences does not help the situation in the long term. There is going to be some pain for everyone – even those of us who acted responsibly – but again, there need to be consequences for poor choices.

    Our economy has been not structured in a way that is sustainable economically, socially or environmentally and the solutions that we come up with need to take a systemic approach to all three aspects to our society. Throwing money at the problem with no transparency and no strings attached will solve absolutely nothing.

    I complete agree about a need for the people who comprise the government – and the rest of this often great nation – to start to be proactive rather than reactive. This crisis provides us with the opportunity to restructure our country and the world in a way that will be happier, healthier and more sustainable. I hope we all can work together to make that happen.

  8. “people have been told for years to start the home buying process by going to a lender to ask, “How much home can I buy?

  9. “…there need to be consequences for poor choices.”

    Correct, but part of that consequence is to the banks who made poor choices, not just the people. Example: Any bank who gave a mortgage to a salaried person on a “stated income” basis, should participate in the consequence of that loan defaulting…no?

    People didn’t know what “stated” meant. They answered the lender’s questions. Lender said “this has to be a stated income loan”. They said “OK (I guess you know what you’re doing)”.

    So how do you justify bailing out the bank and letting all the blame for that scenario fall on the home buyer who trusted the bank to know what they were doing?

  10. Gene,

    Every day people make dinner and feed thousands of people who have no money to eat. Should they use your logic and say that those people “made their bed and so must now lie in it”? Would you stand and watch them starve to death and say “Oh well…you should have done better with your time and resources?”

    Everyone is NOT a BIG BOY at the table of life. Strong government protections were not in place to protect the weakest of its citizenry, and so government needs to pay for that oversight.

  11. Government foreclosure aid is all about trying to help the economy, period. It’s not to be nice to people who got themselves into trouble. There are people who endup in worse situations with no medical insurance, loss of job, divorce with loss of an earner etc, does the government bail them out? No. Stop believing that foreclosure avoidance has anything to do with the goodness of the government to help individuals, it hasn’t. They sure would like you to think that it has though. I don’t like foreclosure aid since I think the gov should be able to come up with a more fair rescue plan to help the economy instead of foreclosure aid which in many cases gives to the reckless and make the responsible foot the bill.

  12. Unfortunately, government intervention will only prolong the pain of the economic downturn. The simple fact is that FAR too many people borrowed more on their homes than they could afford, which led to another problem: real-estate prices grew out of all proportion to incomes. One way or another the only way out of this mess is for real-estate prices to fall MUCH more, down to historical income/price ratios.

    Unfortunately, nearly all of these bail-out proposals merely try and prop up prices (at their current usustainable levels).

    One way or another someone has to take a loss. Either the lenders (or investors of mortgage securities) need to take the hit, the borrowers, or both. The one thing both parties seem to agree on is getting the tax-payer to shoulder the loss. Socializing the losses will just make matters worse (i.e. delaying the necessary real-estate price reductions), and teach a TERRIBLE lesson for future borrowers and lenders.

  13. tj,

    But why do you discount the portion of that responsibility that was the lender’s and not the borrower’s? Some people know didly-squat about financing a home. They asked the lender to tell them how much house the could afford, and the lender gave the the wrong number. Why is that not important in your world?

    When you answer that question, picture the least common denominator…whatever that may be in your mind. Maybe a parent or grandparent for whom English is not their first language.

  14. CB #11 – that falls into my outcry in the Paradigm Shift post. When I started in real estate, even though we all represented sellers and not buyers, it was the duty of the agent to do these things with the buyer (for the benefit of the seller). In fact where I was, the buyer had to submit a financial statement (much like the ones these buyer/sellers need to submit in a short sale today) and that was submitted with the offer as part of the State Mandated offer process.

    More and more the answers to all our woes seem to lie in the past.

  15. Sniglet,

    I don’t disagree. It’s more a matter of do we throw them off the top of a 12 story building? Do we do that but with a net at the bottom? Do we slide them down gently on a slow moving rope?

    It’s now what…it’s how.

  16. That is a good point TJ. I have yet to see a bailout program that doesn’t seem oriented at helping the banks, using some small perceived benefit to citizens as justification. I can still hope though.

    Sniglet, it occurs to me that the reason the government is trying to prop up prices is that it limits the bank losses short term. Young renting families and potential home buyers aren’t at risk of defaulting on bank loans, therefore they don’t matter to the government right now.

  17. “Young renting families…” But is it correct thinking for “young renting families” to want houses like their parents had? More and more I see people who cry about the real estate bubble, wanting the price of a new 2,500 sf home to come down to their level. Is that a realistic thing to push this Country into?

