Foreclosure sales

H. Thomas – Foreclosing on the neighborhood

Foreclosing on the neighborhood: Organized irresponsibility inforeclosure sales

Hannah Thomas, Ph.D., Abt Associates

Abstract

The foreclosure crisis presents an interesting problem. Foreclosures, if sold in the manner of a regular home sale, should not cause a marked difference in either the price that they are sold for, nor who they are sold to. Nor should their sale create secondary negative outcomes in the neighborhoods, towns and cities where they are sold. And yet the data and research over the last twenty years has documented a series of market distortions and negative outcomes associated with foreclosures and foreclosure sales. These market distortions and negative outcomes range from lower sales prices for foreclosed properties and neighboring properties (Haider and McGarry 2005; Immergluck 2010; Mallach 2010; Immergluck 2011), to increased investor purchase of foreclosed properties, to higher rates of vacancy and crime in the vicinity of the foreclosure (Haider and McGarry 2005; Immergluck and Smith 2006; Immergluck and Smith 2006; Immergluck 2010; Mallach 2010),. These outcomes impact the longer-term trajectory of the neighborhood(Li and Morrow-Jones 2010).

Data point to the important role of the institution conducting the sale. Immergluck and Smith found that Federal Housing Authority foreclosures did not have a statistically significant impact on the prices of neighboring properties (Immergluck and Smith 2006b). The identified differencein those sales was the institution selling the properties, suggesting that differences in institutional foreclosure sales practices may create the negative spillover effects in neighborhoods. Yet despite the important role that the mortgage servicer plays, cities and towns have been stymied in their capacity to assign responsibility to any entity in seeking to recover the costs of poorly managed foreclosure sales.

Using data from Boston, this paper will argue that both the increased risk to the community from a foreclosure sale, and the inability of municipalities to assign responsibility emerge from the problem of organized irresponsibility – the phenomenon of a complex system where no one is in charge. The paper will explore the role of the organizations involved in the foreclosure sale focusing particularly on the mortgage servicer and their loss mitigation and asset managementpractices (including protocols, organizational arrangements and decision-making). With foreclosures continuing apace, understanding the organizational ecology of those involved in the foreclosure sale process provides important insights that can help fine-tune existing policiesand suggest new policies to prevent the loss of community assets as a result of foreclosures.

Introduction

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The foreclosure crisis presents an interesting problem. Foreclosures, if sold in the manner of a regular home sale, should not cause a marked difference in either the price that they are sold for, nor who they are sold to. Nor should their sale create secondary negative outcomes in the neighborhoods, towns and cities where they are sold. And yet the data and research over the last twenty years has documented a series of market distortions and negative outcomes associated with foreclosures and foreclosure sales. These market distortions and negative outcomes range from lower sales prices for foreclosed properties and neighboring properties (Haider and McGarry 2005; Immergluck 2010; Mallach 2010; Immergluck 2011), to increased investor purchase of foreclosed properties, to higher rates of vacancyand crime in the vicinity of the foreclosure (Haider and McGarry 2005;Immergluck and Smith 2006; Immergluck and Smith 2006; Immergluck 2010;Mallach 2010). These outcomes impact the longer-term trajectory of theneighborhood(Li and Morrow-Jones 2010).

This paper will present data from an institutional ethnography showingthat it is the loss mitigation and asset management practices of the mortgage servicer that create these distortions and negative outcomes.The negative outcomes and market distortions actually end up harming not only the community surrounding the foreclosure, but also the mortgage servicer and mortgage-backed securities investors by reducingthe sale price of future foreclosure sales in the neighborhood, and increasing the risk of damage to properties currently in the foreclosure process.

This seems counter-intuitive and leads to the question: Why do servicers employ loss mitigation and asset management practices that distort the market for foreclosure sales and potentially harm their and their clients’ future asset interests? The answer, I will argue, is due to a phenomenon known as organized irresponsibility. Organized irresponsibility is the process wherein discrete decisions made by individuals operating within organizations that are part of a larger system result in negative outcomes for the system (or society) for which no one can be held responsible. When a system is characterized by organized irresponsibility it is harder for municipalities, states,federal governments, mortgage backed security investors and other injured parties to levy fines or hold any one individual organization responsible. As Hannah Arendt put it “no-one is in charge!”

Organized irresponsibility in the foreclosure sales market is characterized by the transfer of risk away from organizations. Organizational decisions to manage and limit risk exposure in the

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foreclosure sales market, i.e., the distressed property disposition market, drive decisions by a servicer about how a property is managed,how contracts are written, and, ultimately, who is positioned to buy the property. Risk is transferred away from organizations able to isolate and protect themselves from risk, while that risk concentratesat the neighborhood level. New risks emerge as attempts to control risk by organizations in the system (e.g. servicer) interact with neighborhood character and create problems for a neighborhood in the absence of any state regulation or intervention. This creates a foreclosed property marketplace laden with financial potholes for a buyer and potentially negative costly outcomes for a neighborhood. Borrowing from Jacob Hacker, I call this process “risk shift” (Hacker 2006).

This pattern of risk shift has a distinct geographic pattern. Organizations with the power over decisions that impact foreclosure sales are national or even international, while the communities to which risk is shifted are local. Actors within organizations, such asthe servicer, make decisions aligned with the structured incentives ofthat organization. For organizations with power, in the case of the foreclosure sale, those incentives are to ensure maximum profit or, atleast, to minimize losses and ensure future business. Oriented towardsglobal capital markets, the stakeholders responsible for decisions over how a foreclosing or foreclosed property should sell are focused on minimizing portfolio losses and maintaining large operations. Localreal estate markets do not function in ways that fit with large administrative bureaucracies managing foreclosure sales en masse. Local real estate markets require flexibility and responsiveness to the potential buyer and to the distinctiveness of any particular property and neighborhood. The interaction between these two differently oriented systems creates frictions that manifest as new orshifted risks within the system.

These risks created as friction in the disposition of foreclosed property between the needs of global securities markets for large-scale transactions and local real estate markets focused on individualproperties are externalized and dumped at the local neighborhood level. The neighborhoods most vulnerable to these risks tend to be where foreclosures are concentrated, neighborhoods that have a long history of post-World War II capital abuses from redlining to targetedsubprime and predatory mortgage lending. These risks are above and beyond the risks already absorbed by public and private stakeholders in the foreclosure process and arguably would be unnecessary within a

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differently structured credit market. Figure 1 illustrates the processof this risk shift.

Figure 1: Risk shift in foreclosure sales

Source: Developed by the author.

The following paper will first review the documented market distortions and negative outcomes resulting from how foreclosure salesare conducted and then turn to the literature on organized irresponsibility. Drawing on data from an institutional ethnography of foreclosure sales in Boston, it will then look at the asset management and loss mitigation practices that lead to these market distortions. The following section will seek to answer the question ofwhy the mortgage servicer, a key stakeholder responsible for the assetmanagement and loss mitigation practices that lead to market distortions, operates in the ways that it does. Finally the paper willexplore how these practices are a manifestation of organized irresponsibility and what policy makers might do about it.

Foreclosures, foreclosure sales and negative impacts on neighborhoods

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Foreclosures often negatively impact individuals and families living in or owning foreclosed properties (Nettleton and Burrows 1998;Nettleton and Burrows 2000; Nettleton 2001; Nettleton and Burrows 2001; Ernst, Keest et al. 2006; Ellen, Schwartz et al. 2009; Bradbury,Burke and Trieste, 2013; Thomas 2013). In addition, they can also increase the risk for a variety of negative impacts on neighborhoods and community assets where the foreclosures occur (Haider and McGarry 2005; Immergluck and Smith 2006; Immergluck and Smith 2006; Campbell, Giglio et al. 2009; Center for Responsible Lending 2009; Coulton, Schramm et al. 2010; Buitrago 2011; Ergengor and Fitzpatrick 2011; Simon 2011). In this section I will review the literature on the relationship between foreclosures and neighborhood externalities, whatI call negative neighborhood outcomes, over the short- and long-term and then outline gaps in understanding the mechanisms that lead to these negative impacts. I make the case that the organization of the sales process plays a role in creating many of the neighborhood externalities seen in some neighborhoods hard hit by foreclosures. Throughout the literature review I will refer to foreclosures instead of foreclosure sales, since the literature uses foreclosures rather than breaking out particular sub-categories of the types of sale, an important oversight in helping us understand the dynamics at play.

Short term negative impacts on the neighborhood The evidence that foreclosures lead to negative neighborhood

impacts stems back to at least the 1970s. In the 1970s problems with the FHA 235 program1 led to vacant and abandoned properties because of foreclosures (Immergluck 2010).2 Short-term negative impacts pointed toin the literature include discounted sales prices, increased vacancy rates, and an increased likelihood of violent crime in the vicinity (Haider and McGarry 2005; Immergluck and Smith 2006; Immergluck and Smith 2006; Immergluck 2010; Mallach 2010; Mallach 2010; Immergluck 2011). Additionally, investor-buyers have strong interest in 1The FHA 235 program was a Federal Housing Authority program designed to lowerbarriers to homeownership by providing insurance for private lenders to lend in inner-city areas. The program fostered an unregulated mortgage lending environment in which unscrupulous developers sold poorly rehabilitated buildings to minority families. Those families unable to afford the work needed on these buildings often ended up in foreclosure. The program further helped to segregate America’s cities Gotham, K. F. (2000). "Separate and Unequal: The Housing Act of 1968 and the Section 235 Program." Sociological Forum 15(13-37). 2Unfortunately, no data seem to be publicly accessible on the impacts of the Savings and Loans induced foreclosure crisis of the late 1980s and early 1990s.

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foreclosed properties but research suggests investor-buyers are more likely to leave properties vacant or be poor landlords (Immergluck 2011). This can be harmful to the neighborhood. The following section reviews each of these short-term negative impacts on the neighborhood.

Foreclosed property price discounts. A majority of studies that look at the impact of foreclosures, focus on price changes resulting from foreclosures. Studies generally find that foreclosed and distressed properties sell at a discount (Haider and McGarry 2005; Immergluck 2010; Mallach 2010; Immergluck 2011) or do not appreciate as much as the properties that surround them (Pennington-Cross 2006). Obviously, house price trends are sensitive to the temporal context of the housing market and to the spatial characteristics of the neighborhood where the foreclosure occurs. In the current crisis, most researchers have found significant price discounts for foreclosure sales, though most analysis has been on REO properties rather than on short sales orauctions. These studies have not controlled for geographic heterogeneity. However, a 2012 study re-examining foreclosure data found that controlling for geographic heterogeneity using a fixed effects model substantially reduced the price discount from the foreclosure itself (Gerardi, Rosenblatt, Willen and Yao, 2012). This paper found that price discounts were greater for properties that werevacant, and properties that were lender owned and in below average condition. Conversely lender owned properties in above average condition saw positive effects from the foreclosure sale. The authors of the paper consider different interpretations of these findings, including that foreclosures may drive down prices from an oversupply, and that reduced investment in the property by lender owners may also drive down prices.

Since we are looking primarily at Boston, understanding the property discount rate in the context of a market full of multi-familyproperties is very important. A 2010 study by the Federal Reserve Bankin Boston examined REO sales discounts in Massachusetts (Lee, 2010). Lee found that 33 percent of REO sales in Massachusetts were small multi-family units and that these properties spent longer on the market than single-family and condominium REO properties. Importantly,small multi-family unit REOs, compared with equivalent regular sales, experience greater price differentials (40.6 percent) while single family (19.9 percent) and condominium (29.2 percent) REO properties have smaller differentials. However, these numbers do not take into account the physical state of the property itself or other confoundingvariables to ensure that we are comparing apples to apples. Using a composite model, Lee found that holding all things equal, a small-

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multi-family REO sale in Massachusetts experiences a 4.6 percent discount, the largest discount of all properties in Massachusetts examined in this paper (Lee 2010).

Little writing exists trying to explain these notable price discounts. Some articles point to the neighborhood itself as a confounding factor in the price discounts experienced (and presumably other negative outcomes). Higher REO price differentials are experienced in neighborhoods that have a higher likelihood of foreclosure as determined by a higher share of high-cost loans, higherminority population, and lower income. These studies do not, however, explain the mechanisms in play that lead to the price discounts. This is surprising since case law on foreclosure auctions has developed in an attempt to prevent “price chilling,”-pricing property lower than its value-from occurring in the auction process.

Neighborhood spillover effects. Non-foreclosed neighboring property values arealso impacted by foreclosed and distressed property sales in a processknown as the “foreclosure spillover effect” (Rogers 2010). There is some disagreement about the dollar amount of the foreclosure spillovereffect or the marginal effect, given the potentially non-linear natureof the effect (Shlay and Whitman 2006). Controlling for confounding factors with econometric modeling, the effects demonstrated on surrounding property values from a foreclosure ranged from 0.9 percent(Immergluck and Smith 2006; Rogers 2010) to 8.7 percent (McKernan, Ratcliffe et al. 2009). Increased distance from the foreclosure in time and space reduced the marginal effect in most of the studies (Mikelbank 2008; Schuetz, Been et al. 2008; McKernan, Ratcliffe et al.2009; Rogers and Winter 2009) and early foreclosures seem to have a greater impact than later foreclosures (Been 2008).

Mechanisms of negative externalities from foreclosures. Most of the focus on the question of the foreclosure spillover effect has been on refining models to gauge the dollar losses in a neighborhood. Less effort has been put into examining the mechanisms leading to spillover effects. The primary assumed mechanisms are neighborhood blight from the foreclosure, a glut in the supply of properties on the market, and problems with valuation in the neighborhood (Haider and McGarry 2005).For example, the fact that foreclosed buildings might be more often abandoned or vacant could be at play in creating price discounts. Shlay and Whitman (Shlay and Whitman 2006) found a $7,627 price decline for regular properties with abandoned buildings neighboring them in Philadelphia. Whittaker and Fitzpatrick (2011) found vacant properties reduced surrounding properties’ values by 1.4 percent.

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Large numbers of properties coming onto the market potentially increase the supply of houses for sale, leading to lower prices for the property. Interestingly, in the literature these negative impacts are accepted as inevitable without questioning whether there might be problems in how the property is sold that could be rectified to prevent such negative externalities from occurring in the first place.

Pointing towards the question of whether such negative externalities are necessary, Immergluck and Smith (2006a) found that who the foreclosing lender is has some impact on the negative marginaleffect of the foreclosure on neighborhood property values. They found that Federal Housing Authority (FHA) foreclosures have no significant impact on property values in neighborhoods, while foreclosures with conventional mortgages do.3 This finding suggests that the foreclosure process and sale proceeds may differ by type of lender, perhaps because of internal process and policy, pointing to the possibility that institutional factors may play an important role in whether thereare negative externalities from a foreclosure sale.

The lack of research in understanding why the price of foreclosure sales is discounted and why the foreclosure spillover effect differs by lender, points to a need to better understand the foreclosure sale process. Indeed, Immergluck and Smith’s work reveals that FHA foreclosures do not have significant impacts on neighborhood property values suggesting the importance of the organizational structures involved in managing the foreclosure sale.

Increased rates of crime. There is some limited evidence that foreclosures are linked to increases in crime (Immergluck and Smith 2006). The hypothesized link between foreclosures and increased crime is that foreclosed properties are more likely to be abandoned and vacant leading to negligence and unchecked decay, i.e. the “broken window theory.” According to this theory, abandoned and vacant buildings offer signals of neighborhoods experiencing social disorganization (Shaw and McKay 1942; Sampson and Groves 1989). Social disorganizationtheory posits signs of disorder, such as vacant buildings, signal disinvestment and lead to migration, residential instability (Shaw andMcKay 1942; Sampson and Groves 1989; Sampson and Raudenbush 1999), increased segregation (Krivo, Peterson et al. 2009), and lack of social cohesion. With fewer “guardians” of the streetscape (Jacobs 1961) and markers of lower social cohesion, crime is more likely to

3 Federal Housing Authority mortgages are mortgages made typically to borrowers who do not qualify for conventional private market financing. FHA mortgages are those insured by the Federal Housing Authority to protect private lenders from risk of default loss.

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occur. In the case of foreclosure sales, vacant and abandoned buildings act as a marker of lower social cohesion, as well as fewer eyes on the street, offering more opportunity to create spaces for illegal and dangerous activities.

Higher rates of investor-buyers. Research has found that in the most recent crisis there were a high number of investor-buyers active in the foreclosure sales market, particularly REO buyers (Immergluck and Smith 2006; Newburger 2010). The investor-buyers are often seen as a potential problem by policy makers because in some markets they are liable to either flip a property for a quick profit while making no repairs (Mallach 2010; Ergengor and Fitzpatrick 2011) or to hold the property and keep it vacant instead of finding tenants or reselling toan owner-occupant (Immergluck 2011). Indeed, Mallach points to the negative impacts accruing from foreclosures as being transitory if an owner-occupant purchases the property. However, where an investor purchases the property, Mallach suggests negative impacts can be longer term and more entrenched, depending on the intentions of the investor buyer (Mallach 2010).

In general, researchers and policy makers have thought that owner-occupants increase the stability and social capital built in a neighborhood; although, some research challenges this finding (Dietz and Haurin 2003). Thus, policy goals, especially in Boston, have tended towards increasing owner-occupant homeownership. In Boston, where the housing market has been “hot,” the foreclosure crisis and consequential drop in housing prices in some neighborhoods created an opportunity for families that might not otherwise have been able to afford homeownership to purchase. However, the combination of active investor-buyers and constraints in mortgage financing from conventional lenders meant that owner-occupant buyers have had less success than policy makers might have hoped. Active investor-buyers have been pushing community development corporations and other affordable housing developers out of the market, a challenge seen in deploying Neighborhood Stabilization Program funds (Newburger 2010).

