Short Sales to Increase, Homeownership Not Really – IL Supreme Court

Tuesday, March 5th, 2013  by attorney Chris Hacker

Thank you!

First, a thank you to the Illinois Supreme Court. These new rules will help some future home owners getting into financial trouble by requiring the foreclosing lender to at least swear to the judge that they tried to figure out some kind of workout with the owner/borrower. So if you are about to miss your first payment this month, then by the time your lender takes legal action (ie suing you), they should have been trying to work something out and will have to file a sworn statement saying what and how they did that. Now, with that acknowledgement out of the way …

Why now?

After four years, why February 2013? If this was so important, where have you been? It took two years to put this together? How is that possible? Why was this particular rule so hard to get in place? Was this just a function of the administrative law process, requiring a publish and comment period? Or did it just take 18 months to figure out what made sense? Do any of you really think that this will result in more people keeping their homes?

My prediction: More Short Sales

By passing this rule now, lenders now have a slightly higher incentive to consider a short sale earlier in the process, but homeownership will not be increased – at best it will continue its existing trend, and it may even decline relative to that trend.

As it stands, it already takes 697 days to complete a foreclosure suit in Illinois, according to RealtyTrac. Now they have to add some extra paperwork, and perhaps even actually try to work something out to keep owners in their homes. But a short sale will also be considered a workout option most likely: “Your Honor, we suggested the defendant sell the house short.” Check that box. So, perhaps 697 becomes a full 730, two years. In all reality, it’s just a stay of execution, one that increases costs for lenders and for soon to be non-homeowners as well. Those headed to losing their homes will hang on for a bit longer than they would have otherwise, but they will add, albeit slightly given the circumstance, to the credit damage they are experiencing.

Zero-Sum Result

The extra costs to the lenders will be passed to future borrowers in the form of higher rates and fees as well as higher standards for qualifying for a new loan. If I know that you can default and I can’t get any money back for two years, why would I make that loan? And if I’m going to make that loan, wouldn’t I want to take extra steps to protect myself and to spread the cost of the default across everyone else, since I can’t predict if it’ll be you, or the next couple that I lend to that will default?

With the whole financial mess of the past half-decade came the ‘too big to fail’ meme. Along with it came the ‘too big to regulate’ meme. Both of those refer to massive conversations, too big to delve into. But that’s kind of the point. Murphy’s Law runs rampant in complex systems, leading to complex system policy having its own law – the Law of Unintended Consequences.

I don’t fault the Supreme Court for trying to help. But in a financial system that’s so tightly coupled, it’s almost impossible to avoid zero-sum results. Unfortunately, foreclosures and distressed loans are not a isolated closed system. By reapportioning costs, you simply move the costs around without producing any gain ultimately. And in a tightly coupled system like our financial markets, when you push cost in one direction, it ends up coming back around. The lenders don’t have any incentive to absorb the shifted costs; in fact, their profit directive requires them to recoup it elsewhere.

The Upshot: More Short Sales

That same profit motive will apply additional pressure to lenders to agree to and even promote short sales. Of course, while lenders like Wells Fargo make efforts to simplify the short sale review and approval process, it’ll never be simple. Homeowners will need direction, assistance, and old-fashioned support to get short sales done no matter what. And all of that requires attention and communication. Information must be shared, both pushed out and taken in. It must be logged.