Consumer Law & Policy Blog

State Anti-Predatory Lending Laws Mitigated Foreclosures

by Alan White

Following up on our prior studies, we have posted a new paper finding that states with effective anti-predatory mortgage lending laws had fewer risky subprime loan originations and lower default and foreclosure rates than states without effective laws.  This new paper relies on loan-level data for 1.2 million mortgages observed monthly through 2008, and standard regression analysis to control for non-legal variables differing between states with and without effective laws. The effectiveness of state laws holds both at the state-wide level and when looking at metropolitan areas on borders between states with and without effective laws. 

Brent White Paper on Underwater Mortgages

Brent T. White of the University of Arizona - James E. Rogers College of Law has written Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis.  With more than 12,000 downloads, it's the most downloaded paper to appear in the SSRN LSN Consumer Law Abstracts ejournal thus far.  Here's the abstract:

Despite reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners choose not to strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to encourage homeowners to follow social and moral norms related to the honoring of financial obligations - and to ignore market and legal norms under which strategic default might be both viable and the wisest financial decision. Norms governing homeowner behavior stand in sharp contrast to norms governing lenders, who seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility. This norm asymmetry leads to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse.

Foreclosures: Not Getting any Better

While most of the media covered the monthly Realtytrac numbers released last week, the more reliable quarterly Mortgage Bankers National Delinquency Survey was released Wednesday, and the news is all bad.  The seasonally-adjusted total of mortgages in foreclosure or default is approaching 15%, and remains at record high levels.  Foreclosures remain at quadruple their pre-crisis levels, and more than double the rate experienced in any prior recession since the Depression.  Meanwhile the Administration's HAMP program is mostly offering homeowners false hopes.  For my summaries of publicly available foreclosure data, go here.  We have not turned the corner on foreclosures, and as a result the shadow inventory of unsold homes, at around 7 million, will continue to depress home prices, construction and the economic recovery generally, while the unresolved $10 trillion in residential mortgage debt will continue to depress consumer spending.

The Failure of HAMP - Update

By Alan White

Treasury released the April report on the HAMP mortgage modification program today.  The tally for April is 68,000 permanent modifications, still well short of what the industry was doing without HAMP subsidies a year ago.  According to HOPE NOW's latest report, during the first three months of 2010 two-thirds of mortgage modifications were done by servicers outside the HAMP program, without the HAMP subsidy.  We already know from the OCC/OTS mortgage metrics reports that non-HAMP mods are more likely to reduce principal than HAMP mods.  In short, twice as many workouts are happening without taxpayer subsidy, and for some reason servicers can find something better to offer homeowners in two out of three cases.  If the HOPE NOW numbers are correct, there are actually more modifications being done now than foreclosure starts, so perhaps in the months to come we will actually see the foreclosure inventory come down.

Also worth noting is that almost as many temporary modification plans resulted in cancellation as in conversion to permanent modifications.  My public radio station WBEZ had a story this morning about a homeowner who was in a temporary mod from last July until April, when he got word that he would not qualify for a permanent modification, and by the way now owes thousands more despite making all his payments.  If the nonconversion rate continues at 50% or more, HAMP can ultimately reach fewer than 800,000 homeowners, and obviously not all of them will save their homes.  A far cry from the Administration's initial promises to help 3 million or more.

On the foreclosure front, there should be first quarter numbers out from OCC/OTS and the Mortgage Bankers delinquency survey this week or next.  The news will probably be mixed - the number of foreclosure starts has been declining for the last two quarters, but the number of foreclosure sales is on the rise, and the total inventory of mortgages in default or foreclosure stubbornly refused to come down from peak crisis levels. 

Foreclosure Stories and Goldman Sachs

The Wall Street Journal has an excellent piece telling the stories of several foreclosed homeowners whose mortgages were included in the infamous Abacus deal that has Goldman Sachs in hot water.  The SEC charge is that Goldman sold investors a CDO based on other securities based on these mortgages, without mentioning that hedge fund magnate John Paulson had cherry-picked the mortgage pools for the CDO looking for those most likely to end in default and foreclosure, so he could bet against them.  The Goldman pitchbook for the Abacus CDO is an interesting exercise in omission by misdirection.

