Consumer Law & Policy Blog

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. 

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.

Rate Freeze Mods - Not so much

By Alan White

Looking at the October mortgage modifications (actually 9/25 to 10/25) I noticed that 40% of them were adjustable rate loans with reset dates in the next six months (November to April).  Thinking these might be rate freezes, where the servicer agrees to keep the interest rate and payment the same by delaying or cancelling a rate adjustment, I checked the before and after monthly payments.  Strangely, only 10% remained the same.  About 40% of the mods with imminent rate resets resulted in lower monthly payments, while 50% resulted in current payments being higher than the initial payment. 

Two things seem to be happening.  One is that servicers are concentrating some efforts on working with homeowners whose rates are about to adjust, but then are tailoring modifications according to some unknown set of rules.  Second, some servicers apparently still prefer to make a bad situation worse by increasing borrowers' monthly payments to recover past arrears. 

Meanwhile, JPMorganChase announced today that it will open 24 regional homeowner counseling centers and modify up to 400,000 mortgages in the next two years.  JPMorgan is now the owner of not only Chase Mortgage but also Washington Mutual's portfolio of subprime and option-ARMs, as well as Bear Sterns/EMC Mortgage.

Latest Foreclosure Numbers

By Alan White

New foreclosure filings declined a bit from about 200,000 in July to about 180,000 for September, according to HOPE NOW's latest data.  Completed foreclosure sales likewise leveled off at around 90,000 monthly.  While HOPE NOW reports a continuing increase in monthly modifications, to a high of 98,000 in September, servicers are still filing almost twice as many foreclosures as loan modifications.  HOPE NOW also is combining all forms of loan modifications in its numbers, including term extensions and recasting of arrears that result in higher monthly payments and mortgage balances.  Nevertheless, the significant increase in September mods is welcome news, and may reflect in part some of the FDIC's efforts with the IndyMac portfolio, and/or the implementation of the state attorneys general settlement with Countrywide/BankofAmerica.

Meanwhile, RealtyTrac is reporting a dip in foreclosure starts for September compared with August, running at a level of about 250,000 monthly (their sample and counting method are different than HOPE NOW's).  The credit for this, however, does not go to any Federal initiative, but to the states.  California saw a 50% drop in foreclosures from August to September, because of a new state law effective in September that requires lenders to contact homeowners 30 days before starting foreclosure.  Similar laws have also been implemented in New York and North Carolina, among others.  On the other hand, the various state initiatives provide only temporary relief, and numbers will probably climb again after the initial wave of foreclosure postponements passes.  The state measures can provide homeowners and servicers breathing room to negotiate more restructurings, but all evidence is that it will take far more than 30-day or even 90-day delays to insure that preventable foreclosures are prevented.

The number of seriously delinquent mortgages, meanwhile, is still growing, and stands at more than 2.2 million, not counting foreclosures in process, bankruptcies and REO.  The pipeline of future foreclosures continues to grow at the rate of 150,000 or more per month.

 

A final note - the HOPE NOW press releases include repayment plans in their total of foreclosures prevented.  Short term repayment plans are frequently not successful, and many homeowners have entered into more than one such plan, or have a repayment plan before they get a modification agreement, so in my view the grand total of "foreclosures prevented" reported by HOPE NOW is probably misleading.

FDIC's Foreclosure Prevention

The FDIC, as conservator for IndyMac, has suspended all foreclosures and is aiming to modify 40,000 out of 60,000 currently delinquent IndyMac mortgages.  In the six weeks since the takeover FDIC has mailed out 15,000 loan modification proposals, and has already received signed agreements from 3,500 homeowners.  On average payments are being reduced by $350 monthly.  Details are in Chairman Sheila Bair's testimony today before the Senate Banking Committee. 

In contrast, August and September loan modifications by subprime and alt-A servicers generally are still wildly inconsistent and falling short.  Nearly a third of modifications are still increasing, rather than decreasing, monthly payments.  Some servicers are aggressively modifying loans while others show virtually no modification activity.  I will post a more detailed report when I have the October numbers.

Who Are the Subprime Borrowers and How Many of Them Would Have Been Better Off If No One Had Lent to Subprime Borrowers?

