Homebuyers and Sellers Blacklisted By Lenders

(eFinance) As home prices fall across the nation, lenders are becoming more unwilling to write loans for home purchases in some geographical regions. The result is that financing is almost unattainable in certain areas.

Some of the nation's largest lenders have found an old, but useful way to protect their capital-impaired behinds: blacklists.

BankUnited, Wachovia and Washington Mutual are among the lenders who are shying away from writing loans in areas with declining home values. And they're considering more than just location. Some housing types or projects are also being put on the no-no list--namely condominiums.

The lists aren't widely circulated and usually go under another name. 'We don't call it blacklisting,' a banking official told CNN Money. 'We just don't write the loan.'

Although some banks don't call it blacklisting, there are actual blacklists that contain non-permissible housing projects and geographical areas. To see an example, check out the BankUnited list of non-permissible condominium projects in Miami and Las Vegas.

The practice isn't abnormal, particularly in a housing downturn. The lenders who aren't blacklisting entire areas have pulled back on the amount of money they are willing to loan. For example, CitiMortgage and JPMorgan Chase both reduce the maximum amount they will loan in counties and states that are known to have declining home values. Reductions are usually between five and ten percent.

The Effect of Blacklisting

While it's good that the banks are doing what they can to protect themselves now, they are most certainly putting some people in a precarious position in the process. Anybody who owns a home--and especially a condo--will find it more difficult to sell in areas where credit has dried up.

The end result will be falling home prices. This is not necessarily a bad thing for regions with inflated home values. Prices are bound to decline anyway. The faster they fall, the faster things can get back to normal.

However, it will be interesting to see what kind of domino effect this might create. The banks that financed the now-sweating condo developers and current condo owners in Florida, Vegas and other shaky areas may end up eating the money loaned before the blacklisting began.

Facing Default, Some Walk Out on New Homes

(NYT) When Raymond Zulueta went into default on his mortgage last year, he did what a lot of people do. He worried.

In a declining housing market, he owed more than the house was worth, and his mortgage payments, even on an interest-only loan, had shot up to $2,600, more than he could afford. “I was terrified,” said Mr. Zulueta, who services automated teller machines for an armored car company in the San Francisco area.

Then in January he learned about a new company in San Diego called You Walk Away that does just what its name says. For $995, it helps people walk away from their homes, ceding them to the banks in foreclosure.

Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. The old house is now the lender’s problem. “They took the negativity out of my life,” Mr. Zulueta said of You Walk Away. “I was stressing over nothing.”

You Walk Away is a small sign of broad changes in the way many Americans look at housing. In an era in which new types of loans allowed many home buyers to move in with little or no down payment, and to cash out any equity by refinancing, the meaning of homeownership and foreclosure have changed, economists and housing experts say.

Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989, according to a survey by the National Association of Realtors. Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, said in an e-mail message.

For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.

“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

In recent months top executives from Bank of America, JPMorgan Chase and Wachovia have all described a new willingness by borrowers to walk away from mortgages.

Carrie Newhouse, a real estate agent who also works as a loss mitigation consultant for mortgage lenders in Minneapolis-St. Paul, said she saw many homeowners who looked at foreclosure as a first option, preferable to dealing with their lender. “I’ve had people say to me, ‘My house isn’t worth what I owe, why should I continue to make payments on it?’ ” Mrs. Newhouse said.

“You bought an adjustable rate mortgage and you’re mad the bank is adjusting the rate,” she said. “And sometimes the bank people who call these consumers aren’t really nice. Not that the bank has the responsibility to be your friend, but a lot are just so uncooperative.”

The same sorts of loans that drove the real estate boom now change the nature of foreclosure, giving borrowers incentives to walk away, said Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania.

“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

In the boom market, homeowners took their winnings, withdrawing $800 billion in equity from their homes in 2005 alone, according to RGE Monitor, an online financial research firm.

Since the Depression, American government policy has encouraged homeownership as an absolute good. It protects people from increases in rent and allows them to build equity as they pay off their mortgages. And it creates stability in communities, because owners are invested in their neighbors.

But new types of loans like interest-only mortgages and cash-out refinance loans mean buyers do not pay down their mortgages. And adjustable rate mortgages, which accounted for 39 percent of mortgages written in 2006, expose owners to rent-like rises in their housing costs.

The value of homeownership, then, has increasingly shifted to the home’s likelihood to rise in value, like any other investment. And when investments go bad, people tend to walk away.

“When people don’t have skin in the game, they behave like they don’t have skin in the game,” said Karl E. Case, a professor of economics at Wellesley College, who conducts regular surveys of borrowers as a founding partner of Fiserv Case Shiller Weiss, a real estate research firm.

Though many states give banks recourse to sue borrowers for their losses, Mr. Case said, in practice it’s not often done “It’s tough to do recourse,” he said. “It’s costly, and the amount of people’s nonhousing wealth tends to be pretty slim.”

Christian Menegatti, lead analyst at RGE Monitor, said the firm predicted more homeowners would walk away from their homes if prices continued to drop, regardless of their financial circumstances. If home prices drop an additional 10 percent, Mr. Menegatti said, 20 million households will owe more than the value of their homes.

“Will everyone walk out?” he said. “No. But there’s been a cultural shift. Buying a house used to be like entering a marriage, a commitment for life. Now, if you see something better, you go back into the dating market.”

When homeowners see houses identical to their own selling for much less than they owe, Mr. Menegatti said, “I wouldn’t be surprised to see five or six million homeowners walk away.”

For Raymond Zulueta, the decision to go into foreclosure, and to hire You Walk Away, brought him peace of mind. The company assured him that in California he was not liable for his debt, and provided sessions with a lawyer and an accountant, as well as enrollment with a credit repair agency. He stopped paying his mortgage and used the money to pay down other debts.

Consumer advocates and others question the value of You Walk Away’s service.

“We are more interested in servicers and borrowers coming to mutual resolutions through loan remediation,” said Kevin Stein, associate director of the nonprofit California Reinvestment Coalition. “Even though we are not seeing good outcomes, we’re not willing to throw up our hands and say people should walk away from their homes based on the advice of a company that stands to profit from foreclosure.”

Jon Maddux, a founder of You Walk Away, said the company’s services were not for everybody and were meant as a last resort. The company opened for business in January and says it has just over 200 clients in six states.

“It’s not a moral decision,” Mr. Maddux said of foreclosure. “The moral decision is, ‘I need to pay my kids’ health insurance or my car payment so I can get to work.’ They made a bad decision, but they shouldn’t make more bad ones just because they have this loan.”

Mr. Zulueta said he felt he had let down the lender, himself, and his family.

“But you got to move on,” he said. “I know in a few years my credit’s going to be fine. If I want to get another house, it’s going to be there. I’m not the only one who went through this. I know I’m working the system, but you got to do what you got to do. There’s always loopholes.”

Borrowers Abandon Mortgages as Prices Drop

(WSJ) As home prices plummet, growing numbers of borrowers are winding up owing more on their homes than the homes are worth, raising concerns that a new group of homeowners -- those who can afford to pay their mortgages but have decided not to -- are starting to walk away from their homes.

Typically borrowers who turn in their keys are those who have run into financial trouble or need to relocate but can't sell their homes. But mortgage-industry executives and consumer counselors say they are starting to see people who aren't in dire financial straits defaulting on their mortgages because they don't want to pay for properties that have negative equity.

Many are speculators who had planned to quickly flip the home, but others appear to be homeowners who had second thoughts about their purchase.

"It may not be a big thing yet, and hopefully it won't be," says David Berson, chief economist for mortgage insurer PMI Mortgage Group Inc., of Walnut Creek, Calif. But if it turns out to be a significant trend, he says, it means that "delinquencies and defaults could be higher than the industry is estimating."

Some borrowers feel they have no good alternative. A tight credit market has made it tough for would-be sellers to find buyers or for borrowers looking to lower their mortgage costs to refinance.

Other borrowers are walking away in frustration because they can't arrange a workout with their lenders, says D.J. Enga, director of outreach services for Auriton Solutions, which counsels homeowners nationwide. Mr. Enga expects that 10% to 15% of the roughly 4,000 callers counseled this month by Auriton, of St. Paul, Minn., will walk away from their mortgages.

Sgt. First Class Nicklaus Skaggs is among those looking to walk way. Mr. Skaggs bought his home in April 2005 shortly after returning to California from a one-year tour of duty in Baghdad.

The $455,000 three-bedroom home he and his wife purchased in Vacaville, about one hour northeast of San Francisco, is worth an estimated $285,000 today, well below the $453,000 he owes on his mortgage. The monthly mortgage payment, which jumped after its interest rate increased, is now $4,000, up from $2,980 when he bought the house.

Mr. Skaggs expects to be redeployed to Iraq again later this year. But he can't sell his home, since there are few buyers, and he can't refinance because lenders require a large down payment he doesn't have. Now, the 18-year Army veteran has decided to walk away from his mortgage. He hopes in a few years lenders see his decision as a unique situation created by the housing meltdown. "I don't think that house is going to recover in value any time soon," said the 40-year-old. "I'd just be throwing the money away."

A rise in the number of people choosing to default on their mortgages would represent a significant departure from past behavior of American homeowners, who during past housing downturns tended to walk away only as a last resort, often because they couldn't afford to pay because of unemployment, illness, divorce or other life-altering changes that reduce income. And even then, the number of people who walked away was relatively small. During the oil bust in the Houston area during the 1980s and in California during the early 1990s, for instance, there was a brief spate of people sending in their keys to their lenders.

What's different now, analysts and economists say, is that home prices have fallen so far so quickly that some homeowners in weak markets are concluding that house prices won't recover anytime soon, and therefore they are throwing good money after bad. Also, many borrowers who bought in recent years have put down little if any equity. "If they haven't lived in [the home] very long and haven't put any cash in it, it's a lot easier to walk away," says Chris Mayer, director of the Milstein Center for Real Estate at Columbia Business School. He also notes that new homeowners may not have strong ties to the community.

Some borrowers, says Mary Kelsch, senior director at Fitch Inc., are less willing to make the sacrifices needed to stay in their homes, given the current environment. "It's a change of mind-set" she says. They are "looking more at their home as an investment that has lost its appreciation potential and don't really want to continue to pay."

Some in the industry want to toughen the consequences for borrowers who walk away. Executives at Fannie Mae say they are working to create harsher penalties for people who walk away from mortgages, and they plan to pursue some borrowers in court. They also want to extend the amount of time between when borrowers default and when they become eligible again for a Fannie Mae-backed loan.

"Of course, we will make exceptions for extenuating circumstances, like divorce or death," says Mike Quinn, a Fannie Mae executive. "But who we are trying to get are the people who can afford to make payments but have decided not to."

Goldman Sachs economists estimate that as much as $3 trillion in mortgages could be underwater by the end of the year, leaving 30% of the country's outstanding mortgages in negative equity. Since there is roughly $1 trillion in subprime mortgages outstanding, that means a large amount of better-quality mortgages, such as prime and Alt-A -- a category between prime and subprime -- will be attached to negative equity.

"The focus has been on the [interest rate] resets," said Goldman Sachs economist Andrew Tilton. "But if you're in a deep enough negative-equity position, defaulting has its own kind of logic."

In the Phoenix area, where home prices were off 15% in the fourth-quarter when compared with a year ago, accountant Steven Ulrich says several of his clients have recently said they plan to walk away. One client's home is now worth $100,000 less than the mortgage and the other is $60,000 underwater.

"It surprised me," said Mr. Ulrich, who works at The Focus Group in Scottsdale. "I'd never had people doing that before, if they had to it was something they were forced into. But these people are choosing it as a strategy, and I think it's going to be happening a lot more."

Some financial advisers are even encouraging homeowners who are upside down to consider foreclosure, which they see as a purely financial decision with limited negative consequences. YouWalkAway.com, a Web site started in January that offers foreclosure counseling to homeowners, advises that borrowers who default on one mortgage can typically get another mortgage between two and four years after a foreclosure. Then, "before you know it, you will have this behind you and a fresh start!" the site says.

A foreclosure will stay as a "strong negative" on your credit report for as long as seven years, though the impact on a borrower's credit score declines over time, says Mike Campbell, chief operating officer of Fair Isaac Corp., maker of the popular FICO credit score.

"Every single person we talk to either owes 100% [of their equity] or is upside down anywhere from $10,000 to $300,000," says John Maddux, co-founder of YouWalkAway.com, which charges borrowers about $1,000 for advice. Mr. Maddux says the site has received more than 190,000 visits and about 20% of their clients are investors.

As America's mortgage mess worsens, radical solutions are gaining appeal

(Economist) With brick-fronted townhouses and old-fashioned street lamps, Faulkner's Landing in Ashburn is one of hundreds of new developments that sprouted across the farmlands of northern Virginia during America's housing boom. Less than three years old, these houses originally sold for around $550,000, but are now worth some 40% less that that. Foreclosures are rising. For owners who put little or no money down, points out Danilo Bogdanovic, a local estate agent, it is often not worth paying a mortgage far greater than the value of the house.

As America's house prices slide, fears are growing that more people will post the keys to their lender and walk away. The practice, already common among speculative buyers, has a nickname, “jingle mail”. For a fee, websites such as youwalkaway.com, explain what to do. Laws on repossession differ by state. But thanks to high legal costs, mortgage firms have historically not chased borrowers even when the law allows it.

It is easy to paint grim scenarios. Repossessions are soaring, up 90% from a year ago according to RealtyTrac, a seller of foreclosure statistics. According to the S&P Case-Shiller index, average house prices fell by 9% in 2007 (see chart), and the pace of decline is accelerating. Mark Zandi of Moody's Economy.com reckons that 8.8m mortgage-holders, 17% of the total, have home loans that are greater than the value of the house. If house prices fall by another 10%, as he expects, Mr Zandi expects almost 14m mortgages to be underwater in a year's time.

Given that the typical mortgage is worth $225,000, over $3 trillion of debt would be affected. Since the costs of foreclosure can eat up 25% or more of the value of a loan, the losses could be enormous if a large fraction of these borrowers walk away. Nouriel Roubini, one of Wall Street's most pessimistic seers, worries that the “forthcoming jingle-mail tsunami” could spawn $1 trillion-2 trillion of financial losses, creating a systemic banking crisis.

Experience from previous regional housing busts suggests most people with negative equity do not simply walk away from their houses. But much about today's situation is unprecedented—particularly the high initial loan-to-value ratios. On February 27th Fannie Mae, the government-backed mortgage giant, announced an unexpectedly big loss of $3.55 billion for the fourth quarter of 2007 because of increased foreclosures.

Until recently, Washington's main fear was that foreclosures would soar as the low initial interest rates on some 2m adjustable subprime mortgages reset. In December 2007, to great fanfare, the Bush Treasury cajoled the mortgage industry into promising a (voluntary) temporary rate-freeze for certain groups of borrowers. So far, these efforts have yielded little. But thanks to big rate cuts by the Federal Reserve, resets are becoming less of a problem. One analysis suggests that the typical reset now involves a jump in monthly payments of just over 10%, compared with 25-30% six months ago.

But even as resets become less painful, analysts are realising that they are not the main cause of foreclosure. An influential study from the Federal Reserve Bank of Boston points to falling house prices, and the resultant negative equity, as a far bigger trigger. Stemming foreclosures, points out Paul Willen, an author of the study, will depend on reducing the size of mortgages relative to the value of a house.

One approach under consideration in Congress is to adjust America's personal-bankruptcy law so that judges can “cram down” a mortgage to the market value of a house. Under current law, judges cannot reduce the debt on someone's main residence, though they can do so for holiday homes or investment properties. Proponents of the legislation reckon 600,000 people could avoid foreclosure if the rules were changed.

The mortgage industry is vehemently opposed. And many economists worry that allowing cram-downs will worsen the drought of credit in America's mortgage markets. Chris Mayer of Columbia Business School points out that some $750 billion of annual mortgage lending has dried up as the securitisation of subprime and jumbo loans has collapsed. Changing bankruptcy rules, he argues, would make matters worse by raising the cost and reducing the supply of mortgage credit. Several studies have shown that borrower-friendly laws lead to more restricted credit. However, a new paper by Adam Levitin of Georgetown University Law School and Joshua Goodman of Columbia University finds scant difference in interest rates on mortgages that can already be crammed down (such as holiday homes) and those that cannot.

Unsurprisingly, bankers are lobbying for a different approach, one where the government stems the foreclosure spiral (and limits losses) by buying and refinancing whole swathes of mortgages. One idea, championed by Chris Dodd, the chairman of the Senate Banking Committee, is to recreate a modern version of the Home Owners' Loan Corporation, a Depression-era institution that refinanced mortgages in the mid-1930s when almost half of all home loans were in default. Other proposals have similar aims. A government institution, such as the Federal Housing Administration (FHA), would buy mortgages at a discount and refinance them into new loans with a government guarantee. Credit risk for the refinanced mortgages would shift to Uncle Sam.

How much of a “bail-out” this implies depends on the discount at which the mortgages are bought and on their subsequent performance. Most proposals suggest using the market price; Mr Zandi wants the government to buy mortgages by auction. Some plans are ambitious: Alan Blinder of Princeton University foresees an institution that takes over between 1m and 2m loans, worth $200 billion-$400 billion. Other schemes are narrower. Democratic congressmen talk of an initial capitalisation of around $20 billion.

Another complementary idea, touted by the Office of Thrift Supervision (OTS), is to give mortgage lenders a share of the upside if properties appreciate. Under this scheme, the FHA would insure a new mortgage at a house's current value. The existing lender would get a “negative equity” claim for the difference between that and the original loan, which could be exercised if the house later sold at a higher price. Some proponents of bankruptcy reform want to attach similar provisions to the cram-down. But the details of any “shared appreciation” devices are tricky. If homeowners have little hope of building equity in their house, the incentive to default remains.

All told, all the plans are fraught with problems. Bankruptcy reform will help some of today's borrowers while hurting tomorrow's. Government refinancing potentially puts taxpayers' money at risk. For the moment, the Bush administration opposes both and pins its hopes on voluntary loan modifications. Public opinion is also against any “bail-out”. But the climate in Congress is shifting. As the housing market worsens, bigger government intervention is becoming ever more likely.

