[JPRT, 111th Congress]
[From the U.S. Government Publishing Office]
CONGRESSIONAL OVERSIGHT PANEL
MARCH OVERSIGHT REPORT
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FORECLOSURE CRISIS:
WORKING TOWARD A SOLUTION
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
March 6, 2009.--Ordered to be printed
Submitted under Section 125(b)(1) of Title 1 of the Emergency Economic
Stabilization Act of 2008, Pub. L. No. 110-343
CONGRESSIONAL OVERSIGHT PANEL MARCH OVERSIGHT REPORT
CONGRESSIONAL OVERSIGHT PANEL
MARCH OVERSIGHT REPORT
__________
FORECLOSURE CRISIS:
WORKING TOWARD A SOLUTION
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
March 6, 2009.--Ordered to be printed
Submitted under Section 125(b)(1) of Title 1 of the Emergency Economic
Stabilization Act of 2008, Pub. L. No. 110-343
----------
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C O N T E N T S
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Page
Executive Summary................................................ 1
Section One: The Foreclosure Crisis: Working Toward a Solution... 5
Introduction: The Need for a Comprehensive Foreclosure Plan.. 5
I. The Foreclosure Crisis.................................... 6
II. Inadequate Mortgage Market Data Limits Sound Policy
Decisions.................................................. 10
III. Obstacles to Loan Success and Foreclosure Mitigation:
Past Programs.............................................. 15
IV. Checklist for Successful Loan Modifications.............. 46
V. Policy Issues............................................. 50
VI. The Homeowner Affordability and Stability Plan........... 61
Section Two: Additional Views.................................... 69
I. Rep. Jeb Hensarling....................................... 69
II. Richard Neiman, Damon Silvers and Elizabeth Warren....... 81
Section Three: Correspondence with Treasury Update............... 84
Section Four: TARP Updates Since Prior Report.................... 85
Section Five: Oversight Activities............................... 88
Section Six: About the Congressional Oversight Panel............. 89
Appendices:
Appendix I: Letter from Congressional Oversight Panel Chair
Elizabeth Warren to Treasury Secretary Mr. Timothy Geithner,
dated January 28, 2009......................................... 90
Appendix II: Letter from Treasury Secretary Mr. Timothy Geithner
to Congressional Oversight Panel Chair Elizabeth Warren, dated
February 23, 2009.............................................. 92
Appendix III: Letter from Congressional Oversight Panel Chair
Elizabeth Warren to Treasury Secretary Mr. Timothy Geithner,
dated March 5, 2009............................................ 115
Appendix IV: Mortgage Survey Letter from Congressional Oversight
Panel Chair Elizabeth Warren to Treasury Secretary Mr. Timothy
Geithner, Dated February 4, 2009............................... 117
Appendix V: Mortgage Survey from Congressional Oversight Panel to
numerous recipients............................................ 119
Appendix VI: Mortgage Survey Data from the Office of the
Comptroller of the Currency and the Office of Thrift
Supervision.................................................... 127
Appendix VII: Mortgage Survey Data from the Federal Deposit
Insurance Corporation.......................................... 161
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MARCH OVERSIGHT REPORT
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March 6, 2009.--Ordered to be printed
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EXECUTIVE SUMMARY *
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* This report was adopted by a 4-1 vote on March 5, 2009. Rep. Jeb
Hensarling voted against this report.
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For as long as there have been mortgages, there have been
foreclosures. The reasons are well documented. Job losses,
medical problems, and family breakups can leave families
strapped for cash, unable to meet their monthly payments.
Foreclosures have now skyrocketed to three times their
historic rates. But the causes of this foreclosure crisis are
very different than the foreclosures of the past. Since the
late 1990s, mortgage lending, once considered the safest of all
investments because of the well-researched decision-making that
carefully documented the ability of a borrower to repay,
morphed into an assembly-line business that looked nothing like
mortgages of the past. This new approach to mortgage lending
included steering high-priced mortgages to people who may have
qualified for lower-priced fixed rate mortgages and aggressive
marketing of high-risk loans to people whose incomes made it
clear that they could not possibly repay over the life of the
loan. In effect, such mortgages could be repaid only if the
housing market continued to inflate at historic rates and
borrowers could endlessly refinance their loans. After dizzying
price increases in many parts of the country, housing prices
flattened, refinancing became impossible, and the bubble burst.
Now millions of Americans find themselves unable to meet
their monthly mortgage payments. Millions more people who can
make their payments now recognize that they owe far more than
their houses are likely to be worth for many years, and some
are walking away. Over the next few years, an estimated one in
every nine homeowners is likely to be in foreclosure, and one
in five will likely have a mortgage that is higher than their
house is worth, making default a financially rational
alternative.
Mortgage foreclosures pose a special problem. Millions of
people could make market-rate payments on 30-year fixed
mortgages for 100 percent of the current market value of their
homes. But these can-pay families are driven into foreclosure
because they cannot pay according to the terms of the higher-
priced mortgages they now hold, and refinancing options are
limited or nonexistent. After accounting for the costs of
foreclosure and the lower prices foreclosure auctions bring,
the lenders will lose an average of $60,000 per foreclosure and
recover far less than the market value of the homes.
Foreclosure for can-pay families destroys value both for the
family forced out of its home and for the investor who will be
forced to take a larger loss.
For decades, lenders in this circumstance could negotiate
with can-pay borrowers to maximize the value of the loan for
the lender (100 percent of the market value) and for the
homeowner (a sustainable mortgage that lets the family stay in
the home). Because the lender held the mortgage and bore all
the loss if the family couldn't pay, it had every incentive to
work something out if a repayment was possible.
But the mortgage market has changed. A series of
impediments now block the negotiations that would bring
together can-pay homeowners with the investors who hold their
mortgages. In this report we identify those impediments. These
are structural problems, created as the mortgage business
shifted. They include fallout from securitizing mortgages, the
arrangements with mortgages servicers that encourage
foreclosures over modifications, and severe understaffing of
workout departments. Because of these impediments, foreclosures
that injure both the investor and the homeowner continue to
mount.
Like the crisis in the banking system, the foreclosure
problem has grown so large that it threatens the entire
economy. Foreclosures depress housing and commercial real
estate prices throughout neighborhoods, imposing serious costs
on third parties. Each of the eighty closest neighbors of a
foreclosed property can suffer a nearly $5,000 property value
decline as a result of a single foreclosure. Communities with
high foreclosure rates suffer increased urban blight and crime
rates. When families have to relocate, community ties are cut,
affecting friendships, religious congregations, schooling,
transportation and medical care. Numerous foreclosures flood
the market with excess inventory that depress other sale
prices. Thus, foreclosures can harm other homeowners both by
encouraging additional foreclosures and by reducing home sale
prices, while decreased property values hurt local businesses
and reduce state and local tax revenues.
To help individual families and to stabilize the economy,
Congress has pressed Treasury to devise a plan to deal with
foreclosures.\1\ The Congressional Oversight Panel was
explicitly instructed to review ``the effectiveness of
foreclosure mitigation efforts'' undertaken by Treasury under
the authorization of the Emergency Economic Stabilization
Act.\2\
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\1\ Emergency Economic Stabilization Act of 2008 (EESA), Pub. L.
No. 110-343, at Sec. 109.
\2\Id. at Sec. 125(b)(1)(A)(iv).
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To develop this report, we explored the available data and
discovered how little is known about the current state of
mortgage performance across the country. The ability of federal
banking and housing regulatory agencies to gather and analyze
this data is hampered by the lack of a nationwide loan
performance data reporting requirement on the industry.
Consequently, there is no comprehensive private or government
source for accurately tracking loan delinquencies and loss
mitigation efforts, including foreclosures and modifications,
on a complete, national scale. No federal agency has the
ability to track delinquencies and loss mitigation efforts for
more than 60 percent of the market. Existing data are plagued
by inconsistencies in collection methodologies and reporting,
and the numbers are often simply unverifiable. Worse still, the
data that are collected are often not the data needed for
answering key questions, such as, what are causing mortgage
defaults and why loan modifications have not been working. The
United States is now two years into a foreclosure crisis that
has brought economic collapse, and federal banking and housing
regulators still know surprisingly little about the number of
foreclosures, what is driving the foreclosures, and the
efficacy of mitigation efforts. The Panel endorses a much more
vigorous plan to collect critical foreclosure data.
To evaluate plans to deal with foreclosures, we identified
the main impediments to economically sensible workouts. From
there, we developed a checklist to evaluate the likely
effectiveness of any proposal to halt the cascade of mortgage
foreclosures.
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Checklist for Mortgage Mitigation Program
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Will the plan result in modifications that create affordable monthly
payments?
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Does the plan deal with negative equity?
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Does the plan address junior mortgages?
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Does the plan overcome obstacles in existing pooling and servicing
agreements that may prevent modifications?
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Does the plan counteract mortgage servicer incentives not to engage in
modifications?
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Does the plan provide adequate outreach to homeowners?
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Can the plan be scaled up quickly to deal with millions of mortgages?
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Will the plan have widespread participation by lenders and servicers?
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On February 18, 2009, President Obama announced the
Homeowner Affordability and Stability Plan intended to prevent
unnecessary foreclosures and strengthen affected communities.
The Plan focuses on payment affordability through an expanded
refinancing program involving Fannie Mae and Freddie Mac and a
modification program targeting a wide range of borrowers at
risk. The Plan also includes financial incentives to encourage
both lenders and borrowers to strive for sustainable outcomes.
It also encourages servicers to modify mortgages for at risk
homeowners before they are delinquent. There are additional
incentives available to extinguish junior mortgages.
The Administration estimates that the Plan's expanded
refinancing opportunities for Fannie Mae and Freddie Mac
mortgages could assist four to five million responsible
homeowners, some of whom otherwise would likely have ended up
in foreclosure.
While these projections are encouraging, the Panel has
additional areas of concern that are not addressed in the
original announcement of the Plan. In particular, the Plan does
not include a safe harbor for servicers operating under pooling
and servicing agreements to address the potential litigation
risk that may be an impediment to voluntary modifications. It
is also important that the Plan more fully address the
contributory role of second mortgages in the foreclosure
process, both as it affects affordability and as it increases
the amount of negative equity. And while the modification
aspects of the Plan will be mandatory for banks receiving TARP
funds going forward, it is unclear how the federal regulators
will enforce these new standards industry-wide to reach the
needed level of participation.
The Plan also supports permitting bankruptcy judges to
restructure underwater mortgages in certain situations. Such
statutory changes would expand the impact of the Plan. Without
the bankruptcy piece, however, the Plan does not deal with
mortgages that substantially exceed the value of the home,
which could limit the relief it provides in parts of the
country that have experienced the greatest price declines.
The Administration released additional guidelines for the
Plan on March 4, as this report was prepared for publication.
The Panel will promptly pursue any outstanding issues with the
Treasury Department and will keep Congress and the American
people advised of its ongoing evaluation of the
Administration's Plan.
The foreclosure crisis has reached critical proportions.
The Panel hopes that by identifying the current impediments to
sensible modifications that we can move toward effective
mechanisms to halt wealth-destroying foreclosures and put the
American family--and the American economy--back on a sound
footing.
SECTION ONE: THE FORECLOSURE CRISIS: WORKING TOWARD A SOLUTION
Introduction: The Need for a Comprehensive Foreclosure Plan
America is in the midst of a home foreclosure catastrophe,
unprecedented since the Great Depression. The Congressional
Oversight Panel (``COP'' or the ``Panel'') has been charged
with reporting to Congress on the state of the crisis, gauging
the adequacy of existing responses, and evaluating the promise
of potential responses.\3\ This report is the Panel's first to
focus on foreclosure mitigation efforts. The Panel's goal in
this report is not to endorse or propose any particular
foreclosure mitigation program. Rather, through an examination
of the causes of the crisis and the impediments to its
resolution, this report sets forth a framework to analyze the
problem and a checklist of factors that any successful
foreclosure mitigation program must address. These factors will
provide a metric for the Panel's evaluation of the
Administration's efforts, as well as any other federal, state,
local or private efforts.
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\3\ EESA at Sec. 125(b)(iv).
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The Emergency Economic Stabilization Act of 2008 (the
``EESA'') aimed to stabilize the economy both through direct
support of financial institutions and through encouraging
foreclosure mitigation efforts. These two endeavors are
intertwined. Foreclosures have exerted downward pressure on
real estate markets generally. In turn, the falling real estate
prices have put more pressure on real estate backed assets in
the financial system and applied pressure on the economy as a
whole. To date, the Treasury Department's emphasis in
implementing the EESA has been focused exclusively on
stabilizing the economy by dealing with financial institutions
and insurance and auto companies, at the expense of dealing
with the crisis directly by addressing home mortgage
foreclosures, an approach suggested by the EESA.\4\ The Panel
asked Treasury about foreclosure relief in the context of TARP
in its first report. Treasury responded by referring to several
existing voluntary programs, which were not actually part of
TARP. In this report, the Panel will examine in detail the
reasons that these voluntary programs have proven inadequate to
address the crisis.
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\4\ Id. at Sec. Sec. 109-110.
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The mortgage market, central to both consumer finance and
the broader American economy, has reached crisis stage. An
estimated 10 percent of residential homeowners currently face
foreclosure or have fallen behind on their mortgage payments, a
number nearly ten times higher than historic foreclosure
levels.\5\ The effects of the foreclosure crisis ripple through
the economy, affecting spending, borrowing and solvency for
households and financial institutions alike. Stabilizing the
housing market will not solve the economic crisis, but the
economic crisis cannot be solved without first stabilizing the
housing market. An effective solution to the foreclosure crisis
is necessary not only to help homeowners, but also to help fix
the economy as a whole.
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\5\ Vikas Bajaj and Michael Grynbaum, About 1 in 11 Mortgageholders
Face Problems, New York Times (June 6, 2008). See Section I, infra, for
a more complete discussion about the size and scale of the current
foreclosure crisis.
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Foreclosures generally have both direct and indirect costs
for borrowers and lenders. Further, the cost of foreclosures
can spill over from the parties to the transaction to the
neighborhood, larger community, and even the economy as a whole
as the foreclosure epidemic drives falling real estate prices.
When compared with the costs of foreclosure, the cost of loan
workouts can often provide a more efficient, economically
rational outcome for both the borrower and the lender,
generally making foreclosure a lose-lose situation. But the
rate of loan modifications has not kept pace with the rate of
foreclosures. In this report, the Panel explores how we arrived
at this point and why foreclosure often seems to be the default
option rather than successful, sustainable loan modifications.
This report proceeds in six parts. Part I provides a
picture of the foreclosure crisis and its impact on American
society and the global economy. Part II addresses the need for
reliable information on mortgage markets as a basis for making
sound policy judgments and the inadequacies of current mortgage
market data. Part III examines the obstacles to loan
performance that have been driving the foreclosure crisis and
the obstacles to foreclosure mitigation that have inhibited its
resolution, particularly through a review of past foreclosure
mitigation programs. Part IV outlines a checklist of specific
factors for successful future efforts at foreclosure
mitigation. Part V discusses key policy issues for the future,
including the moral hazard and distributional issues that are
raised by foreclosure mitigation efforts. The report concludes
with a review and assessment of the foreclosure mitigation
initiative recently announced by the Obama Administration.
I. THE FORECLOSURE CRISIS
A. A PICTURE OF THE FORECLOSURE CRISIS
Foreclosures are about the home. The importance of the home
to Americans can hardly be overstated. The home is the center
of American life. It is where we live, where we raise our
families, where we gather with friends, and, in many cases,
where we work. It is the physical and emotional nexus of many
households as well as the centerpiece of many Americans'
finances. The home is the single largest asset of many
Americans.\6\
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\6\ Brian K. Bucks et al., Changes in U.S. Family Finances from
2004 to 2007: Evidence from the Survey of Consumer Finances, Federal
Reserve Bulletin, at A1, A33 (Feb. 2009) (online at
www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf) (reporting
that home equity accounted for 31.8 percent of total family assets).
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The financing of the home is central to the American
economy. Home mortgage debt accounts for 80.3 percent of
consumer debt,\7\ and housing expenses, which are primarily
mortgage and rental payments, account for approximately 22
percent of the economy.\8\ Since the early 1980's consumer
spending has risen from approximately 60 percent of GDP to
approximately 70 percent of GDP,\9\ as a result of falling
savings rates and rising consumer debt. This is not a
sustainable economic structure, and over time the United States
must return to an economy where consumption is wage based and
there is adequate consumer savings. But while the economy
cannot be revived based on more asset-based consumption,
neither can the country afford a continuing asset price
collapse. An orderly return to a more wage-driven economy
requires that we have functioning credit markets. American
homeownership is in crisis. Out of 110 million residential
units in the United States,\10\ around 75 million are owner-
occupied, and of these, nearly 51 million are mortgaged.\11\
Over a million homes entered foreclosure in 2007 \12\ and
another 1.7 million in the first three quarters of 2008.\13\
This means that nearly one out of every twenty residential
borrowers entered the foreclosure process in the past two
years.
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\7\ Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release Z.1: Table L.101 (Dec. 11, 2008) (Table
L.101).
\8\ Hoover Institution, Facts on Policy: Consumer Spending (online
at www.hoover.org/research/factsonpolicy/facts/4931661.html).
\9\ Id.
\10\ U.S. Census Bureau, Housing Vacancies & Homeownership (CPS/
HVS) (Oct. 2008) (Table 4. Estimates of the Total Housing Inventory for
the United States: Third Quarter 2007 and 2008) (online at
www.census.gov/hhes/www/housing/hvs/qtr308/q308tab4.html).
\11\ U.S. Census Bureau, American Housing Survey for the United
States: 2007 (2007) (Table 3-15. Mortgage Characteristics--Owner-
Occupied Units) (online at www.census.gov/hhes/www/housing/ahs/ahs07/
tab3-15.pdf).
\12\ RealtyTrac, U.S. Foreclosure Activity Increases 75 Percent In
2007 (Jan. 29, 2008) (online at www.realtytrac.com/ContentManagement/
pressrelease.aspx?ChannelID=&ItemID= 3988&accnt=64847).
\13\ HOPE NOW, Workout Plans (Repayment Plans + Modifications) and
Foreclosure Sales, July 2007-November 2008 (online at www.hopenow.com/
upload/data/files/HOPE%20NOW%
20Loss%20Mitigation%20National%20Data%20July%2007%20to%20November
%2008.pdf). See also Chris Mayer et al., The Rise in Mortgage Defaults,
Journal of Economic Perspectives (2009) (forthcoming) (reporting 1.2
million foreclosure starts in first half of 2008).
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Over half a million homes were actually sold in foreclosure
or otherwise surrendered to lenders in 2007, and over 700,000
were sold in foreclosure in the first three quarters of 2008
alone.\14\ At the end of the third quarter of 2008, one in ten
homeowners was either past due or in foreclosure, the highest
levels on record.\15\ At the current pace nearly 2,900 families
are losing their homes each day.
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\14\ HOPE NOW, supra note 13; Adam J. Levitin, Resolving the
Foreclosure Crisis: Modification of Mortgages in Bankruptcy, Wisconsin
Law Review (2009) (online at papers.ssrn.com/sol3/
papers.cfm?abstract_id=1071931).
\15\ Mortgage Bankers Association, Delinquencies Increase,
Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec.
5, 2008) (online at www.mbaa.org/NewsandMedia/PressCenter/66626.htm)
(reporting that 2.97 percent of all one-to-four family residential
mortgages outstanding were in the foreclosure process in the first
quarter of 2008, and 6.99 percent were delinquent). See also Vikas
Bajaj and Michael Grynbaum, About 1 in 11 Mortgageholders Face
Problems, New York Times (June 6, 2008). Because of the steadily
increasing level of homeownership in the United States, higher
percentages of past due and foreclosed mortgages means that an even
greater percentage of Americans are directly affected by higher
delinquency and foreclosure rates. See U.S. Census Bureau, Housing
Vacancies and Homeownership (CPS/HVS): Historical Tables (Table 14:
Homeownership Rates for the U.S. and Regions) (online at
www.census.gov/hhes/www/housing/hvs/historic/index.html) (accessed Mar.
1, 2009).
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A comparison to Hurricane Katrina provides some sense of
the scope of the foreclosure crisis. A national disaster,
Katrina created serious social disruptions as many of New
Orleans' residents left, never to return. In the year following
Katrina, New Orleans' population declined by approximately
229,000, according to the Census Bureau. More Americans are
losing their homes in foreclosure each month than left New
Orleans after Hurricane Katrina.\16\ In 2008 alone, the
foreclosure crisis has had the force of a dozen Hurricane
Katrinas.
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\16\ According to the Census Bureau, the population loss after
Hurricane Katrina was 228,782. U.S. Census Bureau, Census Bureau
Announces Most Populous Cities (June 28, 2007) (online at
www.census.gov/Press-Release/www/releases/archives/population/
010315.html). Given the average household size of 2.6 individuals and
2,900 foreclosures per day, more than 226,000 persons are losing their
homes per month. U.S. Census Bureau, Fact Sheet: 2005-2007 (online at
factfinder.census.gov/servlet/ACSSAFFFacts) (accessed Mar. 1, 2009).
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Chart 1: Percentage of 1-4 Family Residential Mortgages in Foreclosure
Process \17\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\17\ Mortgage Bankers Association, National Delinquency Survey:
Seasonally Adjusted (Mar. 4, 2009).
The foreclosure crisis shows no signs of abating, and
without decisive intervention it is likely to continue for
years and directly affect millions of Americans. Current
projections suggest that by the end of 2012, around 8.1 million
homes, or one in nine residential borrowers will go through
foreclosure.\18\
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\18\ Credit Suisse Fixed Income Research, Foreclosure Update: Over
8 Million Foreclosures Expected (Dec. 4, 2008) (online at
www.chapa.org/pdf/Foreclosure UpdateCreditSuisse.pdf).
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Foreclosure has enormous deadweight costs. Lenders lose a
significant part of their loan. Foreclosed properties sell for
highly depressed prices and lenders incur significant direct
costs in the foreclosure process. One study estimates that
lenders incur nearly $60,000 of direct costs on average in the
foreclosure process.\19\
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\19\ Craig Focardi, Servicing Default Management: An Overview of
the Process and Underlying Technology (Nov. 15 2002) (TowerGroup
Research Note No. 033-13C) (stating that foreclosures cost on average
$58,759 and took 18 months to complete).
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For homeowners, foreclosure means the loss of their home
and possibly their home equity. It means having to find a new
place to live and moving, a move that can place extreme stress
on borrowers and their families.\20\ It often means losing
connections with their old neighborhood and community. It
usually means children being moved to a new school.
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\20\ See, e.g., Lorna Fox, Re-Possessing Home: A Re-analysis of
Gender, Homeownership and Debtor Default for Feminist Legal Theory,
William & Mary Journal of Women & Law, at 434 (2008); Eric S. Nguyen,
Parents in Financial Crisis: Fighting to Keep the Family Home, American
Bankruptcy Law Journal, at 229 (2008); Mindy Thompson Fullilove, Root
Shock, at 11-20 (2005); Margaret Jane Radin, Property and Personhood,
Stanford Law Review, at 958-59 (1982). But see Stephanie Stern,
Residential Protectionism and the Legal Mythology of Home, University
of Michigan Law Review (2009). See also Andrea Hopkins, Ohio Woman, 90,
Attempts Suicide After Foreclosure, Reuters (Oct. 3, 2008); Michael
Levenson, Facing Foreclosure, Taunton Woman Commits Suicide, Boston
Globe (July 23, 2008).
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B. SPILLOVER COSTS OF FORECLOSURES
Foreclosures also depress housing and commercial real
estate prices throughout neighborhoods, imposing serious costs
on third parties. When families have to relocate, community
ties are cut. Friendships, religious congregations, schooling,
childcare, medical care, transportation, and even employment
often depend on geography.\21\ A single foreclosure can depress
the eighty closest neighbors' property values by nearly
$5,000.\22\ When multiple foreclosures happen on a block or in
a neighborhood, the effect is exponential. The property value
declines caused by foreclosure hurt local businesses and erode
state and local government tax bases.\23\ Condominium and
homeowner associations likewise find their assessment base
reduced by foreclosures, leaving the remaining homeowners with
higher assessments.\24\
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\21\ See Phillip Lovell and Julia Isaacs, The Impact of the
Mortgage Crisis on Children, (May 2008) (online at www.firstfocus.net/
Download/HousingandChildrenFINAL.pdf) (estimating two million children
will be impacted by foreclosures, based on a projection of two and
quarter million foreclosures).
\22\ Dan Immergluck and Geoff Smith, The External Costs of
Foreclosure: The Impact of Single-Family Mortgage Foreclosures on
Property Values, Housing Policy Debate, at 58 (2006). Immergluck and
Smith found that in Chicago in the late 1990's, a single foreclosure
depressed neighboring properties' values between $159,000 and $371,000,
or between 0.9 percent and 1.136 percent of the property value of all
the houses within an eighth of a mile. For Chicago, which has a housing
density of 5,076 houses per square mile, or around 79 per square eighth
of a mile, this translates into a single foreclosure costing each of 79
neighbors between $2,012 and $4,696. City-Data.com, Chicago, IL
(Illinois) Houses and Residents (online at www.city-data.com/ housing/
houses-Chicago-Illinois.html) (accessed Mar. 3, 2009). See also Mark
Duda & William C. Apgar, Mortgage Foreclosures in Atlanta: Patterns and
Policy Issues, at ii (Dec. 15, 2005) (online at www.nw.org/network/
neighborworksProgs/foreclosuresolutionsOLD/documents/
foreclosure1205.pdf).
\23\ See, e.g., Laura Johnston, Vacant Properties Cost Cleveland
$35 Million, Study Says, Cleveland Plain Dealer (Feb. 19, 2008); Global
Insight, The Mortgage Crisis: Economic and Fiscal Implications for
Metro Areas: Report Prepared for The United States Conference of Mayors
and The Council for the New American City (2007) (online at www.vacant
properties.org/resources/documents/USCMmortgagereport.pdf) (estimating
a $6.6 billion decrease in aggregate tax revenue in ten states
especially impacted by the foreclosure crisis).
\24\ Christine Haughney, Collateral Foreclosure Damage for Condo
Owners, New York Times (May 15, 2008).
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The housing price declines caused by foreclosures can also
fuel more foreclosures, as homeowners who find themselves with
significant negative equity may choose to abandon their houses
and become renters. Numerous foreclosures flood the market with
excess inventory that depress other sale prices. Thus,
foreclosures can harm other mortgagees both by encouraging
additional foreclosures and by reducing home sale prices.
Foreclosed properties also impose significant direct costs
on local governments and foster crime.\25\ A single foreclosure
can cost a city over $34,000.\26\ Foreclosures also have a
racially disparate impact because African-Americans invest a
higher share of their wealth in their homes \27\ and are also
more likely than financially similar whites to have subprime
loans.\28\
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\25\ Dan Immergluck and Geoff Smith, The Impact of Single-Family
Mortgage Foreclosures on Neighborhood Crime, Housing Studies, at 851
(2006); William C. Apgar and Mark Duda, Collateral Damage: The
Municipal Impact of Today's Mortgage Foreclosure Boom, at 9 (May 11,
2005) (online at www.995hope.org/content/pdf/
Apgar_Duda_Study_Short_Version.pdf).
\26\ William C. Apgar et al., The Municipal Cost of Foreclosures: A
Chicago Case Study, at 2 (Feb. 27, 2005) (Homeownership Preservation
Foundation Housing Finance Policy Research Paper Number 2005-1) (online
at www.995hope.org/content/pdf/Apgar_ Duda_Study_Full_Version.pdf).
\27\ Melvin L. Oliver and Thomas M. Shapiro, Black Wealth, White
Wealth: A New Perspective on Racial Inequality, at 66 (2006) (showing
that housing equity accounted for 62.5 percent of all black assets in
1988 but only 43.3 percent of white assets, even though black
homeownership rates were 43 percent and white homeownership rates were
65 percent). See also Kai Wright, The Subprime Swindle, The Nation
(July 14, 2008); Brian K. Bucks et al., Recent Changes in U.S. Family
Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances,
Federal Reserve Bulletin, at A8, A12, A23 (2006) (noting that while
there was only a $35,000 difference in median home equity between
whites and nonwhites/Hispanics in 2004, there was a $115,900 difference
in median net worth and a $33,700 difference in median financial
assets, suggesting that for minority homeowners, wealth is
disproportionately invested in the home).
\28\ Bob Tedeschi, Subprime Loans' Wide Reach, New York Times (Aug.
3, 2008); Mary Kane, Race and the Housing Crisis, Washington
Independent (Jul 25, 2008).
---------------------------------------------------------------------------
Foreclosures also hurt capital markets. Investors in
mortgage-backed securities see their investment's market value
decline both because of direct losses from foreclosures of
mortgages collateralizing their investment and because of the
general decline in housing values, fueled, in part, by
foreclosures. To the extent that these investors are financial
institutions or their insurers, their foreclosures reduce the
value of their assets and, if they have large exposure to
mortgage-backed securities, may place their solvency at risk.
Thus, foreclosures also affect the investors in these financial
institutions. In short, foreclosure is an inefficient outcome
that is bad not only for lenders and borrowers, but for society
at large.
There are important moral questions about borrower and
lender responsibility in the foreclosure crisis, as discussed
in Section V, infra. While the Panel emphasizes the importance
of crafting foreclosure mitigation efforts to reach responsible
homeowners, the Panel also recognizes that the serious
spillover effects of foreclosures on third parties creates a
threat to communities and the economy that counsels for
targeted government action to protect innocent third parties
from the harmful effects of foreclosures.