Reports on the subprime crisis appear to divide subprime borrowers into three groups.  You hear anecdotes about how borrowers fit into one group or the other, but it's not clear how many people belong to each group, or the extent to which the groups overlap.  The first group is made up of victims of predatory lenders.  These borrowers were persuaded to take out loans that they could not possibly pay back or at least were unlikely to pay back unless housing prices increased sharply.  The anecdotal reports create the impression that members of this group did not understand their payment obligations, especially when they entered into adjustable rate mortgages with initial low teaser rates, and many have now defaulted or are struggling to avoid default.  That group seemingly was not helped by the expansion of subprime lending.  I say "seemingly" in part because of the article in yesterday's Times, "Building Flawed American Dreams," about the role of Henry G. Cisneros, HUD secretary in the Clinton administration, which contains the following:

Victor Ramirez and Lorraine Pulido-Ramirez bought a house in Lago Vista in 2002. “This was our first home. I had nothing to compare it to,” Mr. Ramirez says. “I was a student making $17,000 a year, my wife was between jobs. In retrospect, how in hell did we qualify?”

The majority of buyers in Lago Vista “were duped into believing it was easier than it was,” Mr. Ramirez says. “The attitude was, ‘Sign here, sign here, don’t read the fine print.’ ” He added that some fault lay with buyers: “We were definitely willing victims.” (The Ramirez family veered close to foreclosure, but the couple now have good jobs and can make their payments.)

The second group consists of speculators who expected that housing prices would rise and they would flip their houses for a profit large enough to cover their mortgage obligations and transaction costs and still make a profit.  Many of them planned to sell before the rates on their adjustable mortgages rose but found it impossible to do so at a price that would cover their mortgage obligations when housing prices went down, and so they walked away from their investments.  That group too was not helped by the expansion of subprime lending, but it seems fair to say that the fact that the loans were subprime was not the key factor here in that prime borrowers who bought on the assumption that they would be able to flip their investments suffered from the same outcome when prices fell. 

The third group comprises borrowers who could not have obtained a mortgage without the expansion of lenders into the subprime market and who are current on and able to make their payments for the foreseeable future, like the Ramirezes.  it's harder to figure out whether this third group benefited from the expansion into subprime lending or not. The decline in housing prices has hurt that group because their homes are worth less than they paid for them and perhaps even less than they owe on them (though again, it is fairer to lay that at the feet of the decline in home values rather than the expansion into subprime lending).  If they want to sell their homes, they will be in trouble because they may not get enough to cover their mortgage obligations and also because the credit crunch will make it harder for would-be buyers to obtain financing.  But as long as they're willing to stay put, there's an argument that subprime lending has helped them on balance because they now own a house.  But if their home is underwater, they probably would have been better off staying in rental housing, and even if their home is not underwater, they might have been better off staying in rental housing--though to repeat it yet again, that seems attributable more to the fall in housing prices than the mortgage meltdown.

This division is a bit simplistic, but it leaves me with several questions. First, how large are these various groups?  (I haven't gone looking to see if others have answered that question)  Second, what policy implications does all this have?  For example, if many borrowers did not understand their payment obligations (the first group), that suggests that the Truth in Lending Act disclosures failed and need revision.  If, on the other hand, most borrowers did understand their payment obligations, and went ahead anyway, that indicates that the failure was less attributable to TILA, though perhaps credit counseling might have helped.  Ian Ayres, for example, has suggested that information remedies would not have made a difference and that the real problem was that borrowers "simply underestimated the likelihood of a fall in real estate prices."   Another policy implication:  while subprime lending has dried up for the moment (as has a lot of lending, though today's news reports suggest that the credit crunch is easing for some), eventually the credit crunch will end and lenders will once more be willing to extend loans.  The relative sizes of these various groups raise questions about whether subprime lending ought to be encouraged when that happens, or discouraged, or perhaps regulated in new ways so that only those whose lives are enhanced by taking out such loans have access to them.  And that in turn has implications for the Community Reinvestment Act.  My own opinion is that subprime lending is not the culprit per se; that is to say, society is better off if people, whether subprime or prime borrowers, can obtain mortgages that they can afford, understand the terms of, and can handle the risks of incurring, and that the problem is not so much the fact that some borrowers were subprime. But I would be interested in the opinions of observers who are better informed than I. 

