[Joint House and Senate Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 111-373
CURRENT TRENDS IN FORECLOSURES AND WHAT MORE CAN BE DONE TO PREVENT
THEM
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HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
JULY 28, 2009
__________
Printed for the use of the Joint Economic Committee
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Carolyn B. Maloney, New York, Chair Charles E. Schumer, New York, Vice
Maurice D. Hinchey, New York Chairman
Baron P. Hill, Indiana Edward M. Kennedy, Massachusetts
Loretta Sanchez, California Jeff Bingaman, New Mexico
Elijah E. Cummings, Maryland Amy Klobuchar, Minnesota
Vic Snyder, Arkansas Robert P. Casey, Jr., Pennsylvania
Kevin Brady, Texas Jim Webb, Virginia
Ron Paul, Texas Sam Brownback, Kansas, Ranking
Michael C. Burgess, M.D., Texas Minority
John Campbell, California Jim DeMint, South Carolina
James E. Risch, Idaho
Robert F. Bennett, Utah
Nan Gibson, Executive Director
Jeff Schlagenhauf, Minority Staff Director
Christopher Frenze, House Republican Staff Director
C O N T E N T S
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Members
Hon. Carolyn B. Maloney, Chair, a U.S. Representative from New
York........................................................... 1
Hon. Sam Brownback, Ranking Minority Member, a U.S. Senator from
Kansas......................................................... 3
Hon. Elijah E. Cummings, a U.S. Representative from Maryland..... 4
Hon. Kevin Brady, a U.S. Representative from Texas............... 5
Witnesses
William Shear, Director, Financial Markets and Community
Investment, Government Accountability Office................... 7
Susan Wachter, Professor, Finance and Real Estate, The Wharton
School, University of Pennsylvania............................. 8
Keith Ernst, Director of Research, Center for Responsible Lending 10
Joseph Mason, Professor of Finance, Louisiana State University... 12
Submissions for the Record
Prepared statement of Representative Carolyn B. Maloney, Chair... 32
Government Accountability study titled ``Characteristics and
Performance of Nonprime Mortgages''........................ 33
Chart titled ``Estimated Percentage of Seriously Delinquent
Nonprime Loans by Congressional District''................. 90
Prepared statement of Senator Sam Brownback, Ranking Minority
Member......................................................... 91
Prepared statement of Representative Kevin Brady................. 92
Prepared statement of William Shear.............................. 93
Prepared statement of Susan Wachter.............................. 103
Article titled ``Systemic Risk and Market Institutions''..... 105
Prepared statement of Keith Ernst................................ 120
Prepared statement of Joseph Mason............................... 126
Prepared statement of Representative Michael C. Burgess, M.D..... 127
Article titled ``Housing Push for Hispanics Spawns Wave of
Foreclosures''............................................. 128
CURRENT TRENDS IN FORECLOSURES
AND WHAT MORE CAN BE DONE
TO PREVENT THEM
----------
TUESDAY, JULY 28, 2009
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The committee met, pursuant to call, at 10:00 a.m., in Room
210, Cannon House Office Building, The Honorable Carolyn B.
Maloney (Chair) presiding.
Representatives present: Maloney, Hinchey, Cummings,
Snyder, Brady, and Burgess.
Senators present: Brownback.
Staff present: Gail Cohen, Nan Gibson, Colleen Healy,
Justin Ungson, Andrew Wilson, Jeff Schlagenhauf, Jeff Wrase,
Chris Frenze, and Robert O'Quinn.
OPENING STATEMENT OF THE HONORABLE CAROLYN B. MALONEY, CHAIR, A
U.S. REPRESENTATIVE FROM NEW YORK
Chair Maloney. The committee will come to order.
Good morning. I want to welcome our distinguished panel of
witnesses, and thank you all for your hard work and your
testimony today.
Today, the Government Accountability Office released a
study which I requested that looks at the performance of
nonprime loans in every congressional district in the United
States. This is a valuable report because it captures the
national trends and also gives us data so basic we can see the
effects on our constituents.
The default and foreclosure rates for these mortgages in my
New York district are relatively low compared to the rest of
the country, but rising foreclosures continue to inflict pain
in communities across the nation.
Borrowers, lenders, governments and neighbors all pay the
price for vacant houses that attract vandalism and increase
crime, that destroy communities and burden local governments.
The map behind me gives us a snapshot of the mortgage
crisis inherited by the Obama administration. The map
highlights an important point: the pain of foreclosures is not
being felt evenly across the United States. What we see are
pockets of pain, more heavily concentrated in certain areas of
the country, and the red or the darker color highlights where
the foreclosures are, and they are primarily in the States of
California, Florida, Illinois, Massachusetts, Nevada, and New
Jersey.
Congress and the administration have undertaken numerous
efforts to stem the tide of foreclosures. Key measures include
incentives to servicers to modify loans in the administration's
Home Affordable Modification Program and an expansion of
eligibility to receive a low-cost FHA loan in Hope for
Homeowners.
Additionally, Congress has allocated money to counselors to
help homeowners get the information they need to be able to
modify their loans. Today, Treasury and HUD are meeting with
mortgage servicers in an effort to speed the pace of
modifications which are not happening quickly enough.
Servicers may be swamped, but families are literally
drowning.
I look forward to our witnesses' insights into how the
current policies are working and any proposed changes that will
help us keep families in their homes. The pockets of pain may
be due at least in part to differences in house price
appreciation or the local economy, but the problems may also
stem from different lending practices throughout the country.
Earlier this month, the Joint Economic Committee held a
hearing on predatory lending and the targeting of minorities
for high cost loans. In that hearing, we heard testimony that
States have had difficulty enforcing anti-predatory lending
laws because of Federal preemption of those laws for nationally
chartered banks. Fortunately, some state attorneys general,
including my home state of New York, took an active role in
pursuing abuses at nationally chartered banks. While our
immediate efforts are aimed at turning back the current tide of
foreclosures, it is just as important for us to realize how we
got into this predicament and how we can prevent it from
happening in the future.
Last week, the Federal Reserve Board of Governors proposed
significant changes to regulation Z of the Truth in Lending Act
ratcheting up disclosure requirements and altering compensation
to brokers, ending any incentive to direct borrowers into more
expensive products. The improved amendments to disclosure
information for consumers will help consumers gauge the true
cost of mortgages and compare different products.
Additionally, the Fed recognized if brokers have a
financial incentive to steer borrowers into more expensive
products, that improved disclosure may be ineffective. I am
hopeful that these proposed changes will change the flawed
misalignment of incentives between borrowers and brokers.
We must do all we can to keep families in their homes. I
look forward to the testimony today from our witnesses. Thank
you for being here.
[The prepared statement of Representative Maloney appears
in the Submissions for the Record on page 32.]
[The Government Accountability study titled
``Characteristics and Performance of Nonprime Mortgages''
appears in the Submissions for the Record on page 33.]
[The chart titled ``Estimated Percentage of Seriously
Delinquent Nonprime Loans by Congressional District'' appears
in the Submissions for the Record on page 90.]
I now recognize Senator Brownback for up to 5 minutes.
OPENING STATEMENT OF THE HONORABLE SAM BROWNBACK, RANKING
MINORITY MEMBER, A U.S. SENATOR FROM KANSAS
Senator Brownback. Thank you very much, Chairwoman. I
appreciate the hearing, and I appreciate the panelists being
here. I ask that my full statement be included in the record. I
am just going to summarize briefly.
We have got a deep recession going on, no question about
that. We are now seeing unemployment rates continue to inch up.
We are seeing a lot of people not being able to service the
mortgages that they got. It is a very difficult situation.
I think the key thing we need to focus on is getting
unemployment rates down. That is the item that we need to do. I
grow concerned that we may look at doing things that can be
harmful in the longer term, such as modification in bankruptcy
and cram down provisions and things like that that will
actually end up driving interest rates up on individuals
seeking to get a mortgage or to get a loan.
I am also concerned that some of these rewritings of
mortgages, they are not moving very fast. We should note that,
according to a June report of this year by the Congressional
Budget Office, while $50 billion of TARP funds have been
committed to the Administration's foreclosure mitigation plan,
the Treasury has not yet disbursed any of the funds allocated
as of June 17, 2009, for foreclosure mitigation. None of them.
I think if we are going to have an impact here, these funds
need to be used and put forward. I have noted that a number of
mortgages that were modified in the first two quarters, close
to 50 percent of the loans modified in the first two quarters
of 2008 were in default again 9 months after the modification.
Now, you can look at that and say 50 percent of them made it,
and that is a good thing, at least through that 9 months. My
guess is that the group that didn't make it, there was also
something that happened in the employment market to one or
another of the occupants, if it is a married spousal situation,
that was there.
My point in saying these things is I think we need to keep
our eye on the ball here. And the key piece of this being we
have got a mortgage mitigation program that is out there. Let's
get that going. Let's work aggressively on getting unemployment
rates down by getting the economy going again.
I thought some of the provisions that were done that would
stimulate the economy are ones that could help us get these
unemployment rates down. What I am hearing from a number of my
institutions back home, I met with some credit unions about 2
weeks ago, they were saying that people are turning their car
keys over to them even while they are still paying for the car
while they are current in their car payments because somebody
in the family has lost their job. They are looking at the
income stream, and they are saying I know I am current on this
car payment, but I can see what is coming down the road and I
want to give you the car back now. I know I am going to have to
pay the difference, but maybe you can get it sold quicker, and
my situation is deteriorating. I just think we have to keep a
manic focus on these unemployment rates because that is the key
in this whole picture here, particularly on mortgages and
mortgage foreclosures. Because if people don't have the income
stream, they are not going to be able to afford what they have
committed that income stream to. I hope we can focus on what we
need to do to get that unemployment rate down.
Thank you for holding the hearing.
[The prepared statement of Senator Brownback appears in the
Submissions for the Record on page 91.]
Chair Maloney. Mr. Cummings.
OPENING STATEMENT OF THE HONORABLE ELIJAH E. CUMMINGS, A U.S.
REPRESENTATIVE FROM MARYLAND
Representative Cummings. Thank you, Madam Chairman. I want
to thank you for calling this hearing and thank our witnesses
for being here.
As I listened to Senator Brownback, I could not help but
think about an event that we held in my district about a month
and a half ago where we had a thousand people show up, all of
whom were losing their homes. We were able to help at least 4-
or 500 of them, if not more, because we were able to put the
borrower together with the lender and they were able to sit
down and work out things.
The fact is that, you know, I too believe that we need to
address this unemployment problem. But as I told my
constituents, one out of every 10 who was losing their house,
by the way, the question is what will happen. And I told them
we will get through this downturn, but the question is who will
be living in their house after it is over. Who will have their
job. Will their company even exist.
I think that we have to get through this storm. So the fact
is that we have got to, I think going back to what Senator
Brownback said, one of the things that we have got to do is we
have got to do what the President's people are doing today, and
that is get to these lenders and say, number one, you have got
to hire the personnel that you need because what we found, one
of the biggest problems is that when people call, they can't
get anybody on the phone. While we have been bailing out the
banks big time, they ought to be able to find somebody to
answer the phone.
Two, we have discovered that a lot of times when folks try
to get these modifications, that they just could not--they were
basically put on a stall plan. In other words, they were told
you don't have to make any payments right now, we will try to
work it out for you. While they are waiting to get it worked
out, they are falling more and more in debt. And the next thing
you know, by the time the lender comes back and says we are not
going to modify, then they are really in bad trouble.
I think we have to have some practical solutions to this.
The research has shown that borrowers can be separated into
three categories, and this is according to The Post this
morning. It says those delinquent borrowers who will self-cure
or catch up on their loans, even without a modification, those
borrowers, that despite a mortgage modification, will end up in
foreclosure anyway, and those borrowers who cannot make their
current payments but can keep up with a lower modified payment.
It seems as if the lenders, and understandably, according
to The Post this morning, are more concerned, only concerned
about those folks who with a modification can work it out. What
I proposed in legislation is a bill which would give short-term
loans to folks over an 18-month period. Hopefully, they will be
able to find a job and do what Senator Brownback just talked
about, that is, get this economy back going, but it seems to me
if you have a bucket of people who are going into foreclosure
every day, and you have got empty houses, you have got folks,
vultures coming along and picking up those houses for cheap
prices. In my neighborhood, there is one house that is going
for one-sixth of what the other houses are valued at.
Everybody's property values are going down. It seems to me
we need to do something to stop that hemorrhaging. It is one
thing to do something for Wall Street, but it is another thing
to do something for the very people who have supplied the very
money that we have used to bail out Wall Street. My
constituents are saying, ``You are using my tax dollars to bail
out Wall Street, what about me? What about me?''
And they are saying that if the TARP funds have been paid
back and the banks claim to be well, and they have paid back
some $68 billion, why not help some folks who are under stress.
I am interested to hear your solutions to this problem.
The last thing I think we can do is turn our heads to our
constituents, and the chairman pointed out this map because for
every one of these people, they don't want to hear wait, wait,
wait because they won't have a house. They won't have anywhere
to live. It is not just about them, it is bigger than them. It
is about their children and it is about transferring wealth and
it is about generations yet unborn.
Thank you, Madam Chair. I yield back.
Chair Maloney. Thank you.
Mr. Brady.
OPENING STATEMENT OF THE HONORABLE KEVIN BRADY, A U.S.
REPRESENTATIVE FROM TEXAS
Representative Brady. Thank you, Madam Chairwoman. I am
pleased to join you in welcoming the witnesses testifying
today.
There have been a number of policy blunders during the last
20 years that have inflated an unsustainable housing bubble.
On a macro level, the Federal Reserve pursued an overly
accommodative monetary policy for far too long after the 2001
recession. This policy, along with huge capital inflows rising
from international imbalances, kept long-term U.S. interest
rates far too low during much of this decade.
On a micro level, both the Clinton administration and Bush
administration pursued a broadly supported national home
ownership strategy, and increased the home ownership rates
among historically disadvantaged groups.
After 1992, Federal officials pressed commercial banks,
thrifts and mortgage banks to weakened loan underwriting
standards, to reduce downpayments, develop exotic loan products
such as interest only and negatively amortizing loans to help
low income families qualify for mortgage loans to buy homes.
After 2000, Fannie Mae and Freddie Mac spurred the
explosive growth in subprime mortgage lending by purchasing
millions and millions of dollars of privately issued subprime
mortgage backed securities. As in previous bubbles,
unfortunately, swindlers took advantage of the unwary as the
housing bubble neared its zenith. On the one hand, some home
buyers misled lenders about their income and net worth to
secure mortgage credit to speculate in housing.
On the other hand, some builders and lenders deceived home
buyers about the obligations they were assuming. The housing
bubble burst in July 2006. House prices have subsequently
fallen by 32 percent, according to the S&P price index. Fallen
housing prices create uncertainty about the value of mortgage
backed securities that triggered a global financial crisis and
the subsequent recession.
As history proves time and time again, good intentions do
not necessarily produce good results. Today many Americans,
especially historically disadvantaged families that Federal
officials intended to help, are suffering. Interest resets on
adjustable rate mortgage loans, falling housing prices that
make refinancing difficult or impossible, and a rapidly
escalating unemployment rate caused many families to fall
behind on their mortgage payments, to default, and face a
possibility of foreclosure.
Consequently, home mortgage loan delinquency and
foreclosure rates are ballooning, a cascade of foreclosures may
have serious negative externalities, dumping millions of
foreclosed homes on the market may keep housing prices
depressed for years, reducing household wealth, upending the
budget of localities that depend on property taxes, and muting
any economic recovery.
On February 18 of this year, President Obama announced the
making home affordable initiative to refinance or modify
existing mortgage loans to prevent unnecessary foreclosures. So
far, neither this initiative nor earlier programs under
President Bush have produced significant results. For example,
the Hope for Homeownership Program enacted in 2008 helped only
25 homeowners through February of this year. About 4,000 loans
were refinanced through the FHA secure program that expired
late last year, and only 13,000 loans were modified under the
FDIC's conservatorship of IndyMac.
Given the enormity of the home foreclosure problem, I look
forward to hearing from our witnesses today about what can be
done effectively to ameliorate it.
I yield back.
[The prepared statement of Representative Brady appears in
the Submissions for the Record on page 92.]
Chair Maloney. Mr. Hinchey.
Representative Hinchey. Thank you, Madam Chair. I am very
anxious to hear what our friends are going to say.
Mr. Cummings made the points I would make, and I very much
appreciate him for doing it and the way he did it, so I am just
going to pass on and hope we can get into the hearing.
Chair Maloney. Now I would like to introduce our panel of
witnesses.
Dr. William Shear is director of financial markets and
community investment Government Accountability Office. He has
directed substantial bodies of work addressing the Small
Business Administration, the Federal Housing Administration,
regulation of the housing GSCs, the rural housing service and
community and economic development programs. Dr. Shear received
his PhD in economics from the University of Chicago.
