Are Legal Rules Holding the Housing Market Down?

This morning’s Wall Street Journal’s headline reports that delinquencies on home mortgages ticked up in the second quarter. The graphics tell an interesting story:  states that have only judicial foreclosure have a disproportionately large share of loans in foreclosure, while states that make a nonjudicial foreclosure procedure available have a disproportionately small share of loans in foreclosure. 

(For our nonlawyer readers, states vary widely in the procedures required for a lender to foreclose on real property securing a loan, but perhaps the most significant variation is the availability or unavailability of nonjudicial foreclosure.  Judicial foreclosure requires the lender to get on a court docket and persuade a judge that foreclosure is an appropriate remedy, while nonjudicial foreclosure allows a sale of the collateral following a set of defined procedures that do not require an appearance in court.   Some states do not permit nonjudicial foreclosure, forcing the lender to nonjudicial foreclosure; others allow the lender to choose between the two.) 

The economists and statisticians will hasten to point out that five states covered by the Journal article are not a statistically significant sample.  But as a California lawyer unaccustomed lately to hearing that my state is doing better than the law of averages, I have to hope that we are doing something right from a legal standpoint that leads to fewer California loans in foreclosure.  And perhaps the availability of nonjudicial foreclosure is part of the answer.  

Karen Pence of the Federal Reserve has looked more systematically at the impact of state laws on the size of mortgage loans that lenders are willing to make and concluded that in jurisdictions with “defaulter-friendly” rules, the markets make smaller loans available to borrowers (read more here). So it is reasonable to conclude that the choice of rules has an impact on markets – and perhaps here the lack of an efficient remedy for lenders in judicial foreclosure states is holding back the recovery.  The Journal graphics give us a snapshot today. It would be interesting to examine these same measures over time, throughout the downturn and recovery, to learn whether the California advantage holds up over time or merely reflects that we felt more pain early on.   

Real estate law has proved strangely resistant to reform:  even with model laws proposed by the Uniform Law Commissioners, appointed by all 50 states, the pace of adoption is abysmal:  not even one state adopted the Uniform Nonjudicial Foreclosure Act.

But perhaps the different experiences of states with different rules  in this downturn will be the impetus we need to start thinking seriously about mortgage reform and adoption of best practices. 

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