Our legal system is predicated in part on the idea that liability follows error. As Colin Powell said: You break it, you buy it.
Not so in world of credit, however. Here, contract apparently has the power to shift the risk of mistakes to the party who either did not read the contract, or lacked the leverage to negotiate it.
Consider two recent stories.
First, this from Sunday’s New York Times:
It is no secret that lines of credit are harder to find these days. But what many homeowners may not realize is that their existing lines of credit can be eliminated at the lender’s whim.
* * *
“We will increase, decrease or suspend lines based on a number of factors, including a customer’s entire relationship with WaMu, their payment status and history, changes to their creditworthiness, and changes in the value of their property,” said Sara Gaugl, a Washington Mutual spokeswoman. “We believe this is part of being a responsible lender.”
Home values are a particularly large component of the lender’s decision, Ms. Gaugl said, and since the real estate market remains moribund, more credit lines could be cut. “We will continue to evaluate individual home equity lines of credit in relationship to the amount of equity a customer has in their home,” she said, “and if appropriate, we’ll lower the line amount.”
Second, this from Saturday’s Wall Street Journal:
Even as Moody’s Investors Service was handing out triple-A ratings last year on a huge number of securities tied to mortgages, a senior Moody’s analyst involved in rating them was warning about the housing market and asking if the ratings were too optimistic.
In late 2006 and early 2007, the Moody’s Corp. unit continued to rate new collateralized debt obligations even as the analyst, Eric Kolchinsky, aired his concerns to his colleagues and boss, people familiar with the matter said. It wasn’t until October 2007, with mortgage defaults soaring, that the Moody’s unit downgraded hundreds of CDOs, resulting in billions of dollars in losses for investors.
This was on top of reports that at least some of Moody’s AAA bond ratings were the product not of analysis but computer errors.
What does this tell us? That if WaMu mis-valued the house you mortgaged, you have to pay. That if Moody’s misrated the bonds your mutual fund bought, you have to pay. Either way, contract shifted the risk of loss from the person who made the error to the person who has to absorb it—someone probably in no good position to do so.
Now, the law is full of risk-shifting devices, and usually they aren’t exciting. And arguments about the merits of contract are old and tired. But, at some point, you do have to ask: When is enough enough?
Comments
9 responses to “Paying for Mistakes”
The larger story is that second mortgage lenders are holding a lot of borrower’s hostage, in particular National City and GMAC, by refusing to resubordinate an existing second mortgage. Basically, we have borrowers who want to just refinance their first mortgage to a lower rate or fixed rate but can’t because they have a second mortgage that takes the combined loan to value above 90%.
The problem is that the existing second mortgage holder has to agree to be subordinate to a new first mortgage. Many of the banks are refusing to subordinate because they want to force the borrower to pay off the second mortgage, just as they are also freezing credit lines. Lenders no longer offer these products and they do not want the existing ones on their books either. In other words, last year when I gave a client a nat city second mortgage to 100% (80.20) it was all good. Nat City no longer will do second mortgages to 100%. However, now that my client wants to refinance the first, Nat City is applying the NEW guidelines and refusing to allow a new first mortgage even though they already hold the note and the borrower isn’t doing anything except lowering thier first mortgage payment. In effect, they are being held hostage.
In my view, this is unethical. I can understand refusing to subordinate if the borrower is adding additional risk such as going from a fixed to an ARM or taking cash out. However, in these cases, we are talking about borrowers improving their situation by simply doing a rate/term refi to drop their rate. There is no logical reason to not subordinate since they already hold the note. However, since they no longer really want the loans, they are trying to force the borrower to pay the mortgage off. Also, what is unethical is that these companies are willing to subordinate if, and only if, they take out a new first mortgage with that company. So if I try to refi a client’s first mortgage and they have a Nat City second, I can’t. However, the borrower can refinance if they go to get a Nat City first mortgage. Surprise, the rates aren’t that great if they could actually shop.
While I generally have been the lone voice of reason on here, I really wish one of you attorneys would sue the hell out of the lenders for this particular issue.
Am I missing something?
