California says, “No more foreclosures”by Peter Miller
The idea is to have a referendum and simply ban foreclosures. And while this is a thought which is surely attractive in many ways, as a practical matter it’s not going to happen.
Under the proposed referendum to create a Foreclosure Modification Act, lenders in California would lose the right to foreclose.
“No citizen of the State of California shall lose or have that deemed as their personal home or property taken by foreclosure or any instrument thereof or similar to,” would be the law of the state if the referendum passes. Interestingly, this is part of the proposal that could actually be successful.
States can stop foreclosures
States plainly have a right to stop foreclosures, at least temporarily.
In the 1934 Blaisdell case, the Supreme Court ruled that Minnesota could suspend foreclosures. Moreover, there are any number of other situations where foreclosures have been stopped by government action.
But, the California proposal goes further.
“In the event of non payment in the time defined by standard loan contracts due to financial hardship or illness by the home or property borrower,” says the proposal, “then the lending institution, loan servicers, mortgagees, trustees and beneficiaries shall make every effort to assist California borrowers and in the event of a reduction of local property values of more then l 0%, a reduction of principal to reflect the new value shall be used, as well as to reschedule payments and or reduce interest rates and or refinance without credit review of the loan in order to bring said loan current.”
California can’t do this
The problem is that the state of California can’t do this. Neither can any other state or even the federal government.
To understand why, turn to the Constitution. Under the Fifth Amendment the government can only take your property in return for “just compensation.”
In other words, a state cannot simply order a lender to reduce debt or lower mortgage rates.
If the California referendum proposal makes it onto the ballot and is then passed it will quickly go to court and a judge will rule that the entire proposal is invalid.
So is that the end of the story?
The referendum proposal reflects a widespread belief that lenders have grossly abused the system. A ton of signatures would signal to state lawmakers that the public wants either action or a new set of elected officials.
So what could be done within an allowable framework?
In many states lenders are allowed to collect “deficiency” judgments when a mortgage is not fully repaid. In effect, the lender can sue the borrower for any unpaid principal after a home is sold with a short sale or foreclosed.
California already prohibits deficiency judgments against borrowers when a prime residence is foreclosed and the property has been financed with a purchase money mortgage–the loan used to buy the house. The deficiency judgment ban ends if the property is refinanced, and it does not apply to investment property.
The state could go further and prohibit deficiency judgments regardless of how the property is financed. It might also end deficiency judgments against investment properties with one-to-four units.
Since deficiency judgments are already banned in part, there’s no reason why the ban could not be extended. That’s not a taking, that’s just a leveling of the playing field.