II. INADEQUATE MORTGAGE MARKET DATA LIMITS SOUND POLICY DECISIONS
In every area of policy, Congress and the Administration
need quality information in order to make informed decisions.
This is as true for financial and housing markets as it is for
military intelligence. The first step for understanding the
foreclosure crisis and evaluating responses is to have an
accurate empirical picture of the mortgage market. For example,
how many loans are not performing, what loss mitigation efforts
have lenders undertaken, how many foreclosures have occurred,
how many are in the process of occurring, and how many more are
likely to occur? How many of these foreclosures are
preventable, meaning that another loss mitigation option would
result in a smaller loss to the lender? What is driving
mortgage loan defaults? Are there any salient characteristics
of the loans that are defaulting and for which successful
modifications are not feasible? What relationship does
foreclosure have to loan type, to loan-to-value ratios, to
geographic factors, and to borrower characteristics? And
crucially, what obstacles stand in the way of loss mitigation
efforts? These are some of the questions for which the
Congressional Oversight Panel believes the Congress and the
Administration need to know the answers in order to make
informed policy decisions.
Unfortunately, this essential information is lacking. The
failure of federal banking and housing regulatory agencies to
gather and analyze quality market intelligence is striking. The
United States is now two years into a foreclosure crisis that
has brought economic collapse, and federal banking and housing
regulators still know surprisingly little about the number of
foreclosures, what is driving the foreclosures, and the
efficacy of mitigation efforts.
A. THE PANEL'S FORECLOSURE MITIGATION SURVEY
In an attempt to provide Congress and the public with a
more detailed and comprehensive picture of foreclosure
mitigation efforts, the Congressional Oversight Panel
requested, pursuant to its power under section 125(e)(3) of the
EESA that federal banking and housing regulatory agencies
provide it with a variety of information about foreclosures and
loss mitigation efforts from their regulated institutions. The
request was sent to the Departments of Treasury and Housing and
Urban Development (HUD), to the Office of the Comptroller of
the Currency (OCC), the Office of Thrift Supervision (OTS), the
National Credit Union Administration (NCUA), the Federal
Reserve Board, Federal Deposit Insurance Corporation (FDIC),
and the Federal Housing Finance Agency (FHFA). A copy of the
Panel's foreclosure data survey is included as an Appendix.
The results of the survey were distressing. The overall
state of federal banking and housing regulatory agency
empirical knowledge about the mortgage market and the
foreclosure crisis is inadequate. Most agencies have little in
the way of original data, and those that do have conducted
little analysis. Some agencies had no data or knowledge. Most
of those with some knowledge rely on a pair of commercial data
sources that have well-known drawbacks, lack full market
coverage, and are based on voluntary industry reporting, rather
than tailored to regulatory interests.
B. INADEQUATE DATA SOURCES ON LOAN PERFORMANCE AND LOSS MITIGATION
There are four major private sources that track mortgage
delinquencies, foreclosures, and loss mitigation efforts, but
their coverage is either limited or of questionable
reliability. Two private subscription sources, First American
LoanPerformance and McDash, feature loan-level data and are
considered to be reliable sources with sufficiently detailed
data for meaningful analysis about factors driving mortgage
defaults, but these sources have limited market coverage.
LoanPerformance collects loan performance data, including
foreclosures, from the trustees of securitized private label
pools. LoanPerformance supposedly covers over 80 percent of the
subprime market, but has more limited coverage of prime
loans.\29\ McDash collects data from mortgage servicers for
both securitized and portfolio loans and is supposed to cover
between 40-50 percent of the subprime market,\30\ and a similar
range of the prime market.\31\
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\29\ See Vanessa G. Perry, The Dearth and Life of Subprime Mortgage
Data: An Overview of Data Sources for Market Modeling (Jan. 8, 2008)
(online at www.hoyt.org/subprime/vperry.pdf).
\30\ Id.
\31\ Lei Ding et al., Risky Borrowers or Risky Mortgages:
Disaggregating Effects Using Propensity Score Models (Dec. 2008)
(online at www.ccc.unc.edu/documents/RiskyMortg_ Final_Dec11.pdf).
---------------------------------------------------------------------------
In addition to these sources, there is the Mortgage Bankers
Association's quarterly National Delinquency Survey, which is
data that is estimated to cover 80-85 percent of the
market.\32\ The MBA's NDS tracks defaults and foreclosures, but
does not have the granularity to support meaningful analysis
about factors fueling defaults and it does not contain any data
on loss mitigation efforts. Additionally, RealtyTrac publishes
a monthly U.S. Foreclosure Market Report, which tracks
foreclosures, not delinquencies or loss mitigation efforts.
RealtyTrac's report is based on court filings and does not
include information about the specific characteristics of
loans. Moreover, RealtyTrac's methodology overstates the number
of unique properties in foreclosure because it measures
foreclosure filings, and there can be multiple filings for an
individual property. Moreover, many foreclosures that are
initiated result in cure and reinstatement, a workout, a short
sale, or a deed in lieu. RealtyTrac also tracks completed
foreclosure sales, although it does not publish these numbers,
but these are a more reliable indicator of foreclosure
activity, albeit with a significant delay.
---------------------------------------------------------------------------
\32\ The MBA survey is a voluntary survey of over 120 mortgage
lenders, including mortgage banks, commercial banks, thrifts,
subservicers and life insurance companies. See Mortgage Bankers
Association, Learn More About MBA's National Delinquency Survey (online
at www.mortgagebankers.org/files/Research/NDSFactSheet.pdf) (accessed
Mar. 1, 2009).
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Several government agencies track mortgage delinquencies,
foreclosures, and loss mitigation efforts, but only for limited
segments of the market. No federal agency tracks foreclosures
for the entire market.\33\ Several federal agencies subscribe
to the McDash and LoanPerformance databases. Additionally, in
the Treasury Department, the Office of Comptroller of the
Currency and the Office of Thrift Supervision have recently
begun using an expanded version of the McDash data service to
jointly track foreclosures in the servicing portfolios of
fourteen national banks and federal thrifts, which combine for
around 60 percent of the total mortgage servicing market. OCC
and OTS have begun to publish a quarterly Mortgage Metrics
Report, detailing some of its analysis of foreclosure
mitigation efforts. The Mortgage Metrics Report, however, is
still a work in progress. Its first two editions lacked data
about many crucial issues. OCC and OTS have announced that the
March and June editions will include expanded data and
analysis, which the Panel applauds. But the Panel notes that
this expansion in data collection has come about only following
the Panel's request for information in the form of the COP
Mortgage Data Survey. While the Panel is pleased to see the
expanded data collection, the data collection efforts that are
beginning today are ones that should have been implemented by
the agencies months, if not years ago.
---------------------------------------------------------------------------
\33\ Some state agencies attempt to track foreclosure data, but the
process is complicated because foreclosure procedures vary by state,
foreclosures often take place outside of the court system, records are
often maintained on a county level and are not aggregated to produce
state-wide data, and some record-keeping is not automated.
---------------------------------------------------------------------------
Beyond the OCC and OTS, FHFA tracks certain aspects of
Fannie Mae and Freddie Mac's modification efforts, although not
in much detail. In any case, the FHFA could at best oversee
only part of the market, but its jurisdiction does not extend
to loans in the private-label securitization market or
financial institutions' portfolio loans. The Federal Reserve
Board appears to rely solely on analysis of third-party data
sources. FHA and VA track some elements of the performance of
FHA/VA insured loans, but that is only around 10 percent of the
market. FDIC has been monitoring the portfolio of the failed
IndyMac Federal Savings Bank, and has performed much more
detailed analysis than any of the other financial regulators,
but the FDIC is only monitoring the servicing portfolio of a
single institution. Additionally, a working group of states'
attorneys general and the Conference of State Bank Supervisors
has been tracking foreclosures in the servicing portfolios of
thirteen primarily subprime servicers, which make up about 57
percent of the subprime market.\34\ Unfortunately, the state
attorneys general working group's efforts to reach out to the
OCC and OTS to coordinate data collection efforts were rebuffed
due to jurisdictional rivalries.\35\
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\34\ State Foreclosure Prevention Working Group, Analysis of
Subprime Mortgage Servicing Performance (Sept. 2008) (Data Report No.
3) (online at www.csbs.org/Content/NavigationMenu/Home/
SFPWGReport3.pdf). Maryland has made special efforts to track
foreclosures. The Panel also recognizes the concerted efforts of
several other states to deal with the foreclosure crisis, including
California, Illinois, Iowa, Maryland, Massachusetts, New Jersey, New
York, North Carolina, and Ohio.
\35\ Letter from State Foreclosure Prevention Working Group to John
C. Dugan, Comptroller of the Currency, and John M. Reich, Director,
Office of Thrift Supervision (Feb. 2, 2009) (online at
www.banking.state.ny.us/pr090202a.pdf); State Foreclosure Prevention
Working Group, States Urge OCC and OTS to Push for Affordable Mortgage
Modifications (Feb. 2, 2009) (online at www.csbs.org/AM/
Template.cfm?Section=Press_Releases&CONTENTID= 20998&TEMPLATE=/CM/
ContentDisplay.cfm); State Foreclosure Prevention Working Group,
Analysis of Subprime Mortgage Servicing Performance, at 2, 7, 20 (Feb.
2008) (Data Report No. 1) (online at www.csbs.org/Content/
NavigationMenu/Home/StateForeclosurePreventionWork
GroupDataReport.pdf).
---------------------------------------------------------------------------
The result is that no comprehensive private or government
source exists for accurately tracking loan delinquencies and
loss mitigation efforts, including foreclosures and
modifications, on a complete, national scale. No federal agency
has the ability to track delinquencies accurately and loss
mitigation efforts for anything more than 60 percent of the
market. The existing data are plagued by inconsistencies in
data collection methodologies and reporting, and are often
simply unverifiable. Worse still, the data being collected are
often not what is needed for answering key questions, namely
what are causing mortgage defaults and why loan modifications
have not been working.\36\
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\36\ For example, the Office of Comptroller of the Currency (OCC)
and the Office of Thrift Supervision (OTS) have been jointly gathering
data on redefault rates on modified loans in the servicing portfolios
of fourteen national banks and federal thrifts. This data shows a high
rate of redefaults on modified loans. From this the Director of OTS
concluded that modification efforts cannot work. The Comptroller,
however, noted that the data shows nothing more than the fact that
modifications have not worked; without knowing more about the
modifications themselves, we cannot conclude that modifications cannot
work. Cheyenne Hopkins, When Mods Fail, What Next?: Regulators Split on
Implications of Redefaults, American Banker, at 1 (Dec. 9, 2008).
---------------------------------------------------------------------------
C. EXPLAINING THE REGULATORY INTELLIGENCE FAILURE
There appear to be several reasons for the failure of
regulatory intelligence gathering and analysis. First, in the
past, foreclosures have been largely a matter for state courts
and for the county clerks who record transfers of real
property. Many states and counties have not invested in the
infrastructure needed to compile this information because the
level of foreclosures has not reached crisis proportions since
the Great Depression. Bank regulators are further hampered in
their independent data collection efforts by the lack of a
nationwide mortgage loan performance reporting requirement.
Without a similar requirement for performance data in a
standard, electronic format, regulators are limited to
information obtained voluntarily from the industry or from
reviews of individual bank records. Indeed, many states do not
regulate either investors in whole loans or securitized
mortgages or the servicers who service those mortgages.
Similarly, foreclosures and loan modifications have not been a
traditional subject of federal regulatory focus. Yet, absent
adequate information on foreclosures and mitigation efforts, it
is difficult to craft effective responses to the crisis, and
the federal banking and housing regulators have never requested
authority to collect more information.
Second, divided regulatory bailiwicks, an issue that the
Panel has previously drawn attention to in its regulatory
reform report, have contributed to the failure to gather market
intelligence. No agency appears to have identified mortgage
market intelligence gathering and analysis as its
responsibility. Mere jurisdictional divisions, however, are
insufficient to explain or excuse this failure, as federal
banking and housing regulators have coordinated successfully on
other issues before. Nor do divided regulatory bailiwicks
explain why so many agencies lack knowledge of what is
happening within their regulatory sphere. For example, FHFA,
which supervises Fannie Mae, Freddie Mac, and the Federal Home
Loan Banks, did not have any data on hand about such basic
elements as loss severities in foreclosure in the GSEs'
portfolios or about the efficacy of GSE foreclosure mitigation
efforts. The Panel is puzzled how FHFA can be performing its
mission of overseeing the safety and soundness of the GSEs when
it lacks basic knowledge of GSE losses.
Given the state of agency knowledge about the mortgage
market, the Panel must content itself, for this report, with
reporting some of the salient statistics from the existing
publicly-available metrics. These statistics paint a grim
picture of mounting foreclosures, failed private and public
mitigation efforts, and many likely future defaults and
foreclosures. Mortgage default rates and foreclosures are at
historically unprecedented levels, not just for subprime loans,
but for prime loans as well.\37\ And private and government
foreclosure mitigation attempts have failed to make much
headway in either preventing foreclosures or restructuring
loans.
---------------------------------------------------------------------------
\37\ Mortgage Bankers Association, Delinquencies Increase,
Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec.
5, 2008) (online atwww.mbaa.org/NewsandMedia/Press Center/66626.htm).
---------------------------------------------------------------------------
D. THE NEED FOR FEDERAL DATA COLLECTION GOING FORWARD
While there is a clear picture of rising foreclosures and
loss mitigation efforts that fail to keep pace, they do not
provide sufficient information to determine why so many loans
are defaulting and why foreclosure, rather than workouts, have
been the dominant response and why modifications have often
been unsuccessful. These sources often conflict and none has
complete market coverage. In order for Congress and various
regulators to respond properly and promptly to issues in the
residential housing market, better information is needed.
Absent more complete and accurate information, legislators,
regulators, and market participants are flying blind.
The housing market has traditionally been treated as a
state law issue. While states have an important role to play,
housing finance is a national market, closely linked with
capital markets and the financial system. Going forward,
Congress and the regulators need to have much better data
available so they can ensure the smooth and efficient
functioning of the national housing finance market and prevent
future crises. Thus, the Panel believes that Congress should
create a national mortgage loan performance reporting
requirement applicable to banking institutions and others who
service mortgage loans, to provide a source of comprehensive
intelligence about loan performance, loss mitigation efforts
and foreclosure, that federal banking or housing regulators
would be mandated to analyze and share with the public. Such a
reporting requirement exists for new mortgage loan originations
under the Home Mortgage Disclosure Act. Because lenders already
report delinquency and foreclosure data to credit reporting
bureaus, the additional cost of federal reporting should be
small.
III. OBSTACLES TO LOAN SUCCESS AND FORECLOSURE MITIGATION: PAST
PROGRAMS
A. OBSTACLES TO LOAN SUCCESS
Despite gross inadequacies in the existing data on
foreclosures and mitigation attempts, it is nonetheless
possible to discern the basic obstacles to loan performance and
to successful foreclosure mitigation.
1. Affordability
The underlying problem in the foreclosure crisis is that
many Americans have unaffordable mortgages. There are five
major factors behind the affordability problem. First, many
mortgages were designed and underwritten to be refinanced, not
to be paid off according to their terms. Second, lenders
extended mortgage credit to less creditworthy borrowers for
whom homeownership was a financial stretch. Third, fraud, by
brokers, lenders and borrowers produced mortgages that
borrowers cannot afford to pay. Fourth, borrowers who qualified
for lower cost mortgages were steered into higher priced
subprime mortgage products. And fifth, a deteriorating economy
has made it more difficult for many Americans to afford to pay
their mortgage.
a. Affordability problems
i. Changes in mortgage product type
Most mortgages are of relatively recent vintage; the
majority of mortgages are less than seven years old.\38\ In the
last seven years, the mortgage market saw a major shift in
product type to products that had much greater risk of becoming
unaffordable than conventional prime mortgage that historically
dominated the market.
---------------------------------------------------------------------------
\38\ Approximately 76 percent of outstanding mortgages originated
after 2000, with the median year of origination being 2003. U.S. Census
Bureau, American Housing Survey for the United States: 2007, at 164
(2008) (online at www.census.gov/prod/2008pubs/h150-07.pdf) (providing
the data used for the calculations).
---------------------------------------------------------------------------
Starting in 2004, there was a significant growth in
subprime, alt-A, and home equity loans (HEL) markets for new
originations. (See Chart 2.)
Chart 2. Market Share by Product Type \39\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\39\ Inside Mortgage Finance, Mortgage Market Statistical Annual,
at 4 (2008) (Vol. 1).
Each of these products increased the risk that mortgages
would become less affordable. Subprime loans are, by
definition, higher-priced loans. They have been made to both
less creditworthy borrowers and to those with good credit but
who were steered into these loans. Because they are higher
priced and often have sharply escalating payments, subprime
loans have historically had much higher default rates than
prime loans. (See Chart 3.)
Chart 3. Percentage of 1-4 Family Mortgages Seriously Delinquent by
Type \40\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\40\ Mortgage Bankers Association, supra note 17.
Alt-A loans typically required less documentation of the
borrower's ability to repay. Because they are not underwritten
with the certainty of a traditional conforming prime loan, they
are riskier products. Home equity lines of credit (HELs) also
create affordability risk because they add a second mortgage
payment obligation, increasing the risk that a family cannot
maintain payments on either mortgage. In addition, because HELs
are junior mortgages, they are protected by a smaller equity
cushion than a typical first mortgage.
As the type of risky products proliferated, the share of
adjustable rate mortgages among new originations also grew
sharply. (See Chart 4.) Adjustable rate mortgages create an
affordability risk because the interest rate and thus the
monthly payment can reset to a higher (and potentially
unaffordable) amount, creating ``payment reset shock'' for the
borrower.
Many of the adjustable rate mortgages originated in recent
years were so-called hybrid ARMs, such as the 2/28 and 3/27,
which had an initial fixed teaser rate period for two or three
years, after which the monthly payment reset according to an
adjustable rate index for the remaining 28 or 27 years of the
loan. Many hybrid ARMs were underwritten based on the
borrower's ability to make the monthly payments for the initial
fixed-rate teaser period, not after the loan went into the
adjustable rate period. The affordability of the adjustable
rate period was ignored because the products were sold with the
representation that the borrower could simply refinance the
mortgage at the end of the teaser period--with the lender
collecting another round of fees for the refinancing.
Chart 4. Market Share of Adjustable Rate Mortgages \41\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\41\ Inside Mortgage Finance, Mortgage Market Statistical Annual,
at 4 (2008) (Vol. 1).
At the same time that risky products and variable rate
mortgages were expanding, the market share of so-called
``exotic'' mortgage products, such as interest-only, pay
option-ARMs, 20/20s, and 40-year balloons grew dramatically
among new originations. (See Chart 5.) Many of these were
special niche market products designed for sophisticated
consumers with irregular monthly incomes, but they began to be
marketed to the general population.\42\ As with the hybrid
ARMs, these products all have built-in monthly payment amount
resets that can lead to payment reset shock. Like many variable
rate mortgages, these products were sold on the representation
that the loans would be refinanced before the payment reset
shock.
---------------------------------------------------------------------------
\42\ Interest-only mortgages are non-amortizing loans on which the
borrower makes payments of interest only for a fixed period, generally
five to seven years. At the end of the period, the principal would
begin to amortize, with monthly payments becoming much higher. Pay
option-ARMs permit the borrower to choose a monthly payment amount. The
borrower can choose a payment that would lead to a 30-year
amortization, a 15-year amortization, interest only (no amortization),
or negative amortization. If there is too much negative amortization,
the pay-option goes away and the loan resets to a fully amortizing loan
(with higher monthly payments). Like 2/28s and 3/27s, the expectation
was that interest-only mortgages would be refinanced before they began
to amortize. The 40-year balloons are a variation on the 2/28 or 3/27.
These are 30-year loans with a 40-year amortization and a balloon
payment due at the end of the 30th year. The 40-year amortization was
designed to make the monthly payments during the teaser rate periods on
these loans even more affordable to more borrowers (who would be less
likely, therefore, to be able to afford the payments after the teaser
period). The 20/20 is a variation of the 40-year balloon, with a fixed-
rate for 20 years and then an interest rate reset in the 21st year.
---------------------------------------------------------------------------
Chart 5. Market Share of Exotic Mortgage Products \43\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\43\ Inside Mortgage Finance, Mortgage Market Statistical Annual,
at 6 (2008) (Vol. 1).
Finally, the rise of so-called ``no-doc'' and ``low-doc''
loans meant that in many cases underwriting was not based on
actual income and affordability, but rather on an inflated
income that misstated affordability. (See Chart 6.)
Chart 6. Percentage of Full Documentation Loans \44\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\44\ Jesse M. Abraham et al., Explaining the United States'
Uniquely Bad Housing Market, at 11-12 (Sept. 2008) (University of
Pennsylvania Law School Institute for Law and Economics Research Paper
No. 08-34) (online at papers.ssrn.com/sol3/
papers.cfm?abstract_id=1320197).
In the past few years, the mortgage market shifted
dramatically from mortgages issued under conditions that
assured a high likelihood of affordability to a much greater
proportion of mortgages that were higher risk instruments that
either were, or were likely to become, unaffordable.
ii. Fraud
In other cases, poor underwriting, either by brokers or
lenders eager to originate more and larger mortgages or by the
homeowner, created the lack of affordability. Both law
enforcement and industry groups have reported dramatic
increases in the incidence of mortgage fraud over the last
decade.\45\ There is considerable anecdotal evidence of
homeowners overstating incomes, appraisers offering inflated
appraisals, and purchasers of investor properties fraudulently
representing that the properties would be owner-occupied.\46\
There is also a sizeable body of anecdotal evidence of fraud
being committed by intermediaries between borrowers and
lenders, such as mortgage brokers, who inflated information on
borrowers' capacity to pay in order to close deals on more and
larger loans.\47\ And finally, there is also significant
anecdotal evidence of lenders that were happy to look the other
way and forgo rigorous underwriting diligence because they
could quickly sell the loans they made and pass along the
credit risk on those loans to distant investors through
securitization.\48\ The increase in low-doc and no-doc loans,
for example, facilitated fraud, as borrowers had to provide
little information to lenders and lenders made little effort to
verify the information.\49\
---------------------------------------------------------------------------
\45\ See, e.g., Financial Crimes Enforcement Network, Filing Trends
in Mortgage Loan Fraud: A Review of Suspicious Activity Reports Filed
July 1, 2007 through June 30, 2008, at 10 (Feb. 2009) (reporting a
tenfold increase in suspicious activity reports relating to mortgage
fraud between 2002-2003 and 2007-2008); Mortgage Asset Research
Institute, Eighth Periodic Mortgage Fraud Case Report to Mortgage
Bankers' Association, at 2 (Apr. 2006).
\46\ Mortgage Asset Research Institute, Quarterly Fraud Report, at
3 (Dec. 2, 2008).
\47\ Id.
\48\ Federal Bureau of Investigation, 2006 Mortgage Fraud Report
(May 2007) (online at www.fbi.gov/publications/fraud/
mortgage_fraud06.htm); Gretchen Morgenson, Was There a Loan It Didn't
Like?, New York Times (Nov. 2, 2008); David Stout and Eric Lichtblau,
Pardon Lasts One Day for Man in Fraud Case, New York Times (Dec. 24,
2008); Gregg Farrel, Las Vegas Called Ground Zero for Mortgage Fraud,
USA Today (June 3, 2008).
\49\ Mortgage Asset Research Institute, Tenth Periodic Mortgage
Fraud Case Report to Mortgage Bankers Association, at 2, 10 (Mar.
2008).
---------------------------------------------------------------------------
Measuring the role of fraud and speculation in the mortgage
crisis is difficult, but fraud by borrowers, lenders, and
intermediaries undoubtedly played a role in placing many
homeowners in mortgages that they could not ultimately afford.
iii. Steering
Subprime and exotic mortgage products were also frequently
targeted at prime borrowers, as well. Many borrowers with
excellent credit histories, especially minority borrowers with
good credit, were steered to higher-rate loans than those for
which they qualified.\50\ The Wall Street Journal reported that
61 percent 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.'' The
impact on minorities is also stark. A study by the Center for
Responsible Lending found that Latino borrowers purchasing
homes were as much as ``142 percent more likely to receive a
higher-rate loan than if they had been non-Latino and white,''
and that ``African-American borrowers were as much as 34
percent more likely to receive certain types of higher-rate
loans than if they had been white borrowers with similar
qualifications.'' \51\ The growth of subprime and exotic loan
markets cannot be cast solely as a result of a democratization
of credit.
---------------------------------------------------------------------------
\50\ See, e.g., Kenneth R. Harney, Study Finds Bias In Mortgage
Process, Washington Post (June 17, 2006).
\51\ Center for Responsible Lending, Unfair Lending: The Effect of
Race and Ethnicity on the Price of Subprime Mortgages (May, 2006)
(online at www.responsiblelending.org/pdfs/rr011-Unfair_Lending-
0506.pdf). See also Christopher Mayer and Karen Pence, Subprime
Mortgages: What, Where, and to Whom? (June 2008) (National Bureau of
Economic Research Working Paper No. W14083); Consumer Federation of
America, Subprime Locations: Patterns of Geographic Disparity in
Subprime Lending (Sept. 2006); Robert Avery et al., New Information
Reported Under HMDA and Its Application in Fair Lending Enforcement,
Federal Reserve Bulletin, at 344-94 (2005); Paul K. Calem et al., The
Neighborhood Distribution of Subprime Mortgage Lending, Journal of Real
Estate Finance and Economics, at 393-410 (2004).
---------------------------------------------------------------------------
An important driver of the steering of prime borrowers to
higher-rate loans were yield-spread premiums (YSPs), a bonus
which lenders pay independent brokers if they place the
customer into a higher cost loan than the loan for which the
customer qualifies.\52\ Even higher bonuses were awarded for
brokers who could sell a mortgage with a prepayment penalty
that would lock in the higher rate. For example, at Countrywide
Financial, broker commissions were up to 1.48 percent for
standard fixed rate mortgages, but they rose to 1.88 percent
for subprime loans, and jumped to 2.5 percent for pay-option
ARMs.\53\ Similar incentive structures existed for lender sales
representatives making non-brokered loans.\54\ The difference
could mean thousands of dollars more for the broker for each
placement of a non-standard mortgage. This created a strong
incentive for brokers and lenders to steer creditworthy
consumers into high-cost, loans with risky features. The result
is that more homeowners are now in unaffordable and
unsustainable loans.
---------------------------------------------------------------------------
\52\ Howell E. Jackson and Laurie Burlingame, Kickbacks or
Compensation: The Case of Yield Spread Premiums, Stanford Journal of
Law, Business, and Finance (2007).
\53\ Ruth Simon and James R. Hagerty, Countrywide's New Scare--
Option ARM Delinquencies Bleed Into Profitable Prime Mortgages, Wall
Street Journal (Oct. 24, 2007).
\54\ See Gretchen Morgenson and Geraldine Fabrikant, Countrywide's
Chief Salesman and Defender, New York Times (Nov. 11, 2007) (noting
former employee who said commission structure rewarded sales
representatives for making risky, high-cost loans, including, for
example, a commission increase of 1 percent of loan value for attaching
a three-year prepayment penalty; noting that the higher the interest at
reset, the higher the broker's commission).
---------------------------------------------------------------------------
On February 27, 2009, in Prince George's County, Maryland,
the Panel held a field hearing and heard testimony regarding
the disproportionate impact of subprime lending on minority
communities. According to Maryland Secretary of Labor,
Licensing, and Regulation Thomas E. Perez, ``We know that
Maryland homeowners were disproportionately impacted by the
subprime lending spree that led to this crisis. While 18
percent of white homeowners were given subprime loans, 54
percent of African American homeowners and 47 percent of
Hispanic homeowners received subprime loans.'' He went on to
note, ``We had problems of discrimination at the origination
end. It is not a stretch to suggest that there are going to be
potential fair housing issues at the modification level.''
iv. General economic conditions
The result of these trends in the mortgage origination
market over the past few years is that millions of Americans
now find themselves faced with mortgage payments they cannot
afford. The problem has been further exacerbated by the
economic recession. It is important to recall that the
foreclosure crisis began before the general problems of the
economy. Even in normal times, some mortgages, no matter how
well underwritten originally, become unaffordable when the
borrowers are struck by unemployment, illness, divorce, or
death in the family. As the economy worsens and layoffs
increase, traditional factors contributing to mortgage defaults
compound the affordability problems caused by reckless
underwriting.
b. Negative equity and the inability to refinance
Lack of affordability is a serious and complex problem.
However, it would be much easier to resolve if the broad, steep
decline in housing prices had not left so many homeowners with
negative equity. Creditworthy borrowers with equity in their
homes would refinance into more affordable long-term fixed-rate
mortgages, and homeowners who could not qualify for an
affordable mortgage would sell their properties and either
purchase more affordable homes or become renters.
The affordability problem today, however, is compounded by
a negative equity problem. Homeowners with negative equity are
usually unable to refinance because lenders will not lend more
than the value of their home, especially if a market is
declining or projected to experience only slight appreciation
in the near term. Modification of their existing loans may be
the more appropriate option for the many homeowners with
negative equity.
Today, perhaps a fifth of American homeowners owe more in
mortgage debt than their home is worth.\55\ Negative equity is
a function of loans that were initially issued at ever higher
cumulative loan to value (CLTV) ratios and compounded by
declining housing prices. (See Charts 7, 8, and 9.)
---------------------------------------------------------------------------
\55\ First American CoreLogic, Negative Equity Data Report (Sept.