Social capital and foreclosures. Less research has been completed on the impactsof foreclosures and foreclosure sales on neighborhood social capital. By social capital I mean “the collective value of all "social networks" [who people know] and the inclinations that arise from thesenetworks to do things for each other ["norms of reciprocity"].”4 The

4 Definition taken from the Harvard Kennedy School of Government website: http://www.hks.harvard.edu/programs/saguaro/about-social-capital Accessed January 10, 2014

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http://www.hks.harvard.edu/programs/saguaro/about-social-capital


literature on social capital has attempted to operationalize measures of social capital; looking at civic engagement such as voter turnout,trust in government, hours volunteering, or attendance at social clubs(Putnam 2000). We know that foreclosures result in lower rates of trust in institutions, such as banks, for those who lose their homes to foreclosure (Ross and Squires, 2011) but no study has examined the impact on trust in government institutions. We also know that foreclosure sales result in disrupted relationships and networks in the neighborhood; for example, school attendance (Been et al 2011) andschool performance (Bradbury, Burke and Trieste 2013). We also know that foreclosure and foreclosure sales mean that people, both owners and tenants of foreclosed buildings, must leave the neighborhood, reducing the number of eyes that are physically able to watch the street. The hypothesized link between increased crime rates and foreclosed properties is that there is lower social cohesion in neighborhoods experiencing foreclosure because residents must move out; as a result, fewer people are then living in the neighborhood (Immergluck and Smith 2006). Recent research demonstrates a link between high foreclosure neighborhoods and lower voter turnout in the 2008 elections (Estrada and Johnson 2012).

Long-term neighborhood change and foreclosures Short-term negative neighborhood impacts have effects in the medium and long term, yet forecasting those long-term impacts is difficult. Within the extensive neighborhood change literature few studies have looked at the overall medium- to long-term change at the neighborhood level resulting from foreclosures or how foreclosures are disposed or sold. In the medium-term, Coulton, Schramm and Hirsh (2010) looked at data for Cuyahoga County, Ohio, (Cleveland), which experienced an increase in foreclosures much earlier than the rest of the country, peaking in 2007. By February 2010, about half of the properties that had left REO status between 2004 and 2009, but had been sold originally as REO in the lowest price bracket, were vacant and delinquent on taxes. This was double the rate of the overall group, inwhich about one quarter of the REO sales were vacant or tax delinquent.

Preliminary analysis of foreclosure sales in Saint Louis County, Missouri, found properties with a foreclosure more likely to have had one or more foreclosures in the previous five years (Rogers and Winter2009). Increased risk of future foreclosures in properties and neighborhoods that are currently experiencing foreclosures and associated foreclosure sales will possibly impact the longer term

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trajectory of the neighborhood, creating a continued cycle of negativeimpacts such as vacancy and depressed property prices.

Work by Li and Morrow-Jones (2010) attempted to better understandthe longer term impacts of foreclosure on neighborhood change. Using foreclosures that occurred between 1983 and 1989 in Cuyahoga County inOhio, they assessed longer term impacts evident between 1990 and 2000 in high-foreclosure neighborhoods. They found that foreclosures increased the proportion of black households, female-headed households, and households experiencing unemployment in a neighborhood(census tract). Unexpectedly, they also found that certain inner-city neighborhoods, shown as high foreclosure areas in the initial data, had experienced an increase in the median income of households in the neighborhood; while median income in the other high foreclosure neighborhoods had decreased. Li and Morrow posit the existence of two different types of neighborhoods: Type 1, where longer term changes included an increase in black, female-headed and unemployed householdsbut with an increased median income; and Type 2 neighborhoods with an increase in black, female-headed and unemployed households with an associated decline in the median income. They suggested redevelopment and gentrification in the 1990s in Type 1 neighborhoods the likely explanation for the increase in median income of these particular neighborhoods, even though the proportion of black female-headed and unemployed households increased. This suggests that Type 1 neighborhoods might have experienced an increase in inequality.

Li and Morrow-Jones note that who moves into the neighborhood after foreclosures impacts the direction the neighborhood takes. And, who decides to move into the neighborhood is directly affected by who initially buys the properties at foreclosure (investor-buyers, milker,5

rehabbers, flippers or holders, governments, lower income or higher income owner-occupants) and the sale process itself (length of time before sale, marketing of property, maintenance of property, etc.).

Costs to cities Foreclosures cost cities needed funds. Tax delinquency associated withforeclosures (negligent investor buyers, or abandoned properties) impacts the city funds that are available to flow back to the neighborhood to mitigate other negative impacts from foreclosure and influences the funds available to flow into community assets such as

5 A milker is an investor who buys a property, does not rehab it at all, and rents it out, milking the rent from the property without improving it at all. In other words, a milker is a slumlord Mallach, A. (2010). Meeting the Challenge of Distressed Property Investors in America's Neighborhoods. New York, LISC.

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public schools. Moreover costs accrue to the city and taxpayers as a result of mitigating the negative impacts associated with foreclosure.A study in Boston attempted to document the dollar cost of foreclosure-induced vacant properties and associated increases in crime to the city; it pegged the dollar amount per property somewhere between $157,000 and $1 million (Simon 2011). A General Accounting Office (GAO) report from 2011 also documented the costs for cities andcommunities that have increasing numbers of vacant properties throughout the country (GAO 2011). For example, between 2009 and 2011 Detroit spent $20 million to destroy 4,000 vacant foreclosed properties. Recent news reports that cities are attempting to find ways to reclaim some of those costs.6

SummaryIn summary, foreclosures and particularly foreclosure sales impact community assets in several ways:

1. Neighborhood quality – neighborhood safety (rate of property and violent crime) and racial and socio-economic diversity reduces as crime increases and neighborhoods become either gentrified or more low-income. Indicators of social cohesion decline as measured by the visual landscape of the street.2. Housing prices – foreclosure sales diminish the collective value of housing and as a result impact the collective property tax resource base for the city. 3. Housing stock deterioration – the collective value of the physical housingstock in the neighborhood deteriorates as an increase in abandoned properties occurs. 4. Social capital – relationships between residents are interrupted as residents (owners and tenants) must leave the foreclosed buildings in order for a foreclosure sale to proceed. Buildings sit vacant for sometimes years with a smaller number of families living in the neighborhood, visiting businesses, and using neighborhood amenities. Trust deteriorates and civic participation declines.5. Fiscal costs – community and city financial resources are strained in managing the costs of mitigating the impacts of foreclosure sales.

Passing the Buck: Organized Irresponsibility and Risk Transfer

6 The City of Richmond is attempting to prevent the cost of future foreclosures by using eminent domain to purchase mortgages and write down the cost of the mortgage to the real value.

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Foreclosure sales offer an example of a system characterized by organized irresponsibility. Organized irresponsibility is the process when a system produces risks that cannot be tied back to any one organization or individual. Hannah Arendt describes this form of poweras the most “tyrannical” of all since no-one can be held accountable(Arendt 1998). Nobody is in charge! A number of scholars have pointed to organized irresponsibility emerging within different systems, particularly the environmental hazards emerging from industrial production (Alario 2000; Beck 1992, 2007; Crotty and Crane 2004). Sassen, without referring to the term organized irresponsibility, has documented how complicated forms of financial investment instruments, such as derivatives, create their own new level of risk resulting fromthe network of highly leveraged investments which are at the core of derivative products (Sassen 2009). But none have explored the process of how organized irresponsibility actually emerges within a system. This lack of conceptual clarity in understanding the mechanisms of organized irresponsibility provides few levers to develop policy.

Organizations are critical in the distribution of risk. Risk produced by an organization is often transferred away from that entitytowards another. Thus organizations “are both centres for processing and handling risks and potential producers and exporters of risk”(Hutter and Power 2005). Institutional contexts, social milieus and organizational cultures of risk-taking impact how organizations construct, perceive and manage risk (Hutter and Power 2005; Vaughan 1996). Individuals operating within organizations don’t always understand the risks they are undertaking, or how their actions will produce risk (Hutter and Power 2005) because they are isolated from understanding the full context of the organization, and also the system the organization is operating in (Vaughan 1996).

In any system or institution there are multiple entities as sitesof decisions about risk exposure and management. Risk is continuously being created, processed and moved around. Inevitably these risks accumulate in one place more than another and unintended and unforeseen consequences result. But there is often no one clear party to hold accountable when something goes wrong. And so emerges the concept of “organized irresponsibility”: the risks are nobody’s responsibility (Beck 1998).

Method and data As outlined earlier in the paper, two key questions guide this paper. Specifically, what about the structure of the mortgage finance market is driving foreclosure sales to create negative outcomes in

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communities? And then, what can we do about it? The paper draws on research conducted for a larger study that focused on seeking to understand the systemic reasons for increased risk in neighborhoods asa result of foreclosure sales. The following section provides details on the methodological approach of the study, and the data used for this paper.

Institutional ethnography The data used in this paper was gathered using the methodological approach of institutional ethnography. As well as understanding the experiences of informants, institutional ethnography seeks to understand the complex set of social relations7 within an institution (in this case the foreclosure sales market), including economic and social relationships between stakeholders such as workers inside bureaucracies, professionals, and legislators. Institutional ethnographers locate themselves as having a principal interest in the structure of ruling relations of institutions. Ruling relations are those social relations in power that structure how institutions operate. At the same time, the methodology offers a practical understanding of how institutions and actors interlink, revealing the often unintended consequences of rules and regulations within institutions, making it an ideal approach to understanding ways policycan be effective (or not) (Carroll 2006). The purpose of institutionalethnography is not to generalize about a group of people, but instead to find and describe social processes that have generalizing effects (DeVault and McCoy 2006) (18). The larger study that this paper draws data from sought to understand the social relations of the housing finance system that created negative outcomes from foreclosure sales.

Data analysis: Between grounded theory and institutional ethnography Data for this paper was analyzed merging the approaches of grounded theory and institutional ethnography. Grounded theory offers a rigorous approach to qualitative research. Pioneered by Glaser and Strauss (1965), the defining elements of a grounded theory approach include: simultaneous involvement in data collection and analysis, constructing analytic codes and categories from data, using constant comparison during each stage of the analysis, advancing theory development during each step of data collection and analysis, memo-writing to elaborate categories, specify relationships and identify gaps, theoretical sampling, and completion of the literature review

7 Social relations are the set of structural power relationships between organizations and individuals within a social system. See Smith, D. (2005) fora more in depth discussion.

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after developing an independent analysis (Charmaz 2006) (5-6). Grounded theory is well suited to institutional ethnography according to Dorothy Smith, who developed the concept of institutional ethnography in the 1980s and who notes that analysis should be concurrent with data collection to follow trails and markers from interviews and observations that will allow data and fact checking andgive the researcher an increasingly in-depth and complete picture of institutional relations (Smith 2006).

I modified this grounded theory approach to meld with the approach of institutional ethnography. Before beginning to code in Nvivo (the qualitative software package used for this research), I diagrammed the organizations, decisions and social relations involved in each sales process on a large piece of paper along with their relationship to the neighborhood.8 While drawing this map, I wrote memos to articulate different patterns observed in the different sales. With this map established as my basis for understanding the complex set of social relations described in the data, I began to codethe first few interviews in Nvivo using a grounded theory approach, starting with full coding of the entire interview to develop emergent codes. I then used Nvivo to develop out key framing codes which included organizational entities, relationships of power, the different sales, discussions of neighborhood, and discussions of risk.Within each of these codes I drew in the emergent codes and developed out more code categories to deepen the analysis. As the coding progressed, I cycled between coding and memoing within the qualitativesoftware package Nvivo (di Gregorio 2003).

Data sources The data used for this paper was drawn from a wide variety of sources between the period January 2009 and December 2011, including: interviews, observations, textual analyses, Boston sales data, and industry organizational data. A total of 47 interviews were conducted.These included interviews with 26 real estate agents, three real estate lawyers, three foreclosure auctioneers (and an additional threeconversations with auctioneers in the field), four investors, five owner-occupant buyers interested in foreclosures, one non-profit staffperson, and two servicer employees. Other sources of information

8 Institutional ethnographers still lack an appropriate software to provide this level of mapping for their data analysis. I have since discovered Prezi to be a useful tool. However, at the time of initial mapping I was not aware of this software’s potential to be used in this way. Nvivo’s mapping section is limited and not useful for the kind of detail necessary in the mapping endeavor.

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reviewed and analyzed included: short sale, auction and REO sales contracts, marketing materials for foreclosure sales, Multiple ListingService (MLS)9 listings for foreclosure sales, and training materials for real estate agents in general and specifically for foreclosure sales. Field observations were conducted of eight foreclosure auctions, the daily work of an REO real estate agent and three City ofBoston “Buying a Foreclosed Property” classes, and an online training provided for real estate agents on short sales by the National Association of Realtors.

Quantitative data was purchased and examined for all foreclosure petitions in Jamaica Plain and Dorchester zip codes for 2008 supplemented by pulling a sample of 150 petitions to examine subsequent sales data, specifically, whether investors purchased the property and how many times the property was sold after the auction. Data were also collated and analyzed from industry publications such as Inside Mortgage Finance to provide context (scale and business volumes) for each of the different types of organizations involved in the foreclosure sales process. Table 1 summarizes the data drawn on inthis study.

Table 1: Data sources

Type of Data

Type of Foreclosure Sale

Data Sources GeographicRelevance

Interviews REOAuctionShort sale

Real estate agentsAuctioneersLawyersBuyers (investors and owner-occupant)Non-profit employeeMortgage lenderServicer employee

Boston

Sales data REOAuctions

Warren Group dataCity of Boston Foreclosure report data

Dorchesterand Jamaica Plain

Observation REO Auction sales Greater 9 Multiple Listing Service (MLS) is a real estate advertising and marketing company. It provides an online database of all property for sale by real estate agents in the United States. It also includes information about past sales of properties.

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AuctionShort Sale

REO property managementProperty open housesCity of Boston classes

BostonDorchester, JPBoston

Real EstateAgent training materials

REOShort Sale

Online Short Sale trainingReal Estate Agent training materialsForeclosure Sale training material

MassachusettsNational

Sales documents

REOAuctionShort Sale

REO Purchase and Sale contract

Auction sale contract

Short sale Purchase and Sale and Offer contracts

MLS listings

Auction websites and brochures

DorchesterJamaica Plain

Inside Mortgage Finance Data

Servicer industryWall Street InvestorsTrustees

Annual statistics National

Census Bureau data2010

Neighborhood data

Housing Vacancy rates Census tractNational

The approach of drawing on multiple sources of data provided a rich and multi-faceted way to understand foreclosure sales. In collecting data, standard sociological practices for ethnographic observation (Maanen 1988; Emerson, Fretz et al. 1995; Preissle and Grant 2004; Lofland, Snow et al. 2006) and in conducting semi-structured recorded interviews (Weiss 1994; Corbin and Morse 2003; Warren, Barnes-Brus et al. 2003) were drawn upon.

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BostonTwo neighborhoods in Boston were used to explore how foreclosure salesare sold and to look at the ways that organizations interact in the sales process. The goal was to reveal the social processes and relations that structure the sales process, in order to give insights,both theoretical and policy related, into the real potential for socially undesirable outcomes to occur at the neighborhood level as a result of these particular sales.

Boston and specifically two neighborhoods in the city – Jamaica Plain and Dorchester – were selected as the site for this study for mostly practical reasons, related to access and the author’s existing relationships with key stakeholders. Previous research conducted in Boston by the author also provided an additional important perspectiveon the problem of foreclosure sales.

Theoretically Boston is an interesting city for study. It is located on the east coast of the U.S. Its 2010 population was 617, 594, having grown 4.8 percent since 2000. Fifty-three percent of the city’s population is non-white, making it a majority-minority city. The greater Boston Metropolitan Statistical Area (MSA), a larger spatial entity that incorporates the surrounding counties including two New Hampshire counties, is 4.55 million, growing 3.67 percent from2000. This study will refer to the City of Boston rather than the MSA unless otherwise noted. Boston’s housing market is characteristic of a “hot” or desirable location, and yet this is despite experiencing urban industrial decline in the 1970s, characteristic of “old industrial cities,” like Pittsburg, Detroit and Philadelphia. Boston’scity-wide foreclosure rate of 0.4 percent, is low compared with some of these same old industrial cities, including Detroit’s at 1.5 percent (Realty Trac) and New Haven’s at 0.6 percent.

Boston has a recent history of large numbers of foreclosure sales, having seen a peak of foreclosure activity in the savings and loans crisis in the 1990s. The 1990s saw foreclosures and foreclosure sales dramatically increase to higher absolute numbers than currently documented.

In the most recent foreclosure crisis, foreclosures and foreclosure sales started to increase during 2005, rapidly reaching a peak in 2008, and bumping up and down between 2009 and 2010, mostly inresponse to systemic policy-related challenges to the foreclosure process, e.g., the Ibanez decision and robo-signing (see page 17 for details of these cases). The chart below, taken from the “City of Boston Foreclosure Trends” report, provides a graphic representation

18


of the current foreclosure crisis in Boston compared with the last foreclosure crisis in 1992.

Foreclosure deeds (completed foreclosure auctions) are predominantly located in the city neighborhoods of Dorchester, Roxbury, and Mattapan, East Boston and Hyde Park. These are neighborhoods that are lower-income than other parts of the city and with higher percentages of immigrants, African-Americans, Latinos and Asian-Americans. These neighborhoods also received a disproportionate share of subprime mortgages (Campen 2007) and were historically redlined in the mid-twentieth century. The city has designated certainareas of these neighborhoods as foreclosure hot spots with targeted investment and rehabilitation activity. The target hot spots are focused on streets with increased crime and concentrated foreclosures.10

Figure 2: Foreclosure deeds11 in Boston 1990 – 2011

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

0

200

400

600

800

1000

1200

1400

1600

1800

Source: City of Boston Foreclosure Trends report 2009.

Figure 3 shows the cumulative distribution of foreclosure deeds by census tract between 2000 and 2010. Clear clustering can be seen in10 http://www.cityofboston.gov/news/default.aspx?id=4206 11 Foreclosure deeds are completed foreclosure auctions where a lender has sold the property at auction and a completed foreclosure deed is recorded in the registry of deeds.

19

http://www.cityofboston.gov/news/default.aspx?id=4206


Roxbury, Dorchester and Mattapan in census tracts with a low percentage of white families – in other words, in neighborhoods of color. These neighborhoods experienced foreclosures during 2005-2006 at the very start of the foreclosure crisis, before other parts of thecity saw any increased foreclosure activity. They have also seen the greatest drops in house prices (Department of Neighborhood DevelopmentCity of Boston 2010). These neighborhoods rank in the top twenty zip codes in Massachusetts with the highest proportion of housing units inforeclosure. The experience of these high foreclosure neighborhoods isin stark contrast with that of low foreclosure neighborhoods in Boston.

