The substantive issue addressed by the Court concerned the enforceability of a release contained within the standard NWMLS Form 51 Rescission. Per that release, anyone who signs this standard form, a necessary and prudent step before entering into another contract for the purchase and sale of specific property, releases their agent from all liability associated with the transaction. Thus, and as was the case in Craig’s case, even though the deal cratered because of the negligence of the listing agent, the client ostensibly released the agent from resulting liability by signing the rescission. That simply is not fair to the client.

And now the State of Washington agrees. So future clients, who are harmed by the negligence of their agents, should also be successful in challenging this release and still holding their agents liable for losses caused. Great work, Craig, on behalf of the client and on behalf of all consumers of real estate broker services!

For more information about the case, see Craig’s recent post on Rain City Guide.

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The case involved a boundary dispute between adjoining neighbors.  The two properties were originally owned by a Mom and her Son.  Mom and Son were not concerned about the boundary between their properties.  As a result, Son built a large shed mostly on Mom’s property; Son also built a fence that encroached some 40 feet onto Mom’s property.  Mom wasn’t concerned about these structures because she trusted Son to do what was right and he had her permission to use her property as he deemed necessary.

Craig’s clients (Mr. and Mrs. Client) purchased their property from Mom.  Much to Clients’ surprise, Mr. Client had been childhood best friends with Son!  It was a truly remarkable coincidence.  It had been about 15 years since Mr. Client and Son had seen each other, and they were thrilled to be neighbors again.  Because of their relationship, Mr. Client and Son agreed to continue with the arrangment between Son and Mom.  As a result, Son and Client used the properties on both sides of the fence with the true owner’s permission.

Son then sold to a — hmm, how to put this — “difficult” man who proved to be an exceptionally bad neighbor (Mr. Bad Neighbor).  The relationship between Mr. Bad Neighbor and the Clients soon deteriorated.  Eventually, Mr. Bad Neighbor claimed ownership of the shed and all of Clients’ property up to the encroaching fence.  But unfortunately for Mr. Bad Neighbor, he owned the property for only 9 years and 11 months before the Clients filed suit (one must use another’s property for 10 years in Washington in order to take title via adverse possession).

The case involved some tricky hearsay issues (the agreement between Son and Mother, and between Son and Mr. Client) because Son was not to be found and was not a witness.  But Craig handled it with skill and aplomb (at least that’s how he told it!).  It was a bench trial (judge only, no jury) and the judge concluded that Craig’s clients were the true legal owners of the area in dispute.  Great work, Craig!!  Another victory for Blackmon Holmes.

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Here in Washington, the vast majority of foreclosures are non-judicial.  A non-judicial foreclosure happens outside of the court system and thus without judicial oversight.  How does the process work?  When the buyer of a home borrows money for the purchase, the buyer signs two important documents: a promissory note, and a deed of trust.  The note is the legal document that establishes the debt owed.  The deed of trust is the legal document that pledges the home being purchased to secure the debt if the borrower defaults.  When the borrower defaults, the lender (the “beneficiary” under the deed of trust) notifies the trustee (the person identified in the deed of trust with the authority to sell the property upon default).  After complying with various legal requirements primarily dealing with notice to the debtor/owner, the trustee can sell the property at public auction. 

If the borrower believes that the foreclosure is inappropriate, the borrower must file a lawsuit against the lender to stop the foreclosure.  Absent such a lawsuit, the entire non-judicial foreclosure process happens outside of court.  Since very few borrowers file such a lawsuit, most non-judicial foreclosures come and go without anyone really examining whether the process was completed appropriately.

But now somebody has opened the lid of this non-judicial “black box” and peered inside — and boy is it ugly in there.  Really ugly.  The San Francisco (City and County) recorder’s office audited about 400 files of non-judicial foreclosures, about 16% of the non-judicial foreclosures over a nearly three year period (January of ’09 through November of ’11).   Of these files, 99% of them at least suggested some legal violation or suspicious documentation; 84% had at least one clear legal violation; and fully two-thirds had four or more clear legal violations or irregularities. 

But that’s California, right?  It’s different here in Washington, right? Sadly, while that may be true as to our weather and our easy-going attitude, its not true in this context.  The actual report of the audit makes for fascinating reading, beginning with its description of the non-judicial foreclosure process in California.  It turns out that the process there is basically identical to the process here.  And the mortgage market is a national one.  So whatever shenanigans were going on in the Golden State were likely going on here as well.  So its safe to assume that an audit of non-judicial foreclosures in King County would reveal a similar number and percentage of non-judicial foreclosures that did not comply with the law.  And that simply is not good.

