Consumer Law & Policy Blog

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.

Preventing Future Economic Crises Through Consumer Protection Law or How the Truth in Lending Act Failed the Subprime Borrowers

A draft of my article Preventing Future Economic Crises Through Consumer Protection Law or How the Truth in Lending Act Failed the Subprime Borrowers, parts of which I spoke about at the AALS, is now available on SSRN.  Here's the abstract:

This paper argues that one cause of the current economic crisis was that the federal Truth in Lending Act failed to provide mortgage borrowers with the tools to determine whether they would be able to meet their loan obligations, and that as a result many borrowers assumed loans on which they would later default. The paper first explores the disclosures for adjustable rate mortgages - which were commonly used for subprime loans - and explains how those disclosures misled borrowers about their monthly payments. Next, the paper reports on a survey of mortgage brokers conducted in July of 2009. The brokers were nearly unanimous in reporting that borrowers never withdrew from a loan after reading the final TILA disclosures at the closing, and never used those disclosures for their stated purpose of comparison shopping for loans. In addition, brokers reported that many borrowers spent a minute or less with the disclosures, despite the fact that mortgage loans are among the largest, longest-term, and most complex obligations most consumers ever assume. It thus appears that many borrowers enter into their mortgages without comprehending the terms and the ramifications of those loans.

The paper suggests several measures to increase the likelihood that borrowers will attend to and understand their loan terms. At present, disclosures are mandated by governmental entities that do not participate in the loan transaction - thereby reducing their control over how the disclosures are presented; provided by lenders who do not have a stake in having consumers understand the disclosures and in some cases have an interest in obscuring them; and received by consumers who may not appreciate their importance and may even have reasons to overlook them. The paper therefore suggests a switch from the current TILA disclosure regime to a comprehension regime under which lenders would be obliged to insure that borrowers understand their loan terms. Alternatively, the paper suggests that lenders should be required to determine what proportion of their borrowers understands their loan terms and disclose those figures in the hope of generating competition among lenders for better comprehension scores. The hope is that either choice would give a party to the loan transaction - the lender - a stake in borrowers understanding their loan terms. Creation of such an incentive might cause lenders to reduce distractions to consumers reading disclosure forms, enlist the aid of lenders in conveying key terms to consumers, increase the intelligibility of loan terms, and lead lenders to abandon loan terms that consumers cannot comprehend.

If such a proposal proves politically unfeasible, the paper also draws on the work of Cass Sunstein and Richard H. Thaler to suggest “nudges” that might enhance the current disclosure regime. Specifically, the paper advocates requiring borrowers to view a video of the pain and risk of default and foreclosure to make those risks more salient and increase the likelihood that consumers attend to disclosures. The paper also suggests that loan applicants be obliged to draft a budget, taking into account any future increases in loan payments, so that they will understand the consequences of their payment obligations. Finally, the paper calls for requiring borrowers to take a “placement exam” to demonstrate their mastery of their loan terms and the budgetary consequences. Those who fail the exam would not be permitted to borrow unless a neutral credit counselor worked with them and certified that they understand their loan terms.

Rethinking the Foreclosure Plan

By Alan White

This story in the New York Times paints a grim picture of the Obama/Geithner foreclosure crisis response.  The main theme is correct:  without reducing principal balances, no plan will keep homeowners in their homes.  A kind of standoff has resulted from the banks' insistence that principal reduction be paid for by taxpayers, and the understandable reluctance of the Administration and Congress to pay for losses banks would otherwise bear anyway if they just continue foreclosing. 

In the twelve years before the crisis, total mortgage debt in the US tripled, from about 3.5 trillion to more than 10 trillion, reaching its peak of 10.5 trillion at the end of 2007.  The good news is that it is now going down.  The bad news is that it is still at 10.3 trillion as of the third quarter of 2009.  The economy cannot recover until we realign this debt hanging over American families with lower, sustainable home values.

This central issue of the crisis calls for leadership.  It calls for the President and the Treasury Secretary to end the impasse between banks and bailout opponents, to craft a reasonable plan that maximizes debt reduction through modification rather than foreclosure, with the minimum necessary taxpayer subsidy.  In my view, the plan will require considerably more stick, and perhaps only a tad bit more carrot.  Enacting bankruptcy stripdown of mortgages to property values wouldn't hurt either.