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Figure 3: Cumulative foreclosure rate by census tract between 2000 and2010, City of Boston

Source: Warren Group Foreclosure Data provided by the Research Department, Department of Neighborhood Development, The City of Boston; US Census Data race by census tract Table Summary File 1 DP-1 2010 Census data.

ASSET MANAGEMENT AND LOSS MITIGATION PRACTICES THAT CREATE MARKET DISTORTIONS AND NEGATIVE NEIGHBORHOOD OUTCOMES

Before diving into the asset management and loss mitigation practices that create market distortions and negative neighborhood outcomes, I want to provide a brief flavor of how the foreclosure sales process unfolds. The first part of this section of the paper will review the foreclosure auction and the

21


REO sale. Then I will go on to review the specific practices thatcreate problems in the neighborhood.

Foreclosure sale process In each of the different types of foreclosure sales - short sale,auction, and REO sale -certain practices established by the mortgage servicer and by the real estate agent influenced the neighborhood’s community assets. These sales practices limit the pool of buyers, leading to preferences for investors, and lower sales prices while increasing the likelihood of vacancy in the property. The following section will review sales practices at foreclosure auctions and in REO sales, describing the ways that these sales practices can cause a loss of community assets.

Auction sales practices It is a cold, sunny day in Boston. Standing outside the house I watch as three men walk over to the lady auctioneer standing on thesidewalk outside the house everyone assumes is up for auction. Theyjoke and chat with one another as they sign up on her clipboard to participate in the auction. Two of the men, both in their mid-thirties, walk over to the front door of the house. The one with short cropped hair, in a dark jacket and jeans, takes a small flashlight and shines it in through the little window at the top ofthe door, straining on tiptoes to peer in. The second man walks down the steps to the side of the house to look at the electric meter. One of the other bidders, I do not catch who, asks which house is up for auction. The auctioneer clarifies that it is the house on the left. The other bidders start to mutter amongst themselves, obviously confused by this clarification since the listing shows a basement apartment that was clearly non-existent from looking at the house.

“You and Frank together today then,” the auctioneer says to one of the men milling around on the sidewalk. Then she quietly starts reading the deed of the property while standing on the sidewalk. She reads it very quickly out loud and I can’t understand what she is saying. An older man with a beard silently scans another document on his clipboard while she talks. The other men, all of them white, and in their 30s, three of them—one of them has dark sunglasses and short, gelled, dark blonde hair—mill around on the sidewalk, not completely listening, but they look like they are waiting for something, pacing around, turning in small circles. A black man with a cell phone and a hands-free ear piece gets out of a car that has just pulled up to the sidewalk while the auctioneer

22


continues to read the deed. He asks the white man with the sunglasses which property is being auctioned.

The woman auctioneer stops reading the deed and says “it goes on and on, and oh guess what I have…a municipal lien. March 29th $801 and 36 cents. I don’t know about condo association.” One man asks about this, but a bus drives by and I can’t hear the next minute. She says, “No questions? You guys know what you are doing.” And shemockingly remarks about how they will all drive away as soon as it is over. The men then move in tightly, huddling around her. She makes the opening bid, and the man with the blonde hair and dark glasses says “$330,000.” Then she says, “Going once, going twice, sold.” It takes maybe one minute. She stands close with the beardedman muttering with him and periodically calling him the bank. All of the men, except for the guy with blonde hair and dark glasses, walk away quickly back to their cars and drive off. The auctioneer,“the bank” and the highest bidder gather around the hood of the auctioneer’s car, signing paperwork. Five minutes later, the streetis empty again.”

Field Notes from a Dorchester Auction December 2009

The description of a foreclosure auction in Dorchester highlightsthe fast pace of the event, the insider knowledge of regular investor bidders, and the lack of transparency in the sale. Potential buyers cannot see inside the property. Listings and descriptions of the property may be inaccurate or misleading. A buyer must decide within a few minutes whether they will put in abid. Investors interviewed for this study described the extensivebackground work they conducted prior to the auction that allowed them to make such a snap decision. They also knew that if they bought the property and it turned out to be a dud, it was part ofa portfolio strategy that could absorb one or two failed properties. All of these qualities create a scenario that is intimidating for any newcomer especially a homeowner looking to purchase a low-priced property.

The foreclosure auction sale is not just intimidating, it isalso risky. Making a purchase at an auction is high-risk for the

23


buyer due to a number of clauses hidden in the paperwork of the auction sale and the parameters of the sale set by the mortgage servicer. These include: a deposit requirement, liability for thedifference in price between the first and second bidders at the auction, the “as is” clause, inability to see inside the property, a very short closing period, establishment of a price floor, and the forcing of seller (servicer provided) title insurance.

These strategies all reduce the risk of the servicer incurring additional costs that might eat into any returns gainedfrom the auction. Consequently, these strategies limit the pool of buyers at the auction sale to predominantly regular investors who can absorb that risk, and as a result it reduces the price and the likelihood that the property will be sold at auction. Ralph, an investor and auctioneer, described to me the kinds of risks involved in buying at an auction:

RALPH: I personally have been in a situation where the first time I ever bought a house at foreclosure…I was the high bidder, and I bid up…I couldn’tget the bank in there ‘cause I need to get an appraisal. The bank had to send the appraiser. People would not let the appraiser in. It took me three months. Every time I got an extension beyond the month, the bank charged me another $5,000. If I’d backed out, I would be losing 15 grand at that point,instead of five. So it takes nerves of steel, I think. And it’s not for the faint at heart…(emphasisadded). ‘Cause I’ve seen more than my fair share of houses…sold at auctions.People don’t know. It’s like a grab bag. You buy it and you look inside to see what you got. And when you finally get inside, you don’t want it. All the piping has been removed or the heating system. Or the sink has been running for the past three weeks, and now there’s mold. And all these kinds of crazy things, unexpected things that happen. And it just costs lots of money.

Consequently the risk is very high that the property will end up either as an REO property or investor-owned. These two outcomes lead to higher risks for vacant properties in the neighborhood as REO properties are usually vacant for a period, sometimes years, and investor-buyers of foreclosed properties tend to have higher incidences of vacancy (Immergluck 2011). Investor-buyers are also more likely to be problem landlords and to be delinquent on taxes (Coulton, Schramm et al. 2010).

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The sales practices at the foreclosure auction limit the number and type of potential buyers to mainly investor buyers, limits the potential price that may be garnered for the property,and increases the likelihood that the property will become a vacant bank-owned or REO property.

REO propertiesProfessionals like Ralph, working with foreclosure auctions, describe them as the riskiest deal of all foreclosure sales. Bank-owned sales are considered less risky and easier for the buyer to purchase. Homebuyers perceive this difference too, strongly preferring REO sales to buying at an auction. This does not mean that REO sales are not without higher levels of risk than a normal home sale. Bank-owned sales (REO or real estate owned sales) are those in which the servicer that has bought the property at the auction (essentially paying themselves money to close out the mortgage)12 now wants to sell the property. The advantage for the buyer of a bank-owned sale over a foreclosure auction is that the servicer has paid off all of the outstanding mortgage liens on the property. Thus the title of a bank-owned property is usually clearer than at a foreclosure auction, where the highest bidder must cover all outstanding liens on the property e.g., water bills, tax bills, etc. Buyers can also get inside REO properties to view them and see what they are buying. However, recent fiascos in the foreclosure process revealed in USBank vs. Ibanez and the robo-signing scandal (see page 17 for a detailed description of these cases) still make buying an REO property a risky proposition. Challenges to title from servicer mistakes can invalidate REO sales years down the line and the automated nature of the process in large servicers makes these mistakes more likely.

Once a property becomes bank-owned, the servicer moves the property from the loss mitigation department to the asset management department and assigns it an asset manager. The asset manager’s goal is to sell the property as quickly and for as much12 One investor noted that she is seeing more cases of the bank buying the property back at “full debt” where the opening bid is the full amount of the debt owed to the bank. She surmised that this has been since the bail-out where the bank may be able to write off losses incurred at the foreclosure auction and gain some benefit through the bail-out.

25


money as possible. Many servicers, or lenders, in the 2007-ongoing foreclosure crisis are contracted with third party asset management companies to manage the process of disposing of REO properties. This has the added advantage of reducing liability exposure for the servicer by having an entity that is now responsible for managing the property and any liability suits that might come up, for example, a tenant who sues as a result ofan injury obtained from a damaged part of the property. Asset management third party entities also allow the servicer to quickly add capacity.13 Third party standards appear to be low-quality, as evidenced by complaints made by Fannie Mae representatives in a Senate Committee hearing in 2010. Whether itis the servicer or the third party, the representative asset manager contracts with a real estate agent to manage and maintainthe property until it is listed for sale.

By the time the property has moved into and through the REO process, the foreclosure could have taken up to four years (oftenas a result of mistakes in the foreclosure process). The REO property is sold in two ways that increase the risk for the neighborhood. The first is the servicer prefers that the propertyis sold empty and so tenants of the building are offered cash-for-keys to leave the property. For the servicer a vacant property is less of a risk. A vacant property reduces complications for the sale of a property as many institutional buyers prefer vacant properties. Tenants also mean liability, forexample if a tenant breaks a leg on a broken stair. But this leaves the property vacant and susceptible to all the associated problems such as an increase in crime and property deterioration.The second factor that increases risk for the neighborhood is themultitude of requirements in the contract and sales process that make it a risky prospect for an individual owner-occupant or small time investor buyer. The property is thus more likely to end up in the hands of a larger investor. While this is not necessarily always a bad outcome for the neighborhood, there is

13 The web-page for one asset management company, Bank Asset Management REO, states : “Outsourcing of asset management can measurably reduce days in inventory through strict timeline management, ensure high recovery rates versus valuation benchmarks, insulate the seller from third party claims, and provide for temporary or permanent staffing reductions while utilizing the skills and experience of highly trained real estate brokers.” www.bamreo.com Accessed February 9, 2011

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http://www.bamreo.com/


the risk that the investor is an irresponsible landlord14 in the neighborhood. Investors have strategies that are not always in the best interests of the neighborhood and the aggregate impact of large numbers of investors buying in a neighborhood can lead to problems such as the concentration of low-income households orlow-quality properties.15

These issues for the neighborhood are exacerbated when mistakes are made in the foreclosure process by the servicer. Theresult can be that the foreclosure sale process takes many years to resolve and the chances are much higher that the property is vacant during that time.

Transferring risks to the buyer leads to reduced demand for foreclosed propertiesAs illustrated in the description of the auction and REO

sales, in a foreclosure sale, risk is transferred very explicitlytowards the buyer. In a normal property sale the buyer has some negotiating capacity to ensure that the risks of the sale (no sale occurring, over or under-paying, additional closing costs, problems with the title, problems with the property) are shared between the buyer and seller. However, in foreclosure sales, the buyer is responsible for many of the risks of the property by thestructure of the sales contract and the sales process and practice. The exception to this rule is when the servicer pays off outstanding liens at the auction, making the REO sale less risky for the buyer with regards to liens; however the title can still be problematic because of mistakes and sloppy practice by the servicer as was seen in the Ibanez case and the robo-signing scandal. The following table describes the risks that are transferred from the seller to the buyer in a foreclosure sale, particularly an auction or REO sale.

Table 2: Risks transferred from seller to buyer

Risks transferred from seller to buyer

Impact for buyerif risk realized

Type of sale

14 By irresponsible landlord I mean that they do not maintain the buildings well, charge inflated rents, and are non-responsive to neighbor complaints with their property or tenants. 15 For example, one investor interviewed described a strategy of purchasing foreclosed properties to hold as Section 8 rentals until the market improved at which point they would sell the properties for a substantial profit.

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Needed property repairs

Cash or financing neededfor investment

Short saleAuctionREO sale

Compliance with building code

Cash or financing

Short saleAuctionREO sale

Title issues Cash and legal help

AuctionREO sale

Liens against property

Cash and potentially legal help

Auction

Tenants Legal help and time

AuctionREO sale

Damage to property during sale process

Insurance needed= cash impact

AuctionREO sale

Preference for cash vs financing

Reduces likelihood of purchasing REO property

AuctionREO sale

Losing deposit Cash impact AuctionREO sale

Responsible for difference between highest and next highest bid

Cash impact Auction

Deal takes longer toclose than 30 days –fines imposed

Cash impact AuctionREO sale

Losing out on betterproperty

Potential financial cost

Auction

Source: Table developed by author. May 2012.

Part of this strategy of risk transfer to the buyer is the goal of servicer risk deflection to ensure the smallest financiallosses possible. Three key outcomes result: (1) investors buy foreclosed properties more of the time than owner-occupants because they are more able to absorb the financial risks that a servicer deflects, (2) foreclosure sales prices are lower than regular home sales depressing real estate prices in the

28


neighborhood; and (3) a property is more likely to be vacant (both as a result of sales practice and as a result of subsequentinvestor-buyer actions).

Asset management and loss mitigation practices that cause problems for the neighborhoodThis paper does not allow for a review of all the data showing the asset management and loss mitigation practices that cause problems for the neighborhood, however here is a summary of the servicer practices that increase the likelihood that a property will end up with an artificially low sales price, investor owned,vacant and falling into disrepair.

(1) Preference for vacant properties – mortgage servicers prefer that a property that they are managing is vacant. This allows them to reduce the risks associated with having tenants.

(2) Onerous sales contracts – the auction sales contract is particularly risk for any buyer. It requires a buyer to takemost, if not all, the financial costs associated with backing out of the sale, even though the buyer is usually not able to see the inside of the property before buying. The REO sale has a sales contract that requires sellers title insurance, has few protections for the buyer and does not allow for negotiation.

(3) Marketing practices (targeted buyer lists, lack of open houses and staging, lock boxes) – REO realtors target investor buyers to ensure the highest likelihood of sale, they conduct no open houses, and set up lock boxes for otherrealtors to show the property. This is markedly different from how most regular sales go forward.

(4) Preference for cash-buyers – the mortgage servicer prefers cash-buyers because there are not the requirements set by the buyer’s mortgage contract that might derail the sale.

(5) Selective investments in REO properties – mortgage servicers appear to make decisions based on REO realtor’s recommendations about whether to repair or invest in a property e.g. install a new kitchen or bathroom.

(6) Length of time for short sale – the length of time that it takes the loss mitigation department to respond to a request

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for a short sale often leads to the selling realtor losing potential buyers who need a response more quickly.

(7) Lack of responsiveness in price negotiation at auction – for some large servicers, even though the highest bid is just a few thousand less than the required minimum that the servicer will accept, the servicer will still refuse that bid and move the property into REO status increasing the time the property is in limbo and increasing the likelihood the property will become vacant.

(8) Limited realtor payments – limited realtor payments for eachREO management activity means that realtors are operating onefficiencies and not finding incentives to go above and beyond in their work. They are motivated to get the quickestturnaround for the property which is usually from an investor who has purchased an REO before.

(9) Controlled list of tasks for realtor – With a controlled list of assigned tasks for the REO realtor to do, there is limited room for creativity and personal relationships. This is the emotional work that many realtors talk about being a critical part of why they enjoy their job. Several realtors that I spoke with refused to do REO sales because of this. One REO realtor talked about the lack of “puppies and flowers” in the REO sales business and suggested there were very specific types of “money oriented” realtors who were selling REOs. This impacts which clients are attracted to the sales.

These sales practices lead to intermediary impacts seen in Bostonforeclosure sales, such as an increased risk for investor buyers or a higher likelihood of vacancy. The intermediary impacts causea loss of community assets—a decrease in neighborhood safety froman increase in crime, neighborhood environment quality16 decline,

16 Neighborhood environment quality is measured through the aesthetic impact of the neighborhood. The quality would be measured through the quality of the housing stock (abandoned, vacant, boarded up or inhabited and cared for buildings), people on the street, trash and litter prevalence. These are all indicators of social decay. Jane Jacobs has written extensively about the impact that the visual experience can have on a neighborhood, and the crime sociology literature refers to such indicators as signaling the level of social cohesion on a street.

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a decrease in neighborhood diversity through either concentrationof low-income families or gentrification, and a disruption in neighborhood relationships from evicted owners and tenants reducing social capital.

Table 3 describes in more detail some of the outcomes from the sales process, the mechanisms through which these risks are transferred, the specific part of the sales process causing the problem and the type of sale that this problem is seen in. The risk that there will be negative impacts from a foreclosure sale increases along a continuum of related potential points of sale of the property from the short sale through to the REO sale. At the point of the short sale, there is the potential to avoid manyof the neighborhood risks, such as vacancy. A successful short sale will mean that there is the shortest possible time for vacancy in the entire process. If the short sale is not approved,then the highest risk sale of all proceeds—the foreclosure auction. The auction increases the likelihood that the property will be vacated and increases dramatically the risk that the property will be purchased by an investor. At the auction, the property also has a good chance of ending up as an REO sale whichwill extend the vacancy period, increasing the risks for the buyer in the sale and as a result boosts the likelihood that an investor will purchase it. By the point of the REO sale, the property will be in servicer management the longest and the risksfor property deterioration also multiply, though from real estateagent and servicer reports this does appear to depend on the neighborhood.

Table 3: Risks transferred to the neighborhood from the foreclosure sales process

Outcome from sales process

Mechanism Sales process Type of sale

Investors advantage in sales process over owner-occupants – more able to absorb risk

Financial risks to buyer

Bank preference for cash buyers =investors

“As is” clauseTitle insurance

Buying sight unseen (auction)

Marketing to

REO saleAuction

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- access to cash/financing with fewer ties

Information distribution networks to investors

investors

Vacant houses Tenants removed from bank-owned properties

Preference of real estate agentand servicer: selling houses empty

Reduced risk for law-suits from tenants

REO sale

Abandoned houses

Unclear title Undue foreclosureprocess

REO sales

Investors more active

Deal falls through

Length of time for response fromservicer

Short sale

Lower sales prices

Reduces potentialbuyers (fewer buyers interestedin “fixer-uppers”)

Buyer investment needed to improveproperty

Little maintenance or investment by servicer in some neighborhoods

Onerous and riskycontract and process for buyer(“as is,” sight unseen)

Challenging and lengthy sales process

AuctionREO saleShort sale

Source: Table developed by author. May 2012.

