There is broad agreement that predatory subprime lending – along with faulty securitization practices – were important causes of the recent financial crisis. Although the U.S. economy has improved significantly since 2008, it has not fully returned to normal, in part because the housing sector continues to lag. And while the foreclosure crisis been largely resolved in many states, other states – such as Florida, New Jersey and New York — continue to experience a high volume of foreclosures. The communities of color that were targeted for the worst subprime lending practices still experience their lingering effects. In addition, foreclosures remain cause for concern not only to immediately affected areas, but more broadly as well: they generate a host of adverse ripple effects, including declines in home prices and new home construction.
The stock of homes with mortgages in default, in foreclosure, or purchased by the lender after a foreclosure sale (REO, or real-estate-owned) and not put back on the market is called the shadow inventory. Economists generally believe that housing prices will not fully recover until the shadow inventory has been disposed of. Although investors have been purchasing foreclosed properties in more prosperous areas, driving down inventory and contributing to an upswing in housing prices, this has not occurred in many distressed markets.
Yet, in states like New York and New Jersey with judicial foreclosure systems and a large backlog of older cases, foreclosures are taking an average of more than two years to complete (though recent cases are taking considerably less time). Lately, judicial foreclosure regimes have been blamed: critics argue that judicial review creates lengthy processes that in turn only delay the inevitable. Since few borrowers can cure their arrears, some economists argue that costs outweigh benefits. Second, some blame borrowers who strategically default, although studies have found borrowers are averse to walking away, with the result that the percentage of strategic defaulters tends to be relatively low.
Others identify financial institutions as primarily responsible for delays, explaining that servicer banks handling defaults have failed to acquire the capacity to modify mortgages and have committed widespread errors undermining both foreclosures and foreclosure avoidance programs. Above and beyond these phenomena, financial institutions also intentionally delay or abandon foreclosures at times—so-called bank walkaways—leaving homes in legal limbo. In low-value real estate markets, the costs of foreclosure can exceed the value of the properties, particularly when maintenance costs are factored in. The presence of junior mortgages can also impede resolutions, in part because of divergent interests of the mortgage holders. Moreover, few buyers bid on foreclosed properties in stagnant low-value markets; plaintiff banks therefore end up purchasing unwanted properties back at auction. One option is not to file or complete foreclosures, forestalling acquisition of additional REO homes, though that alternative imposes significant social costs.
The related term “zombie foreclosures” has been in widespread use lately. Some use the term to refer to unsatisfied mortgage debt that banks sell to debt collectors after foreclosure. Others define zombie foreclosures as those where borrowers leave their homes before the foreclosure process is complete, with the resulting vacant, unmaintained properties falling into disrepair. Still others employ the term to refer to the stalled or abandoned foreclosures caused by bank walkaways.
It is not the purpose of this post to determine whether banks or borrowers are walking away in larger numbers, or whether judicial foreclosure regimes are to blame, but rather to emphasize that despite the vast amount of attention paid to borrower defaults, financial institutions also engage in similar behavior. I recently published an article reporting on a small empirical study of bank walkaways conducted in Newark, New Jersey in 2011 and 2012. New Jersey has been – and remains — one of the states hardest-hit by foreclosures, and Newark — New Jersey’s largest city — has been one of the hardest-hit cities. My study involved a random sample of 100 foreclosures from a single neighborhood, all filed from 2007-09.
My research complemented similar, prior studies undertaken in Cleveland, Chicago, Florida and nationally by the General Accounting Office (GAO), all of which had determined that banks were stalling or abandoning foreclosures.[1] Several of these studies found that abandoned foreclosures correlated positively with property vacancies. My project, however, was the first to trace the disposition of each property in the sample through both public and private sources, allowing highly accurate conclusions to be drawn. I reached a similar conclusion to the previous studies: without legal excuse or ongoing workout efforts, banks frequently ceased prosecuting foreclosures. The stalled foreclosures in my study, however, did not strongly correlate with property vacancies.
My findings included that uncontested foreclosures were stalled or abandoned at all stages of the process, from failures to serve process on homeowners to failures to move for judgment. Forty-four cases never even reached judgment, a prerequisite to a public foreclosure sale. Fifteen post-judgment cases never reached sale; seven sales were stayed, vacated, or took one to two years to reach sale. Twelve cases settled at some point during the foreclosure process, and eight cases were dismissed voluntarily. Altogether, my very conservative finding was that 37.8% of the sample cases were in limbo, qualifying as stalled foreclosures or bank walkaways.[2]
As a partial update, several months ago, RealtyTrac, a real estate information company and online market for distressed properties, issued a Q1 2015 Zombie Foreclosure Report. The Report found that at the end of January 2015, homeowners had vacated 142,462 homes that were still in the foreclosure process. This figure represented 25 percent of all active foreclosures in the United States. Zombie foreclosures – using this definition – had increased 109 percent in New Jersey since the previous year, and the state had the second highest numerical total of any state with 17,983, representing 23 percent of all properties in foreclosure. By contrast, New York zombie foreclosures increased 54 percent from the previous year to 16,777, the third highest numerical total, representing 19 percent of all residential properties in foreclosure.[3] The RealtyTrac definition differs from the one I used in that its focus is on vacant properties in the foreclosure process, but the totals still indicate the continuing severity of the problem of incomplete foreclosures, regardless of the cause.
While my study was quite small in scale, the results can be extrapolated to the City of Newark, and, to some extent, similar lower-income urban neighborhoods in Northeastern states with judicial foreclosure regimes. The national banks that securitized mortgages during the housing boom followed standard practices of targeting communities of color for the worst subprime loans. They also followed national servicing and foreclosure practices adapted to each state’s laws. Further research can confirm the applicability of this hypothesis to other areas of the country. Nonetheless, there is no disagreement that indefinitely stalling foreclosures – without notice to those affected – is poor policy.
ENDNOTES
[1] See Michael Schramm et al., Stalling the Foreclosure Process: the Complexity Behind Bank Walkaways (2011), http://blog.case.edu/msass/2011/02/07/CUPCD_2011_02_07_Stalling%20the%20foreclosure%20process%20the%20complexity%20behind%20bank%20walkaway.pdf; Geoff Smith & Sarah Duda, Woodstock Institute, Left Behind: Troubled Foreclosed Properties and Servicer Accountability in Chicago (2011), http://www.woodstockinst.org/research/left-behind-troubled-foreclosed-properties-and-servicer-accountability-chicago; Linda Allen et al., Bank Delays in the Resolution of Delinquent Mortgages: The Problem of Limbo Loans, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2018948; U.S. Government Accountability Office, GAO 11-93, Mortgage Foreclosures: Additional Mortgage Servicer Actions Could Help Reduce the Frequency and Impact of Abandoned Foreclosures (2010), http://www.gao.gov/new.items/d1193.pdf.
[2] I informally checked the limbo cases again a year later; very few had made any progress in the interim.
[3] According to RealtyTrac, its methodology is to “gather . . . data for vacant foreclosures by matching foreclosures in the RealtyTrac database with data collected from the United States Postal Service for addresses that the agency has deemed vacant or where the owner has requested a change of address.” See One in Four U.S. Foreclosures are “Zombies” Vacated by Homeowner, Not Yet Repossessed By Foreclosing Lender, http://www.realtytrac.com/news/foreclosure-trends/zombie-foreclosures-q1-2015/.
The preceding post comes to us from Linda E. Fisher, Professor of Law & James B. Boskey Research Scholar at Seton Hall Law School. The post is based on her article, which is entitled “Shadowed by the Shadow Inventory: A Newark, New Jersey Case Study of Stalled Foreclosures and Their Consequences” and available here.