30, 2008) (online at www.facorelogic.com/newsroom/marketstudies/
negative-equity-report.jsp) (stating that over 7.5 million mortgages,
or 18 percent, were in a negative equity position as of Sept. 30,
2008).
---------------------------------------------------------------------------
Chart 7. Average Combined Loan to Value (CLTV) Ratio by Loan Type \56\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\56\ Abraham et al., supra note 44, at 11-12.
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Chart 8. Percentage of Loans with CLTV>80 Percent by Loan Type \57\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\57\ Abraham et al., supra note 44, at 11-12.
---------------------------------------------------------------------------
Chart 9. S&P/Case-Shiller Composite 10 Home Price Index (Year 2000=100)
\58\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\58\ Standard & Poor's, S&P/Case-Shiller Home Price Indices (online
at www2.standardand poors.com/spf/pdf/index/CS
HomePrice_History_022445.xls) (accessed Mar. 4, 2009).
Traditionally, negative equity alone does not usually lead
to foreclosures. In past regional housing busts, as long as the
mortgage payments remained affordable, homeowners with negative
equity typically remained in their homes.\59\ This is not
surprising, because although American families are increasingly
mobile,\60\ many still have strong emotional ties to their
homes \61\ and the costs of relocation are significant.
---------------------------------------------------------------------------
\59\ Christopher L. Foote et al., Negative Equity and Foreclosure:
Theory and Evidence (June 5, 2008) (Federal Reserve Bank of Boston,
Public Policy Discussion Papers Paper No. 08-3) (online at
www.bos.frb.org/economic/ppdp/2008/ppdp0803.pdf).
\60\ U.S. Census Bureau, Geographical Mobility: 2002 to 2003, at 2
(Mar. 2004) (online at www.census.gov/prod/2004pubs/p20-549.pdf)
(noting increasing occurrence of long-distance moves).
\61\ Radin, supra note 20; Stern, supra note 20.
---------------------------------------------------------------------------
On the other hand, past regional housing busts may not
provide good guides to homeowner behavior in the current
crisis. In some parts of the country, negative equity is far
deeper than it has ever been in past regional housing busts,
and the overall condition of the economy is worse.
Data from the Panel's survey of federal banking and housing
regulators indicates that negative equity is a central problem
in the current housing crisis. However, this result is based on
multiple data sets that have significant limitations. It is
likely that income data in these sets does not reflect current
income at the time of default and, furthermore, because of the
high proportion of Alt-A and subprime loans in the sample,
income at origination may not have been verified and may have
been overstated. Data submissions also were incomplete with
respect to a number of fields. For all these reasons, the
results may--or may not--under-estimate the importance of
affordability, negative equity, or other factors in predicting
default.\62\ Nevertheless, this data set represents the most
complete information available and the Panel therefore used it
in the following analyses. The limitations the Panel observed
in the survey data supports the Panel's recommendation for a
national mortgage loan performance reporting requirement.
---------------------------------------------------------------------------
\62\ See Merrill Lynch, Loan Modifications: What Investors Need to
Know, MBS/ABS Special Report, Nov. 21, 2008, at 7-8 (finding that
``Clearly both DTI and current LTV influence [defaults]. However, DTI
seems less important than LTV,'' and cautioning about problems with DTI
data).
---------------------------------------------------------------------------
Chart 10 displays data from the response from the Office of
Comptroller of the Currency and Office of Thrift Supervision to
the Panel's foreclosure mitigation survey. The data relate to
fourteen major financial institutions that cover approximately
60 percent of the mortgage servicing market shown. Chart 10
displays the percentage of loans with particular
characteristics that are 60-89 days delinquent.
As Chart 10 shows, negative equity is the single best
indicator that a property is likely to enter foreclosure for
this data set. Over 20 percent of loans with negative equity
are 60-89 days delinquent, a far higher percentage than for any
of the other characteristics about which the Panel inquired.
Notably, back-end DTI, an affordability measure, does not have
a clear correlation with default, although this may be a
function of data inadequacies. A similar picture emerges in
Chart 11, which shows the percentage of loans with particular
characteristics that are 60-89 days delinquent in the IndyMac
Federal Bank portfolio serviced by the FDIC. The IndyMac
portfolio is mainly low-doc or no-doc Alt-A loans, so robust
DTI information is not available. Again, though, negative
equity is among the leading factors, surpassed only by negative
amortization loans, many of which are likely negative equity.
Chart 10. Percentage of Loans 60-89 Days Delinquent, OCC-OTS Data \63\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\63\ Congressional Oversight Panel, Mortgage Survey Data from the
Offfice of the Comptroller of the Currency and the Office of Thrift
Supervision, Appendix VI, infra.
---------------------------------------------------------------------------
Chart 11. Percentage of Loans 60-89 Days Delinquent, IndyMac Portfolio
\64\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\64\ Congressional Oversight Panel, Mortgage Survey Data from the
Federal Deposit Insurance Corporation, Appendix VII, infra.
The strong correlation between negative equity and default
is also borne out in analysis of private loan performance data
sources. Based on the performance between November 2008 and
January 2009 for all deals issued in 2006 that are covered in
the Loan Performance data set--excluding those that have
already been modified--Chart 12 shows the likelihood that a
loan will become 60+ days delinquent in the next year given its
combined current loan to value (CCLTV) ratios. Thus, at 125
percent CCLTV there is a 7.5 percent chance that a prime fixed-
rate loan will become 60+ days delinquent in the next year,
compared with an 11.7 percent chance for a prime ARM, 23
percent for Alt-A fixed-rate loan, 29.2 percent for Alt-A ARM,
34.1 percent for a pay-option ARM, 32.3 percent for a subprime
fixed-rate loan, and 54.8 percent for a subprime adjustable
rate mortgage. As Chart 11 shows, there is a very strong linear
correlation between delinquency rates and CCLTV. Negative
equity provides the best single indicator of likely default in
this data set.
Chart 12. Annualized Net Flow (Excluding Modifications) from <60 to >60
Days Delinquent by Combined Current Loan to Value Ratios \65\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Given the depth of negative equity and the strained state
of many consumers' finances generally, it is not surprising
that negative equity is a leading indicator of the likelihood
of default. When there is only a small level of negative equity
and prospects for a recovery of the housing market in the
short-term, a homeowner might reasonably be willing to continue
to pay through the negative equity period. Given the slim
prospects of the housing market recovering to 2005-2007 price
levels in the near future, some homeowners might begin to
question whether they will ever have positive equity in their
homes.
---------------------------------------------------------------------------
\65\ Ellington Management Group, LLC. Bold circles indicate median
CCLTV by product.
---------------------------------------------------------------------------
For these homeowners, depending on other factors including
household income in relation to debts, there may be a point at
which they begin to consider abandoning the house and finding
an equivalent (but cheaper) rental property, resulting in a
foreclosure on the house.\66\ A borrower who is further
underwater may be more willing to absorb the impact of a credit
default, which will be carried on a credit report for seven
years, depending on how long it could take her to see positive
equity on the home. If even a small percentage of those with
negative equity but generally affordable mortgages abandon
their homes, foreclosure rates will remain greatly
elevated.\67\ Incentives may be needed to encourage borrowers
with negative equity to adopt a long-term view and to remain in
their homes whenever possible.
---------------------------------------------------------------------------
\66\ Foote et al., supra note 59, at 2.
\67\ David Leonhardt, A Bailout Aimed at the Most Affllicted
Owners, New York Times (Feb. 18, 2009) (citing former Federal Reserve
Governor Frederic Mishkin).
---------------------------------------------------------------------------
When exigent circumstances exist, however, and the borrower
must immediately sell the home, serious negative equity poses
greater challenges. Widespread negative equity can create
disruptions in labor markets, in elderly care, and in the
private home sale market. A homeowner with negative equity
often cannot move to take a new job. In order to move, the
homeowner must sell his house. The house will not sell for the
amount of the loan, only for its fair market value. In order to
discharge the mortgage, the homeowner must make up the
difference, and if the homeowner lacks sufficient cash to do
so, the sale cannot be completed. As a result, homeowners may
be stuck in their homes. This hurts employers' ability to get
the best employees and workers' ability to get the best jobs.
Similarly, negative equity creates problems for elderly
care. Elderly Americans with negative equity in their homes
often cannot relocate to an assisted living facility because
they cannot sell their homes except by paying the difference
between the mortgage amount and the home value itself, and many
elderly Americans lack the ability to do so.
Negative equity also affects the private home sale market.
Homeowners move for numerous other reasons, such as families
outgrowing their homes or empty-nesters wishing to move to
smaller houses. To the extent that negative equity traps
homeowners in their home by requiring an unaffordable balloon
payment upon sale, it decreases the number of private home
sales. The current downward spiral of declining housing prices
creates more negative equity, which leads to more foreclosures,
which increases housing market inventory, further depressing
prices. To break out of this cycle and ensure sustainable
affordability of home mortgages, it is necessary to address
both the affordability and negative equity problems.
B. OBSTACLES TO SUCCESSFUL FORECLOSURE MITIGATION
1. Previous Programs
The ideal solution to the foreclosure crisis would be
voluntary loan modifications and refinancings. In all cases in
which the net present value of a restructured loan would
outweigh the net present value of pursuing foreclosure, lenders
would restructure unsustainable, unaffordable loans into
sustainable, affordable ones. Lenders would thereby minimize
their losses, homeowners would not be forced to relocate, third
parties would not suffer the externalities of depressed housing
prices, urban blight, crime, reduced tax revenue, and disrupted
social relationships as a result of vacant, foreclosed
properties. The housing market would stabilize based on supply
and demand, not on the distortions created by exotic mortgages
or high foreclosures. This is the solution that would attain in
a perfectly functioning market.
Unfortunately, many factors can disrupt a perfectly
functioning market. Accounting issues within financial
institutions with exposures to the residential mortgage market
may pose a significant disincentive for otherwise mutually
beneficial loan restructurings. If mortgages or mortgage backed
securities are being carried at par or close to par, even
though there may be a likelihood of future default, the holders
of those mortgages or mortgage backed securities may be
reluctant to renegotiate those loans because such a
renegotiation would require that assets supported by those
mortgages be written down to the value of the renegotiated
loan.
In evaluating the efficacy of foreclosure mitigation
programs, it is important to recognize that there are some
foreclosures that cannot be avoided. In some cases, foreclosure
will result in a smaller loss than any viable modification. In
other cases, however, loans could perform more profitably than
foreclosure if they were sufficiently modified to be affordable
on an on-going basis. The data are inadequate to say with any
certainty how many loans are in either category.
Loan modification efforts to date have been insufficient to
halt the downward spiral in housing. Three major loan
modification efforts have been announced, in addition to
whatever private arrangements lenders make with borrowers, yet
the pace of foreclosures continues to rise. These efforts are
the HOPE NOW Alliance, FDIC IndyMac modification program, and
the GSE Streamlined Loan Modification Program.
The Major Previous Foreclosure Mitigation Programs
HOPE NOW Alliance is a private, voluntary mortgage industry
association created in October 2007 to provide a centralized
outreach conduit for loan modifications. While HOPE NOW
consulted with the Treasury Department and the Department of
Housing and Urban Development, it is not a government-sponsored
program. HOPE NOW lacks any authority to mandate particular
actions by its members; participation is purely voluntary and
self-regulated. HOPE NOW Alliance members report having engaged
in 2,911,609 workouts between July 2007 and November 2008.\68\
---------------------------------------------------------------------------
\68\ HOPE NOW, supra note 13.
---------------------------------------------------------------------------
This number may substantially overstate the effectiveness
of the HOPE NOW program. The majority (63 percent) of these
workouts have been repayment plans that merely permit repayment
of arrearages over time, rather than affecting the terms of the
loan going forward. If a loan is in default because it is
unaffordable due to anything other than a temporary decline in
borrower income, a repayment plan is unlikely to be a
sustainable solution. Today's foreclosure crisis is not
primarily due to temporary declines in income due to illness or
accidents, but to the underlying cost of mortgages relative to
income. Repayment plans are the wrong solution in many cases.
Even for the 37 percent of HOPE NOW workouts that resulted
in a modification of a loan, it is impossible to say what that
actually means. A major study by Professor Alan White of
Valparaiso University School of Law has found that only 49
percent of loan modifications resulted in lower monthly
payments; 17 percent had no effect and 34 percent resulted in
higher monthly payments, raising very serious concerns about
the effectiveness of the program.\69\ Likewise, the Center for
Responsible Lending estimates that less than 20 percent of HOPE
NOW loan modifications result in lower monthly payments.\70\
Not surprisingly, there is a high redefault rate on modified
loans.\71\ As the State Foreclosure Prevention Working Group
has noted:
---------------------------------------------------------------------------
\69\ Alan M. White, Deleveraging American Homeowners: December 18,
2008 Update to August 2008 Report, Valparaiso University School of Law
(Dec. 18, 2008) (online at www.hastingsgroup.com/Whiteupdate.pdf)
(hereinafter White, Update to August 2008 Report); Alan M. White,
Rewriting Contracts, Wholesale: Data on Voluntary Mortgage
Modifications from 2007 and 2008 Remittance Reports, Fordham Urban Law
Journal (2009) (online at ssrn.com/abstract=1259538) (hereinafter
White, Rewriting Contracts).
\70\ Sonia Garrison et al., Continued Decay and Shaky Repairs: The
State of Subprime Loans Today, Center for Responsible Lending (Jan.
2009) (online at www.responsiblelending.org/pdfs/
continued_decay_and_shaky_repairs.pdf). See also House Committee on
Financial Services, Testimony of Martha Coakley, The Implementation of
the Hope for Homeowners Program and A Review of Foreclosure Mitigation
Efforts, 110th Cong. (Sept. 17, 2008) (noting that ``virtually none''
of the loan modifications reviewed by her office reduced monthly
payments).
\71\ Office of the Comptroller of the Currency, OCC & OTS Mortgage
Metrics: Overall Redefault Rates, at 1 (2008) (online at
www.occ.treas.gov/ftp/release/2008-142b.pdf) (finding that over 50
percent of the mortgages that were modified in the first quarter of
2008 were delinquent within six months); Mortgage Bankers Association,
MBA Study: Industry Initiated More Than 235,000 Loan Modifications and
Repayment Plans in 3rd Quarter (Jan. 17, 2008) (online at
www.mortgagebankers.org/NewsandMedia/PressCenter/59454.htm) (finding
that 40 percent of subprime ARM borrowers in foreclosures had had
repayment or loan modification plans in place).
[O]ne out of five loan modifications made in the past
year are currently delinquent. The high number of
previously-modified loans currently delinquent
indicates that significant numbers of modifications
offered to homeowners have not been sustainable . . .
[M]any loan modifications are not providing any monthly
payment relief to struggling homeowners . . .
[U]nrealistic or ``band-aid'' modifications have only
exacerbated and prolonged the current foreclosure
crisis.\72\
---------------------------------------------------------------------------
\72\ State Foreclosure Prevention Working Group, Analysis of
Subprime Mortgage Servicing Performance, at 3 (Sept. 2008) (Data Report
No. 3) (online at www.csbs.org/Content/NavigationMenu/Home/
SFPWGReport3.pdf).
---------------------------------------------------------------------------
Chart 13: Workouts to Foreclosures by Type, HOPE NOW Alliance Members
\73\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
It is too early to offer a definitive evaluation of the
other two major previous loan modification programs, the FDIC's
IndyMac program and the GSE Streamlined Modification Program
(SMP), but some observations are in order.
---------------------------------------------------------------------------
\73\ HOPE NOW, supra note 13.
---------------------------------------------------------------------------
When the FDIC took over the failed IndyMac Federal Savings
Bank, it began to offer loan modifications to borrowers in
IndyMac's non-securitized portfolio. As of mid-December, only
7,200 of 65,000 eligible IndyMac borrowers had benefited from
the FDIC's program.\74\ The FDIC modified these loans by
temporarily reducing payments to a 38 percent front-end debt
(i.e. principal, interest, taxes and insurance)-to-income
target. The FDIC did this through a combination of temporary
interest rate reduction and principal forbearance. The long-
term sustainability of these modifications is unknown, and the
pace at which these modifications were accomplished has been
quite slow.
---------------------------------------------------------------------------
\74\ Charles Duhigg, Fighting Foreclosures, F.D.I.C. Chief Draws
Fire, New York Times (Dec. 11, 2008).
---------------------------------------------------------------------------
The SMP adopted by the GSEs (in conservatorship) began
November 2008. The SMP does not require any modifications.
Instead, it merely sets a target for modified loan payments
(principal, interest, taxes, insurance) to be no more than 38
percent of gross monthly income (front-end DTI) for the
homeowner.\75\
---------------------------------------------------------------------------
\75\ The SMP standard has also been adopted by the HOPE NOW
Alliance of servicers and is an entirely voluntary program.
---------------------------------------------------------------------------
The Panel has serious concerns about the potential efficacy
of programs based solely on a 38 percent front-end DTI, a
number which has not been justified as effective or even
appropriate. About 85-90 percent of prime and Alt-A loans and
70-75 percent of subprime loans are already below this
threshold.\76\ SMP thus has a standard so low that most
troubled loans already officially complied with it at
origination, and yet foreclosures are soaring. Moreover, it is
not clear whether modifications should be based only on front-
end DTI, as back-end DTI (total monthly debt payments to gross
monthly income) is a better measure of overall affordability.
On the other hand, back-end DTI is harder to verify and can
rapidly change after closing of a modification. A borrower can
load up on credit card debt the day after closing of a
modification, making the back-end ratio much higher than at the
time of the modification. In choosing between front-end and
back-end ratios, there are important trade-offs between
precision and the ability to administer any program involving
DTI ratios. The proper DTI measure will likely depend on other
factors in a loan modification program.
---------------------------------------------------------------------------
\76\ Merrill Lynch, supra note 62, at 7. Reliance on DTI is itself
questionable; loan performance seems to correlate better to loan-to-
value ratio than front-end DTI. Id.
---------------------------------------------------------------------------
The trade-offs between front-end and back-end ratios raise
the question of whether it is unaffordable mortgages that are
causing distress in household finance or whether other debt,
such as credit cards, auto loans, and student loans are also
contributing to borrower distress. Consumer over-indebtedness
has become remarkably acute in recent years. Consumers with
unaffordable mortgages frequently face other financial
problems, and there is a competition among creditors for
limited consumer repayment capacity. To the extent that
foreclosure mitigation programs encourage or require more
generous reductions in mortgage payments, this is a boon to
other consumer creditors and raises the question of why
mortgage creditors, rather than say creditor card lenders,
should forgive or forbear on debt, particularly when the
opposite result would occur if the homeowner filed for
bankruptcy. While this issue goes beyond the scope of the
current report, the question of how the pain of a borrower's
inability to repay should be shared among creditors is a topic
for further consideration.
A 38 percent front-end DTI target has already been rejected
as resulting in unsustainable loan modifications by leading
elements of the mortgage servicing industry. Litton Loan
Servicing, a Goldman Sachs affiliate, uses 31 percent front-end
DTI as its initial target,\77\ FDIC has proposed a general
modification program using a 31 percent front-end DTI
target,\78\ and Bank of America/Countrywide's settlement with
the state Attorneys General requires use of a 25-34 percent
front-end DTI standard.\79\ Moreover, the GSEs' own initial
underwriting guidelines suggest a maximum 25-28 percent front-
end DTI.\80\ If the GSEs do not believe that 38 percent DTI is
prudent underwriting for a loan to begin with, it is not clear
why they would use 38 percent DTI as a modification target.
Moreover, it seems that many loans already had a front-end DTI
of less than 38 percent at time of origination.\81\ Whether
they currently have front-end DTIs of less than 38 percent is
unclear, not least because of the declining incomes due to the
general problems in the economy, layoffs, illness, death, and
divorce. While it appears that past loan modification efforts
are slowly improving, policy-makers need to determine whether
these efforts are accomplishing enough in an acceptable
timeframe.
---------------------------------------------------------------------------
\77\ Senate Committee on Banking, Housing, and Urban Affairs,
Testimony of Gregory Palm, Oversight of the Emergency Economic
Stabilization Act: Examining Financial Institution Use of Funding Under
the Capital Purchase Program, 110th Cong. (Nov. 13 2008) (online at
banking. senate.gov/public/index.cfm?FuseAction=
Hearings.LiveStream&Hearing_id=1d38de7d-67db-4614-965b-edf5749f1fa3, at
minutes 142-144).
\78\ Federal Deposit Insurance Corporation, FDIC Loss Sharing
Proposal to Promote Affordable Loan Modifications (Nov. 14, 2008)
(online at www.fdic.gov/consumers/loans/loanmod/index.html).
\79\ People v. Countrywide Financial Corp., Case No. LC083076,
Stipulated Judgment and Injunction, 14 (Cal. Sup. L.A. County, NW
District, Oct. 20, 2008) (online atag.ca.gov/cms_attachments/press/
pdfs/n1618_cw_judgment.pdf).
\80\ Freddie Mac Single-Family Seller/Servicer Guide, at 37.15
(online at www.freddiemac.com/sell/guide/#).
\81\ Admittedly, DTI reporting is of questionable accuracy. See
Merrill Lynch, supra note 62.
---------------------------------------------------------------------------
An alternative to loan modification is refinancing. The
difference between a modification and a refinancing is that in
a refinancing a new lender picks up the credit risk on the
loan, whereas in a modification the existing lender continues
to hold the credit risk. Refinancing programs have been
ineffective to date either because of restrictive eligibility
requirements or because of negative equity.
Private refinancing is not possible, however, without
dealing with the negative equity problem. Private lenders will
not refinance a loan at more than 100 percent LTV. In a
declining or uncertain housing market, private lenders are
unlikely to refinance absent a larger equity cushion.
Therefore, voluntary refinancing is not possible unless current
lenders are willing to write-down loans to market value or are
otherwise incentivized to refinance at above 100 percent LTV.
Although it leaves the homeowner with a more affordable monthly
payment, the difficulty with refinancing at much over 100
percent LTV is that because of the long-term risk, repayment
incentives are diminished and the homeowner may abandon the
property due to the negative equity overhang. A homeowner who
faces any financial setback, such as a job loss or unexpected
medical bills, may be less inclined to stretch to continue the
home mortgage payments if the house is worth far less than the
mortgage. Similarly, a homeowner who is offered a job in a
distant location or who wants to downsize to a smaller place
may decide it is easier to walk away from a home in which
resale is impossible and the homeowner faces substantial
negative equity.
The existence of junior mortgages also significantly
complicates the refinancing process. Unless a junior mortgagee
consents to subordination, the junior mortgage moves up in
seniority upon refinancing. Out of the money junior mortgagees
will consent to subordination only if they are paid. Thus,
junior mortgages pose a serious holdup for refinancings,
demanding a ransom in order to permit a refinancing to proceed.
The federal government has sponsored a pair of refinancing
programs, FHASecure and HOPE for Homeowners. The 2007 Federal
Housing Administration's FHASecure program allowed refinancing
of adjustable rate mortgages into fixed-rate, FHA-insured
mortgages. Unlike any private program, FHASecure permitted
refinancing for delinquent and underwater borrowers. Thus,
negative equity did not present a refinancing obstacle for
FHASecure. However, delinquencies had to be attributable to the
loan resetting, as borrowers could not generally show any
delinquencies in the six month period prior to the rate reset.
FHASecure was closed down at the end of 2008. The program
was predicted to help 240,000 homeowners.\82\ The program
processed 487,818 loans, but this number appears to be inflated
because it includes a substantial number of loans that would
normally have been placed in other FHA programs.\83\ Only 4,128
of these FHASecure refinanced loans were delinquent at the time
of refinancing.\84\ FHASecure was quite restrictive in its
eligibility requirements, however, which limited its potential
effectiveness.\85\ Had FHASecure been less restrictive, it
would likely have refinanced many more loans, but at the cost
of taxpayers insuring a large number of negative equity
mortgages. FHA noted that maintaining the program past the
original termination date would have had a negative impact on
the MMI fund that would have required offsets by either
substantial across-the-board single family premium increases or
the suspension of FHA's single family insurance programs
altogether.\86\ In any case, the FHA's decision to shut down
FHASecure testifies to the program's ultimate shortcomings in
providing substantial foreclosure relief.\87\
---------------------------------------------------------------------------
\82\ See, e.g., U.S. Department of Housing and Urban Development,
Bush Administration to Help Nearly One-Quarter of a Million Homeowners
Refinance, Keep Their Homes; FHA to Implement New "FHASecure"
Refinancing Product (Aug. 31, 2007) (online at www.hud.gov/news/
release.cfm? content= pr07-123.cfm); U.S. Department of Housing and
Urban Development, FHA Helps 400,000 Families Find Mortgage Relief;
Refinancing on Pace to Help Half-million Homeowners by Year's End (Oct.
24, 2008) (online at www.hud.gov/news/release.cfm?content=pr08-
167.cfm).
\83\ Kate Berry, HUD Mulling How to Widen FHA Refi Net, American
Banker (Feb. 15, 2008).
\84\ Michael Corkery, Mortgage 'Cram-Downs' Loom as Foreclosures
Mount, Wall Street Journal (Dec. 31, 2008).
\85\ Berry, supra note 83.
\86\ Letter from Brian D. Montgomery, Assistant Secretary for
Housing--Federal Housing Commissioner, to All Approved Mortgagees (Dec.
19, 2008) (Mortgagee Letter 2008-41) (online at www.hud.gov/offices/
adm/hudclips/letters/mortgagee/files/08-41ml.doc).
\87\ The Panel understands that fraud concerns might have also
driven HUD to shut down FHASecure. The program reportedly had a high
level of defaults and there were indications, like the high rate of
manual underwriting, that lenders and loan correspondents were
massaging borrower information to fall within program guidelines.
---------------------------------------------------------------------------
The HOPE for Homeowners program was established by Congress
in July 2008 to permit FHA insurance of refinanced distressed
mortgages. While more loans were theoretically eligible for
HOPE for Homeowners, the program does not guarantee negative
equity loans. Instead, the program requires the refinancing to
be at 96.5 percent LTV based on a new, independent
appraisal.\88\ This requires the current mortgagee to write
down the principal outstanding on the loan.
---------------------------------------------------------------------------
\88\ Housing and Economic Recovery Act of 2008, Pub. L. No. 100-
298, at Sec. 1402(e)(2)(B) (requiring a maximum 90 percent LTV ratio
for FHA refinancing). This means that if the lender is perfectly
secured, the lender will have to write down the principal by 10
percent. If the lender is undersecured, the lender will have the write
down the principal by a greater amount. Additionally, all lenders are
required to pay insurance premiums on the mortgage of 3 percent of the
principal initially and 1.5 percent of the principal remaining on an
annual basis. Id. at Sec. 1402(i)(2).
---------------------------------------------------------------------------
HOPE for Homeowners was predicted to help 400,000
homeowners. As of January 3, 2009, it had attracted only 373
applications, and only closed 13 refinancings, none of which
had yet been FHA-insured.\89\ Many factors have contributed to
the shortcomings of HOPE for Homeowners, including limitations
on the program's flexibility and its reliance on private market
cooperation to do the voluntary principal write-downs required
for the refinancing.\90\ Lenders have been unwilling to take
the principal write-down necessary to participate in the
program.
---------------------------------------------------------------------------
\89\ Letter from Brian D. Montgomery, Assistant Secretary for
Housing-Federal Housing Commissioner, to Elizabeth Warren, Chairperson,
Congressional Oversight Panel (Jan. 9, 2009). See also Dina ElBoghdady,
HUD Chief Calls Aid on Mortgages a Failure, Washington Post (Dec. 17,
2008) (online at www.washingtonpost.com/wp-dyn/content/article/2008/12/
16/AR2008121603177.html); Tamara Keith, Despite Program, No Hope for
Homeowners, National Public Radio (Dec. 17, 2008) (online at
www.npr.org/templates/story/story.php? storyId=98409330).
\90\ Dina ElBoghdady, HUD Chief Calls Aid on Mortgages A Failure,
Washington Post (Dec. 17, 2008).
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With a few exceptions, lenders have been very reluctant to
take principal write-downs in their modifications.\91\ Both
principal write-down or interest rate reductions can accomplish
the same level of affordability in many cases. For a lender or
investor, however, a principal write-down has a much greater
impact. The loss from a principal write-down must be
immediately recognized on the institution's books. Moreover,
the lender or investor incurs the full loss from a principal
write-down; if the loan is refinanced in ten years, the lender
has already lost the principal it has forgiven.
---------------------------------------------------------------------------
\91\ See White, Rewriting Contracts, supra note 699.
---------------------------------------------------------------------------
If the lender reduces the interest rate, however, the
monthly payment might be reduced in an amount that is
equivalent to a principal reduction, but the lender is not
required by accounting rules to recognize an immediate loss. An
interest rate reduction's impact on the loan's net yield is
spread out over the full term of the loan. If the loan is
refinanced before term, as most loans are, then the lender will
not incur the full cost of the interest rate reduction.
Accordingly, lenders have been reluctant to write-down
principal, despite calls to do so, including from the Chairman
of the Federal Reserve Board of Governors.\92\
---------------------------------------------------------------------------
\92\ Board of Governors of the Federal Reserve System, Address by
Ben S. Bernanke, Chairman, at the Independent Community Bankers of
America Annual Convention in Orlando, Florida: Reducing Preventable
Mortgage Foreclosures (Mar. 4, 2008) (online at www.federalreserve.gov/
newsevents/speech/bernanke 20080304a.htm).
