Freddie Mac failed to go after foreclosed homeowners who owed more than $4.6 billion on their government-guaranteed loans, passing up the chance to seize second homes and cars from people who defaulted on their mortgage payments.
The company, rescued by the government along with Fannie Mae in 2008, neglected to refer 58,000 foreclosures to servicers for review to find borrowers with assets to repay deficiencies, according to a report yesterday from the Federal Housing Finance Agency Office of Inspector General in Washington. Among those not pursued were real estate investors and other borrowers who stopped repaying their loans while keeping up on other bills, according to the review. The mortgages were all secured by homes in states where post-foreclosure collections are allowed.
Targeting strategic defaulters, those who choose to stop paying on a house that’s losing value, serves as a deterrent to borrowers considering walking away to escape bad real estate investments, according to the report. To set an example, they should be pursued even though recoveries may be only a fraction of the amount owed, the audit said.
“These are pennies on the dollar, but it sets an example,” Frank Pallotta, managing partner at Loan Value Group, a mortgage consulting firm in Rumson, New Jersey that advises lenders on avoiding strategic defaults. “There’s a contagion effect that kicks in when people who are underwater see their neighbors walk away without having to give up cars or boats or vacation homes.”
Strategic defaults typically happen when the amount owed on them is 25 percent or more than their value, Pallotta said. While gains in home prices have reduced the number of underwater borrowers nationwide, such homes still dominate markets in hard-hit states such as Arizona and Nevada. Even after leading the nation in price gains this year, Phoenix home values remain about 40 percent below a mid-2006 peak and Las Vegas home still are worth half their value of the same year.
“Strategic defaults aren’t rampant like they were at the height of the foreclosure crisis, but there still is value in giving a stern warning,” said Diane Swonk, chief economist of Mesirow Financial Inc. in Chicago. “If we want the market to continue to recover, we can’t give any hope to the many people who are still severely underwater that they can drive away in their SUVs with no consequences.”
In about two-thirds of states, including Nevada and Florida, borrowers who default are still responsible for the portion of the mortgage debt that isn’t satisfied by the current value of their homes. Typically, servicers pursuing deficiencies for loan holders like Freddie Mac (FMCC) check credit reports of defaulters to see if they are keeping up on other bills and review real estate records to look for other assets.
In non-recourse states, mortgage debt is satisfied by the foreclosure and lenders are prohibited from pursuing them further. Those states, which include California and Arizona, tend to have the highest proportion of strategic defaults.
The failure to identify defaulted borrowers in recourse states who are able to pay was due to “inadequate policies” and “internal, informal practices that resulted from a mistake by Freddie Mac staff,” according to the report.
At the same time, the findings “should not be construed as encouragement to aggressively pursue borrowers who do not have the ability to pay their mortgage,” the review said.
Freddie Mac is reviewing the report to “determine what, if any, changes to its current collection practices it should make,” said Brad German, a spokesman for the McLean, Virginia-based mortgage financier. Most of the borrowers who owe a mortgage shortfall don’t have the resources to make additional payments, he said.
The Federal Housing Finance Agency, the regulator of Freddie Mac and Fannie Mae, declined to comment beyond a statement in the report from Jon Greelee, an FHFA deputy director, that the agency concurs with the findings and has already taken steps to tighten controls over deficiency collections.
Freddie Mac and Washington-based Fannie Mae buy mortgages from lenders and package them into securities on which they guarantee principal and interest payments. The companies have received $187.5 billion in taxpayer aid since 2008. They’ve sent Treasury dividends totaling $132 billion, including $76 billion this year alone. Those payments count as a return on the government’s investment, not as a repayment of the aid.
Borrowers in recourse states remain on the hook for up to 20 years after banks seize their homes. Loan holders can garnish wages, tap bank accounts and put liens on current and future assets held by debtors. In some states, the collection period can be renewed by going to court. The judgments that allow the collections usually tack on court fees, fines and interest.
About a third of U.S. states, including California and Arizona, prohibit collection efforts on primary residences after foreclosure. In some cases, homeowners waive that protection if they refinance. Most states allow collection on unpaid home equity loans.
People who walk away from homes they can afford have ignored government programs to help homeowners, said Loan Value’s Pallotta. The Home Affordable Refinance Program, or Harp, allows underwater homeowners with Fannie Mae or Freddie Mac mortgages to reset loans at current rates. About 2.7 million borrowers who are current on their loans have used the program, according to the Federal Housing Finance Agency.
“The more a person is underwater, the more likely that they’re going to make the decision that their investment may never be recouped,” said Pallotta. “That’s what makes them walk away. But that decision only makes sense if you don’t have to repay the balance of the mortgage.”
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