Dr. Susan M. Wachter is the Richard B. Worley professor of
financial management and professor of real estate and finance
at the Wharton School at the University of Pennsylvania. Dr.
Wachter served as assistant secretary for policy development
and research at HUD under President Clinton. She served as
president of the American Real Estate and Urban Economic
Association, and was co-editor of Real Estate Economics. She is
codirector of the Penn Institute for Urban Research and
director of the Wharton Geospatial Initiative.
Dr. Keith Ernst is director of research at the Center For
Responsible Lending. He has published research predicting the
subprime foreclosure crisis in 2006, examining the relative
cost of mortgage lending by delivery channel and on evaluating
the effectiveness of State regulations in the subprime mortgage
market. He holds both a law degree and a graduate degree in
public policy studies from Duke University.
Dr. Joseph Mason is the Herman Moyse Jr. Louisiana Bankers
Association endowed professor at the Louisiana State University
and senior fellow at the Wharton School, and a financial
industry and monetary policy consultant. He also formerly
taught at Georgetown University and Drexel University, and
before that was a financial economist at the Office of the
Controller of the Currency in Washington, DC.
Chair Maloney. Welcome to all of our panelists. Would you
begin Dr. Shear for 5 minutes.
STATEMENT OF WILLIAM SHEAR, DIRECTOR, FINANCIAL MARKETS AND
COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY OFFICE
Dr. Shear. Chairman Maloney and members of the committee,
it is a pleasure to be here today to discuss our work on the
state of the nonprime mortgage market. My statement today is
based on a report being released at this hearing. As we all
know too well, non-prime loans accounted for an increasing
share of the overall mortgage market from 2000 through 2006.
Throughout this period, an increasing proportion of subprime
and Alt-A mortgages had loan and borrower characteristics that
have been associated with a higher likelihood of default and
foreclosure.
After the surge in volume, in the summer of 2007, the
subprime and Alt-A market segments contracted sharply, partly
in response to a dramatic increase in default and foreclosure
rates for these mortgages.
With respect to loan performance, serious delinquency rates
were highest for subprime loans and certain adjustable rate
mortgages. In addition, these rates varied by State as shown on
the displayed map. Approximately 1.6 million of the 14.4
million nonprime loans originated from 2000 through 2007 had
completed the foreclosure process as of the end of this March.
Of the 5.2 million loans that were still active at the end
of March, that is, that had not been prepaid or completed the
foreclosure process, almost one quarter were seriously
delinquent, meaning that they were either 90 or more days
behind in payments or already in the foreclosure process.
Serious delinquency rates were especially high for certain
adjustable rate mortgages. For example, in the subprime market,
the serious delinquency rates for short term hybrid ARMs, which
feature a fixed interest rate for two or three years and an
adjustable rate thereafter, was 38 percent as of the end of
March.
In the Alt-A market, the serious delinquency rate for
payment option ARMs, which allow borrowers to make payments
lower than needed to cover accrued interest, was approximately
30 percent. At the state level, California, Florida, Illinois,
Massachusetts, Nevada, and New Jersey had the highest rates.
Each state had serious delinquency rates above 25 percent, and
Florida's rate of 38 percent was the highest in the country. In
contrast, 12 States had serious delinquency rates of less than
15 percent, including Wyoming's rate of 9 percent, which was
the lowest in the country.
We also looked at loans originated from 2004 through 2007,
so a segment of this entire period we looked at. These loans
from these more recent years--what we call cohort years--
accounted for the majority of troubled loans. This trend is
partly attributable to a stagnation or decline in home prices
in much of the country beginning in 2005, and worsening in
subsequent years. Of the active subprime loans originated from
2000 through 2007, 92 percent of those that were seriously
delinquent as of the end of March were originated during this
shorter period between 2004 and 2007.
Furthermore, these loans made up 71 percent of the subprime
mortgages that have already completed the foreclosure process.
Our full report provides additional information on the
performance of nonprime loans. In two subsequent reports at the
request of this committee, we will provide additional
information on the condition of the nonprime mortgage market.
These reports will include examinations of the extent of
negative home equity among nonprime borrowers and the influence
of different loan, borrower and economic variables on the
likelihood of default.
It is a privilege to appear before this committee. I would
be glad to answer any questions.
[The prepared statement of William Shear appears in the
Submissions for the Record on page 93.]
Chair Maloney. Thank you very much.
Dr. Wachter.
STATEMENT OF SUSAN WACHTER, PROFESSOR, FINANCE AND REAL ESTATE,
THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA
Dr. Wachter. Chairman Maloney and members of the committee,
thank you for the invitation to testify at today's hearing.
Today, according to the MBA, the foreclosure rate is 4
percent, four times the historical average and the highest it
has ever been since the Great Depression. It is fair to say,
despite considerable efforts to date, the Federal Government
has failed to stem the foreclosure crisis. While much has been
done and more can be done, there is a fundamental problem that
is difficult to address with policy initiatives. The problem of
foreclosed homes and mortgages in default started in a wave of
foreclosures of subprime loans. In the coming years, there will
be another wave of foreclosures, in part due to the recasting
of payment option mortgages. These, and other complex,
nontraditional mortgages, were a very small part of the market
until they grew at an alarming rate starting in 2003. By 2006,
they were almost half the total volume of mortgage
originations.
As these untested, seemingly affordable but unsustainable
mortgages were originated, they fueled an artificial house
price boom which inevitably collapsed.
While the initial source of the problem was recklessly
underwritten nontraditional mortgages, the asset bubble this
created, the artificially and unsustainably inflated house
prices, has been and is now a problem for many who borrowed for
homes in the years 2004 and later. Homeowners who borrowed
conservatively, putting 20 percent down and using tried and
tested mortgages with steady mortgage payments, are in trouble.
If they must sell due to job loss, for example, many of these
owners who purchased at inflated prices will be forced into
foreclosure.
Americans are now increasingly threatened with loss of
their homes and their jobs, and the problem will get worse
before it gets better.
The chart that is before you shows the growth in
foreclosures and the decline in house prices, demonstrating the
role of plummeting house prices in the worsening foreclosure
problem. The current rate of 4 percent is expected to get
worse, with an additional million homes in foreclosure by the
end of year.
As average home prices fall for more and more households,
and with the increase in the supply of foreclosed homes on the
market, the amount for which they could sell their homes will
increasingly be less than what they owe on their mortgages. A
loss of a job, illness, or a sudden increase in required
mortgage payments will force owners to sell and will force
foreclosure.
Today, the threat of a job loss is worsening and there may
well be an increase in mortgage payments due for option ARMs in
the coming years.
Are there additional steps we can take to mitigate the
crisis? The crisis will abate when home prices stop falling.
But, in fact, home prices are still falling although the rate
of decline is decelerating. They will continue to fall until
fundamentals turn around. The key fundamental factor is
unemployment, thus the importance of fiscal stimulus. It is
also critical that mortgage rates remain affordable, thus the
importance of continuing Federal support for the FHA and the
GSEs, and the maintaining of historically low mortgage rates.
In addition, it is important to stem excess foreclosures
which are adding to the forces driving home prices down in an
adverse feedback loop.
Losses upon foreclosures are extreme. However, if mortgage
amounts due exceed home values, loan modifications based on
lowering or postponing interest rate payments alone may not be
able to stem the growing foreclosure problem.
The administration's HAMP plan is attempting to address the
lack of incentives and capacity of mortgage servicers to
respond to the foreclosure problem. A recently issued GAO
report has suggestions. And, in fact, the administration is
convening a meeting today to encourage further efforts.
In addition, it would be useful to implement, as suggested
in the University of Pennsylvania IUR Task Force Retooling HUD
report, and for which I believe there is legislation,
monitoring of the progress of the HAMP program, especially
spatially since there is, as the map GAO put in front on you,
an important spatial component to the problem.
Further loan modifications through principal write downs
may be necessary. This involves marking mortgages, especially
second mortgages, to market.
The financial system that triggered the crisis encouraged
the production and securitization of uneconomic loans which
eventually brought the system down. As I have written
elsewhere, private label securitization failed, as did the
markets, basically because securitization was not subject to
market discipline.
Is a less pro-cyclical financial system an achievable goal?
I have written with co-authors and wish to enter in the record
an article which addresses the underlying failure of the
regulatory market structure. There we address the incentives to
dismantle lending standards and the artificial housing boom
which made it seem that loans being made were safe when they
were lethal.
Going forward, regulatory supervision needs to be put into
place to prevent this.
Thank you.
[The prepared statement of Susan Wachter appears in the
Submissions for the Record on page 103.]
[The article titled ``Systemic Risk and Market
Institutions'' appears in the Submissions for the Record on
page 105.]
Chair Maloney. Thank you very much.
Mr. Ernst.
STATEMENT OF KEITH ERNST, DIRECTOR OF RESEARCH, CENTER FOR
RESPONSIBLE LENDING
Mr. Ernst. Good morning, Chairwoman Maloney and Ranking
Members Brownback and Brady and members of the committee.
Thank you for your continued efforts to address the
foreclosure crisis, and for the invitation to participate
today.
I serve as director of research for the Center For
Responsible Lending, a nonprofit, nonpartisan research and
policy organization dedicated to protecting homeownership and
family wealth by working to eliminate abusive financial
practices. CRL is an affiliate of Self-Help, a nonprofit,
community development financial institution that has provided
over $5.6 billion of financing to 62,000 low wealth families,
small businesses, and nonprofit organizations in North Carolina
and across America.
Before summarizing our research, it is worth a moment to
reflect on the devastating consequences of the foreclosure
crisis. An estimated 13 million mortgages will have been
foreclosed by 2014. One out of ten mortgagors is currently
delinquent. Tens of millions of homes near foreclosed
properties have suffered a decrease in value resulting in
hundreds of billions of dollars of lost wealth.
Although many factors are important in today's crisis,
risky subprime loans have been a central concern. Empirical
research shows that these loans carried an inherit and
excessive risk. This risk was driven both by the terms of the
loans and by the conditions under which they were made. In
other words, substantial risk was part and parcel of the
subprime market irrespective of borrower qualifications. In
2006, the Center published a projection that one in five
weakened subprime loans would end in foreclosure, a projection
that was derided at the time as pessimistic but actually has
turned out to be an underestimate.
A complementary 2008 study that we undertook with
researchers from the University of North Carolina also found
that subprime loans were risky products. This report showed
that subprime loans were three times more likely to fail than
lower cost, primarily fixed rate mortgages made to comparable
borrowers. The study also found that subprime loans with
adjustable interest rates, prepayment penalties, and those made
through a broker were riskier. In fact, when these factors were
layered into the same loan, the risk of default was four to
five times higher on subprime mortgages.
Finally, CLR published research demonstrating that lower
credit score borrowers who obtained their loan through a
mortgage broker paid significantly more than their counterparts
who dealt correctly with lenders. In a related development last
week, we were pleased to see the Federal Reserve announce a
proposal to eliminate the yield spread premiums that we believe
were at the heart of these disparities. Notwithstanding this
development, and in light of our research, Congress should take
additional steps to prevent reckless lending that could once
again fundamentally disrupt our economy.
Most importantly, we urge you to support the consumer
financial protection agency embodied in H.R. 3126. The measure
would consolidate the consumer protection that is already
currently scattered across different agencies and create a
single agency with the sole mission of protecting families and,
by extension, our economy. The agencies currently charged with
this mission were warned early and repeatedly about the dangers
of subprime mortgages, yet, not only did they fail to act to
protect consumers, but in many instances they frustrated State
consumer protection efforts as well.
It is also imperative to pass legislation that would
require sensible and sound underwriting and prevent abusive
loan practices that contributed to reckless and unaffordable
home mortgages. H.R. 1728 represents a good start to this end.
Finally, we urge Members to take further action to help
save the homes of the millions of families facing impending
foreclosure. As part of this effort, we must closely monitor
and evaluate opportunities to improve the Administration's home
affordable program. At the same time, we strongly believe that
no voluntary program will be effective until there is a
backstop available to homeowners. For that reason, we are
pleased to see that Congress is beginning to revisit the need
to permit judges to modify mortgages in bankruptcy court as a
last resort.
Thank you again for your invitation to appear today. I look
forward to your questions.
[The prepared statement of Keith Ernst appears in the
Submissions for the Record on page 120.]
Chair Maloney. Thank you.
Dr. Mason.
STATEMENT OF JOSEPH MASON, PROFESSOR OF FINANCE, LOUISIANA
STATE UNIVERSITY
Dr. Mason. Thank you, Madam Chair and committee members,
for inviting me to testify today. I have submitted a more
detailed paper I would like to ask to be included as part of
the record. What follows is a summary of that work.
Recent history of servicing is rife with examples of
subprime servicer problems and failures resplendent with detail
on best and worst practices. The industry has been through
profitable highs and predatory lows, over time reacting to
increased competition with greater efficiency.
But intensively customer service-based enterprises, such as
servicing, are hard to evaluate quantitatively so that proving
a servicer's value is difficult even in the best business
environment. Unfortunately, today's is not the best business
environment. So proving servicer value has now become crucial
to not only servicers' survival, but the survival of the market
as a whole.
There are seven key reasons why servicers are facing
difficulty with today's borrowers. First, modification is
expensive.
Second, the arrearages that servicers have to pay to
investors are a drag on profits.
Third, modifications and defaults mean that mortgage
servicing rights values decline for servicers.
Fourth, increased fees are only a partial fix.
I wrote about these in the fall of 2007. Many have been
addressed in recent administration proposals. But, as
congressman Cummings mentioned, when servicers have their
business threatened, employees and the expertise they bring
flee. Reduced servicing staff, particularly with respect to the
most talented employees that have other options, will have a
demonstrably adverse effect on servicing quality. And, indeed,
has had that effect.
So most importantly, what we need to pay attention to now
is that servicer bankruptcy creates very perverse dynamics.
While most securitization documents stipulate a transfer of
servicing if the pool performance has deteriorated, or if the
servicer has violated certain covenants which are expected to
generally precede bankruptcy, the paucity of performance data
makes it difficult for the trustee or the investors to detect
servicer difficulty prior to bankruptcy, to make the change,
and get servicing to someone who can carry it out effectively
and efficiently, and modify loans effectively and efficiently.
Default management is much more art than science. While
modifications can be a useful loss mitigation technique when
appropriate policies and procedures are in place, servicers
that are unwilling or unable to report the volume, type and
terms of modifications--and there have been many--to
securitized investors or regulators may be poorly placed to
offer meaningful modifications.
The main drawback, therefore, with current policy is the
industry can use modification to game the system and investors
are wary of that. Some servicers are taking advantage of both
borrowers and securitized investors, and I think it makes sense
to incentivize the securitized investors to help promote more
modifications where economically meaningful.
There are four major reasons for investor concern. First of
all, and this has been well known since the late 1990s,
aggressive re- aging makes delinquencies look better than they
really are. Re-aging is the process by which you declare a loan
to be current once again after it has been in default.
Investors know that redefault rates on modified loans are high,
approaching 80 percent, so calling the modified loan current
again immediately is disingenuous at best.
Second, aggressive representations and warranties also skew
reported performance. At their best, representations and
warranties help stabilize pool performance. At their worst,
representations and warranties inappropriately subsidize the
securitization. In practice, it is difficult to decompose the
difference between stabilization and subsidization, and we need
to pay attention to that.
Third, re-aging and representations and warranties are used
to keep deals off their trigger points that would lock
servicers out of the value of the subordinate pieces of the
securitization they hold. Residual holders, nee servicers,
continue to push for lowering delinquency levels no matter how
artificially in order to maintain positive residual and
interest only strip valuations that keep the servicer out of
insolvency. Triple A class investors are, therefore, at the
mercy of servicers who are withholding information on
fundamental credit performance through modification.
Fourth, current private sector industry reporting doesn't
capture even these most basic manipulations. Servicers that
utilize unlimited modifications or modifications without
appropriate controls can end up necessitating greater credit
enhancements in securitizations to maintain credit ratings,
whether because of servicer capabilities or the possibility for
maintaining this residual value by delaying step down in the
securitization by skewing delinquencies.
These problems are all well known. The State foreclosure
prevention working group's first report in February 2008
acknowledged that senior bond holders fear that some servicers,
primarily those affiliated with the seller, may have incentives
to implement unsustainable repayment plans to depress or defer
recognition of losses in the loan pool in order to allow the
release of over-collateralization and, therefore, value to the
servicer themselves. This is a clear conflict of interest that
I think can be rectified in the next iteration of policy-making
in this regard.
Regulators can, therefore, do a great service to both
industry and borrowers in today's financial climate by
insisting that servicers report adequate information to access
not only the success of major modification initiatives, but
also performance overall. The increased investor dependence on
third-party servicing that has accompanied securitization
necessitates substantial improvements to investor reporting in
order to support appropriate administration and, where helpful,
modification of consumer loans in both the private and the
public interest. Without information, though, even the most
highly subsidized modification policies are bound to fail.
Thank you.
