Consumer Law & Policy Blog

More on Consumer Financial Protection Agency's Prospects in the Senate

Following up on Jeff's post from yesterday, PIRG's consumer blog has this post on the fight in the U.S. Senate to save the legislation that would establish a Consumer Financial Protection Agency, with links to additional materials.

Consumer Financial Protection Agency Proposal Said to be in Trouble in Senate

by Jeff Sovern

The Wall Street Journal story is here.  Senator Dodd is said to be willing to settle for a beefed-up consumer protection agency within another federal agency, perhaps the Treasury.  Of course, the Office of the Comptroller of the Currency is such an agency, and it has been more of a hindrance to consumer protection than a help.  Settling for such a half-step--and maybe it's not even that--would be a huge disappointment.  The Huffington Post has Elizabeth Warren's take on this proposal and Reuters has this story on her reaction.

The Second Mortgage Problem – Banks Holding Out

by Alan White

The biggest obstacle to reducing principal and effectively working out home mortgages in trouble is the fact that half the homes in foreclosure may have second mortgages or home equity lines of credit.  The investors holding first mortgages understandably object to any debt reduction scheme that would not require the junior lien holders to take the hit first.  The junior mortgage holders are unwilling to recognize the reality that many of their loans are worthless.

Why are second mortgage holders in denial?  Because unlike first mortgages, which are mostly held by investors in mortgage-backed securities, second mortgages are still held by banks on their own balance sheets.  If the major banks were honest about the value of their home equity debt, their capital would take a huge hit.  At a time when the banks are repaying Treasury’s equity investments, they do not want to expose this fundamental weakness in their balance sheets.  Bloomberg reports that the four big banks, who are also the largest servicers of investor-owned first mortgages, have a combined total of $450 billion in home equity debt on their own books.

Bank of America, for example, has $150 billion in home equity debt, and 50% of it is underwater, or nearly, although most borrowers are still making payments, so far.  BofA estimates that half of the home equity debt is on homes with total first and second mortgage debt exceeding 90% of the home value. This at a point when its tier I capital was $191 billion.  Total loss provisioning for this portfolio was 6.4%, or about $10 billion, a figure that is clearly inadequate.   Large write-offs of BofA’s $150 billion home equity assets would take a big bite out of its capital base.

Thus, the essential first step in deleveraging American homeowners, namely big write-downs in second mortgage debt, is stalled by banks in denial.  As a result, the $1 trillion home equity tail is wagging the $10 trillion first mortgage dog.  Treasury is working on a plan to entice second mortgage holders to accept 15 cents on the dollar voluntarily, but banks are unlikely to play ball.   

Ironically, the present Bankruptcy Code allows homeowners to get rid of underwater second mortgages and home equity debt, if the first mortgage eats up all the equity.  Apparently, few homeowners who could benefit from stripping off second mortgages are using bankruptcy, perhaps because of the high costs to hire a lawyer and file a case.  In the absence of better use of bankruptcy stripdowns, or an alternative means to compel write-downs of second mortgage debt, the present stalemate, and the foreclosure crisis, will continue.

Stephen P. King Paper on Tort Law Reform's Effect on Consumers

Stephen P. King of the Faculty of Business and Economics, Monash University has written Does Tort Law Reform Help or Hurt Consumers?.  Here's the abstract:

Legal limits on insurance damages claims have been introduced in Australia, the United States and other jurisdictions. In this paper I construct a simple competitive model to analyze the effect of tort law reforms on consumers. The model shows that reforms to limit non-economic losses make consumers unambiguously worse off ex ante. Although insurance premiums fall and these reductions are passed on to consumers in full, this gain is more than offset by the increased risk that consumers are forced to bear. In contrast, reforms for income related (i.e. economic) losses lead to ambiguous outcomes. The potential benefits from limits to economic loss arise due to the inability of insurers to price discriminate on the basis of income or expected loss. Because of this there is an implicit cross-subsidy from low-income to high-income consumers that is embedded in the insurance premium and relevant product price. Tort law reforms partially unwind this cross subsidy.

