Foreclosure problem turned into lose/lose by lenders

The headline in the Wall Street Journal said “flippers make a comeback.”  The story told of people going to foreclosure auctions to buy and quickly resell houses at a profit.  They can do this because the lender who foreclosed has set the minimum price so low that it is well under the current value of the house.

Why would any lender do that, you might ask.   The short answer, in my opinion, is that they are incompetent.  If they were smart, they might have at least gotten the full current market value of the property, and, in many cases, they could also have kept the homeowners in the home!

There is an example in the WSJ article:  An expensive “dream” home in Scottsdale, outside Phoenix built by a couple name McCaughey.  Things turned sour in their business and they could no longer afford the mortgage on the house.   If their lender, Citigroup, had offered to “cram down” the principle enough, maybe they could have afforded the house.  But that is not what happened.

With cram down off the table, the McCaugheys asked Citigroup to give them some time so they could arrange a “short sale” in which the house would be sold at current market value — well below the mortgage amount.  Citi would take all the money and forget about the mortgage balance.  In this case, Citi probably would have netted about $650,000 on a mortgage closer to $1.3 million.

Citi turned the McCaughey’s down and foreclosed.  The day before the house was to go to auction the minimum bid was dropped from $1.3 million to $379,000!  The winning bid was $486,300.  That’s what Citi got (less expenses).

The auction buyer put $54,000 into the house and its marketing and sold it for around $680,000, netting, he reported, $150,000 cash.

Citi got a lot less than it could have and the homeowner lost their dream house.  Lose/lose.  It makes no sense.

Since the beginning of this crisis, I have pushed for a change in the bankruptcy laws that would allow bankruptcy court judges to “cram down” the principle of a mortgage loan to something not less than 90% of the current market value of the home.  Last January it looked as if the provision might pass when it was reported that Citigroup, having accepted billions of bailout dollars, might change their opposition (see our previous entry: Foreclosure Prevention moving to Bankruptcy Court ).   However, this never happened and now Citi is paying the price.

Let’s look at this case again had the law been changed.  The McCaugheys could have filed for bankruptcy and the judge would have figured out that the house with the $1.3 million mortgage was worth about $675,000 in the current market.  Had the McCaughey’s been able to afford a mortgage on that amount, they could have stayed in the home.  If they could not have afforded that (and the judge would make this determination), they could have arranged a short sale and moved on.

In either case the lender, Citigroup, would have received probably $200,000 more than they actually got!

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