    “Be careful what you wish for” comes to mind. Where should the price of what be? “Begin with the end in mind.”

  18. Assuming everybody’s parents started with a new 2500 sqft home, and that is what every young renting family expects.

  19. Ardell,

    Please read my comments again and try to refrain from straw man fallacies or false analogies. We’re not talking about people who can’t feed themselves because they are victims of war, natural disasters, mental illness, job loss, excessive medical bills, etc. And ….comparing “not forgiving part of someone’s debt” to “not feeding someone who can’t afford food”? Are you serious?

    Nowhere did I say not to help people who truly need it or were victims of fraud – I said just the opposite. And I offered a solution to people who simply borrowed too much: extend the loan. Other options exist too as you know: If the bank wants to accept a short sale, fine – then the bank is taking some responsibility as you suggest. If the family wants to walk and kill their credit rating, most people have that option too.

    I understand a lot of people were mislead, but there are so many ways that you can educate yourself on these issues. Even the poorest of our citizens can use taxpayer funded public libraries, which have books, magazines, computers, etc.

    There were also a lot of people who were not mislead – they mislead themselves. Many people still do.

    I do also agree that the banks (and real estate salespeople, and mortgage agents, etc.) should bear part of the responsibility. I think how the TARP funds have been dispensed is deplorable. I did not defend it, and certainly not the specifics of how it was done. As noted above, the banks will have to eat losses related to short sales and foreclosures. The people who seem to be getting away free here are the real estate and mortgage agents.

    To use similar types of arguments to the ones you’ve used: Maybe we should start calling for the government to take the assets from real estate agents, mortgage brokers, and bank executives and distribute them to the people who were given loans they could not afford?


    People are not entitled to live in homes they should never have been able to afford. If their parents still live in a 2,500ft home, you know what, why don’t they go and live there too? I’ve done it in the past for far longer than I’ve wanted to.

    Treat people like they are responsible adults, and maybe one of these days they will act like them.

  20. Uh… Unless I am missing something, cramdowns DO lower home values and DO fck banks that loaned recklessly. You libertarians should love cramdowns.

  21. I agree biliruben.
    Cramdowns are probably good for everyone but the banks, for all the reasons Tanta and Jillayne mentioned. If the government does something right that is good for most of the populace but not for banks it would build some belief in the new administration on my part.

    Libertarians. I would call myself a social Libertarian and a fiscal moderate democrat. The government should spend money building infrastructure and helping people get a leg up in life, but they shouldn’t be telling people how to live that life.

  22. I also agree with biliruben.

    I have no issue with cramdowns in the cases mentioned in the original article. I do take issue with taxpayer money being used to reduce mortgage obligations (aside from its use as part of the court system to enforce laws and regulations).

    My apologies to everyone if I went off on a bit of a tangent… And I should have noted in one of my posts that Jillayne put together a great article – thanks!

  23. Hey Gene, thanks for the compliment! I’ve been in the classroom all day and am now headed out to see my eldest daughter play in the band at a basketball game so please continue on without me! I’ve been reading your comments all day.

    Kary, I left a vmail for you….

  24. Sniglet wrote: “Unfortunately, government intervention will only prolong the pain of the economic downturn. ”

    Maybe I’m reading too much into this comment, but I don’t believe that’s true. That’s sort of 1920s economic thinking. Government can to a lot to improve things. Done wrong they can do a lot of damage. Whether you think they’re improving things or damaging things would be dependent on your financial position.

  25. Here is my idea for mortgage relief:

    – Take possession of home from the owner through foreclosure
    – With agreement to rent the home to the owner at a price that a third party says you can afford. You get 6 month lease, after that the lender can do what they want with the property.

    This makes sure debtors get a credit penalty and lose the ownership rights, while ensuring they are able to live to their current standard at reduced price for at least six months. After that, they can rent elsewhere like a normal non-homeowner. And someone who can actually afford the home can then purchase it from the bank and own it.

  26. Kary,

    Remember, Sniglet is calling for homes falling to twenty cents on the dollar, so his way produces his desired result…maybe. Yours does not. Gotta watch those “hidden” agendas.

  27. “try to refrain from straw man fallacies or false analogies.” I apologize for doing that, but I seem to do it all the time, as others have pointed it out. It apparently is my natural style to do so.

  28. Hi Ardell,

    a “cram-down” (when applied to a mortgage) is when a bankruptcy judge orders the principal balance of the mortgage loan to be cut down to a level at or below market value as determined by a new appraisal.