[The prepared statement of Joseph Mason appears in the
Submissions for the Record on page 126.]
Chair Maloney. Thank you very much for your testimony.
Chair Maloney. First, I would like to ask all of the
panelists to respond to the article that was on the front page
of The Washington Post today on foreclosures saying they are
often in the lenders best interests. It says in many cases,
there is a financial incentive to let borrowers lose their
homes rather than work out a settlement that some economists
are putting forward.
Dr. Shear, would you like to respond? And Dr. Wachter, you
referenced it in your statement earlier. Dr. Mason, how it
impacts securitization, your point of changing the law is a
relevant one.
Dr. Shear.
Dr. Shear. I would like to comment on it, not directly, but
I want to make reference to, as many of you know, we issue
reports on the TARP program every 2 months. The last one was
issued last week.
When I read this article, I see it through the lens of our
last TARP report which dealt with the HAMP program.
We realize the enormity, as Treasury does, and the
challenges of running this program, and we have made a number
of recommendations. The HAMP program has a lot of incentive
payments to try to get servicers, borrowers, and investors to
come together to resolve, to modify certain mortgages. And so I
see it through our lens as an audit agency that we think that
Treasury really has to develop a strong system of internal
controls to ensure that the different parties are taking the
actions that the incentives are supposed to provide to them.
Chair Maloney. Thank you.
Dr. Wachter.
Dr. Wachter. I haven't read the article, but I have heard
it references a Boston study. All economics studies rely on
assumptions, as this one does, so they must be tested for the
validity of their conclusions.
Nonetheless, it is absolutely true that lenders
individually often do have the incentive to foreclose. It is
often the economic solution for lenders individually, when it
is not for lenders in the aggregate. If lenders foreclose,
adding foreclosure supply, this further drives down prices,
leading to further foreclosures. This is why it is a collective
problem and why we need to address it from a policy
perspective.
I agree with the comments of my colleagues on the panel
regarding the need for reporting and monitoring.
Chair Maloney. Mr. Ernst.
Mr. Ernst. Building off that answer, it is true that
foreclosure starts continue to outpace modifications. In a
sense we are falling behind with each passing month. The
modifications that have been done in the recent past have not
always been as helpful as they could have been. I think some of
the data that went into that article reflected modifications
before the Administration's program went into effect, for
example, and there are reasons to believe there are more
opportunities than that article suggests.
To the extent that article is raising the concern that not
every borrower can be helped, certainly that will be true. But
I think what that article also stands for is that much more can
be done to help borrowers avert needless foreclosure, to
relieve the pressure on declining housing prices and to help
turn communities around that currently are being devastated by
the foreclosure process.
Dr. Mason. Thank you for the question. It is an important
one. It is an issue that I originally brought up in my October
2007 paper that not everyone is suited for a modification. A
borrower has to want a modification and be able to afford a
modification. I was led to this conclusion by working with
members of NACA in Boston who had a very successful community-
based modification effort.
I think that the figures that you are seeing in that
article are suggesting that, because of the substantial number
of redefaults, you can most likely expect to go through the
foreclosure process anyway. So now you add to the cost of the
modification to the cost of the foreclosure that you do anyway;
and of course, the total cost of the two becomes greater than
the cost of just foreclosing in the first place.
So I think we are overextending modification perhaps,
expecting too much out of modification programs.
Can it help? Certainly.
Is it the entire solution? No.
As Dr. Wachter mentioned, we do have a collective problem
that comes down to the inventory of real estate on the market
right now that is suppressing home prices. When we have
builders publicly announcing that they are going to continue to
build now new smaller homes that compete directly with the
price of foreclosed homes on the market, we have an even worse
inventory problem and can expect more down the road.
This introduces what some other members have talked about
today, an interplay between employment and housing. If you are
looking to keep up construction to maintain employment--by
building more houses, that adds to the inventory that
suppresses housing values. I think you are going in a circle
and you need to stop that exercise at some point.
Chair Maloney. Thank you.
Senator Brownback.
Senator Brownback. Thank you.
Dr. Wachter, you were noting in here we have four times the
historical average of foreclosures taking place, which is a
horrific level, and I think everybody is pointing out the
problems that led to it. I really do believe from this point on
forward we need to make sure money is available to buy houses,
maybe we incentivize the repurchasing of houses would be a good
thing as well because you try to get people into the
marketplace to get some of the depressed housing prices off,
but that unemployment is going to be the key figure for us to
be watching from this point on forward. I may be off on that,
but I would like to know if you, or maybe Dr. Shear knows this,
is there a correlation that we have seen historically between
unemployment rates over a period of time and foreclosure rates,
that we could have some predictability or thought as to where
these foreclosure rates go if we get to a 10 percent
unemployment rate into next year, as some are predicting?
Dr. Wachter. Yes, Senator, there is literature that links
unemployment to foreclosure. Indeed, it suggests as
unemployment worsens, foreclosures will increase. I would be
pleased to provide some of the formulas that specifically link
unemployment and foreclosures.
Senator Brownback. Is there a rule of thumb? Do we have any
sort of rule of thumb on unemployment rates over time and
foreclosure?
Dr. Wachter. The reason there is not a rule of thumb is
because there is an interactive variable which is home price
declines. It is the combination of home price declines and
unemployment, so it is not simply linearly related to
unemployment.
Senator Brownback. So as your price declines continue, and
unemployment rates go up, the number of foreclosures go up by
some factor?
Dr. Wachter. That is correct.
Senator Brownback. So we could expect this four times
historical average to go up as unemployment goes up, but as the
housing market flattens, you were noting that the housing
market flattens.
Dr. Wachter. Before the flattening, we still have home
prices declining. We do expect that 4 percent rate to increase.
Senator Brownback. To what?
Dr. Wachter. This is unknowable, since we don't know how
much prices will fall and we don't know how much unemployment
will increase. But nonetheless, estimates out there are that
the foreclosure rate could go as high as 5 or 6 percent. Others
on this panel probably have other estimates.
Senator Brownback. Let me continue that line of
questioning. We are going into next year with a higher
unemployment rate next year as unemployment trails economic
recovery. So does that rate continue to go up through next
year?
Dr. Wachter. Yes, I believe so.
Senator Brownback. Have you seen any estimates on that?
Dr. Wachter. Again, the estimates vary. The consensus
estimate is north of 5 percent.
Senator Brownback. Dr. Shear, do you have a comment or
thought on this?
Dr. Shear. For the most part, I will defer to Dr. Wachter
and the other panelists. I will just point out in the report
that we issued last week, there were some statistics provided
on changes in unemployment rates in different States in the
country and impacts on housing. So there are some simple
statistics in that report that might be useful.
Senator Brownback. So those are higher in the States where
you have high unemployment rates, and higher or more of a
decline in housing prices, correct?
Dr. Shear. Yes. There is a higher level of serious
delinquencies and foreclosures in States with declining home
prices and with--we did it based on increases in unemployment
rates in those States. So we have some statistics that provide
a map with that kind of information.
Senator Brownback. So what are we looking at the highest
foreclosure rates projections into next year in the worse
situations in the country?
Dr. Shear. We haven't projected, so I can't really address
that.
Mr. Ernst. If I might, unemployment is certainly a critical
element of this foreclosure crisis that we are in. But I think
we shouldn't lose sight of what makes this foreclosure
different. In the boom years of subprime lending in 2005 and
2006, subprime loans accounted for one in every five mortgages
being originated. In many, many instances these mortgages were
made without due regard of the ability of the borrowers to
repay. So this crisis, unlike the crises that have developed
some of these formulas that help us understand the important
relationship between unemployment and housing prices, has this
added layer of inherent risk in the outstanding loan pool. I
think that is an important additional dimension.
That is why it is critical that modification efforts be
pursued to their ultimate because these borrowers are not
governed just by the natural laws or the economic laws that
have been driving research to date, but have this added layer
of risk that they are challenged by.
Senator Brownback. It seems like that was the dynamite cap,
a big one, and it has exploded the rest of it.
I would appreciate, Dr. Wachter, the formula, if you could,
if you can get that in to us. Thank you.
Chair Maloney. Thank you.
Mr. Cummings.
Representative Cummings. Following up what you just said,
we are finding now that a lot of prime, and I think you may
have said it, prime borrowers are being foreclosed upon?
Mr. Ernst. Certainly foreclosure and delinquency rates are
up across the board. I think it is a little difficult in some
of the prime data to tease out which are the contributions from
prime mortgages and which are the contributions from Alt-A
mortgages, a segment that is also detailed in the GAO report
that we are getting to see today. But certainly it is true, it
is undeniable that rates are up in every mortgage segment. That
is true.
Representative Cummings. When we look at this map, Dr.
Wachter, it is interesting when you look at this map, when you
look at the middle of the country, they have the lowest
foreclosure rates, and then you look at these other States,
Florida and California and so on with the highest, so is it
safe to say, and I remember many months ago now when Bernanke
came before us, this committee, and they talked about, we were
talking about this whole idea of foreclosure and he and others
kept saying, Well, it is spotty. You have some foreclosures in
some States but you don't have them in others and it is going
to work out, basically. This was awhile back now.
I am wondering, does this mean likely in these States,
following up on what Senator Brownback was talking about, does
this mean that these are likely high unemployment States and
rapid decline in value of property States? Do you follow me?
Dr. Wachter. Yes, that is exactly right. They are both.
Representative Cummings. So how do we get here though?
That's what I am trying to figure out. This is a lot of yellow,
yellow being the least, the States that are better off. And so
they were doing something different.
Dr. Wachter. Yes, that is correct.
Representative Cummings. What were they doing?
Dr. Wachter. This is a continuation of Mr. Ernst's point.
The mortgages that were originated in states shown in the
deeper colors like red were these nontraditional mortgages. So
they had a larger share of the market, therefore causing
artificially high housing prices at which homeowners today can
no longer sell. That problem is pervasive in these States with
high foreclosure problems. These are where the nontraditional
mortgages were disproportionately originated. By the way,
unemployment rates are also higher in these areas, in part
because of the extremity of the housing crisis.
Representative Cummings. So the Obama administration has
put out I will call it a tool kit to try to deal with
foreclosure. As I said a little earlier, in my district when we
were able to put the borrower together with the person, with
the lender, we were able to get some results. The question
becomes is there something, other tools that need to be in this
kit? And what would they be because right now people are
drowning in foreclosure. Listening to the statistics you all
just announced, it looks like we are heading toward a worsening
condition come next year, if not before. So what are the tools
that you would put in that tool kit, if any? Dr. Wachter, and
then I will get to you, Dr. Mason, if I have time.
Dr. Wachter. Counseling is critical. The GAO report
suggests that HUD should monitor that the counseling is
occurring.
Secondly, it is extremely important to monitor the progress
and to look servicer-by-servicer at that progress.
Third, we must look at second liens. Second liens are
indeed a problem, and having the cooperation of the owners of
the second mortgages is key to finding a solution to this
problem.
Representative Cummings. Dr. Mason.
Dr. Mason. You have to keep in mind in some of those
regions that you have a heavy reliance on pay option arm loans
with unnaturally low payments. Those loans help payment
affordability, not price affordability.
In those regions as well, you have a lot of investor
properties. In reviewing the operations of several large
mortgage origination firms, myself and other experts have
established that the labels ``prime'' and ``Alt-A'' assigned by
the originator, mean nothing. The originator has a separate
internally classified area that is called ``stealth prime'' or
``shadow prime'' or ``stealth Alt-A'' which really weren't Alt-
A or prime, but could look like Alt-A or prime loans from the
outside if the lower monthly payments offset the borrowers'
lies about their income.
Part of the reason originators did that was because the
borrower would have four, five, six, I have seen 25 investor
properties. Such an owner has no interest in residing in the
house. They were hoping to ride the bubble; 24 of those homes
are going to be into foreclosure, there is nothing you can do
about that.
But in these regions in particular in red, what you saw was
aggressive expansion to the frontier of the urban area. In many
of these places you have developments literally in the middle
of nowhere, 2\1/2\ hours outside the city center with no easy
access to roads or transport to integrate them in the rest of
the urban area. The idea was to build on spec. Build it and
they will come. There is nothing there now. There is farmland
around it, and no reason to be there. Other spec building was
done in the inner city converting neighborhoods that were
formerly disadvantaged into viable housing. So the same effect
is happening. Again, there is no desire to live there once the
house goes into foreclosure.
I think part of the way out here is the fundamental aspects
of the Community Reinvestment Act that we talked about years
ago of rebuilding communities, not just focusing on the
individual home, but giving a person a reason to live there, in
fact giving a group of people a reason to live there, which
builds community and builds value to the home.
Representative Cummings. Thank you very much.
Chair Maloney. Mr. Brady.
Representative Brady. Thank you, Madam Chairwoman. When you
look at this map, clearly there are areas in the Northeast and
others that are economically distressed. But you also see,
especially California, Florida and Nevada, the result of
speculation. I have an acquaintance who, sadly, told me he has
got a retired mom in Nevada who took out--invested in three
homes, took out zero down payment loans, hoping to make money
for retirement.
We are probably not going to be able to help people like
that. I think it is sort of naive to say that every borrower
can be helped. I want to focus on those who took out loans in
good faith, had a job, have run into a tough situation, need
help; if we can sort of provide that cushion in time, then be
able to work out that distress. We have got a home that has got
a higher value, the family stays in. That ought to be our
focus.
I sometimes wonder if lenders have the specific knowledge
that would allow them to identify those borrowers and really
focus on them.
A couple of points I wanted to follow up on. I have a
frustration that the same bank regulators who provide the
guidance to effectively lower standards and create exotic loans
to help people get in the homes, without recognizing their
inability to repay--and then we are blissfully ignorant of the
impact of all that across our economy--are today in the same
banks, with the same regulators who have declared every
commercial loan to be a problem loan, and blissfully ignorant
of what impact it will have on a spiral down on the commercial
foreclosures that the Chairwoman held a hearing on most
recently.
My point there is, regulators don't always get it right. In
fact, they can exacerbate a problem going both directions. And
it has been hard for Congress to really get a handle on that.
I want to follow up on what Dr. Wachter said earlier. My
question is sort of basic. How long can we expect foreclosures
to rise? When do you think they will level off and hopefully,
at some point, decline? Knowing there are a lot of factors, Dr.
Wachter basically said through the end of 2010 we expect
foreclosures to rise. Is that your general sense? Is that the
general sense of the panel as well?
Yes, Dr. Mason. Mr. Ernst.
Mr. Ernst. Yes, I would agree with that.
Representative Brady. Given a lot of circumstances, do you
expect them to level off in 2011 and start to decline, or are
we waiting to see at that point how the economy does and other
factors?
Dr. Shear. I will start with a partial answer, because we
haven't tried to forecast what will happen to foreclosures
going forward. But what I will say based on what we have done,
there are certainly hundreds of thousands of people who are in
danger of losing their homes with the serious default rates we
see in many parts of the country.
In particular, what I would point to is that now, with the
payment option ARMs, many of them were originated in the years
2004, 2005, 2006, and those are mortgages that had what we call
negative amortization, but after 5 years they get recast. So
many of them are being recast now. You already see a serious
delinquency rate of about 30 percent on those mortgages. And
that is a place where we expect it to get worse.
Representative Brady. Do you expect the foreclosures, as
they rise in 2010, will they level off at a high rate in 2011?
Dr. Shear. We are not forecasting, but I am just pointing
out that there are a number of people that are in trouble. We
don't know--we haven't forecast house prices, but we are
particularly concerned about payment option ARMs because so
many of them are going to be recasting now and will become less
affordable to those homeowners.
Representative Brady. Yes. Other panelists.
Mr. Ernst. Just to come back around to my initial answer.
To put some numbers to it, we have almost 6 million mortgages
in this country right now that are delinquent or in some stage
of the foreclosure crisis. Last quarter, 700,000 homes entered
foreclosure for the first time.
So why are these numbers continually building and going in
the direction they are? One answer is, every effort at
modifying mortgages to date has been predicated on the
voluntary participation of servicers and their willingness and
ability to build up the capacity and the wherewithal to be able
to execute those modification plans.
So I think one of the things that Congress is starting to
revisit is the question of whether there needs to be a fallback
position to help borrowers when the systems designed to
encourage voluntary modification fall short.
Dr. Wachter suggested the principal modifications may be
something that need to be investigated and encouraged. And one
way to think about doing that is through permitting bankruptcy
judges, as a last resort, to play a role.
Representative Brady. I was wondering, trying to get a
handle of the problem going forward, Dr. Wachter, Dr. Mason, do
you want to talk about what 2011 would hold for us? A leveling
off of the high rate of foreclosure, or do we start to see a
decline?
Dr. Mason. A leveling off in 2011. There is some
uncertainty how far you are going into 2011 because of the pay
option ARM problem. The original resets that were in the
contract would have been 2010, 2011, but those resets are also
tied to when the homeowner maxes out the loan-to-value ratio
based upon negative amortization and reassessment at either 115
or up to 125 LTV. So that is bringing those reset dates even
closer in.
