Advocacy group fights foreclosures in housing court, a lesson for Colorado?

Some Cleveland, Ohio neighborhoods have a message for banks that abandon their foreclosed houses or unload them at fire sale prices to speculators: Stop dumping your trash on us.

Using a novel legal technique that could be copied elsewhere, the Cleveland Housing Renewal Project Inc., a private, non-profit housing advocacy group, is asking Cleveland housing court to declare the business practices of Deutsche Bank and Wells Fargo in violation of local public nuisance laws. The suit seeks to force the banks to either fix up their foreclosed houses before selling them or to demolish them entirely — instead of dumping them back on the market at Basement Bob-style real estate prices.

A housing court judge on Dec. 15 granted a restraining order preventing the two banks from selling 36 foreclosed houses for at least two weeks. A ruling on whether to make that decision permanent is expected Monday.

The challenge by a local housing group to the workings of two huge global banks is an attempt to halt the “death spiral” of falling property values in neighborhoods overwhelmed by foreclosures. In cities such as Cleveland, where home values never appreciated much during the housing boom, banks have little interest in holding on to an increasingly bloated inventory of foreclosed houses. After taking the properties back at sheriff’s sales, lenders unload the houses at fire sale prices, often to speculators and flippers. The public has an interest in stopping the practice because cities are losing huge amounts of revenue as property values fall and neighborhoods are devastated, said Kermit Lind, a Cleveland State University law professor representing the housing group.

According to the suit, once a property is sold by a bank at “an extremely distressed price,” things go downhill from there:

“The vacant property enters the cheap housing ‘commodity’ market, where the houses are bought and sold by speculators, sometimes on E-bay and other Internet auctions, sometimes for less than $1,000 – the housing equivalent of trading in ‘penny stocks.’

“The vast majority of speculators that purchase vacant Cleveland homes have no intention of rehabbing or living in the property – they are looking only for the opportunity to ‘flip’ the home for a profit to another speculator. Meantime the condition of the property declines and the impact on its neighbors and its neighborhood is devastating.”

Using local nuisance laws to stop foreclosure sales is a new technique, said Kathleen Engel, a professor at the Cleveland-Marshall College of Law, and an expert in subprime lending. It could also be tried by other cities frustrated by foreclosures and falling property values, she said.

Banks for the most part have not been held accountable for the damage left behind in neighborhoods by foreclosures. The Cleveland suit joins efforts in Chicago and Chula Vista, Calif. to make lenders responsible for the condition of foreclosed houses they sell or leave behind. The Cleveland suit contends that bank-owned properties often are left vacant, vandalized and stripped of any value they had before foreclosure, by the time the bank sells them.

“This is important,” Engel said, of the Cleveland action. “It’s way to hold the institutions responsible for the condition of the properties and to prevent them from just unloading waste onto the community.”

In Cleveland, there are entire blocks where over half the homes are foreclosed on, making the problem so acute it spills over into the entire community, said Patricia McCoy, a University of Connecticut law professor who specializes in banking and securities regulation. The situation in Cleveland and in some other cities illustrates the widespread reach of the subprime crisis, she said.

“In some ways the problem has evolved to include an entirely new set of victims – the neighborhoods,” McCoy said. “Often the holders of foreclosed properties have less and less incentive to keep up their properties. It creates the death spiral of deteriorating neighborhoods as a result, along with the collapse of the property tax base. Cleveland has a strong public interest in trying to make sure these properties don’t go further in creating neighborhood decline.”

Cleveland and other cities are “looking at old bodies of law to address new problems,” McCoy said, because they are trying to fight foreclosures with any tools they can.

Cleveland has taken legal action previously over foreclosures. The city in January sued 21 investment banks, including Wells Fargo and Deutsche Bank, and accused them of creating and enabling the subprime crisis. The suit was filed in Cuyahoga County Common Pleas court.

The latest suit differs in that it was filed in housing court. It also cites specific properties sold by banks and documents the cycle of foreclosure sales and speculation that leads to property value declines and neighborhood blight.