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Surprise!!! You've earned a discharge and a foreclosure

(Credit Slips) Tomorrow, the Senate is expected to vote on the Foreclosure Prevention Act of 2008, Title IV of which would permit bankruptcy courts to modify home mortgages in certain ways if the loan and the debtor met specified criteria. We've described that idea before, but the bill has crucial implications for bankruptcy that are not related to loan modification. Specifically, take a look at section 421, which proposes a solution to a problem with current bankruptcy law. Many Chapter 13 debtors pay for 3 to 5 years on a repayment plan, doing everything the law requires of them, and only a week or two later, face a foreclosure. How does this happen? Because the mortgage servicers frequently assess charges during a bankruptcy case, but fail to disclose these fees. Courts don't approve them; trustees don't adjust the debtor's payments to account for them; and debtors aren't even given notice that these charges are piling up. Instead of emerging from bankruptcy with a fresh start, homeowners find themselves defending a foreclosure or having to immediately pony up hundreds or thousands of dollars. Just last week, Judge Brendan Shannon of the Delaware Bankruptcy Court addressed this issue, challenging lenders to disagree that these undisclosed "surprise" fees don't "frustrate" bankruptcy's home-saving purpose. The Foreclosure Prevention Act of 2008 tackles this problem by requiring mortgage companies to disclose all fees within the earlier of 1 year of assessing the charges or 60 days before the end of the bankruptcy. The law also specifies that a lender may only charge such fees if they are lawful, reasonable, and provided for in the contract. It's sad that this latter requirement is even necessary--it essentially just prohibits mortgage servicers from violating existing law by overcharging consumers, a problem that an increasing body of case law and research suggests occurs with alarming regularity. I see lots of reasons why permitting bankruptcy courts to modify mortgages may be the best comprehensive solution to the foreclosure crisis, but I also hope Congress takes a hard look at the rest of the bill and considers its overall importance. If consumers do their part in bankruptcy and make every payment required by law, the system should honor its promise to give them a financial fresh start.

Paulson says no go on housing bailouts

(Naked Capitalism) Treasury Secretary Hank Paulson has thrown a bucket of cold water on a number of proposals being floated in Washington to rescue troubled borrowers via the explicit use of public funds, such as the idea of reviving the 1933 Home Owner's Loan Corporation to buy underwater mortgages and renegotiate them.

In some respects, Paulson's tough stance is welcome, because many of these proposals would do more for banks and investors than borrowers. Many homeowners, including ones who are capable of servicing their mortages, are walking away because they deem them an unattractive investment. There is now a large class of nominal homeowners who in fact are more akin to renters with a home ownership option that is now deeply out of the money. And they can often rent more cheaply too.

But unfortunately, what is driving Paulson isn't a pragmatic assessment of what measures might be cost effective and not involve undue moral hazard. Instead, he is guided primarily by the ideological imperatives of this Adminsitration, which is to favor so-called private sector solutions. But that construct is dishonest and limiting. For instance, the Journal reports that Paulson maintains that "market-based approach will be enough to keep the situation under control."

If Paulson considers the worst housing market since the Depression to be under control, I shudder to think what an unmanaged situation would look like.

However, a grey area in "private sector solutions" is a willingness to rack up government contingent liabilities. The portfolio ceilings on Fannie Mae and Freddie Mac were lifted Wednesday, and OFHEO's James Lockhart had said earlier this month that the two GSEs could add $100 billion in mortgages in the next six months without running into capital limits. The plan now in place is to keep Fannie and Freddie in remediation mode, setting aside reserves 30% higher than the usual minimum. However, fi the GSEs come under increasing pressure to take on weaker mortgages to salvage the housing market, even those higher reserves may prove insufficient.

Similarly, the Treasury has not nixed some proposals to increase the role of the FHA. The FHA is the historical source of mortgages to middle and lower income borrowers, so an increased role for the FHA could well make sense. But again, it may be subject to pressures to relax its standards and become a warehouse for mortgages on the brink.

The dead body in the room that Pauson has addressed only in part, by his cosmetic Hope Now Alliance plan, is that securitization impedes the traditional practice of having the lender restructure mortgages for those borrowers who can be salvaged. In fairness, due to high loan to value ratios on new mortgages and the heavy use of cash out refinancings and home equity loans, many of the stressed borrowers may in fact not be able to afford even a generous mod. That poses a conundrum: does the collateral damage to communities and lenders warrant rescuing them anyhow? This tradeoff isn't discussed honestly, as it should be; instead all troubled borrowers are wrapped in the mantle of "about to lose their homes."

And the problem with the failure to acknowledge the major impediment, in combination with the Administration's ideological fixation, is that the best available solution is likely to be blocked. The Democrats have proposed changes to bankruptcy laws to give judges more authority to modify mortgages, While this may sound overreaching, in fact this simply puts residential mortgages on the same footing as commercial mortgages and vacation property. In effect, judges will do the mods that the mortgage services are either unwilling or unable to make. But the bill has already been watered down in the House and faces opposition in the Senate.

From the Wall Street Journal:

In an interview yesterday, Treasury Secretary Henry Paulson branded many of the aid proposals circulating in Washington as "bailouts" for reckless lenders, investors and speculators, rather than measures that would provide meaningful relief to deserving, but cash-strapped, mortgage borrowers....

Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee and typically an ally of Mr. Paulson's, said that, until now, he had supported the Treasury's steps to address mortgage delinquencies and the credit crunch they have spawned. "But they're not helping enough people," Mr. Frank said yesterday. "We're not going to get out of the crunch until we stop this cascade of foreclosures."

The Fed's Mr. Bernanke appeared to take a slightly more flexible position than Mr. Paulson, telling a congressional committee yesterday that the turmoil in the housing market doesn't yet merit large amounts of public money. "I don't think we're at that point, but I do think it's worthwhile to keep thinking about those issues," Mr. Bernanke said....

Administration officials "have been willing to broker deals, but they haven't been willing to put taxpayer money on the line," said Mark Zandi, chief economist at Moody's Economy.com, a West Chester, Pa., consulting firm. "I think they're trying to stick to those principles, and now they're running out of ideas that are consistent with those principles."....

"I'm seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes," Mr. Paulson said. "Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street."

The secretary added one caveat: "It would be imprudent not to have contingency plans, but we are so far away from seeing something that would have me calling for a bailout that I don't see it."

Mr. Bush is threatening to veto a Senate bill that includes $4 billion to help states and localities redevelop abandoned and foreclosed houses. "I believe the evidence is clear that these [voluntary industry] initiatives alone will not steer enough families away from foreclosure or our country away from further economic weakening," Mr. Reid wrote in a letter to the president yesterday, referring to the main element of the White House-backed industry plan. "In my view, the enormity of the foreclosure crisis requires a much more aggressive response."

The Reid bill also includes a provision -- opposed by many Republicans and the White House -- that would allow bankruptcy judges to alter the terms of mortgages.

Frank: Bailout-as-you-go

This is what the Financial Times is reporting:

A leading Democratic lawmaker on Tuesday called for $20bn in public funds to be made available to the Federal Housing Administration to purchase and refinance pools of subprime mortgages. . . .

Mr Frank said “we can do it through an existing vehicle rather than a new vehicle”. But the underlying logic of the two proposals is similar.

Mr Frank said that under his plan, the FHA would “buy up packages of mortgages but at a substantial discount”. It would then refinance the loans.

This would require about $20bn up front, but Mr Frank stressed that “the FHA would be repaid” as the loans were refinanced. The ultimate cost of the scheme to US taxpayers, under Congressional scoring practices, would probably be about $3bn to $4bn.

Mr Frank also called for between $5bn and $10bn in loans to the states, which would be used to purchase and refurbish foreclosed homes, and extra funding for counselling services.

Mr Frank said the “lesser efforts” to tackle the mortgage crisis to date “have not been very successful”. The housing crisis was “getting worse not better”.

The externalities involved in foreclosures justified the commitment of public funds. “We are talking about terrible impact on society.”

The main difference between the Frank plan and some of the other proposals circulating is the scale of the intervention envisaged.

Alan Blinder, a professor of economics at Princeton, has called for a new government vehicle modelled on the Home Owners Loan Corporation of the 1930s to borrow between $200bn and $400bn to buy up and restructure distressed loans.

Mark Zandi, chief economist at Moody’s Economy.com told the House financial services committee that it would take about $250bn in upfront funds to purchase all 2m loans expected to end in foreclosure by the end of this decade.

Mr Frank said “reality constrains” and his plan was limited to $20bn for the FHA because of the budget deficit and the need to meet pay-as-you-go spending rules.

So far this morning, my attempts to find more details on the Frank plan have not succeeded. I did, however, find this recently published statement of priorities for the House Committee on Financial Services, of which Frank is the chair:

The Committee on Financial Services urges the congressional budget resolution to prioritize the following critical issues:

(1) Housing Initiative. Over the last six months, the nation has experienced a significant increase in the number of homeowners facing the risk of foreclosure, with estimates of as many as 2.8 million subprime and “Alt A” borrowers facing loss of their homes over the next five years. We have already experienced declining home prices in many areas of the country, and the physical deterioration of certain communities, as a result of waves of vacant homes that were foreclosed or abandoned.

The Financial Services Committee is developing a number of proposals to address these growing problems. Given the urgency to take action, a significant portion of the cost of such proposals will likely be incurred in the current fiscal year. However, there would be some loan activities, FHA administrative costs, and additional housing counseling funding that would be needed over the period of the Budget Resolution.

First, the Committee is working on a proposal to provide refinancing opportunities to save as many as 1 million distressed homeowners from having their homes go into foreclosure. Such a proposal will likely involve using FHA and may involve the federal government purchasing loans. It would be implemented through separate authorizing legislation. Any proposal will require the existing holder to write down the loan to a level that is consistent with the homeowner’s ability to pay, and would exclude investor-owned and second homes. The estimated credit subsidy cost could be as much as $15 billion over the next five years. The Committee is also exploring options to limit federal government exposure and thus reduce costs. We could, for instance, require a limited soft second mortgage to the government that would enhance recoveries resulting from future property sales.

Second, the Committee is working on a proposal to provide as much as $20 billion in the form of grants, loans, or a combination of the two, for purchase of foreclosed or abandoned homes at or below market value. The purpose would be to help stabilize home prices and to begin to reverse the serious physical deterioration of neighborhoods with high numbers of subprime borrowers, defaults, and foreclosures. The structuring of such an initiative as a loan program would help to minimize the cost of the federal government, through net recoveries from the subsequent sale of properties.

Third, a substantial expansion of FHA to help keep homeowners in their home will require the contracting out by FHA for independent expertise for the development of underwriting criteria for refinanced loans and for quality control of the loans as they are being made, as well as increased FHA personnel costs for such activities as loan processing. This will require additional FHA administrative funding in the Budget Resolution for FY 2009 and possibly in subsequent years, in an estimated range of several hundred million dollars a year.

Finally, it is important for Congress to increase funding over FY 2008 levels by at least an additional $200 million a year for federal housing counseling grants. Such grants would increase capacity, in order to ensure that sufficient numbers of borrowers are assisted in implementing these and other initiatives to keep people in their homes.

I still have no particular idea where the "one million distressed homeowners" figure comes from, but we can, I think, conclude that it would be a total number of all FHA-related initiatives, including FHASecure and other kinds of fairly straightforward refinance programs, not just a program that involves FHA purchasing an existing loan in order to refinance it.

If the FT has the number right, we're looking at $20 billion for loan purchases. It's hard to calculate how many loans that would be without knowing just what kind of a discount is on the table. If you assumed a 10% discount and an average original loan balance of $200,000, you'd get just over 100,000 loans. At a 50% discount you could buy around 200,000 loans. That's a long way from a goal of one million loans, however you slice it.

On the other hand, there's the potential of several hundred million dollars a year on the table for independent experts who want to write FHA's credit guidelines for them. We knew that was coming.

The sanity level of this kind of plan still depends on why it is we want FHA to buy these loans and then refinance them, as opposed to simply refinancing them. The risk in the buyout, of course, is always that FHA pays too much for the loan; if buyer and seller need to do the full loan-level analysis to calculate the amount of the necessary loan balance to write off before establishing a price, then the practical thing to do at that point is simply a refinance, without FHA ever owning the old loan. If the point is that there isn't time or capacity for current loan holders to do that analysis, then the amount of the discounted price FHA would pay is uncertain at best.

I am also still eager to hear how this proposes to work from the perspective, specifically, of buying loans out of REMIC pools--and that is, presumably, where the problem loans in question are likely to be, not in bank whole loan investment portfolios. REMICs just cannot sell loans at less than par under current rules; without a change to those rules, it seems likely to me that in the process of selling defaulted loans to the government at a discount, the sponsors of these securities are committing themselves to bringing the deals onto their balance sheets, and possibly facing taxation of the trust itself (not just the investors receiving pass-through income). This is one of the several important differences between the current situation and the old HOLC situation in the Depression (where loans were being purchased from banks and were not securitized).

At this point I'm tempted to think it's a lot of additional mess for $20 billion. The Securities Lawyer Full Employment Act probably wasn't what anyone had in mind . .

Commentary: Not Your Garden Variety Foreclosures

(Housing Wire) RealtyTrac announced today that foreclosures are up markedly. While the number of foreclosure filings, which includes default notices, auction sales notices, and bank repossessions, rose 8% in January compared to the previous month, the new figures represent a 57% increase compared to a year ago.

While the number of subprime mortgages, especially those that were written in 2006 when rational lending guidelines took a hiatus, is a major factor contributing to this increase, another trend that’s emerging is painting a disturbing picture.

A few days ago, Global Economic Analysis (GEA) posted a screen shot from a particular Washington Mutual Alt-A mortgage pool known as WMALT 2007-0C1. The screen breaks down the pool of mortgages into the typical categories, including delinquencies. Here are some of the highlights from the pool:

Weighted Average LTV = 78%
Fico Score = 705
Full Doc Loans = 11%
Geography = 48% California, 15% Florida

The chart breaks down performance by month, starting with July 2007. By most standards, 705 is a respectable credit score, which makes the delinquency numbers all the more surprising. In a period of 7 months, this pool is showing a massive foreclosure rate of 13.17%. Add REOs into the mix and the figure goes to 15%. Even the vintage 2006 subprime pools didn’t default at such a rapid rate.

GEA poses an interesting question as to whether the FICO system has lost its mind or if maybe there’s a larger issue at work. Although it’s hard to imagine borrowers with a 20%+ equity stake (albeit phantom like) and strong credit scores defaulting at a rate that would lead any servicing portfolio manager to jump out of the nearest window, the numbers seem to indicate that borrowers may be walking away when they are 30 or 60 days delinquent, not even waiting for foreclosure. In December 2007, the 90 days delinquent category stood at 3.79%. Even if every one of these delinquencies became a foreclosure, the figure should only double to 7.58% in January. Instead, the foreclosure figure is 13.17%.

A look at the details shows that nearly 93% of the pool was rated AAA yet almost 15% of the entire pool is in foreclosure or REO after 8 months.

What does it all mean? Until recently, I may have been one of the last holdouts on the FICO bandwagon. I’ve seen enough delinquency reports to make me believe in the ability of FICO to accurately predict performance. But something is terribly wrong with this picture. Credit scores north of 700 have not, in my experience, shown such poor performance levels so quickly. While it’s possible that a deterioration in the underwriting guidelines (e.g. reverses after closing) that we saw on the subprime side became part of the fabric in Alt-A lending, it doesn’t explain these numbers, even if most of them were stated income loans. Unless of course, these were mostly No Doc loans, meaning that most of the borrowers didn’t have jobs. It’s hard to imagine just what was going on in the underwriting department.

If there was ever a doubt that the phenomenon recently dubbed as “jingle mail” actually exists, wonder no more. It’s alive and well. Hopefully, it won’t be still be around around come Christmas time. But given the recent trends, that may be wishful thinking.

OFHEO: HPA diverges between purchases and refis

(Housing Wire) U.S. home prices in the conforming mortgage market diverged sharply depending on whether the mortgage was a purchase or refinance transaction, according to data released Tuesday by the Office of Federal Housing Enterprise Oversight.

A price index looking only at conforming purchase transactions — excluding appraisals used for refinancing — found that prices fell dramatically, dropping 1.3 percent between the third and fourth quarters of last year. That’s a sharp decline when compared to the 0.3 decline posted between Q2 and Q3, and it led to a 0.3 percent annual price decline during 2007 for purchase transactions, OFHEO said.

The annual price decline was the first four-quarter decline in the purchase index since the series began in 1991.

Adding in refinancing appraisals, however, erased any evidence of a price decline: home prices actually appeared headed upwards when refinancing activity was included in the fourth quarter index. As a result, OFHEO’s all-transactions housing price index posted a 0.1 gain in the fourth quarter on a quarter-over-quarter basis, and 0.8 percent gain over the past year.

Evidence of inflated appraisals?
OFHEO director James Lockhart only indirectly addressed the divergence in price trends, saying that the results illustrated greater stability in the conforming mortgage market.

“Both OFHEO’s purchase-only index and the all-transactions index show relatively greater house price stability than do other nationwide house price indexes,” he said. “That may reflect, in part, the greater stability in the prime, conforming mortgage market served by the Enterprises than in other segments of the mortgage market,” Lockhart said.

Or it may reflect inflated appraisals, according to sources interviewed by Housing Wire, who said that appraisers face greater pressure to be aggressive on their valuation opinions when the transaction is a refinance.

During the housing boom, that pressure was to hit a target value often so that the borrower could obtain cash-out from the transaction. During the bust, the new pressure appraisers face may be to hit a target value high enough so that the same borrower doesn’t lose their house.

“You’re not looking at the potential loss of a home if an appraisal comes in too low for a purchase transaction,” said one source, who asked not be named in this story. “So the appraisals are sort of more free there to come in where the appraiser really thinks market value is. That’s not always the case if we’re talking about refinancing in this market.”

The mortgage industry has been under intense pressure from the public and from government officials to help millions of borrowers that are faced with the prospect of a mortgage rate reset refinance into a GSE-backed or government-insured fixed-rate loan. But faced with prices that are declining in many neighborhoods, refinancing has become increasingly problematic as highly-leveraged borrowers find themselves owing more on their house than it is currently worth.

It’s pressure that some industry sources think appraisers feel, even if only indirectly.