    Bankruptcy cram-downs as part of a chapter 13 reorganization would mean that the homeowner has a fair shot at receiving a decent monthly reduction in their mortgage payment. For more details, see Kary’s comment number 1.

  29. Actually, cram-down means forcing a plan on a dissenting group of creditors. In practice though it’s come to mean what Jillayne indicated. I’d call the what’s commonly referred to as cram-down as bifurcating the claim into secured and unsecured portions.

  30. Jillayne emailed me the letter regarding the excise tax issue. I’ve only spent about 10 minutes on this, but here are my initial impressions:

    The WAC cited in the letter (not an RCW as claimed in the letter) actually applies to gifts, not short sales.

    And it does seem to address assumption of debt, not short sales.

    Thus, for example, if you give someone a piece of property and it’s subject to a $100,000 lien, that would be a $100,000 transaction for purposes of excise tax. (I think that should be the case always, but the WAC speaks of assumption and when the property was refinanced, etc.)

    As to short sales, I could see the DOR possibly taking the position that the debt would be included where the lender waived the debt. Where the debtor still owed the money after the sale, it wouldn’t be taxed. The problem is, the WAC (458-61A-103) doesn’t seem to cover it, because it says:

    “(1) Introduction. The real estate excise tax applies to transfers of real property when the grantee relieves the grantor from an underlying debt on the property or makes payments on the grantor’s debt. The measure of the tax is the combined amount of the underlying debt on the property and any other consideration.”

    In a short sale it isn’t the grantee relieving the grantor of debt–it’s a third party–the bank.

    On the other hand, the applicable statute (RCW 82.45.020) provides:

    “(3) As used in this section, “total consideration paid or contracted to be paid” includes money or anything of value, paid or delivered or contracted to be paid or delivered in return for the sale, and shall include the amount of any lien, mortgage, contract indebtedness, or other incumbrance, either given to secure the purchase price, or any part thereof, or remaining unpaid on such property at the time of sale.”

    Note the last language–“or remaining unpaid on such property at the time of sale.” I’d argue that the debt is no longer “on such property at the time of sale” with a short sale due to the release, but I could see it being interpreted otherwise.

    Also, I did notice that there is a specific exclusion for deed in lieu transactions.

    Anyway, no clear answer after 10 minutes of research.

  31. I would like free healthcare for everyone, free college and state or government sponsored daycare and old age homes. Yes, I would be prepared to pay for it, I’ve done it before for 10 years and it’s worth it. But I’m not prepared for paying for others to own homes or for loans they took out to spend on cars, vacations and other conumer goods. If they makes me a heartless, selfish sob than so be it.

  32. I’ve been thinking about this excise tax thing further, from a theoretical point of view, rather than just looking at the language of statutes and regulations.

    I’m a bit bothered by the WAC’s use of the word assumption in the gift situation. Perhaps they don’t mean that in the technical sense. But the six month presumption rule (discussed next) is similar to what the rule is or at least used to be for bringing cars into state. If you buy a car out of state and then bring it here within six months, then you owed sales tax (less any sales tax you paid elsewhere). The gift presumption here is if the owner refinanced and presumably increased the loan amount, that amount would be considered a sale amount.

    That makes some sense. Let’s say I have a property free and clear, and I gift it to the daughter. The WAC provides an exception. But what if it’s free and clear and then I borrow 80% of value and then gift it to the daughter? That’s not really that different than just selling it to the daughter for 80% of value and having her get a loan for that amount.

    The short sale situation is completely different. In the gift situation the encumbrance stays with the property after the transaction. In the short sale it is removed.

    Thus, ignoring the language which I didn’t find conclusive, from a theoretical point of view the short sale shouldn’t be taxed at the higher amount.

  33. I couldn’t agree with Gene’s comment more:

    “This is NOT a case where there was a natural disaster. This is mostly a case of a rampant consumerism and greed – so let the people who were greedy pay their debts. I’m fine with extending mortgages to make payments more reasonable, but I disagree with forgiving or reducing debts — except in cases where there was actual fraud or some sort of disaster or serious hardship (ie. medical emergency, etc.).

    “Buying too much crap or things one cannot afford

  34. Kary, re. 37: I believe DOR has stated at a recent Escrow Assoc. meeting that excise tax is due on the loan amount when dealing with a short sale…the “forgiven” amount has excise tax owed on it.

    I think this is WACked.

  35. Kary, are you talking about the short sale issue (excise tax being charged on the forgiven portion of the mortgage)? This would be a great cause for WAR to get behind.

    Can you imagine if liens were to be filed against the properties know owned by those who purchased a short sale? The seller can’t pay it and no body seemed to know about this.

