Consumer Law & Policy Blog

Minnesotans rally for foreclosure moratorium

By Alan White

Homeowners and activists demonstrated at the Minnesota governor's mansion Saturday to support a statewide 12-month foreclosure moratorium. Governor Pawlenty has threatened to veto the Minnesota Subprime Foreclosure Deferment Act, now pending in the state legislature. The governor has proposed voluntary actions by mortgage servicers instead.

Minnesota may join Philadelphia, Massachusetts, and other local and state courts and legislatures in the months to come, as homeowner frustration grows, preventable foreclosures continue to mount and voluntary efforts by the mortgage servicing industry continue to fall short of addressing the need.

Senate bill and moral hazard

by Alan White

The Senate today passed its version of a housing crisis bill, stripped of most provisions that could help homeowners facing foreclosure. The provision that would have permitted bankruptcy judges to modify interest rates and reduce mortgage balances to the current value of a home was removed last week. Apart from some additional authority for state housing finance agencies to use tax-exempt financing to offer refinancing loans, no provisions remain to facilitate either refinancing or modification of mortgages to stem the tide of foreclosures. The only help for homeowners comes in the form of $100 million for counselors.

Builders and lenders, on the other hand, would get billions. A tax credit for buyers of foreclosed homes, as well as aid for states and cities to buy foreclosed homes, would prop up the prices of REO (real estate owned, the growing inventory of homes owned by mortgage servicers.) The chief motivation for mortgage servicers to work out loan modifications with homeowners is that the alternative, foreclosure, now results in huge losses. Fitch Ratings currently estimates loss severities for subprime mortgages at 50% to 60%, i.e. foreclosed homes will sell for less than half of the mortgage debt owed on them. While the need to deal with the increasing inventory of foreclosed homes is real, subsidizing their purchase is a dubious strategy. It reduces the pain felt by servicers who go ahead with foreclosures, and tilts the balance (albeit minimally) in favor of foreclosure and away from workouts.

The least appealing and most expensive feature of the Senate package is $25 billion in tax subsidies for home builders, who admittedly are going through hard times, but who are hardly more deserving than the millions of homeowners looking in vain toward Washington for help. Perhaps the greatest moral hazard of all is created by Senate campaign funding.

Times Articles on Mortgage Crisis and Preemption of Drug Product Liability Suits

Consumer law issues have frequently appeared on the front pages of the Times in recent weeks, and today's edition has two such articles.  In "Drug Makers Near Old Goal: A New Legal Shield," the Times reports on the Supreme Court case to be argued next term in which drug manufacturers argue that once the FDA has approved a drug, state product liability claims involving the drug are preempted.  Some excerpts:

For years, Johnson & Johnson obscured evidence that its popular Ortho Evra birth control patch delivered much more estrogen than standard birth control pills, potentially increasing the risk of blood clots and strokes, according to internal company documents.

But because the Food and Drug Administration approved the patch, the company is arguing in court that it cannot be sued by women who claim that they were injured by the product — even though its old label inaccurately described the amount of estrogen it released.

* * *

Documents and e-mail messages from Johnson & Johnson, made public as part of the lawsuits against the company, show that even before the drug agency approved the product in 2001, the company’s own researchers found that the patch delivered far more estrogen each day than low-dose pills. When it reported the results publicly, the company reduced the numbers by 40 percent.

The F.D.A. did not warn the public of the potential risks until November 2005 — six years after the company’s own study showed the high estrogen releases. * * *

A series of independent assessments have concluded that the agency is poorly organized, scientifically deficient and short of money. In February, its commissioner, Andrew C. von Eschenbach, acknowledged that the agency faces a crisis and may not be “adequate to regulate the food and drugs of the 21st century.”

The entire article is worth reading, though it may make you swear off prescription drugs. 

The other front-page article today, "The Tricky Task of Offering Aid to Homeowners," discusses the congressional goal of helping homeowners facing foreclosure without bailing out speculators or irresponsible lenders, all while minimizing the impact on the treasury.  The piece explains the Democratic plan, as well as other proposals.  A sidebar tracks through an example of how the Democratic proposal would work.

Some of the most interesting reporting on the mortgage crisis appears in the Business section.  Gretchen Morgenson has a column, "A Road Not Taken by Lenders" about how lenders failed to verify borrowers' incomes with the IRS, even though at least 90% of the borrowers gave lenders permission to do so.  The IRS charges $20 per form and takes a day or less to supply the information, but lenders said doing so was too costly or time-consuming.  An excerpt:

Can investors stuck with losses on these loans sue to recover their investments based on this due-diligence failure? After all, mortgage originators made representations and warranties to investors that the quality of these loans was good when it clearly was not. And they made these representations knowing that they had not bothered to conduct quick and easy borrower-income checks.

“Investors hoping to put back the loans for deficient underwriting under reps and warranties would end up going back to the originators,” said Josh Rosner, an analyst at Graham Fisher & Company and an authority on mortgage-backed securities. “Given that many of these lenders are out of business, ultimately this could come back to the bank or investment bank.”

“The general view is this should not be talked about out loud,” Mr. Rosner added.

Wall Street will certainly battle forcefully against such lawsuits, if investors bring them. But its role as one of the great enablers in this mortgage debacle is something that even Wall Street can’t deny.

And here is a graphic that shows for various regions the percentage of mortgages that are subprime and the percentage of subprime mortgages that are in foreclosure.

The New Century saga

The WSJ Law Blog recently reported the release of the Bankruptcy Court Examiner's Report on New Century Mortgage, the subprime lender that once led the market and is now in Chapter 11. The post includes a link to download the 500-page report itself, which contains a wealth of data about the subprime industry and the rise and fall of New Century, and is replete with details of NC's lending practices and evolving corporate culture. Anyone writing a book on the subprime crisis will want to read this primary source material.