“Do you think an appraiser wants to be the reason that someone didn’t get refinanced, and as a result lost their house? No way, no how,” said one source that spoke with HW on the condition of anonymity.

Both Fannie Mae and Freddie Mac, who are regulated by OFHEO, were subpoenaed in November of last year by New York Attorney General Andrew Cuomo, who is suing the First American Corp. over the appraisal practices of its subsidiary eAppraiseIT.

The Wall Street Journal reported Tuesday that both GSEs are nearing a deal with Cuomo’s office that would eliminate broker-ordered appraisals completely, potentially in response to claims that appraisals were being inflated as housing prices rose — and, now, that in some cases they’re being inflated as prices drop.

Reinventing securitization

(Andrew Davidson) ...the current senior/subordinated structure should be revised, simplified or, perhaps, even abandoned. The beauty of the senior/subordinated structure is that the credit quality of the senior classes is based on the quality of the underlying assets, not on the guaranty of any third party. In principle, the diversity of loans in a pool should create a better quality guaranty than even a highly rated corporate guarantor.

The structure works by locking the subordinate investments in place until the senior classes are assured of full payment. To increase the value of the subordinate investments, structures have been devised that allow payments to subordinate investors when that subordination is no longer needed. Herein lies the problem. Issuers, investment bankers, and investors in subordinate classes are always seeking to reduce the amount of credit enhancement and increase the early cash flow to subordinate classes. This has lead to complex overcollateralization targets, multiple triggers, and early step‐down dates. These structures are designed to meet specific rating agency scenarios and may not provide the desired protection in real world scenarios. In addition, the ratings process has lead to the creation of very “thin” classes of subordinate bonds. Some bonds may make up only a small percentage of the total collateral, so when losses rise they can face a complete loss of principal over a very small range of performance change. This makes these bonds extremely difficult to analyze as they may be worth near par or near zero.

The securitization market would function more smoothly if these classes were less complex and were not so finely divided. The “gaming” of rating agency models by underwriters needs to be eliminated. Perhaps it is time to consider whether newer financial tools, such as credit default swaps, could be used to design a more transparent and financially efficient structure.

[Also,] investor capacity to perform independent investment analysis [should be increased]. While there may not be a way to force investors not to rely ratings in making investment decisions, it may be possible to increase the amount of information available to investors to improve the quality of their decision‐making. Over the past few years, too many bonds were sold with insufficient information for investors to form independent views on performance. Ratings should not be a safe harbor against independent analysis. Without detailed loan level information, clear underwriting criteria, and assurances against fraud, it is nearly impossible to form an independent view of a security. The investor’s motto should be: If you can’t assess, then don’t invest.

From the New Deal, a Way Out of a Mess

(Alan Blinder in the NYT) The question of the day seems to be this: Are we in, or heading for, a recession? But so much attention is focused on that question that we may be losing sight of an even greater danger: the possibility that powerful headwinds may prevent a strong recovery from any slowdown.

Most of the potential headwinds stem from the housing slump and related financial crises that began — but, unfortunately, did not end — with the subprime mortgage debacle. Wounded financial markets are supposed to cure themselves: asset prices fall, bargain hunters rush in and markets return to normal. But so far, that doesn’t seem to be happening much. Instead, house prices keep dropping, the mortgage-foreclosure problem grows and new strains in the financial system keep popping up like a not-very-funny version of Whack-a-Mole.

While the problems are multifaceted, I have several reasons for focusing on just one aspect of the mess: the potential tsunami of home foreclosures. First, it strikes home, literally. Foreclosures throw families — some of whom were victims of deception — into the streets. They erode home values, damage neighborhoods and reduce the values of other properties, thereby intensifying the decline in housing prices that underlies many of our current problems. And they might even cut into consumer spending, which would really throw us into recession.

A second reason is that reducing the wave of foreclosures would mitigate the closely related financial crises in home mortgages and the alphabet soup of financial creations based on them (M.B.S., S.I.V.’s, C.D.O.’s, etc.). If those markets perked up, other beleaguered credit markets probably would, too.

A third reason for focusing on foreclosures is that we’ve seen this film before. During the Depression, President Franklin D. Roosevelt and Congress dealt with huge impending foreclosures by creating the Home Owners’ Loan Corporation. Now, a small but growing group of academics and public figures, including Senator Christopher J. Dodd, Democrat of Connecticut, is calling for the federal government to bring back something like the HOLC. Count me in.

The HOLC was established in June 1933 to help distressed families avert foreclosures by replacing mortgages that were in or near default with new ones that homeowners could afford. It did so by buying old mortgages from banks — most of which were delighted to trade them in for safe government bonds — and then issuing new loans to homeowners. The HOLC financed itself by borrowing from capital markets and the Treasury.

The scale of the operation was impressive. Within two years, the HOLC received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages. (Adjusting only for population growth, the corresponding mortgage figure today would be almost 2.5 million.) Nearly one of every five mortgages in America became owned by the HOLC. Its total lending over its lifetime amounted to $3.5 billion — a colossal sum equal to 5 percent of a year’s gross domestic product at the time. (The corresponding figure today would be about $750 billion.)

As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC’s borrowers defaulted anyway. So the corporation eventually acquired ownership of about 200,000 houses, nearly all of which were sold by 1944. The HOLC closed its books in 1951, or 15 years after its last 1936 mortgage was paid off, with a small profit. It was a heavy lift, but the incredible HOLC lifted it.

Today’s lift would be far lighter. And a good thing, too, because our government is far more timid and divided than Roosevelt’s.

Contemporary mortgage finance is also vastly more complex. In the 1930s, banks knew all of their customers, and borrowers knew their banks. Today, most mortgages are securitized and sold to buyers who do not know the original borrowers. Then mortgage pools are sliced, diced and tranched into complex derivative instruments that no one understands — and that are owned by banks and funds all over the world.

But this complexity bolsters the case for government intervention rather than undermining it. After all, how do you renegotiate terms of a mortgage when the borrower and the lender don’t even know each other’s names? This is one reason so few delinquent mortgage loans have been renegotiated to date.

Details matter, so here are a few: First, any new HOLC should refinance only owner-occupied residences. Speculators can fend for themselves — or go into default. Similarly, second homes or vacation homes should be ineligible, as should very expensive real estate. (Precise limits would vary regionally.)

Third, mortgages obtained via misrepresentation by borrowers should be ineligible for HOLC refinancing, but cases of fraud or deception by the lender should be treated generously. Fourth, as the original HOLC found, not all bad mortgages can be turned into good ones. Where families simply can’t afford to be owners, the new HOLC should not be asked to perform mortgage alchemy.

What about the operation’s scale? Based on current estimates, such an institution might be asked to consider refinancing one million to two million mortgages — proportionately less than half the job of its predecessor, and maybe less than a quarter. If the average mortgage balance was $200,000, the new HOLC might need to borrow and lend as much as $200 billion to $400 billion. The midpoint, $300 billion, is one-seventh the size of Citigroup and would rank the new institution as the sixth-largest bank in the United States.

Given current low interest rates, a new HOLC could borrow cheaply and should find it easy to earn a two-percentage-point spread between borrowing and lending rates, for a gross profit of maybe $4 billion to $8 billion a year.

What about loan losses? A 10 percent loss rate, or $20 billion to $40 billion, spread over the life of the institution, seems incredibly pessimistic. (The original HOLC experienced a 9.6 percent loss rate during the Depression.) So the new HOLC seems likely to turn a profit, just as the old one did. But even if it loses a few billion, we must remember its public purpose: to help the economy recover, not to make a buck. By comparison, the new economic stimulus package has a price tag of $168 billion.

It is said that history never repeats itself. But sometimes there are sequels. Now is the time to re-establish the Incredible HOLC.

Larry Summers on preventing US foreclosures

(FT) The American economic outlook remains highly uncertain. But macro­economic policy is now properly aligned, as the economy will benefit over the next several quarters from fiscal and monetary stimulus. To the extent conditions warrant and inflation risks permit, monetary and fiscal policy are appropriately poised to provide further stimulus.

Policy towards America’s failing housing sector is in a far less satisfactory state. All honest analysts accept that policies adopted so far, such as the “teaser freezer” limits on resetting mortgage interest rates and increased federal support for mortgage lending, have had only a marginal impact on what may be the most serious crisis in housing finance since the Depression.

It appears house prices are down by 5-10 per cent from their peak, with derivatives markets predicting further declines of about 20 per cent. Price falls of this magnitude are likely to mean more than 10m would have negative equity in their homes and more than 2m foreclosures would take place over the next two years.

Foreclosures are extremely costly. Between transaction costs that typically run at one-third or more of a home’s value and the adverse impact on neighbouring properties, foreclosures can easily dissipate more than the total value of the home being repossessed. They also inflict collateral economic damage, as reduced wealth and diminished borrowing capacity in homes reduces consumer spending, increases credit market fragility and depresses local tax bases.

What can public policy do? It cannot and should not try to fix the fact that at current prices the supply of homes significantly exceeds demand or the reality that many own homes, often for speculation, that are no longer viable and should be back on the market.

But it can and should address a crucial issue: when the current owner is able and willing to pay more than the lender can get by foreclosing on a house, it makes no sense to go through with a foreclosure. Yet because of conflicts among lenders, legal uncertainties and concerns about encouraging defaults, there are grounds for fearing that wasteful and unnecessary foreclosures will take place on a large scale, hurting families, communities, the economy and the financial system.

How can this problem be addressed? The string has pretty much been played out on hortatory policy, to limited effect. Without finding ways of writing down mortgage liabilities, new finance will do nothing for the problem group that has negative equity. Direct government intervention in mortgage markets risks creating delays, burdening taxpayers and inhibiting necessary adjustments in house prices.

The right focus is on measures that will prevent unnecessary foreclosures by facilitating more efficient settlements between homeowners and their creditors. Legal changes currently being debated, to bring practice with respect to family homes into conformity with general bankruptcy practice in two areas, could make an important contribution.

First, remarkably, bankruptcy laws currently provide that almost every form of property (including business property, vacation homes and those owned for rental) except an individual’s principal residence cannot be repossessed if an individual has a suitable court-approved bankruptcy plan. The rationale is the prevention of costly and inefficient liquidations. It is hard to see why similar protections should not be prudently extended to family homes.

Critics worry that such measures will dry up the supply of mortgage credit. This is a legitimate concern and the reason why legislation should be carefully and narrowly drafted, to be applicable only to past mortgages where there has been no fraud and where foreclosure is otherwise imminent. But it is worth noting that: some inhibition on lending to those who seem likely to go bankrupt might be a good thing; also, there has been an adequate supply of capital and ability to securitise in the market for vacation and rental housing, where debtors are protected; and moreover, chapter 12 of the bankruptcy code enacted in the mid-1980s, which applied these principles to family farms, helped to resolve great financial distress without long-term costs in terms of reduced farm lending – despite protestations much like those that are heard today.

Second, methods need to be found to enable creditors who accept a writedown in the value of their claims to retain an interest in the future appreciation of the homes on which they have mortgages. This is standard practice in situations of corporate distress, where debt claims are partially replaced by equity claims.

Obstacles to such mortgages include uncertainties about tax and accounting rules. But at a time when there are great advantages to inducing lenders to let families to remain in their homes – and when families facing foreclosure are prepared to do things they might not do in ordinary times – it would be desirable to pursue suggestions by the Office of Thrift Supervision for so-called negative equity certificates to support shared appreciation work-outs.

Bankruptcy reform alone could, on some estimates, avert 500,000 foreclosures and, by establishing templates for renegotiation, aid a wider restructuring of mortgage debts. Proper support for voluntary restructurings involving interests in future appreciation should realise still greater benefits. As with fiscal stimulus, rapid bipartisan co-operation between Congress and the administration would benefit the financial system, the real economy and millions of Americans.

Recommendations for fixing mortgage securitization

(Tanta at Calculated Risk) I am generally impressed with the quality of Andrew Davidson & Co.'s analysis of mortgage securitization issues. This particular instance, however, leaves me shaking my head. Certainly I give them credit for trying to find constructive suggestions to make, but I don't think we've drilled down far enough into the issues yet.

This does start out right, I think:

The standard for assessing securitization must be that it benefits borrowers and investors. The other participants in securitization should be compensated for adding value for borrowers and investors. If securitization does not primarily benefit borrowers and investors rather than intermediaries and service providers, then it will ultimately fail.

The trouble is that the standard case for how securitization of mortgages benefits borrowers is simply the observation that it makes capital available for lending at reasonable rates of interest. But that's hardly a benefit if it makes too much capital available for lending at too cheap a cost: supply chases down ever more implausible types of borrowers with ever more implausibly "affordable" mortgages, with ever more aggressive solicitation tactics. We're all learning a lot about the costs to all of us of unlimited mortgage money being provided to the financially weakest of us. Therefore securitization's benefits have to be more than just the provision of capital and the lowest possible interest rates; if securitization cannot function to rationalize lending practices by creating "best practice" lending guidelines and loan product structures outside of which its generous capital is not available, then it always has the potential to blow devastating bubbles.

There's a lot in this essay, but for the moment I just want to focus on the analysis and recommendation for dealing with the front-end part of the problem:

At the loan origination stage of the securitization process, there was a continuous lowering of credit standards, misrepresentations, and outright fraud. Too many mortgage loans, which only benefited the loan brokers, were securitized. This flawed origination process was ignored by the security underwriters, regulators, and ultimate investors. . . .

First, originators should be held responsible for the quality of the origination process. Investors in mortgage‐backed securities rely on the originators of loans to create loans that meet underwriting guidelines and are free of fraud. Borrowers rely on originators to provide them with truthful disclosures and fair prices.

Notice how, in the first paragraph, we slip in the first two sentences from "the quality of the origination process" (something quite obviously under the control of the originator) to "underwriting guidelines," which in any securitization practice I know of are either outright stipulated by the issuer in all respects (Ginnie Maes, standard-contract Fannies and Freddies, a lot of private pools) or are at best negotiated between lender and issuer (most private pools, some GSE business). Once the guidelines are either published by the issuer or agreed to in negotiation between issuer and originator, then it is indeed the originator's job to meet them.

But a whole lot of these loans that are failing right now were originated as 100% CLTV stated-income loans, because the guidelines agreed to by the issuer allowed that. I am scratching my head over the logic here: I spent most of the early years of this decade, just as a for instance, blowing my blood pressure to danger levels every time I looked at the underwriting guidelines published by ALS, the correspondent lending division of Lehman. ALS was a leader in the 100% stated income Alt-A junk. And I kept having to look at them because my own Account Executives keep shoving them under my nose and demanding to know how come we can't do that if ALS does it. I'd try something like "because we're not that stupid," and what I'd get is this: "But if ALS can sell those loans, so can we. All we gotta do is rep and warrant that they meet guidelines that Wall Street is dumb enough to publish." Every lender in the boom who sold to the street wrote loans it knew were absurd, but in fact they had been given absurd guidelines to write to. What on earth good did it do to have those originators represent and warrant that they followed underwriting guidelines to the letter, when those guidelines allowed stated income 100% financing on a toxic ARM with a prepayment penalty?

Currently, investor requirements are supported by representations and warranties that provide for the originator to repurchase loans if these requirements are not met. However, when there is a chain of sales from one purchaser to another before a loan ends up in a securitization, investors may find it hard to enforce these obligations. Similarly, borrowers who have been victimized by an originator may have nowhere to go to seek redress if the company that originated their loan goes out of business. Some in Congress are proposing “assignee liability” as a solution to this problem.

Investors don't "find it hard to enforce these obligations" unless they did zero financial due diligence on the last party in the chain. The way it works, your contract is with the last party to own the loan. If you bought loans from Megabank who bought them from Regional Bank who bought them from First Podunk who bought them from Loans R Us who funded the application for a broker, your contract is with Megabank and if the reps are false, Megabank supplies the warranty (the repurchase or indemnification). Megabank can go collect from Regional, who can go collect from Podunk, as far back as it takes to find the original misrep. It's always possible, of course, that the broker made true reps to Loans R Us, who made true reps to Podunk, but it was Podunk who misrepped to Regional (because Podunk bought under a set of guidelines that might have worked with some other investor, but then decided to slip these loans into a deal with Regional, even though Regional published different rules). The assumption that it is in fact always the first originator (the one who closes the loan) who fails to follow guidelines is a huge logical flaw. The contract theory underlying this--that A in contract with B can enforce terms against D who was in contract with C who was in contract with B--startles me as well.

This necessity of "chained pushbacks" certainly does cause grief: eventually, bad loans get back to the originator, but not nearly soon enough. It could take two years for the thing to work through, and delaying negative consequences is never a good thing in terms of keeping incentives aligned properly. But it doesn't hurt investors: they get paid back at par right away from the first party in the chain. In fact, that may explain why, as a rule, they've never particularly cared about the whole problem of "aggregating," or having whole loans work their way from small local originators into the hands of large financial institution counterparties before they are securitized. The investors think, more or less correctly, that their risk is covered because while the loans might have been originated by Loans R Us, net worth $37,000, they were sold to the investor by Megabank, net worth o' billions, and that takes care of the counterparty risk. Which is to say, it puts the counterparty risk on Megabank, who puts in on Regional, etc.

The obvious thing for security issuers to do, if they want direct liability of the loan originator, is to buy the damned loan from the loan originator. Or, maybe:

Assignee liability, however, may create risks for investors and intermediaries that they are unable to assess. As an alternative to assignee liability, an updated form of representations and warranties – an origination certificate – would be a better solution. An origination certificate would be a guaranty or surety bond issued by the originating lender and broker. The certificate would verify that the loan was originated in accordance with law, that the underwriting data was accurate, and that the loan met all required underwriting requirements. This certificate would be backed by a guarantee from the originating firm or other financially responsible company.

The origination certificate would travel with the loan, over the life of the loan. By clearly tying the loan to its originators, the market would gain a better pathway to measure the performance
of originators and a better means of enforcing violations. Borrowers would also have a clear understanding of whom to approach for redress of misrepresentations and fraud.

While risk arising from economic uncertainty can be managed and hedged over the life of the loan, the risks associated with poor underwriting and fraud can only be addressed at the initiation of the loan. Such risks should not be transferred to subsequent investors, but should be borne by those who are responsible for the origination process.