The results presented in this paper show that tort law reforms may achieve their stated goal, such as lowering monetary prices, but can still make consumers worse off by introducing an uninsurable risk. There is also an important difference between reforms that limit claims for economic and non-economic losses. Insurance for economic loss will generally include an implicit cross-subsidy and, as a consequence, reforms can alter the ex ante utility for different groups of consumers in different ways.

Exploding Mortgages

By Alan White

Of all the subprime mortgages ever made from 2000 through 2007, 14% have been foreclosed already, another 4% are in foreclosure now, and another 9% are now delinquent, for a total of a 27% failure rate.  In fact, the true failure rate is probably worse.  About 58% of all subprime mortgages were prepaid at some point when homeowners refinanced or sold their houses.  Some of the loans used to refinance prior loans ended up in the default and foreclosure categories, and some of the sales were distressed. Only one third of outstanding subprime mortgages are still being paid on time.

These numbers are from a recently announced GAO report which compiles comprehensive outcomes data on alt-A and subprime mortgages from the Loan Performance database, and will provide an invaluable resource for scholars.

The 27% failure rate is not just for ARMs, or just for 2007 subprime loans, or just for no-doc subprime loans, it is for all subprime mortgages made since 2000.  I argued in a paper two years ago (The Case for Bannig Subprime Mortgages) that on balance the harm caused by subprime mortgage lending considerably outweighed any benefits it provided.  It is hard to imagine now what benefits could have outweighed a 27% lifetime foreclosure rate, and the resulting loss of nearly 2.5 million homes.

Colbert Explains

the financial crisis, foreclosures, securitization...

Carol Necole Brown Paper on Reverse Redlining Issues

Carol Necole Brown of North Carolina has written Intent and Empirics: Race to the Subprime.  Here's the abstract:

The United States’ history of racially discriminatory banking, housing, and property policies created a community of black Americans accustomed to exploitative financial services and vulnerable to victimization by subprime lenders. My thesis is that black borrowers are experiencing a new iteration of intentional housing discrimination in the twentieth and twenty-first centuries; lenders identified a vulnerable 'emerging market' of black homeowners and borrowers and knowingly targeted them to receive subprime or predatory loan products when equally situated white borrowers were given superior, prime mortgage products. This Article explores how disparate lending practices coupled with banking deregulation undermined the Congressional push for increased minority homeownership and widened the already burgeoning wealth divide. Millions of borrowers who accepted subprime loans between 1998 and 2006 already have or will lose their homes to foreclosure, resulting in a net loss in homeownership for nearly one million families. Blacks are disproportionately represented among the subprime victims, especially black women. The lending and financial services structure that caused this crisis is complicated by evidence of redlining and of steering blacks into subprime loans, all of which contributed to the present foreclosure crisis. This subprime dilemma merely adds new terminology to a long history of racial discrimination in housing in America. In the end, this Article argues that the search for an understanding of the cumulative events that facilitated the exploitation of blacks by subprime lenders illuminates the institutional and national impediments to reversing the present and future harm of the subprime crisis and to ensuring blacks equal access to one of the benefits of full citizenship - property. First, in Part II, I contend that the disparities in subprime lending experienced by black borrowers and especially by black women result from intentional reverse-redlining and steering by lending institutions, their loan officers, and brokers. Next, in Part III, I consider why blacks and black women are disproportionately victims of subprime mortgages and of predatory lending. Finally, Part IV concludes by discussing the after-effects of subprime and predatory lending and offers possible solutions for rethinking how blacks are to overcome this deeply profound experience with housing discrimination which I suggest made blacks prime subprime victims. It focuses on the property dilemma or rather the dilemma of the landless.

