By: Julia Mas-Guindal
The end of the housing bubble initiated a vicious circle that prompted a disaster for millions of homeowners whose property was repossessed. This widespread crisis has affected countries on both sides of the Atlantic, and has had a major impact on lenders who faced billions of dollars in losses as a consequence of this situation.
Foreclosures helped accelerate a fall in property prices, leading to more foreclosures. The losses to lenders brought the financial system to collapse in the fall of 2008. The recession that came after led to even greater homeowner defaults, as homeowners who lost their jobs were not able to face up to the monthly mortgage payments. Millions of people found themselves “underwater” with mortgages that exceeded the value of their houses.
The origin of these problems stems from the boom years. Home prices were rising and banks looked for profit while paying less attention to the business of mortgage servicing, or collecting and processing monthly payments from homeowners. In the good times, financial entities spent huge amounts of money to create mortgage machines that negotiated new loans, packaged them into securities, and sold them worldwide. When borrowers began to default, banks found themselves with millions of customers on the brink of losing their homes begging to renegotiate the terms of their mortgages.
The case of Spain
The thousands of evictions since the collapse of the housing bubble are one of the most tragic consequences of’ Spain’s private debt crisis. Although the crisis hit hard in both the U.S. and many European countries, the case of Spain is particularly striking for two main reasons:
First, Spain was much more exposed to the housing property bubble than other countries. The Spanish economy was a driving force for economic activity in the European Union for more than a decade, with GDP growth exceeding the average rate of the Eurozone since 1995. The major driver of growth during these years was the construction sector. The collapse of this sector has caused unemployment to skyrocket and left an increased number of people unable to afford their monthly mortgage payments.
Second, Spanish mortgage law differs substantially from laws in other countries. The Spanish Mortgage Act (Ley Hipotecaria), coupled with Article 1911 of the Spanish Civil Code, imposes unlimited personal liability on the borrower in the event of non-payment of the mortgage. Mortgages are tied to both the mortgaged property and all present and future assets of the borrower as collateral. Residential mortgages in Spain are generally recourse loans, meaning that if the homeowner stops making payments, the creditor can take both the property and other assets.
The law gives parties to the mortgage loan the option to opt out of the unlimited responsibility rule. Article 140 of the Spanish Mortgage Law states that the parties can agree that the guaranteed obligation is subject only to the mortgaged property. If this happens, the obligation of the debtor and the action of the creditor is limited to the amount of the mortgaged properties, and the rest of the estate of the debtor will not be affected by virtue of the mortgage obligation. Despite the availability of this legal provision, the reality shows that the mechanism is rarely applied because it means fewer guarantees for clients. So normally when a bank in Spain foreclosures on a house and evicts the borrower, the former home owner still owes the remaining debt to the bank.
Moreover, according to Spanish legislation, during the foreclosure procedure the creditors may request the adjudication of the house for as little as 60 percent of its appraisal value if there are no bidders at the auction. Those evicted, after losing their homes, must still pay the remaining debt as well as the judicial fees.
The numbers are horrifying: between 2007 and 2011: nearly 500,000 families were evicted from their homes in Spain, making the situation worse by leaving approximately three million vacant houses. The best description of reality is “people without houses and houses without people.”
The new political measures: hope for the hopeless?
It is clear that in the midst of this dramatic situation something has to be done. However, it is not easy to find a way to help people of limited financial means without making rules that may limit the supply of credit and damaging the economy as a whole.
On February, 22 the Spanish Minister of Economy and Competitiveness, Mr. Luis de Guindos, announced a set of initiatives, the so-called “Code of Good Practice,” seeking to mitigate the effects of the burst of the housing bubble and the ensuing economic crisis.
This Code would apply to families under a definition of “economic exclusion,” families with few assets who fall and in which none of the members are working. To avoid the eviction of more poor Spanish families, the government requires banks to postpone eviction for two years. This provision will help families stay in their homes and clear up their debts.
Another relevant part of the program is the implementation of the so-called deed in lieu of foreclosure. This measure would prevent banks from attempting to seize the borrower’s personal assets after they have been evicted. Homeowners can clear the debt by handing over their homes. In order to avoid “strategic default,” the Spanish government warned that the deed in lieu of foreclosure would apply only to those cases where the house is the only real estate property owned by the family.
The government is also seeking to make banks accountable for issuing mortgages based on valuations that proved to be unrealistic –in other words, for being predatory lenders- and to establish measures to avoid this irresponsible behavior in the future. De Guindos stated that “[i]t seems reasonable . . . that the lender, as a consequence of a poor appraisal or insufficiently diligent procedure, should be jointly responsible for the differences that exist between the appraisal value and the amount obtained for the house when it is foreclosed.” The government is also promoting mechanisms to favor debtors such as the refinancing of mortgages, the flexibility or postponement of quotas, and a moratorium in the payment of capital.
In order to provide incentives for the banks to take part in the program, the banks will be allowed to deduct from their taxes the losses they suffer as a consequence of applying the Code. Surprisingly, despite the voluntary nature of the measures, Spain’s biggest lenders Santander and BBVA have declared that they are socially committed to the dramatic situation and will try to implement these proposals. Also, they stated that they have already adopted some of the proposed Code recommendations; for instance, they are already renegotiating the terms of the mortgages with the borrowers in certain cases, allowing the postponement of quotas.
The economic situation, the number of unemployed people, and the social problem generated by the burst of the housing bubble require extraordinary measures. Some people consider the new Spanish Code of Good Practice as the magical solution to the deep social problem of evictions which thousands of Spaniards are currently facing. In contrast, other people see this measure as “insufficient” and “propagandistic” due to the voluntary nature of the measures.
Will these set of recommendations be put into practice voluntarily by the financial institutions? Will this Code address the dramatic situation?
In my opinion, this Code is a way of promoting good banking practices in order to benefit those most affected by the crisis. However, being realistic, the government will not be able to implement some of these proposals in a mandatory way because banks, whether on the basis of good reasons or not, will not be willing to give in that much.
In particular, banks will not agree to implement the deed in lieu of foreclosure in every case. Actually, imposing a compulsory deed in lieu of foreclosure with retroactive effects would be against the principle of legal certainty and the pacta sunt servanda that states that the agreements must be kept. What I think it would be reasonable and fair is to force banks to accept this measure in those cases in which they carried out predatory lending practices. It is clear is that this kind of misbehavior cannot be left unpunished. On the other hand, we have to bear in mind that the limitation of the borrower’s liability to the house is a “lesser evil,” because it allows homeowner to clear the debt, but it does not solve the problem of evictions.
In my view, a helpful measure would be to allow the former homeowners to lease the house with an option to buy it in the future. The families could stay in the foreclosed home for a reasonable period while they pay a minimum rent to the bank. This rent should be affordable to the family, lower than the monthly mortgage payment, and also lower than fair market value. Once the reasonable period is over or in case the economic situation of the family substantially improves before this period ends (for instance, because they managed to find a job), the bank could raise the rent. Banks are not real estate agencies; they are facing serious liquidity problems and they do not really want to keep the house. Instead, they would prefer cash. For obvious reasons, this would be better for the families as well, because they avoid being thrown out of the house, and they have the option in the future to become the full owners of the home in which they live.
Julia Mas-Guindal is a practicing lawyer and a PhD candidate at the Complutense University in Madrid (UCM). She earned a dual degree in Law and Business from UCM in 2009 and a Master’s in Marketing from the ESCP-EAP (Paris) in 2008. She is currently a Visiting Researcher at Harvard Law School. Her research interests include Bankruptcy, Law and Economics, Intellectual Property Law, and Family Law.