Wall Street security issuers don't want to buy loans directly from any given originator, because that would require them to have loan purchase and sale agreements with a bazillion little counterparties. They like the idea that Megabank has agreements with one hundred counterparties, who each has agreements with one hundred counterparties, etc. The cost of all this managing of relationships and moving loans up into the biggest buckets--the "aggregator" bucket--never goes away, it just isn't carried operationally by Wall Street.

So the idea here is to keep the middle-men and intervening aggregation of whole loans, but to make sure the original party who closed the loan never gets off the hook by having that party issue some kind of surety bond that would be guaranteed by somebody. So Loans R Us, assuming it has enough capital to back a guarantee, issues this certificate stating that it followed ALS underwriting guidelines to the letter. The loan blows up because ALS underwriting guidelines are stupid. Now what?

And of course this is simply meaningless in the context of originators who go out of business. Go ask the monolines how much a credit guarantee is worth if the counterparty doesn't have any money. As it currently is, regulated depository loan originators are required to reserve for contingent liabilities on loan sales: if you have the risk you might have to repurchase a loan, you have to reserve something for that. State-regulated non-public non-depositories may not have such strict requirements, or may not have them enforced. So if you want to assure that originators appear to have the financial strength to make reps and warranties, then you need to look into financial and accounting requirements for originators. Forcing them to come up with a surety bond--putting investors ahead of the originator's other creditors in a potential bankruptcy because said investors don't want counterparty risk--is a bit much.

That's one of those few cases were you can, in fact, pretty much guarantee that credit costs to consumers will rise unnecessarily. If you just want originators to keep skin in the game, there's this old-fashioned way of securitizing loans called "participations" that you might look into. In that case, the investor only buys a fraction of the loan asset (not a fraction of a security, a fraction of a loan), with the originator retaining some percentage interest. That shares the risk between two parties, but also the reward: if you retain a 10% participation interest in a loan you sell, you get 10% of the monthly payment. If you buy 100% of a loan and collect 100% of the payment, and yet you force the seller of the loan to warrant its risk forever, that seller will find some way to be compensated for that--meaning more points and fees to borrowers.

The idea of assignee liability is that you did, in fact, agree to a set of underwriting guidelines when you bought loans or invested in a pool of loans. If you agreed to guidelines which are harmful to borrowers, then this capital you are pouring into the mortgage market is not helping borrowers. The essential confusion here is between failure to follow responsible guidelines and faithful following of irresponsible guidelines. My sad news for the investment community: a whole lot of what you are suffering from is the latter, not the former.

How can anyone possibly require more proof of that? Starting in 2007, investors rapidly pulled out of the 2/28 ARM subprime product. They just announced they wouldn't buy it any longer. And it went away. You do not have a bunch of mortgage brokers still selling 2/28s to borrowers, or correspondent lenders still throwing 2/28s into new securitizations. As you might have noticed, you don't have new securitizations. You always had the power to click your heels together three times and return to the land of just not buying the paper, but I guess you didn't know that until the pink witch showed up.

And you will note that what immediately happened after you all stopped agreeing to those goofball underwriting guidelines was that a bunch of marginal originators immediately went belly-up. That's all the business they could get: writing junk paper for foolish investors. You put them out of business. You should not be sorry about that, except for the part about how you did business with them for so long that now you might have a bunch of worthless contractual warranties. This is called learning by doing. The solution to it is not to go back to buying any old dumb loan that you can get someone to offer a warranty on.

The solution is for investors to refuse to get within 20 feet of a mortgage-backed security that is backed by dumb loans. If you do not know what a dumb loan is, you might want to consider investing in a different kind of instrument. If the guidelines are not dumb, then by all means hold those originators to every last dotted i and crossed t in their contracts, because it is true that the quality of the process is what the originators control. But if you tell them it's OK for them to make loans without seeing docs, without requiring down payments, without worrying about ability to repay, then that is what you get and what we all get.

ARMed and dangerous

ATHENS, Ga., Feb. 22 (UPI) -- A gun-wielding man in a ski mask robbing a Georgia bank told a teller he wanted payback for losing his house to foreclosure.

The robbery occurred at a Regions Bank branch in Athens just before noon Thursday, the Athens Banner-Herald reported.

"You took my house, now I'm going to take your money," the robber told the teller as he pointed a gun at her, Police Capt. Clarence Holeman said.

Holeman said that the FBI, which is investigating the robbery, would probably check bank records. Bank officials said they could not remember anyone who had been especially upset about losing a house.

Witnesses said the man was middle-aged and 5 foot, 9 inches to 6 feet tall. He took off the mask after leaving the bank, revealing sandy blonde hair.

A man who had been sitting in his truck filling out a deposit slip followed him but lost him when he entered a driveway a few blocks away.

Stimulus Plan Aids Buyers of High-Priced Homes

(NY Times) Elizabeth and Ben Kilgore are back in the real estate market. All it took was a little-publicized section of the economic stimulus package President Bush signed into law last week that lowered the borrowing cost of buying a more expensive home.

The Kilgores, who live in Tiburon, Calif., just north of San Francisco, are looking for a larger home in town for their growing family. Three years ago, when they bought their first home, they resigned themselves to buying a condominium because it meant taking out a mortgage they knew they could manage.

“This will push us into a price range that’s now financially possible,” said Ms. Kilgore, a real estate agent in Marin County.

And if the limit on loans backed by a government-backed housing finance entity like Fannie Mae is raised from $417,000 to the full $729,750 she has been hearing about, Ms. Kilgore said, “we will be able to get a 30-year fixed mortgage for less than what we’re paying now plus our homeowner’s dues.”

The temporary change in the loan limits is not about to revive the housing market on its own. But in some of the higher-priced regions of the country that have been hit hardest by the flagging real estate market, it could make a big difference. For if anything is going to breathe new life into the local housing economy in places like the San Francisco Bay Area, San Diego, Washington and Boston, it is home buyers emboldened by the prospect of larger loans at lower interest rates.

Daniel Billett, a mortgage broker in Seattle, where homes in the downtown area sell for a median price of around $400,000, said that he, like dozens of people he knows, is poised to refinance an existing jumbo loan at a lower interest rate.

“As soon as the loan limits are implemented and lenders are accepting applications. I’ll be the first in line,” said Mr. Billett, whose company, Response Mortgage Services, has been receiving a steady stream of inquiries from clients in recent weeks. “I’m going to save hundreds, and I mean hundreds, of dollars every month on my current jumbo loan, by switching to a conventional loan.”

For years, rates on jumbo loans, those for more than $417,000, were only slightly higher than rates on conforming loans at or below that limit. But now, with the interest rate on conforming loans at around 6 percent, sometimes less, jumbo loans are at least a percentage point higher.

“The difference is as big as it’s ever been,” said Bart Welles, a mortgage broker in Larkspur, Calif.

For a high-priced home, 1 percent can make a big difference. A monthly payment on a jumbo 30-year loan of $729,000 at 7 percent would be $4,850. Monthly payments on a conforming loan of the same amount, at 6 percent, would be $4,371, a $479 difference.

As the credit squeeze deepens, lenders have been reluctant to underwrite jumbo mortgages. That leaves houses languishing on the market, further depressing an already distressed housing market.

The change in loan limits, which allows the federal housing agencies Fannie Mae and Freddie Mac to purchase or guarantee the mortgages, is intended to encourage lenders to write more mortgages because they can easily sell them to the agencies.

It should also stimulate house buying and mortgage refinancing. As the thinking goes, once people start borrowing money, they will set back into motion the economic machine of brokers, agents and lenders that has been stalled for the past year and has helped stall the overall economy.

“Of all the various strategies proposed to help the housing market,” said Gus Faucher, director of macroeconomics at Moody’s Economy.com, “I think this one has the greatest potential, particularly for expensive housing markets.”

The change in loan limits will go into effect sometime in early March and will last at least through the end of the year. In areas where median prices do not exceed $271,050, such as the entire state of Alabama, the basic loan limit will be $271,050.

In areas where the median sales price is higher, the limits will rise to 125 percent of the median price, not to exceed $729,750. (The rules defining which locations qualify and where the borders of the areas will be drawn to determine the appropriate median price are to be written by the federal Department of Housing and Urban Development.)

High-priced housing markets — particularly much of coastal California, with some of the most expensive real estate in the nation — would benefit the most. In a state like California, or in the Northeast and Northwest, where home prices far exceed the national median of about $206,000, jumbo loans are a significant portion of the mortgage market.

In San Francisco, where the median home price is $777,000, 35 percent of all loans were nonconforming, according to First American CoreLogic, a data and analytics company in Santa Ana, Calif.

The anticipated stimulative impact is all the more important because prices are falling sharply. Prices have dropped 20.4 percent over the past year in Contra Costa County, east of San Francisco, and 13.1 percent in neighboring Alameda County, according to DataQuick Information Systems.

Indeed, California is probably the state hardest hit by the housing slump. As inventories rose in most cities, the median price dropped 16.9 percent from May to December, according to DataQuick. (Prices are still high; the California Budget Project, a public policy advocacy group, estimated that a family would need an annual income of $196,878 to afford the median-priced home in San Francisco.)

Across the state, homeowners stuck with high interest rates and potential homeowners who are still searching are watching the situation closely.

The window in the new law is short. But Mr. Faucher, the economist, said that if problems in the market continued, particularly in expensive markets, he would not be surprised to see the higher loan limits extended. “There’s nothing set in stone,” he said.

At first, the strongest interest is expected to come from people refinancing existing loans. In Berkeley, Calif., where the median home is worth about $776,000, MPR Financial, a mortgage brokerage firm, has received dozens of calls from clients asking about the possibility of refinancing their existing loans.

“Quite a few people who got their loans when the rates were higher have called in,” said Paul Riccardi, the firm’s president. “We tell them we have their application, and we’ll have it ready to go.”

In other places where housing prices are high, there is a similar anticipatory buzz about a change in the conforming loan cap.

In San Diego, real estate activity has dropped off noticeably in the past year. According to DataQuick, the number of homes sold in San Diego in January dropped 34 percent from a year ago. A change in the conforming loan limit could give a much-needed boost to the market, said Jim Abbott, a real estate agent there.

“The availability of jumbo loans was so easy,” Mr. Abbott said. “Now they’re not, and it’s really exacerbated the problem. But I don’t think anyone is counting on it until it actually happens.”

Jim Byrnes, a real estate agent in Palo Alto, Calif., where Zillow.com pegs the median home value at $1.4 million, said he had two clients who were first-time home buyers and were waiting for the new law to take effect.

“They’re literally waiting on the sidelines to see what happens,” he said. “If they can get a better interest rate it will make their path so much easier.”

Of course, prices for some houses in certain California enclaves and other luxury locations remain so stratospherically high that a change in the conforming loan limit, no matter how drastic, would have little effect.

“It won’t make so much difference here,” said Edna Sizlo, a real estate agent in Santa Barbara, Calif., where the adjacent suburb of Montecito has homes valued at a median $4.1 million, making them among the most expensive in the nation. “There’s nothing you can even live in for under $1 million.”

A ‘Moral Hazard’ for a Housing Bailout: Sorting the Victims From Those Who Volunteered

(NY Times) Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”

But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

But a growing number of policy makers and community advocacy activists argue that a government rescue may nonetheless be the most sensible way to avoid a broader disruption of the entire economy.

The House Financial Services Committee is working on various options, including a government buyout. The Bush administration may be softening its hostility to a rescue as well. Top officials at the Treasury Department are hoping to meet with industry executives next week to discuss options, according to two executives.

“There are a lot of ideas out there,” said Scott Stanzel, a spokesman for President Bush, when asked at a White House press briefing on Friday about a possible buyout program. “There are many different ways in which we can address this problem and we continue to look at ways in which we can do that.”

Supporters contend that a government rescue could be the fastest and cleanest way to force banks and investors to book their losses from bad mortgages — a painful but essential first step toward stabilizing the housing market.

The government would buy the mortgages at their true current value, perhaps through an auction, at what would probably be a big discount from the original loan amount. The mortgage lenders, or the investors who bought mortgage-backed securities, would be free of the bad loans but would still have to book their losses.

If the government took control of the bad mortgages, supporters of a rescue contend, it could restructure the loans on terms that borrowers could meet, keep most of them from losing their homes and avoid an even more catastrophic plunge in housing prices.

“Every citizen has a dog in this hunt,” said John Taylor, president of the National Community Reinvestment Coalition, a community advocacy group that has developed its own mortgage buyout plan. “The cost of spending our way out of a recession is something that everybody would have to bear for a very long time.”

Mr. Taylor estimated the government might end up buying $80 billion to $100 billion in mortgages. But he said the government could recoup its money if it was able to buy the mortgages at a proper discount, repackage them and sell them on the open market.

Surprisingly, the normally free-market Bush administration has expressed interest. Treasury officials confirmed that several senior officials invited Mr. Taylor to present his ideas to them on Feb. 15. Mr. Taylor said he had also received calls from officials at the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which is part of the Treasury Department.

But even supporters acknowledge that a government rescue poses risks to taxpayers, who could be left holding a very expensive bag.

Ellen Seidman, a former director of the Office of Thrift Supervision and now a senior fellow at the moderate-to-liberal New America Foundation, said the government’s first challenge is to buy mortgages at their true current value. If the government overpaid or became caught by an even further decline in the market value of its mortgages, taxpayers would indeed be bailing out both the industry and imprudent home buyers.

“It’s not easy, but it’s not impossible,” Ms. Seidman said. “There are various auction mechanisms, both inside and outside government.”

A second challenge would be to start a program quickly enough to prevent the housing and credit markets from spiraling further downward. Industry executives and policy analysts said it would take too long to create an entirely new agency, as Bank of America suggested. But they expressed hope that the government could begin a program from inside an existing agency.

But even if the government did buy up millions of mortgages and force mortgage holders to take losses, the biggest problem could still lie ahead: deciding which struggling homeowners should receive breaks on their mortgages.

Administration officials have long insisted that they do not want to rescue speculators who took out no-money-down loans to buy and flip condominiums in Miami or Phoenix. And even Democrats like Representative Barney Frank of Massachusetts, chairman of the House Financial Services Committee, have said the government should not help those who borrowed more than they could ever hope to repay.

But identifying innocent victims has already proved complicated. The Bush administration’s Hope Now program offers to freeze interest rates for certain borrowers whose subprime mortgages were about to jump to much higher rates. But the eligibility rules are so narrow that some analysts estimate only 3 percent of subprime borrowers will benefit.

Bank executives, meanwhile, warn that the mortgage mess is much broader than people with subprime loans. Problems are mounting almost as rapidly in so-called Alt-A mortgages, made to people with good credit scores who did not document their incomes and borrowed far more than normal underwriting standards would allow.

Borrowers who overstated their incomes are not likely to get much sympathy. But industry executives and consumer advocates warn that foreclosed homes push down prices in surrounding neighborhoods, and a wave of foreclosures could lead to another, deeper plunge in home prices.

Right or wrong, the arguments for rescuing homeowners are likely to be blurred with arguments for rescuing home prices. At that point, industry executives are likely to argue that what is good for Bank of America is good for the rest of America.

Homeowners Losing Equity Lines

(Washington Post) In one brief phone call, Nancy Corazzi's lender yanked away what was left of the $95,000 home equity line of credit that she and her husband took out five months ago.

The lender informed her that her Howard County home had plummeted in value and the company did not want the risk that she would owe more than the house was worth.

"I got off the phone and I was shaking," said Corazzi, who was using the money to pay preschool tuition for her twins ."I was near tears. We needed this credit line to get us through some tough times."

Several of the nation's largest lenders, along with smaller ones, are shutting off access to home equity lines in areas where home values are declining. It's an unusually aggressive move as the industry grapples with fallout from the mortgage crisis that began unfolding last year.

Now that home prices have dropped in many parts of the country, lenders are nervous that they may never collect the money that they extended to borrowers. They are responding by freezing or lowering the credit limits on home equity lines, leaving thousands of borrowers like Corazzi in the lurch.

"Nearly all the top home equity lenders I know of are doing this or considering doing this," said Joe Belew, president of the Consumer Bankers Association, which represents some of the nation's largest home equity lenders. "They are all looking at how to protect themselves as real estate values go down, and it's just not good for the borrowers to get so overextended."

Countrywide Financial, the nation's largest mortgage lender, suspended the home equity lines of 122,000 customers last month after reviewing their property values and outstanding loan balances. The company, like others, has an internal automated appraisal system that tracks values.

The company declined to disclose how many of the affected borrowers lived in the Washington area. About 381,000 borrowers in the region had home equity lines at the end of last year, according to Moody's economy.com.

USAA Federal Savings Bank froze or reduced credit lines for 15,000 of its customers, including Corazzi, and will not reconsider its decisions until "real estate values improve substantially," the company said in a statement.

Bank of America is starting to do the same and is contacting some borrowers, said Terry Francisco, a bank spokesman.

"We know this can cause hardship to our customers," Francisco said. "If they used the credit to make payments that are in the pipeline, we will work with them to make sure the payment goes through."

The appeal of home equity lines has always been their flexibility.

They operate like credit cards, with the home as collateral. Borrowers can use the money when they want, up to a limit, then repay it over time. The limit depends on the amount of equity they have in the house. Home equity lines, which grew popular in the late 1980s, have typically attracted educated borrowers with above-average incomes and job stability who tend to repay what they borrow in a timely manner, industry studies show.

Since the crisis in the housing and mortgage markets started, however, delinquencies on home equity lines reached 0.84 percent in the third quarter, the highest level in a decade, the American Bankers Association said.

Because missed payments are often a precursor to foreclosure, lenders are spooked. Companies that hold credit lines typically recoup little, if any, of their money in a foreclosure, hence the retreat on home equity lending.

Larry F. Pratt, chief executive of First Savings Mortgage in McLean, said most mortgage documents he has seen give lenders wide latitude to suspend or freeze credit lines.

"A layperson would not recognize the language because it's not that blatant," Pratt said. "It talks about deterioration of the value of the asset or the value of the collateral. . . . It's not boilerplate language by any means."

Maggie DelGallo did not realize that when she took out a home equity line a few years ago on her home in Loudoun County. Her lender recently froze the line.

DelGallo, a real estate broker, has used some of her credit line over the years. Had she known the freeze was coming, "I would have drained it," she said. "I would have taken every dime and possibly placed it in a money-market vehicle."

