Consumer Law & Policy Blog

The Foreclosure Agenda

By Alan White

The outgoing administration has failed utterly to get a handle on the foreclosure crisis.  Distress sales continue to rise every month, mortgage servicers continue to impose losses of 50% or more on investors (meaning, at this point, you and me) by foreclosing and property values continue to decline.  Right now, the Treasury is dithering about how restrictive and punitive to make the requirements for the FDIC's proposal to insure modified mortgages, insuring only that few homeowners will actually benefit, and few foreclosures will be prevented.

President-Elect Obama can and must end the drift in policy and set a clear agenda to end the foreclosure crisis.  He can do this with a set of policy initiatives, legislation, and by speaking to the American people. Here are a few proposals:

Payday Lending Intitiatives Rejected

The Center for Responsible Lending is reporting that voters rejected ballot initiatives in Arizona and Ohio that would have enabled or extended the legality of payday lending.

Foreclosure Needs Scores

Want to know what the foreclosure "needs scores" are for every community in the United States?  The Local Initiatives Support Corporation has developed such scores sorted by ZIP Code.  According to Housing Policy.org, where you can find a link to the scores, "These scores incorporate measures of subprime lending, foreclosures, delinquency, and vacancies to help state and local officials quickly assess the relative needs of different jurisdictions for neighborhood stabilization funding within each state and allocate funds accordingly."

More Times Reports on Foreclosure Issues, Student Loans, and Target Marketing

More reports from the Times: yesterday's issue included "Another Student Loan Company Settles With New York," about the settlement struck by Attorney General Andrew M. Cuomo with Goal Financial; Goal will become the ninth lender to adopt a marketing code of conduct. 

Back on October 23, the Times ran a series of short but painful pieces under the headline "After the House Is Gone" about the impact of foreclosures on some families.  The day before, October 22, David Leonhardt wrote a column, "Life Preserver For Owners Under Water," in which he explained that the desire to help homeowners in danger of losing their homes also risks helping borrowers who can afford to make their payments but face a temptation to walk away from their underwater homes.  Which borrowers should be bailed out?  Here's what Leonhardt said:

Let’s start by acknowledging that morality cannot be the main criteria, unfortunately.

The government has already passed the point of drawing fine moral distinctions and is now in the business of stabilizing the economy by whatever means necessary. Someone might argue, then, for rescuing everyone who might end up in foreclosure, regardless of the reason.

The problem with this approach — and it’s the heart of the problem with any big-time homeowner rescue — is probably obvious. As soon as the government announces that it will help everyone at risk of foreclosure, a lot of people are suddenly going to decide they’re at risk of foreclosure.

Homeowners who are under water will have an incentive to think of their homes in cold economic terms and threaten to walk away, while those who can just barely afford their monthly payments will have reason to slide into delinquency. Multiply 19 million mortgages by a couple of hundred thousand dollars, and the government could be left with $4 trillion in obligations.

That same day, the Times ran "Drawing a Bead on Debtors" about how banks use databases to make loan offers to consumers who have recently emerged from bankruptcy, other distressed consumers and so forth.  The article reports on both target marketing and lending issues.

I don't know about you, but I'm ready for some good news about consumer law. 

Michael Barr, Jane Dokko, and Benjamin Keys on the Effect of Race on the Likelihood of Troublesome Subprime Loan Terms

Michael S. Barr of Michigan, Jane Dokko of the Fed, and Benjamin J. Keys of Michigan's Economics Department have co-authored "Who Gets Lost in the Subprime Mortgage Fallout? Homeowners in Low- and Moderate-Income Neighborhoods."  Here's the abstract:

With the subprime mortgage crisis going full bore, policy makers face the challenge of resolving the current mess, reforming the mortgage markets going forward, and balancing the risk of "abusive" lending against the rewards of financial deepening and access to credit. To better understand the challenges of homeownership for low- and moderate-income households, this paper makes use of a unique and proprietary dataset of LMI households based on a survey we designed and implemented with the Survey Research Center at the University of Michigan. We establish a profile of the demographic characteristics of homeowners in LMI communities. We then identify relationships between high-cost pricing and demographic characteristics (such as race) in low-income neighborhoods. We find that even within similar low-income neighborhoods, black homeowners are significantly more likely to have prepayment penalties or balloon payments attached to their mortgages than non-black homeowners, even after controlling for age, income, gender, and creditworthiness. We link the attitudes of homeowners and the constraints that they face to their financial decisions. We then suggest key areas for policy reform.