All that negative amortization and reassessment does is
increase the peak that we hit in 2010 versus a shallower
reduction into 2011. We are not sure which is going to occur
there. We are sure that the effects are going to easily drag
into 2011, 2012, and beyond. And that is why I am particularly
maddened by this continued building on adding inventory to
homes.
Chair Maloney. Thank you very much.
Mr. Hinchey.
Representative Hinchey. Thank you, Madam Chairman. This is
a very interesting hearing. I thank you for everything you have
said and the responses to the questions.
We are dealing with one of the most difficult set of
circumstances economically that this country has ever faced.
The worst since the 1930s. We are doing some things about it,
but we are not doing nearly enough.
This subprime mortgage crisis is a major part of it, which
has not been addressed adequately. It is a problem that, as we
have discussed here, has been going on for now more than 5
years, maybe as much as 6 years. In the initial years, it was
completely ignored and intentionally ignored by the regulators
who were supposed to deal with this. And the situation came
about as a result of not just some accident, but some
manipulation of the oversight and regulatory operations that
are necessary to prevent these kinds of things from happening.
We saw what happened back in the 1930s. Situations like
this were addressed. They were addressed adequately. And they
stopped. They stopped not just then, but for 50 years. Now we
are dealing with a situation that has not been addressed
adequately.
The last Secretary of the Treasury, Secretary Paulson, even
though he wanted to ignore the economic problems for a long
time, he focused our attention on the banks. Seven hundred
billion dollars. A lot of us voted against that because we knew
that that wasn't dealing with all of the aspects of this
problem in a very constructive way.
So the subprime mortgage crisis is a major part of the
issue that we are dealing with. And it is going to continue to
be part of the problem. It may have peaked but, nevertheless,
it is going to continue for some time to be a major part of the
problem.
So I wonder if you could tell us what, in your opinion, are
the major regulatory manipulations and shortcomings that led to
this problem that we are facing and what we should be doing--
what this Congress and what this administration should be doing
to stop it and to deal with it more effectively.
Dr. Shear. Okay if I start?
Representative Hinchey. Please, Mr. Shear.
Dr. Shear. You raise a very important question, because
sometimes memories are short and people say, ``Well, once we
get out of this crisis, it won't happen again.'' And there has
been attention placed on how to try to ensure that things like
this don't happen again.
Chairman Maloney referred to changes in regs Z in the Truth
in Lending Act. I will mention that there has been legislation
that has been introduced in both the 110th and the 111th
Congress in House Financial Services that proposed statutory
expansions in the Truth in Lending laws. And I will mention
that we have a report we are issuing Friday, done for that
committee, that looks at the potential impacts of certain
provisions that could protect borrowers.
We have also done work on the regulatory structure
involving the financial services industry. We have a regulatory
structure that doesn't meet the needs of our modern financial
markets; namely, you had a lot of subprime lenders and Alt-A
lenders that are either independent or nonbank subsidiaries
that haven't been subject to sufficient oversight. And we have
addressed those issues.
So I think it is very important to keep our eye on what
changes should occur in the regulatory structure, what changes
should be made to make sure that mortgage lenders that are
outside of banks, how they are regulated, and how Truth in
Lending provisions can protect consumers.
Representative Hinchey. Dr. Wachter, you said specifically
that there was a failure of regulatory market structures. Maybe
you could amplify that.
Dr. Wachter. Yes, there was. In work with colleagues
Patricia McCoy and Andrey Pavlov in an article written in the
Connecticut Law Review, we talk about regulatory arbitrage and
the race to the bottom. In other work with Anthony Pennington-
Cross, we talk about State regulation and preemption, the move,
again, to the regulator with least regulation.
At the same time, there was an expansion of private label
securitization, which in fact incentivized the provision of
mortgages that did not reflect the risk.
Again, in work with colleagues, we showed that, amazingly,
the price of this risk, the cost of this risk to borrowers, was
decreasing over time as securitizers attempted to place more of
these mortgages in the market.
Now the critical piece there is that these securitizations
were not, in fact, marked to market. There was not only
regulatory failure; there was also market failure. These
securities did not face the discipline of the market. They were
heterogeneous and were therefore impossible to trade.
As a finance professor, I believe that markets do indeed
move towards equilibrium, but only if markets are allowed to be
in play. In this case, these securities did not trade. They
were marked to model. Those models were, in part, put together
by the rating agencies, which also failed.
Representative Hinchey. Mr. Ernst.
Mr. Ernst. I agree with that. Certainly, we have issued a
report detailing the failures of specific regulatory agencies,
but I think it is also important to see that there was a
systemic built-in defect in the regulatory system.
We had multiple agencies in charge of consumer protection
and, as a result, we largely had no agency accountable for
consumer protection.
We had interagency guidance, for example, in subprime
lending. But, it came too late and was too weak to prevent the
crisis from unfolding. I think that is why, going forward, we
favor consolidating consumer protection in one agency that can
move forward with that mission and produce timely regulations
that will help prevent the next crisis from happening. There
are specific agencies and these specific problems, but there is
also a systemic dimension to this crisis as well.
Dr. Mason. If I could, I would also like to agree that the
dispersion of responsibility for consumer protection regulation
is a problem. And that can be solved fairly easily. But the way
I look at this, this is a classic--what we call asymmetric
information--crisis. There is risk in the system. There always
is. People took risks, but we get a shock to asset values.
Investors don't know who is exposed to the shock, so they pull
back from the system as a whole until they can get better
information.
But this information shortcoming is not an efficient
markets problem. All the information is used. The problem is
there is not enough information.
Now, anytime you have financial innovation, there is always
a point at which you don't have information. That is part of
financial innovation. That is not a problem unless you get too
much reliance upon the new innovative products. That is what we
had here.
Bank regulators allowed huge reliance upon securitization
and illiquid markets for funding what we typically take to be
the foundation of our financial system, that is, commercial
banks where depositors keep their money. These are institutions
that we have typically kept very conservative and prohibited
from getting too risky. Instead, banks were allowed to go
funding themselves with the newest most innovative financial
instruments in untested markets.
So information is crucial, but information is costly so you
never have enough information. Hence, the trick to allowing
innovation to proceed is balancing the amount of information
that is not out there with other existing risk exposures. This
is a crucial point because the question then comes down to: If
you had a systemic risk regulator, who would listen to it?
Because the systemic risk regulator would not get information
from anywhere to back their argument that a substantial risk
exists because the information doesn't exist.
So part of the job of managing risk and information is to
look for the dog that didn't bark. There wasn't data on these
markets. We didn't know where real estate values were going. We
didn't know what asset-backed securities were worth.
In fact, one key element that triggered the crisis was the
development of what we now know as the ABX that is publicized
by the Markit group which told us an index of the prices on
major residential mortgage-backed securities. In fact, when
investors saw that home values were falling, they started
shorting the market rationally because the information told
them where the market was going. And that is what caused the
crisis.
So we had too much product sold on the basis of this
noninformation and we experienced a shock when information
entered the market.
Dr. Wachter. If I may add to that, the ABX indicator did
not cause the market to fall. In fact, it was a lagging
indicator. I am not as pessimistic as Dr. Mason. I do believe
the information is, and was, out there. I believe it can be
monitored and should be monitored.
Chair Maloney. Thank you very much. That was very
informative.
Congressman Burgess.
Representative Burgess. Thank you. This is indeed a
fascinating discussion this morning.
Dr. Mason, let me just ask you one quick question on
follow-up to something you said. If I understood you correctly,
you said that there is a problem now that builders are
continuing to build, although they are building a different
product, but that different product is now competing with the
existing housing stock which has yet to be absorbed from the
foreclosure bubble; is that correct?
Dr. Mason. That is correct. I look at it as an an inventory
problem. If we add to the inventory, we have more of an
inventory problem.
Representative Burgess. Well, are the builders who are
building these new products able to get the interim financing
to build these new products?
Dr. Mason. You've got me on that one. I would like to know
that myself.
Representative Burgess. Well, Madam Chairwoman, perhaps we
could explore that further, because that would seem to be a
fundamental issue that needs to be addressed.
I want to just talk a little bit about this chart. It is
the first time I have seen it. It is a fascinating chart--and
not because Texas looks so good, but it does. And I will tell
you the reason it does is because we went through a frightening
real estate contraction in the late 1980s with the implosion of
the savings and loans.
I don't think the enthusiasm for pricing real estate really
caught on in Texas because of having so recently been burned in
that last real estate bubble in the 1980s. I can't claim that
it was necessarily Kevin's and my leadership that made Texas a
safe place to be, but we are all grateful that Texas looks as
good as it does.
But it does bring up the point that there are many
congressional districts where things look rather startling. And
it does seem to be something that does follow congressional
district lines.
I am struck by the fact that Michigan, which has been in
crisis for some time as far as its employment figures, actually
doesn't look too bad on the foreclosure side. Perhaps because
all of those foreclosures happened much earlier in this
sequence, and we are just looking now at the aftermath of what
has been a tough and lingering recession in that area.
And, Dr. Shear, I would like for you to comment on this,
since you are the representative from the Government
Accountability Office. In January of this year, the Wall Street
Journal published an article on January 5 dealing with some of
the problems that were brought to the subprime loan industry by
Members of Congress who were encouraging the letting of these
subprime, no-document, ninja loans to people in their
congressional districts to bolster homeownership, to improve
the economy. I don't know why, but this was a rather intense
article. It was a long article.
Dr. Shear, the point that was made over and over again,
that it was also tied to political contributions as well. This
homeowners' group, HOGAR, that was set up to foster home
ownership, if there were contributions through this agency,
people could place fellows that were actually lobbyists within
the organization or they get favorable press releases from a
real estate organization.
Did you encounter any of this in the course of your
investigation? Did you look into this at all?
Dr. Shear. That is something that we haven't looked into.
With respect to your observation about Michigan, let me
make one comment. One of the things that we tend to observe
when we look where this problem is the most pronounced is in
places where you had housing price bubbles that were occurring.
Housing prices were high to begin with, and they were rising.
You had certain bubbles going on and you had kind of intense
marketing of certain products.
Now the bubble has broken in those places. Michigan never
was one that was having the uptick in prices, such as in
California and in some parts in the Northeast.
Representative Burgess. But, again, coming back to the
article last January, the reason that those markets in southern
California and Florida were perhaps having some of the problems
was that it was being generated by, actually, Members of
Congress.
We are talking about new regulations and the Congress is
going to be the one to stop reckless behavior, but it looks
like Congress might have been one of the proximate causes in
driving the reckless behavior.
Dr. Shear. I really don't have any basis to really react to
that.
Representative Burgess. I am going to try to help you get
some basis. Let me put these thoughts down on paper and, Madam
Chairman, I am going to make a request to the Government
Accountability Office that they look into this, because we have
a crisis right now in confidence. No one believes Congress. Our
approval ratings are abysmally low, and no one believes we can
fix the things that we keep telling the American people we are
going to fix. And if we never come back and address the fact
that we may have been a part of the cause of this--we may not
have caused all of it, but we certainly may have lit the fuse
that caused the implosion of the bubble.
I think it is incumbent upon us to deal with that before we
go forward with an entirely new regulatory scheme that--who is
going to believe we can set one up when we couldn't even police
ourselves in 2004 and 2005?
Dr. Shear. And what I say, and it is really a general
statement for the committee and both sides of the aisle, is
that we are always happy to meet with your staffs and to
discuss what issues you think we should be looking at, just as
we have for the committee in looking at this crisis.
Representative Burgess. Well, Madam Chairman, I will make a
copy of the Wall Street Journal from January 5 and I would like
to enter a copy of this into our record today.
[The prepared statement of Representative Burgess appears
in the Submissions for the Record on page 127.]
[The article titled ``Housing Push for Hispanics Spawns
Wave of Foreclosures'' appears in the Submissions for the
Record on page 128.]
Chair Maloney. Thank you very much. I would like to go back
to the loan modification programs by Treasury that everyone is
mentioning. I would like a clarification, Dr. Shear. The loan
modification programs by Treasury are limited to owner-occupied
housing; isn't that correct?
Dr. Shear. Yes, that is my understanding.
Chair Maloney. So, in other words, we are not trying to
bail out speculators, similar to what some of my colleagues
have been talking about, but only those owner-occupied housing?
Dr. Shear. Yes. I think it is focused especially on those
that have high debt-to-income ratios and that are in danger of
losing their homes.
Chair Maloney. We have also heard about high re-default
rates for modified loans. But the FHFA's report shows that loan
modifications in 2008 tended to increase, not decrease
payments. Only recently have modifications led to lower
payments. Do you think this may be part of the problem?
Dr. Shear. We are certainly aware of certain studies done--
what FHFA has observed, what the Office of the Comptroller of
the Currency and others have looked at--that if you are going
to have a chance for modifications to lead to a better outcome,
that you are going to have to reduce the monthly payments that
the borrowers are making.
Chair Maloney. When we talk about the servicers, the same
parties who originated these bad loans are now in the business
of modifying them. Why do you think they will do a better job
this time?
Anyone?
They created these bad loans. Now they are modifying them.
Why are they going to do a better job?
Dr. Mason. That is the point of what I wrote. I see no
reason to keep doing the same thing and expect a different
outcome.
Chair Maloney. There seems to be a problem with
understaffing--which some of you talked about--with the
servicers, which is contributing to the delays. But also it has
been reported that servicers do not have the right incentives
to modify these loans.
That was part of your testimony, Dr. Mason. Your paper on
the disparities in servicer quality seemed to indicate that
mortgage backed securities and collateralized debt that vary by
servicer make it even more difficult for investors to judge the
value of the asset--and, back to one of your points, that not
really knowing the extent of the problem and the value in the
problem.
Why do you think that we have not been using up the $50
billion in TARP funds? Could you share your thoughts, Dr.
Shear, of the efforts of Treasury and loan modification? I
believe you testified that they have not even started to use
this $50 billion.
Dr. Shear. Well, in our report, what we point out is that
there was a certain period of time where there were--I think
they call them trial periods. I think it was actually this
week, which was the first week that those would come. So there
are some numbers included on the highlights page of our report
that reports how many letters went out, how many applications
came in, how many are involved in this trial period. So it is a
matter that I think it is the way the HAMP program was set up
and now we will start to see----
Chair Maloney. So it hasn't really been in the process of
kicking in until now.
Dr. Shear [continuing]. It hasn't kicked in. That is a very
good way of putting it.
Chair Maloney. I have no further questions.
Mr. Burgess, do you have further questions?
Representative Burgess. Yes. Thank you, Madam Chairwoman.
First off, on just the foreclosure rate--and several of you
gave your opinions as far as projections--are we likely to see
a secondary reduction or a secondary increase in foreclosures
because of the joblessness that is now accompanying the
lengthening recession? The initial wave of foreclosures was a
lending practice problem. Some of that is still going on.
I think Newsweek said today the recession was over. But are
we going to see another dip in foreclosures or another increase
in foreclosures because of the job situation? I will take
anyone's answer on that.
I will ask Dr. Mason to comment.
Dr. Mason. We are expecting a feedback loop through to
extend the crisis. I have done some work to parameterize that
feedback loop. It is very rough work but, in general, yes, we
expect the unemployment situation to continue the foreclosure
crisis.
Representative Burgess. I don't have a dollar figure--that
is what I was just looking for--to see if I could tell you how
many billions of dollars Congress has committed to helping
people with the foreclosure crisis. It is a lot. We did
something with Fannie and Freddie last July, we did some more
in September, we did TARP in September and October. We did a
stimulus package and we have done HOPE for Homeowners. How big
a help have those programs been?
Dr. Mason. I want to make the point that there is a
disconnect between the unemployment and the foreclosure
problem. Most people who will be hit by job losses, by and
large, aren't in homes that they are trying to buy. They are
renters. And so that is why the correlation in the foreclosure
effect is less than one, and it is significantly less than one.
So I think if you are thinking about fiscal policy
alternatives, it may make sense to expand unemployment
benefits. That would, of course, help someone in their home
continue to afford the home, perhaps on a modified loan basis,
but also would more broadly help those who haven't had a chance
to enter home ownership and, of course, maybe give them a
chance to do so later on.
Dr. Wachter. I would say that the Federal efforts to date
have been critical in bringing us back from the precipice. We
were at a precipice. We were facing the collapse of the
financial system and the global economy. And we are no longer
at that precipice. This is due to the Federal intervention.
Representative Burgess. Which Federal intervention?
Dr. Wachter. It was actually a series of interventions and
the combination of these interventions that brought us back
from the precipice. But the stimulus was critically important.
Representative Burgess. We haven't spent the stimulus yet.
We are going to spend it right before Election Day, I think.
Dr. Wachter. My understanding is some of it has been spent.
But even the expectation that it will be spent matters.
Secondly, and very importantly, the Fannie and Freddie support,
which kept mortgages at historically low rates of 5 percent,
has been absolutely critical to containing the crisis.
