Mortgages

How to Ruin a Good Announcement

Ellen Seidman — Wed, 12 Nov 2008 16:51:00 -0500

The announcement yesterday of new procedures for streamlined modifications of primarily prime mortgage loans in trouble was a perfect example of a good (albeit overdue) program being drowned by a really inept rollout.

Briefly, Fannie Mae, Freddie Mac, their conservator the Federal Housing Finance Agency, the Hope Now Alliance and a group of large banks announced standard procedures to do quick modifications-involving primarily an appraisal and verification of income-of seriously delinquent loans in either Fannie or Freddie MBS, or in the portfolios of either the GSEs or the banks. There are clear limits on what is involved. The big one is these are largely prime loans, and loans for which the servicer has relatively undivided loyalties. They are not the privately-securitized sub-prime and Alt-A loans that have caused the bulk of the problem to date, especially in lower income communities. That's a big limitation, but the fact is that the prime foreclosure rate is increasing steadily. And as of June 2008, there were about 373,000 Fannie and Freddie owned or guaranteed loans (many of them prime) that were seriously delinquent, and the number was climbing fast. That's Fannie and Freddie alone, not counting loans held in bank portfolios.

A second limit is that the borrower must be 90 days delinquent for the procedure to come into play, thus not helping borrowers who know they're about to get into trouble and want to proactively solve their problem before their credit is shot. Finally, the program doesn't really deal with the situation in which there are second and further junior liens on the property. A 38% housing-debt-to-income ratio may work if that loan is the only housing debt; it will strain any budget where there are additional liens.

The rollout was marred (that's being kind) by the Treasury trying to sell this for far more than it is, intimating that it is a substitute for aggressive action on a broader range of loans, including sub-prime and Alt-A loans and loans not yet seriously delinquent, such as the guarantee program that FDIC Chairman Sheila Bair has been pressing the Treasury to implement. The fact that the Chairman Bair wasn't around for the announcement and the Treasury spokesmen literally ran out of the briefing room to avoid answering questions didn't exactly help the picture.

Nevertheless, there is substantial value in what was announced. First, it may well break a log-jam with respect to Fannie Mae MBS in particular. Lenders have been complaining for some time that Fannie has been reluctant to participate in modifications in any meaningful way. Second, the program applies to all loans in Fannie or Freddie MBS, no matter who owns the MBS. This is a critically important point that the announcement essentially buried. Third, any deferred principal will not earn any interest. While the borrower will still ultimately be on the hook for it, the lender will lose all benefit of that part of the loan being outstanding. In some ways, this isn't really very different than the Hope for Homeowners combination of a big guarantee fee and a requirement that any equity gain be shared between homeowner and the party funding the loan (in that case in effect the government). Finally, if both the GSEs and the banks keep and make public careful records of what happens with these loans, and the program is successful (with limited re-defaults), those who want to apply similar broad standards to securitized loans will have a good case that doing so is in the investors' interest as well as the borrowers' and the country's.

On a related note, all the programs so far have carefully concentrated on owner-occupied primary residences. What that is understandable as a moral matter, especially in the face of substantial evidence of investor fraud in the single family market, it ignores two critical facts. First, each additional foreclosure, no matter who the owner, furthers the downward spiral of house prices, affecting everyone nearby. This is especially a problem in communities where there are a large number of foreclosures. Second, where the investor has rented the property out (common, of course, for 2-4 unit homes), a foreclosure puts the tenants on the street, even if they have been faithfully paying their rent. To some extent this is a matter of changing local laws and lender practices, but if we thought somewhat more broadly about the role played by good owners of small-scale rental housing, which is usually unsubsidized and affordable, we might be able to avoid the trauma in the first place.

*Update*: On Thursday, November 13, as FHFA James Lockhart discussed these and other topics relating to the conservatorship. He was joined by Barry Zigas of the Consumer Federation of America and Gregory Baer of Bank of America. Listen to or view the event.

Ellen Seidman Interviews Michael Barr and Eldar Shafir

Mark Huelsman — Sat, 18 Oct 2008 17:09:00 -0400

Ellen Seidman, director of Financial Services Policy in the Asset Building Program, recently sat down for a short discussion with Michael Barr of the University of Michigan Law School and Eldar Shafir of Princeton University for a short discussion on their new paper Behaviorally Informed Financial Services Regulation.

It's Still Not CRA

Ellen Seidman — Tue, 23 Sep 2008 02:36:00 -0400

When the Wall Street Journal lists the Community Reinvestment Act as only the 6^th Washington policy responsible for the current mess-behind such items as "The Federal Reserve," "Banking regulators" (the Fed gets dinged in this category too), and "a credit-rating oligopoly," I suppose those of us who think CRA did (and continues to do) some good should be pleased. After all, it was not so long ago that CRA was being fingered by conservative commentators as "the" cause of the crisis. But just to remind folks why CRA shouldn't even be on the Journal's list at all (their major compliant is that CRA "compels" banks to make loans to "poor borrowers who often cannot repay them," which describes one hell of a lot of not poor borrowers who banks made loans to without any prodding), I thought it would be useful to republish this blog's first posting. Here it is:

It has lately become fashionable for conservative pundits (Larry Kudlow, George Will) and disgruntled ex-bankers (Vernon Hill, for example, in his March 7 American Banker editorial) to blame the current credit crisis on the Community Reinvestment Act. This is patent nonsense. The sub-prime debacle has many causes, including greed, lack of and ineffective regulation, failures of risk assessment and management, and misplaced optimism. But CRA is not to blame.