In a future post I’ll examine the implications for buyers of REO (i.e., bank-owned) homes, since all of these homes were previously foreclosed upon by the bank.

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What does this mean for us? Essentially, bad news, as the “worst case scenario” may be on the horizon: Prices stabilized somewhat in 2010 because of the artificial price support generated by the homebuying tax credit; with that credit gone (it expired June 30) the market has returned to its “normal” trajectory following the bubble, and the bottom is still some ways out into the future.

If that’s the case, what are the practical implications for buyers? Clearly its a bad time to buy for an investment, unless you are guaranteed a positive cash flow, which would offset the presumed short-term depreciation of the asset. On the other hand, if you’re buying a residence, then the possibility of “catching a falling knife” (in Wall Street-speak) must be balanced against historically low interest rates, tax benefits, the need to live somewhere, etc. In other words, even under the worst case scenario, it still makes some sense to buy a residence now, particularly if you anticipate living there for some time (which should allow for some recovery of equity, since the house may depreciate further right after you buy it).

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Seriously, why hire a full service broker with a 3% commission if you have to treat the sale of your home as a full time job? If you have to go to other open houses to get staging ideas? If you have to troll the internet to constantly assess the best price for the home? Aren’t these tasks the job of the listing broker, who is getting paid handsomely (how handsomely depends on the price, of course) for the job?

The answer is obvious, at least to me: You don’t need to hire a full service broker if you’re going to do the work yourself. And that means you don’t need to pay a 3% commission. There are MANY alternatives to the full service model — if you’re going to work this hard yourself, use one of ‘em and save a lot of money. Needless to say, one option is WaLaw Realty…

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For Part 3 in my series I will talk about the local (i.e. Washington State) implications for the national foreclosure mess. Before I do so, though, and as a last word on the “big picture” I recommend reading this NYTimes piece that appeared in the Sunday Week in Review.

Now, onto our own Washington. This state is primarily a “non-judicial foreclosure” state. Virtually every residential buyer purchases a property by signing a promissory note (the document that creates the debt to the bank) and a deed of trust (the document that pledges the house to secure the debt). When the borrower defaults, a lender has the option of foreclosing non-judicially (where the trustee under the deed of trust exercises his legal authority to sell the property in order to satisfy the debt) or foreclosing judicially (lender files a lawsuit and forecloses the deed of trust in a civil action).

Both methods lead to the sale at auction where the proceeds are applied to the debt. However, there are important differences: (1) in a non-judicial foreclosure, the debt being foreclosed is extinguished even if it remains unpaid after the auction; (2) in a judicial foreclosure, once the property is sold a judgment is entered against the borrower for the difference (i.e. the borrower remains liable for the full amount borrowed); and (3) the auction following a judicial foreclosure is less likely to get the “true market value” of the property when sold (because the borrower has a right of redemption following a judicial foreclosure). Also, a nonjudicial foreclosure is quicker and cheaper for the bank.

Given these realities, the vast majority of foreclosures in this state are non-judicial. A borrower always has the option of suing to stop a non-judicial foreclosure if the lender in reality does not have the right to foreclose. Thus, unlike those states where judicial foreclosure is prevalent, here in WA borrowers have the ability to stop a foreclosure if some “Robo-signer” made an egregious error and the bank is attempting to foreclose on the wrong house. In contrast, borrowers in judicial foreclosure states have no such option — they are already in court! They’re getting screwed WITHIN the civil justice system, so obviously the civil justice system cannot act as a brake on the process. Accordingly, since our borrowers have the right to escalate and seek the protection of the courts, the significance of lying “robo-signers” is greatly reduced in this state. That said, non-judicial foreclosure still requires statements made under penalty of perjury, so “robo-signers” are not completely off the hook.

Second, the vast majority of foreclosure auctions lead to repossession of the property by the bank. The bank then resells the property by listing it on the MLS (this is an “REO”, for “Real Estate Owned”, property). At the resale, the buyer almost always obtains a policy of title insurance, which then protects the purchaser from any claim to the property as a result of some irregularity in the foreclosure process. A local title expert believes that, as a result, there will be little impact on the local market.

Finally, the bad news: lenders did suspend their foreclosures here in WA (although, sadly, I am unaware of the current state of affairs in this regard), and investigations are continuing. Any delay in foreclosures just delays the inevitable downward pressure on prices until the excess inventory is absorbed by the market. So while we managed to avoid the worst of the “foreclosure mess,” we will still feel its effects.

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I planned on waiting a couple of days before moving onto the practical implications — from a national perspective — but darn it if I wasn’t scooped by the NY Times! So onward I forge.