Mistakes in the foreclosure process mean abandoned foreclosed properties Not only does the intentional process of foreclosure sales

increase risks for the buyer but unintentional mistakes cause problems that compound the community asset loss seen in

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concentrated foreclosure sales. During the course of two years offieldwork I witnessed two major cases of what have been termed “foreclosure fiascos” (Engel 2011) that led to increased rates ofabandoned foreclosed buildings around the neighborhoods of Boston. The first is generally termed “the Ibanez decision.” Thisbegan when the assignment of the mortgage, necessary for the servicer to foreclose on the property, had been conducted after the foreclosure began. Judge Long, in the Massachusetts judiciary, ruled that this was illegal and that the foreclosure must be correctly conducted, which invalidated the foreclosure and subsequent sale. As a result of this ruling, thousands of properties (we do not have good estimates of the numbers) in Massachusetts were thrown into a state of legal limbo and responsibility and ownership reverted to the original owner who lost the property in the foreclosure. However, most of these owners were not still living in the property and were not notified of their new responsibilities. The servicer had to submit a new and correct foreclosure after correctly assigning the mortgage. This process took years in some cases, and many of the 2008 foreclosures affected by this ruling sat vacant until 2011. Still by 2012 some of these properties have not been resold. These vacant properties are costly to the neighborhood, leading to an increase in vacancies, and as a result an increase in opportunity for crimes. Neighborhood property values also decrease further impacting neighbors who are not in foreclosure.

The second case that occurred during my fieldwork was the “robo-signing” scandal where it appeared that hundreds of thousands if not millions of foreclosure documents had been illegally signed by workers at signature factories instead of thevice-presidents of the foreclosing servicer as required by the law. When this came to light in judicial foreclosure states, Bankof America was forced to suspend foreclosures across the country to assess their foreclosure processes to ensure that this did nothappen again. Non-judicial foreclosure states such as Massachusetts were unable to assess the extent of the issue, and are still unable to assess and contest the validity of signaturesin the foreclosure documents. For the foreclosure sales market, this ruling had an impact in that it slowed the foreclosure process down as well as gumming up the resulting inventory of foreclosed properties. It did not however, directly impact the

33


foreclosure sale process itself other than extending the time forpossible short sales and impacting the capacity of servicers responding to the issue.

WHY DOES THE MORTGAGE SERVICER BEHAVE IN WAYS THAT MAY NEGATIVELY IMPACT THEIR CLIENT – THE TRUSTEE AND MBS INVESTORS?

To understand why the mortgage servicer behaves in the ways that it does, we need to have a more in-depth understanding of the organizational ecology of the housing credit market as it relates to foreclosure sales. Figure XX (page XX) provides a visual representation of the relationships between each stakeholder and the geographical nature of the entity itself.

Table 9 on the following page provides a more detailed overview of the types of relationships between the different entities that makeup the housing credit market involved in foreclosure sales. For the purposes of understanding the larger groupings, industry group refers to the nexus of related entities. The Servicer industry group includesthe servicer and all of its third party contractors, and the Trustee industry group includes the Trustee and the investors that the Trusteerepresents. Particularly note-worthy is the geographical nature of each organization, which moves from the investors being international in actual location and in orientation, to the REO real estate agents who are generally local though possibly regional. Government is an important stakeholder in the housing credit market that structures howthe housing credit market unfolds and is discussed later in this section of the paper.

Table 9: Groups/organizations making up the housing credit market in foreclosure sales

Organization Industry Group Geography RelationshipsInvestor Investor International/

nationalBuys Trustee tranche

Trustee Investor International/national

Pools mortgagesContract with servicer

Servicer Servicer National Contract with TrusteeContracts with third party

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entitiesLoss mitigationcompany

Servicer – third party

National Contracts with servicer

Asset management company

Servicer – third party

National Contracts with servicer

Law Firm Servicer – third party

State-wide/regional

Contracts with servicer

Auctioneer Servicer – third party

Regional Contracts with servicer

REO real estateagent

Servicer – third or fourth party

Local/regional Contracts with servicer or asset management co.

Source: Developed by the Author. May 2012.

While Table 9 provides detail on most of the groups and organizations making up the housing credit market, there are permutations and variations. For example, some REO real estate agents work in groups asproperty management companies. I have not included these variations since they can be considered as variations on the main category included here.

Figure XX: The social relations of the foreclosure sales market organizations

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Source: Developed by Author. May 2012.

Global Financial Investors and “the Trustee”When a mortgage is originated it is usually packaged together

with other mortgages into a Trust. The Trust then sells the rights to the income from the mortgages to investors. The Trust establishes a set of rules, or a contract, up front, which determines how the Trust will operate and who it will contract with to manage the mortgage income, an arrangement that allows the Trust to remain tax neutral through something known as “passive management.” Passive management isan Internal Revenue Service (IRS) designation that requires the Trustee to not make any decisions about how the mortgages and income

36


from the mortgages are managed. The Trustee, usually a large investment bank such as Deutsche Bank, contracts with a servicer to manage the mortgage income, creating a contract known as a pooling andservicing agreement that outlines the cost structures and expectationsthe Trust has of the servicer. From the point of signing this contract, the Trustee will not require or ask for additional or alternative management arrangements. To do so would mean the Trust was now actively managing the mortgages in the portfolio and making the investment vehicle taxable. The bond-holders, i.e., investors, could require that the Trustee actively manage the servicer. However this requires usually two thirds of the bond-holders in a Trust, many of whom have different interests from one another, to vote for such a proposal. Unsurprisingly there are few attempts by bondholders to assert active servicer management. The insurer of the Trust, where insurance has been bought, may perform due diligence and require changes in servicing, but this is also rare.

The Trust sells “slices” or tranches of the overall Trust income (from the collective mortgage payments) to investors according to the level of risk. The lowest risk tranche will receive the smallest return on investment but will be paid first from the mortgage paymentspaid into the Trust each month. The highest risk investors will be paid last by the last mortgage payments each month coming into the Trust, but will get the highest potential rates of return assuming allthe payments come in. However, if over a certain portion of the mortgage payments are delinquent, this highest risk tranche investor will not be paid at all.17 The mortgages in the Trust are spread acrossthe United States, usually packaged together where the mortgages themselves are similar and of a similar credit risk. This further detaches the investment from any geographic location.

Importantly, if Trustees “actively manage” the Trust they lose the low/no tax status inferred by passive management. Trustees argue this means not actively managing the contracts that they have established with servicers, even if a servicer is not acting in the best interest of investors, i.e., foreclosing too quickly on a mortgage. And yet the servicer is foreclosing on behalf of, and often in the name of the mortgage-backed security sold and managed by the Trust.

In Boston between 2005 and the end of 2010 there were 375 Trustees foreclosing on properties in Boston. The top three Trustees were Deutsche Bank, Wells Fargo and US Bank representing 3,492

17 For an excellent in depth description of this process, please refer to NPR’s Toxic Asset news segment http://www.npr.org/series/124587240/planet-money-s-toxic-asset (Thompson 2009)

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http://www.npr.org/series/124587240/planet-money-s-toxic-asset

http://www.npr.org/series/124587240/planet-money-s-toxic-asset


foreclosing mortgages over that time period, just over 30percent of all foreclosing mortgages in that time period in Boston. Most of the organizations operating are national investment banks, mortgage/lending companies or banks, many of whom have imploded in a spectacular fashion. Many are national subsidiaries of global entities. Deutsche Bank for example, with the greatest number of foreclosure petitions in Boston, is a national subsidiary of a global bank based out of Germany. Data on the total number of trustees does not exist for the country. However, Boston data, displayed in Chart 12(following page), gives us some idea of the organizations that are acting as Trustees on behalf of investors and a sense that there are likely large numbers of different Trustees in operation nationally.18

Table 10 (page XX) provides an overview of the entities that invest in mortgage related security holdings. Many of these entities have gone bankrupt and been bought out or bailed out, e.g., Countrywide which is now part of Bank of America, and Washington Mutual which is now part of JP Morgan Chase. Option one, Taylor Bean and Whitaker, and Fremont, some of the larger subprime mortgage lending companies, were shut down by 2008.

Prior to 2008, Fannie Mae and Freddie Mac represented the two largest investors in mortgage related securities. Formed in the mid-twentieth century they bought large volumes of mortgages until recently when they ran into financial trouble because of over-purchasing in the troubled subprime mortgage market. In 2008 they wereput into conservatorship with the Federal Housing Finance Agency, explaining their low volume of activity in that year. In 2008 the two largest entities investing were commercial banks and mutual funds, with foreign investors the third largest share. By 2009, Fannie and Freddie and the US Treasury/NY Federal Reserve Bank held a substantialportion of mortgage securities resulting from the federal bail-out of troubled banks in 2008/09.

18 The Trustee with the fourth greatest number of petitions was MERS, or Mortgage Electronic Registration Service. MERS acts on behalf of servicers andTrustees, foreclosing in their name and obscuring who the real Trustee is. MERS offers a way to simplify the recording process in the registry of deeds, allowing one entity to be registered as the holder of the mortgage. However this also has the impact of hiding who the actual holder is, reducing potential accountability in problems that arise with the mortgage.

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Chart 12: Numbers of foreclosure petitions19 for the top 25 Trustees inBoston 2005-2010

0

200

400

600

800

1000

1200

1400Total petitions filed

Source: Data provided courtesy of the Department of Neighborhood Development, City of Boston 2011

There are limited interactions between investors and other stakeholders in the housing market. Investors have limited ability to regulate the actions of the Servicer since there is usually a 25 percent quorum needed in order for a vote to be brought, and there is the disincentive of potential challenges to the tax status of the managing Trust.20 Real estate agents have no interaction with Trustees and financial investors. They are completely isolated from the true owner of the property that they are selling. In interviews, real estate agents would make reference to the investors if a short sale, for example, needed approval from the investor in order for the sale to go ahead. In such cases, the sale would be delayed while permissionwas gained by the servicer. An interview with a former servicer employee revealed that in some cases the bond-holders or insurer

19 A foreclosure petition is a foreclosure start, i.e., when a Trustee begins foreclosing on the home. The servicer files the petition in the name of the Trustee.20 Some initial lawsuits are now being brought against servicers by investor groups managed and coordinated by law firms (Levitin and Twomey 2011).

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needed to give permission for the sale to go ahead, for example, in a short sale situation. Investors and Trustees, however, were mostly completely invisible parts of the day-to-day foreclosure transaction, even though the contracts that they signed with the servicer structured the nature of how the sale could proceed, whether a short sale, auction or REO sale. So while they remain invisible, the marks of the structure they establish with the servicer tend to be pervasivein setting up how the sale proceeds. However, it is the servicer that has the most control in creating the specifics of the sale embodied inthe sales contract and the relationships with its contracting organizations.

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Table 10: Mortgage-Related security holdings by investor 2005-200921 (dollars in billions)

Investor Type

2005

($)

2006

($)

2007

($)

2008

($)

2009

($)

2009MarketShare

(%)

Fannie Mae/Freddie Mac

1,123.20

1,074.10

1,039.60 112.60

1,107.00 15.88

Commercial banks 897.10 972.30 971.40

1,088.60

1,171.70 16.81

Mutual funds 521.00 550.00 720.00 995.00 855.00 12.27

Foreign Investors 882.00

1,020.00

1,220.00 920.00 930.00 13.34

Other investors 326.00 430.00 700.00 565.00 155.00 2.22

Life insurancecos 285.00 315.00 360.00 475.00 400.00 5.74

State/local government 225.00 253.00 285.00 280.00 180.00 2.58

Private pension funds 160.00 199.00 225.00 268.00 215.00 3.08

Public pensionfunds 180.00 215.00 235.00 245.00 198.00 2.84

Savings institutions 242.70 223.40 264.60 211.80 184.70 2.65

Securities brokers & dealers 95.00 130.00 175.00 171.00 100.00 1.43

FHL Banks 122.30 128.70 143.50 160.00 150.00 2.15

Property/ 90.00 125.00 145.00 145.00 113.00 1.62

21 The latest data available at the time of writing was for 2009. The data for2010 will likely be released towards the end of 2011.

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Casualty insurers

US Treasury/NYFed 0.00 0.00 0.00 71.50

1,098.90 15.77

Credit unions 35.00 35.00 40.00 45.80 56.00 0.80

REITs 103.70 93.50 72.70 38.70 65.00 0.93

Total outstanding

5,288.00

5,764.00

6,596.80

5,793.00

6,970.50 100.00

Source: Inside Mortgage Finance 2010 Mortgage Market Statistical Annual Vol. II table. Total Outstandingrecalculated by Author.

Servicer: “the Bank”The servicer, commonly known as “the bank,” is the organization that most impacts how the foreclosure sale proceeds. It links the local actors (mortgage holders and buyers of foreclosure sales) and the Trustee and Investors. Its main task is to manage the mortgages, e.g.,collecting mortgage payments, managing defaults and disposing of foreclosed properties. It is largely invisible to the world, operating through a series of sub-contracting entities, and usually far removed from the neighborhoods in which it is conducting foreclosure sales. It is not a “bank” in the conventional sense, although many servicers are subsidiaries of or part of a regular depository institution. Recognizing that servicers are critical, policy makers have focused more attention on these entities though only limited regulation has been passed. However, they have missed thesub-contracting organizations involved in the servicer industry group who are often doing the actual work for the servicer. In this sectionI will explore the servicer, and then move to looking at the servicer sub-contractors.

For mortgages that are sold on the secondary market, many end up held in investment pools that don’t also carry out the servicing (collection of payments) of the mortgage. In this case the Trustee contracts with the servicer. When the mortgage is delinquent, the servicer forecloses on the delinquent mortgage on behalf of the Trustee and Investors. The Trust that holds mortgages on the secondarymortgage market contracts with the servicer to manage the mortgages inthe trust, primarily collecting the mortgage payments and passing themback through to the Trust and then the investors. The servicer deals with the mortgage when it becomes delinquent, and is able to charge

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late fees to the borrower that go directly to the servicer and not theTrust (Senate Committee Hearing, 2010; Levitin and Twomey 2011; Thompson 2009).

When a borrower is more than three months delinquent, the servicer responds to the short sale request, manages the foreclosure auction, or if it buys the property back at the auction, manages the disposal of the bank-owned or REO property. Within the servicer are three different departments that handle each of the three types of possible foreclosure sale. The short sale is handled largely by the internal loss-mitigation department, although third-party loss-mitigation contractors are starting to show up in the marketplace. Theauction is contracted out to external lawyer houses that specialize indoing foreclosure auctions. The REO sale is sometimes handled by an internal asset management department, but often contracted out to third-party asset management companies. The asset manager assigned theREO property then contracts out to a real estate agent, and sometimes a property management company, to manage the property and get it readyfor sale. The departments that handle different types of foreclosure sale (short sale, auction and REO sale) are usually highly segmented.

Chart 13: Top twenty-five mortgage servicers market share and volume 1997-2009

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

0.00%10.00%20.00%30.00%40.00%50.00%60.00%70.00%80.00%90.00%

$0.00$1,000.00$2,000.00$3,000.00$4,000.00$5,000.00$6,000.00$7,000.00$8,000.00$9,000.00

marke...

Source: Inside Mortgage Finance 2010 Mortgage Market Statistical Annual Vol. II table. Total Outstandingrecalculated by Author.

There are over 100 servicers across the country though complete numbers are hard to find. Inside Mortgage Finance, an industry publication,provides statistics on the top 30 to 40 servicers every year since 1995. This data show how servicers have become increasingly

43


concentrated over the last ten years, servicing a greater volume of mortgages, and with an increasing share of servicing happening amongsta few companies. Chart 13 shows the changing volume and market share for the top 25 mortgage servicers in the US over the last ten years.

The share of outstanding mortgages serviced by these top 25 increased to 76.6 percent by 2009. Of these top twenty-five, the majority of servicing is again concentrated in the hands of a few. Thetop five servicers serviced 59.5 percent of the outstanding mortgage volume in 2009, and the top servicer (Bank of America) serviced 20 percent, or one in five of all outstanding mortgages in the US in the same year. This means that loss mitigation specialists in these large organizations are dealing with tens of thousands of loans. For efficiency the loans are managed through electronic systems, but this prevents nuanced property management approaches described to me by oneservicer employee. Nuanced approaches to short sales, auctions and REOsales mean a constant process of adjusting to the local real estate market and conditions on the ground. Smaller servicers are more able to respond in these nuanced and nimble ways. The following extract from an interview with a smaller servicer provides some illustration of the problem with large servicers as they negotiate foreclosure sales.

“Well I foreclosed on these properties six months ago. I’ve got title to them. I’ve cleaned them up. They’re listed for sale. Well Chase is sending property inspectors out to inspect the properties if they got an interest in them. I wiped their interest out six months ago. But they’vegot so many properties they didn’t realize that. I mean it’s just that they’re getting to it when they get to it.

… they set out a number and their numbers are hard numbers. Like for example I gave, if I say, you know, “I want 80 thousand.”, and a bid gets to 77 thousand, I want to be able to, we’re going to be able to be nimble enough to say, “Take the 77”. If a larger servicer gets involved and said 80, and they get 79,900 they don’t have the mechanics in place to make a decision quickly enough to tell that auctioneer, “Take the 79. …

…and … in short sales dealing with particularly Chase and Countrywide’s very bad where… they have a second trust interest … let’s say Chase had a second trust on [a property] for $10 thousand and we got all the way down to, you know, the last couple of days of January [for the sale] and something fell through … And Chase is getting let’s say $15 thousand on their second trust to release their second trust. So we want them to takea smaller pay off and then the … seller has to go to Chase … and say, “Please can you take less than the 15 thousand that you approved a month ago?”… Well, it takes them 30 or 45 days to make their decision. They don’t have 30 or 45 days, because if they … don’t say, “Let’s take $10

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thousand.”, in five days I’m going to foreclose and they don’t get anything…. And you would think if they would get someone on the phone and say, “Yeah, we’ll take it. We’ll take it, because you know, if you go to foreclosure we get nothing.” And it’s not because anybody at the larger servicers are making a bad decision, they can’t get a decision that quickly.

The large servicer with automated systems cannot respond nimbly and quickly and as a result may turn down an offer that falls $3,000 short of the set goal. The investor stands to lose more from the costsof disposing of the REO property than that $3,000.

Smaller servicers have different processes and experiences with foreclosure sales, often holding the same mortgages that they are servicing. In these cases the negative impacts from the foreclosure sale are less since turnaround times for sales are smaller and the servicer is often closer to and can respond more easily to the realityon the ground in the neighborhood.

