Community Collateral Damage: a Question of Priorities Andrea J
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Loyola University Chicago Law Journal Volume 43 Article 4 Issue 1 Fall 2011 2011 Community Collateral Damage: A Question of Priorities Andrea J. Boyack Fordham University Law School Follow this and additional works at: http://lawecommons.luc.edu/luclj Part of the Housing Law Commons Recommended Citation Andrea J. Boyack, Community Collateral Damage: A Question of Priorities, 43 Loy. U. Chi. L. J. 53 (2011). Available at: http://lawecommons.luc.edu/luclj/vol43/iss1/4 This Article is brought to you for free and open access by LAW eCommons. It has been accepted for inclusion in Loyola University Chicago Law Journal by an authorized administrator of LAW eCommons. For more information, please contact [email protected]. Community Collateral Damage: A Question of Priorities Andrea J. Boyack* Today's soaringmortgage default rate and the uncertainty and delay associated with mortgage foreclosure proceedings threaten to cause financial tragedies of the commons in condominiums and homeowner associations across the country. Assessment defaults in privately governed communities result in an inequitable allocation of upkeep costs-a phenomenon that current law has failed to prevent. But the collateral damage caused by delayed foreclosures and insufficient recoveries can be minimized by increasing the payment priority of the associationlien. In a majority of states, association liens are completely subordinate to the first mortgage lien. At foreclosure of the mortgage lien, the juniorpriority assessment lien will be extinguished whether or not there are sufficient proceeds to reimburse for community charges. Assessment delinquencies grow over time, so the longer it takes to complete foreclosure, the greater the costs to the neighborhood. Although several states have adopted a limited lien priorityfor up to six months' worth of unpaid assessments, foreclosures today take far longer than six months, and the amount ultimately owed to a community can be significant and far exceed that cap. Federal housing policy affects the resolution of the issue because the Federal Housing Administration ("FHA'), Fannie Mae and Freddie Mac only permit qualifying mortgages to be subject to a six-month assessment lien priority. The deceleratingpace of foreclosure further exacerbates the already unjustifiable financial impact borne by non-defaulting neighbors. The lien priority status quo fails to adequately protect communities in today 's context of widespread,delayed foreclosures and * Visiting Professor of Law at Fordham University Law School and former Visiting Professor of Law at George Washington University Law School; J.D., University of Virginia School of Law; M.A.L.D., Fletcher School of Law and Diplomacy, Tufts University; B.A., Brigham Young University. I am deeply indebted to both Robert M. Diamond and Professor Dale Whitman for their insight and invaluable input. 53 54 Loyola University Chicago Law Journal [Vol. 43 under-collateralized mortgage loans. Decreasing the first mortgage lien's priority during aforeclosure delay would mitigate the harm. Lien priority statutory changes could protect associationfinances in the future, and such provisions might be applied retroactively as well. In other contexts, states have held that changes to a lien priority regime could apply to existing associations and existing mortgages without unconstitutionally impairing contract or property rights. This has been particularlytrue where the association's lien was deemed to have been created on the date the community's organizationaldocuments were recorded (priorto any unit's mortgage). Historically, bank lobbyists have opposed any enhanced assessment lien priority. However, supporting property upkeep and making assessments more predictable and collectible would actually benefit lenders by shoring up the value of their collateral. Moreover, increased certainty with respect to homeowner payment obligations would enable more responsible credit underwriting and contribute to economic recovery. Shoring up assessment lien priority would not only ensure a fair allocation of community costs, but also would help to contain the current housing market decline. 2011] Community Collateral Damage 55 TABLE OF CONTENTS INTRODUCTION......................................... 56 I. THE PROBLEM OF PRIVATE GOVERNANCE AND MEMBER DEFAULTS ......................................... 64 A. Negative Externalities of Default ....... .... ........... 64 1. Lower Comparable Sales Valuation ............... 65 2. Constructive Abandonment ................ ..... 66 3. Government Rescue Efforts ..................... 68 B. Financial Entanglement ..................... 72 1. The CIC Ownership, Assessment, and Services Model .............................. 