Moral Hazard, Strategic Default, and Debt Reduction

By Alan White

Opponents of mortgage debt reduction, with or without taxpayer subsidies, often invoke moral hazard and strategic default.  They argue that if delinquent borrowers are offered the chance to have part of their debt canceled to prevent foreclosure, other borrowers who can manage their payments will elect to stop paying in order to join the debt cancelation program, i.e. they will engage in strategic default.  The problem with this argument is that it ignores the competing incentives homeowners have to default in two opposing scenarios--one where mortgages are reduced to home values, and one where mortgages are not reduced so that homeowners face persistent negative equity.  I am not aware of any good research quantifying the likelihood that homeowners who can otherwise pay will default in order to benefit from modification programs.  The modifications offered to date, in both HOPE NOW and HAMP flavors, featuring capitalization of unpaid interest and temporary rate reductions that lead to future payment shocks, would not tempt a rational and strategic borrower, but perhaps some future hypothetical modification program might do so.  Deliberate default to benefit from modifications is a risky strategy when there is a screening process to determine hardship and eligibility for modifications is uncertain.

What is well established is that NOT reducing principal will result in strategic defaults.  In other words, as more homeowners face mortgage debts exceeding their home value, and the realization sinks in that home values will not return to 2007 levels any time soon, some will choose to stop paying their debt and walk away.  These strategic defaulters would be much less likely to walk away, and more likely to keep their payment promises, if their equity was restored through modest debt reduction.  A recent study helps to quantify exactly how much negative equity needs to be eliminated to prevent widespread strategic defaults.

The study by Luigi Guiso, Paola Sapienza and Luigi Zingales is based on a survey of homeowners.  Respondents would not elect to default as soon as their home equity is negative, due to both economic considerations (relocation costs) and moral restraints.  However, when the negative equity reaches a certain point they are much more willing to consider walking away.  Specifically, when negative equity reaches 20%, 12% will walk away, and at a 50% negative equity level, 17% will walk away.   The survey also found that respondents who knew of mortgage defaults by others judged 26% of them to be strategic.  This latter finding, reflecting a variety of values and judgments about others, should be taken with some skepticism, but is important because the survey also finds that there is a contagion effect.  Other things being equal, homeowners are more likely to walk away when they perceive that many of their neighbors have already done so, and more generally when foreclosures in their area increase.

Strategic default is not linear.  There is a tipping point effect, both because moral restraints on defaulting loosen as negative equity reaches hopeless levels, and because news of neighbors being foreclosed increases the willingness to walk away.  This all suggests that principal reduction, targeted at areas with significant and persistent negative equity, and with the use of appropriate screening to mitigate moral hazard, will prevent strategic defaults and resulting foreclosure losses. 

Moralizing Bankers

By Alan White

Last week the chief executives of JP Morgan Chase, Bank of America and Wells Fargo home lending wrote to Congress, and decried the danger and immorality of forgiving debts.  Specifically, they protested that any effort to compel them to reduce the principal owing on mortgages that exceed home values would strike at the heart of the sanctity of contract, and furthermore, discourage bankers from ever making any future mortgage loans. 

Moral hazard in money lending, of course, runs both ways.  The more we condemn the debtor, imprison her, and flog her for breaching her promise, the more reckless the lender can become in making loans that cannot possibly be repaid.  Rigid enforcement of loans creates moral hazard for lenders, while fair and realistic bankruptcy relief and debt jubilees cause banks to lend prudently and fairly.  Chase is now the owner of billions in reckless loans made by Washington Mutual, and Bank of America now has the Countrywide portfolio, both of which are fattened with the infamous “option ARMs,” loans so hopelessly unrepayable that the borrowers were not asked to pay even the full interest due every month. 

In various faith traditions, the moralizing is more likely to condemn the lender than the borrower.  Isaiah railed:  “ye have eaten up the vineyard; the spoil of the poor is in your houses.”  The Q’uran and the Dhamappada are to the same effect.  Saint Thomas Aquinas urged the restoration of all interest as essentially the fruit of theft.

One might also note that Washington Mutual, unable to keep its promises to bondholders and depositors, relied on Chapter 11 bankruptcy and the FDIC to cancel its promises or fulfill them in its stead, and Bank of America compromised with bondholders on $36 billion in promises made by Countrywide.

Yes, homeowners made promises, nearly eleven trillion dollars of promises.  But these obligations were placed on them by moneylenders who should have known better, and whose imprudence has now cost millions of people their homes, their jobs and their life savings.  If forgiveness of debt today will make lenders more reluctant tomorrow, then let us forgive our debtors.