Representative Burgess. Dr. Wachter, in your statement,
when you were talking about marking mortgages to market, you
have this sentence--and I don't want to take it out of context.
It says: There's an uncomfortably high probability that the
Obama modifications will not succeed in quelling the
foreclosure crisis due to the impact of so many underwater
homeowners being so deeply under water.
Could you expound on that statement?
Dr. Wachter. It is absolutely the case. We are seeing an
increase in foreclosures. And it is a concern. We have been
through a great recession and we were facing the potential
collapse of the economy. So we have had significant positive
impacts of a series of programs.
That is not to say that the foreclosure problem has been
completely stemmed. This is an ongoing problem. It continues to
pull down the economy and it needs to be further addressed.
Representative Burgess. Well, I think Chairwoman Maloney
referenced the fact that $50 billion that was available under
TARP has yet to be dispersed for Help for Homeowners. Did I
understand that exchange correctly? Dr. Shear.
Dr. Shear. The Hope for Homeowners program--again, we
looked at HAMP. It still hasn't played out yet--because of when
the program basically started--in terms of those who completed
the trial period and are really heading into loan
modifications. I think this is the first week. With the
meetings going on and outlined----
Representative Burgess. Did you say this is the first week?
Dr. Shear [continuing]. It is the first week where
modifications would occur. There was a certain 3-month period
that was worked into it. Again, I could pull out some
information and provide it to the committee from our report as
far as the timelines involved in the program.
Representative Burgess. The timeline would be extremely
helpful because people are going to say you passed TARP in
September, October; now we are seeing help this week on the
homeowner front. That is a significant lag between action and
reaction.
Dr. Shear. And we can certainly make that material--it is
in our report from last week--but if the committee wants it, we
could put it into the record for this hearing.
[The report entitled, ``Troubled Asset Relief Program:
Treasury Actions Needed to Make the Home Affordable
Modification Program More Transparent and Accountable,'' was
released by the Government Accountability Office on July 23,
2009, and can be found on the GAO website at http://
www.gao.gov.]
Representative Burgess. Dr. Wachter, so I understood.
Your comments from earlier, the bailout bill--we weren't
supposed to call it that--the financial rescue package that was
enacted by Congress in October you feel was one of the things
that was important in preventing the crisis, the foreclosure
crisis from being worse?
Dr. Wachter. I do think we would have had significantly
more job losses without the stimulus.
Representative Burgess. I was referring to the financial
rescue package that most of us call the bailout, for
convenience, that passed the 1st of last October.
Dr. Wachter. Yes, absolutely. I do think the bank rescue
has been very significant in bringing civility back to markets.
Representative Burgess. So this has been a bipartisan
rescue of both the Bush and Obama administrations that
prevented the abyss from being deeper?
Dr. Wachter. I do believe some efforts that were begun even
prior to Obama's Presidency contributed to the move back from
the precipice.
Representative Burgess. Thank you, Madam Chairwoman. I will
yield back the balance of my time.
Chair Maloney. Thank you very much.
I would like to thank all of our witnesses for being here
today to talk about the trend in nonprime foreclosures and what
can be done to prevent it in the future. We must do everything
we possibly can to keep American families in their homes, to
stabilize our housing prices, stabilize our economy.
I thank all of you for your research, your time here today,
and your commitment to helping our country solve these really
critical challenges.
Thank you very much for being here. I appreciate it.
Meeting adjourned.
[Whereupon, at 11:36 a.m., the committee was adjourned.]
SUBMISSIONS FOR THE RECORD
Prepared Statement of Carolyn B. Maloney, Chair, Joint Economic
Committee
Good morning. I want to welcome our distinguished panel of
witnesses and thank you all for your testimony today.
Today, the Government Accountability Office released a study which
I requested that looks at the performance of non-prime loans in every
Congressional district in the United States. This is a valuable report,
because it captures the national trends and also gives us data so
granular that we can see the effects on our constituents.
The default and foreclosure rates for these mortgages in my New
York district are relatively low compared to the rest of the country,
but rising foreclosures continue to inflict pain in communities
throughout the nation.
Borrowers, lenders, governments, and neighbors all pay the price
for vacant houses that attract vandalism and increase crime, which
destroy communities and burden local governments.
The map behind me is a snapshot of the mortgage crisis inherited by
the Obama Administration.
The map highlights an important point--the pain of foreclosure is
not being felt evenly across the United States. What we see are pockets
of pain more heavily concentrated in certain areas of the country--most
notably California, Florida, Illinois, Massachusetts, Nevada, and New
Jersey.
Congress and the administration have undertaken numerous efforts to
stem the tide of foreclosures.
Key measures include incentives to servicers to modify loans in the
Administration's Home Affordable Modification Program and an expansion
of eligibility to receive a low cost FHA loan in Hope for Homeowners.
Additionally, Congress has allocated money to counselors to help
homeowners get the information they need to be able to modify their
loans.
Today, Treasury and HUD officials are meeting with mortgage
servicers in an effort to speed the pace of modifications, which are
not happening quickly enough.
Servicers may be swamped, but families are drowning.
I look forward to our witnesses' insights into how the current
policies are working and any proposed changes that will help us keep
families in their homes.
The pockets of pain may be due at least in part to differences in
house price appreciation or the local economy. But the problems may
also stem from different lending practices throughout the country.
Earlier this month, the Joint Economic Committee held a hearing on
predatory lending and the targeting of minorities for higher cost
loans. In that hearing, we heard testimony that states have had
difficulty enforcing anti-predatory lending laws because of federal
pre-emption of those laws for nationally chartered banks.
Fortunately, some state attorneys general, including in my home
state of New York, took an active role in pursuing abuses at nationally
chartered banks.
While our immediate efforts are aimed at turning back the current
tide of foreclosures, it is just as important for us to realize how we
got in this predicament and prevent it from happening again.
Last week, the Federal Reserve Board of Governors proposed
significant changes to Regulation Z of the Truth in Lending Act
ratcheting up disclosure requirements and altering compensation to
brokers. The improved amendments to disclosure information for
consumers will help consumers gauge the true cost of mortgages and
compare different products.
Additionally, the Fed recognized that, if brokers have a financial
incentive to steer borrowers into more expensive products, then
improved disclosure may be ineffective. I am hopeful that these
proposed changes will change the flawed misalignment of incentives
between borrowers and brokers.
We must do all we can to keep families in their homes. I look
forward to the testimony of our witnesses to help us do just that.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Prepared Statement of Senator Sam Brownback, Ranking Republican
I wish to thank Chair Maloney for arranging today's hearing and to
thank today's expert panel on home foreclosures and foreclosure
mitigation.
American households are suffering in the current deep recession:
many have experienced large losses in their retirement and housing
wealth; millions of workers have lost their jobs and unemployment is
expected to continue to rise; and a large and growing number of
families have faced foreclosures on their homes. We are observing the
painful effects of the collapse of the housing bubble.
As is well known, home foreclosures are not only devastating for an
individual homeowner, but also for neighborhoods and communities.
Unfortunately, given the depth of our current post-bubble recession,
foreclosures continue to grow at a rapid pace and at a faster pace than
home retention and loan modification efforts. We hear reports that the
capacities of loan servicers to modify mortgage loans are strained;
that struggling homeowners find it difficult to negotiate the maze of
steps necessary to execute a mortgage modification; that loan servicers
fear possible legal repercussions from modifying a mortgage when a
borrower has more than one mortgage; and that some unscrupulous
borrowers and lenders may be trying to game the loan modification
initiatives. I look forward to hearing from our panel today about
impediments to stepping up the pace of mortgage loan modification
efforts for struggling American families.
There are numerous private and government-sponsored initiatives
aimed at increasing the pace of loan modifications and keeping
creditworthy borrowers in their homes. However, it does not appear that
the government-sponsored initiatives have had much of an impact on the
large and growing number of home foreclosures. And in too many
instances, even when a mortgage has been modified, re-default rates are
high--close to 50% of loans modified in the first two quarters of 2008
were in default again nine months after the modifications. Some of the
re-defaults likely arise because of the depth of the recession, which
has pushed a large number of American workers into unemployment, making
it difficult or impossible for them to keep up on even a modified
mortgage. Re-defaults also arise because of continued declines in home
prices, which push borrowers further underwater, even under modified
loan terms.
We are in a difficult economic situation in which continuing
declines in home prices are pushing more borrowers underwater on their
mortgages and in which growing unemployment prevents an increasing
number of homeowners from keeping current on their mortgages. There
have been some signs of late that the housing market may be bottoming
out. If so, an arrest of the plunge in home prices may help reduce the
growth in foreclosures. At the same time, most forecasts are for
continued increases in the unemployment rate for some time to come,
which will contribute to more foreclosure activity ahead.
Some argue that the lackluster performance of loan modification
efforts to date calls for a sledgehammer approach of modifying the
bankruptcy code to allow judges to ``cram down'' modifications of
loans. This would be the wrong answer. Given that mortgage loan
servicers are struggling to handle the large volumes of modifications
they are facing, it is difficult to imagine that bankruptcy judges
would have an easier time. More importantly, allowing for cram down,
even if sold as a temporary solution only for loans made over the past
few years, would lead to higher interest rates on future mortgages and
fewer mortgage loans. Lenders, quite simply and rationally, would have
to build into the rates they charge an expectation of a possible future
mortgage modification in a bankruptcy proceeding. Cram down would lead
to higher interest rates on mortgages and effectively would penalize
the vast majority of Americans who did not overextend themselves or
speculate during the bubble but, rather, lived within their means.
Loan modification efforts to stem the tide of foreclosures have
been progressing at an increasing pace. Yet that pace is not keeping up
with the rate of growth of new foreclosures and loan defaults and re-
defaults. Unfortunately, the Administration's latest effort to provide
mortgage relief, called the ``Making Home Affordable'' program that was
launched on February 18 of this year, has yet to show any significant
results. I wish to note that, according to a June 2009 report by the
Congressional Budget Office, while $50 billion of TARP funds have been
committed to the Administration's foreclosure mitigation plan, the
Treasury has not yet disbursed any of the funds allocated, as of June
17, 2009, for foreclosure mitigation. Given the gravity of the
foreclosure problem, this delay is unacceptably long. If this is an
example of the efficiency of a government that is supposed to be able
to operate a ``competitive'' health care plan to keep private health
care providers efficient, I am highly skeptical.
While our focus today will be on residential foreclosures and
mortgage modifications, we need also to keep in mind the deteriorating
market for commercial real estate, a topic that we considered in an
earlier Joint Economic Committee hearing. Given recent warnings by
Federal Reserve Chairman Bernanke of possible future need for Federal
action to help stem a growing tide of commercial foreclosures, it would
be helpful for the Fed, Treasury, and the Administration to provide a
contingency plan and to provide information about whether TARP funds
might be used and under what conditions. Looking forward and planning
would be a welcome change from a recent atmosphere of hurried reaction.
I look forward to the testimony of today's expert panelists.
__________
Prepared Statement of Kevin Brady, Senior House Republican
I am pleased to join in welcoming the witnesses testifying before
us today on the rapidly escalating number of home foreclosures.
A number of policy blunders during the last twenty years inflated
an unsustainable housing bubble. On a macro level, the Federal Reserve
pursued an overly accommodative monetary policy for far too long after
the 2001 recession. This policy along with huge capital inflows arising
from international imbalances kept long-term U.S. interest rates far
too low during much of this decade.
On a micro level, both the Clinton and Bush administrations pursued
a National Home Ownership Strategy to increase the home ownership rate
among historically disadvantaged groups. After 1992, federal officials
pressed commercial banks, thrifts, and mortgage banks to weaken loan
underwriting standards, reduce down-payments, and develop exotic loan
products such as interest only and negatively amortizing loans to help
low income families qualify for mortgage loans to buy homes. After
2000, Fannie Mae and Freddie Mac spurred the explosive growth in
subprime mortgage lending by purchasing millions and millions of
dollars of privately issued subprime mortgage-backed securities.
As in previous bubbles, swindlers took advantage of the unwary as
the housing bubble neared its zenith. On the one hand, some home buyers
misled lenders about their income and net worth to secure mortgage
credit to speculate in housing. On the other, some builders, realtors,
and lenders deceived home buyers about the obligations that they were
assuming.
The housing bubble burst in July 2006. House prices have
subsequently fallen by 32 percent according to the S&P/Case-Shiller
Home Price Index. Falling housing prices created uncertainty about the
value of mortgage-backed securities that triggered a global financial
crisis and the subsequent recession.
As history proves again and again, good intentions do not
necessarily produce good results. Today, many Americans, especially
historically disadvantaged families that federal officials intended to
help, are suffering. Interest resets on adjustable rate mortgage loans,
falling housing prices that make refinancing difficult or impossible,
and a rapidly escalating unemployment rate caused many families to fall
behind on their mortgage payments, default, and face the possibility of
foreclosure.
Consequently, home mortgage loan delinquency and foreclosure rates
are ballooning. A cascade of foreclosures may have serious negative
externalities. Dumping millions of foreclosed homes on the market may
keep housing prices depressed for years, reducing household wealth,
upending the budgets of localities that depend on property taxes, and
muting any economic recovery.
On February 18, 2009, President Obama announced the Making Home
Affordable initiative to refinance or modify existing mortgage loans to
prevent unnecessary foreclosures. So far, neither this initiative nor
earlier programs under President Bush have produced significant
results. For example, the Hope for Homeowners program, enacted in 2008,
helped only 25 homeowners through February 3, 2009. About 4,000 loans
were refinanced through the FHA-Secure program that expired on December
31, 2008. Only 13,000 loans were modified under the FDIC's
conservatorship of IndyMac.
Given the enormity of the home foreclosure problem, I look forward
to hearing from today's witnesses about what can be done to ameliorate
it.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Prepared Statement of Susan M. Wachter
Chairwoman Maloney, Vice Chairman Schumer, and other distinguished
members of the Committee:
Thank you for the invitation to testify at today's hearing on
``Current Trends in Foreclosure and What More Can Be Done to Prevent
Them.'' It is my honor to be here today to discuss the continuing wave
of foreclosures for nonprime borrowers in the residential housing
market and current policy options to reduce foreclosure rates and
modify mortgages.
Today according to the MBA, the foreclosure rate is 4.00%, four
times the historical average and the highest it has ever been since the
Great Depression.
It is fair to say that the considerable response to date by the
federal government has not yet worked to stem this crisis. Why is this?
While much has been done and more can be done, there is a fundamental
problem that is difficult to address through policy initiatives. In my
comments today, I will discuss this, the causes behind the difficult
situation we are in today, and what might be done going forward.
The problem of foreclosed homes and mortgages in default started in
a wave of foreclosures of subprime loans; in the coming years there
will be another wave of foreclosures, in part, due to the so-called
recasting of payment option mortgages. These and other complex
nontraditional mortgages were a very small part of the mortgage market
until they grew at an alarming rate starting in 2003; by 2006, they
were almost half of the total volume of mortgage originations. As these
untested, seemingly affordable, but unsustainable mortgages were
originated, they fueled an artificial house price boom which inevitably
collapsed. While the initial source of the problem was recklessly
underwritten nontraditional mortgages, the asset bubble this created,
the artificially and unsustainably inflated house prices, has been and
is now a problem for many who borrowed for homes in the years 2004 and
beyond. Homeowners who borrowed conservatively, putting 20% down using
tried and tested mortgages with steady mortgage payments are in
trouble; if they must sell due to job loss, for example, these owners
who purchased at inflated prices will be forced into foreclosure.
Americans are now increasingly threatened with loss of their homes
and their jobs and the problem will get worse before it gets better.
The chart that is attached, showing the growth in foreclosures and
the decline in house prices, demonstrates the role of plummeting house
prices in the worsening foreclosure problem. As average home prices
fall, for more and more households, the amount for which they could
sell their homes is less than what they owe on their mortgages. A loss
of a job, illness, or increases in required mortgage payments will
force owners to sell and will force foreclosure, since homes cannot be
sold for the amount of the mortgage due. Today the threat of job loss
is worsening as unemployment grows, and there will be a new wave of
rises in mortgage payments required for option ARMs in the coming
years.
Are there additional steps we can take now to mitigate the crisis?
The crisis will abate when home prices stop falling. A key fundamental
factor is growing unemployment, thus the importance of fiscal stimulus
that is currently in place. It is also critical that mortgage rates
remain affordable, thus the importance of continuing federal support
for FHA and the GSEs and the maintenance of today's historically low
mortgage rates. In addition, it is important to stem excess
foreclosures which are adding to the forces driving home prices down.
In an adverse feedback loop, more homes on the market pull down prices,
which results in even more homes that cannot sell for the mortgage
amount. This feeds an expectation that prices will fall more, further
foreclosures, and a downward spiral.