The Foreclosure Mess is going to worsen two inter-related problems. First, it’s going to significantly gum up the foreclosure process. The legal system simply cannot tolerate systemic lying, otherwise the system itself loses legitimacy. Clearly that is not acceptable — a properly functioning legal system is a veritable bedrock of a healthy society. Accordingly, the legal system will no longer accept at face value a foreclosing lender’s assertion that it is the holder of the note and has the right to foreclose. Given the “tidal wave” of foreclosures that is still cresting, this will further slow down the “working through excess inventory” process that is necessary to restore a healthy, value-sustaining balance to the housing market. So problem 1: Further delay in working through this lousy housing market. Ouch.

Second, this is going to further stress our banking system. When each promissory note was sold by the lender to the trust (which then repackaged and resold pooled mortgages as mortgage-backed securities), the lender essentially guaranteed that the loan was properly underwritten and otherwise a sound loan. We all know now (and many of us knew back then!) that many, many loans were NOT properly underwritten. If the lender lost the note, thus jeopardizing the holder’s ability to foreclose to preserve principal, then that too breaches the lender’s promises at the time of sale. The purchasers of these securities are beginning to demand that the original lender repurchase the loans given these breaches. And since we’re talking tens and possibly hundreds of billions of dollars, these legitimate and legal demands to repurchase loans — that are worth MUCH lesss than as sold — are going to cause further stress on our banking system. That’s problem 2.

Not pretty, to say the least. Time will tell whether we can weather this latest development, or whether it’s going to kick us in the teeth circa 2008. My final post on the issue will look at the implications for our beloved Evergreen State.

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The “big deal” concerns a fundamental tenet of property law.  Some types of property (such as all real property, and some personal property such as a car) require an owner to register or otherwise record his ownership.  Once ownership is recorded (e.g. once the deed by which a buyer takes title is recorded with the County Recorder) then the owner is known and can be determined by others, regardless of the location of the property. 

In contrast, the owner of most personal property is identified primarily by possession.  If you have possession of personal property, it is presumed that you are the owner, subject to the adverse claim of another (which could be proven with other evidence of ownership, such as testimony, receipt of purchase, etc.)  This second category includes a financial instrument such as a promissory note.  The “holder” of such a note (i.e. the person entitled to repayment of the debt set forth in the note) does not register or record his ownership.  Rather, possession of the note is on its face evidence of ownership.

In the context of a promissory note secured by real property, the law has evolved literally over a thousand years (this area of the law can be traced directly back to English law that evolved in the Middle Ages).  In order to exercise the rights of ownership of a promissory note, the “holder” must have possession of it.  Otherwise, there is no way to confirm ownership, and thus no way to confirm that the person seeking to enforce those rights really HAS those rights to enforce.

Now the problem: Over the last decade, mortgage loans were commodified.  Way back in the last century — yep, just ten years ago — a lender would typically make a loan and then retain ownership and possession of the note.  However, to introduce greater fluidity into the mortgage market, banks took to selling these loans to trusts (typically maintained by investment banks).  The trusts would then sell “shares” of ownership in the trust (which includes ALL of the mortgages pooled within the trust) to investors.  These are known as “mortgage backed securities.”

As part of this process, the original promissory note in EACH instance should have been forwarded to the trust for safekeeping.  But guess what?  That did not always happen.  So now the original note has been lost in many instances.  To account for this reality, all 50 states in one form or another allowed a “holder” to attest under penalty of perjury that it was the legal holder of the note thus giving the holder the right to foreclose on the home securing the loan.  The “holder” no longer had to present the original note in order to prove that it was entitled to the rights conferred by that note.

But as we now know, lenders failed to actually confirm that they really were the “holder.”  Instead, low level employees responsible for HUNDREDS of files every day simply signed so indicating without actually confirming as much. Lenders proceeded to foreclose on loans even though they simply lied when saying they had confirmed that they had the right to do so even though they could not produce the original note.

In other words, banks routinely lied under oath and the law does not appreciate such conduct. Indeed, for the 23 states that require a lawsuit in order for foreclose, these lies were made directly to the court!  Bad form, to put it mildly!!  Moreover, the banks misused the legal system to their advantage at the expense of homeowners by lying about the procedural requirements designed to protect the homeowners/borrowers, who may not have the resources necessary to otherwise defend themselves in court. The government — i.e. the entity tasked with insuring that the law is followed and applied correctly — has taken notice.

So that’s the background.  Over the next few days I will explain in Part II the problems created or worsened by this conduct and how this might play out in the future.  In Part III I’ll explain how this relates to our fair state of Washington.

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