Fannie and Freddie by the Numbers

By Alan White

     I’m coming back to a theme here, but the myth that Fannie and Freddie caused the crisis keeps being repeated.  The subprime crisis was in no way caused by Fannie Mae and Freddie Mac, nor by Congressional regulation or nonregulation of them.  To put some numbers behind the facts, I turned to my two-volume Mortgage Market Statistical Annual for 2008, published by Inside Mortgage Finance.  I take it as a given that the current crisis was caused by the rapid and unexpected increase in defaults and foreclosures on subprime mortgages.  Subprime losses led to subprime-backed securities losing value, which led to big losses for banks and investment banks, small towns in Norway, the collapse of Lehman Bros, etc. etc.  There were of course, other problems, such as excess leverage in investment banks and hedge funds, the opacity of the credit default swap market, etc., but I don’t think anyone is blaming Fannie and Freddie for those systemic problems.  When you look at the numbers, it is easy to see that Fannie and Freddie were bit players in the subprime crisis.

Mortgage restructuring and moral hazard

By Alan White

Although moral hazard concerns for banks and securities investors went out the window with the various bailouts and government guarantee schemes, homeowners are not getting their debt written down, paid, insured or assumed by the Treasury. My review of August and September remittance reports found about 7% of mortgage modifications reduced principal, compared with 34% increasing principal and 59% leaving principal the same. The mortgage modification machine is increasing overall mortgage debt for homeowners, not reducing it.

One excuse we hear from mortgage servicers is their worry about moral hazard. Countrywide, for example, included a provision in its deal with state attorneys general giving it an out from loan modification requirements if it detects "material levels of intentional nonperformance by borrowers that appears to be attributable to the introduction (!) of the loan modification program."

I know of no empirical evidence to support the bizarre idea that homeowners who were current on payments and could afford them have decided or will decide to stop paying and risk foreclosure, solely because they thought they could or should get a loan modification. Given the demonstrated psychological importance of homeownership and the ridiculous lengths to which many homeowners in bankruptcy will go to maintain mortgage payments even when they have serious negative equity, this version of moral hazard for mortgage payers seems far-fetched, to say the least.

Consider also that according to the New York Federal Reserve's data, by the end of August, only 57% of subprime mortgage borrowers were still paying on time. The other 43% are already delinquent or in foreclosure. The number of homeowners who could be infected by moral hazard is rapidly dwindling. Consider also the competing moral hazard: the longer we refuse to write down mortgage principal for homeowners who are behind and owe more than their homes are now worth, the greater the chances they will just give up and walk away. At some point, even the most dedicated mortgage payers will realize that their home values will never catch up to their 2006 and 2007 mortgage debts, and they will cease payments. The real moral hazard is that we allow millions of families to be evicted from their homes for the sake of a theoretical construct.

The Fannie Freddie Fable

At last night's debate, Senator McCain trotted out the discredited fiction that Fannie Mae and Freddie Mac were the root cause of the foreclosure crisis, and that they started the practice of making reckless loans to homeowners who couldn't repay them. Senator Obama correctly shifted the emphasis to deregulation, but did not set Senator McCain straight on the facts, seeming hesitant to defend Fannie and Freddie.

The fact is that subprime lending caused the crisis, and subprime loans were, by definition, loans that Fannie and Freddie (the GSEs) would NOT purchase. Let's say that again. A subprime loan was a loan that was not eligible for purchase by the GSEs, also known as a "nonconforming" loan. A mortgage was ineligible for GSE purchase for one of two reasons: either the amount exceeded the GSE ceiling of about $350,000, or the underwriting was too lax to meet GSE standards. Subprime loans were sold to investors through so-called private label securitizations, which means a securitization that was NOT sponsored by Fannie or Freddie. So, for example, Aurora Loan Services, an unregulated nondepository lender, made no-doc loans interest-only loans and sold them to investors through a Lehman Brothers securitization. The subprime lending and securitization machine was pumping out toxic mortgages for years before Freddie, and to a lesser extent Fannie, started purchasing the subprime securities to boost their profits. At worse, the GSEs, along with every bank, insurance company and institutional investor in the world, acted as enablers for the subprime lending boom to continue, and were victims, not catalysts of the crisis.