  36. Hi All,

    I’m here at the Sea King Co Assoc of Realtors office right now and I have their position statement. It’s a one page doc that reminds Realtors that we should always be referring homeowners in financial distress to an attorney and that at this time, WAR and SKCAR are working to resolve the issue as quickly as possible. If anyone wants me to fax them a copy, please email your fax number to me at jillayne at gmail.

  37. From Inman news today:

    “Shiller wants to see some radical changes to the mortgage market, such as the creation of mortgages with built-in mechanisms for workouts when the economy is in a recessionary period.

    Also, he proposes federal subsidies to support financial adviser services for the public at large. “It would be ideal that every family has a financial adviser committed to helping them with broad and long-term problems — something like a physician who stays with you and who has long-term loyalty to you.”

    The lack of finance education was a contributor to the latest economic disaster, Shiller said.

    “To me it seems like part of the problem that caused the mess we’ve gotten into was that people were not getting advice. Investor education is a good thing.”

    He likened this insufficient education to a scenario in which the “medical professional didn’t exist and all we had were drug companies with salespeople” who were not upfront about the best treatment.”

  38. From Housingwire:

    “Both Fannie Mae and Freddie Mac said Thurday morning that they had extended a prior freeze on foreclosure sales and evictions on single-family properties through Jan. 31, as both continue to work on implementation details surrounding the Streamlined Modification Program, or SMP.

    Both GSEs had halted foreclosures and evictions on Nov. 21, originally suggesting the freeze would expire on Jan. 9.

    For Fannie Mae, the extension will also provide additional time for the company to operationalize what it is calling its new National REO Rental Policy, which will allow renters in company-owned foreclosed properties to stay in their homes”

  39. “Shiller proposes federal subsidies to support financial adviser services for the public at large. “It would be ideal that every family has a financial adviser committed to helping them with broad and long-term problems — something like a physician who stays with you and who has long-term loyalty to you.

  40. Brad,
    To me, a fiduciary, particularly in real estate, is someone who is paid to sell you a product but has a legal requirement to not blatantly screw you over.

    A financial adviser who is paid just to give you good advice would be completely different.

  41. Cautious buyer – A fiduciary is a practitioner who is legally bound to act in his or her client’s best interests. That’s a whole lot different than just “not blatantly screwing” them. A fiduciary can’t just sell a product to a customer. In the perfect case, the fiduciary has no conflicts of interest with his or her client. In the real world that’s a tough standard. So in the real world, a fiduciary needs to minimize any conflicts of interest and then fully and fairly disclose conflicts that remain and manage his or her activity to best ensure that any remaining conflicts do not affect his or her objectivity in serving the client’s interests. It’s very difficult for a salesperson to really be a fiduciary, since if your selling yours or someone elses product, you are necessarily acting on behalf of the product provider and not your client – big conflict of interest! Fiduciaries cannot serve two masters.

    By the way, since 6/12/08, mortgage brokers in the state of Washington are legally bound (new law) to act as fiduiaries to their clients. Sadly, most don’t know about this new law, and few of those who do know about it know what that means.

  42. Rhonda, I certainly wouldn’t, but I also wouldn’t ask a mortgage professional for financial advice except for that pertaining to their mortgage products and my status in qualifying for them. I might consider paying a more neutral financial planner like Shiller suggested to help go over retirement planning, whether and how much to spend on a home, etc.

    Brad, so to use Shiller’s example, a doctor makes a good fiduciary because (for the most part) he/she is only paid to look after your health. A drug company representative makes a bad fiduciary because they represent the company which needs to sell some drugs. Real estate agents and mortgage professionals are more similar to the drug company rep because they are paid based on selling the product. The difference is that agents and mortgage professionals are subject to laws requiring them to be fiduciaries, but that creates the conflict of interest. Some of them aren’t even aware of the laws?

  43. Curious Buyer – I agree that a doctor is a fiduciary, but I would correct your comment that a drug company rep “makes a bad fiduciary” – they simply are not fiduciaries – good or bad doesn’t apply.

    The second correction I would offer regards your apparent perception of the “mortgage industry”. What most people think of as “the mortgage industry is actually two very different industries. There are mortgage bankers/lenders – they offer mortgage products or loans. They are not fiduciaries under Washington law, nor can they be since they represent their own interests in lending money – they are like the drug company, they make money selling loans.

    Then there are mortgage brokers. Mortgage brokers do not lend money. All mortgage brokers offer is a service, which is sometimes described as mortgage origination service. You, the borrower pay them for that service. As a part of that service, mortgage brokers connect the borrower with a lender (what the industry calls a wholesale lender). In the process brokers either explicitly or implicity make recommedations – “these loan terms from this lender are right for you”.