Study of Medical Causes of Home Mortgage Foreclosures

Christopher T. Robertson of Harvard, Richard Egelhof , and Michael Hoke have co-authored Get Sick, Get Out: The Medical Causes of Home Mortgage Foreclosures, 18 Health-Matrix Journal of Law and Medicine.  Here's the abstract:

In recent years, there has been national alarm about the rising rate of home foreclosures, which now strike one in every 92 households in America and which contribute to even broader macroeconomic effects. The "standard account" of home foreclosure attributes this spike to loose lending practices, irresponsible borrowers, a flat real estate market, and rising interest rates. Based on our study of homeowners going through foreclosures in four states, we find that the standard account fails to represent the facts and thus makes a poor guide for policy. In contrast, we find that half of all foreclosures have medical causes, and we estimate that medical crises put 1.5 million Americans in jeopardy of losing their homes last year.

Half of all respondents (49%) indicated that their foreclosure was caused in part by a medical problem, including illness or injuries (32%), unmanageable medical bills (23%), lost work due to a medical problem (27%), or caring for sick family members (14%). We also examined objective indicia of medical disruptions in the previous two years, including those respondents paying more than $2,000 of medical bills out of pocket (37%), those losing two or more weeks of work because of injury or illness (30%), those currently disabled and unable to work (8%), and those who used their home equity to pay medical bills (13%). Altogether, seven in ten respondents (69%) reported at least one of these factors.

If these findings can be replicated in more comprehensive studies, they will suggest critical policy reforms. We lay out one approach, focusing on an insurance-model, which would help homeowners bridge temporary gaps caused by medical crises. We also present a legal proposal for staying foreclosure proceedings during verifiable medical crises, as a way to protect homeowners and to minimize the negative externalities of foreclosure.

HAMP homeowners stuck in limbo

By Alan White

More than 700,000 homeowners are in three-month "temporary" trial loan modification plans, but mortgage servicers have managed to convert only 31,382 to permanent  modifications, according to the Treasury Department's November report released today.   

Given that the industry voluntarily modified, permanently, more than 100,000 mortgages per month just before HAMP was announced, these results are abysmal.  Testimony before a Congressional hearing Tuesday on HAMP confirmed that 70% or more of homeowners on temporary modification plans are making payments, so the problem is largely in getting the paperwork for permanent HAMP modifications done.  

Once again the report also highlights huge disparities in performance among different mortgage servicers.  The chart at right compares cumulative temporary modifications reported in the August report with permanent modifications reported through November.  The four big banks, BankofAmerica, Chase, Citi and Wells Fargo, converted fewer than 1%, fewer than 1%, 4% and 11% of their temporary mods, respectively.  Ocwen, meanwhile, has converted 89% of borrowers who were on temporary modifications in August to permanent mods by November.  Although scale is clearly a problem, Aurora, servicer of a large portfolio, managed to convert 23% of its modified loans to permanent modifications. 

Homeowners on trial modifications continue to be reported as delinquent to their credit bureaus, continue to accumulate unpaid interest, and face continuing threats of foreclosure.  Given the very large subsidies HAMP will pay the mortgage servicers if they can do this right, and the fact that the four biggest servicers were bailed out by the taxpayers in numerous other ways, we ought reasonably to expect better performance than this.   

Although Treasury officials had promised to report some information on performance of modified loans, none was included in the December report.  The fiasco in the making that this report reveals, and the fact that HAMP still does not deal effectively with the huge negative equity problem, compel the conclusion that we need a new plan to tackle the foreclosure crisis.

HAMP class action filed

New York City homeowners have filed a class action lawsuit alleging that Aurora Loan Servicing has systematically breached its contract with Fannie Mae to receive subsidies in return for modifying mortgages under the Home Affordable modification program (HAMP).  The lawsuit raises a number of interesting legal questions, including whether homeowners can sue as intended third-party beneficiaries of the contracts between Fannie and mortgage servicers, and how to apply contracts that call for one party, the U.S. government, to modify and add terms by directives (i.e. by fiat.)  The complaint also alleges that homeowners have a sufficient property interest in HAMP assistance to require servicers, Treasury and Fannie Mae to provide due process before denying assistance.

A preliminary injunction was denied in a similar lawsuit filed in July in Minnesota, on the basis that plaintiffs were not likely to prevail on the merits, because the court found that HAMP did not create protected property interests.  These will be interesting cases to watch.

