During the last 20 years, there have been two major real estate meltdowns involving easy money for questionable real estate deals.
The first was the RTC/FDIC debacle during the late 1980s and early 1990s, and the second, of course, is the current home mortgage meltdown. Without belaboring in detail the similarities and differences between the two, each episode contains the following elements: (1) vast amounts of capital (far exceeding the market demand) flowing into the real estate market, (2) the “conventional wisdom” being adopted that real estate values would only go up and (3) the federal government, turning a blind eye to regulatory oversight on the front end and then, once economic peril looms, swooping in and using taxpayer money to rescue lenders and borrowers who enthusiastically participated together in the events leading up to the problem.
While both events involved significant amounts of residential real estate, the earlier episode had a much larger commercial real estate component.
Both Congress and the Colorado State Legislature are considering, or have passed, measures that would address the subprime mortgage situation. Already passed is the “Mortgage Forgiveness Debt Relief Bill” signed by the president during December that forgives the tax liability a homeowner would have in the event the homeowner and their lender agree to debt reduction or forgiveness of part of the mortgage.
Previously, the reduction of the mortgage would have been characterized as debt forgiveness and would have resulted in a taxable event for the homeowner.
Although a more comprehensive federal package sponsored by Barney Frank (D-Mass.) may be temporarily off the table, both parties are working on a revised version that could be enacted later this year.
The aspects of the federal package being discussed are broad in scope and include changes to the Bankruptcy Code, restructuring the rules and regulations governing the Federal Housing Administration as well as Fannie Mae and Freddie Mac, as well as rescue funds and incentives for banks and builders. There also are provisions that would help individual homeowners. The Colorado version is more narrowly addressed to the residential foreclosure process.
Two aspects of each of the proposals should be considered.
At the federal level, one item being considered is to amend the Bankruptcy Code to allow Bankruptcy Court judges to effect a loan reduction and to expand the powers of the court to amend other mortgage terms for the benefit of the bankrupt homeowner.
This has met with resistance from the mortgage industry for obvious reasons and it is unclear how the relief would extend to homeowners not in bankruptcy.
Under the existing code, only in extraordinary situations does the judge have the authority to effect “a cram down” on the lender, whereby the overall amount of the loan is reduced. That would change and the judge would be given far greater authority to reduce the debt.
However, as noted, the vast majority of distressed homeowners are not in Bankruptcy Court to be able to avail themselves of this existing avenue or proposed change.
In Colorado, Reps. Sarah Gagliardi (D-Arvada) and Mark Ferrandino (D-Denver) are proposing an amendment to the foreclosure statute that would allow State District Court Judges the latitude to order a 90-day cessation of the foreclosure process to provide a time period for the lender and homeowner to negotiate an alternative to proceeding to foreclosure.
Currently, the District Court’s involvement in the foreclosure process is limited. (So limited, in fact that the procedure is often referred to as a “quasi-judicial” process). The foreclosure act, which went through significant amendments in the last two years, is fairly streamlined, and those recent changes have eliminated the homeowners’ post foreclosure redemption period while extending the cure period between the time of filing and the date of sale. The proposal being offered would presumably extend the time prior to the foreclosure sale.
The unfortunate reality is that for the housing crisis, it is not the foreclosure, tax or bankruptcy statutes that are broken. More likely, the root cause of our present difficulties lies in the strength of the lending lobby and their ability to advocate regulations that result in unrealistic underwriting standards, the financial irresponsibility of so many of the borrowers and a societal amnesia as to what happens when real estate is touted as only going up and never coming down.
Kent Karber is a partner in the Colorado Springs office of Holland & Hart LLP. He can be reached at KKarber@hollandhart.com.