    Unfortunately, mortgage brokers have contended for years they represent neither the lender nor the borrower. But anyone who examines the roll of the broker objectively would have to conclude that they represent the borrower. The debate has gone on for years behind the scenes. However, until our legislature acted this past year there was little legal precedent to say that brokers represent only the borrower and hold brokers to fiduciary standards. That changed abruptly (and I think appropriately) on June 12.

    It is now a matter of law in Washington that mortgage brokers – not bankers – owe fiduciary responsibility to borrowers. As you might imagine, after decades of active resistance to this proposition, brokers and the broker industry are reluctant to acknowledge and embrace this legal standard. Too bad for borrowers! The sooner brokers accept this new legal responsibility and embrace it, the better off borrowers will be. When you work with a broker you have a legal right to expect that broker (or his loan officer) to be acting as your agent with utmost loyalty to you in assiting you to obtain a loan under terms and at a cost that serves your interests. He or she cannot simply be selling you a loan. At least, that is what the law says – we will see if the broker industry steps up to that standard without making more lawyers rich in the process.

  44. Kary, when did you stop being a monster! LOL YOU added a photo–how refreshing. 🙂 BTW I totally agree with you on comment 55.

    I’m so tired of hearing “the law of unintended consequences is still the law”–BLAH!

  45. Brad, I agree. Mortgage brokers should be promoting that they have a fiduciary duty beyond what a mortgage banker can offer.

    I was very disappointed when the State forced Correspondent Lenders to become a part of the CLA instead of MBPA. What a step backwards.

  46. Brad, I stand corrected with regard to mortgage brokers. I still wouldn’t go to any mortgage professional to get advice on how much I should put away towards retirement vs a home vs a safety net, or any other financial advice except that regarding the right mortgage products.

    I think Shiller was saying that people would go to mortgage providers or agents (or listening to the NAR et al) to figure out how much they should spend on a home or whether it was the right time for them to buy. A “financial adviser committed to helping them with broad and long-term problems” would give them more impartial advice, and may make them less likely to overextend themselves on a mortgage.

  47. Rhonda – I think brokers must go way way beyond “promoting” the fact that they are fiduciaries. The must actually be fiduciaries. They must walk the walk – this isn’t marketing, it’s a legal responsibility. But for those who walk the walk, there is value in advertising that fact.

    By the way, I fully agree with the action taken by the state regarding correspondent lenders. Lenders are lenders. They are in the business of selling loans. For that reason, RESPA does not require them to disclose YSP for example. YSP is to a lender, correspondent or otherwise, a form of markup. In working with a lender (correspondent or otherwise) the borrower is dealing with a salesperson and should not presume that that salesperson is acting in the borrower’s best interest, but should assume that the salesperson is motivated by factors that represent conflicts to the borrower’s interests. That is exactly the where the correspondent lender is. For the past few years wholesale lenders have enouraged brokers to become correspondent lenders for the simple reason that in doing so they can avoid disclosure of YSP and therefore be in a better position to keep the YSP – this is patently contrary to the borrower’s interests. That is the privilege of a lender. And that’s OK for a lender. And lenders are regulated differently for that reason.

    Brokers, or what DFI has recently been referring to as “pure brokers” do not lend money. They do have fiduciary responsibility and therefor must disclose anything that may represent a conflict of interest, such as YSP. But disclosure alone is inadequate for a fiduciary. Fiduciaries must actively seek to eliminate conflicts of interest. That is why I support the crediting of YSP to the borrower in every brokered loan. I don’t think there needs to be new regulation to require that, it is just what a fiduciary must do – and brokers are now legally obligate to act as fiduciaries.

  48. Cautious Buyer – I agree that it would be unwise to seek advice on a broad range of financial planning issues from someone who is only licensed as a mortgage broker. However there are many different kinds of mortgage loans and under each kind of loan there are choices to be made, such as interest rate, that affect the pricing of the loan. When working with a broker, one who is ACTING as a fiduciary, the broker should be helping the borrower choose among these alternatives based on what serves the borrower’s interest, not based on what generates more revenue for the broker.