DelGallo said she does not think she is in dire straits. "It's more like a huge disappointment," she said. "I have this line of credit attached to my home that's useless."

Last year, 34 percent of borrowers said they used their home equity lines to pay off other debt and 29 percent used them for home renovation, according to a survey of lenders by BenchMark Consulting International. Another 31 percent used them to pay for other things, such as medical bills, weddings or vacations.

Corazzi initially used her line to consolidate debt. She and her husband took out the credit line in October because they thought her job was in jeopardy.

It was. In December, her salaried position as a loan-processing manager at a local mortgage bank changed to a commission-only job.

Given the slowdown in the industry, Corazzi has collected only one paycheck since then. Her husband, Ron, sells large-format copiers and printers to builders, and his salary alone cannot support them and their four children, ages 4 to 8.

By the time their lender called, the couple had $45,000 remaining unused on the credit line. Ron Corazzi is now looking for a second job, and his wife is hoping to pick up work as a substitute teacher.

Meanwhile, they are trying to open a new home equity line elsewhere, but chances are slim given the change in Nancy Corazzi's job status and the drop in their home's value. Five months ago, the Ellicott City house was appraised at $560,000; the lender says it is now worth $469,100.

"I told them, 'You guys are wrong,' " Nancy Corazzi said. "They said, 'Sorry, this is what we're doing in the entire area.' "

Corazzi said she was blindsided by what's happened. "I didn't know they could do that. I thought I was too smart to have something like this happen to me."

The Bank of America bailout

(Calculated Risk) I have no particular qualms about hanging BoA's name on this proposal. For one thing, they seem to have sent the memo. For another, they just "bought" Countrywide. (Who knows what the price would be net of this proposed government buyout of all the bad loans?) Edmund Andrews in the New York Times:

WASHINGTON — Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”

But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.

So that answers the questions everyone had about the OTS-NEC proposal, such as how the hell it would work with securitized loans: it wouldn't. The government would buy those loans out of those pools first, so the NEC thingy wouldn't be owned by the security. But if you "position" it as a bailout of homeowners, nobody will "perceive" it to be a bailout of the bond market?

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

But a growing number of policy makers and community advocacy activists argue that a government rescue may nonetheless be the most sensible way to avoid a broader disruption of the entire economy. . . .

Ellen Seidman, a former director of the Office of Thrift Supervision and now a senior fellow at the moderate-to-liberal New America Foundation, said the government’s first challenge is to buy mortgages at their true current value. If the government overpaid or became caught by an even further decline in the market value of its mortgages, taxpayers would indeed be bailing out both the industry and imprudent home buyers.

“It’s not easy, but it’s not impossible,” Ms. Seidman said. “There are various auction mechanisms, both inside and outside government.”

A second challenge would be to start a program quickly enough to prevent the housing and credit markets from spiraling further downward. Industry executives and policy analysts said it would take too long to create an entirely new agency, as Bank of America suggested. But they expressed hope that the government could begin a program from inside an existing agency.

But even if the government did buy up millions of mortgages and force mortgage holders to take losses, the biggest problem could still lie ahead: deciding which struggling homeowners should receive breaks on their mortgages.

Administration officials have long insisted that they do not want to rescue speculators who took out no-money-down loans to buy and flip condominiums in Miami or Phoenix. And even Democrats like Representative Barney Frank of Massachusetts, chairman of the House Financial Services Committee, have said the government should not help those who borrowed more than they could ever hope to repay.

But identifying innocent victims has already proved complicated. The Bush administration’s Hope Now program offers to freeze interest rates for certain borrowers whose subprime mortgages were about to jump to much higher rates. But the eligibility rules are so narrow that some analysts estimate only 3 percent of subprime borrowers will benefit.

Bank executives, meanwhile, warn that the mortgage mess is much broader than people with subprime loans. Problems are mounting almost as rapidly in so-called Alt-A mortgages, made to people with good credit scores who did not document their incomes and borrowed far more than normal underwriting standards would allow.

Borrowers who overstated their incomes are not likely to get much sympathy. But industry executives and consumer advocates warn that foreclosed homes push down prices in surrounding neighborhoods, and a wave of foreclosures could lead to another, deeper plunge in home prices.

Right or wrong, the arguments for rescuing homeowners are likely to be blurred with arguments for rescuing home prices. At that point, industry executives are likely to argue that what is good for Bank of America is good for the rest of America.

Nobody is going to create a functioning new agency with the relevant expertise and staffing and funding and clear mandate out of thin air fast enough to do what this wants to do, if what we want to do is stave off recession. FHA probably has the expertise to credibly attempt the loan-level workouts, but not enough hands to get saddled with $739 billion worth that has to be dealt with before everybody's lawns go brown. Ginnie Mae is, in my view, one of the most efficient and quietly professional government agencies ever: they run a highly successful program with a tiny staff. I can't imagine Ginnie Mae is ready to manage reporting and remittances on a brand-new government-owned pool o' junk of this size with existing resources.

So of course the whole thing would be outsourced to some private company. I'm sure there's a financial institution out there willing to write up a proposal for how the government can pay it a management fee to orchestrate the government's bailout of its last attempt to manage mortgage-lending-related program activities.

City asks people to 'adopt' vacant houses

(Minneapolis - St. Paul StarTribune) With the number of boarded-up homes increasing because of foreclosures, Minneapolis city officials are encouraging neighbors and block clubs to "adopt" a vacant property on their block.

Here are some suggestions from the Minneapolis Police Department.

• If you see someone inside or around a vacant property, call 911.

• If you observe anything on the property that could be a health or safety problem call 311.

• To report a building that is open to trespass, but has not yet been boarded up, call the Housing Inspections Boarded Building Unit (612) 673-5828.

• Check on a vacant property occasionally to ensure doors and windows are closed and that the building is not open to trespass.

• It's all right to shovel snow, rake leaves, and pick up or remove flyers and litter without notifying the property's owner.

• Do NOT dig, climb on a building, enter a building or make improvements to vacant property before you have written consent from the property owner.

• If your block has a property with an ongoing problem, call your Crime Prevention Specialist at your police precinct.

MBA and Cramdowns

(Calculated Risk) I see America's mortgage lenders have put aside their differences long enough to unite against cram-down legislation:

The nation's largest lending institutions are lobbying hard to block a proposal in Congress that would give bankruptcy judges greater latitude to rewrite mortgages held by financially strapped homeowners.

The proposal, which could come to a vote in the Senate as early as next week, is being pushed by Democratic congressional leaders and a large coalition of groups that includes labor unions, consumer advocates, civil rights organizations and AARP, the powerful senior citizens' lobby.

The legislation would allow bankruptcy judges for the first time to alter the terms of mortgages for primary residences. Under the proposal, borrowers could declare bankruptcy, and a judge would be able to reduce the amount they owe as part of resolving their debts.

Currently, bankruptcy judges cannot rewrite first mortgages for primary homes. This restriction was adopted in the 1970s to encourage banks to provide mortgages to new home buyers.

The Democrats and their allies see the plan as an antidote to the recent mortgage crisis, especially among low-income borrowers with subprime loans. The legislation would prevent as many as 600,000 homeowners from being thrown into foreclosure, its advocates say.

"We should be giving families every reasonable tool to ensure they can keep a roof over their heads," said Sen. Richard J. Durbin (Ill.), the Senate's second-ranking Democrat and author of a leading version of the legislation.

But the banks argue that any help the proposal might provide to troubled homeowners in the short run would be offset by the higher costs that borrowers would have to pay to get mortgages in the future. The reason, banks say, is that they would pass along the added risk to borrowers in the form of higher interest rates, larger down payments or increased closing costs.

If banks were unable to pass on the entire cost, they could be forced to trim their profits.

"This provision is incredibly counterproductive," said Edward L. Yingling, president of the America Bankers Association. "We will lobby very, very strongly against it."

You are, of course, really and truly living in Wonderland if you think that larger down payments and higher credit-risk premiums aren't already starting to get here in part and will only get more "severe" until we return to something like normal lending practices. Just yesterday Freddie Mac published a new Bulletin, adding another 30 bps in delivery fees to loans with LTV/CLTV at or over 80% and FICOs less than 740 (that's 0.125 or less in rate), plus basically getting rid of almost all conventional (non-FHA) loans with LTV greater than 97%. This is "serious" credit tightening only in the context of the egregiousness of the last few years, of course. But it's rather amusing that the MBA seems to think that we could avoid reversion to mean lending standards if only we didn't approve bankruptcy changes to allow cram-downs.

It's particularly amusing just after the OTS made a bit of a splash with its "Negative Equity Certificate" proposal, which is as close to a Chapter 13 cram-down as you can get without a judge involved. Regardless of what you might think about the NEC proposal--insofar as any of us really has enough detail to understand it at the moment--you must recognize that it represents a clear statement from the regulator of the largest thrifts and savings banks in the country--like, you know, Countrywide and WaMu--that principal is going to be charged off. Somehow. Some way. Sooner or later. The MBA can natter on all it wants to about how cram-downs would add 1.50% to mortgage interest rates (wherever that number comes from); if that's true, though, then it is entirely not clear why that 1.50% isn't already on its way even in the absence of cram-down legislation. As usual, the MBA lets the cat out of the bag in its breathless prose:

In December, the U.S. House of Representatives Committee on the Judiciary passed bankruptcy reform legislation that would allow bankruptcy judges to change unilaterally the terms of many mortgage loans, including the loan balance, as part of Chapter 13 bankruptcy proceedings. By granting judges this power, this bill throws into question the value of the collateral that backs every mortgage made in this country -- the home. Even a change Congress says will be temporary will be interpreted by the market as an additional risk, which lenders' prices must reflect.

That's right; there's no question about the value of the collateral now. It would only be in question if we let BK judges see those appraisals.

What this really means is that a successful cram-down would tell the investors in mortgage-backed securities that people can prove to a judge that 1) they cannot afford the mortgages they have and 2) the current value of the home is nowhere near the amount of the mortgage and 3) they do not, actually, want to just "walk away." (Nobody sane who really didn't care about keeping the home would subject themselves to a Chapter 13 just to get a cram-down; they'd mail in the keys.)

Apparently the MBA thinks that item 2) is not yet common knowledge among investors in mortgage-backed securities. This is ridiculous enough an idea that we have to assume it's willful smoke.

My own view is that a lot of mortgage lenders are still in serious denial on items 1) and 3). That'd be the whole "people who can afford their mortgages are just walkin' away" meme we've been dealing with. To admit to the fact that these mortgages are unaffordable for a lot of folks would be to admit that the whole stated-income/bogus DTI/teaser-rate qualifying games that lenders participated in for years was, in fact, what it appeared to be: a way to put people into mortgages who couldn't afford them. This is not a crisis of uncertainly about the collateral valuation. It is the recognition that the loans were made in the first place only because of the assumption that the borrower could always sell or cash-out when the true costs of the thing made themselves manifest, either through rate resets or just a couple of months of the reality of spending 50% or more of your gross income on house payments setting in. This recognition, which, frankly, the credit markets are actually getting to, contra MBA, is less about uncertain value of the collateral than exceptionally dubious reliance on such an uncertain thing to make loans work.

You have to keep remembering that the MBA is the same bunch who was all excited about increasing the conforming loan limits until mortgage bond traders--representatives to a man of that "market" the MBA is so solicitous of--announced, basically, that they had no intention of buying a pig in a poke (again). You do not make larger loan amounts less risky, especially in a declining value market, by simply declaring that "average" now means "125% of median." Mainstream media reports are getting fired up on the TBA issue, and as is generally the case with something this technical, they're not really getting it right. The issue isn't so much "segregation" of the new larger loans, it's specification.

In fact, there isn't any reason why the lower-balance currently-conforming loans couldn't go with the new higher-balance formerly-jumbo loans in a specified pool. (You just can't do it that way in a TBA pool.) It wouldn't necessarily be wise to do that, given that the lower-balance loans might get a better "execution" in TBA pools, but the point is that this isn't about "segregating" loans by balance. It's about, in essence, how much mortgage bond traders are willing to take on faith in "fungibility." TBA pools are sight-unseen: you are putting a price on loans not yet pooled, probably not yet even originated. You do this because you have the assumption that a conforming loan is a conforming loan, once it's got that GSE guarantee on it, so it doesn't matter which exact ones you get. The SIFMA announcement that the higher-balance loans would have to go in specified pools just means that you are putting a bid price on this exact pool of loans, and no other. If the loans are no longer truly "fungible"--if some of them are going to have characteristics that differ substantially from historical GSE pooling practices--then they're just not fungible. That doesn't mean they're bad loans or that nobody's going to bid on the things; it means traders need to know exactly what they're bidding on to price the prepayment risk adequately.

No, really. We've got specified pools. We have increased due diligence levels. We have the rating agencies adding additional data fields to pool-level tapes in order to rate them. We have the GSEs adding new loan-level reporting requirements so that correspondent and brokered loans can be identified in pools. This has all been going on for months and months now. "The market" wants to see, in rather more detail, just what it is we're putting in these pools. "The market" is already pretty sure there's some "uncertainty" here.

Strangely enough, at the same time the MBA is basically saying that all borrowers will get "priced" to the risk of underwater borrowers if cram-downs are allowed, as if we've never heard of the practice of risk-based loan-level pricing before. Either that, or everyone will have to make a down payment and verify income and meet reasonable ratio requirements. Which would, if it happened, pretty much make those loans "fungible" again, besides making them much less likely ever to end up in Chapter 13.

The mortgage industry's major lobbying group is coming out and telling you, explicitly, that cram-downs would ruin the party because we'd either have to disclose these bankruptcy-in-the-making loans to "the market" and watch it slap a punitive bid on the things, resulting in a rate the borrowers could never afford, or we'd have to stop making bankruptcy-in-the-making loans. Or perhaps we are being told that the MBA knows of no possible way to screen loan applications to cull out the ones most likely to end up in BK. That's rather a startling point of view from the folks who are supposed to be experts in mortgage lending.

To be perfectly honest, I'm not especially impressed with the rationale given for the cram-down proposal. I'm not convinced that 600,000 families are going to flock to Chapter 13 if the bill passes and end up financially better off and still in possession of their homes as a result. Most likely, they'll either be financially better off or still in possession of their homes, but not both. I support the bill, nonetheless, because giving residential mortgage lenders preferential treatment in BK proceedings has not worked out well for us, and if it takes the threat of cram-downs to sober everyone up on credit standards and pricing, then let's get on with it. At the very least we ought to be able to force the MBA to come clean on its rhetoric.

Banks Lose to Deadbeat Homeowners as Loans Sold in Bonds Vanish

Feb. 22 (Bloomberg) -- Joe Lents hasn't made a payment on his $1.5 million mortgage since 2002.
That's when Washington Mutual Inc. first tried to foreclose on his home in Boca Raton, Florida. The Seattle-based lender failed to prove that it owned Lents's mortgage note and dropped attempts to take his house. Subsequent efforts to foreclose have stalled because no one has produced the paperwork.

``If you're going to take my house away from me, you better own the note,'' said Lents, 63, the former chief executive officer of a now-defunct voice recognition software company.

Judges in at least five states have stopped foreclosure proceedings because the banks that pool mortgages into securities and the companies that collect monthly payments haven't been able to prove they own the mortgages. The confusion is another headache for U.S. Treasury Secretary Henry Paulson as he revises rules for packaging mortgages into securities.

``I think it's going to become pretty hairy,'' said Josh Rosner, managing director at the New York-based investment research firm Graham Fisher & Co. ``Regulators appear to have ignored this, given the size and scope of the problem.''

More than $2.1 trillion, or 19 percent, of outstanding mortgages have been bundled into securities by private banks, according to Inside Mortgage Finance, a Bethesda, Maryland-based industry newsletter. Those loans may be sold several times before they land in a security. Mortgage servicers, who collect monthly payments and distribute them to securities investors, can buy and sell the home loans many times.

Housing Boom
Each time the mortgages change hands, the sellers are required to sign over the mortgage notes to the buyers. In the rush to originate more loans during the U.S. mortgage boom, from 2003 to 2006, that assignment of ownership wasn't always properly completed, said Alan White, assistant professor at Valparaiso University School of Law in Valparaiso, Indiana.

``Loans were mass produced and short cuts were taken,'' White said. ``A lot of the paperwork is done in the name of the original lender and a lot of the original lenders aren't around anymore.''

More than 100 mortgage companies stopped making loans, closed or were sold last year, according to Bloomberg data.
The foreclosure rate, at 1.69 percent of all U.S. homeowners, is the highest since the Mortgage Bankers Association began tracking it in 1993. The foreclosure rate for subprime borrowers, who have bad or incomplete credit and whose mortgages typically are securitized by private banks rather than government-sponsored entities Fannie Mae and Freddie Mac, is at a four-year high, according to the mortgage bankers.

750,000 Homeowners
More than 1.5 million homeowners will enter the foreclosure process this year, said Rick Sharga, executive vice president for marketing at RealtyTrac Inc., the Irvine, California-based seller of foreclosure information. About half of them, 750,000, will have their homes repossessed, Sharga said.

Borrower advocates, including Ohio Attorney General Marc Dann, have seized upon the issue of missing mortgage notes as a way to stem foreclosures.

``The best thing to do is to keep people in their homes and for everybody to take steps necessary to make that happen,'' said Chris Geidner, an attorney in Dann's office. ``These trusts are purchasing these notes, and before they even get the paperwork, they foreclose on people. They become foreclosure machines.''

Lost-Note Affidavits
When the mortgage servicers and securitizing banks that act as trustees of the securities fail to present proof that they own a mortgage, they sometimes file what's called a lost-note affidavit, said April Charney, a lawyer at Jacksonville Area Legal Aid in Florida.

Nobody knows how widespread the use of lost-note affidavits are, Charney said. She's had foreclosure proceedings for 300 clients dismissed or postponed in the past year, with about 80 percent of them involving lost-note affidavits, she said.

``They raise the issue of whether the trusts own the loans at all,'' Charney said. ``Lost-note affidavits are pattern and practice in the industry. They are not exceptions. They are the rule.''

State laws generally make it difficult to foreclose because they favor the homeowner, said Stuart Saft, a real estate lawyer and partner at the New York firm Dewey & LeBoeuf LLP.