The large and even medium sized servicers operate nationally. Prior to the foreclosure crisis, there were a series of bank mergers accelerating the process of consolidation of banks at the national level. The foreclosure crisis and massive failure of banks across the country has consolidated the housing credit and servicing industry. Asa result, many servicers that once existed do so no longer (e.g., Countrywide). The pattern has been that fewer and larger servicers nowmanage mortgages, and as a result foreclosures, and foreclosure sales.

Chart 14: Top 25 mortgage servicers 2009 volume (billions dollars)

45


$0.00$500.00

$1,000.00$1,500.00$2,000.00$2,500.00

Source: Inside Mortgage Finance 2010 Mortgage Market Statistical Annual Vol II table. Total outstanding recalculated by Author.

As a result, servicers attempt to create a national playing fieldwith standardized processes, using contracts and centralized systems of administration, all of which have profound impacts on how foreclosure sales proceed and thus consequences for communities. For example, practices of weaker title insurance standards used in southern states have been imposed in Massachusetts foreclosure sales contracts, despite a standard de facto real estate industry practice.22

The economies of scale that national servicers need for the business models to work are fine in times when the mortgage portfolio is performing well. But in managing delinquent properties, the economy ofscale means that the servicer is unable to engage in high-touch

22 Servicers are looking to standardize processes across the 50 states for increased efficiency. Again, prior to the foreclosure crisis and failure of banks, a battle was raging in the halls of state and federal legislatures overwhether to move towards federal preemption of state banking laws that would have established a national stage matching the increasingly national nature ofthe servicer industry. The reality today, in the middle of the foreclosure crisis and with many hundreds of banks having failed over the last four years,is that there is a larger push than ever towards federal preemption (which advocates are concerned will be weaker than the strongest state laws).

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servicing more necessary to minimize losses for the Trust in the foreclosure sale.

Distance from the neighborhood also creates problems for nationalservicers. Staff don’t know the local specifics of the real estate market and so constantly need to take the temperature of that market to help them arrive at decisions about a price for the sale. They do this by using broker price opinions (BPOs) a quick and dirty appraisalof the value of the property by real estate agents who do a quick drive-by assessment of the property and look at comparable sales in the same neighborhood.23

National-based servicers have a limited capacity to meet the needs of specific neighborhoods and communities compared with smaller,local servicers or local foreclosing banks. One real estate agent I interviewed who chose specifically not to do REO sales had made one exception by working with a local community bank that was foreclosing on a property. Having observed other agents in her office doing REO sales with national banks, she noted how careful the community bank was in trying to find the right buyer for the property that would benefit the local community. She was very impressed by the accountability and interest in the local community exhibited by the president of the bank.

The national scale, high-volume workflow, and hierarchical bureaucratic structure of the national servicers means that this kind of community accountability is almost impossible (perhaps even laughable) for the loss mitigation “negotiators” and asset managers, let alone the President of the servicing company. In fact, the client orientation of the servicers is towards the Trustees, the source of their own future business opportunities and profit. The local neighborhood and community does not factor in as important, not even in protecting the value of foreclosed assets held as REO property.

Diane Thompson from the National Consumer Law Center suggests that servicers’ incentives are skewed towards foreclosing quickly and not doing loan modifications or short sales (Thompson 2009). She argues that there are two main incentives for servicers to do quick foreclosures. The first is that servicers are rated by ratings agencies on how quickly they complete foreclosures. A fast foreclosureindicates efficiency of operations and fewer costs for the servicer’s clients since lengthy foreclosures are more costly than quick

23 BPOs are substantially cheaper than a formal appraisal.47


foreclosures. The credit ratings are used by Trustees (banks) to determine which servicer to do business with.24 So servicers who foreclose quickly will presumably get more business. The second incentive is structured into the contract with the Trustee, a representative for the investor. The contract states that servicers can charge borrowers for fees (late fees, legal fees) on a mortgage and that any fees not paid are gathered from the proceeds of the foreclosure sale prior to paying the Trustee the proceeds of the sale.If the servicer has not been paid, it is in its interest to recoup thefees through foreclosure. Thompson argues that this is why we don’t see more loan modifications or short sales, despite Trustees includingin the contract incentive payments of $1,000 or more for such outcomes. The structure of incentives for the servicer is towards the foreclosure.

Levitin and Twomey (2011) point to a complicated highly specialized and large scale industry operating through automated systems that are little able to respond to the needs of a specific case. They point to limited regulation and accountability by government regulators or from the Trustee or investors meaning decisions often don’t meet the needs of investors, homeowners or communities.

Other sets of morals and assumptions rooted in the culture of theorganizations and the banking industry play out in impacting how foreclosure sales play out. Speaking with a few servicers for this research, they were sensitive to wanting to prevent moral hazard and exploitation of sellers (and presumably also themselves) by real estate investors. The entry of these real estate investor players intothe buyer market meant many short sale deals that started, ultimately fell through and servicers I spoke with specifically avoided approvinga sale to real estate investor-buyers, sales that actually might have prevented the property from going to foreclosure and becoming vacant.

George, the manager of the asset management and loss mitigation department of a medium-sized national servicer describes below the process of deciding whether to approve a short sale. Critical to his decision is weighing the price, the pace of the sale and the potentialfor moral hazard in the market.

“Well, you know, the short sale is, you know, we weight each one individually. And, obviously it’s viewed in comparison to the dispositionprocess for how long it’s going to take to foreclose, what the underlying

24 This builds into into economic sociology’s work on the importance of reputation in economic transactions (Harris 2009), suggesting that in the absence of social ties, more formal signals of trust must be established, suchas credit rating systems like Standard and Poors.

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value of the collateral is, and the consideration that’s being paid to allthe parties. I mean as we’ve seen in the last… six months to nine months there’s like a sub culture in the industry that’s become somewhat predatory on billable hours. You know, it’s the realtor/attorney/mediation specialist that jumps in and they’re trying to find short sales…. And sometimes they’re beneficial; sometimes they’re not, they’re just trying to introduce third parties to a transaction and they’re asking for … some scrape off of what their consideration would be.… But when you look at the transactions, these guys are being paid, 5, 6,70 percent of the transaction. ….

He then also re-articulates the importance of maintaining the standardand rigid price floor that he had earlier said was so important in creating problems with the larger servicers: he wanted to make sure that the sale gets at least 85% of what the BPO says.

We would generally take a look at that and we’d probably look at that favorably as assuming no one is taking advantage of the transaction.… But,you know, we get a short sale offering that’s less than 85 percent of the BPO value, we’re generally going to turn that down and proceed with the foreclosure.”

The BPO is the broker price opinion, a ‘quick and dirty’ appraisal, based on a drive-by, which is much cheaper than doing a full appraisalof the property.

Under-capacity and third party entitiesMany of the problematic outcomes that increase the probability of a foreclosing property going all the way to REO status, result from the lack of appropriate capacity in the servicing industry group. Capacityis increased by third party entities, but the use of automated systemsand increasing distance between the neighborhood and decision-makers in the servicer means the desired nuanced approach that George earlierdescribed is almost impossible.

Real estate agents noted in interviews that Bank of America was the least responsive in negotiations for short sales and REO sales. This is likely related to an overwhelming volume of loans in default and inappropriate capacity for an organizations that is responsible for one in every five mortgages serviced and likely similar volume in foreclosures sales. Individuals working at “mega-servicers” like Bank of America are dealing with tens of thousands of accounts, which George described as meaning “…there is no individual consideration they can afford on a loan level basis. It’s an account number, and it's 90 days. And that means you go to this procedure.”

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Bank of America’s inadequate capacity is likely a result of its takeover of Countrywide, a deal that was not subject to community scrutiny under the terms of the Community Reinvestment Act.25 As of June 2011 Bank of America was reported to have improved its process using a new electronic management and communication system called Equator which allows more efficient and reliable communication with real estate agents. But for many neighborhoods this is all too late, with several years of foreclosed properties having changed hands whilebeing impacted by the inadequate internal processes of this bank. Additionally the automated system means losing nuance in the sales process as earlier described. So a servicer might give up a reasonablesale because rules in the automated system prevent small but helpful compromises being made.

At the end of 2010, senators on the Banking Housing and Urban Affairs committee were concerned that servicers were under-capitalizedto manage potential financial risks, and were running under capacity to deal with the demands of foreclosure mitigation/modification work(Senate Committee Hearing, 2010). There has been little examination ofthe nature of the industry ramp-up in disposing of foreclosed properties, but it seems from the employment of third party asset management companies that again, servicers may be under-resourced. According to the hearing with federal regulators on December 1, 2010 at the Senate Committee on Banking, Housing and Urban Affairs, the main issue with servicers is that they were designed to function well when times were good, i.e., they were not designed to be able to deal with the scale of foreclosures currently under way. It is likely, given reports from real estate agents about their experiences with different kinds of foreclosure sales, that servicers remain under-resourced both on the short sale end as well as the foreclosure auction and REO sales.

The main strategy to increase capacity has been to outsource to third party companies, and there has been minimal reported oversight of these third party entities’ activities. Certainly there is no regulatory review of them. A Freddie Mac executive reported in the above hearing (Senate Committee Hearing, 2010) that he had fired several servicers for poor performance but had real concern over the

25 Prior to the financial crisis, the Community Reinvestment Act enabled and encouraged federal regulators to hold community hearings about proposed bank mergers. These community hearings enabled customers and stakeholders in the bank’s service area to comment positively or negatively about the bank’s activities. It was an important forum where banks could be held accountable tothe community. In the midst of the financial crisis, bank mergers were takingplace with no community hearings or scrutiny.

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lack of quality and choice in the industry. One REO real estate agent mentioned one third party asset management company in particular that he felt was very good because it took an interest in community outcomes, but that the general feeling was that the quality of third party asset management companies was very low. Evidence from the hearing points to the similar poor quality of third party loan modification companies, also responsible for determining short sales.

Notable is the level of administrative ramp-up necessary to deal with the foreclosure crisis, and the lack of capacity on the part of not just servicers, but also the contractors and the mortgage regulatory structure. Real estate agents have had to rapidly increase their knowledge of the different kinds of foreclosure sales as their real estate markets have become, in many cases, focused on these kindsof sales. Real estate lawyers and auction companies have had to increase their knowledge of foreclosure sales, as have the non-profit homeowner education providers. As the foreclosure sales industry has developed over the last five years, there has been little to no government oversight. Certainly the bank regulators have not considered the issue of foreclosure sales seriously, and government departments such as the Treasury and Department of Housing and Urban Development have limited knowledge of the growing and unregulated industry of foreclosure sales. The monetary and societal costs of developing this knowledge, capacity and finally hopefully some kind ofregulation is huge.

Outsourcing allows servicers to increase capacity while ensuring a reduced risk profile for hiring and firing in the event that the foreclosure crisis lessens. Instead, third party providers hire and fire. There are substantial costs involved with this activity. Government and industry-wide actions, such as the foreclosure moratoria of 2010, impact the third party providers instead of the servicers. Servicers can thus deflect some of the risk involved in increasing capacity away from themselves. The issue for the servicers is that the third party providers often have quality control problems,and individual actors within the organization are even less able to detour from the parameters of service provision laid out in the contract, meaning potentially even less nuance in the sales process even though the organization may be closer to the market.

Poor integrationThe servicer, as described above, is integrated vertically with clear assignment paths between the various individuals and contractors employed by the servicer. However horizontal integration within the servicer is very limited. The departments working on each type of sale

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are different even though the same property may move from one department to another as it shifts from a delinquent loan property to a foreclosure, and finally to an REO property. Real estate agents frequently spoke about the lack of communication between servicer departments about a property, for example a short sale could be approved even after the auction had occurred, with the loss mitigationdepartment in the servicer not knowing about the auction. This is likely a function of the dual track process and the nature of sub-contracting out specific work without communication paths between subcontractors, or even perhaps between servicer departments. And critically this is also a function of problematic relational coordination, i.e., a lack of horizontal coordination within the organization.

The servicer industry is structured to maintain a dual-track process so that if a modification or a short sale is started, the foreclosure process will continue at the same time (both in the private servicer industry as well as the Government Sponsored Entities26) (Senate Committee Hearing, 2010). This may well explain theconfusing experiences of real estate agents and homeowners trying to conduct a short sale and having the property foreclosed on shortly before the sale might have been completed. The dual-track process is important for the servicer since it wants to ensure that the often lengthy process of foreclosure proceeds quickly enough to ensure a maximum financial return for the servicer. For example, Donald Bisenius, an executive vice-president at Freddie Mac explained that the dual track strategy was an effort to recoup as much money as possible for the taxpayer of America (financial risk management strategy), since the longer loans sat delinquent, the more money was lost by the investor, which in the case of Freddie Mac is the taxpayer. In a previous hearing before the same committee, executives from both Bank of America and Chase Manhattan bank had explained that they were able to change this dual-track strategy but that much of thepressure was coming from the GSEs. While there is some obvious back and forth and excusing of actions in front of the Senate committee, the bigger message is that there is real tension between the goals of the servicers (to foreclose and recoup as much as possible) and the goals of policy makers (to reduce foreclosures).

The goals of the servicer are perhaps obscuring a need to have more horizontal communication between departments that would allow for

26 Government Sponsored Entities (GSEs) include secondary mortgage market entities, Fannie Mae and Freddie Mac. They are financial entities created by the federal government to stimulate the flow of credit to mortgage markets in the case of Fannie and Freddie.

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an effective dual-strategy process where homeowners were given time-limited opportunities to pursue a modification or a short sale and where, in the case of an anticipated successful short sale or modification, the foreclosure would be stopped or extended to allow the successful resolution of this policy preferred outcome. This wouldalso serve the interests of the investor (represented by the Trustee) who structures in financial incentives to the contract with the servicer for loan modifications and short sales. Currently, according to Diane Thompson’s analysis, the incentive payment is not sufficient to over-ride the potential fees that the servicer can make from proceeding with the foreclosure (Thompson 2009). The evidence then suggests that the issue of a lack of horizontal integration may be driven by the incentive structure of the servicers.

Sales incentives and disincentivesOstensibly servicers are incentivized to minimize the losses from a foreclosure. But where they are contracting with the private security bond market, servicers are looking to cover expenses, charge fees, andforeclose as quickly as possible (Levitin and Twomey 2011). These incentives stem from the pooling and servicing agreements between servicers and Trustees.27 Further incentives operate within the organization at odds with the larger goal of a fast and efficient foreclosure. Servicer staff are paid bonuses for meeting certain targets. Towards month end, if an asset manager was close to reaching and exceeding her target, she would be more willing to negotiate down on price or shift the terms so that the deal would close. If the assetmanager was nowhere close to meeting her target, she would stall on the deal hoping to push it to the next month where they might stand more of a chance of meeting or exceeding the target and getting the bonus.

The servicer itself has structured incentives towards certain types of sales. A short sale is incentivized by the Trustee agreement,often coming with a bonus of $1,000 or more per short sale. However, the monetary incentive for the individual short sale is countered by the organizational incentive of accruing late and delinquency fees which are then cashed in at foreclosure. The servicer then has a strong incentive to not allow short sales, but instead move a propertyalong to foreclosure getting substantially more in fees than would be reaped through the short sale incentive payment. Federal regulators

27 The pooling and servicing agreement is the contract established between theTrustee and the Servicer and which structures the work that the Servicer does,as well as the limits to modifications that the Servicer can make to individual mortgage contracts.

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noted the misaligned incentives in the industry, and Professor Kurt Eggert in the same Senate hearing pointed to the unregulated nature ofthe industry with clear incentives and evidence of bias in these structured incentives (Senate Committee Hearing, 2010). Analysis by Christopher Mayer (Mayer 2010) points to the trend of servicers being more likely to foreclose on third party loans (i.e., investor held loans) than loans held by their own entity.

Servicer Sub-Contractors The servicer contracts with several different types of organizations to conduct different aspects of business. These include: law firms andauctioneers to conduct the foreclosure auction and preceding legal notices and filings for the foreclosure to proceed; asset management companies to manage the disposition of REO properties; real estate agents to contract with the asset management companies (or internal asset management department) to sell the REO property and often be the“eyes and ears” on the ground in the neighborhood. There are also now loss mitigation sub-contractors to manage the pre-foreclosure period including the short sale.

“Well there’s … a whole host of companies that are kind of offshoots of the credit repositories and the national appraisal vendors and … they provide a whole host of default management services, whether it be doing property lock outs, whether it’s cleaning properties, whether it’s doing BPOs, whether it doing property inspections, whether it's boarding properties up… I mean it’s like a la carte pricing on whatever, you know,a servicer would need in order to project, you know, their presence into these markets.”George, medium servicer

The following section will review some of these sub-contractors, particularly those that real estate agents mentioned in interviews.

Auction sale brokers Auctioneers are employed by law firms that contract with the servicer to conduct the foreclosure proceedings from the notice of delinquency through to the auction sale. In Massachusetts, the law firms are oftenlarge and specialize in foreclosure activities within the state. The law firms have websites with basic information on upcoming auctions including whether an auction is postponed or cancelled. No informationis provided on the website about the terms of the sale other than the amount of the deposit. By law, the auction must be posted in newspapers for three weeks prior to the auction date providing a description of the title of the property.

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Auctioneers are guided by strict codes of how to conduct a foreclosure auction. They are paid by the servicer to conduct the auction. There is little room for variation in how the auction is conducted. Auctioneers can help orient potential buyers who have not been to a foreclosure auction before. Some auctioneers provide a full review of the property in a folder, while others provide minimal information.

Auctioneers are constrained in how much time they can spend at a foreclosure auction given their tight scheduling. They are scheduled for about eight auctions a day, often far from each other. They spend large amounts of time in their car. Their incentive is to conduct the auction as quickly and efficiently as possible, and if the auction is cancelled, they still turn up to make sure potential bidders know the auction is cancelled, and to communicate the rescheduled auction date and time. Auctioneers are paid by the auction or on a salary basis.

Foreclosure law firms have been implicated in some problematic activities. Both auctioneers I spoke with referred to one large Massachusetts law firm as a “foreclosure factory” that operated in a sub-par way, completing large numbers of foreclosures with little respect for the families losing their homes, or maintaining real attention to detail in ensuring the process was completed accurately. Law firms are paid for the number of motions (motions include the documents filed) filed in a foreclosure proceeding, resulting in many unnecessary filings all the while collecting substantial fees(Morgenson and Glater 2008).