    As an example, consider pre-payment penalties. Pre-payment penalties have received much deserved bad press over the past year. One big reason is that pre-payment penalties were sometimes attached to a loan without the borrower’s knowledge (hard to imagine since the borrower signed documents that plainly showed the penalty – but that’s a new subject). In some cases the borrower may even have been told that the pre-payment penalty was required, even though it was not. Why would brokers push pre-payment penalties? It’s because the lender pays more YSP if there is a pre-payment penalty on the loan. And in too many cases, the broker simply used this to increase his revenue. There was, and is, a conflict of interest with regard to YSP that motivates brokers (or their loan officers) to maneuver the borrower into terms that increase YSP and thereby increase the broker’s revenue. If a broker is acting as a fiduciary, then the choice of a pre-payment penalty will be presented in a very different light. The broker might say to the borrower, “you know, since you plan to be in this home with this mortgage for many years, you might consider adding a pre-payment penalty that applies for the first few years. In doing so, your closing costs will be reduced by the amount of increased YSP from the lender.

  49. Brad, I think ANY one originating a mortgage should have fiduciary duties or at least act as if they do. I did not mean this solely marketing for mtg. brokers… it is an advantage they have over other LO’s who cannot say they legally have these duties regardless if they’ve always acted as if they did.

  50. Rhonda – In acting as though they have fiduciary responsibility, whether or not a practitioner has a legal duty to do so, means striving for the highest order of honest, ethical, client centric behavior. Clearly it would be a much better world if all LO’s, or any other business people for that matter, aspired to do so.

    But I have met, as I am sure you have, plenty of people in the mortgage industry as well as other businesses who would have their customer believe that they are acting in the client’s interests whether they are or not. There are numerous sales training courses and books that teach salespeople exactly how to get their customers to believe this to be true. The common come-on is “learn how to position yourself as a trusted advisor”. How is the customer to be able to differentiate between a practitioner who talks a good story and one who really means it?

    The principle of caveat emptor says that customers are in it by themselves and that they need to be wary – they bear sole responsibility for the outcome of their decision. That is the principle that governs the vast majority of transactions in the business world. Knowing this, and even though the practitioner talks a good story and appears to have the best of intentions, the customer is best advised not to be too trusting. The customer alone is responsible for doing his or her own due diligence. It would be nice if this was not the case, but we are dealing with human nature.

    So it seems to me to be a pretty important differentiator when we say this practitioner or that practitioner has a duty under the law to act in the client’s best interest. When dealing with a fiduciary, the client is no longer in an arms length transaction and the principle of caveat emptor no longer applies. With a fiduciary, the client has an ally in the transaction – one who is duty bound to serve the client’s interests. The client is engaging the services of the fiduciary with the idea that the fiduciary will perform some or even all the required due diligence on behalf of his client. This situation is very rare in the business world.

    If there are problems with a mortgage transaction and if the borrower had worked with a non fiduciary (a banker or lender under Washington law) the borrower is on his own. So long as the lender provided the legally required disclosures and did not do something dishonest, conceal or misrepresent facts, the borrower has little recourse – he is responsible for his own decision. But if the borrower is working with a broker, under current Washington law, he is not alone in his decision. He may reasonable trust in and rely on the broker’s recommendations. The broker bears some responsibility for the decision that is made. And if there are problems, the fact that the broker provided the legally required disclosures will not absolve the broker of responsibility for the decision that was made.

    Everybody in business ought to act as though they have fiduciary responsibility to their customers. But it’s a pretty big deal for a borrower to know that he has an agent, an ally, who is shares responsibility with the borrower for decision being made and the outcome that results. Anyone can say, “trust me”. But only the fiduciary is legally liable for violating that trust.

  51. Jillayne:

    You mention in your article that distressed homewoners should use H4H.

    Do you have any stats as to the number of homeowners that have been helped by H4H?

    I looked, but could not find any..the web has it’s limitations…

    I am specifically wondering if any banks have started to use the principle reduction mechanism in that law.

    It doesn’t seem that they have, at least not in any significant numbers.

  52. Hi Roger,

    Aubrey Cohen over at the PI wrote a post on this recently and provided those H4H numbers.

    Banks aren’t terribly motivated to participate. Right now it’s just a voluntary agreement to participate but the banks aren’t going out of their way to communicate the H4H option to homeowners.

  53. Found it!

    OK, that didn’t work out too well. Only 312 applications, no mention of the # of approvals.

    Reminds me of that fund the WA legislature threw together last year…with enough funding to help all of 16 homeowners, and still no applications.

    Well, they don’t send you to Olympia or Washington DC to do nothing…guess it’s back to the drawing board.

  54. Brad wrote: “If a broker is acting as a fiduciary, then the choice of a pre-payment penalty will be presented in a very different light. The broker might say to the borrower, “you know, since you plan to be in this home with this mortgage for many years, you might consider adding a pre-payment penalty that applies for the first few years. In doing so, your closing costs will be reduced by the amount of increased YSP from the lender.