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Moreover, so long as lenders believe that there will be a
bailout from the taxpayers, they are reluctant to reduce
interest, much less principal. Lenders who anticipate that a
bailout might be coming down the road will not impair loans
voluntarily themselves. So long as banks think TARP will cover
their losses in full on loans no one will pay back, they have
no incentive to make concessions to homeowners. For financial
institutions that are at or near insolvency, the problem is
particularly acute: recognizing losses in the loan portfolio,
even if they produce greater prospects of long-term repayment,
may produce immediate consequences that the banks wish to avoid
at all costs. The consequences of this behavior are especially
negative for taxpayers, as the losses that then have to be
addressed through bank bailouts are larger than they would have
been had the mortgage portfolios been managed in an
economically rational way. To the extent that the mortgage
situation continues to deteriorate, it may exacerbate funding
requirements within the TARP programs.
Dealing with negative equity raises important questions
about what happens if there is future appreciation of the
home's value after principal reduction. To this end, proposals
to deal with negative equity sometimes consider the possibility
of shared appreciation plans in which borrowers, lenders, or
even the government, agree on a manner in which they will share
future increases in a home's value. Shared incentive plans
might incentivize lenders to engage in voluntary principal
reductions, although they would also require changes in
accounting practices. It is also unclear how these programs
would be administered over time.
Although affordability of monthly payments is critical to
reductions in foreclosures, the sustainability of foreclosure
mitigation efforts will require attention to be paid to the
problem of negative equity.
2. Why Previous Programs Have Limited Success
The reasons for the limited success of past loan
modification programs are many and complex. As an initial
matter, however, it must be recognized that some foreclosures
are not avoidable and some workouts may not be economical. This
should temper expectations about the scope of any modification
program. Nonetheless, there are many foreclosures that destroy
value and that can and should be avoided. There are numerous
obstacles--economic, legal, and logistical--that stand in the
way of voluntary workouts. Removing these obstacles could
greatly improve the circumstances of both homeowners and
investors, help stabilize the housing market, and provide a
sound foundation for rebuilding the economy.
a. Outreach problems
First, there are serious outreach problems. Many troubled
borrowers are unaware that there may be options to save their
home or prevent a foreclosure. But because lenders do not want
to take losses unless they have no other choice, homeowners are
rarely presented with modification offers before they default.
When a financially distressed homeowner defaults on her
mortgage, she does not typically receive a modification offer
immediately. Instead, the homeowner receives dunning calls and
dunning letters demanding payment. Often other creditors are
also clamoring for repayment. The result is that financially
distressed homeowners frequently avoid opening their mail or
answering the phone because they wish to avoid the pain
associated with aggressive debt collection. By the time a
mortgagee recognizes that modification may be needed and
invites the homeowner to workout the loan, the homeowner is
unlikely to read the mortgagee's communications.\93\ Even if
the homeowner reads the offer, the homeowner is often
suspicious of the mortgagee and fails to respond.
---------------------------------------------------------------------------
\93\ Some servicers have responded to this problem with impressive
creativity, such as sending out fake wedding invitations or canisters
of dice labeled ``don't gamble with your home.''
---------------------------------------------------------------------------
The result is that very few financially distressed
homeowners are actually receiving loan modification offers that
are sent. As the State Foreclosure Prevention Working Group has
noted, ``[n]early eight out of ten seriously delinquent
homeowners are not on track for any loss mitigation outcome.''
\94\ Whatever problems stand in the way of the actual
modifications and in ensuring that they are meaningful, unless
outreach to financially distressed homeowners improves,
voluntary loan modification problems will only be able to
prevent a very limited number of foreclosures.
---------------------------------------------------------------------------
\94\ State Foreclosure Prevention Working Group, Analysis of
Subprime Mortgage Servicing Performance, at 2 (Sept. 2008) (Data Report
No. 3) (online at www.csbs.org/Content/NavigationMenu/Home/
SFPWGReport3.pdf).
---------------------------------------------------------------------------
Outreach problems are further compounded by unscrupulous
vendors masquerading as government agencies or businesses
preying on vulnerable homeowners by convincing them that their
services are necessary to obtain a loan modification. Borrowers
can be left wondering which entities can be trusted to assist
them in obtaining foreclosure relief.
During the field hearing in Prince George's County, MD, the
Panel explored the issue of mortgage fraud, a significant
problem in that community. Witnesses at the hearing described a
number of foreclosure rescue scams employed by con artists to
deceive distressed homeowners. Mortgage swindlers in Prince
George's County are known to misrepresent themselves as
government housing officials and prey on the elderly and poorly
educated. A typical scheme is reconveyance, a ploy in which a
fraudulent mortgage broker promises to help a struggling
homeowner avoid foreclosure and repair their damaged credit.
The broker arranges conveyance of the property to a third party
with the expectation that at a certain point in the future the
property will be reconveyed to the homeowner. The homeowner is
led to believe that the transfer is necessary in order to
improve his or her credit rating and allow for more favorable
mortgage terms when the title is returned. In reality, the
homeowner has unwittingly relinquished the title, the property
has been refinanced to strip out the existing equity and the
third party, or ``straw'', purchaser ultimately defaults on the
refinanced note and the original homeowner is evicted upon
foreclosure. John Mitchell of Forestville, MD, testified at the
Prince George's County field hearing and was the victim of such
a scam. Mr. Mitchell was unaware that he had been defrauded
until the local sheriff arrived at his home to evict his
family.
The reconveyance scheme was the scam of choice for the
Metropolitan Money Store, reputedly the most notorious
perpetrator of mortgage fraud in Maryland history. The
proprietor of the Metropolitan Money Store, Joy Jackson, a
former exotic dancer with no prior experience in the credit
industry, is currently facing Federal mail fraud and money
laundering charges for allegedly defrauding Maryland homeowners
out of $10 million in home equity.\95\ At the field hearing,
Maryland Secretary of Labor, Licensing and Regulation Thomas
Perez said the Metropolitan Money Store scam illustrated ``the
absence of any meaningful barriers to entry'' to the mortgage
industry.\96\
---------------------------------------------------------------------------
\95\ Ovetta Wiggins, Md. Couple Indicted in Fraud Probe, Washington
Post (June 13, 2008).
\96\ Congressional Oversight Panel, Testimony of Thomas Perez,
Maryland Secretary of Labor, Licensing & Regulation, Coping with the
Foreclosure Crisis: State and Local Efforts to Combat Foreclosures in
Prince George's County, MD (Feb. 27, 2009) (online at cop.senate.gov/
documents/testimony-022709-perez.pdf).
---------------------------------------------------------------------------
b. Servicer capacity problems
Second, when homeowners try to contact their servicers to
request a modification, they are often unable to reach them.
Homeowners often have to wait on the phone for hours to get
through to a servicer representative at a call center.\97\ For
working families in particular, the time involved in trying to
contact the servicer can be prohibitive. Homeowners who are
trying to deal with their mortgage during their lunch breaks or
between two jobs often give up because they cannot get through
to their servicers.
---------------------------------------------------------------------------
\97\ Brian Ross and Avni Patel, On Hold: Even Congresswoman Gets
the Runaround on Bank Help Lines, ABC News (Jan. 22, 2009) (online at
abcnews.go.com/Blotter/Story?id= 6702731&page=1).
---------------------------------------------------------------------------
At the Prince George's County field hearing, Lisa McDougal,
Co-Chair of the Coalition for Homeownership Preservation in
Prince George's County, stated that several servicers have
openly acknowledged that they simply were not prepared for the
volume of loss mitigation requests that this crisis has
generated.\98\ Phillip Robinson of Civil Justice, Inc. noted
that many borrowers are stymied by the inability to even get
someone on the phone. ``The number one thing that homeowners
say to us when they get to any one of the different vehicles in
the Maryland system is [that] they don't know what their
roadmap is . . . they don't know what their options are,''
Mr. Robinson testified. ``They're calling their servicers and
can't get an answer. No one is answering the phones. No one is
responding to them.'' \99\ Ms. McDougal stressed that
aggressive follow-up is necessary to get any response from most
servicers. Many borrowers are ignored until they retain the
assistance of a legal advocate or local public official.
---------------------------------------------------------------------------
\98\ Congressional Oversight Panel, Testimony of Lisa McDougal, Co-
Chair of the Coalition for Homeownership Preservation in Prince
George's County, Coping with the Foreclosure Crisis: State and Local
Efforts to Combat Foreclosures in Prince George's County, MD (Feb. 27,
2009) (online at cop.senate.gov/documents/testimony-022709-
mcdougal.pdf).
\99\ Congressional Oversight Panel, Testimony of Phillip Robinson,
Executive Director, Civil Justice, Inc., Coping with the Foreclosure
Crisis: State and Local Efforts to Combat Foreclosures in Prince
George's County, MD (Feb. 27, 2009) (online at cop.senate.gov/
documents/testimony-022709-robinson.pdf).
---------------------------------------------------------------------------
Anne Balcer Norton of the St. Ambrose Housing Aid Center
noted that poor staffing and a lack of accountability and
oversight are to blame for the unresponsiveness of most
servicers. ``Servicers either lack the staffing to effectively
respond to loss mitigation requests or have artificially ramped
up capacity at a level that precludes training and oversight of
staff,'' Ms. Norton told the Panel.\100\ As a result, borrowers
must often wait up to three to five months for a decision.
---------------------------------------------------------------------------
\100\ Congressional Oversight Panel, Testimony of Anne Balcer
Norton, Director of Foreclosure Prevention, St. Ambrose Housing Aid
Center, Coping with the Foreclosure Crisis: State and Local Efforts to
Combat Foreclosures in Prince George's County, MD (Feb. 27, 2009)
(online at cop.senate.gov/documents/testimony-022709-norton.pdf).
---------------------------------------------------------------------------
It is difficult for homeowners to initiate productive
discussions with lenders because many servicers lack the
capacity to deal with a large volume of modifications. Part of
this is a staffing issue. Servicers are hired by the loan
holders to manage the routine tasks associated with the
mortgages. Previously, the majority of servicers' work centered
on routine tasks, such as collecting mortgage payments, which
are highly automated. As delinquencies have mounted, however,
the business focus has shifted to loan mitigation, which is
slower, more complex, and much less automated. Servicers are
generally understaffed for handling a large volume of consumer
loan workouts. Staffing is not simply a matter of manpower, but
also of sufficiently trained personnel and adequate
technological support. Servicer understaffing is a function of
both servicers' cost-benefit analysis of hiring additional
employees to handle loan workouts, the time it takes to train
the employees, and the high turnover rates among consumer
workout specialists.
c. Junior mortgages
There are multiple mortgages on many properties,
particularly recent vintage mortgage originations. (See Chart
14, below.) Some second lien loans are ``piggybacks'' or 80/
20s, structured to avoid private mortgage insurance. By 2006,
more than half of Alt-A mortgages included a second mortgage at
the time of original funding. Across a range of products, many
second mortgages were originated entirely separately from the
first mortgage and often without the knowledge of the first
mortgagee. In addition, millions of homeowners took on second
mortgages, often as home equity lines of credit. As Chart 14
shows, in recent years second mortgages have become far more
common. Those debts also encumber the home and must be dealt
with in any refinancing effort.
The prevalence of multiple mortgage homes creates a
coordination problem for the homeowner and the mortgagees. It
also means that senior mortgagees are reluctant to offer
concessions because the benefits of better loan performance
accrue first to the junior mortgagees. Junior mortgagees may
recognize that they have no ability to collect in an immediate
foreclosure, but they have the power to hold up any
refinancing. These second mortgage lenders are reluctant to
give up their leverage and agree to any concessions absent a
payoff. Multiple mortgages on the same home present a serious
obstacle for loan workouts.
Chart 14. Percentage of Mortgage Originations on Properties with a
Junior Mortgage by Year \101\
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
\101\ Abraham et al., supra note 44, at 11-12.
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d. Special problems with securitized mortgages
While outreach, staffing, and second mortgage problems
present difficulties for the entire mortgage industry, there
are special problems for securitized mortgage workouts. This is
especially problematic because foreclosure rates are higher
among securitized loans.\102\ Over two-thirds of residential
mortgages originated since 2001 are securitized.\103\ For
subprime, alt-A, and conforming loans, the securitization is
over three-quarters in this period, and in 2007 it was over 90
percent.\104\
---------------------------------------------------------------------------
\102\ Tomasz Piskorski et al., Securitization and Distressed Loan
Renegotiation: Evidence from the Subprime Mortgage Crisis, at 3 (Dec.
2008) (University of Chicago Booth School of Business, Working Paper
No. 09-02) (online at papers.ssrn.com/abstract=1321646) (finding a 19-
33 percent decrease in the relative mean foreclosure rate among
portfolio loans).
\103\ Inside Mortgage Finance, Mortgage Market Statistical Annual,
at 3 (2008) (Vol. 2).
\104\ Id.
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Residential mortgage securitization transactions are
technical, complex deals, but the core of the transaction is
fairly simple. A financial institution owns a pool of mortgage
loans, which it either made itself or purchased from another
source. Rather than hold these mortgage loans (and the credit
risk) on its own books, the institution sells them to a
specially created entity, typically a trust (SPV). The trust
pays for the mortgage loans by issuing bonds. The bonds are
collateralized (backed) by the loans now owned by the trust.
These bonds are called residential mortgage-backed securities
(RMBS). Typically the bonds are issued in tranches with a
senior/subordinate structure.
Because the SPV trust is only a shell to hold the loans, a
third-party, called a servicer, must be brought in to manage
the loans. The servicer is required by contract to manage the
loans for the benefit of the RMBS holders. The servicer
performs the day-to-day tasks related to the mortgages owned by
the SPV, such as collecting mortgage loan payments from the
homeowners and remitting them to the trust, and handling loss
mitigation efforts (including foreclosure) on defaulted loans.
The servicer is often, but not always, a corporate affiliate of
the originator of the mortgage loans. Once the trust receives
the payments, a corporate trustee with limited duties is
responsible for making distributions to the bondholders.
i. Contractual limitations on modification of securitized
loans
Securitization creates contractual limitations on private
mortgage modification. Servicers carry out their duties
according to what is specified in their contracts with the SPV.
This contract is known as a ``pooling and servicing agreement''
or PSA. As noted by the American Securitization Forum, most
securitizations provide servicers with significant flexibility
to engage in loan modifications and other loss mitigation
techniques where the loan is in default or where default is
imminent or reasonably foreseeable.\105\ The decision to modify
mortgages held by an SPV rests with the servicer, and servicers
are instructed to manage loans as if for their own account and
maximize the net present value of the loan.\106\
---------------------------------------------------------------------------
\105\ House Committee on Financial Services, Testimony of Thomas
Deutsch, Private Sector Cooperation with Mortgage Modifications:
Ensuring That Investors, Servicers and Lenders Provide Real Help for
Troubled Homeowners, at 5, 110th Cong. (Nov. 12, 2008).
\106\ See 26 U.S.C. Sec. 1860A et seq. (Real Estate Mortgage
Investment Conduit (REMIC) treatment); SFAS No. 140 (off-balance sheet
accounting treatment).
---------------------------------------------------------------------------
Nevertheless, some PSAs contain additional restrictions
that can hamper servicers' ability to modify mortgages.
Sometimes the modification is forbidden outright, sometimes
only interest rates can be adjusted, not principal, and
sometimes there are limitations on the amount by which interest
rates can be adjusted. Other times the total number of loans
that can be modified is capped (typically at 5 percent of the
pool), the number of times a loan may be modified will be
capped, or the number of modifications in a year will be
capped. Generally, the term of a loan cannot typically be
extended beyond the last maturity date of any loan in the
securitized pool. Additionally, servicers are sometimes
required to purchase any loans they modify at the face value
outstanding (or even with a premium).\107\ This functions as an
anti-modification provision.
---------------------------------------------------------------------------
\107\ Greenwich Financial Services Distressed Mortgage Fund 3, LLC
v. Countrywide Financial Corp., Index No. 650474-2008, Complaint (N.Y.
Supr. Ct., N.Y. Co., Dec. 1, 2008) (online at iapps.courts.state.ny.us/
iscroll/SQLData.jsp?IndexNo=650474-2008) .
---------------------------------------------------------------------------
The PSA is usually part of the indenture under which the
MBS are issued. Under the Trust Indenture Act of 1939,\108\ the
consent of 100 percent of the MBS holders is needed in order to
alter the PSA in a manner that would affect the MBS's cash
flow, as any change to the PSA's modification rules would.
Changes that do not affect cash flow require either a 51
percent or a 67 percent majority approval. It is arguable
whether a change that allows more modifications affects cash
flow; if so, the structure of the securitization becomes
another factor to consider.
---------------------------------------------------------------------------
\108\ 15 U.S.C. Sec. 77ppp(b).
---------------------------------------------------------------------------
There can be thousands of MBS certificates from a single
pool and these certificate holders might be dispersed world-
wide. The problem is exacerbated by resecuritizations, second
mortgages, and mortgage insurance. MBS issued by an SPV are
typically tranched--divided into different payment priority
tiers, each of which will have a different dividend rate and a
different credit rating. Because the riskier tranches are not
investment grade, they cannot be sold to entities like pension
plans and mutual funds. Therefore, they are often resecuritized
into what are known as CDOs. A CDO is a securitization in which
the assets backing the securities are themselves mortgage-
backed securities rather than the underlying mortgages. CDOs
are themselves then tranched, and the senior tranches can
receive investment grade ratings, making it possible to sell
them to major institutional investors. The non-investment grade
components of CDOs can themselves be resecuritized once again
into what are known as CDO2s. This process can be
repeated, of course, an endless number of times. Thus it
becomes virtually impossible for a servicer to get unanimous
consent for any MBS issue or for a single holder to purchase
100 percent of the MBS in the issue.
In addition, many MBS holders would have no incentive to
consent to a change in the PSA. The out-of-the-money junior
tranches have no incentive to support the modification, and the
senior most tranches have a substantial enough cushion of
subordinated tranches that they have no incentive to support
the modification.
The difficulty of modifying PSAs to permit modification on
a wide scale is further complicated by the fact that many
homeowners have more than one mortgage. Even when the mortgages
are from the same lender, they are often securitized
separately. If a homeowner is in default on two or three
mortgages it is not enough to reassemble the MBS pieces to
permit a modification of one of the mortgages. Modification of
the senior mortgage alone only helps the junior mortgage
holders, not the homeowner. In order for a loan modification to
be effective for the first mortgage, it is necessary also to
modify the junior mortgages, which means going through the same
process. This process is complicated by the fact that senior
lenders frequently do not know about the existence of the
junior lien on the property.
A further complication comes from insurance. An SPV's
income can exceed the coupons it must pay certificate holders.
The residual value of the SPV after the certificate holders are
paid is called the Net Interest Margin (NIM). The NIM is
typically resecuritized separately into an NIM security (NIMS),
and the NIMS is insured by a financial institution. This NIMS
insurer holds a position similar to an equity holder for the
SPV. The NIMS insurer's consent is thus typically required by
contract both for modifications to PSAs and modifications to
the underlying mortgages beyond limited thresholds. With
nothing more to lose from foreclosure and the ability to hold
up a refinancing as their only leverage, NIMS insurers'
financial positions are very similar to out-of-the-money junior
mortgagees. Like junior mortgagees, NIMS are also unlikely to
cooperate absent a payoff.
Thus, the contractual structure and economic incentives of
securitization can be an obstacle to private modifications of
distressed and defaulted mortgages, even when that would be the
most efficient outcome for the lenders and borrowers.\109\
---------------------------------------------------------------------------
\109\ A fourth category--legal obstacles--in the form of REMIC tax
provisions and Financial Accounting Board standards, are no longer a
significant obstacle to modifying securitized loans. There are
potentially adverse tax and accounting consequences if servicers
engaging in too many voluntary modifications. Residential MBS are
structured to enjoy pass-thru REMIC status under the Internal Revenue
Code, 26 U.S.C. Sec. Sec. 1860A et seq., which enables the MBS to avoid
double taxation of income. REMIC rules generally preclude wide-scale
modification of securitized loans or their sale out of securitized
pools, and these REMIC rules are further reflected in the contract with
the servicer. The IRS has relaxed application of REMIC rules to
mortgage loan modification programs. See Rev. Proc. 2008-28, 2008-23
I.R.B. 1054.
Likewise, accounting standards under SFAS 140 indicate that too
many modifications would result in the servicer/originator having to
take the securitized loans back onto its balance sheet. SEC Staff,
however, have indicated that they do not believe that modifications of
imminently defaulting loans would require on-balance sheet accounting.
Letter from Christopher Cox, SEC Chairman to Rep. Barney Frank,
Chairman of Committee on Financial Services, United States House of
Representatives (July 24, 2008) (online at www.house.gov/apps/list/
press/financial svcs_dem/sec_response072507.pdf); Letter from Conrad
Hewitt, Chief of Accounting, SEC to Mr. Arnold Hanish, Chairman of the
Committee on Corporate Reporting, Financial Executives International
and Mr. Sam Ranzilla, Chairman of the Professional Practice Executive
Committee, The Center for Audit Quality, American Institute of
Certified Public Accountants (Jan.8, 2008) (online at www.sec.gov/info/
accountants/staffletters/hanish010808.pdf).
---------------------------------------------------------------------------
While restrictive PSAs present an obstacle to foreclosure
mitigation efforts, it is important not to overstate their
significance. The Panel's examination of modifications in
several securitized pools with a 5 percent cap on the
percentage of loans that may be modified reveals that
modifications have not approached the cap. This indicates that
the cap is not the major obstacle to successful
modifications.\110\ Further, to date the Panel knows of no
litigation against mortgage servicers for engaging in
modifications that violate the terms of PSAs.\111\
---------------------------------------------------------------------------
\110\ See White, Rewriting Contracts, supra note 69.
\111\ Litigation brought against Bank of America and Countrywide is
for a declaratory judgment that Bank of America and Countrywide must
repurchase modified mortgages at face, not for doing unauthorized
modifications.
---------------------------------------------------------------------------
Previous legislative remedies have been of indeterminate
success. In order to provide servicers with an incentive to
participate in the Hope for Homeowners program, Congress
created a safe harbor from legal liability for refinancing
owners into the Hope for Homeowners program as part of the
Housing and Economic Recovery Act of 2008. Despite the safe
harbor provision, the program has had very limited
participation. Restrictive PSAs do not appear to be the main
immediate obstacle to loan modifications, but they present a
significant limitation on expanded modification efforts.
ii. Incentive problems created by securitization
Securitization can also create incentive misalignment
problems that can lead to inefficient foreclosures. Servicers
have a duty to service loans in the best interest of the
aggregate investor and to maximize the net present value on
loans. Nonetheless, mortgage servicer compensation structures
can create a situation in which foreclosure is more profitable
to servicers than loan modification, even if it imposes bigger
losses on both the homeowners and the investors. As a result,
even wealth-destroying foreclosures may occur in large
numbers.\112\
---------------------------------------------------------------------------
\112\ Archana Sivadasan, The 800 Pound Gorrilla in the Room:
Servicers Profit While Investors Face Losses, RGE Monitor (Nov. 4,
2008) (online at www.rgemonitor.com/globalmacro-monitor/ 254261/
the_800_pound_gorrilla_in_the_room_servicers_profit_while_investors_
face_losses).
---------------------------------------------------------------------------
Servicers receive three main types of compensation: a
servicing fee, which is a percentage of the outstanding balance
of the securitized mortgage pool; float income from investing
homeowners' mortgage payments in the period between when the
payments are received and when they are remitted to the trust;
and ancillary fees. When a loan performs, the servicer has
largely fixed-rate compensation. This is true also when a loan
performs following a modification.
Thus, if a servicer modifies a loan in a way that reduces
monthly payments, the servicer will also have a reduced income
stream. This reduced income stream will last only so long as
the loan is in the servicing portfolio. If the loan is
refinanced or if it redefaults, the loan will leave the
portfolio. Generally servicers do not expect loans to remain in
their portfolios for long. For example, a 2/28 ARM is likely to
be refinanced by year three, when the teaser rate expires, and
move to another servicer's portfolio. Moreover, for non-GSE
RMBS, servicers are not compensated for the sizeable costs of
loan modification. Thus, when a servicer modifies a loan, the
servicer loses servicing and float income (which it will not
have long into the future anyhow) and incurs expenses.
By contrast, when a servicer forecloses, servicer
compensation shifts to a cost-plus basis. The servicer does not
receive any additional servicing fee or float revenue from the
loan, but it does receive all expenses of the foreclosure,
including any fees it tacks on, such as collateral inspection
fees, process serving fees, etc., although it is unclear to
what extent these fees produce profits. These fees are paid off
the top from foreclosure recoveries, so it is the MBS holders
that incur the losses in foreclosure, not the servicers.\113\
This arrangement can also create an incentive for servicers to
sell foreclosed properties at low prices.\114\
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\113\ Servicer income in foreclosure is offset in part by the time-
value of advancing payments owed on defaulted loans to the trust until
foreclosure. These payments are recoverable by the servicer, but
without interest.
\114\ Carrick Mollenkamp, Foreclosure `Tsunami' Hits Mortgage-
Servicing Firms, Wall Street Journal (Feb. 11, 2009).
---------------------------------------------------------------------------
The fees servicers can add in foreclosure can be
considerable, and there is effectively no oversight of their
reasonableness or even whether the agreements authorize such
fees.\115\ MBS holders lack the ability to monitor servicer
decisions, and securitization trustees do not have the
responsibility to do so. Servicers essentially receive cost-
plus-percentage-of-cost compensation when they foreclose. The
incentive misalignments from this form of compensation are so
severe that it is flatly prohibited for federal government
contracts.\116\
---------------------------------------------------------------------------
\115\ Katherine M. Porter, Misbehavior and Mistakes in Bankruptcy
Mortgage Claims, Texas Law Review (2008).
\116\ See 41 U.S.C. Sec. 254(b); 10 U.S.C. Sec. 2306(a).
---------------------------------------------------------------------------
Servicer incentives are further complicated by the
requirement that servicers advance payments of principal,
interest, taxes, and insurance on non-performing loans to the
MBS holders typically through foreclosure and until the
property is disposed of. This too can also create an incentive
for servicers to sell foreclosed properties at low prices in
order to sell the property quickly and stop making
advances.\117\ While servicers are able to recover all of their
advances off the top of sale proceeds, they lose the time value
of these advances, which can be considerable.\118\ While the
requirement of making advances creates an incentive to modify
defaulted loans, if the loan redefaults, the servicer will find
itself making the advances anyway after incurring the expenses
of the modification.
---------------------------------------------------------------------------
\117\ Mollenkamp, supra note 114.
\118\ Taxes and insurance are sometimes recoverable from other
loans in the pool.
---------------------------------------------------------------------------
The choice between modification and foreclosure is a choice
between limited fixed-price income and a cost-plus contract
arrangement with no oversight of either the costs or the plus
components. For mortgage servicers, this can create an
incentive to foreclose on defaulted loans rather than to modify
them, even if modification is in the best interest of the MBS
holders.\119\ The contractual requirement to make advances may
mitigate this incentive alignment somewhat. The specific
dynamics of servicer incentives are not well understood, but
they appear to be a factor inhibiting loan modifications.
---------------------------------------------------------------------------
\119\ Alternatively, if a servicer modifies a loan in a way that
guarantees a quick redefault, it might be even more profitable. This
might explain why so many modifications have resulted in higher monthly
payments and why a large percentage of foreclosures have been after
failed modification plans. See Jay Brinkmann, Mortgage Bankers
Association, An Examination of Mortgage Foreclosures, Modifications,
Repayment Plans, and Other Loss Mitigation Activities in the Third
Quarter of 2007, at 10 (Jan. 2008) (online at www.mortgagebankers.org/
files/News/InternalResource/59454_LoanModificationsSurvey.pdf) (noting
that nearly 30 percent of foreclosure sales in the third quarter of
2007 involved failed repayment plans).
---------------------------------------------------------------------------
iii. Servicer litigation risk aversion
Servicers may also be reluctant to engage in more active
loan modification efforts because of litigation risk. Servicers
face litigation risk both for the number of modifications they
do as well as for the type of modifications. Servicers are
contractually obligated to maximize the net present value of
the loans they manage. Net present value calculations are
heavily dependent upon the assumptions made in the calculation,
such as what a foreclosure sale return will be, the likelihood
and likely timing of redefault on a loan modification, and
future trends in housing prices. Net present value calculations
are usually done through computer software platforms, and there
is no standardized system or set of inputs. Changes to the
assumptions in net present value calculations can shift whether
a servicer will pursue foreclosure or a loan modification.
Servicers face potential scrutiny and litigation from
investors based on their net present value calculations and
whether they have adhered to those calculations. Investors in
MBS are typically tranched in a senior/subordinate structure.
This means that senior tranches will want the more certain and
immediate recovery on a defaulted loan because they will be
shielded from losses by the subordinated tranches. Therefore,
the senior tranches are likely to push for quick foreclosure.
By contrast, the subordinated tranches stand to lose
significantly in foreclosure, and may push for the possibility
of a larger recovery in a modification. The type of a
modification a servicer engages in can also have a disparate
impact on different tranches of MBS investors, as principal and
interest payments are often allocated separately among
investors. Thus, a reduction in interest rates affects
different investors than a reduction in principal. The result
is what is known as ``tranche warfare,'' with the servicer
caught in between competing groups of investors.\120\
---------------------------------------------------------------------------
\120\ Kurt Eggert, Comment on Michael A. Stegman et al.'s
`Preventive Servicing Is Good for Business and Affordable Homeownership
Policy': What Prevents Loan Modifications, Housing Policy Debate, at
290-91 (2007).