Law firms’ incentives, then, are to conduct the foreclosure so they can charge legal fees. They look to standardize the process as much as possible, creating efficiencies of scale, and to increase the legal activity involved in the foreclosure that brings with it legal fees. There is little incentive for law firms to look for ways to improve the process or act in the neighborhood’s interest. For example, a recent foreclosure in Newton revealed that the deed included preventing the sale of the property to a non-white family. The foreclosing law firm, Harmon Law Associates, either did not notice, or did not have an incentive to put the deed into compliance with the law or a moral read of the situation. Auctioneers mostly do the bidding of the servicer, but can potentially create mistakes in the process resulting in the need for re-foreclosure. This sub-contractor is responsible for the auction sale, but the structure and parameters of the auction are set by Massachusetts law and by the contract the servicer uses at the auction.

Asset management companies

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Asset management companies contract with servicers to perform the rolethat the internal asset management department would normally perform, disposing of a bank-owned or REO property. Once a property has moved through the foreclosure auction to become bank-owned, it becomes the responsibility of the asset management department within the servicer.When servicers need to expand their capacity, i.e., they have too manyREO properties to manage given their asset management department size,they hire third party asset management companies. The servicer gets toincrease capacity without having to invest capital. The asset management companies attempt to work to appear as if they are the servicer, providing the branding of the company. For example, one website says: “We are a Hybrid Outsourcer that provides a seamless integration with our clients by adopting their business philosophy, goals, policies and procedures in the marketing, management and disposition of REO.” Both internal and contract asset managers work with a large number of properties and contract out with a real estate agent to manage the properties and then the sale.

It is hard to estimate how many asset management companies exist,though, David, an REO real estate agent I spoke with, estimated 800 nationally. He worked with several asset management companies. Displayed on the white board in his office were the GSE-owned properties managed by sub-contracting asset management companies that he was currently managing. Data are not available from standard industry sources such as Inside Mortgage Finance on the size of the asset management sub-contracting field. These organizations do not yet have an industry association, and regulators don’t seem to have data on them as of yet. These organizations existed prior to the foreclosure crisis, but have expanded substantially in response to it.

From the interviews I conducted with REO real estate agents, different asset management companies approach sales differently. David, working out of Brockton, spoke about New Vista as being very community oriented and concerned about how their actions would impact the community. He said that other asset management companies that he worked with did not have the same regards for the community, and were more concerned about disposing of the property quickly.

Table 11 (following page) provides some details on asset management companies working with Fannie Mae. Asset management companies are not only involved in REO asset management, but may also be active in doing third party loan modification and short sales. Theyalso advertise on their websites doing work such as property valuationand post-sale analyses of loss for the servicer. They operate at a national level.

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Asset management departments and companies make decisions about whether or not to invest in an REO property to improve the structure. Three REO real estate agents mentioned differential rates of investment in property according to the area that the property was located. These decisions are based on reports provided to the asset management company by real estate agents. The real estate agent will draw up the information about the costs involved in making repairs to the property, and then the likely resale value.

Table 11: Asset management companies working with Fannie Mae

Asset management company

Services provided Service Area

24 Asset management Asset management NationwideAtlas Asset management NationwideChrisley Asset Management

REO asset management, loan mod andshort sales

Nationwide/ West Coast

Equity Pointe Complete default servicing technology for servicer

Nationwide

Executive Asset Management

REO asset management Nationwide with regionalapproach

First Preston Management

REO asset management + additional real estate services

Nationwide

Green River Capital REO Asset managementShort sale for servicer

Nationwide

Keystone Asset Management

REO asset management Nationwide

National Default Services

REO asset managementLoss mitigation

Nationwide

Nationstar Servicer and asset management NationwideNationwide REO Brokers Inc.

Coordinating entity for REO brokers around country

Nationwide

New Vista REO Asset Management NationwideOld Republic Default Management Services

Website is faulty

Owen REO, LLC REO Asset Management UnclearPhoenix Asset Management

REO Asset ManagementShort Sale ServicesPortfolio Due DiligenceProperty Management

Nationwide

PMH Website is faulty

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Source: Fannie Mae marketing materials for REO real estate agents and websites of asset management companies

The asset manager makes decisions about the investment based on whether the investment is profitable or not at a preset rate of return. Three REO real estate agents talked about how there were certain neighborhoods where investments were not made, or were delayeduntil right before closing, and that in neighborhoods like Dorchester and Brockton, REO properties were more likely to be sold “as is” rather than “as repaired.”

Asset management companies are negatively impacted when the flow of REO properties slows down. They initially ramped up quickly to respond to an increased need for asset management capacity at servicers. But as various roadblocks have been placed in the path of foreclosure, such as title issues resulting from mass foreclosure filings, asset management companies stand to lose business. An industry news source suggested that the slowing of inventory moving through the foreclosure sales pipeline has led to asset management companies looking increasingly financially precarious. They owe debt used to increase their capacity when they anticipated a need from foreclosing servicers. But the roadblocks have slowed down the expected pace of business. This means that asset management companies are extended beyond their capacity financially in some cases (Marshall2010).

For the servicers contracting with the asset management companies, this is perhaps another form of risk management, whereby servicers don’t have to build internal capacity with all the costs that this might entail. They can rely on a sub-contractor company to manage the ebbs and flows of the REO inventory as it moves through thepipeline without needing to capitalize such capacity. The servicer is able to take all the benefits of this situation with few of the apparent downsides.

REO Real Estate AgentHow foreclosures (short sales, auctions and REOs) are sold is very dependent on the structures, decisions and actions of the entities that the real estate agents work for. Within these structures real estate agents have some control, but their decisions and actions are largely guided by the constraints and parameters of the larger system that they are working within. In essence, real estate agents selling foreclosure sales have limited power. Listing agents are able to be more or less effective in their work as they understand and learn to negotiate the system, but their work is very closely determined by thesystems that the servicers have set for selling properties. Listing

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agents are not even able to make determinations on marketing strategies for a property, so closely monitored are they. And yet theyare the ones bearing the responsibility for sales that do not proceed quickly, despite servicers pushing for practices that real estate agents felt actually decreased interest in the property.

REO listing agents influence the level of investment that a servicer might put into a property. They submit reports to the servicer on the needed repairs to the REO property, and the likely return on investment the servicer could expect from such an investment. The real estate agent thus creates some of the reality of pricing and investment in a neighborhood. They do have to, however, respond to “market trends” in that neighborhood. So there is a tendency to add to the decline of neighborhoods or add to the value ofhot neighborhoods to ensure that the servicer makes a “safe investment”. The real estate agent’s job is on the line if they inaccurately estimate the direction of the market. Organizations or entities interested in stabilizing markets might operate in different ways, making recommendations for investments that didn’t have as high rates of return. The real estate agent is still constrained by the servicer’s requirements for recommendations of investments in markets that return more than 50percent of the investment.

Considering the whole picture, the real estate agent is fairly limited in her power to influence foreclosure sale outcomes. In many ways, the buyer ends up disadvantaged in foreclosure sales, because their representative and mediator, the real estate agent, has such limited power in the negotiations of the sale. The age-old sociological debate of structure and agency plays out in this case study of real estate agents’ agency (power) in foreclosure sales. Ultimately their agency is very limited by the structures established through the social relations between the financial services industry and the local real estate markets (real estate agents, neighborhoods and buyers). These social relations are embodied in work processes andsales contracts.

Government: A Critical but Limited Stakeholder in the New Housing Credit MarketOne institution that obviously has a huge impact on the social relations of the financial services industry is the state. While government officials have been particularly focused on preventing foreclosures by putting pressure on the servicer, there has been limited engagement with the process of foreclosure sales. The process for foreclosure auctions is clearly laid out in the law based on nineteenth century property law principles. But there is no engagement

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with or regulation of how short sales or REO sales unfold. The role ofgovernment in relation to foreclosure sales has predominantly been a ‘mitigating impacts’ role rather than engaging with the process upstream of how the foreclosure sales themselves proceed.

The housing credit market is regulated in limited ways that does not engage with its full complexity. There is a mismatch between the structure of the industry and its regulation by government. Chung (2000) notes that this is a more general challenge of regulatory policy of the new structure of business, since corporate law is structured with the idea that the corporation is an autonomous unit rather than a series of inter-relating organizations with dense relational networks.

Table 12 provides some illustration of the regulating entities, who they regulate, the main thrust of the regulation and the problems and gaps in that regulation.

Table 12: Regulation of foreclosure sales

Regulating entity

Entity regulated

Thrust of regulation

Problems

Legislation enforced by Banking regulators e.g.,Federal Reserve

Servicers None directly related to foreclosure sales

Lack of actual review and regulation

State legislation enforced by state regulators

Servicers Process of foreclosure process and auction

Many servicers fall outside of state regulator control

Judiciary Selling entity

Process of foreclosure auction

Limited to foreclosure auction

Criminal activity prosecution e.g., State Attorney Generals or FBI

Servicer Process of foreclosure

Limited to contravening laws – no laws re. foreclosure sales

Senate CommitteeHearings

Servicer Process of foreclosure

Political stale-mateCurrent interestin preserving homeownership

City government Property Zoning for Municipal laws 60


foreclosed propertyMunicipal rules

can be overturned at state level and often are

Source: Author developed. May 2012.

Foreclosure sales thus fall in very limited ways under the remit of public review with the predominant area of regulation falling on the process of foreclosure and the auction. The energy of regulators and policy makers focuses earlier in the foreclosure process, leaving only very limited public resources to examine and manipulate outcomes from the disposal of foreclosed properties. Despite the investment of public funds in programs such as the Neighborhood Stabilization Program, and other state and local allocation of funds to purchase foreclosed properties, there has been no examination and no regulationof the process of the sales themselves. These sales fall under the governance of standard property law, despite the public impact of the sale process which might suggest more parameters and regulation of thesales would occur. In effect the government has ceded power to the private market, notably the servicing entities themselves.

Local and State Government Leverage PointsIn the absence of effective and large scale policy, local and state governments have been tinkering around the edges, using federal resources to try to buy up the very worst foreclosed properties, and attempting to stall the foreclosure process to prevent more propertiescoming into the pipeline. But leverage points in the system are limited. For example, city governments have not been able to buy REO properties at discounted rates as required for the federal Neighborhood Stabilization Program. Cities have not so far been able to sue servicers and investors for the substantial damages and costs incurred as a result of negative outcomes from foreclosure sales.

Local and state governments have to focus where they can have an impact. In the City of Boston, when foreclosed properties are bought, the real estate agent, who has perhaps the least power in relation to the government entity, takes the financial hit to make the deal financially feasible for the City. In the case of Boston, the City requires the real estate agent to take a drastically reduced commission for a property that they may have been managing for severalmonths with no pay up until that point. Real estate agents are thus regulated and managed, perhaps because they are the easiest leverage point in the web of relationships involved in the purchase of such REOproperties. The City has relatively limited power in the relationship with the servicer, for example, and little access to the investors and

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Trustees who could possibly assist with negotiations. So the discount that the city needs to make the purchase workable with the limited Federal assistance that it has must come from the most easily accessible and least powerful player in the industry grouping. That entity happens to be the REO listing real estate agent.

Leverage points for policy makers to mitigate the impacts of foreclosure sales are local, whereas the organizations and their leaders who are shaping the system are national and international. There are currently few leverage points for government entities to grasp as they look for ways to mitigate longer term impacts of foreclosure sales for neighborhoods. As the table above notes, the only federal and state legislation impacting the way a foreclosure sale proceeds, are the foreclosure laws, which have existed since the 1930s, with periodic updates in relation to case law. State and federal legislative bodies have done little to improve the ability of government regulators and cities to gain leverage points for directingthe outcomes of foreclosure sales in socially desirable directions. For Massachusetts, even getting a state law passed that would require judicial review of the foreclosure action itself has been difficult toobtain. The federal legislative agenda has been extremely quiet on this issue, with effort focused on counseling of borrowers in foreclosure, and limited funding to help borrowers get back on track. Only very limited attempts have been made to examine the processes of the servicers in the form of Senate and House hearings with no legislative outcomes resulting. The federal conversation is very much focused on protecting gains that have been made, such as the Consumer Financial Protection Bureau.

There are leverage points that could be pressed. For example at the Trustee level, government requirements in the form of IRS rules have ensured that the Trustee maintains a passive relationship in managing the actions of the servicer, i.e.,, the Trustee cannot instruct the servicer on a course of action different from that established by the parameters of the contract signed to initially manage the mortgage Trust. The result has been the servicer taking actions which are not in the best interest of the Trust and the investors in the Trust. The IRS has been unwilling to remove these restrictions, and Trustees remain inactive in ensuring the best possible outcomes for their investor clients. Important to note is that the Trustees may have branches of their organization doing servicing, complicating their fiduciary interests. The result is that negative externalities from the larger mortgage origination process of the 1990s and 2000s, are pushed on to the localities to deal with, as we will see both in the outcomes for

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the community directly affected by foreclosure, as well as the local organizations contracting with the servicers. The servicer pushes the risks of regulation (those risks being the possibility of having to internalize negative externalities) onto the least powerful entities. When particularly local governments are looking then for leverage points to increase their effectiveness in dealing with the outcomes offoreclosures and foreclosure sales, the easiest leverage point to negotiate with is also the least powerful entity. Thus the risks the servicer took by managing their portfolio and aggressively foreclosingon some properties are pushed down and across different sub-contracting entities, as well as on to local governments and neighborhoods. Local government are able, in some cases, to shift small proportions of those costs back onto real estate agents and in some cases have been able to extract small fines from the servicer. But so far, local governments and communities bear costs that they hadno part in creating.

The Structure of the Housing Credit Market The nature of the social relations in the housing credit market structures how foreclosure sales proceed. The social relation structures most important to how foreclosure sales unfold are determined by: 1) the trustee servicer contract; 2) the servicer incentives/profit making needs and their future business goals; 3) thenational service area of the servicer and thus the volume of mortgagesbeing managed; 4) economies of scale operating in the foreclosure sales market leading to high volumes of mortgages being managed by automated systems; 5) sub-contractors thus working with economies of scale. These structures emerge as important in the absence of clear state regulation.

The result of these structures is two-fold. Firstly a specific spatial organization of the housing credit market emerges characterized by the needs of a global credit market and the challenges inherent in managing a local place specific real estate market. Secondly, risk is transferred away from organizations such as the servicer through complex contractual relationships that ensure limited negotiation of terms by sub-contractors. The following sectionwill review these two emerging qualities, foreshadowing chapter six’s discussion of organized irresponsibility and the commodification of the real estate market.

Spatial Organization within the Foreclosure Sales MarketSpace operates in foreclosure sales, cascading capital and risk down the organizational hierarchy from international to local level. The entities in the investor-trustee industry group are international and

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national in scope. The servicer is national, as are some of its subcontractors such as the asset management companies. However, the real estate agents and the buyers are local or regional in scope. How properties are sold is structured by operating systems composed of contracts and electronic management systems that are national in scope, accommodating some regional and state variations, but super-imposing a national legal base onto how foreclosure sales are sold, and an international agenda regarding the flow of capital. I will return to this point in the following chapter examining the secondary circuit of capital. This creates a markedly different sales process from regular sales in Boston, which are predominantly local in scope.

The geographical organization of the entities in this organizational ecology is largely facilitated by the information technology available to organizations. Real estate agents communicate mostly with the asset manager (whether through the servicer or contracting organization) through a web-accessible server database that provides lists of tasks to complete, the capacity to upload documents and communicate with the asset manager. This allows asset management contracting companies to be national in scope, similar to the servicers. Real estate agents must be close to the property given the nature of the work involved. But there are unlikely to be direct personal relationships with asset managers and real estate agents because of the large number of potential asset managers involved. Realestate agents mentioned frequently that they never got the same asset manager twice. Their personal relationship with the individual was built up over the course of managing and selling one property.

This allows the development of what Sturgeon has called “modular production networks” (Sturgeon 2002) where the brand name of the servicer goes on the foreclosure sale, but the work of producing the sale is done by entities contracting with the servicer. This creates amore flexible network that often changes with the creation and destruction of large servicers and asset management companies. Economic sociology understands industrial and business groups, and firm networks to be characterized by dense and spatially proximal relationships (Davis 2005). The servicer industry group (and likely the Trustee investor industry group) are marked by both clustering andgeographical dispersion.

Asset management companies tend to be clustered around the same areas that servicers are located. However, the real estate agents and law firms are, because of the fixed nature of the properties and the governing of real estate law at the state level, forced to be state orlocally based. Thus an industry group within foreclosure sales is

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geographically dispersed but maintains dense social relations through electronic and information technological means as opposed to maintaining spatial proximity of all the actors involved in the industry group. This presents various challenges to the management of those relations. For example the tasks to be performed by the real estate agent are heavily prescribed by the asset manager to minimize the need for the development of trust. This is perhaps compensation for the preferable face-to-face interactions that might develop with spatial clustering of business groups and industrial networks as discussed in the economic sociology literature.

The addition of global capital flows in the case of internationalinvestors, and international Trustees such as Deutsche Bank, brings ininternational capital demands which appear to be misaligned with the local goals that residents, policy makers and real estate agents mighthave.

Differentiation and specialization With a highly differentiated and specialized set of organizations performing tasks throughout the housing credit system no-one is looking across the entire system to assess the outcomes from foreclosure sales. The Trustee is not in that position since it has a passive management status, and the Investor is not in that position either, though this seems to be beginning to change. In highly complexorganizations where tasks are specialized and siloed, accountability becomes very difficult to establish. Diane Vaughan documents how the complex organizational structures at NASA in the 1970s and early 1980smeant that there was not a clear line of accountability within the organization for the decisions made that led to the Challenger disaster. Decisions that were made in the Challenger launch were tied back to middle management rather than across the organizational system. Vaughan documents how differentiation means that individual actors in the system do not have a sense of the ethical and systemic implications of their decisions and actions because they do not have aview of the whole system (Vaughan 1996). Within the housing credit market industry groups, particularly the servicer industry group, differentiation and specialization of tasks, not just within the organization, but also between organizations with outsourcing of work to sub-contractors, means that few individuals making decisions withinlarge servicers have a sense of the overall picture.

