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It is estimated that as many as 9 million homeowners may lose their homes to foreclosure over the next four years, with nearly one in eight mortgages currently delinquent or in the process of foreclosure. And the foreclosure crisis is not limited to borrowers who were offered subprime loans, either. The most recent data available from the Mortgage Bankers Association shows that prime loans account for most new foreclosures.
State courts in the United States already are facing a deluge of home foreclosures. The number of foreclosure filings have doubled in those states hardest hit by the housing crisis, with some counties in Florida and California registering 10-fold increases over levels at the beginning of the crisis two years ago. National headlines capture the crisis, highlighting case files shuttled around overworked courtrooms on hand trucks and embattled homeowners receiving sometimes as short as 15-second hearings before losing their homes.
Behind the headlines, however, lurks even worse news—most judges discover that the vast majority of foreclosure proceedings in their courts are the first time homeowners and their mortgage lenders and mortgage servicing companies have discussed these financial crises writ small across our country. The judges’ experiences bear out estimates that more than 80 percent of homeowners at risk of losing their homes had not engaged in any efforts to mitigate foreclosures with their lenders or servicers as of the end of last year.
In addition, jurisdictions in nine U.S. states now employ so-called “alternative dispute resolution” methods, and in particular mediation, to help at-risk homeowners deal with looming foreclosures by mortgage lenders or servicers. These states now realize that mediation helps reduce the impact of the housing crisis on neighborhoods, unclog courts, and achieve faster, cheaper, and better resolutions for homeowners, mortgage lenders and servicers, and the community at large. These mediation programs are still young, but the best ones are showing impressive results, resolving in nearly three-quarters of all participating foreclosure cases without the need for formal foreclosure proceedings.
The federal response to this burgeoning foreclosure crisis has also ramped up significantly since the Obama administration took office. The administration created the Making Home Affordable Program, or MHP, in late February 2009 to help at-risk homeowners keep their homes by refinancing or modifying their loans through two related programs: the Home Affordable Refinance Program, or HARP, which offers refinancing at attractive rates to homeowners with loans owned or guaranteed by Fannie Mae or Freddie Mac, including those who may owe slightly more on their house than it is currently worth; and the Home Affordable Modification Program, or HAMP, which seeks to help at-risk homeowners by providing incentives to their mortgage servicers to modify loans by reducing the interest rate, extending the length of the mortgage, or forbearing interest on the loan to reduce a homeowner’s payments to a sustainable 31 percent of her gross income.
Each of these programs has already reached over 50,000 homeowners in the first few months, but it is far from certain that all eligible homeowners are receiving MHPcompliant modification or refinancing offers. MHP’s compliance audit will not begin for another quarter and its efficacy is unknown, a concern already being voiced by members of Congress. Adopting mandatory mediation in the foreclosure process provides homeowners who do not receive assistance under MHP, irrespective of the reason, an opportunity for sustainable modifications and refinancings. Among these are not only those deemed ineligible under MHP, but also the nearly 25 percent of homeowners whose servicers are not participating in the program.
In this paper we will argue that the federal government has an important role to play in expanding the implementation of mandatory mediation programs at the state and local level, as described below. Given the magnitude of the crisis and the degree to which the federal government is already invested in mortgages, we believe the federal government should take a more direct role in providing opportunities for mediation, as follows:
- Congress should fund state and local mandatory mediation programs just as it provides neighborhood stabilization funds to alleviate the housing crisis.
- In the interim the Department of Housing and Urban Development should issue guidance that explicitly permits community development block grants to be used to fund mandatory mediation programs.
- The government should require mediation for all federally insured home mortgages. This would be an extension of HUD’s existing requirement that all servicers of Federal Housing Administration loans engage in loss-mitigation efforts prior to foreclosure and would minimize losses to the already stressed FHA insurance fund.
- By extension the Federal Housing Finance Agency, acting as the conservator of Fannie Mae and Freddie Mac, should require all servicers acting on behalf of those entities to participate in mediation prior to foreclosure.