---------------------------------------------------------------------------
A lawsuit was filed on December 1, 2008, by Greenwich
Financial Services Distressed Mortgage Fund 3 LLC and QED LLC,
against Bank of America.\121\ While the lawsuit did not dispute
that Bank of America and Countrywide Financial had the
authority to modify mortgages, the plaintiff hedge fund claimed
that modifications meant that Bank of America was required to
repurchase mortgages originated by Countrywide Financial once
those mortgages had been modified in settlement of a predatory
lending lawsuit. House Financial Services Committee Chairman
Barney Frank said of this lawsuit, ``[O]f all the outrageous
acts of social irresponsibility I have ever seen, it is the
lead plaintiff in that lawsuit, who bought the paper solely for
the purpose of doing it (filing the lawsuit).'' \122\
---------------------------------------------------------------------------
\121\ Greenwich Financial Services Distressed Mortgage Fund 3, LLC
v. Countrywide Financial Corp., Index No. 650474-2008, Complaint (N.Y.
Supr. Ct., N.Y. Co., Dec. 1, 2008) (online at iapps.courts.state.ny.us/
iscroll/SQLData.jsp?IndexNo=650474-2008).
\122\ House Committee on Financial Services, Statement of Chairman
Barney Frank, Oversight Concerns Regarding Treasury Department Conduct
of the Troubled Assets Relief Program, 110th Cong. (Dec 10, 2008)
(online at financialservices.house.gov/hearing110/hr121008.shtml).
---------------------------------------------------------------------------
Servicer conduct is evaluated under a deferential business
judgment standard that shields servicers from a great deal of
litigation risk. To date no litigation has been filed alleging
that servicers have engaged in too many or too few
modifications or the wrong type of modifications. Nonetheless,
fear of litigation risk may be chilling some loan modification
efforts. Clear industry standards and procedures for
modifications would provide comfort to servicers in this
regard, and the efforts of HOPE NOW, Treasury, HUD, FHFA, and
the GSEs in creating the Streamlined Loan Modification Program
represents important progress in this regard, although it does
not technically affect the legal standard by which servicers
are judged.
iv. Servicer business models
Finally, it is unlikely that mortgage servicers will be
able to conduct mass loan modifications. Mortgage servicers
perform two services that require very different skills and
recourses. Servicers process transactions and engage in loss
mitigation on defaulted loans. Transaction processing consists
of sending out billing statements and receiving payments. It is
a highly scalable and automatable business that involves little
discretion, expertise, or manpower. Loss mitigation, in
contrast, involves tremendous discretion, expertise, and
manpower. It does not benefit from economies of scale and needs
significant human labor to staff call centers, which have very
high employee turnover rates.
When housing markets perform well and there are few
defaults, servicers' business is largely transaction
processing. When default rates rise, however, servicers'
business is increasingly a loss mitigation enterprise. Mortgage
servicers have not staffed or built their operations around
handling defaults at current levels. They lack the trained
personnel to handle mass modifications. They lack sufficient
personnel to handle a large volume of customer contacts and the
trained loan officers necessary to handle the volume of
requested modifications, which are essentially the underwriting
of a new loan. Servicers are simply in the wrong line of
business for doing modifications en masse.
Given the special obstacles to loan modification caused by
securitization, it is not surprising that non-securitized
portfolio loans perform better in the first place,\123\ are
more likely to be modified, and are less likely to redefault
after modification.\124\ Portfolio loans superior performance
might be in part because portfolio loans are of better quality
initially.\125\ Even when ``hard'' underwriting
characteristics, like LTV, FICO scores, and DTI ratios are held
constant, lenders who hold their own mortgages are able to
engage in more customized underwriting for their portfolio
loans than is practical for credit rating agencies and MBS
investors.\126\
---------------------------------------------------------------------------
\123\ Benjamin Keys, et al., Did Securitization Lead to Lax
Screening? Evidence From Subprime Loans (2008) (University of Chicago
Working Paper) (online at papers.ssrn.com/sol3/papers.
cfm?abstract_id=1093137).
\124\ Piskorski et al., supra note 102, at 3.
\125\ Piskorski et al., supra note 1022, at 3.
\126\ Yingjin H Gan and Christopher Mayer, Agency Conflicts, Asset
Substitution, and Securitization (2006) (National Bureau of Economic
Research, Working Paper No. 12359) (online at www.nber.org/papers/
w12359).
---------------------------------------------------------------------------
There are many practical, economic, and legal obstacles
standing in the way of successful and sustainable large-scale
loan modifications.
IV. CHECKLIST FOR SUCCESSFUL LOAN MODIFICATIONS
While Congress needs better information about foreclosure
mitigation efforts, the urgency of the matter precludes delay.
For a solution to be timely it is important that it be
implemented promptly. Neither American homeowners nor the
economy can afford another failed attempt at foreclosure
mitigation.
A. DATA COLLECTION
Congress and the Administration cannot craft optimal policy
responses to the mortgage crisis without sufficient
information. The current state of federal government knowledge
about mortgage loan performance and loss mitigation efforts is
inadequate. The Panel recommends that Congress initiate a
national mortgage loan performance reporting requirement,
similar to the reporting required under the Home Mortgage
Disclosure Act, to provide a complete source of data. In
addition, federal banking and housing regulators should be
mandated to analyze these data and to make them publicly
available, providing comprehensive information about mortgage
loan performance and loss mitigation efforts.
B. METRICS
In order to evaluate the likely success of any foreclosure
prevention effort, it is necessary to establish meaningful
metrics. Based on the Panel's review of the evidence available,
its consultation with experts, and its field hearing, the panel
has developed a list of standards that will aid in the
evaluation of any foreclosure mitigation plan. Some of these
standards apply solely to voluntary or incentive-based
modification or refinancing programs; others apply to all
methods. The Panel recognizes that there are significant
obstacles to voluntary mortgage loan restructuring, and
believes involuntary restructuring programs are an essential
option.
The Panel plans to evaluate any proposal's performance on
these criteria using the following checklist.
Checklist for Mortgage Mitigation Program
Will the plan result in modifications that create
affordable monthly payments?
Does the plan deal with negative equity?
Does the plan address junior mortgages?
Does the plan overcome obstacles in existing pooling and
servicing agreements that may prevent modifications?
Does the plan counteract mortgage servicer incentives not
to engage in modifications?
Does the plan provide adequate outreach to homeowners?
Can the plan be scaled up quickly to deal with millions of
mortgages?
Will the plan have widespread participation by lenders and
servicers?
1. Affordable Monthly Payments
Ensuring affordable monthly mortgage payments is the key to
mitigating foreclosures. Any foreclosure mitigation plan must
be based on a method of modifying or refinancing distressed
mortgages into affordable ones. Clear and sustainable
affordability targets achieved through interest rate
reductions, principal write-downs, and/or term extensions
should be a central component of foreclosure mitigation.
Affordability targets must be set low enough that consumers
are not at risk for redefault shortly after the modification.
The Panel is concerned that the DTI target of 38 percent in the
Streamlined Modification Program is too high. The Panel also
recognizes that affordability is part of a broader picture of
consumer finances, and that efforts to make mortgages
affordable must consider other sources of consumer debt
burdens, such as credit cards, student loans, auto loans, and
medical debt, along with declining household incomes.
2. Sustainable Mortgages
It may not be enough simply to make mortgages affordable.
Mortgages must also be sustainable. Serious negative equity may
undermine the sustainability of any restructured mortgage.
While mortgage payments can generally be restructured to
affordable levels through reduction of interest rates and
increases in loan term, the long-term sustainability of loan
workouts, be they through modification or refinancing, may
depend upon the degree of negative equity.\127\
---------------------------------------------------------------------------
\127\ See Leonhardt, supra note 67.
---------------------------------------------------------------------------
Homeowners with negative equity cannot sell their homes
unless they can make the balloon payment that lurks in the
background. Many homeowners will eventually need to move for
jobs, for assisted living, for larger or smaller living spaces,
or to be near family. If they can find rental housing at an
equivalent monthly payment price, they will abandon homes
burdened by negative equity. Significant negative equity raises
the serious risk that foreclosures have merely been postponed,
not prevented.
Negative equity will create significant distortions in the
labor, elderly care, and housing markets. Moreover, negative
equity will keep foreclosures above their historically low
levels. These delayed foreclosures will continue to plague the
US housing market and financial institutions' books for
decades.
Attempts to deal with negative equity must also address the
question of who bears the loss from any write-down of the
mortgage to reduce negative equity and who should benefit from
any future appreciation on written-down mortgage.\128\ Although
affordability is key for short-term success in foreclosure
mitigation, sustainability is equally important in ensuring
future economic stability.
---------------------------------------------------------------------------
\128\ The experience of past housing bubbles suggests that it will
be a decade or more before we see much housing price appreciation.
---------------------------------------------------------------------------
3. Junior Mortgages
Junior mortgages pose a significant obstacle to
restructurings of first mortgages because of junior mortgagees'
ability to free ride on modifications and hold up refinancings.
Any modification that reduces payments on the first mortgage
benefits the junior mortgagee because the modification frees up
income that is available to service the junior mortgage.
Because of this free-riding problem, first mortgagees may be
reluctant to engage in modifications.
Junior mortgagees are also able to stymie refinancings of
first mortgages. Unless the junior mortgagee's consent is
gained, the junior mortgagee gains priority over the
refinancer. As a result, refinancing is extremely difficult
unless the junior mortgagee agrees to remain subordinated, and
junior mortgagees often seek a payment for this. The problem is
particularly acute with totally underwater junior mortgagees,
who only have hold-up value in their mortgage.
Attempts to restructure mortgages for affordability and
sustainability must also have a clear method for dealing with
junior mortgages.
4. Restrictive Pooling and Servicing Agreements (PSAs)
Restrictions on mortgage servicers' ability to modify loans
are an obstacle that has contributed to foreclosures that
destroy value for homeowners and investors alike. For private
voluntary solutions to work on a large scale, mortgage
servicers must be able to modify loans when doing so is value-
enhancing. There are only a limited number of ways to deal with
restrictive PSAs: either abandoning voluntary, servicer-
initiated foreclosure mitigation for some form of involuntary
loan modification or refinancing, including judicial
modification in bankruptcy or narrowly tailored legislation
that voids restrictions on modifying residential mortgage loans
if the modified loan would have a net present value greater
than the foreclosure recovery. Creation of a safe harbor from
legal liability in addition to creating a market standard could
provide an incentive for more workouts by servicers.\129\
Restrictive PSAs must eventually be addressed to ensure
prevention of uneconomic foreclosures.
---------------------------------------------------------------------------
\129\ See Anna Gelpern and Adam J. Levitin, Rewriting Frankenstein
Contracts: Workout Prohibitions in Residential Mortgage-Backed
Securities (Feb. 2009) (Georgetown Public Law Research Paper No.
1323546) (online at papers.ssrn.com/sol3/
papers.cfm?abstract_id=1323546).
---------------------------------------------------------------------------
5. Servicer Incentives
For private solutions to work on a large scale, mortgage
servicers must have appropriate incentives to restructure
loans. Incentives might come via sticks (e.g., loss of future
GSE business, bankruptcy modification of mortgages, and eased
investor and homeowner litigation) or carrots (e.g., per/
modification bounties and litigation safe harbors) or a
combination of both. Proper alignment of servicer incentives
will be necessary to ensure that any foreclosure mitigation
plan is smoothly implemented.
6. Borrower Outreach
The success of any foreclosure mitigation program depends
not only on the quality of loan restructuring, but also on the
number of preventable foreclosures it can help avoid. Key to
maximizing the impact of any foreclosure mitigation program is
putting financially distressed homeowners in contact with
someone who can modify their mortgages. This contact is
essential for any negotiated workout attempt. Servicer outreach
efforts have been hobbled by financially distressed homeowners'
suspicion of servicers and simple unresponsiveness to attempts
to contact them due to repeated dunning. Moreover, many
servicers are not skilled or experienced with outreach. The
Panel believes that TARP funds could be used effectively to
fund outreach efforts through community organizations or
through direct federal efforts.
In addition, the government should consider devoting some
portion of borrower outreach funds to prevention of ``predatory
modifications'' in which businesses charge exorbitant fees to
obtain loan modifications the borrowers could have obtained for
free. Funding could be directed towards a public education
campaign. Credible outreach directly from the government could
tell homeowners what sorts of mortgage help is available, and
could be effectively targeted to high foreclosure zip codes.
Specific security features in the communication could provide
even further reassurance that the communication is not from one
of the fraudsters impersonating the government. Further, the
government should consider whether it has the necessary
personnel, resources, and enforcement authority to crack down
on the predators who misrepresent themselves as being a part of
or acting on behalf of the federal government in negotiating or
providing loan modifications, as well as those who use loan
modifications as another opportunity to rip off vulnerable
consumers.
7. Servicer Capacity
Servicers lack capacity to handle current demand for loan
workouts, and they have no apparent ability to handle a greater
volume of modifications. Foreclosure mitigation plans should
consider methods that would assist servicers to move distressed
homeowners through the system more quickly. For example, a
federal pre-qualification conduit that could be combined with a
temporary stay of foreclosure on pre-qualified loans to speed
the process. While a pre-qualification conduit could take many
forms, utilizing technology, such as a web portal, could
provide even further efficiency and capacity enhancements.
Technology could provide even greater expansion through use of
an automated mitigation process, similar to the automated
underwriting processes employed in making the initial loans.
Following prequalification by the conduit, a borrower could
be put in touch with the servicer who would assign a date and
time for meeting as well as tell the borrower what
documentation is necessary. This orderly process could provide
a temporary stay of foreclosure to people who meet basic
qualifications. Mitigation efforts should also consider methods
for encouraging efficient use of servicing resources, such as
servicers with capacity constraints to enter into subservicing
by servicers with excess capacity.
8. Industry Participation
Any foreclosure plan will ultimately succeed or fail based
on whether millions of troubled loans are diverted from
foreclosure to modification. Whether incentives, mandates, or
some combination are used to drive enrollment, designers of the
plan must always be conscious of the level of industry
participation. Eligibility for borrowers must depend on the
criteria set forth in the plan, rather than the willingness of
the servicer or lender to participate in the foreclosure
mitigation. Only broad servicer and lender participation can
ensure that the plan reaches all or most of the borrowers who
would need the relief offered by the mitigation initiative.
V. POLICY ISSUES
A. ALLOCATION OF LOSSES
Any attempt to address the policy issues involved with the
housing crisis must start with recognition of losses. The
housing crisis has already caused trillions of dollars in
losses, spread among homeowners, financial institutions, and
investors--with trillions more in losses imposed on third
parties, such as neighbors, taxing authorities, and those whose
livelihood are in housing or related industries. Worse, the
losses will continue. Whether these losses are recognized
immediately or loss recognition is delayed, the losses are
real. It may be possible to mitigate some of the losses, but
not all can be avoided. The central question is how to allocate
those losses among various parties. There is no escaping the
distributional question: Any solution to the housing crisis--
including doing nothing--is a distributional decision.
Ultimately, there are two basic distributional choices: letting
the losses lie where they may, or bailing out investors.
1. Let Losses Lie Where They May
Investors and lenders who willingly assumed credit risk
will be stuck with their losses. This is what they bargained
for, no more and no less. Letting losses lie where they may
means that some financial institutions may find themselves
insolvent and need to either be liquidated or recapitalized,
but the United States has well-established methods for doing
so: business bankruptcy, FDIC proceedings, and state insurance
insolvency proceedings. Homeowners, too, will suffer, as
foreclosures will likely proceed apace. Because of other
impediments to mortgage modification, some of these
foreclosures may destroy value for both the investor and the
homeowner. There will be the serious third-party spillover
effects on neighbors, on communities, on local government, and
on other lenders as foreclosures beget more foreclosures and
result in lower foreclosure sale prices.
A second way to allocate losses among private parties would
be to amend the bankruptcy laws to permit judicial modification
of mortgages. This would give lenders and investors at least as
much as the current market value of the property, an amount
that typically exceeds by tens of thousands of dollars the
value released in a foreclosure sale. Such an approach would
also reduce the number of foreclosures, reducing the losses
faced by homeowners and avoiding the deadweight economic loss
and spillover effects imposed on third parties. Bankruptcy
relief would not involve the use of any taxpayer funds to bail
out investors, but it could allow for better outcomes than the
foreclosure process.
Third, the government could seize mortgages and pay
investors just compensation for them, halting the cycle of
foreclosures and declining prices. This would allow the
government to modify the mortgages at will, while providing
investors and lenders with the value of their loans and nothing
more.
a. Bankruptcy modification
It is also possible for mortgages to be modified without
the consent of the mortgage investors. The principal mechanism
to accomplish this would be through bankruptcy proceedings.
Bankruptcy freezes all collection efforts temporarily,
including foreclosures.\130\ Businesses and consumers are able
to restructure all types of loans in bankruptcy, rewriting
mortgages on business properties, rental property and vacation
homes. The sole exception is that mortgages secured by a
person's principal residence cannot be modified.\131\ There is
presently legislation pending in Congress that would amend the
Bankruptcy Code to permit judicially-supervised modification of
all mortgage types in bankruptcy.\132\
---------------------------------------------------------------------------
\130\ 11 U.S.C. Sec. 362(a).
\131\ 11 U.S.C. Sec. 1322(b)(2).
\132\ Helping Families Save Their Homes in Bankruptcy Act of 2009,
S. 61, 111th Cong. (2009); Helping Families Save Their Homes in
Bankruptcy Act of 2009, H.R. 200, 111th Cong. (2009); Emergency
Homeownership and Equity Protection Act, H.R. 225, 111th Cong. (2009).
---------------------------------------------------------------------------
The type of bankruptcy modifications proposed for mortgages
on principal residences differs from the debt restructurings
that are currently permitted for vacation homes or rental
property, if they are modified in Chapter 13. In Chapter 13,
all debts, including the reduced principal amount, must be
repaid within the three-to-five years duration of the
bankruptcy plan. In Chapter 11, by comparison, vacation homes,
rental property and mortgages on all business property can be
stretched over decades. The proposed bankruptcy modification
would permit the modified loan on the principal residence to be
held to maturity and repaid over as much as thirty years. The
length of the anticipated repayment period in the proposed
bankruptcy modification would be more like the treatment of
mortgages on vacation homes, rental property and all business
property in Chapter 11.
Bankruptcy modification would permit homeowners to bypass
all of the obstacles to voluntary loan modification--practical
outreach and staffing problems, restrictive pooling and
servicing agreements, and improperly motivated mortgage
servicers. It could be administered immediately through the
existing bankruptcy court system. Mortgage modification in
bankruptcy would not impose any direct costs to taxpayers.
Bankruptcy modification has some significant limitations.
Because of strict income and property limitations, not all
homeowners would qualify. Even among those who qualified, many
homeowners might be unwilling to file for bankruptcy, either
because of moral reservations or because they are unwilling to
make extensive public declaration of their financial
circumstances, commit all their disposable income for three to
five years to repaying creditors, and commit to living on a
court-supervised, IRS budget for those three-to-five years.
Several concerns have been raised about the adverse
economic impact of permitting judicially-supervised
modification of mortgages in bankruptcy: that it would result
in higher costs of credit and/or less mortgage credit
availability going forward; that it would trigger a flood of
bankruptcy filings that the courts cannot handle; that the
increase in filings would have adverse effects on other
creditors such as credit card lenders; that it would create
additional losses for mortgagees; and that it would force
losses on AAA-rated mortgage-backed securities because of an
unusual loss allocation feature in mortgage-securitization
contracts.\133\ Additionally, concerns have been expressed that
judicial modification of mortgages would reward some homeowners
who undertook cash-out refinances and purchased luxury goods or
services.\134\
---------------------------------------------------------------------------
\133\ See, e.g., Todd J. Zywicki, Don't Let Judges Tear Up Mortgage
Contracts, Wall Street Journal (Feb. 13, 2009).
\134\ See, e.g., id.
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Although there has been significant discussion of the
potential impact of judicial modifications on mortgage credit
price and availability, unfortunately there is not a sizeable
body of academic work that speaks to this point. Mortgage
industry participants such as the Mortgage Bankers Association
have said that permitting judicial modification would result in
a 2 percent across the board increase in mortgage interest
rates and a possible reduction in credit availability.\135\
While they do not have empirical data, they cite the market-
based need for lenders to price to increased risk, including
new legal risk.
---------------------------------------------------------------------------
\135\ House Committee on the Judiciary, Subcommittee on Commercial
and Administrative Law, Statement of David G. Kittle, Mortgage Bankers
Association, Straightening Out the Mortgage Mess: How Can We Protect
Home Ownership and Provide Relief to Consumers in Financial Distress?--
Part II: Hearing on H.R. 3609, 110th Cong., at 3 (Oct. 30, 2007)
(online at judiciary.house.gov/hearings/pdf/Kittle071030.pdf) (2
percent rate increase claim); Letter from Stephen A. O'Connor, Senior
Vice President of Government Affairs, Mortgage Bankers Association, to
Representative Brad Miller (Apr. 18, 2008) (providing alternative
calculation and 1.5 percent rate increase claim).
---------------------------------------------------------------------------
The only independent, empirical research on the effect of
permitting judicial modification of home mortgages indicates
the opposite: that it is unlikely to result in more than a de
minimis increase in the cost of mortgage credit or reduction in
mortgage credit availability.\136\ The data show that when they
price mortgages or mortgage insurance for non-homestead
property where judicial modifications are allowed, lenders have
not raised prices to deal with possible write downs in
bankruptcy. This finding is consistent with basic economic
theory: so long as lenders' losses from loan modification in
bankruptcy would be smaller than those in foreclosure, lenders
will not price against bankruptcy modification.
---------------------------------------------------------------------------
\136\ Levitin, supra note 14.
---------------------------------------------------------------------------
Making meaningful bankruptcy relief available to
financially-distressed homeowners would, in the absence of
another foreclosure mitigation option, likely result in an
increase in bankruptcy filings. There is no reason, however, to
believe that the bankruptcy courts would be overwhelmed by the
rise of filings.\137\ As Professor Michelle J. White, President
of the American Law and Economics Association, has observed,
there was a dramatic spike in filings in the fall of 2005,
before the effective date of the Bankruptcy Abuse Prevention
and Creditor Protection Act of 2005, and the bankruptcy court
system successfully handled the filing volume with more limited
staffing than currently exists.\138\ Moreover, much of the
workload in bankruptcy cases is not handled by judges, but
rather by debtors' attorneys and Chapter 13 trustees; judges
would not decide on the terms of a mortgage modification, but
would merely approve or deny the requested modification
depending on whether it conformed to statutory requirements.
The valuations that are necessary in any proposal to modify
home mortgages are similar to the work that bankruptcy courts
do every day in valuing business real estate, equipment, cars,
partnerships, and all other kinds of property.
---------------------------------------------------------------------------
\137\ See Alan Schwartz, Don't Let Judges Fix Loans, New York Times
(Feb. 27, 2009). Likewise, Professor Schwartz's concerns about
interminable valuation litigation are unfounded; after a handful of
initial valuation decisions in each bankruptcy court, settlement
parameters will become clear, so parties will settle on valuation
rather than engage in expensive litigation.
\138\ Michelle J. White, Bankruptcy: Past Puzzles, Recent Reforms,
and the Mortgage Crisis, at 18 (Dec. 2008) (National Bureau of Economic
Research Working Paper 14549) (online at www.nber.org/papers/w14549).
---------------------------------------------------------------------------
An increase in bankruptcy filings could create additional
losses for credit card lenders. On the other hand, it is
possible that families who can get some mortgage relief will be
more stable economically and more able to pay off their credit
cards and other loans.
Bankruptcy losses might not fall within the normal senior/
subordinate tranching of MBS. But modification of mortgages in
bankruptcy would not create mortgage losses where they
otherwise do not exist. Instead, bankruptcy merely forces
recognition of existing losses. Bankruptcy requires that a
secured lender must receive at least the fair market value of
the collateral.\139\ In the case of a homeowner facing
foreclosure, this amount is often far in excess of the amount
the lender would receive through foreclosure. If bankruptcy is
viewed as an alternative to foreclosure, it should not create
new losses on mortgages and may, in fact, save mortgage lenders
money.
---------------------------------------------------------------------------
\139\ 11 U.S.C. Sec. 1325(a)(5).
---------------------------------------------------------------------------
As discussed in the section on moral hazard, infra, any
foreclosure mitigation effort will inevitably create concerns
about both spendthrift homeowners and irresponsible lenders
abusing the system by socializing losses; there is nothing
specific to bankruptcy in these important concerns. Unlike
other bailout proposals, however, bankruptcy already has
important safeguards against abuse by debtors.\140\ As a
further safeguard, some have suggested crafting bankruptcy
modification to focus on situations in which borrowers have
made a good faith effort to obtain a mortgage modification
prior to filing for bankruptcy, and there is no evidence of
borrower fraud.
---------------------------------------------------------------------------
\140\ See 11 U.S.C. Sec. Sec. 1325(a)(3) (good faith filing of
bankruptcy petition required), 1325(a)(7) (requiring good faith plan
filing); 1325(b) (requiring all of a debtor's disposable income be paid
to unsecured creditors); 1328(a) (exceptions to discharge).
---------------------------------------------------------------------------
Regardless of how these concerns about bankruptcy
modification are resolved, bankruptcy modification by itself is
unlikely to solve the foreclosure crisis. Credit Suisse
estimates that permitting modification of mortgages in
bankruptcy would prevent 20 percent of foreclosures.\141\ The
ability to declare bankruptcy to deal with a mortgage in
default would, however, likely change the non-bankruptcy
negotiations. Currently, homeowners who are unable to make
their mortgage payments have few options other than to force
the lender to go through foreclosure proceedings or to plead
for the lender to modify the mortgage. A homeowner who could
credibly threaten to file for bankruptcy might find that
servicers were more responsive and that lenders were more
willing to make modifications available.
---------------------------------------------------------------------------
\141\ Credit Suisse Fixed Income Research, Bankruptcy Law Reform: A
New Tool for Foreclosure Avoidance (Jan. 26, 2009) (online at
www.affil.org/uploads/3r/NH/3rNHuGFNnZ2Of5BEwiAeqw/Credit-Suisse-
1.29.09-Bankruptcy-Reform.pdf).
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In the absence of a convincing voluntary modification or
refinancing program, bankruptcy modification presents one
option for immediate foreclosure mitigation.
b. Takings
Another way of letting losses lie where they may while
mitigating the impact of uneconomic foreclosures would be for
the federal (or state) government to seize mortgages under
eminent domain power.\142\ These takings are essentially
government conversion of property, for which just compensation
(not necessarily full face value) must be paid. If the
government took mortgages, it could modify them at will.
Although the costs of a large-scale takings of mortgages are
unknown, it would at the very least implicate significant
taxpayer funds and might raise Constitutional issues. Takings
would not result in an investor bailout, however. Investors and
lenders would get the value of their loans and nothing more.
Thus, takings provides a way to mitigate the impact of wealth-
destroying foreclosures while not changing contractual loss
allocation rules.
---------------------------------------------------------------------------
\142\ Howell E. Jackson, Build a Better Bailout, Christian Science
Monitor (Sept. 25, 2008) (online at www.csmonitor.com/2008/0925/p09s02-
coop.html); Lauren E. Willis, Stabilize Home Mortgage Borrowers, and
the Financial System Will Follow (Sept. 24, 2008) (Loyola-Los Angeles
Legal Studies Paper No. 2008-28) (online at papers.ssrn.com/sol3/
papers.cfm? abstract_id=1273268).
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2. A Bailout for Investors
Rather than leaving the losses among private parties, the
government can bail out investors, as it has already done in
the automotive, insurance, and banking sectors. A bailout of
investors could be direct, such as through government purchases
of troubled assets, guarantees of bank obligations, loans, or
direct government investments. A bailout could be indirect,
through foreclosure mitigation programs that facilitate
restructuring troubled mortgages so as to maximize their value.
There are many potential variations for how to construct a
direct or indirect bailout, but they all aim toward socializing
losses to some degree by shifting them from investors to the
taxpayers.
Indirect bailouts of investors might involve helping
homeowners and minimizing the third-party spillover effects of
foreclosures as well, but whether money goes directly to
homeowners to pay their mortgages or directly to investors
holding the mortgages, the effect is to bail out the investors.
A bailout of investors need not make them whole, of course. If
investors are expecting 25 cents on the dollar (the price at
which many RMBS are trading currently), then a program that
gives them a return of 50 cents on the dollar gives them a
significant bailout without making them whole. It is also
possible for responses to the foreclosure crisis to split the
difference between the options of letting losses lie where they
may and bailing out investors. Unfortunately, it seems that
many investors are dissatisfied with receiving only a partial
bailout that would result in substantially higher returns than
offered on the market currently because they are hoping that
the taxpayers will give them a full bailout and not require
them to recognize their losses.
3. Bailout for Homeowners
There has been a great deal of popular concern about
bailouts of irresponsible homeowners. These are the people who
purchased too much house and lived too large, those who cashed
out home equity and squandered it on frivolous items, or those
who used home equity to pay off credit card debts or medical
bills. The culture of conspicuous consumption is an
appropriately troubling issue for many Americans, and it goes
far beyond home mortgages into every area of the consumer
economy. The Panel understands and sympathizes with the
frustration and resentment of hard-working Americans who played
by the rules and lived within their means. It is affirmatively
unfair to ask these citizens to shoulder the expense of their
neighbors' profligacy, just as it is unfair to ask taxpayers to
shoulder the hundreds of billions of dollars of costs to bail
out banks and insurance companies that reaped huge profits and
took enormous risks and are now in shambles.