Texas Consumer Laws Prevented Banking Crisis

by Richard Alderman

Paul Krugman's editorial in the New York Times today compares the results of the financial crisis in Georgia with Texas, noting that Texas did not face similar problems. He states, "Why didn’t the same thing happen in Texas? The most likely answer, surprisingly, is that Texas had strong consumer-protection regulation. In particular, Texas law made it difficult for homeowners to treat their homes as piggybanks, extracting cash by increasing the size of their mortgages. Georgia lacked any similar protections (and the Bush administration blocked the state’s efforts to restrict subprime lending directly). And Georgia suffered from the difference."

Krugman is correct that throughout the 1990s, Texas law prohibited home equity loans and made it difficult for consumers to get over their heads in what appeared to be low interest rate debt. What he doesn't note, however, is that Texas has since amended its law to permit home equity loans. Although the Texas law does have some consumer protections, I don't think we will fare as well in the next economic crisis.

Mortgage Crisis Update: Treasury Tinkers with Failed HAMP Program, Delinquencies and Foreclosures Stubbornly Refuse to Go Away

By Alan White

While the stimulus package and bank bailouts have treated the symptoms of the crisis and saved the banking and mortgage finance systems from collapse, the foreclosure crisis itself is about as bad as ever.  As the foreclosure crisis enters its fourth year, there are some signs that things are not getting worse, but little evidence they will get better any time soon.  New foreclosure starts reached a peak of about 250,000 monthly in the third quarter of 2009, or about quadruple their level in mid-2006 just before the crisis.  The fourth quarter saw a significant decline in foreclosures starts, in both the Mortgage Bankers survey and the OCC/OTS report, to something like triple the pre-crisis numbers.  On the other hand the inventory of foreclosures remains at their peak of more than three times pre-crisis levels, as do total delinquent mortgages (about one in seven mortgages are now delinquent or in foreclosure, compared to less than one in twenty just before the crisis began.) 

Something like 2.2 million foreclosure sales have been completed since July 2007, which should have eliminated almost half a trillion dollars in mortgage debt.  On the other hand, an equal number of mortgages have been modified, in the majority of cases resulting in significant increases in mortgage principal through capitalization.  Net mortgage borrowing for all Americans has been negative for the past six quarters, but total mortgage debt has declined only slightly, from $10.5 trillion to about $10.2 trillion, from the peak in March 2008 to the Fed’s latest sounding on December 31, 2009.  The deleveraging of American homeowners has a long way to go (total mortgage debt was less than $5 trillion at the beginning of 2001.) 

Another way to think about it is to compare the drop in mortgage debt to the drop in home values, i.e. just how underwater are we?  The Case-Shiller index of home prices has declined about 30% from its peak, and mortgage debt is down by only 3%.  This can’t be good.  Incidentally, credit card and other consumer debt is down only about 5% from its 2008 peak, after a 30% runup in the five years prior.

The Administration’s HAMP program to address foreclosures by paying servicers to modify mortgages they should be modifying anyway, has failed.  It has resulted in a net decline in monthly modifications and no perceptible dent in the foreclosure inventory.  The HOPE NOW servicer coalition claims that in January 2010 for the first time HAMP modifications plus modifications servicers did without Treasury help rose to 150,000, significantly higher than the 120,000 monthly total modifications done before HAMP was launched in March 2009.  If true this would be good news, but the investor reports I follow are not showing the large increase in modifications HOPE NOW is touting.  In any event, 100,000 to 150,000 monthly modifications, even if they were all successful, does not solve the problem of 200,000 new foreclosures filed every month and an inventory of 6 million mortgages delinquent or in foreclosure. 

Latest HAMP report: Treasury program a failure

By Alan White

Treasury released its latest Home Affordable modification program (HAMP) numbers today. Despite their efforts to put a positive spin on it, the program is a failure.   A million homeowners have been lured into temporary payment plans with false promises of permanent loan restructuring.  After 11 months, only one in ten has had their mortgage permanently modified.  More disturbing is the fact that these one million homeowners in trial mods, i.e. short-term payment plans, were given a deadine of January 31 to convert to a permanent mod.  Treasury reports that about 33% of those who have been in trial payments for three months or more have missed payments.  The other two-thirds are making their payments.  That means that more than 500,000 homeowners are in trial modifications, making payments on time, but about to be kicked out of the program, presumably because of missing paperwork.

 

Mortgage servicers were permanently modifying around 100,000 loans a month before HAMP started.  HAMP’s highest monthly total yet was the 50,000 additional permanent modifications achieved in January 2010 (116,000 reported this month minus 66,000 reported last month).  Meanwhile, new foreclosure filings are adding 250,000 to 300,000 homes to the crisis every month. 

 

Rather than owning up to this dismal performance, Treasury continues to obfuscate the statistics.