``All these loan documents are being sent to the inside of a mountain in the middle of America and not being checked very carefully,'' Saft said. ``The lenders can't find the paper. We're dealing with a lot of paper produced in a mortgage closing.''

`Waste of Time'
Requiring banks to produce the paperwork at a foreclosure hearing is a nuisance, said Jeffrey Naimon, a partner in the Washington office of Buckley Kolar LLP.

``It's a gigantic waste of time,'' Naimon said. ``The mortgage may have transferred five, six, eight times. It's possible that you don't have all the pieces of paper, but it was enough to convince the next guy in the chain. There's no true controversy over whether the owner owns the loan.''

Judges are becoming increasingly impatient with plaintiffs who produce no more proof of ownership than a lost-note affidavit or a copy of the note, said Michael Doan, an attorney at Doan Law Firm LLP in Carlsbad, California.

``Things are heating up,'' Doan said.
In Ohio, where RealtyTrac reported an 88 percent jump in foreclosures last year, Dann, the attorney general, is now arguing 40 foreclosure cases that challenge ownership of mortgage notes, according to his office.

`Cavalier Approach'
U.S. District Judge David D. Dowd Jr. in Ohio's northern district chastised Deutsche Bank National Trust Co. and Argent Mortgage Securities Inc. in October for what he called their ``cavalier approach'' and ``take my word for it'' attitude toward proving ownership of the mortgage note in a foreclosure case.

John Gallagher, a spokesman for Frankfurt-based Deutsche Bank AG, said the bank had no comment.
Federal District Judge Christopher Boyko dismissed 14 foreclosure cases in Cleveland in November due to the inability of the trustee and the servicer to prove ownership of the mortgages.

Similar cases were dismissed during the past year by judges in California, Massachusetts, Kansas and New York.
``Judges are human beings,'' said Kenneth M. Lapine, a partner at the Cleveland law firm Roetzel & Andress LPA. ``They no doubt feel the little guy needs all the help he can get against the impersonal, out of town, mega-investment banking company.''

Warning Plaintiffs
U.S. Bankruptcy Judge Samuel L. Bufford in Los Angeles issued a notice last month warning plaintiffs in foreclosure cases to bring the mortgage notes to court and not submit copies.

``This requirement will apply because developments in the secondary market for mortgages and other security interests cause the court to lack confidence that presenting a copy of a promissory note is sufficient to show that movant has a right to enforce the note or that it qualifies as a real party in interest,'' the notice said.

Quick foreclosures benefit communities because properties in default lose value and homeowners in financial distress don't maintain their houses or pay real estate taxes, said Saft of Dewey & Leboeuf.

Painted as the Enemy
``When banks originally made the loans they used people's money from pension funds and savings accounts and they should be allowed to foreclose the loan as quickly as possible before the property depreciates in value any more,'' Saft said. ``The mortgage industry has been painted as the enemy when all they did was make loans to enable people to buy homes. Now there's less money available for new borrowers to buy homes and that's what's causing the value of homes to go down.''

Lents is former CEO of Investco Inc., a Boca Raton, Florida-based developer of voice recognition software. In 2002, the U.S. Securities and Exchange Commission sanctioned Lents and others for stock manipulation, according to the SEC Web site. He lost his job, was fined and his assets were frozen. That's the reason he couldn't pay his mortgage, he said.

``If the homeowner doesn't object to the lost-note affidavit, the judge rubber-stamps it,'' Lents said. ``Is it oversight, or are they trying to get around the law?''

Washington Mutual spokeswoman Geri Ann Baptista said the bank had no comment.
Looking for Loopholes
``I can't believe the handling of notes is worse than it was five years ago,'' said Guy Cecala, publisher of Inside Mortgage Finance. ``What we didn't have back then were armies of attorneys out there looking for loopholes. People are challenging foreclosures and courts are paying a lot more attention to foreclosures than they ever did before.''

American Home Mortgage Investment Corp., the Melville, New York-based lender that filed for bankruptcy last August, said it was paying $45,000 a month to store loan paperwork and petitioned U.S. Bankruptcy Judge Christopher Sontchi in Wilmington, Delaware, for the right to toss it all. Sontchi ruled last week that American Home Mortgage could charge banks from $3 to $13 a file to retrieve documents.

The home-loan industry has had a central electronic database since 1997 to track mortgages as they are bought and sold. It's run by Mortgage Electronic Registration System, or MERS, a subsidiary of Vienna, Virginia-based MERSCORP Inc., which is owned by mortgage companies.

No Tracking Mechanism
MERS has 3,246 member companies and about half of outstanding mortgages are registered with the company, including loans purchased by government-sponsored entities Fannie Mae, Freddie Mac and Ginnie Mae, said R.K. Arnold, the company's CEO.

For about half of U.S. mortgages, there is no tracking mechanism.
MERS rules don't allow members to submit lost-note affidavits in place of mortgage notes, Arnold said.
``A lot of companies say the note is lost when it's highly unlikely the note is lost,'' Arnold said. ``Saying a note is lost when it's not really lost is wrong.''

Lents's attorney, Jane Raskin of Raskin & Raskin in Miami, said she has no idea who owns Lents's mortgage note.
``Something is wrong if you start from what I think is the reasonable assumption that these banks are not losing all of these notes,'' Raskin said. ``As an officer of the court, I find it troubling that they've been going in and saying we lost the note, and because nobody is challenging it, the foreclosures are pushed through the system.''

Short View: Destructive momentum in the housing market

(FT) Momentum, as we know from politics and securities markets, is a powerful force. However, it could be at its most damaging when it comes to housing.

Housing is illiquid. It is hard to trade and it takes time for supply to respond to demand. As a result, once house prices start to rise, they can develop momentum - until gravity reasserts itself and prices fall back to earth.

Factors that should affect house prices include affordability (a function of interest rates), incomes and demographics - the number of adults needing a first home.

However, Tim Bond of Barclays Capital points out that once house prices start to accelerate, people expect them to keep on rising at that rate. All other factors are swamped. As he says: "After a period of strongly rising prices, the expectational component comes to the fore and becomes the key factor determining real house prices."

If people see house prices rising, greed trumps everything else. In the short-term, this is a self-fulfilling prophecy.

The behaviour of bankers assists the build up of momentum. ABN Amro points out that US lenders have been lending at a higher proportion of purchase prices, even as those prices have taken a larger and larger share of the average first-time buyer's income.

The problem with momentum in housing, as in equities, is that when it goes into reverse, the falls can be dramatic. In the US, a plateau in housing prices has been followed by a fall - the S&P Case-Shiller index is now down about 8 per cent from its peak. Meanwhile, this week's data on US housing supply showed continuing falls.

There is every reason to expect the same phenomenon in countries such as Spain and the UK, which also have housing bubbles. In the UK, house price rises seem finally to have run out of momentum. We know what happened next in the US.

FBI Will Not Go After Borrowers Who Lied on Mortgage Applications

(HomeGuide123) Borrowers who defrauded lenders by lying on their mortgage application could be thrown in prison for up to 30 years and forced to pay a $1 million fine under the current federal law. But the FBI says there is no intention to pursue borrowers at this time.

In 2006, the FBI studied three million mortgage loans and found that 30 to 70 percent of early payment defaults can be linked to misrepresentations in mortgage loan applications.

The figures aren't really surprising when you consider the fact that most of the defaults occurring right now involve borrowers who have not yet seen a payment reset. It is blatantly obvious there were an overwhelming number of borrowers approved for mortgages they could not afford.

The only way for this to happen was for someone to lie on a mortgage application. Some media stories have implied that it was lenders who did the lying and that most borrowers are victims of predatory lending schemes.

The truth is that borrowers did their fair share of lying too. More than 40 percent of subprime borrowers received loans without having to document their ability to pay. The borrowers simply 'stated' their income on the mortgage applications.

Almost 60 percent of stated-loan applicants inflated their incomes by at least 50 percent, according to the Mortgage Asset Research Institute. The worst part is that everyone knew the income was being inflated. The industry even had a name for these kinds of loans--'liar's loans.'

FBI Barking Up the Wrong Tree

Although lying on a mortgage application is a federal crime, borrowers who committed mortgage fraud are low on the FBI's list of priorities. Joseph Schadler, an FBI spokesman, said investigators will be focusing on organized property flipping rings and bogus foreclosure rescue schemes instead of lying buyers.

'We're going to pick the ones that are the most egregious and have the greatest impact on the economy,' Schadler said. 'Fraud for property is less impactful on the economy than the speculative fraud where people are trying to flip homes for profit.'

Time out.

The FBI had better run the numbers again. Borrowers who committed fraud by lying on their mortgage application could cost this country trillions of dollars.

There are plans to allow lying borrowers to refinance loans they cannot reasonably afford through federally sponsored mortgage programs implicitly backed by taxpayers. Presidential candidates are talking about robbing taxpayers to help lawbreakers and other homeowners who are facing foreclosure.

The impact to the economy will be enormous and beyond any effect created by a foreclosure rescue scam or house flipping ring.

States Not as Lenient

Although the FBI has no intention of enforcing federal laws, borrowers may not be able to get away with lying much longer if some states have their way.

In Texas a new state law was passed last year that holds borrowers accountable for the information supplied on mortgage applications. Borrowers are required to swear that all of the information they supply is correct.

Lenders who suspect they are being lied to are required to report borrowers to new task forces that are being set up specifically for this purpose. Borrowers who are reported will have no idea what is going on until it is too late because lenders are not allowed to notify borrowers that the task force has been contacted.

Borrowers who are caught lying or inflating income could face up to 99 years in jail and a $10,000 fine.

When "Underwater" Isn't the Same as Negative Equity

(Felix Salmon) The NYT has one of its big 2,000-word pieces on the housing market today, this time concentrating on the phenomenon of negative equity. The estimate the article cites is very high, and was greeted with some skepticism by Calculated Risk:

With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody's Economy.com.

But if you read the piece more closely, it doesn't quite say that "underwater" is the same thing as having a mortgage worth more than your house. Instead, consider the three homeowners it cites as grappling with this problem:

• Stuart Breakstone, who had to write a check for $65,000 when he sold his custom-built house for $170,000. He and his wife, who between them earn more than $250,000 per year, now have a $670,000 mortgage, which is "perhaps more than the house itself is worth".
• Collie Tuttle, who bought her house for $270,000 with no money down; she has since paid the mortgage down to $248,000. One potential buyer is willing to pay $269,000 for the house - 8.5% more than the mortgage, but not enough to cover the mortgage plus brokers' fees plus closing costs.
• Jane and Kevin Naus, who have a $192,000 mortgage on a house they're not living in; they have cut the asking price from $239,000 to $220,000. That's not only more than the mortgage: it would even cover all the costs of selling and leave them with $6,000 to spare. They're willing to continue paying the $1,400 monthly mortgage payments on an empty house for the time being, but they're not willing to cut the price any further (or, seemingly, to rent out the house and cover the mortgage payments that way).

So we have one rich couple who lost money on a custom-built house but seem reasonably comfortable. There's one woman who is more or less breaking even. And there's one couple who probably could have sold their empty home by now and paid off the mortgage with the proceeds, but who for unclear reasons haven't. If this is what is meant by "underwater", just wait until the United States starts suffering from real negative equity.

As for the graph accompanying the piece, it's frankly worthless. It shows that in mid-2009, one in four homeowners in the West will have zero or negative equity in their homes - but it doesn't say what kind of price appreciation or depreciation that projection is based on. Given that the number is pegged at about 10% now, one has to assume that there's quite a lot of house-price depreciation being assumed over the next year or so - enough to put just about anybody who's bought a house in the past few years underwater. It would be polite, I think, to tell us what that depreciation number is, so that we can judge for ourselves how realistic the negative-equity numbers really are.

Rescues for Homeowners in Debt Weighed

(NY Times) Prodded in part by some of the nation’s biggest banks, the Bush administration and Congress are considering costly new proposals for the government to rescue hundreds of thousands of homeowners whose mortgages are higher than the value of their houses.

Not since the Depression has a larger share of Americans owed more on their homes than they are worth. With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody’s Economy.com.

Administration officials say they still oppose any taxpayer bailout for either people who borrowed more than they could afford or banks that made foolish loans during the height of the speculative bubble in housing.

But with the current efforts to arrest the housing collapse so far bearing little fruit, Washington is being forced to explore new ideas, among them the idea of a federal mortgage guarantee for troubled borrowers.

And policy makers are listening to proposals from industry and community groups to use government funds to purchase and refinance billions of dollars in mortgages now in danger of default.

Many owners are only gradually becoming aware that their homes would sell for less than the debt against them — a phenomenon, said Richard T. Curtin, director of the Reuters/University of Michigan Surveys of Consumers, that is “beginning to weigh on people, making them uncertain and nervous about the future.”

That nervousness is evident across the country, particularly in places like Memphis, a city of nearly 1.3 million people where falling home prices and negative equity are new experiences.

The housing slumps of the mid-1970s and late 1980s were confined to the coasts. The current bust, while leaving some cities relatively unscathed, has cut a far wider path and it comes just when home debt is at its highest level since World War II.

For Stuart B. Breakstone, the problem hit home when he was forced to come to the closing on the sale of his eight-year-old custom-built house with a check for $65,000. The money, out of his own pocket, was to pay the difference between what he still owed on the mortgage for his home and the lower selling price.

Mr. Breakstone, a 42-year-old lawyer, and his wife, Lori, chief of customs agents at Memphis International Airport — who together earn more than $250,000 a year — managed to extricate themselves by paying off the mortgage. But millions of others are trapped in their homes. They have jobs, make their mortgage payments on time, but cannot raise enough cash to cover the shortfall.

Some eventually default, surrendering to foreclosure. But the vast majority — embedded in their communities, their children in public schools, their reputations at stake — wait nervously in hope that prices will bottom and rise once again, eliminating their negative equity and restoring their freedom to sell or refinance.

“People can’t believe this is happening to them,” said Robert Moulton, president of the Americana Mortgage Group in Manhasset, N.Y.

In Washington, it will be difficult to engineer a bailout similar to the one for savings and loan companies in the early 1990s, because Democrats and Republicans alike cringe at the very word bailout and fear a backlash by people who never became overextended.

But with millions of homeowners already underwater and the prospect that millions more may face the same situation, Democrats and Republicans alike are scrambling for ideas to keep people from simply walking away from their homes and to help those struggling to pay their bills.

Bank of America, which is in the process of acquiring Countrywide Financial and has potentially huge exposure, has circulated a proposal to create a new federal agency that would buy vast quantities of delinquent mortgages at a deep discount and replace them with fixed-rate federally guaranteed loans.

The bank warned that tightening credit conditions were leading to “escalating levels of delinquency and default among borrowers” and “an unprecedented number” of homes that would enter foreclosure.

Administration officials have given the Bank of America plan a cold reception. But the idea is similar to one proposed by Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Senate Banking Committee.

The Federal Housing Administration, meanwhile, is examining ways to expand its new insurance program, known as FHA Secure, to help people replace their costly subprime mortgages with federally guaranteed fixed-rate mortgages.

Mortgage industry executives have complained that the F.H.A.’s eligibility requirements are so restrictive that the new program has helped only a trickle.

Credit Suisse executives said they have held lengthy meetings with F.H.A. officials and have urged the agency to relax rules that currently disqualify many borrowers.

One idea, company officials said, was to allow borrowers who had simply made six payments during the course of their mortgage to qualify.

Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, has ordered his staff to come up with options for a broader rescue bill. An aide to Mr. Frank said his bill would, among other things, allow the government to buy up at least some troubled mortgages.

A more modest plan is being developed by John M. Reich, director of the Office of Thrift Supervision, the agency that regulates savings and loan companies. His plan, still in rough form, would create a voluntary system under which mortgage lenders would reduce debt and monthly payments to reflect the diminished sales value of a home.

It would take the remainder of the mortgage as a “negative amortization certificate,” a lien that the investor could recoup if the house were later sold for its original mortgage value or higher.

In an interview, Mr. Reich said he hoped that most of the old mortgages would be replaced by cheaper mortgages insured through the F.H.A.

“It isn’t a bailout,” Mr. Reich said. “It is a market-driven solution.”

For Americans caught in a mortgage trap and owing more on a home than it would sell for, consumer spending and confidence are the most immediate casualties, Mr. Curtin reports. But the damage goes deeper.

People cannot move easily to jobs in other cities if they have to sell their homes at a loss. The $168 billion federal stimulus package is likely to be less effective than intended because many homeowners may simply use their government checks to pay down their debts.

Housing prices in Memphis fell by 2.5 percent last year, only the second decline since records began to be kept in 1968, and by far the largest dip, according to Chandler Reports, which gathers this data for Greater Memphis.

The Memphis metropolitan area highlights the larger national trend, with the average first-mortgage debt, at $153,764, edging above the average home price, $152,815, for the first time. And that does not count refinancing and home equity loans, as well as closing costs.

Collie Tuttle, in her early 60s, is caught in this bind. Four years ago, she purchased a newly built four-bedroom three-bathroom house in the Memphis outer suburb of Olive Branch, Miss., for $270,000. She put nothing down, relying on her six-figure income from selling furniture to pay down the mortgage, reducing it to $248,000.

But then she lost her job, and in her next one — also selling furniture, but at lower pay — she is being forced to choose between her home and the rest of her life.

“It was a big mistake on my part to buy this house,” she said. Divorced, with two grown sons, she rattles around in it alone. She had thought the house would add to her wealth.

But now, to sell it for the $269,000 a potential buyer was recently willing to pay, “I would have to come up with $6,000 from my pocket,” Ms. Tuttle said, explaining that she cannot afford to invade her meager retirement account. “All I’m asking is for enough so that I come out even.”

Her house payments and utilities come to nearly $2,400 a month. That is affordable, she said, on her present income. But very little is left over to replace her 11-year-old car, to travel, to pay down her credit card debt, or even to buy new clothes.

“I’m stuck,” she said. “I’ve tried everything and I can’t get rid of this house.”

The reluctance to sell at a loss helps to explain why the number of homes listed for sale in the Memphis area has climbed to more than 13,000 from 9,000 a year ago.

Jane and Kevin Naus, in their mid-40s, have had their home on the market since last May; their attempts to sell for a price that covers their debts are skewing their lives.