Losses upon foreclosure are extreme. However, if mortgage amounts
due exceed home values, loan modifications based on lowering or
postponing interest rate payments alone may not be able to stem the
growing problem. The Administration's Home Affordable Modification Plan
(HAMP) is attempting to address the lack of incentives and capacity of
mortgage servicers to respond to the foreclosure problem. The recently
issued GAO report has a number of suggestions and in fact the
administration is convening a meeting today to encourage further
efforts. In addition, it would be useful, as suggested in the Penn IUR
Task Force Report to HUD, to monitor the progress of the HAMP program
spatially, since as documented by research (see Wachter 2009 and
Wachter, forthcoming, and Bernstein et al.) there is an important
spatial component to the problem. Further loan modifications with
principal write-downs may also be necessary. This involves marking
mortgages, especially second mortgages held by banks, to market.
The financial system that triggered the crisis encouraged the
production and securitization of uneconomic loans which eventually
brought the system down. As I have written elsewhere, private-label
securitization itself failed, since these securities were not in fact
subject to market discipline. Is a less pro-cyclical financial system
an achievable goal? I have written with co-authors and wish to enter
into the record an article to appear in the Yale Journal on Regulation
which addresses the underlying failure of the regulatory and market
structure. There we address the incentives to dismantle lending
standards and the artificial housing boom which made it seem that the
loans being made were indeed safe when they were lethal. Going forward
regulatory supervision needs to be put into place to prevent this.
bibliography
Scott Bernstein, ``How Do We Know It's Affordable? Helping
Households Succeed Financially by Counting Location Efficiency and
Housing +Transportation Costs,'' Presentation Given to the Interagency
Task Force on Redefining Affordability, held at U.S. Dept. of Housing
and Urban Development (July 8, 2009).
Bostic, Raphael, Souphala Chomsisengphet, Kathleen C. Engel,
Patricia A. McCoy, Anthony Pennington-Cross, and Susan M. Wachter.
``Mortgage Product Substitution and State Anti-Predatory Lending Laws:
Better Loans and Better Borrowers?'' Working Paper (2008).
Pavlov, Andrey D. & Susan M. Wachter. ``Systemic Risk and Market
Institutions,'' Yale Journal on Regulation (forthcoming 2009).
Penn Institute for Urban Research. ``Retooling HUB for a Catalytic
Federal Government: A Report to Secretary Shaun Donovan,'' Penn MR Task
Force Report to HUD Secretary Shaun Donovan (2009).
Wachter, Susan M. ``Bad and Good Securitization,'' Wharton Real
Estate Review (forthcoming).
Wachter, Susan M. ``Understanding the Sources and Way Out of the
Ongoing Financial Upheaval,'' International Real Estate Review (2009).
Zandi, Mark M. ``Obama's Housing Policy,'' Moody's Economy.com
(March 9, 2009).
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Prepared Statement of Keith S. Ernst, Center for Responsible Lending
Good morning Chairwoman Maloney, Vice Chair Schumer, ranking
members Brady and Brownback, and members of the committee. Thank you
for your continued efforts to address the foreclosure crisis and for
the invitation to participate today.
I serve as Director of Research for the Center for Responsible
Lending (CRL), a nonprofit, non-partisan research and policy
organization dedicated to protecting homeownership and family wealth by
working to eliminate abusive financial practices. CRL is an affiliate
of Self-Help, a nonprofit community development financial institution
that consists of a credit union and a non-profit loan fund. For close
to thirty years, Self-Help has focused on creating ownership
opportunities for low-wealth families, primarily through financing home
loans to low-income and minority families who otherwise might not have
been able to get affordable home loans. Self-Help's lending record
includes a secondary market program that encourages other lenders to
make sustainable loans to borrowers with weak credit. In total, Self-
Help has provided over $5.6 billion of financing to 62,000 low-wealth
families, small businesses and nonprofit organizations in North
Carolina and across America.
In September 2007, our CEO Martin Eakes testified before this
committee about the wave of coming subprime foreclosures and about some
ways to prevent the crisis from escalating. As it turned out, our
predictions--dismissed by some as pessimistic--actually underestimated
the dimensions of the crisis. In light of what has happened, it is more
essential than ever that Congress take immediate, strong steps to
prevent foreclosures and bar the return of abusive, unsustainable
lending that otherwise might once again fundamentally disrupt our
economy.
We recommend several key actions to mitigate the continued flood of
foreclosures and avert similar crises in the future:
(1) Create a Consumer Financial Protection Agency as outlined
in H.R. 3126;
(2) Pass legislation requiring mortgage originators to
determine a consumer's ability to repay the mortgage and
encourage the Federal Reserve Board to finalize its proposed
rules banning yield spread premiums;
(3) Ensure that the Administration's current efforts to prevent
foreclosures--the Home Affordable Program and the Hope for
Homeowners Program--work as effectively as possible, including
ameliorating the tax consequences of loan modification and
principal reduction; and
(4) Lift the ban on judicial loan modifications of mortgages on
principal residences.
i. foreclosures continue to soar and the mortgage market continues to
suffer.
Our most recent report on subprime mortgages shows that over 1.5
million homes have already been lost to foreclosure, and another two
million families with subprime loans are currently delinquent and in
danger of losing their homes in the near future.\1\ Projections of
foreclosures on all types of mortgages during the next five years
estimate 13 million defaults (over the time period 2008Q4 to 2014).\2\
Right now, more than one in ten homeowners is facing mortgage
trouble.\3\ Nearly one in five homes is underwater.\4\
---------------------------------------------------------------------------
\1\ Center for Responsible Lending, Continued Decay and Shaky
Repairs: The State of Subprime Loans Today, p.2 (Jan. 8, 2009)
[hereinafter ``Continued Decay''], available at http://
www.responsiblelending.org/mortgage-lending/research-analysis/
continued-decay-and-shaky-repairs-the-state-of-subprime-loans-
today.html.
\2\ Goldman Sachs Global ECS Research, Home Prices and Credit
Losses: Projections and Policy Options (Jan. 13, 2009), p. 16; see also
Credit Suisse Fixed Income Research, Foreclosure Update: Over 8 Million
Foreclosures Expected, p.1 (Dec. 4, 2008).
\3\ Mortgage Bankers Association National Delinquency Study (March
5, 2009).
\4\ First American Core Logic (March 4, 2009).
---------------------------------------------------------------------------
The spillover costs of the foreclosure crisis are massive. Tens of
millions of homes--households where, for the most part, the owners have
paid their mortgages on time every month--are suffering a decrease in
their property values that amounts to hundreds of billions of dollars
in lost wealth.\5\ These losses, in turn, cost states and localities
enormous sums of money in lost tax revenue and increased costs for
fire, police, and other services. As property values decline further,
the cycle of reduced demand and reduced mortgage origination continues
to spiral downward.
---------------------------------------------------------------------------
\5\ Continued Decay, p. 3.
---------------------------------------------------------------------------
As a result of the foreclosure crisis, the mortgage market itself
is in deep trouble. Overall mortgage activity has plummeted. For 2008,
residential loan production cratered: $1.61 trillion compared to $2.65
trillion in 2007.\6\ Originations of subprime and Alt-A, (nonprime)
mortgages all but stopped in 2008. Only an estimated $64 billion in
such mortgages was originated last year.\7\ At its high point in 2006,
non-prime lending constituted a third (33.6%) of all mortgage
production. By the fourth quarter of 2008, it had fallen to 2.8%.\8\
These loans are not being originated in large part due to the collapse
of the secondary market for these mortgages, which was driving demand
and facilitating production. So far, 2009 has seen no reversal of this
investor retreat.
---------------------------------------------------------------------------
\6\ National Mortgage News (March 9, 2009).
\7\ Inside B&C Lending (February 27, 2009).
\8\ Id.
---------------------------------------------------------------------------
On the consumer demand side as well, every major indicator is down.
Between 2006 and 2008, existing home sales dropped 24 percent,\9\ while
new home sales and new construction starts plummeted by 54 and 58
percent, respectively.\10\ In February, mortgage applications for the
purchase of homes hit their lowest levels since April 1998.\11\
---------------------------------------------------------------------------
\9\ National Association of Realtors, http://www.realtor.org/
research/research/ehsdata.
\10\ US Census Bureau, http://www.census.gov/const/
quarterly_sales.pdf and http://www.census.gov/const/www/
quarterly_starts_completions.pdf.
\11\ Based on the Mortgage Bankers Association's Weekly Mortgage
Applications Survey for the week ending February 27, 2009. The four-
week moving average for the seasonally adjusted Purchase Index reached
its lowest level since April 1998. See www.mortgagebankers.org/
NewsandMedia/PressCenter/67976.htm.
---------------------------------------------------------------------------
ii. risky loans, not risky borrowers, lie at the heart of the mortgage
meltdown.
In October of last year, CRL provided lengthy testimony to the
Senate Banking Committee that describes the origins of this crisis in
detail.\12\ In this testimony, we focus on the question of whether the
core problem in the subprime market was risky borrowers or risky loans.
Specifically, many in the mortgage industry blame the borrowers
themselves, saying that lower-income borrowers were not ready for
homeownership or not able to afford it.\13\ Yet our empirical research
shows that the leading cause of the problem was the characteristics of
the market and mortgage products sold, rather than the characteristics
of the borrowers who received those products.
---------------------------------------------------------------------------
\12\ Testimony of Eric Stein, Center for Responsible Lending,
before the Senate Committee on Banking (Oct. 16, 2008) [hereinafter
``Stein Testimony''], available at. http://www.responsiblelending.org/
mortgagelending/policy-legislation/congress/senate-testimony-10-16-08-
hearing-stein-final.pdf.
\13\ Favorite industry targets to blame for the crisis are the
Community Reinvestment Act (CRA) and Fannie Mae and Freddie Mac (the
GSEs). For a complete discussion of why CRA and the GSEs did not cause
the crisis, see Stein testimony, pp. 25-33.
---------------------------------------------------------------------------
More specifically, research has shown that the risk of foreclosure
was an inherent feature of the defective subprime loan products that
produced this crisis. Loan originators--particularly mortgage brokers--
frequently specialized in steering customers to higher rate loans than
those for which they qualified. They also aggressively sold loans with
risky features and encouraged borrowers to take out so-called ``no
doc'' loans even when those borrowers typically had easy access to
their W-2 statements and offered them to the originators.\14\ Market
participants readily admit that they were motivated by the increased
fees offered by Wall Street in return for riskier loans. After filing
for bankruptcy, the CEO of one mortgage lender explained the incentive
structure to the New York Times: ``The market is paying me to do a no-
income-verification loan more than it is paying me to do the full
documentation loans,'' he said. ``What would you do?'' \15\
---------------------------------------------------------------------------
\14\ See, e.g., Glenn R. Simpson and James R. Hagerty, Countrywide
Loss Focuses Attention on Underwriting, Wall Street Journal (Apr. 30,
2008).
\15\ Vikas Bajaj and Christine Haughney, Tremors at the Door: More
People with Weak Credit Are Defaulting on Mortgages, New York Times
(January 26, 2007).
---------------------------------------------------------------------------
These risky, expensive loans were then aggressively marketed to
homebuyers and refinance candidates, often irrespective of borrower
qualifications. In fact, in late 2007, the Wall Street Journal reported
on a study that found 61% of subprime loans originated in 2006 ``went
to people with credit scores high enough to often qualify for
conventional [i.e., prime] loans with far better terms.'' \16\ Even
applicants who did not qualify for prime loans could have received
sustainable, thirty-year, fixed-rate subprime loans for--at most--half
to eight tenths of a percent above the initial rate on the risky ARM
loans they were given.\17\ Perhaps even more troubling, originators
particularly targeted minority communities for abusive and equity-
stripping subprime loans, according to complaints and affidavits from
former loan officers alleging that this pattern was not random but was
intentional and racially discriminatory. \18\
---------------------------------------------------------------------------
\16\ Rick Brooks and Ruth Simon, Subprime Debacle Traps Even Very
Credit-Worthy As Housing Boomed, Industry Pushed Loans To a Broader
Market, Wall Street Journal at A1 (Dec. 3, 2007).
\17\ Letter from Coalition for Fair & Affordable Lending to Ben S.
Bernanke, Sheila C. Bair, John C. Dugan, John M. Reich, JoAnn Johnson,
and Neil Milner (Jan. 25, 2007) at 3.
\18\ Julie Bykowicz, ``City can proceed with Wells Fargo lawsuit'',
Baltimore Sun (July 3, 2009) (available at http://www.baltimoresun.com/
news/maryland/baltimore-city/bal-
md.foreclosure03jul03,0,5953843.story).
---------------------------------------------------------------------------
In 2006, the Center for Responsible Lending published, ``Losing
Ground: Foreclosures in the Subprime Market and their Cost to
Homeowners.'' \19\ In this report, we projected that 1 in 5 recent
subprime loans would end in foreclosure--a projection that turns out to
have actually underestimated the scope of the crisis, although it was
derided at the time as pessimistic and overblown. Our research showed
that common subprime loan terms such as adjustable rate mortgages with
steep built-in payment increases and lengthy and expensive prepayment
penalties presented an elevated risk of foreclosure even after
accounting for differences in borrowers' credit scores. It also showed
how the risk entailed in these loans had been obscured by rapid
increases in home prices that had enabled many borrowers to refinance
or sell as needed. The latent risk in subprime lending has been
confirmed by other researchers from the public and private sectors.\20\
---------------------------------------------------------------------------
\19\ Ellen Schloemer, Wei Li, Keith Ernst, and Kathleen Keest,
``Losing Ground: Foreclosures in the Subprime Market and their Cost to
Homeowners'' (Center for Responsible Lending, December 2006) available
at http://www.responsiblelending.org/mortgage-lending/research-
analysis/foreclosure-paper-report-2-17.pdf.
\20\ See e.g., Yuliya Demyanyk, ``Ten Myth About Subprime
Mortgages'', Economic Commentary, Federal Reserve Bank of Cleveland
(May 2009) (available at http://www.clevelandfed.org/research/
commentary/2009/0509.pdf); Karen Weaver, ``The Sub-Prime Mortgage
Crisis: A Synopsis'' Deutsch Bank (2008) (available at http://
www.globalsecuritisation.com/08_GBP/
GBP_GSSF08_022_031_DB_US_SubPrm.pdf) (concluding that subprime
mortgages ``could only perform in an environment of continued easy
credit and rising home prices).
---------------------------------------------------------------------------
A complementary 2008 study that we undertook with academic
researchers from the University of North Carolina at Chapel Hill,
``Risky Borrowers or Risky Mortgages: Disaggregating Effects Using
Propensity Score Models,'' supports the conclusion that risk was
inherent in the loans themselves.\21\ The study compared the
performance of loans made through a loan program targeted to low- and
moderate-income income families and comprised primarily of lower-cost
30-year fixed-rate loans to the performance of subprime loans, most of
which were broker-originated and had nontraditional terms, such as
adjustable rates and prepayment penalties.
---------------------------------------------------------------------------
\21\ Lei Ding, Roberto G. Quercia, Janneke Ratcliff, and Wei Li,
``Risky Borrowers or Risky Mortgages: Disaggregating Effects Using
Propensity Score Models'' Center for Community Capital, University of
North Carolina at Chapel Hill (September 13, 2008) (available at http:/
/www.ccc.unc.edu/abstracts/091308_Risky.php).
---------------------------------------------------------------------------
In this study, the authors found a cumulative default rate for
recent borrowers with subprime loans to be more than three times that
of comparable borrowers with lower-rate loans. Furthermore, the authors
were able to identify the particular features of subprime loans that
led to a greater default risk. Specifically, they found that adjustable
interest rates, prepayment penalties, and broker originations were all
associated with higher loan defaults. In fact, when risky features were
layered into the same loan, the resulting risk of default for a
subprime borrower was four to five times higher than for a comparable
borrower with the lower-rate fixed-rate mortgage from a retail lender.
CRL also conducted a more targeted study to focus on the cost
differences between loans originated by independent mortgage brokers
and those originated by retail lenders. In ``Steered Wrong: Brokers,
Borrowers and Subprime Loans,'' CRL analyzed 1.7 million mortgages made
between 2004 and 2006.\22\ After matching brokered to retail-originated
loans along multiple dimensions, including borrower credit scores,
product type, and levels of debt and income verification, we observed
consistent and significant price disparities between loans obtained
through a broker and those obtained directly from a lender.
---------------------------------------------------------------------------
\22\ Center for Responsible Lending, Steered Wrong: Brokers,
Borrowers and Subprime Loans (April 8, 2008), available at http://
www.responsiblelending.org/mortgage-lending/research-analysis/steered-
wrongbrokers-borrowers-and-subprime-loans.pdf.
---------------------------------------------------------------------------
Specifically, for subprime borrowers, broker-originated loans were
consistently far more expensive than retail-originated loans, with
additional interest payments ranging from $17,000 to $43,000 per
$100,000 borrowed over the scheduled life of the loan. Even in the
first four years of a mortgage, a typical subprime borrower who has
gone through a broker pays $5,222 more than a borrower with similar
creditworthiness who received their loan directly from a lender.