Obama Administration doubles down on HAMP

The Administration has sent a clear signal that its primary foreclosure mitigation initiative, the Home Affordable modification program (HAMP), is not working.  In a press release today, Treasury and HUD announced new efforts to convert three-month trial modifications to permanent mortgage restructuring.  Of 650,000 homeowners in 3-month deals so far, 375,000 are said to be coming to the end of their trial periods by December.  In October the Congressional Oversight Panel revealed that only about 1,700 permanent modifications had been completed. 

Treasury promises to tell us for the first time in its December report, due around the 8th or 9th, how many trial mods each servicer should have made permanent by now, and how many have actually converted.  While the tone of the release suggests that much of the problem lies with homeowners failing to provide documents on time, the evidence from counselors and mediators is that there is a massive systems failure on the part of the mortgage servicing industry.  While some of the temporary mods are likely to fail, so far reports are that 80% of homeowners in the program are making their payments.  It would be unconscionable for these homeowners to lose their homes on account of missing paperwork.

2 million homes lost

In 2006 the Center for Responsible Lending predicted that the subprime foreclosure crisis would result in 2 million foreclosed homes.  That sad milestone was reached some time last month. 

HOPE NOW's September foreclosure report gives the grim news – there were roughly 90,000 more completed foreclosure sales for the month, i.e. running at 1 million per year, and rapidly approaching 2 million completed foreclosure sales since July 2007 (about half of them subprime).  At the current pace subprime foreclosure sales alone will reach 2 million by the end of 2011.  New foreclosure filings eased off a bit, but are still near their crisis peak levels of about 250,000 monthly or 3 million per year.  The number of foreclosure filings far exceeds the completed sales, partly because of successful modifications and refinancings, and partly because there is a huge inventory of homes in the foreclosure process.

It is also clear that the subprime crisis, while still ongoing, has spread to prime mortgages.  Subprime loans account for 11% of all mortgages, 39% of completed foreclosure sales, but only 29% of new foreclosure filings.  Subprime loans accounted for more than half of foreclosure filings and sales in the first half of 2008.

Interestingly there were 75,000 permanent modifications reported, for a period in which the Federal government’s Home Affordable mortgage program (HAMP) achieved fewer than 2,000 permanent modifications.  It seems odd that servicers choose to implement significant numbers of modifications outside the HAMP program, foregoing substantial payments from Treasury for successful mods.  It may be that the September non-HAMP modifications represent mortgage servicers concluding deals that were initiated before last April.  We’ll know more next week, when Treasury has promised to report the total number of permanent HAMP modifications achieved so far. 

 

Happy Talk from Treasury

By Alan White

Today Treasury released the October monthly report on the Home Affordable modification program.  Once again Treasury gives us only the good news - 650,000 temporary 3-month payment plans with homeowners since the program started in April.  By now, we should be seeing significant numbers of permanent modifications, but Treasury again refuses to divulge this key data.  I am hearing that the conversion of temporary modifications to permanent ones is still appallingly low.  We the taxpayers have contracted to pay the servicers billions of dollars to prevent foreclosures and modify loans, and so far they are not doing the job.  It will not do at this point to keep pointing the finger at homeowners, hundreds of thousands of whom are entering payment plans and making payments.

There are also early indications that two-thirds to three-quarters of homeowners on temporary modifications have made all their payments, but fewer than one in a hundred has a permanent modification after three months.   In some cases, legal aid lawyers are going to court to stop foreclosure sales for homeowners who are making payments on a temporary modification plan.  Treasury needs to demand performance from BankofAmerica, Chase, Citi, Wells Fargo, and the other mortgage servicers who are slated to receive billions in HAMP subsidies (not to mention all the other TARP subsidies).  Treasury also needs to start reporting the temporary-to-permanent conversion rate, and the homeowner default rate on temporary modifications.  If this emperor has no clothes, then let's get the tailor working on a new outfit.

Federal/State Agencies Obfuscate on Bankruptcy

Foreclosurebuzz has done an interesting survey of government web sites purporting to offer aid to consumers facing foreclosure.  Most agency web sites do not mention bankruptcy at all, despite the fact that Chapter 13, and in some cases Chapter 7, can provide an array of tools to restructure debt, and in the case of underwater second mortgages, eliminate debt.  The Comptroller of the Currency characterizes bankruptcy as a scam, more or less.  The FTC also implies that bankruptcy is not a legitimate option, discussing it only in the context of rescue scams. Senator Durbin is right - the banks own Washington (and apparently many state bank regulators as well.)