Mr. Naus took a job in Greenville, N.C., last March, at a local bank. His wife stayed behind, putting their house up for sale, just a month before prices began to unravel.

But there were no offers at the $239,000 the couple asked for their four-bedroom brick house on a one-acre corner lot, so they gradually cut the price to $220,000, barely enough to cover the $192,000 in mortgage debt and an additional $22,000 in closing costs and broker’s fees. It still did not sell.

Mr. Naus says prices are under downward pressure because of competition from the auctioning of foreclosed homes at bargain prices. There were 5,714 foreclosures in Memphis in 2007. “In our neighborhood alone,” Mr. Naus said, “five houses were sold last September and October, and four of the five were foreclosures.”

Mrs. Naus joined her husband in Greenville in December but he lost his job in January, when his division was shut down. The couple decided to stay in Greenville, to be near the family of Mrs. Naus, who has multiple sclerosis and no longer works.

Her $1,800-a-month in disability pay, however, falls short of the $1,400 in monthly payments on the Memphis house and the $700 in rent for an apartment in Greenville. The Nauses make up the difference with his severance pay, and occasional dips into their savings, which have fallen below $100,000.

“We don’t want to lose the house or cut the price,” Mrs. Naus said, “and end up owing money.”

“Basically,” she added, “we are praying that the house sells before my husband’s severance runs out.”

The Breakstones are similarly in danger of sinking, despite their high income. After forking over $65,000 on the house they just sold, they are struggling with $670,000 in debt on their present, larger home — perhaps more than the house itself is worth.

The Breakstones, each previously divorced, married in 2006, bringing three children to their union. They needed a bigger house than the one Mr. Breakstone had built.

Mr. Breakstone thought that he could sell his other home quickly, but it sat on the market for 17 months and finally brought only $170,000. He covered the shortfall by borrowing against his present home — bringing it closer to being underwater, too.

Now the Breakstones are saddled with $4,000 a month in house payments, and $14,000 more in fixed outlays, including child support, car leases, taxes, consumer debt and utilities, using up the bulk of their income.

“I used to think,” Mr. Breakstone said, “that I would pay the piper later and enjoy life now. I’ve totally reversed that view.”

Naked Capital on Housing Bailout Plans (Part 1)

(Naked Capitalism) Any doubts that we are going down the Japan path of trying to shore up inflated asset value rather than letting the market find the right level, should now be over. Bloomberg tells us that the Office of Thrift Supervision is looking into a plan that will enable homeowners to refinance houses that have negative equity.

Before we get into the fact that this might be very difficult to put into effect (as Tanta alludes), this move is all about propping up the portion of the housing market where the lenders/investors have the most to lose, and correspondingly, where it is most rational for the homeowner to walk away. Consider, as Credit Slips did, that the Hope Now Alliance program was also targeted at borrowers who had very low (less than 3%) to negative equity) and as Credit Slips discussed, 75% of the interventions resulted repayment plans. These do not change the terms of the mortgage.

A different post at Credit Slips discussed the concept of "hostage value" in these loans:

A side note for the Not-Commercial-Law-Jocks: "Hostage value" in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to repossess the collateral. The classic example was the old practice of taking a security interest in all of a family's household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released. This version of the practice involving household goods is now banned by the FTC. In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions.

Rescue programs [operated by the states] limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender. But the mortgage lenders want more. If they don't get it, they won't release the mortgage--even though the lenders won't get anything close to 100% of the value of the home if they are forced to foreclose. They hold the home hostage: Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home.

Irony of ironies, borrowers may be savvying up to the fact that it isn't rational to let the bank threaten to make you pay more for your property than it is now worth (morality is another issue.....).

Increasingly, economists are finding that falling house prices, and not just payment stress, leads to higher default/foreclosure rates. The lending industry is no doubt alarmed that "jingle mail" is on the rise, and even some borrowers who can afford to make payments are abandoning their homes.

The last 15+ years of encouraging homeowners to view their residence as a financial asset are coming home to roost. By any rational calculus, staying in a home with negative equity, particularly if you are having trouble making the payments, is not a good bet.

Thus, it isn't clear how much this OTS concept, even it if sees the light of day, will help. But if it does, it benefits the mortgage industry far more than the public at large. Notice it also makes an explicit subsidy of underwater houses with government resources, We have now entered explicit bailout territory.

Update 9:00 PM: I wanted to clarify the point in the paragraph above about explicit government subsidies, since most reporting on this (and the reporting is muddied, which may be due to the plan being in flux) is the idea that the old, above market mortgage balance will be validated and continued via a government guaranteed new mortgage, or perhaps merely the warrant would be guaranteed.

This proposal flies in the face of good sense. The reason home prices are falling in many markets is that they are out of line wit incomes and rental prices. This measure appears to be an attempt to stymie various proposals to enable mortgages to be restructured by writing balances down to something more consistent with current market values. One such proposal is a Democrat-sponsored bankruptcy bill, which is regularly attacked by Republicans and the mortgage industry as allowing judges to rewrite mortgages, In fact, what this does is bring practice for residential mortgages in line with bankruptcy rules for businesses. Wonder why none of these critics has a problem with judges reducing a secured loan to the value of its collateral when the borrower is a corporation.

The idea that a government guarantee is not a bailout is such a canard that it is almost beneath comment, but this Administration knows no shame.

Update 2/22, 12:50 AM: Later reports (as per the New York Times) indicate that the negative amortization certificates would be privately issued, but the underlying fixed rate mortgages could come from the FHA. Still looks sus to me (one wonders, for instance, how generous the FHA appraisals will be, since they will determine the level at which the mortgage ends and the certificate begins).

From Bloomberg:

The U.S. Treasury is ``interested'' in a proposal to help homeowners facing foreclosure by refinancing their mortgages on homes that have fallen in value, a department spokeswoman said.

The Office of Thrift Supervision is developing a program to prevent borrowers from abandoning homes worth less than the amount of the loan. Homeowners would be able to refinance their mortgage at the current market values, with the lender getting a ``negative-equity certificate'' to be redeemed once the home is sold, OTS Director John Reich said yesterday.

``Treasury certainly wants to hear all ideas on ways to help homeowners, so we are interested in learning the details of this proposal as they develop,'' Treasury spokeswoman Jennifer Zuccarelli said. ``We welcome innovative, market-based proposals to encourage flexibility for struggling homeowners.''

The OTS, the Treasury's savings-and-loan regulator, joins other policy makers in suggesting ways to head off the worst housing slump in a quarter-century by limiting foreclosures. Treasury last week announced an agreement with loan servicers to place a 30-day freeze on foreclosures for borrowers meeting certain criteria.

Negative-equity certificates could help servicers limit loan losses and avoid an ``avalanche of borrowers who choose to walk away from the mortgage,'' Scott Polakoff, the agency's senior deputy director, said yesterday. The Federal Housing Administration could help homeowners refinance, he said.

Earlier today, Robert Steel, the Treasury's undersecretary for domestic finance, told Reuters that ``we're just learning about it,'' adding that he had talked with Reich about the proposal last night. ``They're still working out the details too,'' Reuters quoted Steel as saying.

Naked Capitalisn on Housing Bailout Plans (Part 2)

(Naked Capitalism) Man, not only does the Administration tell whoppers, but it is completely shameless about them. The latest sighting comes from Reuters:

Treasury Undersecretary Robert Steel told the Reuters Housing Summit it is proper for homeownership to hold a special status....

"If I default on my credit card debt, no one here knows and it has no affect on your credit card debt. If I am your next-door neighbor and I get foreclosed and thrown out, and the grass goes to heck and the home is boarded up ... that affects you," he said at the Reuters Summit in New York and Washington.

With that in mind, Steel said, the Treasury Department is working to develop programs that aid borrowers who are facing foreclosure, but a government bailout of the housing sector is not now needed.

Let's deal with the minor misrepresentation before dealing with the larger one. Do the people in the Treasury live in the real world? Rising defaults on credit cards ARE affecting other credit card borrowers. The issuers are cutting back on credit lines and raising their interest charges and fees even higher. The effect of abandoned houses on a neighborhood is obvious, but Steel is disingenuous to pretend that rising credit card defaults don't impose costs on other borrowers. The industry is pulling out all stops to both contain risks and increase revenues.

And while losing your access to credit cards isn't as awful or visible as losing your home, it isn't as invisible as Steel suggests. I certainly notice when people pay only in cash. I figure they either have credit issues or are trying not to leave a paper trail (in New York, one reason might be that they are claiming residence in a lower-tax state).

Now to the bigger issue. A Treasury representative has the gall to get up and say the Treasury doesn't do bailouts when the idea floated by the Office of Thrift Supervision has all the earmarks of being one. As reported in the New York Times (which repeated the canard that the Administration "oppose[s] any taxpayer bailout"):

A more modest plan is being developed by John M. Reich, director of the Office of Thrift Supervision, the agency that regulates savings and loan companies. His plan, still in rough form, would create a voluntary system under which mortgage lenders would reduce debt and monthly payments to reflect the diminished sales value of a home.

It would take the remainder of the mortgage as a “negative amortization certificate,” a lien that the investor could recoup if the house were later sold for its original mortgage value or higher.

In an interview, Mr. Reich said he hoped that most of the old mortgages would be replaced by cheaper mortgages insured through the F.H.A.

Let's parse this. The plan is to take mortgages now in the hands of private investors (remember a lot of this paper is in securitized vehicles; there will need to be a substitution of assets; that alone is problematic, but let's assume the Fed will sprinkle fairy dust so this can happen) and substitute is with a new fixed rate mortgage probably from the FHA plus a "negative amortization certificate". (Note that the Washington Post story on this plan was more definitive, that the FHA would provide the mortgage).

Intuitively, I don't see how this will fly if the FHA doesn't also guarantee the certificate too, and that was Tanta's first reaction (I'm sure well see her usual robust analysis soon enough):

Apparently, only the FHA mortgage would be a lien against the property, with the certificate being an obligation of FHA? It certainly surprises me that the OTS feels confident it can work out the legal kinks with that quickly enough to make a difference.

Now I may be making the mistake of assuming this plan is earnest. It may be a deeply cynical effort to muddy the waters, with the real intent of simply stymieing the proposal to allow judges to modify mortgages in bankruptcy (as we discussed in an earlier post, the idea isn't as heinous as its critics make it sound). Given the difficulties with asset substitution in securitized deals, this could take a long time to see the light of day (if ever), which may be the whole point.

But if the powers that be seriously intend to move ahead with it, the presentation treats the public as too dumb to understand that the government is indeed stepping in and assuming considerable financial risk, which will lead to hard costs. The "this is not a bailout" really means "we don't don't have to ask Congress to authorize a disbursement." The idea that increasing FHA mortgages to weak borrowers isn't a liability that will result in losses down the road is absurd. The FHA didn't qualify these borrowers initially (remember, the reason the FHA lost share to subprime is that they have good procedures as far as borrower screening is concerned). For this program to have any impact, the FHA almost certainly will have to relax its lending criteria considerably. And even if a fixed rate obligation reduces the homeowner's payment stress, the presence of the negative equity certificate will lower his incentive to keep the home. The market will have to appreciate considerably for him to show any gain.

There are good odds that homeowners may go through the hassle of getting the new financing and conclude in a year or two if their housing market doesn't improve, that they are better off giving up on the house (remember, research is now concluding that falling housing prices play a far bigger role in defaults than previously recognized).

So we'll see a transfer of losses. Instead of investors taking foreclosure-related losses now, we'll see the FHA taking foreclosure-related losses later. But that isn't a bailout because the Bush Administration is sticking its successors with it.

As Joseph Goebbels said,

The most brilliant propagandist technique will yield no success unless one fundamental principle is borne in mind constantly - it must confine itself to a few points and repeat them over and over.

So expect to see every homeowner rescue program assigned the preferred tag line "private sector solution" no matter how much in the end winds up coming from the public purse.

Mortgage rates post biggest jump in 14 years

(Housing Wire) Mortgage rates jumped dramatically during the past week, rising to an average of 6.37 percent for a 30-year conforming fixed-rate mortgage — 41 basis points above the average rate just one week earlier. According to Bankrate.com’s weekly national survey of large lenders, rates on 30-year jumbos soared to 7.55 percent. The jump in rates represents the single largest weekly increase since April 1994.

Housing Wire reported Wednesday that mortgage application activity has fallen off of a cliff as rates have risen amid a renewed focus on inflation within the bond market.

But inflationary concerns aren’t the only driver behind the mortgage rate increase, according to traders on Wall Street that agreed to speak with HW on an anonymous basis. One of the key factors now driving mortgage rates, they say, is growing secondary market sentiment that even conforming mortgages will soon be less fungible than they have been in the past.

“That sort of uncertainty gets priced into the trade, no question about it,” said one source.

In particular, while SIFMA has said it will keep newly-conforming jumbo mortgages trading on a specified-pool basis rather than including such loans in TBA trades, investors face a growing uneasiness over just what else is going to be thrown at the market. Congress is already considering a housing stimulus package that would make modifications of mortgage principal allowable in Chapter 13 bankruptcies, for one; news today that the OTS is considering the creation of a “negative equity certificate” market is another source of uncertainty.

Sources suggested to HW this week that federal regulators, as well, are considering new rules surrounding securitization designed to help provide rate benefits for ‘jumbo conforming loans.’ It’s unclear how any move by the Treasury here would impact the TBA market, in particular, but it appears that what is already out there is enough to move prices in the short-term.

The TBA trade is hinged on the perceived fungibility of mortgages being traded — on other words, that one mortgage pool is more or less similar to another mortgage pool. With the uncertainty now hanging over the mortgage markets, investors are seeing the potential for much greater risk, even in TBAs.

“What we’re seeing now may be an overreaction,” said one source, “but in the current market environment, you just can’t seem to tell what’s coming next.”

How to help both homeowners and lenders at no public cost

(Felix Salmon) I really like this idea from the Office of Thrift Supervision: it looks like it can reduce foreclosures and help provide liquidity to struggling mortgage lenders at the same time. Here's how it works: take a borrower who's underwater, with a mortgage for more than their house is worth. Refinance the mortgage so that it comes down to the value of the house, and then give the lender a tradeable warrant for the difference. Mortgage payments come down, because the mortgage has come down, and the lender, if it needs cash, can simply sell the warrant on the secondary market. If the house gets sold for more than the value of the new mortgage, the excess goes in the first instance to the warrant holder; the homeowner makes money only if the house is sold for more than it was bought for.

The big problem, as I see it, is securitization - the legal obstacles to doing this with a securitized loan are huge. But they may not be insurmountable, especially if this scheme is shown to work for mortgages held by a lender.

Bob Lawless is more skeptical: his problem is that the homeowner has very little incentive to maximize the sale price on the property. I have three responses to him:

1) If you're under water on a non-recourse mortgage, you already have no incentive to maximize your sale price. This changes nothing.
2) The homeowner does share in the upside, so long as the house is sold for more than it was bought for.
3)In any event, the whole point of this plan is to prevent people from putting their houses on the market in the first place, and rather to find a way to help them to stay in their houses.

I reckon this plan is definitely worth a try. If it catches on, it could be very helpful indeed. And the great thing about it is that it can all be done unilaterally: there doesn't need to be any legislation first.


Would You Like Fries With that Bailout?

(Mortgage Insider) On Wednesday, the Office of Thrift Supervision (OTS) unveiled a plan to help mortgage borrowers in trouble. The government agency urged federal savings and loan lenders under its authority to refinance loans by reducing mortgage balances to the current market value of the property.

The twist on this proposal is that lenders aren’t being asked to forgive the difference between the old mortgage and a home’s current value. Instead, the OTS is encouraging lenders to issue a “negative amoritization certificate” or warrant for the deficiency balance. If the home is sold at a later date and then regains its value, lenders would recoup the money.

As an example, if a home has a $350,000 mortgage but the market value is $300,000, the lender could refinance the home at $300,000 and issue a $50,000 warrant for the balance. If the house sells in the future and the value has gone up, the lender gets some or all of the money back. If the house is worth more than what’s owed, they could charge interest and anything left over goes back to the homeowner. The fact that the warrants could be publicly traded could make this attractive, given Wall Street’s love of financial wizardry.

Although the plan wouldn’t require any legislation it’s clear that participation would be voluntary. Given that some markets are in the midst of a price free-fall, it seems unlikely that lenders would participate in the most over-valued markets MSAs, the areas that need the most help.

So what’s the impact? On the scale of ideas we’ve heard floated it’s relatively benign. It’s an effort to prevent foreclosures while minimizing the hit lenders might take, without socking it to the taxpayer. Compared to freezing rates, it’s an improvement. At least the investor who bought the security and is anticipating an increased payment stream from the soon-to-adjust ARM isn’t getting blind-sided. In the short-term, no one is getting bulldozed because of government intervention. But it’s hard to envision it having much impact.

Looking at different borrower scenarios helps to identify what value if any comes from this program. Keep in mind, that any loan modification or workout only makes sense if the borrower has the ability to make the payments going forward.

Borrower A – currently paying on-time with a fixed rate. No motive for the lender to refinance at market value and issue a warrant.

Borrower B – currently paying on-time with an ARM. If the borrower can’t afford the payment increase, this program would help, but the borrower is probably a better candidate for a rate freeze. Why take the writedown if you don’t have to?

Borrower C – currently delinquent and holding a fixed rate. This borrower would get some relief if the reduction in principle balance would make the payment manageable. Ironically, it doesn’t appear the OTS developed this program with the fixed rate borrower in mind, although there are no limitations on the type of loan a borrower holds. The conundrum is that while the principle balance is being reduced, the deficiency balance for the late payments on the current mortgage would likely have to be recast into the new mortgage, thus increasing the principle balance or the size of the warrant. Then again, I suppose it doesn’t really make a difference right? What’s another $15,000-$20,000 in principle balance anyway.

Borrower D – currently delinquent holding an ARM. This borrower needs the most help but is probably the one who never should’ve taken out the loan in the first place. Unfortunately, if they are behind today, they won’t be able to afford the payment when the rate increases. Thus, lowering the principle balance won’t save them from foreclosure.

However, this program could, in a relatively short period of time lead to the supersize bailout, (a.k.a. “would you like fries with your mortgage intervention program") by freezing rates, lowering the principle balance and issuing a warrant. The ultimate mortgage combo.