Risk TransferRisks are transferred down the organizational hierarchy. The risks at the community level have been clearly articulated. Table 13 reviews the risks revealed through this research that exist at each

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organization level and how the organization deflects that risk. Information on asset management companies is limited.

The analysis reflected in table 13 suggests a large proportion ofthe risk that is deflected away from organizations involved in the foreclosure sale lands in the neighborhood with no accountability mechanism back up the hierarchy. Some risks do stick to the organizations, however. The servicer does absorb risks when it buys the property at the foreclosure auction. It must foot the bill for anyoutstanding liens. This is a financial cost that it does absorb. The servicer also takes the risks associated with price fluctuations in local housing markets. The servicer, then, is taking on board a substantial amount of risk and financial loss although clearly, much of this risk could be avoided by helping facilitate a short sale. For some entities, like Countrywide, this was too much and the company went bankrupt. Now absorbed in Bank of America, it is not clear in 2012 whether Bank of America will be able to fully absorb all the losses associated with the mortgage portfolio of Countrywide. While the servicer is deflecting risk to the neighborhood, it does not mean that it is able to avoid all risk. A critical policy question that hasyet to be raised in any seriousness, is how to avoid these large organizations that are considered “too big to fail.”

Table 13: Organizational Risk protection

Organization

Risk attempting to protect against

Strategies employed to deflect risk

Where risk ends up

Investor Losing money on their investmentBeing held accountable for negative impacts from investment

Incentive payments for short sales and loan modifications

Invest through non-traceable tranches

Neighborhood

Trustee Risk of being taxed if active managementof servicer

Passive Management, so no action taken even if problemsin servicing

Across system(investors and neighborhood not protectedfrom negativeexternalities)

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Servicer Losing future businessInsufficient fee income to cover expensesBusiness loses money

Law suits from tenants

Sale falls through (increases costs)Costly property repairs needed = lose money on property

Moving to foreclosure quicklyOutsourcing to third party entitiesTenants evicted/asked toleaveCash-buyers“As is” clause in contract

Property

Third party entities

Neighborhood

Asset managementcompany

Insufficient workflow to maintaindebts owed - overcapitalizedRisk of lawsuits

Unknown strategies

Unknown

Law firm, auctioneer

Lengthy foreclosuresnot properly reimbursed

Payment based onwork vs. numbersof foreclosure

Previous ownerNeighborhood

REO Real estate agent

Asset manager reassigns property to another real estate agent

Quick sale to cash or investor-buyers

Neighborhood

Neighborhood risks that are often realized as a result of the deflection of risk include the risks detailed in chapter three, such as vacant buildings, reduced property prices, reduced tax bases and increased crime. But there are ancillary impacts from these impacts which play out across the neighborhood and broader fiscal community such as reduced ability to cover policing and schooling costs, and lower school enrollment for example. The neighborhood includes not only the municipal institutions and residents, but also businesses that may experience reduced sales as residents are forced to leave theneighborhood. Table 13 refers specifically to the neighborhood as a conceptual short-hand for these range of impacts. These are risks and costs that were created by the way the housing market and mortgagemarket operated during the last decade. They are also risks created bythe incentive of the servicer to move towards foreclosure instead of

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finding a way to structure a loan modification. It is arguable that alternatives to foreclosure could yield less socially costly outcomes,which perhaps explains why the focus has for so long remained on preventing rather than dealing with foreclosures.

The reality is that someone can be seen to be responsible. But there are few ways to tie responsibility back to an organization for two main reasons: the organization may be legally well protected in preventing accountability; and the state has often not established a legislative framework that would require shared accountability across the system. As a result risk is shifted away from those organizations and new risk emerges.

Risk shift is the transfer of risk away from the organization producing it. Scholars have noted three main levels where risks are transferred: global/institutional; organizational; and individual. Risk emerges as a global phenomenon, as systems work together to transfer risk globally (Beck 2007). Beck points to the new environmental hazards of climate change and pollution that are global in nature. Another example can be seen in the securitization of mortgages in the derivatives market. The derivatives themselves provide for firms’ risk transfer to “less risk sensitive sectors in the economy”. The complex network of risk transfer created through derivatives trading creates a collective institutional market risk(Sassen 2009). The second risk transfer mentioned earlier, is risk transfer away from the organization. Organizations seek to make sure the risk they produce is transferred away from themselves.

Collectivizing, deflecting and accumulating riskThere are three active processes of risk transfer in the foreclosure sales market important to describe. These are collectivization of risk, deflection of risk, and accumulation of risk. These three processes amount to the “dumping” of risk. Collectivization of risk occurs in the financial markets through the use of derivatives. Sassendescribes this process that occurs as derivatives are used to move risk away from an organization and are moved to organizations holding less risk (Sassen 2009). Organizations that purchase the derivatives have more of an appetite to manage risk than the organizations sellingthe risk.28 Collectivization of risk also occurs as a result of 28 A derivative is a contract between two parties for an agreed upon price based on an underlying asset. The origin of the derivative was as a way to manage equitable international exchanges given fluctuating currencies. CompanyA would buy from company B an asset or a good. A third party investor would guarantee a fair currency exchange that parties A and B could agree on. If thecurrency exchange rate increased then the investor would make money, but the

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organizations deflecting risk. Deflection of risk occurs in foreclosure sales specifically when an organization uses contracts, for example the purchase and sale contract, to remove liability for certain risks, for example the physical state of a property. These risks usually involve some financial liability that would impact the profitability of the organization, often the servicer. Risk deflected either stays in the collective realm if it can, or is accumulated at the local level.

Risk accumulates at the local level when it is specifically deflected and transferred there by the organization deflecting. For example, the servicer that deflects the risk of needed repairs on the property in question to the buyer is deflecting the risk to the local level. Risk can also accumulate at the local level when the risk is collectivized, mostly because the capital is located within the property at the local level. An example of this process is when the servicer is absolved of responsibility for the property as a result ofproblems in the foreclosure process (e.g., U.S. Bank vs. Ibanez, described earlier). The servicer is no longer responsible for the property by law, despite the incorrect foreclosure resulting from the servicer’s (and its contractors’) faulty foreclosure implementation. Risk becomescollectivized in that it is no-one’s clear responsibility to manage the property, and so the property itself becomes the site of risk, inevitably falling into disrepair or becoming the site of criminal activity. The nature of the “commodity” as having a fixed location in a place but multiple entities that have ownership and stakes in the value of the property, means that the collectivized market risk is immediately transferred to the local level. With the “owners” of the property not stepping in to manage it, the local government in Boston takes responsibility for the costs of at least securing the property, turning the collectivized market risk into a local and public risk. Risk then accumulates at the local level as the negative impacts from one foreclosure add to the likelihood of another property in the same neighborhood going into foreclosure as house prices drop. This is a cycle seen in Dorchester, particularly. Real estate agents described this process occurring in different parts of Dorchester.

Emergent Systemic Risk: the Case of Commodification“the application of perfect, rational and promising risk strategies is itself a source of second-order risks” (136) (Beck 2009)

rate the two parties A and B exchanged at would stay the same. If the exchangerate decreased then the parties would still be exchanging at the same rate, but the investor would lose money. This model is used with many different assets currently including mortgage-backed securities.

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Earlier sections of this paper introduced the perfectly rational decisions that the organizations involved in foreclosure sales were making to protect themselves from risk exposure. These ‘rational decisions’ made in the context of a lack of understanding the entiretyof the context of their decision led to risk transfer. Not only do risks get transferred, but new risks also emerge from those set of decisions.

For example, servicer decisions to require REO properties to be vacant interacts with the neighborhood that the vacant property is in,potentially leading to increased crime to the property itself and in the vicinity of the property. From the servicer perspective, vacating the property is a perfectly rational decision which allows the property to be more easily viewed and thus sold, increasing the likelihood of a sale and reducing the risk of profit loss (an approachto the house as a commodity). This meets the needs of the credit market investors that own the property and who wish to liquidate the property as quickly as possible. However a vacant property in certain neighborhoods in Dorchester, for example, will be more susceptible to break-ins, squatting, use for partying and potentially will lead to increased violent crime in the vicinity. If the property was located in a less vulnerable neighborhood with a more established economic base and a smaller concentration of foreclosures in time and space, the likelihood that this outcome would be seen would be substantially lower. Servicers respond to this risk by deciding whether or not to invest in the property based on the neighborhood and the risk of losing the investment to opportunistic thieves. Thus a vacant propertyby itself is not necessarily a bad decision. But when it interacts with another part of the system of foreclosure sales, i.e., the neighborhood, the outcomes may be damaging to the servicer and the neighborhood. This risk of increased crime is a new risk that emerges from the system itself and as a result of the mismatch between the needs of the global credit markets that own the property, and the reality of the neighborhood and local real estate market, i.e., the specifics of place. Hendry street in Dorchester, offers an example ofhow this cycle of vacancy can impact a micro-neighborhood. As more andmore foreclosures occurred in a vulnerable area, the street became a site for “flophouses” and gang activity.

These new risks emerging from the institution involved in foreclosure sales emerge distinctly from the interaction between the global credit markets and the local real estate market. The process ofcommodifying local real estate presents a challenge to the global credit markets that we see emerging in foreclosure sales. The story of

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foreclosure sales is the story of the liquidation of a commoditized neighborhood housing market by global financial capital sources in thesecondary circuit of capital (Gotham 2006, 2009; Gottdiener 1994).

The secondary circuit of capital refers to capitalist investmentsinto land and buildings as representations of capital at that moment in time. In other words, capital investments in a particular time period result in a built housing stock. The secondary circuit is distinct from the primary circuit. The primary circuit is concerned with capital’s relationship with industry and manufacturing production. Capital in the secondary circuit rides a fine line betweenbuilding and destroying real estate environments because the fixed nature of the buildings and land means capital is tied up for substantially longer than is preferable since capital aims towards being liquid and able to move from one place to another. Harvey particularly pointed to the ways that capital destroyed built areas inorder to free the capital up again (Harvey 1973; Harvey and Chatterjee1974). This process occurred in the ways that capital left a neighborhood, leaving properties in disrepair and uncared for. Capitalwas removed by the banks that made the mortgages as they foreclosed onthe houses. The buildings themselves ended up being torn down as they ended up in a sufficiently bad state of repair. While this extreme level of physical destruction has not been the norm in Boston, in cities like Detroit and Cleveland, this pattern has played out in eerily familiar ways reminiscent of Baltimore in the 1970s the location when Harvey was developing his theory of capital.

Capital has tendencies to want to remove local distinctiveness inorder to create a standard uniform product that can be easily traded and exchanged – the essential process in commodification. This is no less true in real estate than in the primary circuit of capital. Capital uses various means to abstract space and create this standard uniform product. It attempts to homogenize the particularities of theproperty and the neighborhood (physical and social space) in order to manage the flow of capital in and out of the secondary circuit of capital. For example, the process of mortgage securitization was abouthow to extract liquid value (rent) in increasing rapidity from a fixedilliquid object through a set of socio-legal relations such as derivatives and mortgage-backed securities (Gotham 2009).

Foreclosure sales are another example of this process of space abstraction to create capital liquidity. As we understand the process of these foreclosure sales, we see ways that legal contracts, power and practice intersect to transfer risks and homogenize the injection and removal of capital from specific neighborhoods, in the process writing off neighborhoods by ignoring the specific social place-making

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value of the property and neighborhood (use value). This occurs in Dorchester as real estate agents fill out forms to recommend whether the servicer should make investments and repairs in a property, or simply manage that property to sell it as quickly as possible without trying to improve it or the neighborhood. The value of the property isseen merely in whether or not there will be sufficient return on investment. The property is not assessed by the historical value of the property, or the ability of the revitalized property to transform the neighborhood. The property is not even seen as a potential home for future renters or homeowners. Thus in some neighborhoods like Dorchester, the foreclosed property is managed in ways that allow it to deteriorate over time, rather than in suburbs of Boston where the property is managed to enhance value of the property and in so doing enhance the value of the place (neighborhood).

As this sale occurs, the commodified nature of the property is revealed in the homogenized and standardized way the property is sold.The result is unanticipated neighborhood outcomes as the risk management strategy that attempts to deflect risks ends up interactingwith the reality of the local real estate market causing problems thatresult for example from the vacant property.

These new emergent risks visible in the neighborhood over time donot fall as the responsibility of any one entity. They are new systemic institutional risks. These risks emerge from attempts to deflect (transfer away) other kinds of risk in the process of standardizing the real estate for the credit market and in standardizing operating procedures. So in the case of vacant buildings, the servicer is attempting to deflect risk exposure to tenants. By keeping the property empty as it interacts with the neighborhood, crime around the property and to the property may increase. The servicer may bear the brunt of some of this crime in reduced property values and lost investment but now the neighborhood must bear a new emergent cost/risk that perhaps did not previously exist.

Not every neighborhood experiences these risks as being realized.In fact it appears that certain neighborhoods where foreclosure sales are less frequent experience fewer impacts from foreclosure sales, i.e., the risks are not realized. An upper middle-class neighborhood, such as sections of Jamaica Plain, may have a foreclosure sale occur with little to no impact on the neighborhood. While the property mightsit vacant, and have a potentially lower sales price, there is a lowerrisk that it will become a site for crime because crime is lower in general in the neighborhood. So while the risk is there, it is not actualized. This is an important reality to be acknowledged, and is

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perhaps what makes holding the servicer accountable difficult. The neighborhood conditions can be blamed for the negative impacts, ratherthan seeing an interaction between the actions of the servicer and theneighborhood itself.

Preconditions for Organized IrresponsibilityOrganized irresponsibility does not occur in a vacuum. Certain conditions allow it to emerge. The case of foreclosure sales provides some context in understanding what those preconditions might be. In the case of foreclosure sales, the establishment of a priori legal contracts between the servicer, the Trustee, the Investor, and the buyer of the property, ensures that each entity, but most often the Servicer, is protected from legal liability – specifically being held accountable to risks that it might be passing on, particularly in the foreclosure sale. These legal contracts allow risk to be transferred while ensuring accountability is removed if the risks result in actualharms.

With an appropriate legislative framework that established accountability, these legal contracts would not be sufficient to prevent parties holding one another accountable to risks that were transferred. But there is no legislative framework that establishes accountability across the system, meaning that the structure of risk transfer is maintained through legal contracts designed to prevent accountability (what is also called liability) from being established between the buyer and the seller of the property, or between the neighborhood and the seller (servicer, investor, trustee industry groups).

This case points, then, points to two important preconditions necessary for organized irresponsibility to occur in foreclosure sales: legal contracts that prevent accountability (liability) for transferred risks, and the absence of an appropriate legislative framework that could hold parties accountable to one another.

Risk and AccountabilityFor entities managing risk, deflecting risk away from the organizationmeans ensuring that accountability, or liability for hazards, is minimized or eliminated. Risk management is effectively removing accountability flows to the organization. The organizations, as described earlier in this dissertation, do this by creating legal contracts that isolate the risk and ensure that the organization deflecting the risk cannot be held accountable. This does not prevent some accountability from occurring, but it limits how much accountability can be created. Outsourcing and involving multiple

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organizations also acts as a mechanism for deflecting risk by ensuringthat the risk is spread across multiple organizations. For example, byoutsourcing to a contractor organization, the risks for managing a property and getting it ready for sale are isolated from the servicer.This fact is not lost on the servicing industry. At least one asset management company was advertising that it minimized liability for theservicer in this way.

So limiting accountability through risk deflection and isolation across the system is important to the process of organized irresponsibility. Attempts to establish accountability in earlier stages of the mortgage process have met with resistance from the housing credit market. Specifically attempts were made to establish assignee liability in many state laws passed in the first decade of the twenty-first century. Assignee liability ensures that if the mortgage origination process was abusive, then the investors that bought the mortgage could be held responsible. The goal was to try to establish more due diligence by the secondary mortgage market investors that would policy the mortgage origination process. However,assignee liability has not yet been legislated despite its potential role for establishing accountability in management of mortgages.

Foreclosure Sales: Neighborhood Risk Dumping The process of risk transfer (risk dumping) to the specific space

of the neighborhood (place) has certain characteristics that we can see in the process of foreclosure sales, specifically decisions that are made by the entity trying to transfer risk away from itself. Additionally we see how new risk emerges in attempts to homogenize theliquidation of the already commoditized property using standard operating procedures, much as commodities are traded on the financial markets. The following table (Table 14) provides some specific examples of actions in the selling of a foreclosed property that are about risk minimization for the servicer particularly, and also about homogenization and standardization of the property for sale, i.e., thecommodification. Risks are both transferred and emerge in reaction andresponse to the conditions of the neighborhood. Particularly in the case of the emergent risks, neighborhoods and cities are not able to claim reparations for costs incurred in remedying negative outcomes that result from the actions of the servicer or Trustee that cascade into new risks. And in the case of the risks that the servicer transfers, the contracts that guide the social relations between organizations protect those entities from being held responsible for the consequences of that risk transfer.