This finding was not surprising given what we know about broker
compensation. Mortgage brokers typically receive two primary types of
revenue: an origination fee and a yield spread premium (YSP). The
origination fee is paid directly by the borrower and is generally
calculated as a percentage of the loan amount. The YSP is an extra
payment that brokers receive from lenders for delivering a mortgage
with a higher interest rate than that for which the borrower qualifies.
In the subprime market, lenders usually will pay the maximum YSP only
if a loan contains a prepayment penalty. The penalty ensures that the
lender will recoup their YSP payment either through excess interest
collected over time or from the penalty fee, should a borrower
refinance to avoid those interest costs. Ironically, while most
subprime borrowers believed their mortgage broker was looking for the
best-priced loan for them, the YSP serves as a powerful financial
incentive for brokers to steer borrowers into unnecessarily expensive
loans.
iii. preventing risky lending in the future.
A. Create the Consumer Financial Protection Agency
In light of our research, we believe there are important additional
steps Congress should take to prevent reckless lending that could once
again fundamentally disrupt our economy. Most importantly, we urge you
to support H.R. 3126, which would establish the Consumer Financial
Protection Agency.
As demonstrated above, the subprime market itself delivered loans
with significant inherent risks over and above borrowers' exogenous
risk profiles through the very terms of the mortgages being offered.
Although financial regulatory agencies were aware of this risk,
regulatory action was discouraged by the concern that any regulatory
agency taking action against these types of loans would place their
regulated institutions at a competitive disadvantage. In addition, the
ability of lenders to choose their regulator has resulted in a system
where lenders may exert deep influence over their regulator's
judgment.\23\
---------------------------------------------------------------------------
\23\ See e.g., Silla Brush, ``Audit: OTS knew bank data was
skewed'', The Hill (May 21, 2009) (available at http://thehill.com/
business--lobby/audit-ots-knew-bank-data-skewed-2009-05-21.html).
---------------------------------------------------------------------------
The Consumer Financial Protection Act would gather in one place the
consumer protection authorities currently scattered across several
different agencies, and would create a federal agency whose single
mission is to protect our families and our economy from consumer abuse.
The Agency would restore meaningful consumer choice by averting the
race to the bottom that has crowded better products out of the
market.\24\
---------------------------------------------------------------------------
\24\ See Center for Responsible Lending, Neglect and Inaction: An
Analysis of Federal Banking Regulators' Failure to Enforce Consumer
Protections (July 13, 2009) available at http://
www.responsiblelending.org/mortgage-lending/policy-legislation/
regulators/neglect-and-inaction-7-10-09-final.pdf.
---------------------------------------------------------------------------
H.R. 3126 is appropriately balanced to enhance safety and soundness
and allow appropriate freedom and flexibility for innovation. The bill
also incorporates the elements that are essential to an effective
consumer protection agency. These include the following:
The bill provides the Agency with essential rule-making
authority to prevent abusive, unfair, deceptive and harmful acts and
practices and to ensure fair and equal access to products and services
that promote financial stability and asset-building on a market-wide
basis.
The bill provides the Agency with strong enforcement
tools, along with concurrent authority for the States to enforce the
rules against violators in their jurisdictions. We urge that the bill
also ensure that individuals harmed by violations of the Agency's rules
have redress.
The bill reforms the preemption of State laws to ensure
that States are not hamstrung in their efforts to react to local
conditions as they arise and preserves the ability of states to act to
prevent future abuses.
The bill gives the Consumer Financial Protection Agency
supervisory authority to ensure that financial institutions comply with
the rules it puts in place and to give the Agency access to the real-
world, real-time information that will best enable it to make evidence-
based decisions efficiently.
In other areas of the economy, from automobiles and toys to food
and pharmaceuticals, America's consumer markets have been distinguished
by standards of fairness, safety and transparency. Financial products
should not be the exception--particularly since we have demonstrated
that it is the subprime mortgage products themselves that raised the
risk of foreclosure. A strong, independent consumer protection agency
will keep markets free of abusive financial products and conflicts of
interest. Dedicating a single agency to this mission will restore
consumer confidence, stabilize the markets and put us back on the road
to economic growth.
B. Prohibit predatory lending, particularly unsustainable loans, yield
spread premiums and prepayment penalties.
It is also imperative to pass legislation that would require
sensible and sound underwriting practices and prevent abusive loan
practices that contributed to reckless and unaffordable home mortgages.
For this reason, we urge the passage of H.R. 1728. While there are some
ways in which this bill should be strengthened, it represents a
critical step forward in requiring mortgage originators to consider the
consumer's ability to repay the loan and to refinance mortgages only
when the homeowner receives a net tangible benefit from the
transaction.
Another crucial advantage of H.R. 1728 is its establishment of
certain bright line standards that will result in safer loans and in
more certainty for originators of those loans. The bill's safe harbor
construct would grant preferred treatment to loans made without risky
features such as prepayment penalties, excessive points and fees,
inadequate underwriting, and negative amortization. It would also ban
yield spread premiums--which, as we explained earlier, were key drivers
of the crisis--and it would permit states to continue to set higher
standards if necessary to protect their own residents.
Similarly, we strongly support the Federal Reserve Board's recently
released proposal to ban yield spread premiums for all loan
originators. While the Board's rule is not yet written tightly enough,
it represents an important step forward in the recognition that
disclosure alone is not enough to protect consumers and that certain
practices themselves give rise to unfairness and unnecessary risk.
Many industry interests object to any rules governing lending,
threatening that they won't make loans if the rules are too strong from
their perspective. Yet it is the absence of substantive and effective
regulation that has managed to lock down the flow of credit beyond
anyone's wildest dreams. For years, mortgage bankers told Congress that
their subprime and exotic mortgages were not dangerous and regulators
not only turned a blind eye, but aggressively preempted state laws that
sought to rein in some of the worst subprime lending.\25\ Then, after
the mortgages started to go bad, lenders advised that the damage would
be easily contained.\26\ As the global economy lies battered today with
credit markets flagging, any new request to operate without basic rules
of the road is more than indefensible; it's appalling.
---------------------------------------------------------------------------
\25\ Id.
\26\ For example, in September 2006, Robert Broeksmit of the
Mortgage Bankers Association told Congress, ``Our simple message is
that the mortgage market works and the data demonstrate that fact,''
and ``I strongly believe that the market's success in making these
`nontraditional' products available is a positive development, not
cause for alarm.'' Statement of Robert D. Broeksmit, CMB Chairman,
Residential Board of Governors, Mortgage Bankers Association, Before a
Joint Hearing of the Subcommittee on Housing and Transportation and the
Subcommittee on Economic Policy, U.S. Senate Committee on Banking,
Housing and Urban Affairs, Calculated Risk: Assessing Non-Traditional
Mortgage Products, available at http://banking.senate.gov/public/
_files/broeksmit.pdf./. In May 2007, John Robbins of the Mortgage
Bankers Association said, ``As we can clearly see, this is not a macro-
economic event. No seismic financial occurrence is about to overwhelm
the U.S. economy. And we're not the only ones who think so.'' John M.
Robbins, CMB, Chairman of the Mortgage Bankers Association at the
National Press Club's Newsmakers Lunch--Washington, D.C., available at
http://www.mortgagebankers.org/files/News/InternalResource/
54451_NewsRelease.doc.
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iv. avoiding additional unnecessary foreclosures stemming from the
current crisis.
Finally, we urge this Committee to take further action to help save
the homes of the millions of families facing impending foreclosure.
A. Ensure that Current Anti-Foreclosure Efforts are as Strong as
Possible.
It is very important for all of us to monitor and evaluate the
Treasury's Home Affordable Modification Program (HAMP) and HUD's Hope
for Homeowners (H4H) program.
The HAMP program has the potential to modify millions of mortgages.
However, it has gotten off to a slow start, hampered by a severe
problem with servicer capacity, by a piece-by-piece rollout of
complementary programs addressing second liens and short sales, and by
lagging compliance and appeals procedures. Many servicers who are
participating in this voluntary program are apparently not following
all of the program's directives. Most importantly, experience shows
that they are not consistently following the requirement that loans be
evaluated for HAMP eligibility before foreclosure proceedings are
commenced.
To improve HAMP, servicers should be barred from proceeding with
any portion of a foreclosure action prior to considering the consumer
for a modification. In other words, they should not be permitted to
institute an action, and if an action has already been instituted, they
should not be permitted to move forward at all. Right now, reports
indicate that many servicers are operating as if the only thing
prohibited before consideration for a modification is the final
foreclosure sale--and, even worse, many foreclosure sales are still
going forward while the HAMP review is in process.
In addition, the net present value model must be far more
transparent to consumers, consumers who are turned down must be told
the specific reason for their denial through a formal declination
letter, and the program needs to roll out a clear process for appeal of
a decision above and beyond the servicer's own internal procedures.
One way to help with the various concerns just listed is to create
a mediation program that would require servicers to sit down face-to-
face with borrowers to evaluate them for loan modification eligibility.
Similar programs are at work in several jurisdictions across the
country, and they can be very helpful to ensure that homeowners get a
fair hearing and that all decisions are made in a fair and transparent
way.\27\
---------------------------------------------------------------------------
\27\ Andrew Jakabovics and Alon Cohen, ``It's Time we Talked:
Mandatory Mediation in the Foreclosure Process,'' Center for American
Progress (June 2009) (available at: http://www.americanprogress.org/
issues/2009/06/pdf/foreclosure_mediation.pdf ).
---------------------------------------------------------------------------
It is also crucial that the loan-level data that will be available
to the Treasury Department by early August be released to the public,
both in report form and in the maximum possible raw disaggregated form
so that independent researchers and other interested parties can
analyze the data themselves. In addition, the Treasury Department
should publish benchmarks against which program performance will be
evaluated.
Considering the difficulties that HAMP is encountering as it tries
to scale up, it would be prudent to institute a deferment program along
the lines of the Home Retention and Economic Stabilization Act
introduced early this session by Representative Matsui and Senator
Menendez (H.R. 527 and S. 241). This legislation permits homeowners
making less than a certain income who are stuck in dangerous home
loans, such as subprime or payment option ARM mortgages, to avoid
foreclosure for up to nine months as long as they make a market-based
mortgage payment and remain responsible during their deferment period.
This deferment period would end if the homeowner was offered a HAMP or
other sustainable modification.
As for the H4H program, so far, that program has failed to even
begin to fulfill its promise. We supported recent legislative changes
that offer some possibility for improving this program in a way that
would jump start its use; however, the continued resistance of
servicers and lenders to principal reduction and the need to extinguish
all junior liens will likely continue to hamper this program's
potential going forward. We do not believe the potential of this
program will be able to be realized until Congress also lifts the ban
on judicial modifications of primary residence mortgages (see section
IV(B) below). We also must fix the perverse tax consequences that could
befall homeowners using either one of these programs.\28\
---------------------------------------------------------------------------
\28\ For more information on tax consequences of principal
reduction, see Stein Testimony, p. 10.
---------------------------------------------------------------------------
B. Lift the Ban on Judicial Modifications of Mortgages on Primary
Residences
We strongly believe that no voluntary program will be effective
until there is a mandatory backstop available to homeowners. For that
reason, we are pleased to see that Congress is beginning to revisit the
need to permit judges to modify mortgages on principal residences.
This solution, which carries zero cost to the U.S. taxpayer, has
been estimated to potentially help more than a million families stuck
in bad loans to keep their homes.\29\ It would also help maintain
property values for families who live near homes at risk of
foreclosure. And it would complement the various programs that rely on
voluntary loan modifications or servicer agreement to refinance for
less than the full outstanding loan balance.
---------------------------------------------------------------------------
\29\ Mark Zandi, ``Homeownership Vesting Plan'', Moody's
Economy.com (December 2008) (available at http://www.dismal.com/mark-
zandi/documents/Homeownership_Vesting_Plan.pdf).
---------------------------------------------------------------------------
Judicial modification of loans is available for owners of
commercial real estate and yachts, as well as subprime lenders like New
Century or investment banks like Lehman Bros., but is denied to
families whose most important asset is the home they live in. In fact,
current law makes a mortgage on a primary residence the only debt that
bankruptcy courts are not permitted to modify in chapter 13 payment
plans.
Proposals to lift this ban have set strict limits on how it must be
done. Such proposals would require that interest rates be set at
commercially reasonable, market rates; that the loan term not exceed 40
years; and that the principal balance not be reduced below the value of
the property. And if the servicer agrees to a sustainable modification,
the borrower will not qualify for bankruptcy relief because they will
fail the eligibility means test. As Lewis Ranieri, founder of Hyperion
Equity Funds and generally considered ``the father of the securitized
mortgage market,'' \30\ has recently noted, such relief is the only way
to break through the problem posed by second mortgages.\31\
---------------------------------------------------------------------------
\30\ Lewis Ranieri to deliver Dunlop Lecture on Oct. 1, Harvard
University Gazette, Sept. 25, 2008, available at http://
www.news.harvard.edu/gazette/2008/09.25/06-dunlop.html.
\31\ Lewis S. Ranieri, ``Revolution in Mortgage Finance,'' the 9th
annual John T. Dunlop Lecture at Harvard Graduate School of Design,
Oct. 1, 2008, available at http://www.jchs.harvard.edu/events/
dunlop_lecture_ranieri_2008.mov (last visited Oct. 13, 2008). Ranieri
is ``chairman, CEO, and president of Ranieri & Co. Inc. and chairman of
American Financial Realty Trust, Capital Lease Funding Inc., Computer
Associates International Inc., Franklin Bank Corp., and Root Markets
Inc. He has served on the National Association of Home Builders
Mortgage Roundtable since 1989. . . .'' Harvard University Gazette,
Sept. 25, 2008.
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conclusion
As we survey the broken mortgage market, it is important to
remember that the benefits of homeownership have not changed. Long-term
homeownership remains one of the best and most reliable ways that
families can build a better economic future, and all of us have a
strong national interest in ensuring that the mortgage market works to
build our economy, not tear it down. In an effective home lending
market, lenders and borrowers will enter transactions with the same
fundamental measure of success--that is, a commitment to a mortgage
that represents a solid investment both short-term and long-term. We
urge Congress to take the actions we have outlined to ensure that
opportunities for sustainable homeownership remain open and meaningful.
__________
Prepared Statement of Joseph R. Mason
Thank you Congresswoman Maloney, Senator Schumer, and Committee
Members for inviting me to testify today.
Recent history is rife with examples of subprime servicer problems
and failures, resplendent with detail on best--and worst--practices.
The industry has been through profitable highs and predatory lows, over
time reacting to increased competition with greater efficiency and,
where sensible, increased concentration reflective of scale economies
in processing and knowledge.
Servicing is nothing if not a service industry, motivating
borrowers to pay the loans under the servicer's own management even
when the borrower cannot afford to pay others.
But intensively customer service-based enterprises such as
servicing are hard to evaluate quantitatively, so that proving a
servicer's value is difficult even in the best business environment.
Unfortunately, today's is not the best business environment, so proving
servicer value has now become crucial to not only servicer survival,
but the survival of the market as a whole.
There are seven key reasons why servicers are facing difficulties
with today's borrowers:
1. Modification is Expensive. Modified and defaulted loans can cost
thousands of dollars per loan per year to service, compared to roughly
fifty dollars for performing loans.
2. Arrearages are a Drag on Profits. Servicers have to pay
investors as if the loan was current until the servicer resolves the
delinquency, whether through modification or foreclosure.
3. Mortgage Servicing Rights Values Decline. When loans default,
servicing fees end, so the values of the loan servicing contracts
decline.
4. Increased Fees are only a Partial Fix. It is difficult to
convince investors to accept a doubling of servicing fees, and even
that will not cover typical increased costs. Servicers are reluctant to
impose fees directly on borrowers, however, as those fees have been
viewed as per se predatory in the past.
5. When Servicers are Threatened, Employees (and Expertise) Flee.
Reduced servicing staff, particularly with respect to the most talented
employees that have other options, will have a demonstrably adverse
affect on servicing quality.
6. Servicer Bankruptcy Creates Perverse Dynamics. While most
securitization documents stipulate a transfer of servicing if pool
performance has deteriorated or if the servicer has violated certain
covenants, which are expected to generally precede bankruptcy, the
problem is that the paucity of performance data makes it difficult for
the trustee or the investors to detect servicer difficulties prior to
bankruptcy to make the change.
7. Default Management is More Art than Science. While modifications
can be a useful loss mitigation technique when appropriate policies and
procedures are in place, servicers that are unwilling or unable to
report the volume, type, and terms of modifications to securitized
investors or regulators may be poorly placed to offer meaningful
modifications.
The main drawback with current policy is therefore that the
industry can use modification to game the system and investors are
wary. There are four major reasons for investor concern.
1. Aggressive Reaging makes Delinquencies Look Better than they
Really Are. Investors know that redefault rates on modified loans are
high, so calling the modified loan ``current'' again immediately is
disingenuous at best.