- Likewise, the federal government should require all servicers participating in HAMP to participate in mandatory mediation prior to foreclosure in cases where a modification is not possible under program rules as a way of ensuring a level playing field and speedy resolution of offers for short sales and deeds in lieu of foreclosure.
For state and local governments, we present a set of recommendations for best practices gleaned from our analysis of existing programs in Philadelphia, Pennsylvania; Connecticut; Florida; and California. Philadelphia and Connecticut are examples of successful, established programs. Florida and California are examples of as yet ineffective responses. In addition, we analyze the forthcoming program in Nevada.
In Philadelphia, the Supreme Court of Pennsylvania established a pilot program that uses a two-step mediation system. The court runs an open session once a week during which servicers’ counsel, homeowners, housing counselors, and pro bono attorneys engage in informal negotiations. Those cases that reach impasse are referred to formal mediation. The program receives no funding and relies on volunteers and housing counselors.
Connecticut runs a successful statewide program with 30 full-time staff including a dedicated mediator and clerk in each of the state’s 12 counties. The program is funded by the state, but its geographic scope makes the inclusion of local housing counselors at the mediations impractical.
Unlike Pennsylvania and Connecticut, California, is a nonjudicial foreclosure state, which means that servicers need not involve the court to foreclose on a property. It has foregone true mediation and requires only that the parties conduct an informal telephone conference prior to foreclosure. Notably, it does not require the servicer to include its loss mitigation staff on that call.
In contrast to California, Nevada—also a non-judicial foreclosure state hit hard by the crisis—will deploy a full-blown mediation program on July 1, 2009. The program shares many characteristics with those in Philadelphia and Connecticut, including enhanced notice, referral to a housing counselor, and the requirement that servicer make available a representative with the authority to settle. If homeowners request mediation, any further action by the servicer is stayed until mediation concludes; the parties split the cost of mediation, capped at $400.
And in Florida so far it has been each judicial circuit for itself, with responses running the gamut: mandatory mediation, voluntary mediation, informal negotiations, and even a paper-based modification request resembling HAMP. The state’s Supreme Court has a task force working to coordinate efforts with a report expected in August.
Our analysis of these programs leads us to propose a list of best practices for mandatory mediation—best practices that maximize benefits for all parties facing the prospect of foreclosing on a home. (See the “best practices” sidebar on page 3 for a list of these recommendations.) These best practices in mandatory mediation will help homeowners keep their homes or arrange for a “graceful exit.” They will help servicers shortcut the foreclosure process, saving them and their investors time and expense and resulting in an economically superior outcome. They will help courts save resources. And they will help communities reduce the tax and social costs of foreclosure.
We detail how the best practices work in existing state programs and how they could work across the nation in the appendix beginning on page. We believe the dissemination of data and the practical experience gained from these programs is important for other state governments grappling with their own foreclosure crises and for the federal government, which can and should plan a more expansive role in deploying foreclosure mediation programs. As we will demonstrate, our analysis shows that mandatory mediation will help mitigate today’s national housing crisis by reducing unnecessary foreclosures, minimizing losses to investors, and easing the burden on local governments and taxpayers, thereby helping our economy recover more quickly from the recession bequeathed to us by the Bush administration.
In the pages that follow, we will first outline how mandatory mediation would fit into ongoing federal efforts to stem the national foreclosure crisis. We will then explore state foreclosure mediation programs in Pennsylvania, Connecticut, Florida, California, and Nevada going into extensive detail so that other state policymakers understand how these programs could work in their states and so that federal policymakers grasp where federal policy and state mandatory mediation programs could and should overlap.
We will then address possible barriers to mandatory mediation, including a detailed look at the complex array of contracts that govern mortgage-backed securities, which of course are where most residential mortgages reside these days. This analysis will enable us to demonstrate that there are no barriers to the institution of mediation in the foreclosure process based on either the Constitution’s Contracts Clause or on takings concerns. In addition to a discussion of the issues at the Federal level, we also detail possible issues that may arise at the state level between the legislative and judicial branches.
We conclude with a summary of our recommendations for Congress and the Obama administration as well as state and local governments. We’re confident these recommendations represent the best way to bring today’s housing crisis to a swifter conclusion.
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