What Happens if Michigan Goes Belly-Up?

This is a post from the State Bar of Michigan's official blog.  The post is the original content of University of Indiana School of Law Professor Gerard Magliocca.

Not that this would ever happen in Michigan, but Prof. Magliocca guest blogs at Balkinization on the constitutional implications of a state going into default, in "Too Big To Fail" States".  He says we better get ready, especially for a default by a big state:

The prospect that a state like California might default or need a bailout raises two interesting constitutional questions. The first is whether Congress can attach conditions to a bailout that would require a state to undertake substantial reforms of its constitution. I think the answer is yes. Under South Dakota v. Dole, Congress has broad authority to place strings on the receipt of federal money so long as there is some relationship or germaneness between the money and the terms. After all, the state is always free not to take the funds.

 

The much harder question is what happens if a state threatens to default unless it gets a bailout. In the case of a small state, this is not much of a threat. A default there would not cause any systemic problems. If California or another large state defaults, however, that's a different story. These states may be "too big to fail." What's worse, they know this. It is clear that Congress cannot just order a state not to default--that would run afoul of New York v. United States and the Tenth Amendment. Thus, if California comes to Congress for a bailout, the state is the one with the leverage. ("Give us a bailout on generous terms or else.") In effect, this would create the possibility of a "reverse unfunded mandate"--the federal government picking up the tab for a profligate state.

 

What can be done to address this issue? One possibility, I suppose, is that Congress could declare that a state in default is not "a republican form of government" under the Guarantee Clause and then order them not to default. That's a pretty heavy lift though, especially since states that defaulted in the past were never considered "not republican." The other thought is that Congress could threaten to withhold other federal spending from a renegade state. Would this be constitutional? I'm not sure. There's a difference between saying to a state, "Here's a gift with some conditions. Take it or leave it" and saying "Here's a gift. Take it or else we are going to kick you in the teeth." Nevertheless, that might be the only way to make a default so costly for the state that it would have to accept a bailout under stringent terms.

 

One reason we got into trouble in 2008 is that there were no default rules (or analysis) in place when "too big to fail" financial institutions started to fail. We'd better not make the same error when it comes to state governments.

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Posted in: law school,Professor Gerard Magliocca,State Bar of Michigan,strategic default

Walking Away From Mortgage(s) Can Hurt You in the Long-Run

This is the original post and content of the Wink & Wink bankruptcy law firm of Denver, Colorado.  The topic is timely here in Michigan as many homeowners and divorcing couples, struggle to keep their homes.

Strategic Default. You Walk Away. “Should you walk away from your underwater mortgage?”

These phrases have been reaching fever pitch in the news media lately because of the continuing economic crisis and its huge toll on house values nationwide. The gist of the idea is that if your house is underwater, chances of you ever regaining the equity you have lost are slim to none. However, the media seems to be silent with regard to the risk of deficiency judgment, which often lurks out there like a predator waiting to attack!

The thought of continuing to pay the debt on your mortgage, knowing that your house is now worth much less than the amount you will be struggling to pay for the next few decades, drives people to look for a way out. This is the reason “strategic default”, which occurs when people stop paying the mortgage, even though they can technically afford to keep paying. Because the housing market is in the dumps and appears unlikely to bounce back anytime soon, ‘strategic default’ is becoming more and more common. So common, in fact, that it has been linked to the recent uptick in consumer spending.

The decision to walk away is definitely a way out from underneath that mortgage. But it does not come without a cost. This is because when you walk away, you aren’t simply leaving the debt behind. Oh, No. In most cases the debt is likely still following you, stalking you. Waiting to pounce. Walking away from your mortgage has consequences in most states, such as Colorado, and they go by the name of a deficiency judgment.

What Is A Deficiency Judgment?

When you take out a mortgage, or two, you are liable on the note or deed for that debt in the amount your contract states. When you stop paying your mortgage (either strategically or because you can no longer keep up with the payments) the end result in most cases is a foreclosure sale of the property. At that foreclosure sale, the property is sold, usually at a loss.

