A Deficiency of Judgment

Since the real estate bubble burst, millions of people have lost their homes to foreclosure. Putting people through foreclosure is bad enough, but for some banks that just isn't enough.

After Ben and Lori Jensen lost their home in Idaho to foreclosure, the bank sued them for $140,000. You would think that giving the house back to the bank should settle the score. After all, the bank agreed that the house was worth that much by issuing the loan. If the bank didn't think it was worth that much, it should have never issued the loan. Right? As long as the house is in the same condition that it was in when the buyer bought it, giving the bank the house should be the end of it. Right? The bank knew it was taking a risk when it gave the loan, that's why banks get interest. Right?

Except in most states foreclosure isn't the end of the story. Banks can sue you for the amount they lost if the sale price is less than the loan. This is called a deficiency judgment. After they get your house, the banks can garnishee your wages go after your other stuff.

In normal circumstances this would not be unreasonable. If someone buys a house, trashes it and skips out on the loan, the bank should have every right to go after them. But the real estate bubble was not normal. By issuing loans to just about everyone regardless of ability to pay, banks either intentionally or unintentionally inflated the price of housing. Many people, especially in Florida and Nevada, were the victims of house flippers who sold houses back and forth between straw buyers to jack up the value, and then sold it to a sucker at some crazy price.

There's no question that banks should have detected these kinds of scams, but they were too busy raking in closing fees and selling the loans to mortgage bundlers. If the banks had done their due diligence on the thousands of scams, the excess demand in the market would have been eliminated and prevented the bubble from getting so totally out of control. Reducing demand by even a few percent when an economic system is running at full capacity can stop inflation cold.

The question is, why are banks bothering to go after people who lost their homes? Most of these people don't have any money: that's why they lost their homes in the first place. Are the banks just getting their jollies by forcing these people into bankruptcy?

Nope, they're trying to turn their deficiency judgments into a profit center. According to Terri Pickens, a private practice attorney in Boise, lenders are selling deficiency claims. "I do know some private investors who are coming in and purchasing up bank loan packages and have been paying literally pennies on the dollar; just sitting on the paper, waiting for the right time to collect on it."

This can be as long as 20 years in some states. That means that if you've lost your house to foreclosure, some collection agency could jump out of the shadows in 10 or 15 years and grab your next house, or your car, or your child's college education fund.

But despite the scary sounding numbers, some people do manage to come to some kind of reasonable agreement:

In the Jensens' case, their attorney was able to work out a settlement. They turned over their savings and agreed to pay $75 each month for three years. They say it doesn't make sense to them that the bank went through so much effort to recover a total of about $8,000, prolonging the nightmare of their foreclosure.

That means the bank got less than 6% of the $140,000 they originally sued the Jensens for. But if you figure the amount of money they spent on lawyers and filing fees, it's hard to see how the bank could have broken even.

Which begs the question: how much would the bank would have gotten if they had renegotiated the loan with the Jensens instead of foreclosing?

At this point it seems pretty obvious that everyone -- banks, homeowners, the construction industry, and the economy in general -- would have been far better off if the banks had all just renegotiated all those loans down to reasonable values three years ago.

Yeah, everyone would have taken a minor hit, and some freeloaders would have gotten off. But now everyone is suffering. Oh, except for all those Wall Street bankers who are still pulling down those big bonuses for sticking it to the Jensens and the millions of other people just like them.

So why are people still arguing against Obama's mortgage refinance program, and why are banks stubbornly refusing to make deals with people who are stretched to the breaking point? Call it a deficiency of judgment.