In the mortgage market, it is difficult to know where the
just and the unjust sit. For every homeowner who used a second
mortgage to finance a vacation, how many homeowners were
tricked into signing documents they did not understand? How
many were steered into more expensive mortgages so that a
mortgage broker could pick up a few thousand dollars more? How
many were told that they were refinancing so that their
payments would fall, only to discover that they had signed on
only for a teaser rate whose expiration would cost them their
homes? As mortgage products got more dangerous and the housing
market inflated, profligacy and scams traveled the same paths.
While it is tempting to see foreclosure mitigation programs
as saving deserving homeowners while potentially rewarding
irresponsible homeowners, the alternative is either a direct
bailout of investors or letting losses lie where they may. The
former may be even less palatable to many Americans, while the
latter risks tremendous deadweight economic losses and powerful
spillover costs. The enormous losses from the housing bubble
can be allocated only one way or the other.
It is also important to acknowledge that neither of the two
basic loss allocation options offers homeowners a bailout.
Homeowners would not receive a windfall under any of the plans
proposed. Under every proposal, if homeowners cannot pay at
least the current market value of their homes, they will lose
them. There is no proposal to assist homeowners without a
source of income or those who bought a house that is simply
more expensive than they can afford. They will lose their
homes. Instead, the most generous proposals permit families to
stay in place and pay the current market value for the home--
the same way a new purchaser would. This is the result that
would occur in a perfectly functioning market; lenders would
restructure loans that could perform to market. Government
programs that merely correct market failures are not bailouts.
Insisting that homeowners make payments that were part of a
bargain struck in a different financial universe would bind
homeowners in a way that businesses are not bound. It would
also turn the sanctity of contract into a social suicide pact
with enormous spillover effects on neighbors, on communities,
on local governments, and on the entire economy.
4. Moral Hazard and Externalities
a. Moral hazard
Moral hazard is an important issue for any foreclosure
mitigation plan to address. Moral hazard arises when persons or
institutions do not bear the full consequences of their
actions, as they may act less carefully than otherwise. To the
extent that homeowners or lenders are shielded from the
consequences of ill-advised mortgages, it rewards past
mistakes, while it sets a precedent that may encourage
excessive risk-taking in the future.
Moral hazard concerns exist for both homeowners and lenders
(including MBS investors). To the extent that government
foreclosure mitigation efforts relieve homeowners who entered
into poorly-considered mortgages, either out of failure to
undertake proper diligence, unwarranted financial optimism, or
outright borrower fraud, a moral hazard concern is created.
Similarly, a moral hazard concern would exist with any
reduction in negative equity for homeowners who engaged in cash
out refinancings that tapped out their home equity, leaving
them vulnerable to ending up in a negative equity position.
Moral hazard concerns also exist for lenders and investors.
To the extent that government foreclosure mitigation efforts
spare lenders and investors from losses that they would have
otherwise incurred because of poorly underwritten loans, it
rewards reckless past lending and encourages future
irresponsibility. The originate-to-distribute lending system
allowed lenders to ``cash out'' too, by selling securitized
loans to capital market investors, taking the profits and
running before the losses became apparent. Many of these
lenders purchased the securitized loans themselves without due
diligence or, worse, knowing that the assets were built on an
unsustainable model. Relieving these lenders from losses on the
MBS they purchased would shield them from the consequences of
their actions.
Yet it is important to remember that moral hazard concerns
exist only when homeowners or lenders do not bear the
consequences of their actions. When a mortgage ends up in
distress due to factors over which the homeowner or lender had
no control, there is no moral hazard issue. The risks of
complex, exotic mortgage products were not always properly
explained to homeowners. Brokers and lenders encouraged
homeowners to take out loans that they knew would become
unaffordable by pushing low teaser rates and the promise of
refinancing at the end of the teaser period. Other homeowners
were fraudulently placed into mortgages that they could not
afford. Likewise, many homeowners have found themselves deeply
underwater because of the fall in housing prices, fueled in
part by foreclosures. And no fault can be found with homeowners
who find their income impaired because of unemployment due to a
general economic turndown, illness, divorce, or death.
Similarly, lenders and investors who conducted proper
diligence and sold safe mortgage products, such as traditional
fixed-rate, fully-amortizing conventional loans, cannot be
faulted for mortgage defaults which were not predictable and
over which they had no control. These lenders and investors
have been hurt by the downward spiral of housing prices fueled
in part by other lenders' and investors' irresponsible lending
and by other mortgagors' irresponsible borrowing, as well as
general economic factors.
b. Contagion fires
There is an important exception to moral hazard, one for
so-called ``contagion fires.'' \143\ The contagion fire
exception holds that when third parties bear the costs of ill-
advised decisions, moral hazard concerns should give way to
action. For example, when the fire department rescues people
who cause fires by smoking in bed, it creates a moral hazard,
because the smokers do not have to face the full consequences
of their actions. But if there were no government intervention,
the fires could easily spread and injure innocent neighbors.
---------------------------------------------------------------------------
\143\ Lawrence Summers, Beware Moral Hazard Fundamentalists,
Financial Times (Sept. 23, 2007).
---------------------------------------------------------------------------
While the actions of some homeowners and lenders and
investors have proven irresponsible and troubling, the current
foreclosure crisis bears many of the marks of a ``contagion
fire'' that counsels for intervention. Foreclosures have
tremendous third-party costs, as discussed, supra, in Part I.
Like a contagion fire, a foreclosure can damage neighboring
properties by depressing neighbors' property values.\144\ In so
doing, they depress property tax revenues that must be made up
with higher tax rates or decreased services.\145\ Foreclosures
spur crime, fires and neighborhood blight.\146\
---------------------------------------------------------------------------
\144\ See Immergluck and Smith, supra note 22.
\145\ See, e.g., Johnston, supra note 23; Global Insight, supra
note 23.
\146\ See Immergluck and Smith, supra note 25; Apgar and Duda,
supra note 25; Apgar et al. supra note 26.
---------------------------------------------------------------------------
Foreclosures are also contributing to continued financial
market instability. So long as they continue at unpredictably
high levels, mortgage-backed securities and derivatives
products will remain toxic, difficult to value and unattractive
in any portfolio. These impaired assets, in turn, make the
solvency of many financial institutions suspect. These third-
party costs of foreclosures are not always apparent because
they are not directly imposed, but they are real and very
costly nonetheless, and they offset much of the moral hazard
concerns associated with foreclosure mitigation efforts.
Ideally, a foreclosure mitigation program would be able to
sort through borrowers and lenders, to help those honest but
unfortunate ones who acted responsibly and to deny assistance
to those who behaved strategically. Sorting between responsible
and irresponsible borrowers and lenders is an inherently
difficult process that is complicated by the inevitable trade-
off between speed and precision. Foreclosure mitigation can be
done slowly and precisely on an individualized basis or quickly
through wholesale measures. While precision is desirable, time
is also of the essence. The longer the foreclosure crisis drags
on, the more injury is imposed on responsible homeowners and
lenders and the longer and deeper the financial crisis will be.
Finally, there is no escaping the fact that there are
serious losses in the mortgage market. Currently, those losses
are allocated to homeowners, who lose their homes and any
equity they have in them, and to mortgage lenders and their
investors. There will be a good number of mortgages that cannot
successfully be restructured on any reasonable economic terms.
These include many investor-owned properties. For these
mortgages, foreclosure is the only likely outcome.
But for foreclosures that can be averted on reasonable
economic terms, loan restructuring inevitably involves some
level of losses and an allocation of those losses. The
distributional issues involved in the loss allocation are
ultimately political questions. To be convincing, however, the
answer must be clearly articulated and must relate to the risks
that parties willingly and knowingly assumed and what the
parties could expect to receive absent a foreclosure mitigation
program. Some have suggested that attempts to deal with
negative equity by mandating principal write down could be
paired with plans for equity sharing plans, so that the
distributional consequences are mirrored both as to losses and
as to future gains. When businesses restructure loans, they are
not required to share any future appreciation, which means this
restriction would be imposed only on homeowners.
As Chart 10 shows, negative equity is the single best
indicator that a property is likely to enter foreclosure, and
the downward pressure on home prices from foreclosures begets
more negative equity, which in turn begets more foreclosures.
As Chart 12 shows, likelihood of default corresponds very
strongly with loan-to-value ratios--the more deeply underwater
a property is, the more likely a default and a foreclosure are.
The problem of contagion fires is real--our neighbors' houses
are on fire with foreclosures, and the fire is spreading to
ours. In these circumstances, we should be concerned with
putting out the fire, not questioning our neighbor's past
financial judgments.
B. FORECLOSURE MORATORIUM
While the Panel does not make a specific recommendation,
another policy option for consideration is a foreclosure
moratorium. During the foreclosure crisis of the Great
Depression, many states implemented foreclosure moratoria or
took other steps to add delay to the foreclosure process.\147\
These moratoria were upheld by the Supreme Court of the United
States.\148\ In the current crisis, a few states have changed
their foreclosure laws to delay the process.\149\ There have
also been proposals for a federal foreclosure moratorium or
other measures to slow down foreclosures.\150\ The Washington
Post praised Maryland for passing ``some of the nation's most
ambitious legislation'' in the wake of the foreclosure crisis,
including foreclosure timetable extensions and a variety of
other reforms.\151\ Additionally, some local law enforcement
officials charged with overseeing the foreclosure process, such
as the Sheriffs of Cook County, Illinois and Philadelphia
County, Pennsylvania, have refused to conduct foreclosure
auctions or evictions.\152\ By and large, however, states have
not elected to change their laws to slow the foreclosure
process.
---------------------------------------------------------------------------
\147\ D.P.K., Comment, Constitutional Law--Mortgage Foreclosure
Moratorium Statutes, 32 University of Michigan Law Review, at 71 (1933)
(noting that, in 1933, twenty-one states enacted legislation that
functioned as foreclosure moratoria). Depression-era foreclosure-
moratorium statutes seem to have either extended the period of
redemption post-foreclosure, prohibited foreclosures unless the sale
price was at some minimum percentage of property appraisal, or granted
state courts the power to stay foreclosures. Id.
\148\ Home Building & Loan Association v. Blaisdell, 290 U.S. 398,
437 (1934) (upholding Depression-era Minnesota foreclosure moratorium
in face of contracts-clause challenge, and noting that economic
conditions of the Depression ``may justify the exercise of its
continuing and dominant protective power notwithstanding interference
with contracts'').
\149\ Cal. Civ. Code, at Sec. Sec. 2923.5-6 (West 2008) (imposing
delay and a net present value maximization requirement); Mass. Gen.
Laws, at ch. 244, Sec. 35A(a) (2008) (imposing ninety day pre-
foreclosure cure period); Md. Code Ann., Real Prop., at Sec. Sec. 3-
104.1, 7-105.1 (LexisNexis 2008) (requiring post-default delay and
specific form of service for foreclosure actions).
\150\ See, e.g., Home Retention and Economic Stabilization Act of
2008, H.R. 6076, 110th Cong., at Sec. 128A(a)(2) (2008) (providing for
deferral of foreclosure up to 270 days if, inter alia, minimum payments
were made); Minnesota Subprime Foreclosure Deferment Act of 2008, H.F.
3612, 2008 Leg., 85th Sess. (Minn. 2008) (providing for foreclosure
deferral up to one year if, inter alia, minimum payments were made)
(online at www.revisor.leg.state.mn.us/bin/getbill.php?number
=HF3612&session=ls85&version=list&session_number= 08session_year0);
Senator Hillary Clinton, Details on Senator Clinton's Plan to Protect
American Homeowners (Mar. 24, 2008) (online at 2008central.net/2008/03/
24/clinton-press-release-clinton-calls-for-bold-action-to-halt-housing-
crisis).
\151\ National Governors Association, Center for Best Practices,
State-by-State Listing of Actions to Tackle Foreclosures (Feb. 22,
2009); Philip Rucker, Sweeping Bills Passed to Help Homeowners,
Washington Post (Apr. 3, 2008).
\152\ Ofelia Casillas and Azam Ahmed, Sheriff: I Will Stop
Enforcing Evictions, Chicago Tribune (Oct. 9, 2008); Jeff Blumenthal,
Moratorium on Sheriff's Foreclosure Sales Draws Debate, Philadelphia
Business Journal (Apr. 4, 2008) (online at
philadelphia.bizjournals.com/philadelphia/ stories/2008/04/07/
story10.html).
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There are three reasons to consider implementing steps to
slow down the foreclosure process. First, delay could
facilitate loan workouts by making the foreclosure process more
costly for servicers and lenders. Delay means that lenders must
carry non-performing loans on their books longer. Unless the
property sells for more than the principal balance due, the
lender will have, at best, a hard-to-collect, unsecured
deficiency claim for the interest that accrued between the time
the foreclosure was commenced and completed, and if the loan is
non-recourse, then the lender will not even have a deficiency
judgment. For servicers, delay imposes costs too because
servicers must advance delinquent payments to MBS investors out
of pocket. These advances are reimbursed off the top of
foreclosure sale or REO sale proceeds, which reduces servicers'
incentive to sell foreclosed and REO properties for top dollar,
but the reimbursement does not include the time value of the
money, which can be considerable if a foreclosure takes 18-24
months.
Second, to the extent that new foreclosure mitigation
programs take time to implement, delay would allow the programs
to help more homeowners. Thus, a foreclosure moratorium or
other delay in the foreclosure process could be used to smooth
the transition to a new foreclosure mitigation program.
Third, delay could also help ease some of the servicer
capacity concerns, discussed infra section III. It is important
to recognize that foreclosure moratoria or other delays in the
foreclosure process need not be across-the-board solutions that
apply to all homeowners. A foreclosure moratorium could be
targeted to specific classes or loans or borrowers. For
example, a targeted foreclosure moratorium could be used to
facilitate servicer triage and ease capacity problems. To
utilize servicer capacity with maximum efficiency, it is
necessary to have a streamlined process for sorting and
triaging modification requests. Many servicers have their own
triaging methods, but a centralized triage system that would
sort or pre-qualify homeowners for modifications might help
ease servicer capacity issues, and could possibly be combined
with a government outreach program. A prequalification program
could be combined with a moratorium on foreclosures on
prequalified loans until a good faith effort has been made to
modify the loan. Government outreach would also allow servicers
to focus resources on modification programs.
To the extent that delay from a de facto or de jure
foreclosure moratorium is positive, it would function much like
the current bankruptcy system: the automatic stay stops
foreclosure proceedings, but unless the homeowner can cure and
reinstate the mortgage, the stay will be lifted.\153\ In other
words, a foreclosure moratorium is only a temporary solution.
The real problem of modifying the mortgage has been pushed down
the line to be solved elsewhere--or not at all.
---------------------------------------------------------------------------
\153\ 11 U.S.C. Sec. Sec. 362(d), 1322(b)(5), 1322(c).
---------------------------------------------------------------------------
Any consideration of a foreclosure moratorium should be
mindful, however, of the potential costs. It is possible that
delay might merely create a greater backlog of modification
requests and place greater strains on servicer capacity. Delay
could also affect future mortgage-credit availability and
cost.\154\ Delay could prevent some economically efficient
foreclosures.
---------------------------------------------------------------------------
\154\ Karen M. Pence, Foreclosing on Opportunity: State Laws and
Mortgage Credit, Review of Economics and Statistics, at 180 (2006)
(online at works.bepress.com/cgi/
viewcontent.cgi?article=1001&context=karen_pence).
---------------------------------------------------------------------------
Again, this raises the question of whether the economic
efficiency of foreclosures should be viewed in the context of
individual foreclosures or in the context of the macroeconomic
impact of widespread foreclosures. If the former, then caution
should be exercised about foreclosure moratoria and other forms
of delay to the extent it prevents efficient foreclosures. But
if the latter is the proper view, then it may well be that some
individually efficient foreclosures should nonetheless be
prevented in order to mitigate the macroeconomic impact of mass
foreclosures.
VI. THE HOMEOWNER AFFORDABILITY AND STABILITY PLAN
A. DESCRIPTION
On February 18, 2009, President Obama announced the
Homeowner Affordability and Stability Plan (the ``Plan''), a
proposal to prevent unnecessary foreclosures and to strengthen
affected communities. The Panel is encouraged with the renewed
emphasis on foreclosure mitigation. The financial crisis facing
the nation cannot be resolved without effectively addressing
the underlying problem of foreclosures.
The Administration released additional guidelines for the
Plan on March 4, as this report was prepared for publication.
Because some of the issues raised by the Plan may be addressed
in these guidelines, the Panel will defer our follow-up
questions until a review of the Plan guidelines has been
completed. The Panel will promptly pursue any outstanding
issues with the Treasury Department and will keep Congress and
the American people advised of its ongoing evaluation of the
Administration's Plan.
The Plan as initially described involves three main parts.
1. Refinancings
In the first part, borrowers with mortgages owned or
guaranteed by Fannie Mae and Freddie Mac, estimated to be
between one-third and half of all mortgages, will be able to
refinance their mortgages to current low interest rates with
Fannie Mae or Freddie Mac. Refinancing will be authorized even
if the ratio of the loan to the current market value of the
home would be more than 80 percent, up to 105 percent. The
Administration estimates that this will provide expanded access
to refinancing and affordable payments for four to five million
responsible homeowners. These refinancings will not be
available to speculators, and will target support to working
homeowners who have made every effort to remain current on
their mortgages.
2. Modifications
The second part of the Plan is targeted at borrowers with
high mortgage debt to current income, or whose mortgage is
greater than the current value of the home, particularly
subprime borrowers whose loans are held in private portfolios.
The scope of the modification program is comprehensive, and
includes early intervention for borrowers who are still current
but are at risk of imminent default. This program will
encourage lenders, investors and servicers to modify the
mortgage to a more affordable rate.
The Administration projects that three to four million
homeowners at risk of default would be helped by this aspect of
the Plan, which involves the commitment of $75 billion in
government funds. All institutions receiving Financial
Stability Plan financial assistance going forward will be
required to engage in loan modification efforts that are
consistent with the Treasury guidelines released on March 4.
The guidelines will also set new standards for all federally-
supervised institutions. Based on the initial announcement of
the Plan, the modification aspect will contain the following
elements, to be expanded upon in the new guidelines:
Debt Ratios. The lender would be expected to
reduce the mortgage interest rate to an affordable level where
front end DTI would be 38 percent. Thereafter, the Treasury
Department will match further interest rate reductions on a
dollar-for-dollar basis to a DTI of 31 percent. The Treasury
would not subsidize interest rates below 2 percent. Lenders and
servicers could reduce principal rather than interest and would
receive the same matching funds that would have been available
for an interest rate reduction.
Counseling. If the borrower had a back-end debt
ratio of 55 percent or more, he or she must enter a debt
counseling program.
Incentives. There are a number of incentives to
encourage program participation and a focus on successful
outcomes. First, servicers will receive an up-front fee of
$1,000 for each modification. Second, servicers will receive
``pay for success'' fees as long as the borrower stays current
on the loan. This fee will be paid monthly, up to $1,000 per
year for three years. Borrowers will receive a monthly balance
reduction up to $1,000 per year for five years, as long as they
stay current on their payments. There will be an incentive
payment of $1,500 to the mortgage holder and $500 to the
servicer for modifications made while the loan is still
current. Finally, incentive payments will be available to
extinguish second liens.
Guarantees. The Treasury Department will also
provide $10 billion for the creation of a home price decline
reserve fund. In this partial guarantee initiative, holders of
modified mortgages under the Plan would be provided with
insurance payments that could be used as reserves in the event
that home prices fall and associated losses increase. The
payments would be linked to declines in the home price index.
The goal is to discourage lenders and servicers from pursuing
foreclosure at the present due to weakening home prices.
Bankruptcy. The Plan contains a narrow amendment
to the bankruptcy laws to provide in terrorem encouragement for
modifications. Under such an amendment, bankruptcy judges would
have the authority to modify to a limited extent mortgages
written in the past few years where the size of the loan is
within the Fannie Mae/Freddie Mac conforming loan limits. The
judge would be allowed to treat the amount of the mortgage loan
in excess of the current value of the home as unsecured, and to
develop an affordable repayment plan for the homeowner with
respect to the balance. As a condition to receiving this
reduction, the homeowner must first have asked the mortgage
lender or servicer for a modification and certify to the judge
that he or she has complied with reasonable requests from the
lender or servicer to provide information about current income
and expenses.
FHA and Housing Support. The Plan includes
enhancements to Hope for Homeowners, the existing FHA refinance
program for troubled borrowers. Fees for participation will be
reduced, and other program parameters such as debt ratios for
qualification, will be expanded. Additionally, to address the
community impact of foreclosures, HUD will provide $2 billion
in competitive Neighborhood Stabilization Program grants and
$1.5 billion in assistance to displaced renters.
The lender or servicer would have to keep the modified payment
in place for five years. Thereafter, the rate could be
increased gradually to the GSE conforming rate in place at the
time of the modification. Loan modification would only be
expected if the net cost of the reduction would be less than
the net cost of a foreclosure.
3. Supporting Low Mortgage Interest Rates
A third part of the Plan focuses on supporting low mortgage
interest rates by strengthening confidence in Fannie Mae and
Freddie Mac. Using funds that Congress already authorized apart
from the TARP, the Treasury Department will increase its
purchase of preferred stock in these government-sponsored
entities from $100 billion to $200 billion each. Additionally,
the size of the GSEs' retained mortgage portfolios will be
increased by $50 billion to $900 billion. The Treasury
Department will also continue to purchase Fannie Mae and
Freddie Mac mortgage-backed securities to provide liquidity and
further instill market confidence. Collectively, this package
of support to the GSEs is intended to support low mortgage
interest rates and thereby provide more affordable payments to
homeowners.
B. HOW DOES THE PLAN MEASURE UP AGAINST THE CHECKLIST?
Many of the details of the Homeowner Affordability and
Stability Plan are scheduled to be announced on March 4, just
two days before the Panel's March report. Consequently, the
Panel will not be able to perform an assessment of the plan
before the publication of the March report. Based on the Plan's
initial term sheet to date, however, many of the Plan's
elements address the major impediments to successful
foreclosure mitigation and other recommendations that are
highlighted in this report and specifically included in the
checklist.
1. Affordability
The centerpiece of the Plan is encouraging more affordable
mortgages where doing so would result in greater net present
value to the mortgage lender or owner than a foreclosure. The
GSE Plan would significantly reduce interest rates, which
should result in significantly lower mortgage payments for
certain eligible homeowners. The Loan Mod Plan will result in a
borrower's front-end DTI ratio being reduced to 31 percent for
eligible homeowners. Although the Loan Mod Plan measures
affordability using front-end DTI, it would collect information
on back-end DTI and a borrower with a back-end DTI of 55
percent or higher would have to agree to credit counseling.
2. Negative Equity
The Plan does not deal with mortgages that substantially
exceed the value of the home. It allows homeowners with
mortgages guaranteed by Fannie Mae or Freddie Mac to refinance
to a lower rate only if the amount of the mortgage does not
exceed 105 percent of the current appraised value.\155\ In
areas in which property values have dropped significantly, this
limitation may prove highly constraining. In an area that has
seen a 40 percent drop in home values, for example, a home that
had been purchased three years ago for $200,000, might easily
have a mortgage of $160,000 or more. But if current property
values place the home at $120,000, the homeowner is not
eligible for modification. In effect, the homeowners most at
risk for foreclosure because of negative equity will be shut
out of the program.
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\155\ The Panel is concerned whether the GSEs have the statutory
authority to carry out the refinancings called for by the Plan. The GSE
cannot generally own or guarantee mortgages originated at above 80
percent LTV absent mortgage insurance. It is unclear whether existing
insurance coverage would continue on refinanced loans or whether new
insurance could be placed on the refinanced loans. The Panel inquired
with FHFA on the matter and was sent a copy of an FHFA letter to the
Executive Vice President of Mortgage Insurance Companies of America
that did not resolve the matter or respond to all of the Panel's
inquiries. The Panel intends to address this issue in future reports.
---------------------------------------------------------------------------
Additionally, in order to provide an incentive to lenders
who are reluctant to modify mortgages because they fear further
real estate price declines, the Administration and the FDIC
have developed an insurance fund of up to $10 billion that will
provide partial guarantees against further drops in real estate
values by making payments to the lender based on declines in a
home price index. The partial guarantee may mitigate the
incentive for lenders to foreclose when prices are falling,
creating negative equity.
To the extent that the Plan also includes bankruptcy
modification, the problem of negative equity could be
addressed. Because the proposed amendment would give bankruptcy
judges the power to write mortgages down to 100 percent of the
value of the home, negative equity would disappear. As noted
earlier, not all homeowners would be eligible for bankruptcy,
and not all of those who are eligible would be willing to file.
Nonetheless, the combination of the bankruptcy amendment and
the Plan's mortgage modification options would help address
negative equity.
3. Junior Mortgages
While the efforts to help homeowners are encouraging, it is
important to note that the plan does not fully deal with second
mortgages. While incentive payments will be available to
extinguish junior mortgages when primary loans are modified, it
is not clear whether the payments will be a sufficient
enticement for the lien holder to agree. The high rate of
second mortgages at the time of loan origination, combined with
the unknown number of second mortgages added after the loans
were completed, particularly by families under financial
stress, suggest that the number of homes in foreclosure that
are encumbered by two mortgages may be substantial. Those
second mortgages must be paid, in full and on time, or the home
will remain subject to foreclosure, this time by the holder of
the second mortgage. These second mortgages can substantially
impair affordability, undermining the effects of modifying
first mortgages.
Further, even if the first mortgage can be refinanced
because it fits within the Plan's 105 percent limitation, the
failure to deal with the second mortgage may mean that the home
continues to carry substantial negative equity. If the
refinancing does not address the negative equity, then its
benefits in preventing foreclosure may be sharply limited.
4. Dealing with Pooling and Servicing Agreements
The Plan does not deal with pooling and servicing
agreements. There is no safe harbor for servicers of
securitization pools who modify mortgages despite restrictive
pool and servicing agreements. By providing uniform guidelines
for loan modifications, the plan helps to establish a standard
of reasonable conduct. Moreover, by paying mortgage holders
$1,500 for each modification completed before a loan becomes
delinquent, the servicer is better able to demonstrate that the
net present value of a modification exceeds the value of
foreclosure. Whether these modest adjustments will be adequate
to deal with the impact of restrictive PSA agreements, and
whether they will be adequate to offset the fear of mortgage
servicers that they may incur legal liability if they modify
securitized mortgages, is an open question.
5. Servicers Incentives
Under the Plan, servicers would receive a number of
inducements to participate in the program. They will receive an
up-front fee of $1,000 for each modification, with an
additional $500 for each modification made on current loans. In
addition, they will be eligible for ``pay for success'' fees so
long as the borrower remains current on the loan. This fee will
be paid monthly, up to $1,000 per year for three years. To
address servicer or investor fears about the high re-default
rates on previous modification, the Administration Plan adds
incentives for borrowers to stay current. Borrowers will
receive a monthly balance reduction up to $1,000 per year for
five years, as long as they stay current on their payments.
Again, whether these incentives are adequate to offset the
current financial advantages to pursuing foreclosures remains
an open question.
6. Borrower Outreach
The Plan also addresses the serious outreach problems
facing any loan modification program. First, HUD will make
unspecified funding available for non-profit counseling
agencies to improve outreach and communications, although there
is an absence of direct federal communication to homeowners.
Second, it would avoid some of the difficulties in
communication between servicers and borrowers by paying
incentive fees of $1,500 to the mortgage holder and $500 to the
servicer for modifications made while the loan is still
current.
7. Capacity
To the extent that the Plan promotes more outreach and is
effective, there will be a surge of borrowers seeking
modifications and further straining capacity. The incentive
fees might be used to help address some of this need,
offsetting some of the capacity strain. On the other hand, to
the extent that the incentive fees are consumed in greater
operational costs, the power of the incentive declines, leaving
servicers to continue their current practices of pursuing
foreclosures.
8. Industry Participation
The Plan encourages industry participation through a
combination of carrots and sticks. The various incentive and
success fees should encourage lender participation. However, it
remains to be seen whether the levels are sufficient to compel
widespread servicer and lender participation, especially given
the investments they will need to make to handle the expected
business surge. The bankruptcy provisions could provide an
incentive for lenders to engage in stronger foreclosure
mitigation efforts. Treasury also announced that going forward,
all financial institutions receiving assistance under TARP will
be required to engage in loan modification efforts consistent
with new Treasury guidelines. It is likely that this provision
will provide the strongest incentive for lender participation
in the near future.
-------------------------------------------------------------------------------------------------------------------------------------------------
Checklist for Mortgage Mitigation Program
------------------------------------------------------------------------
Will the plan result in modifications that create affordable monthly
payments?
------------------------------------------------------------------------
Does the plan deal with negative equity?
------------------------------------------------------------------------
Does the plan address junior mortgages?
------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------------------------------
Does the plan overcome obstacles in existing pooling and servicing
agreements that may prevent modifications?
------------------------------------------------------------------------
Does the plan counteract mortgage servicer incentives not to engage in
modifications?
------------------------------------------------------------------------
Does the plan provide adequate outreach to homeowners?
------------------------------------------------------------------------
Can the plan be scaled up quickly to deal with millions of mortgages?
------------------------------------------------------------------------
Will the plan have widespread participation by lenders and servicers?