Consumer Lawyer on ABC News

ABC News has put together a web page to accompany last night's story featuring Jessica Attie, a legal services lawyer fighting foreclosures in Brooklyn. The message to homeowners -- if you have legal claims, get a lawyer -- has been missing from most of the media coverage of the crisis, which has focused instead either on homeowners choosing to walk away from overmortgaged homes, or on the frustrations of homeowners trying to work with their lenders or through the HOPE NOW servicer consortium. In many subprime foreclosure cases that appear hopeless on the financial side, there can be significant fraud, deceptive practices or Truth in Lending claims that will permit homeowners to restructure (and reduce) their mortgage debt.

Fitch Ratings: HOPE NOW not working

In a report dated March 25, 2008 (login required), Fitch Ratings has again revised (upward) its estimates of foreclosures and losses for subprime mortgages made in 2006 and 2007. The news is not good. Fitch reports that fewer homeowners who are behind are successfully catching up on payments ("rolling current") and far fewer are able to sell or refinance their homes to avoid foreclosure. Fitch predicts that 44% to 50% of 2006 subprime mortgages, and 40% to 45% of the 2007 subprime mortgages, will end in foreclosure and sale. It further predicts that loss severities will range from 56% to 64%. In other words, investors will recover 36% to 44% of the principal, interest and fees owed after foreclosure.

Their comment on the HOPE NOW Alliance and its efforts to reach out to borrowers: "Fitch has seen little evidence to date that these alternatives have helped mitigate foreclosure rates." Perhaps after being repeatedly accused of painting rosy scenarios to support its ratings, Fitch now is erring on the side of being too pessimistic. Let's hope so.

HT to Kevin B.

Obama on foreclosures

Senator Obama gave a speech this morning in New York with his views and proposals on the foreclosure crisis. The advance text is available here (login may be required). It will probably be posted on the campaign web site soon. The other two leading candidates' recent speeches can be read via the links posted here on Tuesday. Senator Obama expresses support for the Frank bill and an unspecified version of the bankruptcy mortgage modification legislation, offers a $10 billion fund to help homeowners sell homes they cannot afford, penalties for fraud and better disclosures.

What Would Senators McCain, Clinton and Obama Do?

In a speech delivered today in Orange County California (ground zero for many subprime lenders as well as foreclosed homes) Senator McCain offered some details of his plan to deal with the foreclosure crisis. Rather than spin the speech, I commend the original text to the reader's attention. One proposal that struck me was his call to increase the down payment requirements for FHA mortgages. I understand the sentiment, but in the absence of a national savings policy, it is hard to see how that would increase homeownership. It would also run contrary to current FHA efforts to offer refinancing loans to homeowners now facing foreclosures, who have little or no equity. He does not rule out government aid to mortgage defaulters, although he wants to be selective about any such program. Senator Clinton's speech on the housing crisis yesterday in Philadelphia is available here. Senator Obama has not given a speech on the housing crisis recently. His last speech on the economy on his web site is here but it is short on specifics. His issue paper offers tax subsidies for homeowners, better disclosure, a rescue fund of unspecified amount for foreclosure victims and support for the bankruptcy legislation to permit limited loan term modifications.

Law Firm Incentives to Avoid Foreclosure

In an interesting story today, the Philadelphia Inquirer reports on an initiative by Fannie Mae & Freddie Mac to provide foreclosure firms with financial incentives to negotiate repayment plans and loan modifications, instead of foreclosing. Fannie Mae reportedly is willing to write down principal as well as interest to save homes. Unfortunately, servicers in the subprime market cannot turn to an investor like Fannie or Freddie to obtain these sorts of incentives. The rights and duties (and compensation) of subprime servicers are usually fixed in pooling and servicing agreements that cannot be modified without the unanimous consent of investors, an unlikely eventuality.

It's Time for Another National Commission on Consumer Finance

Back in 1968, Congress created a bipartisan National Commission on Consumer Finance.  See Pub. L. No. 90-321. The Commission reported and went out of business.  It's probably fair to say that the Consumer Credit Protection Act would be a very different statute had the Commission not existed, though of course it's impossible to know. 

We need such a commission now.  The truth is there's a lot we don't understand about the subprime meltdown specifically and the consumer credit system generally.  We need to know more about what caused borrowers to take out these loans, and what caused lenders to make them.  We need to know more about whether disclosures can prevent this type of crisis, and if so, what kind of disclosures, and if not, what alternatives we have.  Plenty of solutions to the problem have been suggested, and we might solve the problem by happenstance, but then again, we might not.  A long careful look at the problem would be more likely to prevent recurrences than a rush to action in the heat of the moment.

It's clear that the marketplace, existing laws, and existing regulatory structures were not up to preventing the crisis.  In that light, it seems unwise to depend solely on the marketplace or existing regulatory structure to prevent the crisis from happening again. 

Of course appointing a commission is sometimes a substitute for taking action.  I'm not suggesting a commission should be used to create the illusion of action: the members of the commission should be chosen to represent all the various constituencies and should be committed to working hard on the business of the commission.  The commission should also have subpoena power and enough financing to conduct a serious investigation.  We need a body that can cut across jurisdictional lines while giving us an overview of what happened and what to do.

Such a commission should not confine its acts to investigating the subprime crisis.  It should also take a long look at other ills affecting the consumer credit system.  Can more be done about identity theft?  What about predatory credit cards?  Is our structure for regulating consumer credit transactions the best we can do?  I'm sure readers of this blog can come up with plenty of other things for the commission to explore.

We face probably the worst consumer credit crisis in decades. It's been forty years since we stepped back to see how we could do better.  Now it's time to do it again.