If a home equity lender determines that your house no longer has any equity – for example, due to changed market conditions – and shuts down your line of credit, how do you “have to pay”? They won’t let you borrow any more money on the house, and that can be a problem if you were expecting to be able to borrow more money on it, but I don’t get the “you have to pay” line. “You have to pay” and “You don’t get to borrow” are not synonyms.
And why is a change in value in the real estate securing the home equity loan even a “mis-valueation” or a “mistake” by the lender? Housing prices are dropping like a stone. Why was a home equity line given three years ago a “mistake” by the lender if the value of the real estate declined? Because real estate somehow isn’t allowed to lose value? Why?
Would it be the lender’s “mistake” in giving you a home equity line if the house burned down? Or was destroyed by a flood? Is it your position that the right to shut down a home equity line, due to an absence of equity, is never a reasonable contract provision? Why would lenders provide home equity loans without that kind of protection?
Some of the more amorphous grounds for reducing the equity line are troubling. But your example was the mistake of “mis-valuing” the property, and I’m just feeling your outrage at that.
That should read “not feeling your outrage at that.”
Sorry.
I’d pay extra for enough to be enough.
Enough of clients telling me they want to buy this dream home.
Enough of “well, they’re standard terms.”
Enough of “it’s never been a problem in the past.”
Enough of my letters that start “you have elected to take the following actions…” and end with “against my legal advice and your own interest…”
And as for suing the lenders… we need to sue the borrowers!
The WSJ story is a non-story. Ratings agencies use a committee process that allows for the airing of a divergence of views on a rating. Senior managers and junior analysts all have an opportunity to have their say and vote. Sometimes these professionals disagree just like…. I don’t know… lawyers. Was the one analysts seeing something clearly before his colleagues, perhaps, but obviously his arguments weren’t persuasive. Nobody, I repeat nobody, forsaw the unprecedented 20% drop in house values – including the Fed, Congress, state regulators, investment banks, mortgage lenders, borrowers, their lawyers. And noone wanted to blow the whistle on the dangerous drop in origination standards, even folks closest to it like — let’s see — borrowers and their lawyers. The rating agencies are an easy convenient target – there is much blame to go around.
With regard to the commentary by Russ on June 10, 2008, that scenario is the exact one in which my next door neighbours find themselves. However, they are mostly able to overcome the situation and will be OK. They consider themselves fortunate to have a fixed rate first mortgage. These people are the kind of neighbours we want to keep. They are good people.
Borrowers are getting sued.
@Russ re: refusal to resubordinate. If the borrowers are able to obtain a new 2nd mortgage, they can pay off the existing one when they refi the first. Done deal, end of story. If the borrowers are not able to obtain a new 2nd mortgage, which means nobody else would lend to them, why should the existing lender be forced to extend credit again? Businesses should be allowed to make their own decisions on granting credit, no? They lent 3 years ago but they won’t lend now. I don’t see anything wrong with that. Just like borrowers are exercising their rights to refi, lenders are exercising their rights not to lend when certain events happen. If anybody thinks the borrowers are a good risk, why don’t they lend to them?
The second mortgage holders generally aren’t being asked to “relend” or extend new credit – they are just being asked to sign a subordination agreement, keeping them in exactly the same 2nd position they were in before the refi of the first mortgage. The only difference is the identity of the first mortgage holder, and if the homeowners got a better rate on their refi, a few more dollars a month in the homeowner’s pocket – which they may even use to pay their second mortgage.
But, a refinancing of a first mortgage is a moment of leverage for second mortgage holders – many of whom are ‘out of the money’ in terms of having their second mortgages attach to any equity in the real estate. So, the second mortgage holders play dog-in-the-manager, attempting to get the homeowners to pay them off (or pay them something). Not illegal – just a by-product of the ‘first in time, first in right’ rule and falling prices in today’s housing market.
It’s too bad the second mortgage holders are using subordination refusal on refi’s as a collection tool. However, it isn’t illegal for them to refuse to subordinate, and if the second mortgage holder plays its hand too strong, they may end up seeing their second being stripped off in a Chapter 13.