------------------------------------------------------------------------
In summary, the Plan focuses on payment affordability
through an expanded refinancing program involving Fannie Mae
and Freddie Mac and a modification program targeting a wide
range of borrowers at risk. The Plan also includes financial
incentives to encourage both lenders and borrowers to strive
for sustainable outcomes. It also encourages servicers to
modify mortgages for at risk homeowners before they are
delinquent. There are additional incentives available to
extinguish junior mortgages. The Administration estimates that
the Plan's expanded refinancing opportunities for Fannie Mae
and Freddie Mac mortgages could assist four to five million
responsible homeowners, some of whom otherwise would likely
have ended up in foreclosure.
While these projections are encouraging, the Panel has
additional areas of concern that are not addressed in the
original announcement of the Plan. In particular, the Plan does
not include a safe harbor for servicers operating under pooling
and servicing agreements to address the potential litigation
risk that may be an impediment to voluntary modifications. It
is also important that the Plan more fully address the
contributory role of second mortgages in the foreclosure
process, both as it affects affordability and as it increases
the amount of negative equity. And while the modification
aspects of the Plan will be mandatory for banks receiving TARP
funds going forward, it is unclear how the federal regulators
will enforce these new standards industry-wide to reach the
needed level of participation. The Plan also supports
permitting bankruptcy judges to restructure underwater
mortgages in certain situations. Such statutory changes would
expand the impact of the Plan. Without the bankruptcy piece,
however, the Plan does not deal with mortgages that
substantially exceed the value of the home, which could limit
the relief it provides in parts of the country that have
experienced the greatest price declines.
The Panel will continue to review the guidance issued by
Treasury as this report went to publication and will pursue any
outstanding issues with the Treasury Department and will keep
Congress and the American people advised of its ongoing
evaluation of the Administration's Plan.
C. DATA COLLECTION
The Plan addresses collection of data about modifications
undertaken as part of the Plan. Every servicer participating in
the program will be required to report standardized loan-level
data on modifications, borrower and property characteristics,
and outcomes. The data will be pooled so the government and
private sector can measure success and make changes where
needed. This is an important first step in the type of national
mortgage loan performance data reporting requirement envisioned
by the Panel.
D. CONCLUSION
The financial crisis we battle today has its origins in the
collapse of the housing market. Since its establishment under
the EESA and appointment by the Congress, the Congressional
Oversight Panel has been among the many voices urging Treasury
to offer a serious plan to address the foreclosure crisis.
Treasury's initial focus on financial institutions and credit
markets were essential steps towards recovery, but these
programs did not address the problems facing homeowners
directly. Taking on the foreclosure crisis addresses the root
causes of the financial market downturn. With the release of
the Obama Administration's foreclosure reduction plan, the
Panel will continue to examine the federal government's efforts
to revive the housing market.
This report, and the factors it identifies as essential to
any sustainable foreclosure reduction, will serve as the
Panel's framework for evaluating the success of the
Administration's efforts. The challenges of crafting an
effective and fair foreclosure prevention plan are daunting.
But this is a task from which the Administration and Congress
cannot shirk.
SECTION TWO: ADDITIONAL VIEWS
I. REP. JEB HENSARLING
A. INTRODUCTION
The topic of the March report of the Congressional
Oversight Panel (COP) is an investigation of foreclosure
mitigation efforts. This topic is not only timely given the
recent TARP initiatives announced by the Obama Administration,
but it is also one of the several areas explicitly mentioned in
the Emergency Economic Stabilization Act of 2008, Pub. L. No.
110-343, which states that the regular reports of the COP shall
include the ``effectiveness of foreclosure mitigation
efforts.'' To that end, I believe that this month's report is
an appropriate exercise and I welcome this opportunity to
review what is being done to help address the large number of
foreclosures that far too many borrowers are currently facing.
There is no question that we are witnessing an explosion in
the number of foreclosures in our economy. According to a
January report by RealtyTrac, an online foreclosure listing
firm, more than 2.3 million properties were subject to
foreclosure filings in 2008, an increase of more than 80
percent from 2007 levels.\156\ Separately, the Mortgage Bankers
Association's (MBA) National Delinquency Survey for the third
quarter of 2008 found that the percentage of loans in the
process of foreclosure--2.97 percent--set a new record, and the
seasonally-adjusted total delinquency rate--6.99 percent--was
the highest recorded in the history of the MBA survey.\157\ For
the millions of people facing foreclosure and the untold number
of others who might be on the brink of housing trouble, the
economic hardship and worry associated with potentially losing
one's home are real, tangible, and pressing problems worthy of
attention.
---------------------------------------------------------------------------
\156\ RealtyTrac, Foreclosure Activity Increases 81 Percent in 2008
(Jan. 15, 2009) (online at www.realtytrac.com/ContentManagement/
pressrelease.aspx?ChannelID=9&ItemID=5681&accnt =64847).
\157\ Mortgage Bankers Association, Delinquencies Increase,
Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec.
5, 2008).
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Any investigation into the effectiveness of foreclosure
mitigation efforts should start by identifying all the factors
that contributed to its cause, the borrowers who are directly
affected, the relative costs and benefits of government-
subsidized foreclosure mitigation efforts, and the possible
policy alternatives that could help provide relief to borrowers
in a fair, responsible, and taxpayer-friendly way. The answers
to these questions will, I believe, help steer policymakers in
the correct direction and provide help to those deserving of
it, while preventing less deserving actors from benefitting
from their own mistakes and ultimately preventing more taxpayer
dollars from going to waste.
B. CONTRIBUTING CAUSES
Before we can address the foreclosure problem, we must
first understand its cause. In his remarks to a joint session
of Congress on February 24, President Obama stated, ``it is
only by understanding how we arrived at this moment that we'll
be able to lift ourselves out of this predicament.'' \158\ To
that end, I could not agree with the President more.
---------------------------------------------------------------------------
\158\ The White House, Remarks of President Barack Obama--Address
to Joint Session of Congress (Feb. 24, 2009) (online at http://
www.whitehouse.gov/the_press_office/Remarks-of-President-Barack-Obama-
Address-to-Joint-Session-of-Congress).
---------------------------------------------------------------------------
One of the primary causes of the difficulties that some
borrowers are facing has been the general federal objective of
enabling and encouraging people to buy homes that were too
expensive for them to otherwise afford. In a perfect world, the
laws of supply and demand would be the fundamental driver of
our mortgage markets, with qualified borrowers having reliable
access to suitable mortgage products that best fit their needs.
Yet, in reality, the cost of homeownership has in many places
so thoroughly outpaced the ability of borrowers to afford a
home that the government has chosen to intervene with various
initiatives to defray parts of the cost of a mortgage. That
intervention has taken many forms--affordable housing programs,
federal FHA mortgage insurance, tax credits and deductions,
interest rate policies, etc.--as part of a concerted effort to
increase homeownership. For almost a decade, those efforts
succeeded, pushing homeownership rates steadily up from 1994
through their all-time high in 2004. That increase in demand,
in turn, contributed to a corresponding increase in home
prices, which rose from the mid-1990s until hitting their peak
in 2006. Yet those price increases created a cycle of
government intervention--home price appreciation made homes
less affordable, which in turn spurred further government
efforts to defray more of their cost--and the involvement of
the federal government in our housing markets only grew deeper.
Increased government involvement in our housing markets
created significant distortions and disruptions. This increased
involvement is contrary to the oft-repeated, now disproven
claims of proponents of expanded government control of our
economy that a ``wave'' of market deregulation over the last 20
years caused the current crisis. To the contrary, facts
indicate that there were at least five key factors which
contributed to our situation, at least four of which were a
direct result of government involvement. Those four factors--
highly accommodative monetary policy by the Federal Reserve,
continual federal policies designed to expand home ownership,
the congressionally-granted duopoly status of housing GSEs
Fannie Mae and Freddie Mac, and an anti-competitive government-
sanctioned credit rating oligopoly--are thoroughly discussed in
the Joint Dissenting Views to the COP's ``Special Report On
Regulatory Reform'' that I offered along with Senator John
Sununu, along with a fifth factor (failures throughout the
mortgage securitization process that resulted in the
abandonment of sound underwriting practices).\159\ As such, a
thorough recitation of those points here would be redundant.
However, a brief review of what I believe to be the two most
relevant factors to the foreclosure debate--federal policies
designed to expand home ownership and the market manipulations
of Fannie and Freddie--may be instructive.
---------------------------------------------------------------------------
\159\ Congressional Oversight Panel, Special Report on Regulatory
Reform: Modernizing the American Financial Regulatory System:
Recommendations for Improving Oversight, Protecting Consumers, and
Ensuring Stability, at 54-89 (Jan. 29, 2009).
---------------------------------------------------------------------------
For well over twenty years, federal policy has promoted
lending and borrowing to expand homeownership, through
incentives such as the home mortgage interest tax exclusion,
the Federal Housing Administration (FHA), discretionary HUD
spending programs, and the infamous Community Reinvestment Act
(CRA). CRA is a federal program created to encourage banks to
extend credit to ``underserved'' populations by requiring that
banks insured by the federal government ``help meet the credit
needs of its entire community.'' As noted in the Joint
Dissenting Views, CRA has led to an increase in bank lending to
low- and moderate-income families by 80 percent. However, to
make these loans, banks were encouraged to relax their
traditional underwriting practices to achieve and maintain
compliance. Those reduced standards led to a surge in non-
traditional loan products, particularly adjustable rate
subprime and Alt-A loans, which are now largely seen to be
risky products. Thus, mandates like CRA ended up becoming a
significant contributor to the number of foreclosures that are
occurring because they required lending institutions to abandon
their traditional underwriting standards in favor of more
subjective models to meet their government-mandated CRA
obligations.
Perhaps even more important than the impact of federal
policy mandates were the unparalleled market distortions of
Fannie Mae and Freddie Mac, the two now-failed, trillion-dollar
housing GSEs. Fannie and Freddie exploited their
congressionally-granted charters to borrow money at discounted
rates. They dominated the entire secondary mortgage market,
wildly inflated their balance sheets and personally enriched
their executives. Because market participants long understood
that this government created duopoly was implicitly (and, now,
explicitly) backed by the federal government, investors and
underwriters chose to believe that if Fannie or Freddie touched
something, it was safe, sound, secure, and most importantly
``sanctioned'' by the government. The results of those
misperceptions have had a devastating impact on our entire
economy.
Given Fannie and Freddie's market dominance, it should come
as little surprise that once they dipped into the subprime and
Alt-A markets, lenders quickly followed suit. In 1995, HUD
authorized Fannie and Freddie to purchase subprime securities
that included loans to low-income borrowers and allowed the
GSEs to receive credit for those loans toward their mandatory
affordable housing goals. Fannie and Freddie readily complied,
and as a result, subprime and near-prime loans jumped from 9
percent of securitized mortgages in 2001 to 40 percent in 2006.
In 2004 alone, Fannie and Freddie purchased $175 billion in
subprime mortgage securities, which accounted for 44 percent of
the market that year. Then, from 2005 through 2007, the two
GSEs purchased approximately $1 trillion in subprime and Alt-A
loans, and Fannie's acquisitions of mortgages with less than
10-percent down payments almost tripled. As a result, the
market share of conventional mortgages dropped from 78.8
percent in 2003 to 50.1 percent by 2007 with a corresponding
increase in subprime and Alt-A loans from 10.1 percent to 32.7
percent over the same period. These non-traditional loan
products, on which Fannie and Freddie so heavily gambled as
their congressional supporters encouraged them to ``roll the
dice a little bit more,'' now constitute many of the same non-
performing loans which have contributed to our current
foreclosure troubles.
C. NECESSARY CONSIDERATIONS IN EVALUATING FORECLOSURE MITIGATION PLANS
In evaluating the effectiveness of a government-subsidized
foreclosure mitigation plan, there are several fundamental
questions that must be asked. Perhaps the most salient
questions are determining who you want to help, why you want to
limit help to them, and who you might hurt by doing so. Those
considerations are closely linked to questions of the inherent
fairness and moral hazard of any government-subsidized
foreclosure mitigation plan. For example, it is a fact even
admitted by the majority report that some loan modifications
are simply not economical and thus some foreclosures are
inevitable. Even in the best of times, the MBA's National
Delinquency Survey shows that between 4-5 percent of loans
become delinquent and 1 percent go into foreclosure.\160\ Those
unpaid loans likely stem from many reasons including the
uncomfortable truth that some people, try as the might, are
simply not ready for the responsibility of homeownership. It
follows that efforts to keep such individuals in their homes
will be a costly losing battle, diverting time, attention, and
critical resources away from those who might otherwise be
worthy candidates for help. On the other end of the spectrum,
policymakers need to determine where to draw the line to stop
offering assistance to those who do not actually need it
because they have other means at their disposal or the option
to resolve their own difficulties without the expenditure of
taxpayer funds.
---------------------------------------------------------------------------
\160\ Mortgage Bankers Association, Delinquencies Increase,
Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec.
5, 2008).
---------------------------------------------------------------------------
In between the extremes of those who cannot be saved and
those who should not be recipients of government-subsidized
foreclosure mitigation assistance is a considerably diverse
group of borrowers who might be technically eligible for a
program but might have made decisions or behaved in ways that
would call into question the desirability of expending taxpayer
dollars to assist them. While a more thorough discussion of
which specific undesirable decisions might merit exclusion is
included below, one general characteristic worth considering
involves the ability to pay. Without a doubt, in any loan
mitigation program there will be some otherwise eligible
borrowers who can pay their mortgages but who choose not to pay
them or not to make the difficult decisions to sacrifice on
other things because they want to get relief. Sorting this
group of unwilling payers out from those who are unable to pay
is a fundamental concern that must be addressed in every
foreclosure mitigation plan. Unfortunately, this concern has
been nearly universally omitted from previous government
proposals on the subject. Until that concern is resolved, it is
my great fear that we will continue to provide a tremendous
incentive for borrowers on the bubble to opt not to fix (or,
even worse, purposefully exacerbate) their own problems in
hopes of gaining government assistance at a time when we ought
to enact incentives to encourage the opposite behavior.
A closely related concern to who will receive assistance is
the question of how much will that assistance cost. This
fundamental concern is excluded from the majority's report. So
far, over the last 16 months, the federal government has
pledged more than $9 trillion to address our economy's credit
crisis between new initiatives undertaken by the Federal
Reserve, the Treasury Department, the FDIC, and HUD.\161\ Those
commitments come on top of our existing $10.9 trillion national
debt \162\ and an estimated 2009 budget deficit of $1.8
trillion.\163\ Given the unprecedented economic challenges we
are now facing, the American people have an absolute right to
be suspicious of the cost of developing new government-
subsidized foreclosure mitigation programs. Those that dismiss
such concerns as narrow-minded display how disconnected they
are from the undeniable hypocrisy of asking hardworking
Americans to do more with less while their government continues
to run up massive debts that it will not be able to repay
without substantial tax increases.
---------------------------------------------------------------------------
\161\ Mark Pittman and Bob Ivry, U.S. Taxpayers Risk $9.7 Trillion
on Bailout Programs, Bloomberg (Feb. 9, 2009) (online at
news.yahoo.com/s/bloomberg/20090209/p_bloomberg/agq2b3xegkok).
\162\ TreasuryDirect, The Debt to the Penny and Who Holds It
(online at www.treasurydirect.gov/NP/BPDLogin?application=np) (accessed
Mar. 5, 2009).
\163\ Republican Caucus, House Committee on the Budget, The
President's Budget for Fiscal Year 2010: the Good, the Bad, and the
Ugly (Feb. 27, 2009) (online at http://www.house.gov/
budget_republicans/press/2007/pr20090227potus.pdf).
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The question of cost is also significant because it helps
further define the universe of deserving people to whom
assistance could be directed. It should be clear that with an
unlimited supply of money, you could prevent any foreclosure
for every borrower if you did not care about their worthiness.
But, given a limited amount of resources, it becomes critical
that you focus your attention on those who are actual
priorities and limit those who are less deserving. Budget
concerns also raise another question: how much assistance is
appropriate to commit to any one borrower? Clearly, with finite
resources, the more money you use to help those with large
financial needs, the fewer total number of people you can help.
For example, the original Hope for Homeowners law limited the
size of eligible single-family loans to no more than 132
percent of the 2007 conforming loan limits for Freddie Mac, or
roughly $550,000 for most places. According to the U.S. Census
Bureau, that amount was well more than double the median
national purchase price of $234,991 for a newly constructed
home built in the last four years.\164\ Accordingly, all things
being equal, you would be able to provide the same proportional
amount of assistance to more than two borrowers at the median
price for every one borrower at the upper limit. Thus, if the
goal of a program is to help the maximum number of people
possible, then it makes sense to target assistance towards
people on the lower end of the income/loan scale; if the goal
of a program is to provide the most robust assistance to
borrowers, then the reverse would be true.
---------------------------------------------------------------------------
\164\ U.S. Census Bureau, American Housing Survey National Tables:
2007 (2007) (Table 3-14: Value, Purchase Price, and Source of Down
Payment--Owner-Occupied Units) (online at http:// www.census.gov/hhes/
www/housing/ahs/ahs07/tab3-14.pdf).
---------------------------------------------------------------------------
A further necessary consideration of the effectiveness of
government-subsidized foreclosure mitigation plans is how
successful they will be in keeping assisted borrowers out of
future foreclosure difficulty. Unfortunately, there is strong
evidence to suggest that despite recent loan modification
efforts at various levels, a significant number of modified
borrowers end up back in default anyway, often very quickly. A
December 2008 joint report by the Office of the Comptroller of
the Currency (OCC) and the Office of Thrift Supervision (OTS)
on the state of first lien residential mortgages serviced by
national banks and federally regulated thrifts found that loan
modifications were ``associated with high levels of re-
default.'' The report found that for ``loans modified in the
first quarter of 2008, more than 37 percent of modified loans
were 30 or more days delinquent or in the process of
foreclosure after three months [and a]fter six months, that re-
default rate was more than 55 percent.'' \165\ For loans
modified in second quarter of 2008, the number of 30 or more
days delinquent modified loans was even higher, coming in at
40.52 percent.\166\ Such results seem to indicate that many of
the current recipients of loan modification assistance might
either fall into the category of those who have loans that are
not economical to modify or those who are simply not ready for
the responsibility of homeownership.
---------------------------------------------------------------------------
\165\ Comptroller of the Currency and Office of Thrift Supervision,
OCC and OTS Mortgage Metrics Report: Disclosure of National Bank and
Federal Thrift Mortgage Loan Data (Dec. 2008) (online at
files.ots.treas.gov/482028.pdf).
\166\ Id.
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D. UNIVERSE OF PEOPLE
As mentioned earlier, there is little doubt that the sheer
number of foreclosures we are experiencing is unprecedented in
modern times. Caught up in this wave of foreclosures are
certainly people who, through little fault of their own
actions, now find themselves in distress. These are the
borrowers who have suffered what industry professionals refer
to as ``life events,'' such as the involuntary loss of a job,
the onset of an illness or disability, a divorce, or had some
other unexpected hardship that has materially changed their
living/earning circumstance. For those individuals, the
commitment required for homeownership has shifted from a
manageable responsibility to a crushing burden from which they
may be powerless to resolve without third-party assistance.
These ``life event'' affected borrowers are noteworthy
because relatively few object to efforts to find achievable
solutions for trying to help keep these distressed borrowers in
their current residences whenever possible. Similarly, another
sympathetic group of distressed borrowers involves people who
were legitimate victims of blatant manipulation or outright
fraud by unscrupulous lenders who pressured them into homes
they could not afford. To many, those legitimate victims are
certainly equally deserving of assistance. Of course, such
borrowers do have the added burden proving that they were
indeed victims of actual wrongdoing. However, they also have a
potential remedy of pursuing legal action against fraudulent
lenders, an option which is not available to others.
If the universe of individuals in mortgage distress
included only borrowers from ``life event'' and fraud victims
groups, the task of crafting an acceptable government-
subsidized foreclosure mitigation plan would be much easier.
However, the number of individuals in mortgage distress
stretches far beyond those groups to include a much larger
section of people who, for a wide variety of reasons, are no
longer paying their mortgage on time. While certainly not an
exhaustive list, that larger group includes:
people who took out large loans to purchase
more house than they could have reasonably expected to
afford;
borrowers who lied about their income,
occupancy, or committed other instances of mortgage
fraud;
speculators who purchased multiple houses
for their expected value appreciation rather than a
place to live;
individuals who decided to select an exotic
mortgage loan with fewer upfront costs, lower monthly
payments, or reduced documentation requirements;
borrowers who took advantage of refinance
loans to strip much or all of the equity out of their
house to finance other purchases;
those who simply made bad choices by
incorrectly gambling on the market or overestimating
their readiness for homeownership; and
borrowers who have made a rational economic
decision and, given their particular circumstance, it
no longer makes sense to them to continue paying their
mortgage.
Borrowers who fall into those categories are much less
sympathetic in the eyes of many, and attempting to develop a
government-subsidized foreclosure mitigation plan to assist
them will inevitably raise significant moral hazard questions
for policymakers.
A fundamental measure of the effectiveness of a foreclosure
mitigation program is what steps the program has taken to sort
those risky borrowers out from their more deserving
counterparts to avoid the moral hazard of rewarding people for
their bad behavior. Although that risky group might be
difficult to quantify, there has been ample anecdotal evidence
in the media highlighting the types of risky borrowers who
should not be treated in the same way as other, responsible
borrowers. For example, a 2006 USA Today story reported on a
24-year-old former website designer in California who bought
eight homes in four states with no money down in seven of the
eight deals, and then quickly went broke.\167\ The Wall Street
Journal, in 2007, published an article telling the story of a
Detroit woman who refinanced her mortgage with an adjustable
rate subprime loan but soon fell into delinquency after she
used the proceeds of the new loan to settle old department-
store bills, subsidize out-of-work relatives, and pay off some
of her back property taxes.\168\ A 2008 Bloomberg article
featured a 28-year-old self-employed Californian cabinetmaker
who took out a mortgage loan with monthly payments of $6,900,
and then almost instantly fell behind when his business revenue
declined.\169\
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\167\ Noelle Knox, 10 Mistakes That Made Flipping a Flop, USA Today
(Oct. 22, 2006) (online at www.usatoday.com/money/economy/housing/2006-
10-22-young-flipper-usat_x.htm).
\168\ Mark Whitehouse, `Subprime' Aftermath: Losing the Family
Home, Wall Street Journal (May 30, 2007) (online at online.wsj.com/
article/SB118047548069017647.html).
\169\ Kambiz Foroohar, Vulture Fund Deals With Delinquent
Homeowners Lost by Subprime, Bloomberg (Feb. 28, 2009) (online at
www.bloomberg.com/apps/news?pid= 20601109&sid=aaKT9Z_X9okg&refer=home).
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There have also been several stories of the rich and famous
falling behind on their mortgages, including former Major
League Baseball player Jose Canseco,\170\ former NBA player
Latrell Sprewell,\171\ pop singers Whitney Houston \172\ and
Michael Jackson,\173\ and even an elected Member of
Congress.\174\ Although the financial details of each situation
may be unique, the fact remains that all of those borrowers
probably earned far more than the $50,000 that the Census
Bureau has determined was the median annual income for
households in 2007.\175\ Additionally, according to a 2008
report by the MBA, at least 18 percent of loans in foreclosure
in 2007 were for non-owner occupied homes.\176\ Separately, the
National Association of Realtors in 2008 found that known
second home sales accounted for 33 percent of all existing- and
new-home sales in the previous year, a figure which was close
to historic norms.\177\ While the individual needs of the rich
and famous and those who own multiple homes might be great,
surely this collection of borrowers is not the universe of
people on whom we ought to spend limited taxpayer dollars to
extend government-subsidized foreclosure mitigation efforts.
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\170\ Jose Canseco: Former Slugger's Home Foreclosed, Associated
Press (May 5, 2008) (online at archives.chicagotribune.com/2008/may/05/
sports/chi-jose-canseco-080505-ht).
\171\ Federal Marshal Seizes Sprewell's Yacht, Associated Press
(Aug. 22, 2007) (online at http:// www.usatoday.com/sports/basketball/
2007-08-22-sprewell-yacht_N.htm).
\172\ Houston, We Have A Problem: Whitney's Foreclosure, Associated
Press (Nov. 15, 2006) (online at cbs2.com/local/
Whitney.Houston.Mortgage.2.524392.html).
\173\ Alex Veiga, Records: Michael Jackson Late on Payments for
Family Home, Associated Press (Feb. 28, 2008) (online at
www.usatoday.com/life/people/2008-02-28-jackson-home_ N.htm?csp=34).
\174\ Report: Congresswoman's Homes Defaulted 6 Times, Associated
Press (May 31, 2008) (online at cbs2.com/politics/
Laura.Richardson.Default.2.737694.html).
\175\ U.S. Census Bureau, Household Income Rises, Poverty Rate
Unchanged, Number of Uninsured Down (Aug. 26, 2008) (online at
www.census.gov/Press-Release/www/releases/archives/income_wealth/
012528.html).
\176\ Jay Brinkmann, Mortgage Bankers Association, An Examination
Of Mortgage Foreclosures, Modifications, Repayment Plans and Other Loss
Mitigation Activities in the Third Quarter of 2007 (Jan. 2008) (online
at www.mortgagebankers.org/files/News/InternalResource/
59454_LoanModificationsSurvey.pdf)
\177\ National Association of Realtors, Second-Home Sales Accounted
for One-Third of Transactions in 2007 (Mar. 28, 2008) (online at
www.realtor.org/press_room/news_releases/2008/03/
second_home_sales_one_third_of_2007_transactions).
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Beyond those who made unwise borrowing decisions, attention
must be paid to excluding individual borrowers who committed
outright fraud in obtaining their mortgages. Many of these
loans likely fall into the no-doc/low-doc category of Alt-A
loans where borrowers were not required to provide real
verification of their income to lenders. According to a
February 2009 by the Department of the Treasury's Financial
Crimes Enforcement Network (FinCEN), reports of mortgage fraud
have increased more than 1,600 percent from 2000 to 2008, and
almost doubled since June 2006.\178\ Despite heightened
concerns and a depressed real estate market, the report found
that the total number of suspected mortgage fraud reports filed
in 2008 was 62,084, a 44 percent increase over 2007. FinCEN
also reports that mortgage loan fraud remained the third most
prevalent type of suspicious activity reported in 2008. Given
the tremendous potential for fraud, it should be readily
apparent to all that preventing taxpayer money from being used
to aid these criminal borrowers must be a priority for any
government-subsidized foreclosure mitigation plan.
---------------------------------------------------------------------------
\178\ Financial Crimes Enforcement Network, supra note 45;
Financial Crimes Enforcement Network, Mortgage Loan Fraud: An Update of
Trends Based Upon an Analysis of Suspicious Activity Reports (Apr.
2008) (online at www.fincen.gov/news_room/rp/files/
MortgageLoanFraudSARAssessment.pdf)
---------------------------------------------------------------------------
Distinct from a moral hazard question, in any consideration
of the effectiveness of a taxpayer-funded foreclosure
mitigation program, there is an inherent question of fairness
as those who are not facing mortgage trouble are asked to
subsidize those who are facing trouble. After all, why should a
person be forced to pay for their neighbor's mortgages when he
or she is struggling to pay his or her own mortgages and other
bills? To many people, this question is the most important
aspect of the public policy debate. On this point, despite the
persistent externality admonitions of some economists, it is
difficult to dismiss the concerns of those members of the
ultimate ``no fault of their own'' demographic.
The evidence supporting the potential unfairness of current
government-subsidized efforts is compelling. According to
recent Census Bureau statistics, in 2007 there were roughly
110,692,000 occupied housing units in the United States.\179\
Of those units, approximately 35,045,000 were occupied by
people who were renters.\180\ The remaining 75,647,000 housing
units were occupied by people who were to some degree
homeowners, both those with active mortgages and those who
owned their homes outright with no mortgage. The latter group,
those with no mortgage, totaled approximately 24,885,000.\181\
Thus, the aggregate total of those who either rent their
housing or own their homes outright is roughly 59,930,000
people, or more than 54 percent of the entire occupied housing
unit market. That majority group, by definition, cannot be late
on a mortgage payment, yet as taxpayers they are being asked to
subsidize, at least in part, the mortgages of some of the
minority 46 percent of the population that has an active
mortgage.
---------------------------------------------------------------------------
\179\ U.S. Census Bureau, American Housing Survey National Tables:
2007 (2007) (Table 2-1: Introductory Characteristics--Occupied Units)
(online at www.census.gov/hhes/www/housing/ahs/ahs07/tab2-1.pdf).
\180\ Id.
\181\ U.S. Census Bureau, American Housing Survey National Tables:
2007 (2007) (Table 3-15: Mortgage Characteristics--Owner-Occupied
Units) (online at www.census.gov/hhes/www/housing/ahs/ahs07/tab3-
15.pdf).
---------------------------------------------------------------------------
The numbers become even more pronounced when you factor in
which people from the active mortgage group are actually
currently in delinquency. According to the MBA's National
Delinquency Survey for the third quarter of 2008, which
includes data on more than 85 percent of the active mortgages
on the market, the non-seasonally adjusted total of loans
beyond 30-days past due was percent 7.29, and the percent of
loans in foreclosure was 2.97, for a combined total of 10.26
percent of loans not being paid on time.\182\ Assuming that
rate was consistent for all of the 50,762,000 active mortgages
projected by the Census Bureau's statistics, that would mean
that there were some 5,208,000 loans which were currently not
being paid on-time versus 45,554,000 loans which are being paid
on-time. Adding together the number of mortgages being paid on-
time with the total of those who rent or own their homes
outright, you get a total of 105,484,000 housing units that are
not delinquent on a mortgage, or 95.3 percent of the
110,692,000 occupied housing units in the United States.