  55. “A doctor is not a fiduciary. I’m not sure why either of you would think that.”

    Wholeheartedly agree. With increased pressure from HMOs and big pharma, it is increasingly necessary to find an advocate when having to negotiate the healthcare system; particularly if you have something seriously wrong with you.

    I am just starting to see organizations (primarily staffed with nurses) popping up to fill that need.

  56. Kary – RCW 19.146.095 enacted under SB 6381. This bill became law on June 12, 2008.

    You are right that no one knows exactly what fiduciary responsibility means with regard to mortgage brokers. That’s because absent specifics in the law, it becomes a matter for the courts to interpret. So we could debate what it means all day long and never resolve the matter. What the law does say is that as a fiduciary “A mortgage broker must act in the borrower’s best interest and in the utmost good faith toward the borrower…” While it might take lawyers and the courts to define the nuance of this statement, it doesn’t take a rocket scientist or a lawyer to see that too much of what goes on in the mortgage broker industry today is not done in the “utmost good faith” to the borrower and “in the borrower’s best interest”. These issues have seen their day in the courts in other industries, the investment advisor industry for example, and there are some parallels to be drawn. So I am not pulling my thoughts on the subject completely from the thin air.

    If a broker or LO chooses to ignore this part of the law, they will get away with it. DFI isn’t likely to proactively enforce this. It will take complaints before the DFI or the courts step in to “punish” practitioners who fail to meet fiduciary standards. And those complaints are unlikely to materialize since the consumer doesn’t understand enough about the loan transaction let alone the meaning of fiduciary responsibility to know what to complain about. So despite the legislature’s good intentions (or stupidity if you see it that way), little will change as a result of this law unless brokers understand the importance and value of being fiduciaries to borrowers and aspire to meet the intent of the law. I am not holding my breath! The mortgage broker industry has a sales culture that looks at the law as a set of troublesome requirements that must be minimally complied with to stay out of trouble with regulatory enforcers. It will take strong, courageous leadership to change this focus – and there is no sign of anything like this on the horizon. Until and unless the debate (not that there’s even much of that) shifts from “the law doesn’t say I have to do that

  57. Kary and biliruben – I am not arguing that a doctor is a fiduciary. I know nothing of the legal standards applicable to the medical profession. It’s an analogy that I have heard used a number of times, and I am just going with the flow on that one. I am content to make comparisons to the Registered Investment Advisor – he is a fiduciary, and that is a sound legal fact. But, unfortunately, too few people understand what an RIA is and the extent to which the specifics of his fiduciary responsibilities have been established by case law. And, sadly, there are many RIA’s who neither understand nor adhere to that responsibility. Most people can use the doctor analogy to understand these issues – they generally appreciate that their doctor is trying to help them rather than sell them something. To that extent at least the doctor analogy seems useful.

  58. I’d agree. I’m just saying the legislature has created a lot of uncertainty, and that if they wanted certain things to occur or not to occur, they would have been better off saying that, rather than leaving it up to each mortgage broker to determine for themselves what is allowed and prohibited.

    It’s the difference between effective legislation and feel good legislation.

  59. I agree – trustees are fiduciaries. There are parallels to be seen there as well. In my view the RIA example is more useful. The investment securities world is divided along the lines of fiduciary and non-fiducirary both working within the same product environment. Stock brokers (broker-dealers) are non-fiduciaries who sell investments and investment products. RIA’s are fiduciaries who advise clients with regard to investment products and assist investors in obtaining investment products. Consequently, that part of the financial services industry provides is an interesting “case study” that I find useful in understanding the differences between banker-lenders who do not have fiduciary responsibility and who sell “mortgage products” and mortgage brokers who now have fiduciary responsibility and advise with regard to mortgages and assist borrowers in obtaining “mortgage products”.

    The debate over practice standards applicable to investment advisors has a lengthy history already. The debate over practice standards applicable to mortgage brokers has yet to begin.

  60. Brad,

    re: “If there are problems with a mortgage transaction and if the borrower had worked with a non fiduciary (a banker or lender under Washington law) the borrower is on his own.”

    If the borrower works with a lender, they’re not entirely on their own–lenders are still under DFI as CLAs and DFI will take action when needed.

    The impact of fiduciary duty with mortgage brokers won’t be really known until it’s tested by a law suit.

