Consumer Law & Policy Blog

Worst yet to come?

The New York Times published a gloomy anonymous email from a banker castigating his own industry yesterday.  The banker predicts further bank collapses as more credit card receivables go into default. The banker makes the point that credit card divisions in banks rely on stated income and assets in much the same way that the mortgage industry relied on "liar" loans and are continuing to aggressively market high cost debt to those that cannot repay it.

In general, my impression has been that credit card lenders have been more sophisticated in managing default risk because they lacked the cushion of collateral. Moreover, unlike mortgages, credit card portfolios were not so obviously exposed to an asset bubble.  Still, as the recession spreads and Congress continues to sharpen moral hazard with financial institution give-aways (irrespective past consumer abuse) one cant help but wonder.

Courts Mediate Foreclosures

Local courts around the country are implementing mediation programs in order to reduce foreclosure sales and encourage negotiated workouts.  The Philadelphia program  (photos here) is one of the most ambitious, enlisting the aid of hundreds of counselors and volunteer lawyers and mediators.   Senator Spector presided at an October 24 hearing (link to witness testimony) at which participants described some of their successes, as well as the need for more resources for counselors and legal services and volunteer lawyers.  Programs have also been established in Seminole County Florida (click here for the court's order).  The state court systems of Ohio, Connecticut, and New Jersey have also adopted foreclosure mediation programs. These initiatives are certainly deserving of a modest slice of the federal government's bailout money.

Foreclosure and Modification Data

By Alan White

We now have foreclosure and mortgage modification reports coming from five sources on a periodic basis:  the Mortgage Bankers Association National Delinquency Survey (watch for the 3rd quarter report due the first week of December), the FHFA report on Fannie/Freddie mortgages, the State Foreclosure Prevention Working Group, HOPE NOW and the OCC/OTS mortgage metrics from banks and thrifts.  I have compiled the data into a spreadsheet (Download Excel file here) to facilitate comparisons and tracking of trends.  The different sources cover different segments of the mortage market, which explains some of the variance in the numbers. 

Generally, foreclosure starts and foreclosure sales continue to increase each month.  Modifications increased significantly in the first quarter, but leveled off somewhat over the summer, although HOPE NOW reports a big jump in September.  Foreclosures dipped in September, but that is largely due to the California foreclosure delay resulting from new notice requirements (California and Florida account for 40% of all foreclosure starts).  Expect to see a big jump in October and November when California foreclosures resume.  For now, the crisis continues to deepen, and the voluntary modification effort is still failing to contain the crisis.

Paying (but not overpaying) the Servicers

By Alan White

Why are foreclosures continuing, when each foreclosure results in an average loss of $100,000 and frustrated homeowners and counselors are trying to get reasonable loan workouts?  One of the many answers to this complex question is how mortgage servicers get paid (or don’t). 

Today's Fannie/Freddie Relief Plan

By Alan White
The plan to modify loans controlled by Fannie Mae and Freddie Mac announced today, while a step forward, suffers from two major drawbacks.  First, Fannie and Freddie do not hold most of the delinquent subprime and alt-A mortgages, so the plan will affect only about 10% of delinquent homeowners.  Second, as an extension of the FDIC model for modifying IndyMac mortgages, the plan calls only for monthly payment reductions, not for principal reductions.  While it is a good thing to streamline the process, and set an ambitious target of reducing payments to 38% of income (compared with the 55% standard that prevailed in the subprime market), Fannie and Freddie, like the FDIC, are still proposing to defer mortgage debt that far exceeds home prices, rather than writing it off, i.e. kick the can down the road.  We still need to deal with the servicers and investors who control most of the problem mortgages, and we still need to attack the $10 trillion problem of the overleveraged homeowner.

The Case for Homeowner Debt Relief

Today's New York Times reports that nearly a quarter of Americans with mortgages owe more than their home's current value.  One example cited in the story is a homeowner with a $630,000 mortgage from 2005 on a home now worth $420,000.  His interest-only mortgage, once the initial period ends, will require monthly payments of $12,000.  On the other hand, a fixed-rate amortizing 30-year mortgage at 6% for the $420,000 actual home value would require payments of $2,500 (plus taxes and insurance.)  Dropping the rate temporarily to 3% could bring the payment down to $1,800, in the event of a bona fide hardship. 

Or, the lender could foreclose.  It would then incur additional interest advances and foreclosure costs or $20,000 to $30,000 or so while holding the property, and perhaps sell it for $350,000 to $400,000 next year, resulting in a loss to investors (that's us) of $250,000 to $310,000, not to mention a loss of all future interest.

Servicers could provide homeowners an incentive to make payments, and hedge against possible return of home price growth, by offering a principal writedown after 12 months of on-time payments, and linking it to a second mortgage for the difference between the old and the modified mortgage.  The second mortgage should be progressively reduced over five years, to provide equity build-up if home prices do not come back to 2005 levels.  Let's swap homeowner debt for equity, just as we have been doing with banks.

Negative Prepayments

By Alan White

That's what mortgage servicers call it when a loan is modified by adding fees and interest to the principal.  Based on reports to investors, I estimate that in September and October $288 million was added to homeowner mortgage balances as a result of modification deals.  While the popular perception of mortgage modifications is that some people are getting "bailed out" or at least getting a break on their loans, the reality is quite different.

In the October investor reports I reviewed, covering about half the subprime and alt-A market, 72% of modifications reported included a "negative prepayment", i.e. upped the loan balance.  The average negative prepayment for these folks was $11,200.  The average amount of debt forgiven for these homeowners?  $97.51. Meanwhile, on loans that were foreclosed and sold, the average loss was $121,000.  For ALL modified loans, the average write-off was $1,914.  Even for the small subset of modified mortgages that did not include any negative prepayment, i.e. the most generous mods, the average write-off was $6,588.

This is insanity.  Servicers (with a few notable exceptions) are preferring to foreclose at a $121,000 loss per loan rather than to forgive more than a few hundred dollars of any homeowner's debt.  While there is much wringing of hands about the fact that many homeowners get "modifications" and then fall behind again, is it any wonder?  We can't really evaluate the success or failure of mortgage modifications that reduce debt, because there have hardly been any yet. 

Ray Brescia on the Social Capital Response to the Subprime Mortgage Crisis

Ray Brescia of Albany has written "Capital in Chaos: The Subprime Mortgage Crisis and the Social Capital Response," 56 Cleveland St. L. Rev. 271 (2008).  Here's the abstract:

This article explores the extent to which social capital theory can respond to the crisis in the subprime mortgage markets. Building on the groundbreaking theories of Robert Putnam in his book BOWLING ALONE: THE COLLAPSE AND REVIVAL OF AMERICAN COMMUNITY, this article seeks to explore the role of trust and social capital in micro-economic transactions, specifically those involving homeownership in general and the subprime mortgage crisis in particular. The article posits that asymmetries of information, the lack of fiduciary obligations between the mortgage broker and the subprime borrower, the incentives built into the subprime mortgage market as a result of mortgage securitization that promote abusive lending practices, deregulation that led to the influx of subprime mortgage products into communities of color, the limits of anti-discrimination laws to address this influx adequately, and restrictions on refinancing built into securitization agreements have all led to the current crisis. In response to these causes of the current crisis, this article suggests changes to the broker-borrower relationship, the promotion of greater consumer education and the creation of problem-solving courts to address the looming foreclosure crisis.

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:

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."