---------------------------------------------------------------------------
\182\ Mortgage Bankers Association, Delinquencies Increase,
Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec.
5, 2008).
---------------------------------------------------------------------------
In light of these statistics, an essential public policy
question that must be asked regarding the effectiveness of any
taxpayer-subsidized foreclosure mitigation program is ``Is it
fair to expect 19 out of every 20 people to pay more in taxes
to help the 20th person maintain their current residence?''
Although that question is subject to individual interpretation,
there is an ever-increasing body of popular sentiment that such
a trade-off is indeed not fair. Given the massive direct
taxpayer costs that have already been incurred through TARP and
the potential costs that could be incurred through the assorted
credit facilities and monetary policy actions of the Federal
Reserve, I believe that it is difficult to justify asking those
19 out of 20 Americans to shoulder an even greater financial
burden on yet another government foreclosure mitigation program
that might not work.
Moreover, while the effect of the underlying credit crisis
has been nationwide, statistics show that the bulk of the
foreclosure wave has been concentrated in a few places where,
admittedly, the problem is robust. According to the
aforementioned January RealtyTrac report, nearly half (47.4
percent) of the 2.3 million properties with foreclosure filings
in 2008 were concentrated in exactly four states: Nevada,
Florida, Arizona, and California.\183\ In fact, 15 of the top
16 and 18 of the top 22 metropolitan areas with the highest
foreclosure rates were located in those four states. If you add
to those four states the states with the five next highest
foreclosure rates--Colorado, Michigan, Ohio, Georgia, and
Illinois--the top nine foreclosure rate states contain more
than two-thirds (66.9 percent) of all the properties with
foreclosure filings in the country. Additionally, in its third
quarter 2008 National Delinquency Survey, the MBA found that
there were only nine total states which had rates of
foreclosure starts above the national average (Nevada, Florida,
Arizona, California, Michigan, Rhode Island, Illinois, Indiana
and Ohio), while the remaining 41 states were all below the
national average.\184\ Clearly, these data show that the
foreclosure problem is very real, but it is also very
concentrated in select areas, so much so that a few states are
skewing the statistical average for the preponderance of the
other states. This fact must be taken into consideration when
considering the effectiveness of any government-subsidized
foreclosure mitigation effort.
---------------------------------------------------------------------------
\183\ RealtyTrac, supra note 156.
\184\ Mortgage Bankers Association, Delinquencies Increase,
Foreclosure Starts Flat in Latest MBA National Delinquencies Survey
(Dec. 5, 2008).
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E. VOLUNTARY MITIGATION ALTERNATIVES
In reviewing the effectiveness of government-subsidized
foreclosure mitigation efforts, it is important to keep in mind
that there is no single reason why borrowers decide to buy a
home and there is no single reason why some borrowers go into
foreclosure. Home buying and home owning, like any other
activity, are the culminations of a wide variety of individual
factors including cost, location, availability, and station in
life. Different people can approach the decision in distinct
ways, weigh competing factors differently and perhaps even make
unwise, foolhardy, or bad choices despite every reason to the
contrary. Nevertheless, because the factors that go into the
decision to buy and keep a home can vary greatly, it stands to
reason you cannot devise a single foreclosure mitigation
program that will appeal to or benefit everyone who might be at
risk. Thus, a more sensible approach would be to encourage a
series of different mitigation programs and approaches instead
of attempting to force all distressed borrowers into one
massive government-subsidized foreclosure mitigation effort.
To that end, since the onset of the mortgage crisis the
federal government has worked with banks and other private
parties to develop a number of voluntary initiatives to assist
borrowers in danger of foreclosure. While by no means perfect,
these efforts have been helping borrowers to varying degrees
without having to resort to government mandates or increased
taxpayer risk. Some of these initiatives have included:
HOPE NOW: In response to the downturn in the U.S.
mortgage market in 2007, the Bush Administration helped broker
an alliance of mortgage lenders, servicers, counselors, and
investors called the HOPE NOW Alliance. The goals of HOPE NOW
are to ``maximize outreach efforts to homeowners in distress to
help them stay in their homes'' and to ``create a unified,
coordinated plan to reach and help as many homeowners as
possible.'' HOPE NOW estimates that it has helped nearly 3.2
million homeowners avoid foreclosure since July 2007.\185\
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\185\ HOPE Now, Mortgage Lending Industry Prevented Almost 240,000
Foreclosures in December (Jan. 29, 2009) (Online at www.hopenow.com/
upload/press_release/files/HOPE%20
NOW%20December%202008%20Data%20Release%20.pdf).
JP Morgan Chase: On October 31, 2008, JP Morgan
Chase announced it would expand its mortgage modification
program by undertaking multiple initiatives designed to keep
more families in their homes, including extending its
modification programs to customers of Washington Mutual, which
Chase acquired in September, and EMC Mortgage, the lending arm
of Bear Stearns, which Chase acquired in March 2008.\186\ Chase
will open regional counseling centers, hire additional loan
counselors, introduce new financing alternatives, proactively
reach out to borrowers to offer pre-qualified modifications,
and commence a new process to independently review each loan
before moving it into the foreclosure process. Chase has
selected sites for 24 Chase Homeownership Centers in areas with
high mortgage delinquencies where counselors can work face-to-
face with struggling borrowers. Chase anticipated 13 of these
centers--in California and Florida--open and serving borrowers
by the end of February 2009. The other 11 around the country
will be open by the end of March 2009. Chase expects these
changes will help an additional 400,000 borrowers. While
implementing these enhancements, Chase will not put any
additional loans into the foreclosure process.
---------------------------------------------------------------------------
\186\ JPMorgan Case, Chase Further Strengthens Robust Programs to
Keep Families in Homes (Oct. 31, 2008) (online at
files.shareholder.com/ downloads/ONE/514430481 x0x245621/b879b4eb -
40c0-43f8- 8614-6F2113759d0c /344473.pdf).
Wells Fargo Home Mortgage Servicing: Over the past
year and a half, through the Leading the Way Home program,
Wells has provided more than 700,000 foreclosure prevention
solutions.\187\ Wells' program is designed to work with all its
customers--including those not yet in default--to determine if
they qualify for a modification. For example, since Wells
acquired Wachovia and its unique Wachovia Pick-a-Payment option
ARM loans, Wells will use more aggressive solutions through a
combination of means including permanent principal reductions
in geographies with substantial property declines. In total,
Wells predicts 478,000 customers will have access to this
program if they need it.\188\ Wells has also extended a
foreclosure moratorium on loans it owns through March 13, 2009.
---------------------------------------------------------------------------
\187\ Wells Fargo and National Urban League Publish New Foreclosure
Prevention Workbook: Advice from Foreclosure Experts Given to
Homeowners Across the Country, Business Wire (Feb. 28, 2009) (online at
www.businesswire.com/portal/site/home/permalink/?ndmViewId= news
_view&newsId=20090228005030&newsLang=en).
\188\ Wells Fargo, Wells Fargo Merger Gives 478,000 Wachovia
Customers Access to New Wells Fargo Solutions if Their Mortgage
Payments Become At-Risk (Jan. 26, 2009) (online at www.wellsfargo.com/
press/2009/20090126 _Wachovia_HMS).
Bank of America: In early October, Bank of America
announced the creation of a proactive home retention program
that will systematically modify troubled mortgages with up to
$8.4 billion in interest rate and principal reductions for
nearly 400,000 Countrywide Financial Corporation customers
nationwide.\189\ (Bank of America acquired Countrywide July 1,
2008). The program was developed together with state attorneys
general and is designed to achieve affordable and sustainable
mortgage payments for borrowers who financed their homes with
subprime loans or pay option adjustable rate mortgages serviced
by Countrywide and originated prior to December 31, 2007. Bank
of America has also implemented a foreclosure sale moratorium
on mortgages it holds as well as mortgages owned by investors
that have agreed to the moratorium for mortgages it services
until final guidelines are issued by the Obama Administration
on its foreclosure plan.
---------------------------------------------------------------------------
\189\ Bank of America, Bank of America Announces Nationwide
Homeownership Retention Program for Countrywide Customers: Nearly
400,000 Countrywide Borrowers Could Benefit After Program Launches
December 1 (Oct. 6, 2008) (online at newsroom.bankofamerica.com/
index.php?s= press_releases&item=8272).
Citigroup: In November 2008, Citigroup announced
the Citi Homeowner Assistance Program for families particularly
in areas of economic distress and sharply declining home values
whose mortgages Citigroup holds.\190\ In February, Citigroup
also initiated a foreclosure moratorium effective through March
12 while awaiting implementation of the Obama Administration's
foreclosure plan.
---------------------------------------------------------------------------
\190\ Citigroup, Citi Announces New Preemptive Initiatives to Help
Homeowners Remain in Their Homes (Nov. 11, 2008) (online at
www.citigroup.com/citi/press/2008/081111a.htm).
---------------------------------------------------------------------------
These initiatives, coupled with other efforts like the
federal Hope for Homeowners law and the FDIC's IndyMac loan
modification program, are providing options to distressed
borrowers. However, some have complained that these programs
are not doing enough to help more borrowers and are advocating
for a larger government program to fill that void. Such calls
seem to ignore the reality that loan modifications can be
complicated, time consuming exercises and are of course
dependent upon the borrower being willing and qualified to
participate. As noted in the majority's report, foreclosures
can cost lenders up to $70,000 in costs and fees, providing
ample economic motivation for lenders to avoid such an outcome
wherever possible.
Ultimately, instead of creating new government-subsidized
programs, the best foreclosure mitigation program is having a
strong economy, a job, and the freedom to keep more of what you
earn. That's why I have supported legislation to encourage an
economic turnaround, help preserve jobs, and spur widespread
economic growth by lowering the tax burden that job-creators
face, such as the Economic Growth Act of 2008. That
legislation, introduced last year by Rep. Scott Garrett, would
have provided for full, immediate business expensing, a
significant reduction in the top corporate tax rate, an end the
capital gains tax on inflation, and simplification of the
capital gains rate structure. Any one of those components would
have increased our economic growth, and helped hardworking
Americans keep their jobs and earn more money. For example,
while reviewing the impact of just one component of the bill,
Dr. Mihir Desai of the Harvard Business School has estimated
cutting the corporate capital gains rate from 35 percent to 15
percent could unlock $1 trillion worth of wealth for the
economy.\191\ Even though such proposals might not contain a
specific foreclosure mitigation program, the vast economic
growth and prosperity that bills like the Economic Growth Act
could unleash would help countless numbers of Americans pay
their mortgages and other bills without government-subsidized
foreclosure mitigation plans.
---------------------------------------------------------------------------
\191\Americans for Tax Reform, America's Growth Agenda Part Four:
Cut the Corporate Capital Gains Rate to 15%, Unlocking Wealth for Job
Creation (Jan. 21, 2008) (online at 74.6.239.67/search/cache?ei=UTF-
8&p=%22Mihir +Desai%22+capital+gains &fr=my-myy&u=atr.org/content/html/
2008/jan/012108pr-
growthcorpcapgains.html&w=%22mihir+desai%22+capital+gains&d
=AwxrU52uSUbL&icp= 1&.intl=us).
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Additionally, providing tax relief to Americans instead of
creating new government programs would help address some of the
fairness concerns behind such programs because tax relief is
unbiased towards home owners, borrowers, and renters.
Additionally, tax relief proposals have the added benefit of
being able to provide more relief to more people at a lower
cost. For example, the tax reduction alternative offered by
Reps. Dave Camp and Eric Cantor to the recently enacted $1.1
trillion stimulus bill contained several provisions that would
help America's small businesses and employers.\192\ Those
provisions combined--creating a 20 percent deduction for small
business income (which would affect 99.9 percent of the 27.2
million businesses in America), extending the favorable bonus
depreciation rules for small businesses, extending the Net
Operating Losses carryback rules for previously profitable
companies to seek immediate cash refunds of past taxes paid,
and repealing of 3 percent withholding requirement for
government contractors--would have cost less than $83.1 billion
over 11 years. That amount is slightly more than the one year
cost of the $75 billion Homeowner Affordability and Stability
Plan proposed by President Obama last month, which would affect
fewer people.\193\
---------------------------------------------------------------------------
\192\ House Committee on Ways and Means Republicans, Summary of
Camp-Cantor Substitute to H.R. 1 (Jan. 28, 2009) (online at
republicans.waysandmeans.house.gov/showarticle.asp?ID=462).
\193\ Federal Deposit Insurance Corporation, Homeowner
Affordability and Stability Plan (online at www.fdic.gov/consumers/
loans/hasp/index.html) (accessed Mar. 5, 2009).
---------------------------------------------------------------------------
II. RICHARD NEIMAN, DAMON SILVERS AND ELIZABETH WARREN
The dissenting views offered by Congressman Jeb Hensarling
raise a number of issues that the Panel intends to pursue in
the course of its oversight. We all share the goals of ensuring
that the government-sponsored entities (GSE) function in an
optimal manner and targeting limited public foreclosure
prevention resources to responsible borrowers. Part of the
Panel's mission is to consider these and other important topics
with the benefit of our diverse experiences and viewpoints.
One point mentioned in the dissent, however, is strikingly
inaccurate and necessitates an immediate clarification to
Congress and the American people. And that is the Congressman's
statement concerning the Community Reinvestment Act (CRA):
``Thus, mandates like CRA ended up becoming a
significant contributor to the number of foreclosures
that are occurring because they required lending
institutions to abandon their traditional underwriting
standards in favor of more subjective models to meet
their government mandated CRA objectives.''
This statement misinterprets both the nature of the CRA
requirement and the positive impact that the CRA has had on the
mortgage market over the past thirty years. But most disturbing
is the suggestion that CRA has been a factor in the current
financial meltdown, when the facts demonstrate just the
opposite.
The CRA was passed in 1977 and requires banks to be
responsive to the needs of the communities in which they accept
deposits, especially low and moderate-income (LMI)
neighborhoods. Banks are evaluated in terms of their lending
and investment activities, as well as the innovative services
they provide. The CRA was one response to the common practice
of ``red lining'' or refusing to offer credit and other
services in neighborhoods that were often communities of color.
While the CRA encourages banks to recognize emerging
business opportunities in LMI areas, there is no ``requirement
to abandon traditional underwriting.'' Banks were never
encouraged to provide loans that violated safety and soundness;
they were encouraged to be creative in marketing and developing
products that were tailored and appropriate for a group of
consumers with unique needs.
The success of the CRA speaks for itself. Banks' CRA
activities have leveraged infusions of public capital into LMI
communities, perhaps by as much as 10 to 25 times, attracting
additional private capital in the process.\194\ And in the last
ten years alone, CRA has contributed to bank lending to small
businesses and farms in excess of $2.6 trillion, exactly the
type of stimulus we need to preserve in these challenging
economic times.\195\
---------------------------------------------------------------------------
\194\ Office of the Comptroller of the Currency, Remarks by John C.
Dugan Comptroller of the Currency Before the Enterprise Annual Network
Conference, at 6 (Nov. 19, 2008) (online at www.occ.treas.gov/ftp/
release/2008-136a.pdf).
\195\ Id. at 4.
---------------------------------------------------------------------------
But what about CRA's influence in the area of home mortgage
lending- were CRA loans the culprit in the mortgage meltdown?
The notion that CRA loans were somehow to blame in triggering
the cascade of foreclosure is a false one that the facts
quickly put to rest. Only six percent of higher-priced loans
were originated by banks subject to the CRA.\196\ Of course,
originating loans is not the only way in which banks could be
involved in higher-priced or subprime lending. In certain
circumstances, banks may also receive consideration under the
CRA for loans that they have purchased. However, less than two
percent of the higher-priced, CRA-eligible loans originated by
independent mortgage bankers were purchased by banks for CRA
credit.\197\
---------------------------------------------------------------------------
\196\ Board of Governors of the Federal Reserve System, Speech by
Governor Randall S. Kroszner at the Confronting Concentrated Poverty
Policy Forum (Dec. 3, 2008) (online at www.federalreserve.gov/
newsevents/speech/kroszner20081203a.htm).
\197\ Id. at 10.
---------------------------------------------------------------------------
We agree with Congressman Hensarling that the market
excesses of the past decade led to lax underwriting standards
and the origination of many dubious mortgages. But the CRA has
been one of the few examples of what has worked, and provides a
model for preserving responsible lending and homeownership as
we work together to strengthen and reform the mortgage market.
SECTION THREE: CORRESPONDENCE WITH TREASURY UPDATE
As Treasury reworks its efforts to combat the financial
crisis and restore confidence in the economy, the Panel
continues to review government actions, to study and
investigate different aspects of the financial crisis and EESA
programs, and to pose questions to Treasury on behalf of
Congress and the American people. On January 28, 2009, the day
after Treasury Secretary Timothy Geithner's confirmation by the
U.S. Senate, the Panel sent a letter to the Treasury Department
welcoming the Secretary and renewing its request for answers to
the many unanswered questions from its December report with an
emphasis on four categories: bank accountability, increased
transparency, foreclosure reduction, and overall strategy. The
Panel received a reply from Treasury on February 23rd. Both
letters are attached in the appendices.
While this reply did not offer any direct answers to the
Panel's questions as posed, some of Treasury's actions as
described in the letter represent progress toward increased
bank accountability, improved transparency and a plan to
address the foreclosure crisis. The Panel recognizes this
progress, but it also observes that Treasury left many
questions unanswered. The Panel must insist that Treasury
address outstanding questions from previous oversight reports.
While many questions remain open, the Panel is particularly
interested in probing the strategy behind Treasury's new
programs for the second tranche of EESA funds. Treasury has not
yet offered Congress and the public its diagnosis of the causes
of the current crisis nor explained how its program address the
root causes of the crisis. Once Treasury articulates a clear
and consistent strategy behind its actions, banks, businesses
and consumers will be better-equipped to anticipate and plan
for future government intervention.
On March 5, 2009, Chairwoman Elizabeth Warren replied to
the Treasury Secretary's letter with a request for a direct
response to the Panel's outstanding questions about Treasury's
overall strategy for combating the financial crisis.\198\
Future correspondence with Treasury will be discussed in
subsequent oversight reports.
---------------------------------------------------------------------------
\198\ See Appendix III, infra.
SECTION FOUR: TARP UPDATES SINCE PRIOR REPORT
The Obama Administration presented an outline of its
Financial Stability Plan (the ``FSP'') on February 10. The FSP
has five parts. More detailed outlines of the terms of the
three of the five parts, the Homeowner Affordability and
Stability Plan, the Capital Assistance Plan, and the Term
Asset-Backed Loan Facility were published on February 18,
February 25, and March 3, respectively.
On February 27, the Treasury Department announced a
restructuring of its interests in Citigroup in order to
increase Citigroup's tangible common equity. Three days later,
on March 2, the Treasury Department and the Federal Reserve
Board announced a restructuring of their interests in American
International Group to increase their capital support for that
company to provide more time for an orderly reorganization--
including generation of cash through sale of substantial
portions of that company.
On February 26, the President released his FY-2010 budget
outline. The outline included a $250 billion contingent reserve
for further efforts to stabilize the financial system and
suggested that a reserve of that size'' would support $750
billion in asset purchases.''
The Administration's stimulus package included several
amendments to the Emergency Economic Stabilization Act,
including a tightening of limits on the compensation of the
most senior officers of financial institutions that receive
federal assistance and easing the way for repayment to the
Treasury of capital infusions made under the Capital Purchase
Program.
The Financial Stability Program
The Financial Stability Program has five parts:
Financial Stability Trust. This part of the plan
alters the Treasury's program of direct bank assistance. It was
fleshed out in a set of documents issued on February 25
regarding the new Capital Assistance Program (the ``CAP''). It
described the CAP as having two related objectives, namely ``to
help banking institutions absorb larger than expected future
losses, should they occur, and to support lending to
creditworthy borrowers during the economic downturn.'' It also
outlined a two-pronged strategy to accomplish these objectives.
The first is the so-called ``bank stress test,'' what Treasury
refers to as ``forward looking capital assessment of major
institutions.'' The second is the provision of ``contingent
common capital'' to institutions whose economic situations
justify assistance.
Full implementation of the CAP would alter the economic
relationship between Treasury and the institutions that receive
financial assistance. Although the complete terms are complex,
the key element would allow those institutions to convert
Treasury's investment in them to common stock--bolstering their
capital but also bolstering the risk for taxpayer dollars--if
the institutions' financial condition makes additional capital
necessary.
The CAP appears to be aimed primarily at institutions whose
financial condition is not yet critical but could become so as
economic conditions worsen. Institutions that are already
experiencing critical capital deterioration may receive greater
assistance with ``individually-negotiated'' terms and timing.
For either set of institutions, the Treasury strategy candidly
anticipates a substantial--at least temporary--increase in the
public ownership of major financial institutions.
Affordable Housing Support and Foreclosure
Prevention Plan. The Obama Administration announced its
Homeowner Affordability and Stability Plan on February 18. This
plan has three components.\199\ First, the plan targets between
four and five million homeowners with conforming loans owned or
guaranteed by Fannie Mae and Freddie Mac who are currently
ineligible to refinance at today's low interest rates to
refinance their loans. Second, it will devote $75 billion to a
system of incentives and payments to help an estimated three
and four million homeowners and their servicers modify their
mortgages. Third, it will increase Treasury's purchase of
preferred stock in Fannie Mae and Freddie Mac to $200 billion
each (from $100 billion) and increase the size of their
retained mortgage portfolios (and allowable debt outstanding)
to up to $900 billion. The housing plan will take effect March
4, when the Administration will publish detailed rules
governing the programs.
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\199\ U.S. Department of the Treasury, Homeowner Affordability and
Stability Plan Executive Summary (Feb. 18, 2009) (online at
www.financialstability.gov/initiatives/eesa/homeowner- affordability-
plan/ExecutiveSummary.pdf).
Public-Private Investment Fund (PPIF). The PPIF is
intended to deal with the politically sensitive issue of
valuing the ``legacy'' toxic assets that have plummeted in
value since the beginning of the crisis. The federal government
will provide public financing to the Fund in order to leverage
$500 billion to $1 trillion in private capital to make ``large-
scale'' purchases of the previously illiquid assets.\200\
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\200\ U.S. Department of the Treasury, Fact Sheet (Feb. 10, 2009)
(online at www.financialstability.gov/docs/fact-sheet.pdf).
Consumer and Business Lending Initiative. This
initiative expanded the size and scope of the joint Treasury-
Federal Reserve Term Asset-Backed Securities Loan Facility
(TALF). Treasury will now provide $100 billion of credit
protection to leverage $1 trillion in Federal Reserve
financing. This facility will provide non-recourse loans
collateralized by asset-backed securities of auto loans,
student loans, credit cards, SBA loans and commercial real
estate mortgages. The inclusion of commercial mortgage-backed
securities represents an expansion of the program.\201\
Treasury has indicated that the program may be expanded further
to include non-agency residential mortgage-backed securities.
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\201\ Id.
New Equity Injections into Citigroup and AIG. On
February 27, Treasury announced that it would convert up to $25
billion of its preferred Citigroup shares into common stock,
giving the company a large new injection of tangible common
equity. Other holders of preferred stock were expected to make
similar conversions, diluting the existing shareholders by as
much as 74 percent. Although this move did not require an
additional infusion of TARP funding, it substantially increased
the risk that taxpayers will not be paid back. On March 2,
Treasury announced a similar effort to shore up AIG's balance
sheet. Treasury converted the $40 billion in AIG preferred
stock that it owns into securities that have more of the
characteristics of common stock, giving Treasury 77.9 percent
of AIG's equity. In addition, Treasury made available to AIG an
additional $30 billion in TARP funding as needed, in exchange
for non-cumulative preferred stock. The AIG move was prompted
by an impending credit rating downgrade on AIG debt, in
response to AIG's record $62 billion quarterly loss.
SECTION FIVE: OVERSIGHT ACTIVITIES
The Congressional Oversight Panel was established as part
of EESA and formed on November 26, 2008. Since then the Panel
has issued three oversight reports, as well as a special report
on regulatory reform which came out on January 29, 2009.
Since the release of the Panel's February oversight report,
the following developments pertaining to the Panel's oversight
of the TARP took place:
On February 4, 2009, the Panel sent a survey
requesting mortgage performance data to Fannie Mae, Freddie
Mac, FDIC, the Federal Reserve, FHFA, HUD, OCC, OTS, and
Treasury.\202\ The Panel received responses from FHFA (on
behalf of Fannie Mae and Freddie Mac), NCUA, OCC/OTS and the
Federal Reserve during the week of February 16, 2009, and HUD,
FDIC, and Treasury during the week of February 23, 2009.
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\202\ See Appendix IV, infra.
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Treasury Secretary Timothy Geithner sent a
response letter on February 23, 2009 \203\ to the Panel in
response to a letter from Elizabeth Warren sent January 28,
2009.\204\ Both letters are attached as appendices.
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\203\ See Appendix II, infra.
\204\ See Appendix I, infra.
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On behalf of the Panel, Elizabeth Warren sent a
reply to Secretary Geithner on March 5, 2009.\205\ This letter
acknowledged positive steps taken by Treasury under the
Secretary's tenure but pressed for answers to the questions
posed by the Panel in previous reports and letters. In
particular, the Chair posed a set of strategic questions for
Secretary Geithner to answer in advance of the Panel's April
report on overall TARP strategy.
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\205\ See Appendix III, infra.
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The Panel held a field hearing in Largo, MD on
February 27, 2009 entitled, ``Coping with the Foreclosure
Crisis: State and Local Efforts to Combat Foreclosures in
Prince George's County, Maryland.'' Following opening remarks
from Congressman Chris Van Hollen and Congresswoman Donna
Edwards, the Panel heard from two panels of witnesses. The
first panel consisted of homeowners affected by the foreclosure
crisis while the second panel featured community leaders and
policymakers.
Upcoming Reports and Hearings
In April 2009, the Panel will release its fifth oversight
report. The April report will focus on assessing TARP strategy,
and the Panel will hold a hearing during the month of March to
explore this topic in greater detail. That report will also
update the public on the status of its TARP oversight
activities. The Panel will continue to release oversight
reports every 30 days.
SECTION SIX: ABOUT THE CONGRESSIONAL OVERSIGHT PANEL
In response to the escalating crisis, on October 3, 2008,
Congress provided the U.S. Department of the Treasury with the
authority to spend $700 billion to stabilize the U.S. economy,
preserve home ownership, and promote economic growth. Congress
created the Office of Financial Stabilization (OFS) within
Treasury to implement a Troubled Asset Relief Program. At the
same time, Congress created the Congressional Oversight Panel
to ``review the current state of financial markets and the
regulatory system.'' The Panel is empowered to hold hearings,
review official data, and write reports on actions taken by
Treasury and financial institutions and their effect on the
economy. Through regular reports, the Panel must oversee
Treasury's actions, assess the impact of spending to stabilize
the economy, evaluate market transparency, ensure effective
foreclosure mitigation efforts, and guarantee that Treasury's
actions are in the best interests of the American people. In
addition, Congress has instructed the Panel to produce a
special report on regulatory reform that will analyze ``the
current state of the regulatory system and its effectiveness at
overseeing the participants in the financial system and
protecting consumers.''
On November 14, 2008, Senate Majority Leader Harry Reid and
the Speaker of the House Nancy Pelosi appointed Richard H.
Neiman, Superintendent of Banks for the State of New York,
Damon Silvers, Associate General Counsel of the American
Federation of Labor and Congress of Industrial Organizations
(AFL-CIO), and Elizabeth Warren, Leo Gottlieb Professor of Law
at Harvard Law School to the Panel. With the appointment on
November 19 of Congressman Jeb Hensarling to the Panel by House
Minority Leader John Boehner, the Panel had a quorum and met
for the first time on November 26, 2008, electing Professor
Warren as its chair. On December 16, 2008, Senate Minority
Leader Mitch McConnell named Senator John E. Sununu to the
Panel, completing the Panel's membership.
Acknowledgements
The Panel thanks Adam J. Levitin, Associate Professor of
Law at the Georgetown University Law Center, for the
significant contribution he made to this report. Special thanks
also go to Tai C. Nguyen for research assistance, Professor
John Genakopolos, Professor Susan Koniak, and Ellington
Management Group, LLC for generously sharing data, and Jesse
Abraham, Professor William Bratton, Thomas Deutsch, Rod
Dubitsky, Professor Anna Gelpern, Dr. Benjamin Lebwohl, Mark
Kaufman, Professor Patricia McCoy, Mark Pearce, Eric Stein,
Professor Susan Wachter, Professor Michael Walfish, and
Professor Alan White for their thoughts and suggestions.
APPENDIX I: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH
WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED JANUARY 28,
2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX II: LETTER FROM TREASURY SECRETARY MR. TIMOTHY GEITHNER TO
CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH WARREN, DATED FEBRUARY
23, 2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX III: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH
WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED MARCH 5, 2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX IV: MORTGAGE SURVEY LETTER FROM CONGRESSIONAL OVERSIGHT PANEL
CHAIR ELIZABETH WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER,
DATED FEBRUARY 4, 2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX V: MORTGAGE SURVEY FROM CONGRESSIONAL OVERSIGHT PANEL TO
NUMEROUS RECIPIENTS
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX VI: MORTGAGE SURVEY DATA FROM THE OFFICE OF THE COMPTROLLER OF
THE CURRENCY AND THE OFFICE OF THRIFT SUPERVISION
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX VII: MORTGAGE SURVEY DATA FROM THE FEDERAL DEPOSIT INSURANCE
CORPORATION
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]