  61. Rhonda – Too true and too sad. It’s sad that most practitioners will wait for the courts to tell them what it means to act in the borrower’s best interests. We are not smart enough to figure that out for ourselves? Once the courts weigh in, we will then complain of the result because, obviously, that judge doesn’t know anything about the mortgage business. And even (or if) the courts ever do, they will challenge their decision until there is an enforceable black and white standard written into the regulatory code and a threat of penalty for failure to comply.

    Fiduciary standards do not lend themselves to black and white regulatory standards. They are aspirational on the high end and fuzzy at best at the low end. In a culture that looks to meet minimum disclosure standards along the way toward earning the maximum possible on a transaction, there seems little hope for improvement. At best we will just see more required disclosures added to the pile to be signed a closing. That won’t help the borrower, it will just help keep us out of trouble with regulators.

    The impact of fiduciary duty doesn’t need to wait – each of us in the industry has the power today to begin to assess what we do under a different light. Ask the question – do I have conflicts of interest that do or may influence my recommendations and actions in a manner that does not serve the borrower’s best interests? Can I eliminate those conflicts or reduce the extent to which they might influence me? How might I change my practices to better serve my borrower’s interests – whether he knows about it or not? We, each of us, need to review everything we do, even if we have been doing it since the day a respected mentor taught us to do it, looking for how we might change that practice to better serve our borrower’s interests. We will not all agree on what that means. But if we each make an honest effort to take our business in that direction, the borrower won’t have to wait for the courts to tell us how to behave.

    Yeah, I know – get real Brad!

  62. “Fiduciary standards do not lend themselves to black and white regulatory standards. ”

    There’s no need a fiduciary standard needs to be used. As I said, the legislature is just being lazy. They can define what you are or are not supposed to do.

    The worst example is in the distressed property law, where a buyer of property can become a fiduciary of the seller. Absurd.

  63. Getting back to the excise tax issue on short sales . . . Annie Fitzsimmons covered it in her Friday legal question. An excerpt:

    For the moment, it is true that the Department of Revenue has stated a position that it will collect excise tax on the purchase price paid by buyer and on the amount of any forgiven or released debt. While the Washington REALTORS and many escrow and title industry representatives believe this is an erroneous interpretation of state law, it is the law of the land, at least for now.
    . . .

    The Department has promised to reconsider its interpretation regarding this issue expeditiously. We are hopeful that a revised decision will be announced next week but there is absolutely no assurance of that.
    In the meantime, this issue has a significant impact on short sales. Escrow companies will have no choice but to collect excise tax on the amount of any forgiven or released debt. Often, the amount of this debt is unknown to the escrow agent, especially since the amount of forgiven or released debt increases on a daily basis as interest and penalties increase on any defaulted loan. . . .

    The Department has said that if it determines that its interpretation of the statute is in error, it will refund any excise tax wrongfully collected. That is encouraging but REALTOR members should not make any promises of refunds at the moment. “

  64. Hi All,

    Doctors have a different set of duties v. say, a lawyer. They are similar but different. We would say doctors have duties of informed consent. When a patient must undergo an invasive medical procedure, the patient must give his/her informed consent. This means the doctor must fully inform the patient of all the possible consequences, both positive and negative, of the procedure. The explanation happens verbally and also in writing.

    Next, the doctor must make sure that the patient fully understands all the possible consequences.

    Next, the doctor must make himself/herself available to answer questions about the procedure.

    Compare that to folks who were not well served by their mortgage broker (since we’re on the subject of brokers, we’ll stick with brokers.)

    Many say that the homeowner had a “personal responsibility” to make sure they understood the loan docs they were signing.

    I assert that many laypeople do not really understand complex financial documents and many relied, *trusted* their broker making the mistake that the broker had higher duties to the consumer. Clearly many brokers flat out lied to the consumer. Ex: “This is a fixed rate loan” when in fact it was only fixed for a short period of time.

    I assert that there is a power/knowledge imbalance between what a broker knows and what the average random consumer knows about mortgage lending. This is where the fiduciary duty places more of a burden on the broker to FULLY INFORM the homeowner of the POSSIBLE CONSEQUENCES of the loan.

    And then the broker, in my perfect world, would also have a duty to make sure the consumer understands everything.

    And then the broker, in my perfect world, would also have to make himself/herself available to the consumer to answer questions.

    Think about all the times that we heard about when the consumer received bait and switch documents and at closing, they ended up in an ARM loan or they ended up paying a HUGE YSP yet the broker was nowhere to be found when the consumer called from the closing room.

    Because of this, the professional assoc I founded, NAMF is actually nearing completion on an Informed Consent Process for brokers.

    This is NOT a form or a checklist. It’s a process.

  65. Pingback: Loan Modifications | Rain City Guide

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