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Table 14: Adverse impacts for neighborhood of risk management and commodification processes in foreclosure sales

Action Risk Management Standardization Adverse impacts Emergent risksEvict (ask to leave) tenants from property

Yes – prevents potential lawsuits

Yes – standard empty houses for sale on market

Vacant properties Crime to propertyViolent crime in vicinity

Sales Contracto Eliminates offer contract that establishes initial period to review property with ahome inspector

o “As is” clauseo Over-rides standard MA purchase agreement – standardized for country so includes all states possiblelaws

o Auction doc pushes responsibility for property after purchase signed onto buyer

o Title insuranceis limited and standardized

o Limited abilityto view state of property

Yes – manages cost of preparinglegal documents and of unanticipated costs to the servicer during sales process (e.g., negotiation around needed house repairs)

Yes – provides basic replicable purchase and sales agreement to use across theUS

Allows standardized contracts to be pumped out by “foreclosure factory” law firms

Eliminates buyer protections

Prevents negotiation on price

Sets parameters that favor investors over owner-occupant buyers

Requires substantial cash reserves for unanticipated expenses not discovered in sales process

Investor-buyers that are “slum-lords”

Concentration of poorly maintainedproperties

Property flipping

No negotiation ofprice once inspection is

Yes – Prevents servicer from taking on

Yes – prevents servicer responding to

Willing buyers are lost in the process

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Action Risk Management Standardization Adverse impacts Emergent riskscompleted

Maintain power insales negotiation

unanticipated costs in the middle of process

specific situations on a case by case basis

Property price adjustment occursover multiple buyers so property on market longer

Multiple appraisals and Broker Price Opinions (BPOs) of property

Yes – helps servicer price the property right and theoretically wastes less time on market

Yes – standard basis for pricingproperty

Pricing often does not take into account the specifics of the local market thatvary street to street in Boston

No standard MA protections for buyer around deposit

Yes – protects servicer from losing a buyer

Yes – standardizes process across states

State level consumer protections are removed

Property falls below minimum livable standards

Timeline Yes – ensures process moves forward quicklyIf viability of buyer in question, servicer able to move on to next buyer

Yes – creates a standard time-frame for operation of saleacross US

Often waived because of difficulties in financing from mortgages

Limits buyers to those with cash on hand, i.e., investors

Selective investment in repairs to REO property dependent on neighborhood

Yes – ensures appropriate rate of return for servicer/Trustee

Creates selectively homogenous properties dependent on neighborhood e.g., ‘bad’ neighborhoods allsold “as is”

Neighborhoods written off by servicers (and real estate agents) as not providing sufficient returnon investment will have REO property in worserepair as it enters the market, impactingoverall prices in

Deterioration of overall standard of property in neighborhood

Negative direction for neighborhood change

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Action Risk Management Standardization Adverse impacts Emergent risksthe neighborhood and likely buyers

Electronic management of Real Estate Agent– little autonomy

Yes – ensures no fraud

Yes – ensures real estate agentfollows same process for property management and disposal across country

Real estate agentis not able to price and market property according to specific markets

Source: Author developed May 2012.

How the servicer views the property as a commodity to be liquidated can be seen very clearly in the following example as described by George, the head of asset management and loss mitigation at a medium sized national servicing company. The servicer decides whether to invest in a property and that decision is based on whether there will be a decent return on investment. As he points out, those properties where his company invests in repairs tend to out-perform properties from larger servicers that do not do these kinds of repairs. This suggests that how the property is looked after and whether investmentsare made into it, impacts the neighborhood sales price, and presumablythe type of buyer for that property.

GEORGE: And so I deal with the condition of the property as we get it. And that’s how, you know, that’s the cost that we assume or the risk that we assume on some of these properties.INTERVIEWER: Uh-huh. And so as far as the, so you get the REO, the properties (inaudible) hopefully, maybe have paid off, so just to sort of move to the next step with the REO property, it’s moved into a control now (inaudible). What do, do you sort of keep the residents in,if it's a rental property, do you, what is the next process…GEORGE: We only take the properties that are vacant. We, obviously we do not take properties that are occupied. We get a vacant property, we get, I normally get two or three (inaudible) which are, you know, basically just market analysis of that the property is. And I have a couple of realtors. We have them look at it. And we ask them to give us opinions on what it's worth now……what’s the reasonable marketing period, and what type of repairs could actually benefit in a shorter marketing period or, you know, some type of price support if you will…. And then based on that we’ll put money into a property in order to take it (inaudible) to sell quicker for a higher dollar…. And as, you know, as we tell the realtors, we’re not looking, we’re not looking to make a trophy property, but if it's a matter of painting a property or putting new appliances in it we may not get dollar for dollar back on that. But

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if it helps you sell the property quicker than what the market would indicate otherwise, spend the money…. And that’s I think that’s something where we’ve been able to take some advantage of our larger competitors out there because generally they just take the property backand they sell it as is…. And they may cut the price, but, you know, we feel like we’ve (inaudible) our assets have out preformed them in the markets that we’re in.INTERVIEWER: Uh-huh. And so in terms of the sort of investments or repairs of bits here and there that you could do, does that differ by market in terms of how you think about that?GEORGE: Oh, absolutely. You know, if it’s a good market, you know, I have not problem putting, you know, good money into a property. I putin the past, you know, 10 to 30, $40 thousand into a property… If it's just a bad market and it does not matter what you put into the property it's not going to help it sell at a better price or a quicker price, we sell it as is.It is perhaps, then, no surprise that as we see the foreclosure

sale property being treated as a commodity and having risk transferredto it, that investor-buyers are more active in the marketplace than owner-occupant buyers. Investor-buyers are both more able to manage risk and often turn it into an opportunity. They are also more able toconverse with the language and business practices of a commodities market as it is liquidated in the foreclosure sale.

This dissertation actually points to the importance of key entities exporting risk within a system that is characterized by organized irresponsibility. It is in these key entities that risk is both deflected and created for exportation. In the case of foreclosuresales, this key organization is the Servicer. The servicer represents the intersection between two worlds: the global credit market and the local real estate market. The global credit market is a conceptual space embodied by investors trading securities that are backed by credit agreements. So in the case of the mortgage credit market, the mortgage-backed securities are traded back and forth between differentinvestors, investors, as described in chapter 5, that are often global.

The servicer in some ways acts as a moderator of risk, managing the assets backing the global credit market, as well as a creator and exporter of risk through its own incentive structure, which is largelyunrelated either to the needs of the global credit market or the localreal estate agents. However, since it operates within the logic of themarketplace, it is protected from realizing the risk that it deflects by a set of legal contracts that isolate the risk from it, even thoughfor some servicers this was not sufficient to protect them from realizing the risks they had created. In the absence of any legislative framework, the risks and harms to the neighborhoods where

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the risk lands cannot be pinned on the servicer, since the servicer inthis case has protected itself in legal contracts from being blamed. And additionally, some of these risks and harms, such as increased crime, result not from the direct actions of the servicer, but insteadas a result of vacant properties which are not in themselves actually harmful. It is the combination of the actions of the servicer and the context of the neighborhood that creates the realized risk, i.e., the harm, and this is the reason that we can articulate organized irresponsibility as the process at play.

Organized irresponsibility – finding new policy leversI started this paper with the two questions of why we see socially undesirable outcomes occurring as a result of foreclosure sales at theneighborhood level, and what social relations in the housing credit market lead to the heightened risk for negative outcomes for which no accountability can be established. The data I present in this paper point to a key process responsible for these negative outcomes emerging from the sale of foreclosed and foreclosing properties. This process is the transfer of risk across the housing credit market away from organizations which are attempting to manage their own risk exposure. Some of this transferred risk is an omnipresent risk of financial gain or loss involved in any investment. But some of this risk is newly emergent from unintended interactions of risk managementdecisions and local contexts. The interaction of the housing credit market with the local neighborhood real estate market particularly creates such new risks as it attempts to liquidate as a commodity place-based real estate where people live in a context of limited state regulation. These processes create what we understand as organized irresponsibility: where unintended risks emerge within a system but for which no one can be held responsible. Separating out and understanding the specific risk creation and transfer processes moves the sociological understanding of the process of organized irresponsibility forward. Thus the paper not only updates our understanding of the basic way that foreclosure sale properties are sold, but also our understanding of the way the housing credit market functions. It gives us the means to re-examine basic policy questions about how to prevent the negative outcomes and increased risks for those outcomes that emerge from how foreclosure sales occur. And it offers the means to examine ways we could change more broadly how we structure the housing credit market.

For example, this analysis helps us re-examine the ways that we might look at “bank regulation.” The public legal and regulatory system perceives “the bank” as a homogenous entity. However, as

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demonstrated throughout Chapter five, the reality is far more complex and heterogeneous. “The bank” represents a servicer who is working on behalf of the investor that owns the particular mortgage and now property, and the servicer has many departments within its midst, notably the asset management department that deals with the sale of the REO property, but also the loss mitigation department which deals with the short sale before the property is foreclosed. These differentdepartments might be in-house within the servicer, or they could be, especially in the case of the asset management department, outside of the servicer, a third independent party that the servicer has contracted with to expand its capacity to manage and dispose of the numerous foreclosed properties it holds. Yet the financial regulatory system is stuck within a historical model that is based on the identity of “the bank” as a homogenous, small and manageable organization instead of an institutional ecology of organizations global in reach and set up to isolate and distribute accountability.

This final section of the paper will explore the potential policyintervention points gleaned from the analysis in the rest of the paper, pointing to key leverage points to interrupt and possibly change the relationships between organizations, thus preventing risk transfer and new risk creation within the system. Ultimately the goal in these policy recommendations is to prevent risk from being concentrated in certain neighborhoods that are already vulnerable, preventing and perhaps reversing the stratification of risk that Beck refers to in Risk Society (Beck 1992).

The analysis points to three potential policy intervention pointsto address the issue of institutional risk transfer and emergent risk creation in foreclosure sales. This approach would help to short circuit the question of who is responsible and move to an approach of dealing with the systemic problem. The first possible intervention andleast proactive is to mitigate the negative impacts of the foreclosuresales. This strategy includes increasing policing in locations where negative impacts are realized, or boarding up vacant or abandoned buildings. The advantage of this strategy is that it allows cities to respond only to those areas where negative impacts occur. However it may miss negative impacts that become more visible many years later, for example, clustering of investor-owned section 8 properties, which result in re-concentrating poverty in certain neighborhoods or keepinga neighborhood poor for a long time.

The second strategy is to short-circuit the relationship between the risk and the negative outcome. This is the category that many cityand state programs fall within. For example, the City of Boston’s strategy of buying up foreclosed properties as REOs short circuits

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some degree of risk shift, moving the property to city ownership and with some deliberate say over what happens to the property. There is still some risk incurred by the neighborhood as the property may be vacant, the principal strategy for servicers attempting to minimize landlord or property management risk.

The third strategy is to actually prevent risk from being dumped in the neighborhood. City, state and federal policy makers have not really addressed this level of policy to date, partly for political reasons. Community groups have attempted to push back on risk dumping in Boston. For example City Life/Vida Urbana has organized foreclosed residents to stay in the property, thus reducing the risks associated with vacant and abandoned properties and forcing the lender to resell the property to the former owner. This strategy reduces the risks associated with vacant and abandoned properties. The servicer might argue that this increases its risks in managing the property, while CityLife would probably argue that it reduces the overall risk for theservicer, even if the servicer does not realize it. Certainly it reduces risks for the neighborhood.

Preventing or mitigating this risk shift is important for policy makers. Foreclosures have tended to cluster disproportionately in neighborhoods hard hit by disinvestment in the 1960sa nd 70s. These neighborhoods are ones that have struggled over the last thirty or forty years with entrenched poverty. The foreclosure itself means financial and social stress for the homeowner that is losing the property. Their kids and social networks in the community are also impacted. The risk transfer and creation of new risks adds insult to injury in many cases, providing an additional shock that such neighborhoods are not well prepared to handle.

Risk is not always actualized negatively. As Giddens (1998) points out, risk can also present an opportunity. In the case of foreclosure sales, risk presents as both a positive potential opportunity as well as a negative one. The positive presents for the investor-buyer ready to purchase up the property and make some money. For the City of Boston and the neighborhood, the risk/opportunity nexus presents as the potential to increase homeownership for familieswho might not otherwise be able to own (because housing prices are depreciated as a result of the risk shift). The important policy question, then, is whether the city and neighborhood can actualize that risk into an opportunity. The city is perhaps in the best possible position to actualize risk into opportunity, armed as it is with departments, bureaucracies and power. But the question is whetherthere is sufficient power to shift risk or actualize that risk positively. Currently, the City of Boston has been able to actualize

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risk with positive benefits through its homeownership programs, helping families to purchase foreclosed properties for the first time.This has been facilitated by Neighborhood Stabilization Program (NSP) funding from the federal level but only for a relatively small number of properties. The City of Boston has had less success in shifting risk. It has been unable to negotiate contracts for general sales outside of the standard sales. Where it has had success has been in negotiating purchases of property through the Boston Redevelopment Authority, which has required that the servicer involved reduce its price. It is in this area that different servicers have different outcomes in the negotiations. This seems to point to a need for regulation to be at the state or federal level to be effective.

The focus of the paper has been to examine the practice of foreclosure sales to provide an emergent framework that might be helpful in further policy analysis. Following is a diagram of that policy framework emerging from this risk analysis.

Figure 8: Policy intervention points to prevent risk transfer in the foreclosure sales process

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Source: Author developed. May 2012.

This model incorporates three key policy intervention moments, which I will explore more in this chapter and which I earlier introduced. These are: (1) mitigating negative impacts; (2) preventionof negative risk actualization; (3) prevention of risk shift.

Each of these policy intervention points engages with a differentlevel of the system of risk shift. Arguably only number three actuallyengages with the problem of organized irresponsibility that has been discussed as the main problem within the housing system resulting in the accumulation of risk at the neighborhood level. This third intervention point is possibly the hardest to implement because of theneed for coordinated engagement across the system, and questions of political will and power at the federal level, the necessary intervention level due to federal preemption and regulation of the credit markets.

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The question of who pays for this emerges as a problem because these policy interventions are not without cost. In a system of organized irresponsibility no one is willing to take responsibility for the emergent systemic costs. Governments have a role to play here in levying system-wide taxes and fines to cover the costs of the risksand harms emerging from the systemic organized irresponsibility. This would force those costs to be absorbed into the system. Governments could also force a more thorough planning and evaluation process to examine the potential pitfalls in the system as part of the regulatoryprocess. Thus before major steps were taken in deregulation and legislation passed in the 1980s and 1990s that helped to create the secondary mortgage market, regulators and policy makers could have taken lessons from the 1970s foreclosure crisis in the Federal HousingAuthority loans and applied these learnings to the emerging structure of the late twentieth century mortgage market to try to avoid emergentrisks by forcing systems of accountability for costs that might emergeas a result of the system.

Clearly given the absence of an effective regulatory structure offoreclosure sales, one needs to be established that would ensure accountability between the investor, the Trustee, the servicer and theneighborhood where the property is located. This strategy falls mainlywithin the remit of the third policy intervention point: the prevention of risk shift. It also requires a more systemic analysis ofthe context that foreclosure sales are operating in, namely a broader understanding of the entire securitized housing credit mortgage marketsystem to effectively establish accountability structures throughout the system. Currently the Community Reinvestment Act, a piece of legislation designed at the end of the 1970s to hold a local communitybanking industry to account, does not cover the correct institutions, nor contain sufficient frameworks for regulation of an entirely new housing credit market. Building on the existing strengths of the legislation, a broader framework could be established to ensure that risk is not shifted to the residents and neighborhoods where the mortgage is originated.

The question then is what policies could be put in place to prevent risk shift to the neighborhood. There are several questions toanswer first in thinking through a strategy. What is the appropriate level to manage such a process to ensure robustness? What are the resources available for implementing a policy? What is the likely political will for a policy?

The appropriate level for addressing this risk shift is both at the federal and the state level. Foreclosure laws are state laws, withevery state having its own foreclosure law. So some level of state

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action is necessary to ensure policy meshes with existing law and practice. But the servicers and credit markets that are involved with foreclosure sales are national, and even international. Additionally the regulation of the servicing organizations and their associated banks is federal. Thus a level of federal oversight is also necessary to ensure at least a basic floor in the prevention of risk shift. Further the federal government, if it has the political will, has probably the greatest power to force servicers towards certain practices. Current politics do raise very real questions, though, about the likely political will.

Policies that might be implemented here include establishing a standard national sales contract that protects the buyer from having to assume risk in the purchase of a foreclosed property. Best practiceforeclosure sale practice might be eventually codified into law, and institutional incentives could be more vigorously structured to provide the most possible incentive for early sales in the process such as the short sale model discussed in the previous section.

Establishing foreclosure laws that engage with the process not just in how they do the foreclosure auction itself, but how the other foreclosure sales (short sales and REO sales) proceed. As the propertyis disposed of, clear measures of costs and benefits not only to the bottom line of the servicer and investors, but also to the neighborhood residents and future buyer need to be established. In neighborhoods identified as vulnerable by local governments, additional measures could be taken to ensure the foreclosure sale process does not undo decades of investment by governments, residents and community organizations. Such measures might include requirements that no foreclosed building sit vacant, or that foreclosed buildings owned by the servicer have improvements and repairs made to them. Suchrequirements could be built into existing legislative infrastructure such as the Community Reinvestment Act. While these policy intervention points are all helpful, ultimately we do need to look systemically at how the credit market is constructed and ask the question whether there is a better way to organize it.

Credit MarketsIf foreclosure sales are representative of larger processes at play inthe housing credit market, then this analysis suggests a need to realign and restructure that credit market to meet the goals and needsof the neighborhood rather than externalization of risk and commodification of housing towards the needs of the financial markets.Re-aligning the system might arguably result in an overall benefit to the system and the entitites within it, though short-term profits

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would be impacted. The financial commodification of residential real estate markets leaves neighborhood needs out of the analysis. Risk shift, an essential process in that financial commodification, likely occurs in other parts of the housing market. The unequal power relationship between the buyer and the seller in the foreclosure salesmarket allows such risk shift to occur. State and federal legislation has not kept up with the shifts in organizations conducting the foreclosure sales, organizations that make up the housing credit market. Happy to see the successful market of the 1990s and early 2000s, legislators did not respond to calls from housing advocates formore up to date regulation. However housing advocates have focused their energies on preventing rather than mitigating foreclosures.

Disappointingly, the current policy conversation continues to be focused around a mortgage market securitized by the private investmentof a global commodities market. While this works for the majority of homes in the country, there are neighborhoods and cities where we perhaps need to look to capital that can better serve the needs of that neighborhood without creating externalized costs that are borne by the neighborhood. The longer term health and vitality of the neighborhood can and should form a part of the decision-making in the provision of credit and in disposing of the property if a foreclosure becomes necessary.

A few of the real estate agents who I spoke with pointed to the different way that small community banks disposed of foreclosed property. This points to perhaps a need to explore some of these institutional changes in greater detail. Could we, for example, rate servicing based on how well the communities that mortgages are locatedin are thriving? We might measure a thriving neighborhood where vacancy rates are low and homeownership is accessible to a range of different income levels. There are ways to hold servicers accountable to the outcomes that they can cause in a community.

Should we break up the housing credit system to bring back local neighborhood accountability such as exists in the community banking system? We have the mechanics of a system that could provide liquidityto such a system, but instead of being driven by the needs of the investors, the credit needs of the neighborhood would be a key driver of measuring success in the housing credit system.

What can we learn from other credit organizations that are successfully providing credit without causing neighborhood harms? Organizations like Self-Help in North Carolina, and small community banking institutions could offer models for creating models of credit provision and servicing to base a re-structuring of the current housing credit market.

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