First, the timing is all wrong. CRA was enacted in 1977, its companion disclosure statute, the Home Mortgage Disclosure Act (HMDA) in 1975. While many of us warned against bad subprime lending before the turn of the millennium, the massive breakdown of underwriting and extension of risky products far down the income scale-without bothering to even check on income-was primarily a post-2003 phenomenon. To blame a statute enacted in 1977 for something that happened 25 years later takes a fair amount of chutzpah.

It's even more outrageous because of the good CRA clearly did in between. The 1990s were the heyday of CRA enforcement-for a variety of reasons including the raft of mergers and acquisitions that followed the 1994 Riegle-Neal Interstate Banking and Branching Act, increased scrutiny of lending practices by the media and activism by housing advocacy groups and tougher enforcement by the Clinton Administration.That period saw increased home mortgage lending to lower income households and in lower income communities by the banks and thrifts covered by CRA, and a steady increase in the homeownership rate, especially for lower income and minority families. (See The Joint Center for Housing Studies ). In addition, there was significant investment in affordable rental housing, community facilities and broader community economic development, directly by banks and thrifts earning investment credit under CRA or indirectly through bank investment in Community Development Financial Institutions and other community-based organizations.

New research by Ingrid Gould Ellen and Katherine O'Regan of NYUWagner, presented at a conference sponsored by the Philadelphia Federal Reserve Bank, convincingly demonstrates that property values went up dramatically in low and very low income urban census tracts during the 1990s, reversing severe declines during the prior two decades. While Ellen and O'Regan point out that this does not necessarily mean that everyone in those communities benefited, relating the improvement in home values in distressed communities to the effects of a statute designed to increase access to mortgage credit in those communities, during a period when the statute was vigorously enforced, is a reasonable connection.

Second, CRA does not either encourage or condone bad lending. Bank regulators were decrying bad subprime lending before the turn of the millennium (see Interagency Guidance on Subprime Lending), and warning the CRA-covered institutions we regulated that badly underwritten subprime products that ignored consumer protections were not acceptable. Lenders not subject to CRA did not receive similar warnings.And we also explained to those we regulated how to serve lower income communities and borrowers in a manner that was good for the borrower, good for the bank, and earned CRA credit.

For example, in October 2000, when I spoke to the National Association of Affordable Housing Lenders, a group of CRA-covered lenders, I said, "key to successful community reinvestment activity is being a responsible lender. Being responsible means making loans on responsible terms to people who can afford to pay them back, and making certain borrowers both understand the terms of the loan and have the opportunity to get the best terms available given their credit and financial position. But it also means expanding both the market for and affordability of loan products. It means working with customers to make them more bankable, helping families find the loan that is right for them, and investing in their success and yours by supporting organizations that assist you by counseling these individuals on the front and the back end of a loan."

CRA enforcement became a lower priority for bank regulators after 2001. My successor at the Office of Thrift Supervision, in fact, led an effort-eventually thwarted-to unilaterally loosen CRA regulations for institutions with more than $1 billion in assets. See 70 Fed. Reg. 10023. Nevertheless, CRA regulations were eased more generally in 2005. See 70 Fed. Reg. 44256.

The years that coincided with reduced CRA enforcement are also the years when CRA-covered entities wandered deeper into "higher priced loans," a category that includes, but is not limited to, "exploding ARMs" and other particularly pernicious kinds of loans. Thanks to the valiant efforts of late Fed Governor Ned Gramlich, starting in 2004 we have data about "higher priced loans." In that year, bank, thrifts and their subsidiaries-the entities covered by CRA-made about 37% of high cost loans. By 2006, the bank, thrift and subsidiary percentage was up to 40.9%. That a lack of interest in CRA enforcement coincided with CRA-covered entities getting into higher priced lending does not seem to me an argument for less CRA enforcement. Rather, it's an argument for better enforcement of a statute that, when well enforced, had proven its worth in helping both borrowers and communities.

Finally, it is nevertheless the case that CRA-covered lenders are not the source of the problem. One of CRA's major failings, in fact, is that it only applies to banks and thrifts. Remember all the investment banks who demanded product and then sliced and diced loans until it was impossible to understand their quality?They're not covered. Neither are the independent mortgage banks, the kinds of firms that have gone bankrupt or nearly so because of their abysmal lending practices, who regularly made about 50% of the high cost loans. Bank affiliates, another uncovered group, made about 12% of the high cost loans.