If the property is sold for less than you agreed to pay on the mortgage, you are still liable for the difference—the deficiency—between what you agreed to pay by contract and what the lender received through the foreclosure sale. So, if your mortgage is for $300,000 and the property sells at foreclosure for $250,000, you are still liable for the $50,000 your lender is still owed under your mortgage contract.

When you have two mortgages, a first and a second, what often happens is that the first lender often “bids the note” at the foreclosure sale, which means they purchase the property for the same amount as the note. This means there is no deficiency as to the first mortgage. However, it also leaves the second mortgage lender unfulfilled, and holding a claim against you for the entire amount of the second mortgage. (Don’t forget that all these amounts generally increase as a result of the fees and charges that get tacked on as a result of the foreclosure process. They never miss an opportunity to lop on some fees!)

A deficiency judgment is what happens when one of the lenders to which you owe a deficiency decides to sue you to collect on that amount. After the lawsuit, the amount gets converted into a judgment against you, a deficiency judgment. And in Colorado, where I practice bankruptcy law, the holder of a deficiency judgment can garnish your wages – 25% of your wages, to be exact. That is not a risk to be taken lightly.

How Likely Is A Deficiency Judgment?

You may be thinking “but I haven’t heard of anyone getting sued for a deficiency judgment.” And at this point in time, this is mostly true. But this is changing, see “Lenders Pursue Mortgage Payoffs Long After Owners Default”.  The predators (eh..I mean creditors) are getting hungry!

What is very likely to happen with the huge amounts of deficiency claims lenders are sitting, and that will continue to pile up as the foreclosure rates soar (yes, foreclosures are still spiking, we are far from out of the woods yet) is that lenders will begin to package these debts and sell them to third-party collection agencies, just like the credit card companies. When that starts happening, everyone who though they got out Scott-Free will have to face a painful reality. And they have plenty of time to wait to nail you, too.

In Colorado, they have Six years to wait before they sue you. Six years to sit back and wait to get there ducks in a row, maybe even wait for you to start earning more money, and then Whammo! You’re served a Summons to appear in court and you end up with your wages garnished or your bank account seized to satisfy the judgment.

Bankruptcy Can Shut the Door on a Deficiency Judgment

Bankruptcy generally removes your liability to repay the note on your home. So, whether you file for bankruptcy before or after foreclosure, the lender cannot pursue a deficiency judgment against you. If you file after the deficiency judgment is secured, the bankruptcy can still wipe out your liability for the judgment. It can even stop the garnishment if the lender has proceeded to that level.

All of this means that you should consult a bankruptcy attorney if you are considering defaulting on your mortgage.

For most other people, stopping mortgage payments on an underwater home is not a choice. It is something that the current economic situation has forced them into, and the idea of bankruptcy is likely part of the mix, along with rising credit card debt and stress levels.

However, for the true “Strategic Default”, where the decision to stop paying the mortgage is made even though the money to pay the mortgage is there, bankruptcy is usually the last thing on the radar. Most in this position look at the default as a business decision. They made an investment, it went belly-up, and they are cutting their losses. However, even “strategic” defaulters should take the time to understand their rights.

Bankruptcy can not only shut the door on a possible deficiency judgment, enabling you to move forward without worrying about what lurks behind, it can help you rebuild your credit faster. Think about it – if you walk away from the mortgage without filing for bankruptcy your credit takes a hit (foreclosures stay on your credit report for 7 years) AND you still may be liable for the deficiency, just when you are getting back on your feet and have regained your credit score. If you file for bankruptcy, you get rid of any chance of a deficiency judgment, wipe out any other dischargeable debt you’re struggling with, and start rebuilding your credit from day one.

Additionally, if you plan it correctly you can live in your house rent free until the foreclosure, which in Colorado usually means 8-12 months.

The bottom line is to be prepared, have a plan and explore your options. Walking away without knowing the risks exposes you to what I like to call the stalking predatory of the deficiency judgment. It’s only a matter of time before these debts start being sold to collection agencies, and with those creditors – you need to watch your back!

info@clarkstonlegal.com
http://www.clarkstonlegal.com/

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Posted in: bankruptcy,Bloomberg,creditors,deficiency judgment,mortgage,short sale,strategic default