One cited property, for example, has been through sheriff’s sales twice in three years, the suit said, with Deutsche Bank purchasing it both times. At the first sheriff’s sale on June 17, 2005, Deutsche bought the property for $72,600. It sold it to Nu Way Real Estate for $24,000 a few months later, on Aug. 4. Nu Way sold the same property to Dante Head Real Estate for $93,000 on March 17, 2006. Dante Head then lost the property in a foreclosure to Deutsche Bank, which purchased it again at a second sheriff’s sale for $25,400 on Jan. 15, 2008.

Deutsche Bank and Wells Fargo were singled out in the suit as the two top sellers of foreclosed properties for $10,000 or less in Cuyahoga County. Because the suit cites their business practices, the ruling would likely affect more than just the 36 properties named in the suit – 25 owned by Deutsche and 11 by Wells Fargo. Both banks did not provide anyone to comment on the suit.

Municipal housing court judges in Cleveland and Buffalo have been aggressive in holding banks accountable for the deteriorated state of their foreclosed properties, Engel said. Banks have fought legal action in the past by contending they serve as trustees for investors in mortgage-backed securities, and that servicers are responsible for maintaining foreclosed homes. But, as Cleveland blogger Bill Callahan noted, Cleveland housing court often doesn’t buy that argument.

Deutsche and Wells are of course claiming that they’re not really the owners, it’s the servicers who are responsible, etc., etc. But (Housing Court Judge) Pianka’s court has held trustees responsible for code violations in the past.

Cuyahoga County Treasurer Jim Rokakis, who has been outspoken in his criticism of banks that made subprime loans in Cleveland, said the suit could help the city deal with the crisis. Ohio lawmakers in mid-December approved a land bank the county can use to take control of foreclosed properties and sell or reuse them.

“I think it’s a great idea,” Rokakis said. “It’s an all hands on deck approach.”

But others are more cautious. Michael Collins, founder of the PolicyLab Consulting Group in Ithaca, N.Y., a mortgage research firm, said the suit is a sign that “cities are desperate – and certainly they should be. Cities have every right to be worried and to try to do something.”

But falling values caused by foreclosures are a continuing problem that can’t be easily or quickly fixed, even by a novel lawsuit. The real value of the lawsuit, he said, is to put lenders and servicers on notice that they need to take better care of their properties.

In Chula Vista, lenders must hire a management company to maintain foreclosed homes The city of Chicago requires lenders to pay for a night watchman to check on their vacant properties, Collins said. The cost serves as an incentive to get banks to sell or maintain the properties, he said, and Cleveland’s lawsuit might serve a similar purpose.

“It’s grabbing them (banks) by the scruff of the neck and saying, ‘Pay attention here,’” he said. “But there is no good solution. They can’t just stop the market.”

Many of the properties that have been flipped or abandoned are so far gone at this point that they are “the worst of the worst of the worst,” he said. Cities might be better off “making the best of this situation” by clearing them away, instead of trying to force banks to clean them up.
“In some of the cities, subsidizing bulldozers is probably a good solution,” he said. “Some of these properties are not salvageable.”

In housing markets that experienced the heights of housing boom, a backlog of bank-owned properties is less of a problem, because the houses still are valuable enough that homeowners buy them at sheriff’s sales. But bank behavior in handling other foreclosed properties has come under fire. The Federal Deposit Insurance Corp. this summer sent a letter warning banks to maintain their foreclosed properties and to continue paying taxes on them. TWI reported last January that banks in Cleveland and elsewhere have walked away from properties without following through with foreclosures because the legal costs surpassed the value of the properties. Cities get stuck with the cost of cleaning up or demolishing the houses.

Engel said that if the neighborhood group is successful, the housing court could set up an inspection system under which banks would have to prove they had maintained their properties before putting them up for sale.

But even if the suit doesn’t succeed, she and others said, it’s a sign that cities aren’t going to stand by while lenders dump their foreclosure problems on them.