FTC Cracks Down on Debt Settlement Firms

As previously discussed here, so-called "debt negotiation" companies are engaged in questionable practices in the name of helping consumers. David Giacalone's f/k/a blog notes that the FTC recently settled claims against several debt negotiation firms that the FTC says had "led many into financial ruin." The settlement prohibits the companies from engaging in a variety of deceptive practices, including the companies' claim that they could reduce consumers' debt by up to 60 percent.

Times Reports on Lending Issues and Do-Not-Mail Lists

I've fallen embarrassingly far behind in my reading of the Times, but here are some of the articles I have managed to get to:

Today's edition includes an extraordinary column by Gretchen Morgenson, "Was There a Loan It Didn't Like?" about loan underwriting by WaMu.  Ms. Morgenson apparently interviewed a former WaMu senior mortgage underwriter, Keysha Cooper, about the pressures she experienced to approve loans, including loans which she believed were fraudulent.  Some excerpts:

“At WaMu it wasn’t about the quality of the loans; it was about the numbers,” Ms. Cooper says. “They didn’t care if we were giving loans to people that didn’t qualify. Instead, it was how many loans did you guys close and fund?”

* * *

One loan file was filled with so many discrepancies that she felt certain it involved mortgage fraud. She turned the loan down, she says, only to be scolded by her supervisor.

“She told me, ‘This broker has closed over $1 million with us and there is no reason you cannot make this loan work,’ ” Ms. Cooper says. “I explained to her the loan was not good at all, but she said I had to sign it.”

The argument did not end there, however. Ms. Cooper says her immediate boss complained to the team manager about the loan rejection and asked that Ms. Cooper be “written up,” with a formal letter of complaint placed in her personnel file.

* * *

Ms. Cooper says that her bosses placed her on probation for 30 days for refusing to approve the loan and that her team manager signed off on the loan.

Four months later, the loan was in default, she says. The borrower had not made a single payment. * * *

The rest of the article is definitely worth reading.  Ms. Cooper is now unemployed. 

Yesterday's Times brought Joe Nocera's column, "A Rescure Hindered By Politics," listing various proposals to help homeowners stay in their homes.  Nocera also explains his view about why the administration hasn't adopted a homeowner plan yet:

As I understand it, the money is not the hang-up. * * *

No, the hang-up, apparently, is that aid is going to homeowners, not giant financial institutions, with the negotiations revolving around who will be eligible for the program and what will constitute an affordable new mortgage. [The FDIC's ] Ms. Bair is arguing for a broad definition; the Treasury wants something narrow, which of course will mean fewer people will get help. This is hardly a surprise. One of the reasons previous efforts at helping homeowners have had such little success is precisely because the Treasury has insisted on defining the number of eligible homeowners as narrowly as possible.

* * *

The only legitimate reason for [treating banks better than homeowners] is the one that my colleague David Leonhardt has put forth — that if the government says it is going to help homeowners in danger of foreclosing, it will create an incentive for a lot more homeowners to decide that they’re in danger of foreclosing. But I would argue that the country is far better served at this late date by erring on the side of generosity. Isn’t it better to let a few homeowners get relief who might not need it (just like JPMorgan!) than restricting the eligibility so narrowly that people in real trouble will not be able get their mortgages modified? Yet the Treasury instinctively prefers the latter.

And, he concludes: "To delay any longer isn’t just short-sighted. It’s inexcusable."  Back on October 24, the Times ran "U.S. Vows More Help for Homeowners" about the administration's efforts to create such a plan. 