72 2. Tragedy of the Financial Commons ...... ......... 76 3. Barriers to Market Recovery .................... 80 4. Association Bankruptcy........................ 84 C. Payment Collection and Lien Priority ................. 87 1. Association Collection Efforts ................... 87 2. Priority Baseline ............................. 93 II. ALTERNATIVES TO FAILED PRIVATE GOVERNANCE . ............. 98 A. Other Attempted and Proposed Solutions .............. 98 1. Limited Priority Liens ........... .............. 98 a. UCIOA and Six-Month Limited Priority Lien........ 98 b. Federal Housing Impacts on Association Fiscal Recovery .............................. 104 c. State Efforts to Add or Enhance Lien Priority......... 107 d. Inadequacy of Limited Priority Liens ...... ..... 112 2. Creative Litigation Strategies ............. ...... 115 3. True Lien Priority: An Analogy to Property Taxes....... 121 4. Consent and Control by Community Members............. 122 B. Eroding Mortgage Priority................ .......... 128 1. Equitable Reallocation of Payment Default Costs ........ 128 2. Promoting Foreclosure as Policy ................. 130 3. Lender Disorganization and Misbehavior ..... ..... 132 4. Association Assessment Abuses . ................. 137 CONCLUSION ............................................... 139 56 Loyola University Chicago Law Journal [Vol. 43 INTRODUCTION Culpable parties in today's housing crisis are legion,' but innocent bystanders are directly and tangibly harmed by the fallout. Nonpayment of upkeep charges by financially strapped owners forces guiltless neighbors to fund the community budget revenue gap. The problem is exacerbated by foreclosure delay, since a property conveyance would replace an insolvent owner with a solvent one. Whether a foreclosure delay results from mortgage lenders' strategic behavior 2 or from procedural missteps by servicers, 3 the result is the same-hard-working, I . Mortgage brokers pushed unrealistic loans. Steven Krystofiak, President, Mortgage Brokers Ass'n for Responsible Lending, Statement at the Federal Reserve (Aug. 1, 2006), available at http://www.federalreserve.gov/secrs/2006/august/20060801/op-1253/op-1253_3_1 .pdf. Appraisers validated unrealistic prices. See Jonathan R. Laing, The Bubble's New Home, BARRON'S ONLINE (June 20, 2005), http://online.barrons.com/article/SBl1l905372884363176. html (discussing economist Robert Shiller's forecast of the housing market). Homeowners borrowed money they could not repay, and lenders lent funds while ignoring credit and market risks. Ben Steverman & David Bogoslaw, The Financial Crisis Blame Game, BLOOMBERG BUSINESSWEEK (Oct. 18, 2008, 12:01 AM), http://www.businessweek.com/investor/content/ oct2008/pi20081017_950382.htm. Secondary market purchasers and investors overly relied on securitization, and regulators and credit rating agencies blessed the entire system in error, negligence, or both. See, e.g., Carol Ann Frost, Credit Rating Agencies in Capital Markets: A Review ofResearch Evidence on Selected Criticisms of the Agencies, J. ACCT., AUDITING, & FIN. (forthcoming 2006), available at http://ssm.com/abstract-941861 (analyzing the criticism of the credit rating agencies); John Patrick Hunt, Credit Rating Agencies and the "Worldwide Credit Crisis": The Limits of Reputation, the Insufficiency of Reform, and a Proposalfor Improvement, 1 COLUM. Bus. L. REv. 109, 114 (2009) ("It is not plausible to argue that rating agencies have a valuable reputation for rating instruments they have never rated before."); Robert T. Miller, Morals in a Market Bubble, 35 U. DAYTON L. REv. 113, 136 (2009) ("Alan Greenspan and his colleagues on the Federal Open Market Committee made some mistakes in the early years of this decade by keeping interest rates very low for a very long time."); Randolph C. Thompson, Mortgage Backed Securities, Wall Street, and the Making of a Global FinancialCrisis, 5 AM. U. Bus. L. BRIEF 51, 53 (2008) (providing an overview of the "misguided confidence in these debt instruments."); Jeff Madrick, How We Were Ruined & What We Can Do, N.Y. REV. OF BOOKS, Feb. 12, 2009, available at http://www.nybooks.com/articles/archives/2009/feb/12/how-we-were- ruined-what-we-can-do/ (providing an overview of the securitization and the financial crisis); Ronald Colombo, A Crisis of Character, HUFFINGTON POST (May 12, 2009, 4:58 PM), www.huffingtonpost.com/ronald-j-colombo/a-crisis-of-character_b_202562.html (lamenting the erosion of morals in the modem economy). 2. In a normal housing market, pushing foreclosures through quickly is in a lender's best interest. But in a depressed market, lenders have discovered that a foreclosure with a low prospect of a quick resale actually causes them to lose money. In 2009, lenders canceled up to 50% of foreclosure sales in some