Janet Yellin, President and CEO of the Federal Reserve Bank of San Francisco recently made this point, saying "Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households." And a recent study by Traiger & Hinckley LLP (See also the addendum).

CRA is not perfect. It doesn't cover a substantial portion of the financial services landscape. It has become complex, and the primary focus is on numbers of loans, with less attention to the quality of those loans. Asset-building depository and other services are given short shrift. And banks and thrifts have been allowed to "count" loans made by affiliates that are not subject to effective regulatory scrutiny. Governor Gramlich was right when he said that these entities-like the independent mortgage bankers-should be subject to far greater regulatory scrutiny, for many reasons. Certainly banks should not be allowed to count loans made by these affiliates for CRA purposes without such scrutiny.

But these are not reasons to repeal CRA or blame it for a mess caused primarily by those not subject to its reach during a period when even those under its umbrella were not encouraged to take it seriously. Rather, our challenge is to respond to the ongoing credit crisis in part by modernizing CRA, expanding its reach and making it even more effective than it was in the 1990s.

Fiscal Honesty Through the Tax Code? Unlikely

Ellen Seidman — Thu, 21 Aug 2008 13:35:00 -0400

Holman Jenkins ends his opinion piece about Fannnie Mae and Freddie Mac in Wednesday's Wall Street Journal with the memorable line: ". . .and (if we really feel more subsidy to homeowning is needed) insisting that Congress do it the fiscally honest way, through the tax code." Come on, Mr. Jenkins, if we want to be fiscally honest, we should do it through appropriations. Or at least through a capped, income-phased-out, refundable tax credit, which somehow I doubt was what he meant (although I'd be pleased to learn otherwise).

The standard tax code technique, an uncapped deduction, ends up subsidizing those who don't need it and neglecting those who do. The fiscal 2009 budget projects tax expenditures of over $100 billion for the home mortgage interest deduction. Honest budgeting would recognize that much of this goes to people who don't need it and artificially props up house prices. If we want to subsidize homeownership honestly, we'd get rid of the tax deduction and appropriate money to be directed to those who would not be homeowners without the subidy. But then, of course, we'd have to get serious about making the Department of Housing and Urban Development work.

FDIC Practices What it Preaches: IndyMac Loan Modifications Are On Their Way

Ellen Seidman — Wed, 20 Aug 2008 20:22:00 -0400

This afternoon FDIC Chairman Sheila Bair and her team took the next important step in making good on their promise to treat borrowers whose loans are held or serviced by IndyMac as the Chairman has urged other banks to treat their borrowers. Simply put, the FDIC announced a blanket loan modification program, under which the loans of borrowers in default or having trouble making their mortgage payments will be automatically modified into fixed rate loans whose terms will be set so that housing debt consumes no more than 38% of the borrower's income.

Many of the loans covered will be Alt-A loans, the kind that enabled borrowers to pay no interest for the first few years of the loan, leading to payment shock when that period ended that can far exceed the already substantial shock on a sub-prime loan that resets from, say, 7% to 10%.

Most of the loans will be modified into fixed rate loans for the remaining term of the loan at the interest rate of similar-term conforming loans (currently about 6.5%). If that still yields too high a payment, the loan will carry a lower interest rate for 5 years, and then will gradually increase to the conforming rate. The modifications come with no fee or other charges.

The critically different thing about this plan is that it's automatic. The FDIC is conditionally modifying the loans before the borrower even says "help!". All the borrower needs to do to seal the deal is to send in a check for the new loan amount and a verification of the borrower's current income. And this is no "pilot" program: the first round of modification letters will go to 4,000 people.

This step on the FDIC's part is apparently based on the joint premises that (i) when an Alt-A (or indeed, a sub-prime) borrower gets into trouble, the trouble is very big and cannot be resolved without a major restructuring of the loan; (ii) foreclosure, especially in the California markets in which most of IndyMac's loans are located, is almost always a far worse proposition economically for the bank (and the FDIC), as well as for the borrower, than getting principal on the loan repaid; and (iii) the borrowers at issue will be both willing and able to live up to their new obligation. As yet, there's no indication the program will include reductions in principal. Given the ups and downs of the housing market in general and in California in particular, that may be an important limitation on the program's success in avoiding foreclosures.

Nevertheless, this is a bold and important move on the FDIC's part. If it succeeds, it will not only demonstrate that Chairman Bair has had it right all along (which undoubtedly will make her feel somewhat better about the fact that her proposals have not gotten the traction they should have), but more importantly, it will set the stage for all those other banks to follow suit. See "Indy Mac's Next Role: Modification Test Case," American Banker (Aug. 14, 2008). It will be critical that the FDIC keeps us fully informed of what it is doing, and what the results are, including the extent to which there are re-defaults. And it will also be helpful if the FDIC's examiners in other banks don't discourage any other institution that wants to, from emulating the mother ship.