2. Aggressive Representations and Warranties also Skew Reported
Performance. At their best, representations and warranties help
stabilize pool performance. At their worst, representations and
warranties inappropriately subsidize the deal. In practice, it is
difficult to decompose the difference between stabilization and
subsidization.
3. Reaging and Representations and Warranties are used to Keep
Deals off their Trigger Points. Residual holders, nay, servicers,
however, continue to push for lowering delinquency levels, no matter
how artificially, in order to maintain positive residual and interest-
only strip valuations that can keep them from insolvency. Aaa-class
investors are therefore at the mercy of servicers who are withholding
information on fundamental credit performance in lieu of modification.
4. Current Industry Reporting does not Capture even the Most Basic
Manipulations. Servicers that utilize unlimited modifications or
modifications without appropriate controls could end up necessitating
greater credit enhancement to maintain credit ratings, whether because
of servicer capabilities or the possibility for delaying step-down by
skewing delinquencies.
The State Foreclosure Prevention Working Group's first Report in
February 2008 acknowledged that senior bondholders fear that some
servicers, primarily those affiliated with the seller, may have
incentives to implement unsustainable repayment plans to depress or
defer the recognition of losses in the loan pool in order to allow the
release of overcollateralization to the servicer.
Regulators can therefore do a great service to both the industry
and borrowers in today's financial climate by insisting that servicers
report adequate information to assess not only the success of major
modification initiatives, but also performance overall. The increased
investor dependence on third-party servicing that has accompanied
securitization necessitates substantial improvements to investor
reporting in order to support appropriate administration and, where
helpful, modification of consumer loans in both the private and public
interest. Without information, even the most highly subsidized
modification policies are bound to fail.
__________
Prepared Statement of Michael C. Burgess, M.D.
Thank you Madam Chair, and I thank the witnesses for testifying
here today.
I am looking forward to hearing more about the current home
foreclosure situation and the effectiveness of the government workout
plans to date.
Most people in my district share the opinion of CNBC's Rick
Santelli in his epic rant on the floor of the Chicago Mercantile
Exchange back in February. They don't want to support other adults who
signed a contract to pay a mortgage that they ultimately could not
afford and they don't want the government to help people who are
delinquent on their mortgages. Yet, foreclosures raise interest rates
for everyone and hurt home equity and appraisal values. What do we say
to those people who are still paying their monthly mortgage but are now
living in a home that has lost $50,000 or $100,000 in equity? These
homeowners have very little incentive to continue to make that payment,
especially if they experience a significant life event like the loss of
a job or major medical situation.
Home foreclosures seem to be rising despite the government's best
efforts to reverse the trend through programs like ``Hope for
Homeowners'' and changes to Federal Housing Administration loan
provisions. Perhaps the continued foreclosure trend can be attributed
to the fact that foreclosure is often the best method to work out or
``cram down'' mortgages. As the front page of today's Washington Post
put it, ``banks and other lenders in many cases have more financial
incentive to let borrowers lose their homes than to work out
settlements.'' According to the article, the Administration is seeking
to influence lenders' calculus in part by offering them incentives to
modify home loans.
If banks need more financial incentives to help people in this
economic environment, they are clearly not in a position to take on the
risk of continuing to carry less than prime or high risk loans. The
idea that we can pay off banks in order to save some delinquent
homeowners is one that continues to anger not just Rick Santelli and
the guys on the floor in Chicago, but people across this country who
feel like they are the victims of their own responsible behaviors.
Banks and lenders are being rewarded and given incentives despite
the fact that they were engaged in risky lending behaviors in order to
appease political activist groups who pushed them into tough lending
situations. [WSJ Article, ``Housing Push for Hispanics Spawns Waves of
Foreclosures''].
With that, I yield back the balance of my time.
__________
Housing Push for Hispanics Spawns Wave of Foreclosures
(By Susan Schmidt and Maurice Tamman, the Wall Street Journal, 5
January 2009)
(Copyright (c) 2009, Dow Jones & Company, Inc.)
California Rep. Joe Baca has long pushed legislation he said would
``open the doors to the American Dream'' for first-time home buyers in
his largely Hispanic district. For many of them, those doors have
slammed shut, quickly and painfully.
Mortgage lenders flooded Mr. Baca's San Bernardino, Calif.,
district with loans that often didn't require down payments, solid
credit ratings or documentation of employment. Now, many of the
Hispanics who became homeowners find themselves mired in the national
housing mess. Nearly 9,200 families in his district have lost their
homes to foreclosure.
For years, immigrants to the U.S. have viewed buying a home as the
ultimate benchmark of success. Between 2000 and 2007, as the Hispanic
population increased, Hispanic homeownership grew even faster,
increasing by 47%, to 6.1 million from 4.1 million, according to the
U.S. Census Bureau. Over that same period, homeownership nationally
grew by 8%. In 2005 alone, mortgages to Hispanics jumped by 29%, with
expensive nonprime mortgages soaring 169%, according to the Federal
Financial Institutions Examination Council.
An examination of that borrowing spree by the Wall Street Journal
reveals that it wasn't simply the mortgage market at work. It was
fueled by a campaign by low-income housing groups, Hispanic lawmakers,
a congressional Hispanic housing initiative, mortgage lenders and
brokers, who all were pushing to increase homeownership among Latinos.
The network included Mr. Baca, chairman of the Congressional
Hispanic Caucus, whose district is 58% Hispanic and ranks No. 5 among
all congressional districts in percentage of home loans not tailored
for prime borrowers. The caucus launched a housing initiative called
Hogar--Spanish for home--to work with industry and community groups to
increase mortgage lending to Latinos. Mortgage companies provided
funding to that group, and to the National Association of Hispanic Real
Estate Professionals, which fielded an army to make the loans.
In years past, minority borrowers seeking loans were often stopped
cold by a practice called red-lining, in which lenders were reluctant
to lend within particular geographical areas, often, it appeared, on
the basis of race. But combined efforts to open the mortgage pipeline
to Latinos proved successful.
``We saw what we refer to in the advocacy community as reverse red-
lining,'' says Aracely Panameno, director of Latino affairs for the
Center for Responsible Lending, an advocacy group. ``Lenders were
seeking out those borrowers and charging them through the roof,'' she
says.
Ms. Panameno says that during the height of the housing boom she
sought to present the Hispanic Caucus with data showing how many
Latinos were being steered into risky and expensive subprime loans.
Hogar declined her requests, she says.
When the national housing market began unraveling, so did the
fortunes of many of the new homeowners. National foreclosure statistics
don't break out data by ethnicity or race. But there is evidence that
Hispanic borrowers have been hard hit. In part, that's because of large
Hispanic populations in areas where the housing bubble was pronounced,
such as Southern California, Nevada and Florida.
In U.S. counties where Hispanics account for more than 25% of the
population, banks have taken back 6.7 homes per 1,000 residents since
Jan. 1, 2006, compared with 4.6 per 1,000 residents in all counties,
according to a Journal analysis of U.S. Census and RealtyTrac data.
Hispanic lawmakers and community groups have blamed subprime
lenders, who specialize in making loans to customers with spotty credit
histories. They complain that even solid borrowers were steered to
those loans, which carry higher interest rates.
In a written statement, Mr. Baca blamed the foreclosure crisis
among Hispanics on borrowers' lack of ``financial literacy'' and on
``lenders and brokers eager to make a bigger profit.'' He declined to
be interviewed for this story.
But a close look at the network of organizations pushing for
increased mortgage lending reveals a more complicated picture.
Subprime-industry executives were advisers to the Hogar housing
initiative, and bankrolled more than $2 million of its research.
Lawmakers and advocacy groups pushed hard for the easy credit that
fueled the subprime phenomenon among Latinos. Members of the
Congressional Hispanic Caucus, who received donations from the lending
industry and saw their constituents moving into new homes, pushed for
eased lending standards, which led to problems.
Mortgage lenders appear to have regarded Latinos as a largely
untapped demographic. Many were first or second-generation U.S.
residents who didn't own homes. Many Hispanic families had multiple
wage earners working multiple cash jobs, but had no savings or
established credit history to allow them to qualify for traditional
loans.
The Congressional Hispanic Caucus created Hogar in 2003 to work
with industry and community groups to increase mortgage lending to
Latinos. At that time, the national Latino homeownership rate was 47%,
compared with 68% for the overall population. Hogar called the figure
``alarming,'' and said a concerted effort was required to ensure that
``by the end of the decade Latinos will share equally in the American
Dream of homeownership.''
Hogar's backers included many companies that ran into trouble in
mortgage markets: Fannie Mae and Freddie Mac, both now under federal
control; Countrywide Financial Corp., sold last year to Bank of America
Corp.; Washington Mutual Inc., taken over by the government and sold to
J.P. Morgan Chase & Co.; and New Century Financial Corp. and Ameriquest
Mortgage Corp., both now defunct.
Hogar's ties to the subprime industry were substantial. A
Washington Mutual vice president served as chairman of its advisory
committee. Companies that donated $150,000 a year got the right to
place a research fellow who would conduct Hogar's studies, which were
used by industry lobbyists. For donations of $100,000 a year, Hogar
offered to provide news releases from the Hispanic Caucus promoting a
lender's commercial products for the Latino market, according to the
group's literature.
Hogar worked with Freddie Mac on a two-year examination of Latino
homeownership in 63 congressional districts. The study found Hispanic
ownership on the rise thanks to ``new flexible mortgage loan products''
that the industry was adopting. It recommended further easing of down-
payment and underwriting standards.
Representatives for Hogar declined repeated requests for comment.
The National Association of Hispanic Real Estate Professionals, one
of Hogar's sponsors, advised the group, shared research data and built
a large membership to market loans to Latinos. By 2005, its ranks had
grown to 16,000 agents and mortgage brokers.
The association, called Nahrep, received funding from some of the
same players that funded Hogar. Some 22 corporate sponsors, including
Countrywide and Washington Mutual, together paid the association $2
million a year to attend conferences and forums where lenders could
pitch their loan products to loan brokers.
While home prices were rising, the lending risk seemed minimal,
says Tim Sandos, Narhep's president. ``We would say, `Is he breathing?
OK, we'll give him a mortgage,' '' he recalls.
Nahrep's 2006 convention in Las Vegas was called ``Place Your Bets
on Home Ownership.'' Countrywide Chairman Angelo Mozilo spoke, as did
former Housing and Urban Development Secretary Henry Cisneros, a force
in Latino housing developments in the West.
Countrywide and other sponsors contracted with Nahrep to set up
regional events where they could present loan products to loan brokers
and their customers. Mr. Sandos says his organization doesn't get paid
to promote particular lenders.
At the height of the subprime lending boom, in 2005, banking and
finance companies gave at least $2.3 million in campaign contributions
to members of the Hispanic Caucus, according to data from the Center
for Responsive Politics.
In October 2008, a charitable foundation set up by Mr. Baca
received $25,000 from AmeriDream Inc., a nonprofit housing company and
Hogar sponsor. Mr. Baca has long backed AmeriDream's controversial
seller-financed down-payment assistance program. AmeriDream provided
down-payment money to buyers, a cost that was covered by home builders
in the form of donations to the nonprofit.
New housing legislation last fall outlawed the program. Mr. Baca is
cosponsoring a bill that would allow AmeriDream and similar nonprofits
to resume arranging seller-financed down-payment assistance to low-
income Federal Housing Administration borrowers.
Such seller-financed loans comprise one-third of the loans backed
by the FHA, and have defaulted at nearly triple the rate of other FHA-
insured loans, according to agency spokesman William Glavin.
In a news release, AmeriDream said the donation to Mr. Baca's
foundation was intended to fund the purchase of gear for firefighters
in his district. Local news reports say the foundation gave away
$36,000 in scholarships this year.
Internal Revenue Service records indicate that Mr. Baca's son, Joe
Baca Jr., has an annual salary of $51,800 as executive director of the
Joe Baca Foundation, which is run out of the congressman's home. Joe
Baca Jr. says he currently is taking only about half that listed
salary.
Mr. Baca's office declined to comment on the AmeriDream
contribution.
Mr. Baca remains opposed to strict lending rules. ``We need to keep
credit easily accessible to our minority communities,'' he said in a
statement released by his office.
Mortgage lending to Hispanics took off between 2004 and 2007,
powered by nonprime loans. The biggest jump occurred in 2005. The 169%
increase in nonprime mortgages to Hispanics that year outpaced a 122%
gain for blacks, and a 110% increase for whites, according to a Journal
analysis of mortgage-industry and federal-housing data. Nonprime
mortgages carry high interest rates and are tailored to borrowers with
low credit scores or few assets.
Between 2004 and 2007, black borrowers were offered nonprime loans
at a slightly higher rate than Hispanics, but the overall number of
Hispanic borrowers was much larger. From 2004 to 2005, total nonprime
home loans to Hispanics more than tripled to $69 billion from $19
billion, and peaked in 2006 at $73 billion.
Mortgage brokers became a key portion of the lending pipeline. Phi
Nguygn, a former broker, worked at two suburban Washington-area firms
that employed hundreds of loan originators, most of them Latino.
Countrywide and other subprime lenders sent account representatives to
brokerage offices frequently, he says. Countrywide didn't respond to
calls requesting comment.
Representatives of subprime lenders passed on ``little tricks of
the trade'' to get borrowers qualified, he says, such as adding a
borrower's name to a relative's bank account, an illegal maneuver. Mr.
Nguygn says he's now volunteering time to help borrowers facing
foreclosure negotiate with banks.
Many loans to Hispanic borrowers were based not on actual income
histories but on a borrower's ``stated income.'' These so-called no-doc
loans yielded higher commissions and involved less paperwork.
Another problem was so-called NINA--no income, no assets--loans.
They were originally intended for self-employed people of means. But
Freddie Mac executives worried about abuse, according to documents
obtained by Congress. The program ``appears to target borrowers who
would have trouble qualifying for a mortgage if their financial
position were adequately disclosed,'' said a staff memo to Freddie Mac
Chairman Richard Syron. ``It appears they are disproportionately
targeted toward Hispanics.''
Freddie Mac says it tightened down-payment requirements in 2004 and
stopped buying NINA loans altogether in 2007.
``It's very hard to get in front of a train loaded with highly
profitable activities and stop it,'' says Ronald Rosenfeld, chairman of
the Federal Housing Finance Board, a government agency that regulates
home loan banks.
Regions of the country where the housing bubble grew biggest, such
as California, Nevada and Florida, are heavily populated by Latinos,
many of whom worked in the construction industry during the housing
boom. When these markets began to weaken, bad loans depressed the value
of neighboring properties, creating a downward spiral. Neighborhoods
are now dotted with vacant homes.
By late 2008, one in every nine households in San Joaquin County,
Calif., was in default or foreclosure--24,049 of them, according to
Federal Reserve data. Banks have already taken back 55 of every 1,000
homes. In Riverside, Calif., 66,838 houses are owned by banks or were
headed in that direction as of October. In Prince William County, Va.,
a Washington suburb, 11,685 homes, or one in 11, was in default or
foreclosure.
Gerardo Cadima, a Bolivian immigrant who works as an electrician,
bought a home in suburban Virginia for $330,000, with no money down.
``I said this is too good to be true,'' he recalls. ``I'm 23 years old,
with a family, buying my own house.''
When work slowed last year, Mr. Cadima ran into trouble on his
adjustable-rate mortgage. ``The payments were increasing, and the price
of the house was starting to drop,'' he says. ``I started to think, is
this really worth it?'' He stopped making payments and his home was
sold at auction for $180,000.
In the wake of the housing slump, some participants in the Hispanic
lending network are expressing second thoughts about the push. Mr.
Sandos, head of Nahrep, says that some of his group's past members,
lured by big commissions, steered borrowers into expensive loans that
they couldn't afford.
Nahrep has filed complaints with state regulators against some of
those brokers, he says. Their actions go against Nahrep's mission of
building ``sustainable'' Latino home ownership.
These days, James Scruggs of Northern Virginia Legal Services is
swamped with Latino borrowers facing foreclosure. ``We see loan
applications that are complete fabrications,'' he says. Typically, he
says, everything was marketed to borrowers in Spanish, right up until
the closing, which was conducted in English.
``We are not talking about people working for the World Bank or the
IMF,'' he says. ``We are talking about day laborers, janitors, people
who work in restaurants, people who do babysitting.''
Two such borrowers work in Mr. Scrugg's office. Sandra Cardoza, a
$28,000-a-year office manager, is now $30,000 in arrears on loans
totaling $370,000. ``Her loan documents say she makes more than me,''
says Mr. Scruggs.
Nahrep agents are networking on how to negotiate ``short sales'' to
banks, where Hispanic homeowners sell their homes at a loss in order to
escape onerous mortgages. The association has a new how-to guide: ``The
American Nightmare: Strategies for Preventing, Surviving and Overcoming
Foreclosure.''