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A Market-Based Tool to Reduce Systematic Undervaluation of Collateral in Residential Mortgage Foreclosures

by Stephen Guynn
100 Va. L. Rev. 587 (2014)
Note

This Note addresses the problem of the systematic undervaluation of collateral in residential mortgage foreclosures. Public policymakers have been wrestling with this problem for nearly a century. As a result of the perceived flaws in the typical foreclosure auction, public authorities have tried to supplement the auctions with various rules intended to encourage higher sale prices or to protect against substantial undervaluation. While each of the supplemental devices promulgated by public policymakers has its strengths and weaknesses, none of them has completely solved the undervaluation problem.

This Note uses the underlying principles of credit bidding in bankruptcy proceedings to develop a new market-based tool that can deter the systematic undervaluation of collateral in residential mortgage foreclosures. Deficiency forfeiture sales options—the tool developed in this Note—target the two main problems with foreclosure auctions: (1) accurately determining the fair market value of the underlying property and (2) incentivizing lenders to bid that value at the auction. Similar to credit bidding, the new tool proposed by this Note will result in a transfer of wealth from lenders to borrowers, but only if lenders bid or collude with or tolerate third-party bidders who bid below the fair market value of the underlying property at the foreclosure auction. The threat of this permanent transfer of wealth from the lender to the borrower should be an effective and efficient deterrent of systematic undervaluation of collateral in residential mortgage foreclosures, just as the threat of a transfer of value from a bankrupt estate to a secured creditor as a result of credit bidding deters undervaluation in bankruptcy proceedings.

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