This week, the AP reports on efforts by eight state legislatures to stop a new wave of fraudsters who are targeting desperate homeowners facing foreclosure. These scam artists knock on doors, cold-call and post flyers in the neighborhood offering to "rescue" the homeowner from their lenders.

In reality, their "solutions" are worse than the homeowner’s problems. In the worst cases, the homeowner ends up not only losing their house but still owing their entire mortgage to the bank. In the best case, they give the "rescuer" a few hundred dollars, and then never hear from him again. Of course, these aren't petty theives stealing in the dark of night. These fraudsters work in plain sight and the courts even assist them by enforcing arcane contracts that the homeowners did not understand.

The opportunity for foreclosure fraudsters is now huge, given that the number of foreclosures nationwide has jumped 46% this year. (I, along with two co-authors, are now investigating the causes of this spike, using a survey of 2000 homeowners in four states.)

Our friends at the National Consumer Law Center have been leading on this foreclosure fraud issue for several years (see their report (pdf)). We at the Harvard Legal Services office have also developed a concise single-sheet guide for the homeowner facing foreclosure. I'd be happy to provide a copy upon request.

Below the fold: legislative solutions to the scammer problem.

In my view, one of the most egregious methods is to impersonate a government agency, by using an official-looking seal, name, and address, in order to draw a consumer into a position of trust. (For example, the NCLC exposes (PDF p. 55) one group that called itself the "United States Homeowners Protection Agency" and even used an address just down the street from the White House.) In a similar vein, I routinely receive mailings from the "National Student Loan Agency" trying to finagle me into refinancing. When it comes to stopping scammers, this is low-hanging fruit.

Then there are the “foreclosure rescuers” who swoop in to buy the house for cash “as-is.” (You may have seen advertisements on late-night TV offering to train these guys.) This is a ridiculously quick way for the “rescuer” to take tens of thousands of dollars of the homeowners’ equity. Given the present rules of our game, however, these investors arguably perform a worthwhile service – they offer financial liquidity that the homeowner desperately needs. (Though if you were to take the amount of profit that the investor makes and spread it over the amount of time before the house is flipped, in many cases it will be equivalent to a loan with thousands of percent interest.) Moreover, in many cases, the homeowners have better options available to them.

While states can (and should) implement policies to prevent this particular scam tactic or that scam tactic, it may be more worthwhile to try to address the fundamental problem. The problem is not just that some people are naïve, that some people are irresponsible, and that some people are evil. Rather, the problem is that the current process of foreclosure puts intense, artificial time-pressure on the homeowner, which culminates with a sheriff’s sale on the courthouse steps. Such a forced sale inevitably brings far less than the house is worth. The scammers thrive in the shadow cast by that ugly outcome.

Why not instead have a soft-landing law that allows homeowners to make an orderly process of divesting themselves of the house, paying off the loan, and preserving whatever equity they have? After all, the mortgage lender only has a right to recoup its security interest – it should not also have the right to destroy the homeowner’s equity (the portion of the house value beyond that security), by demanding an extremely fast sale. Instead, we need something like the automatic stay that kicks in during bankruptcy. It needs to be just long enough to allow an orderly sale, but without the expense and baggage that comes with a full-scale Chapter 13 petition. (Some people already use Chapter 13 for this purpose, but it is dramatic overkill.) This same stay could prevent the fraudsters from meddling, since any contracts concerning the property would be subject to review by a trustee. To fund this process and to create the right incentives, the trustee would get a small cut from the final sale.

Such a soft-landing provision would be good not only for the homeowner, but also for their neighbors. What do you think happens to your property value and for the quality of your neighborhood when the guy next door is forced out at a sheriffs' sale? Moreover, given the billions of dollars that the federal and local governments have invested to encourage home ownership -- through tax breaks, loan gaurantees, subsidies, etc -- it seems a little silly just to turn our backs when homeowners get in trouble.