SCOTUS Takes Arbitration Case, Justice Department to Increase Fair Credit Enforcement, and Repoed Toddler

by Jeff Sovern

A few recent consumer law reports: The SCOTUS Blog has reported that the Supreme Court has granted cert in what could be an important arbitration case.  Here's their description:

Docket: 09-497
Title: Rent-A-Car, West, Inc. v. Jackson
Issue: Whether the district court is in all cases required to determine claims that an arbitration agreement subject to the Federal Arbitration Act (“FAA”) is unconscionable, even when the parties to the contract have clearly and unmistakably assigned this “gateway” issue to the arbitrator for decision.

• Opinion below (9^th Circuit)
• Petition for certiorari
• Brief in opposition
• Amicus brief of the Pacific Legal Foundation

One reason this may be significant is that arbitrators have an incentive to rule that such a contract is not unconscionable, since if the arbitrator finds the contract unconscionable the arbitrator would have to terminate the arbitration, thus eliminating the possibility of additional fees from the case, while if the arbitrator denies the unconscionability defense, the arbitrator can continue hearing the matter, and reap additional fees.  Consequently, a ruling that arbitrators can decide such matters is likely to reduce the number of contracts found unconscionable even in cases where such a finding would be warranted. 

The Times reports that the federal Department of Justice is creating a new unit to focus on unfair lending practices and especially reverse-redlining.  Among the reasons this seems like a particularly good move: First, it is difficult for private plaintiffs to bring successful actions under the Equal Credit Opportunity Act, and second, the subprime crisis has lent credence to claims that reverse redlining is common.

From time to time a car is repossessed with a child inside.  Here's another report on such an act.  Imagine how frightened the child must have been.  The UCC forbids self-help repossessions that breach the peace; this one, with a police helicopter search and chase involved, sounds like it qualified.

Obama Foreclosure Plan Still Falling Short

Treasury has issued its report on mortgage modifications under HAMP for December.  The total number of permanent HAMP mods rose from 31,000 at the end of November to 66,000 at the end of December.  In other words, HAMP is resulting in 33,000 permanent modifications per month.  A year ago, the industry was voluntarily and permanently modifying more than 100,000 mortgages per month.  In November and December, about 420,000 new foreclosures were started and about 170,000 foreclosure sales were completed.  HAMP is just not working.

 

Despite Treasury’s fanfare about its drive to convert temporary modifications to permanent modifications, the pace of conversion did not increase significantly in December.  Treasury tries to mask the sad reality by reporting only cumulative numbers each month, rather than giving a more honest report of month-by-month numbers, requiring those of us who care about what is actually happening to do some arithmetic to get at the truth. 

 

Securitization is a Problem for Mortgage Workouts

By Alan White

The Office of the Comptroller of the Currency's 3rd quarter report on foreclosures and mortgage modifications reveals the huge disparities between workouts offered to homeowners whose mortgages are securitized, compared to those with mortgages held on the lender's own books, known as "portfolio" loans.  The report also confirms once again that if a modification reduces the borrower's payments it has a much better chance of succeeding, while modifications that increase debt burdens go back into default at discouraging rates (60% or more).

Two features of loan modifications illustrate the disparity between securitized and portfolio loans.  First is principal reduction.  Many economists and other pundits support principal reduction as the best means to insure sustainable mortgages over the long term.  Lenders holding their own mortgages offered principal reduction in some amount for about one-third of their modifications.  Servicers handling investor-owned mortgages, on the other hand, wrote down principal essentially never. 

Another problematic feature of modifications is the capitalization of unpaid interest and fees.  While investors understandably would prefer to add these amounts to borrower's balances rather than write them off, the result is to increase the homeowner's debt burden, and the likelihood of eventual default and foreclosure.  Lenders modifying their own loans used capitalization in fewer than 20% of their modifications, while securitized mortgage modifications included capitalization 70% to 80% of the time. 

Although portfolio loans are different in other ways (many option ARMs were held in portfolio, for example), these disparities suggest that there is something to the idea that securitization makes aggressive and effective loan modification more difficult.