But the government is not the only entity that can help homeowners.  The Times also reported yesterday that "Banks Alter Loan Terms to Head off Foreclosures."  The article explains: 'On Friday, JPMorgan Chase became the latest big bank to pledge to cut monthly payments, by lowering interest rates and temporarily reducing loan balances for as many as 400,000 homeowners."  Banks engaging in such practices are acting out of self-interest and ultimately are helping only a small percentage of borrowers in trouble.

Still in yesterday's paper, Ron Lieber's Your Money column reports on a novel way to avoid taking out bad loans in "Financial Wisdom in Groups."  An excerpt:

* * * as we consider how to avoid this collective financial mess again, one question keeps rolling around in my head: How much better off would the world be right now if people had their own personal finance committee to consult before making big money decisions?

The balance of the column reports on the story behind a new book, "The Smart Cookies' Guide to Making More Dough,"and the related web site, smartcookies.com, about five women who formed such a committee.  Somehow I doubt we're going to see that one added to the Truth in Lending Act.

Going back in time in the Times, Bob Tedeschi reported on October 26 in "Reverse Mortgages Retooled" on the new rules for reverse mortgages.  Tedeschi notes that the new law requires counselors to pass exams that test their knowledge of reverse mortgages and that "borrowers will pay for counseling sessions, which can cost $125."

And just to get away from lending, the October 25 issue had an interview with Michael J. Critelli executive chairman of Pitney Bowes headlined "In Defense of That Daily Visitor, Unsolicited Mail,"  about the effort to enact do-not-mail legislation, similar to the do-not-call registry.  Critelli's perspective: "it’s not an environmental issue, and it’s not an identity theft issue. It’s the right of people to decide what they get. "

Returning to lending issues, the October 24 edition included "Some Hedge Funds Argue Against Proposals to Modify Mortgages."  The story reported that "Two funds recently warned mortgage companies that they might take action if the companies participated in government-backed plans to renegotiate delinquent loans in a way that undercut the funds’ interests."  That brought an article the following day: "Mortgage Threat From Hedge Funds Irks Democrats."

More when I get more time.

Behaviorism and Mortgage Workouts

By Alan White

Some useful applications of behavioral economics have emerged from efforts to deleverage American homeowners through mortgage renegotiations.  Servicers have complained that they have great difficulty persuading borrowers to respond when they offer help and solicit information, like current income verifications, in order to rewrite loan terms.  The FDIC/Indymac program took the simple additional step of calculating a new (lower) monthly payment that could result from a successful application for modification, and included that vital bit of information in its mailing to homeowners.  It's the same behavioral device as a pre-approved credit card.  Not surprisingly, borrower response rates improved.  According to a story in Friday's L.A. Times, Indymac got a 73% response rate from borrowers who had previously called, and to whom it sent a proposed modification with a prepaid, return FedEx envelope.  73% is an unheard-of response rate in this context.

The state regulators' September data release reports that there remains a large gap between homeowner applications for workouts and completed workout deals, on the order of two or three to one.  Why would a homeowners start the process and not see it through?  Or on the other hand, why would servicers spend time and effort beginning a workout application but not see it through?  From the standpoint of rational choice theory, both parties would have much to gain and little to lose, assuming that the servicer has done some initial screening (foreclosure value prospects not good, homeowner still in the home, homeowner believes they have income to service modified loan.)  Remember, we are talking about applications that remain undecided, not applications that are rejected. 

The large drop-off in foreclosure workout applications may in part be due to inadequate staffing and resources on the servicer side.  But it could also be due to channel factors, i.e. exactly what affirmative steps the borrower must take, and how and when they receive some positive encouragement about the process.

There are, of course, some possible rational choice explanations for low borrower response rates:  perhaps many borrowers who don't call or follow through realize their income is just too low.  They may have found a better, cheaper housing alternative, or have been involved in a questionable or fraudulent mortgage application, as is the case with investors who misrepresented themselves as owner-occupants.  Nevertheless, the large difference in response rates produced by very simple servicer strategies reinforces my view that more foreclosures can be prevented.