Why Do Banks Use Foreclosure And Auction As A Final Resolution When It Produces The Worst Possible Result?
How true, how sad… all that occurs is a huge loss for both the bank and the borrower, and in most cases because of personal guaranties there remains enormous personal debt that must still be cleared up… frequently by a bankruptcy. What other choices are there? It sounds ridiculous, yet it is the law of the land. Default on a secured loan results in foreclosure and liquidation auction of the collateral. There is a reason, not a practical one, but a logical and understandable one. Unfortunately, it yields the worst possible results but satisfies what is considered to be a higher priority.
The issue is steeped in lender liability issues. The bank has a fiduciary responsibility to treat the borrower fairly and with a higher level of responsibility beyond that of avoiding mere negligence. The bank must act with a higher accord for the borrower’s financial condition, that is well established. Thus, the presumption is that if an auction is well-advertised, repeated several times before the entire community, then the entire community is on notice and anyone interested in bidding will be present. The presumed result is the highest possible bid because of the competitive nature of an auction and because the entire market was informed publicly and repeatedly. This protects the bank from any claim that it did not respect the borrower’s rights or treat the borrower appropriately as a fiduciary responsibility requires them to do.
In short, despite the clear understanding that we all have—banks as well—that such a process seldom results in anything other than a bid far below market value, it is considered “fair” because it was publicized and thus gives everyone interested an opportunity to bid and compete for the right to purchase at the highest price. If only that were true.
The end result is not fair market value, this we know, but it is a fair approach… or so the illusion goes. The courts have long ago agreed that this is full satisfaction of the banks requirements to deal fairly and appropriately as a fiduciary must. To protect themselves from any claim of misdealing should they sell it privately or give it to a broker to sell or any other possible avenue of liquidation, the banks auction. Worst case results, yet the most defensible, safe and secure action… for the bank. This is why they foreclose and then auction, it is the defined way that works. In the eyes of the courts, this is the ultimate indication that fair market value was achieved, as everyone in the market was noticed and everyone had an opportunity to bid and compete openly and squarely with no single party having an advantage other than “highest bidder wins.”
A direct comparison would be the need to multiple list a property prior to a short sale to demonstrate that the entire market area had the opportunity to bid, or at least offer. It’s the same concept, presumably providing assurances that the system is being fair to the defaulting borrower by making certain an inside deal was not arranged against the best interests of the borrower or the bank.
Sure, they’re great ideas, but they fail to really accomplish the goal to support the highest liquidated price. It does not work very well, but it is the system we use. Oh well, who ever said logic rules in the case of default?