Don’t be surprised if this becomes part of the next major government proposal.

Mortgage Plan Seeks To Stem Foreclosures

(Washington Post) The Office of Thrift Supervision is preparing a plan to help mortgage borrowers who owe more than their homes are worth and to discourage them from abandoning those properties, agency officials said yesterday.

Under the regulatory agency's proposal, still in its early stages, these borrowers would refinance into government-insured loans that cover the current value of their homes. The refinancing would pay part of what's owed to the original lender. For the remainder, the lender would get what the plan's backers call a "negative equity certificate." The lender could redeem the certificate if the home is eventually sold at a higher price.

The plan is a sharp change from the way troubled mortgages are handled now. It is the latest government initiative aimed at containing the mortgage market mess that surfaced last year when subprime borrowers began defaulting at an alarming rate. The administration and Congress have weighed in with their own plans in recent months, and the OTS proposal is meant to dovetail with those. "We're trying to find something that could operate in tandem with all these other proposals" without taking the borrower off the hook and without using taxpayer money, said Kevin Petrasic, an OTS spokesman. "We want to avoid having people walk away from their homes."

The agency, which has been closely involved in talks about government responses to the mortgage problems, focused on borrowers whose home values have plummeted because a growing number of people are in that situation and unable to refinance.

The proposal was briefly mentioned at a regular quarterly news briefing. More details should emerge over coming weeks, Petrasic said. The plan has been extensively analyzed internally and is now being discussed with policymakers and industry officials, he said.

The plan would separate a troubled mortgage into two parts. The first would cover the current fair-market value of the home and would be refinanced by the Federal Housing Administration. The remainder would be issued to the original lender as a certificate.

If the borrower eventually sells the home, the FHA mortgage would be paid off first. Remaining cash would be applied to paying off the value of that certificate. Anything left over would go to the borrower.

If there's not enough profit to pay off the certificate, the original lender would take a loss, which makes this proposal a gamble. However, the plan anticipates that there would be a market where these certificates are traded. That means the lenders could sell them immediately to offset some of the loss or hold them with the hope that they will appreciate, said Jaret Seiberg, an analyst at Stanford Policy Research.

The certificates would likely trade for small amounts, maybe $2 for every $100 in home value, and the amounts would increase as the housing market strengthens, Seiberg said.

But there are still many political and logistical hurdles.

This plan has not been vetted by the White House, Congress or other policymakers. The FHA declined to comment on the specifics except to say it is "regularly looking at new ideas and actively exploring ways to expand the eligible pool of creditworthy borrowers FHA can serve."

Whether investors will embrace the idea depends on many details that aren't resolved, Seiberg said. But it could be a way for lenders to cut their losses. "It beats foreclosure," Seiberg said. "These certificates enable [investors] to share in the upside if the housing market recovers."

For borrowers, avoiding foreclosure means they get to keep their homes and reduce damage to their credit.

"What we tried to do is figure out the best way to create market incentives for all the parties involved," Petrasic said.

New plan from OTS would have lenders reduce mortgage balances, but let them collect the difference later

(CNNMoney.com) -- A plan that would help troubled mortgage borrowers today - and might make lenders whole later on - was unveiled today in Washington.

The Office of Thrift Supervision (OTS) is urging the federal savings and loans lenders under its authority to refinance loans by reducing mortgage balances to the current market values of the homes. Thanks to falling home prices, many homeowners are now stuck with mortgages that are actually worth more than the houses themselves.

But instead of having lenders forgive the difference between the old mortgage and a house's current resale value, called a short sale, the OTS advises that lenders issue a warrant or "negative amortization certificate" for the difference. If a home regains its market value and is then sold, lenders have first claims to the profits.

"If a house has a $100,000 mortgage originally," said Bill Ruberry, a press spokesman for the agency, "and the fair market value is $80,000, there's $20,000 in negative equity. The lender could refinance for $80,000 and a warrant [for the $20,000 in lost value]."

If the house later sold for $100,000, the lender would collect the $80,000 mortgage balance plus the $20,000. If the sale realized more than $100,000, the certificate holder might even get interest on top of the $20,000. Any profit beyond that would go to the borrower. The warrants could be publicly traded.

The hope is that this plan will help prevent foreclosures while minimizing the hit that lenders will take, all without putting any burden on the taxpayers.

All borrowers are likely to be eligible, according to Jaret Seiberg of the Stanford Group, a policy research company, but the proposal appears to be aimed at those with subprime ARMs, negative amortization mortgages and interest-only mortgage borrowers. They're the ones most likely to have negative equity.

The savings and loan industry, which held 31% of mortgage loans last year, saw record losses of $5.24 billion for the fourth quarter of 2007, according to the OTS.

Few details about the plan have been settled, but it would not involve any legislation, nor would it be mandated in any way. Adoption would be on a voluntary basis by the hundreds of thrift institutions in the United States, like Washington Mutual (WASH) and IndyMac Bancorp (IMB).
Indeed, banks may not want to take this approach in markets where prices have fallen so steeply that it is unlikely they'll recover any money.

The plan's biggest attraction for lenders, according to Seiberg, is that rather than spending $50,000 to foreclose on a home or to write-off the negative amortization in a short-sale, they get a certificate that permits them to share in the up-side, if and when housing markets recover.

"The plan still needs to be discussed, but it has some attractions," said Ruberry. "We're putting it out there and urging our institutions to give it a look."

Another victim of the subprime crisis

(Credit Slips) In my free-time, I frequently cruise the sites of horse rescues and adoption facilities. I certainly don't need another large, four-legged, hairy family member, but, like visiting the local ice cream shop, it's fun to look. Anyway, I've come across several comments describing some of the less-recognized effects of the economic downturn and the increase in home foreclosures. Namely, it appears that as people lose their homes and their jobs, they are increasingly forced to leave their horses at rescues or other shelters. (Even more disturbing, because the market is currently flooded with horses and they are so expensive to maintain, many end up slaughtered rather than at rescues and shelters.) And back in December, The Columbus Dispatch ran a piece on families who had lost their homes in foreclosure and had to leave their dogs at the Franklin County Dog Shelter. The director of the shelter, Lisa Wahoff, said: "There's even a national term for it: 'foreclosure dogs.' We started seeing it more about 18 months ago, people writing 'foreclosure' or 'financial reasons' on their surrender forms."

Losing one's home is painful for many reasons--loss of security, loss of self, loss of a family space, loss of the American dream. But I would expect that the loss is especially acute when the family has to part with their pet, because, as most pet-owners will tell you, they may have four legs, but they are still members of our families. Certainly this isn't as consequential as homelessness, but my guess is that it doesn't make it any less painful when Mom or Dad has to leave their child's horse or the family dog at the shelter. It's just another example of the range of the fallout from our current economic situation in this country.

HOPE NOW adopts Project Lifeline

(Housing Wire) In what probably was a foregone conclusion after it was first announced, HOPE NOW said Tuesday that all alliance members will officially adopt the Project Lifeline initiative no later than March 31, in an effort to help more homeowners save their homes.

“This is another integral step toward a very important initiative that will help more Americans stay in their homes,” said Faith Schwartz, executive director of HOPE NOW. “Foreclosures are bad for everyone, and servicers are committed to helping homeowners who want to stay in their homes avoid foreclosure. Project Lifeline is in addition to our many other outreach initiatives. ”

Last week, Project Lifeline was originally announced by Bank of America, Chase, Citigroup, Countrywide, Washington Mutual and Wells Fargo — six HOPE NOW members whose loan portfolios represent approximately 50 percent of U.S. mortgages serviced.

Project Lifeline is a targeted outreach to seriously delinquent homeowners, designed to help troubled borrowers and servicers make contact; a recent study by Freddie Mac found that the single largest reason borrowers failed to reach a workout with their servicer was that a majority weren’t aware that workout options existed to begin with.

Subprime mortgage litigation outpaces S&L crisis

(Housing Wire) As the estimated financial cost of the current mortgage crisis surpasses the damage of the savings & loan crisis of the late 1980s, a new study released late last week found that the number of subprime-related cases filed in federal courts is also outpacing the savings-and-loan (S&L) litigation of the early 1990s.

The number of subprime-related cases filed in 2007 already equals half of the total 559 S&L cases handled by the Resolution Trust Corporation (RTC) over a multiple-year period, according to financial advisory firm Navigant Consulting, Inc. The subprime numbers represent only federal court filings — so the actual number of cases may be higher.

“The S&L crisis has been a high water mark in terms of the litigation fallout of a major financial crisis. The subprime-related cases appear on their way to eclipsing that benchmark,” said Jeff Nielsen, managing director of Navigant Consulting.

The number of subprime-related cases filed doubled during the second half of 2007, from 97 to 181 (for a total number of 278) cases. These cases included borrower class actions (43 percent), securities cases (22 percent), and commercial contract disputes (22 percent), along with bankruptcy, employment, and other cases.

“This appears to be just the beginning,” said Nielsen. “We are already observing a steady acceleration of continuing litigation activity into 2008. The course of regulatory investigations, the prospect of government intervention and marketplace variables may affect the volume of filings, but the explosion of cases in 2007 suggests a daunting forecast of what is still to come.”

The study found that virtually every participant in the subprime collapse is being sued.

Fortune 1000 companies were named in 56 percent of cases. Mortgage Bankers and Loan Correspondents represent the highest percentage of defendants (32 percent) but defendants also include mortgage brokers, lenders, appraisers, title companies, homebuilders, servicers, issuers, underwriting firms, bond insurers, money managers, public accounting firms and company directors and officers, among others.

LoanPerformance HPI shows widespread downward trend

(Housing Wire) Home prices fell across a wide swath of U.S. ZIP codes during the fourth quarter of 2007, according to a new report, suggesting that the nation’s housing troubles have extended well beyond so-called ‘bubble’ areas and are reaching into areas some thought might have been insulated from the mortgage and housing debacle.

click for larger version

According to data released late last week by First American CoreLogic, housing prices fell in more than 75 percent of the nation’s primary ZIP codes over the last three months. The graphic to the right shows the three-month price performance by state.

“Of the 7,472 ZIP codes tracked by the LoanPerformance HPI, home prices in 5,691 (76.16 percent) of these ZIP codes have decreased over the last three months,” said Damien Weldon, vice president, collateral and prepayment analytics for First American CoreLogic.

“Year-over-year, however, just 4,028 (53.91 percent) of the ZIP codes we track indicate decreasing property values,” added Weldon.

The widespread drop during the fourth quarter is an area of concern for U.S. policymakers and industry participants; while yearly price gains are intact in many areas, continued widespread drops will eventually wipe out any gains in annual terms.

“This clearly suggests we have some way to go before this correction plays out,” said one manager at a national bank, who asked not to be named. “Anyone focusing on the annualized results without looking at quarterly trending is missing the larger picture.”

California was hit particularly hard, with 97.67 percent of the ZIP codes tracked in the state posting an annualized decline.

For more information, visit http://www.loanperformance.com.

Servicers push loss mitigation out to credit counseling agencies

(Housing Wire) Underscoring just how reliant the industry has become on third parties to manage the loss mitigation process, Computer Sciences Corp. said late last week that it has teamed with HOPE NOW Alliance members to extend its EarlyResolution loss mitigation platform to third-party credit counseling agencies.

Called the EarlyResolution Counseling Portal, CSC said it delivered the new platform to Wells Fargo, Bank of America, Countrywide and the Consumer Credit Counseling Service of Greater Atlanta Inc. in January for pilot testing. The full ERCP service will be available widely by the end of this month, CSC said.

EarlyResolution is a loss mitigation tool that CSC says is used by five of the top 10 mortgage servicers; the new counseling portal provides a common platform for mortgage servicers and nonprofit consumer counselors to work together. With ERCP, mortgage servicers can make loan data accessible to participating credit counselors, while counselors can complete debt evaluations more quickly in order to return workout recommendations to the servicer.

“This is a unique cohesive effort between nonprofit counseling groups and mortgage servicers who are aligned to preserve home ownership,” said Ed Delgado, Wells Fargo Home Mortgage senior vice president and HOPE NOW Alliance Technology Committee chair.

“With CSC’s help, HOPE NOW is providing a scalable, national solution to help stabilize the housing market.”

CSC and participating pilot institutions say that counselors will be able to handle a higher volume of inquiries and reduce training time and costs. ERCP’s technology will also streamline loss mitigation referrals to servicers, they say, by recommending workout options for delinquent borrowers that are consistent with servicer guidelines and in compliance with investor rules.

“CSC’s work with the HOPE NOW Alliance advances our objective of putting the right tools in place across all potential borrower contact channels — servicers, counseling agencies and borrowers,” said Kevin Schlumpf, managing director of the EarlyResolution practice at CSC.

FHA must expand failed US foreclosure plan-panel

(Reuters) - A federal plan to help homeowners facing foreclosure must be expanded after drawing a tepid response from borrowers since its unveiling in August, panelists at a bond organization meeting said on Tuesday.

A study circulated within the American Securitization Forum last month proposed the Federal Housing Administration broaden its FHA Secure loan refinance program to stem more foreclosures. The program should allow borrowers delinquent for any reason to refinance into an FHA loan, versus the narrow requirement that borrowers face a higher interest rate.

The ASF proposal comes amid signs that falling home prices will continue to push foreclosures higher. FHA Secure thus far has refinanced about 1,000 borrowers, making it a "failure" so far, Rod Dubitsky, a managing director at Credit Suisse, said on an ASF panel here.

The ASF plan, reported by Reuters on Jan. 27, "would allow another loss mitigation alternative that's not available to servicers today," said Stephen Kudenholdt, a partner with Thacher Proffitt & Wood and an author of the ASF's federally supported streamlined rate-freeze plan.

The ASF plan would be the only vehicle that would allow a "short refinancing," in which a borrower refinances a loan whose balance is more than the underlying property's value, Kudenholdt said. The new loan would cover the lower home value, giving investors in the first loan a principal loss.

Whether accepting a loss of principal or a lower interest rate, investors generally agree that modifying loans is a better alternative than foreclosure, especially in a market with falling prices.

Lenders have boosted modifications under their own plans and another written by the ASF, but the success has fallen short of what's needed to reduce foreclosure rates, panelists said.

The current FHA Secure program may be unattractive because lenders may have a hard time selling the loans, Credit Suisse's Dubitsky said. FHA's securitization arm, under pressure from traders, pledged to keep its FHA Secure loans out of its standard Ginnie Mae bonds, which are prized for their liquidity.

Fostering a program to allow for short refinancings is important since homeowners without equity are at most risk for default, Dubitsky said. Concerns about defaults based on slated interest-rate increases should subside since mortgage rates have dropped in recent months, he said.

With a short refinancing, "the borrower would be able to stay in the house," Kudenholdt said. "It's not a distressed sale" and that protects property values.

The current FHA Secure program is poised to help around only 44,000 subprime borrowers, or 5 percent of those who are more than two months behind in their payments, according to the study circulated by the ASF. The new guidelines would reach 607,000 subprime borrowers, or 68 percent of those who are severely delinquent, it said.

Fear and loathing, and a hint of hope

Not all is lost for the structured-finance business. But it faces further discomfort before it can start to recover some of its past sheen... (from The Economist)

As gags go, it was cheap. But irresistible. As a banker from Citigroup placed his chips on the roulette table, a watching wise-guy sniggered: “There goes another $15 billion.”

Even though it was held (as usual) in Las Vegas, this year's conference of the American Securitisation Forum (ASF), between February 3rd and 6th, was a subdued affair. First staged only in 2004, the event has become a mecca for those whose job it is to spin mortgages, credit-card debt and other bread-and-butter financial assets into tradable securities. But this time attendance was down—and tension up, as the neck-masseuses in the exhibit hall could attest. Black humour and self-deprecation replaced the self-congratulation of past years. John Devaney, a hedge-fund manager who had to sell his 142-foot yacht, Positive Carry, and his Gulfstream IV after making bad bets on mortgage bonds, told an audience: “I'd like to thank the market for dealing me a direct hit. As a trader if you don't get sucker-punched every once in a while, you don't understand what risk is.”

You might suppose that meeting in America's gambling capital would provide symbolism enough. But the conference Super Bowl party had plenty more. It was hosted by Countrywide, a big, troubled mortgage lender that has had to fall on the charity of Bank of America. And, as the guests digested the dramatic ending of the New England Patriots' long winning streak by the New York Giants, they may have sensed an uncomfortable parallel. After a quarter-century of growth that turned structured finance from a capital-market cog into an engine of growth, their business has been buckled by the crash in subprime mortgages and the successive blows throughout credit markets. Worse, some blame securitisation for causing the pile-up in the first place.

The limits of gonzo finance

Securitisation has greatly enhanced the secondary market for loans, giving originators, mainly banks, more balance-sheet flexibility and investors of all sorts greater access to credit risk. Both have embraced it. By 2006 the volume of outstanding securitised loans had reached $28 trillion (see chart 1). Last year three-fifths of America's mortgages and one-quarter of consumer debt were bundled up and sold on.

Along the way, banks cooked up a simmering alphabet soup. The ingredients included collateralised-debt obligations (CDOs), which repackage asset-backed securities, and collateralised-loan obligations (CLOs), which do the same for corporate loans, as well as structured investment vehicles (SIVs) and conduits, which banks used to keep some of their exposure off their balance sheets.

The breakneck growth of this business went into reverse last summer, when it became clear that defaults would undermine the structures built around America's mortgage markets. So tarnished has the subprime-mortgage market become, because of shoddy loan underwriting and fraud, that investors are likely to shun securities linked to it for months if not years. Securitisation of better-quality “jumbo” mortgages—too big to be bought by government agencies—is also at a near-halt. “Mortgages were traditionally seen as very safe assets. Now all but the very best are stamped with a skull and crossbones,” says Guy Cecala, of Inside Mortgage Finance, a newsletter.

CDOs are unlikely to regain a following in a hurry (see chart 2). Still less popular are CDO-squareds (resliced and repackaged CDOs) and higher powers. CLOs have also been battered as the leveraged loans they are linked to have tumbled in value. However, their collateral is sounder than that backing subprime CDOs, being based on company financials rather than the blandishments of mortgage brokers.

The prospects for SIVs are bleaker still. SIVs borrow short-term to invest in long-dated assets; and investors will no longer tolerate such mismatches in vehicles shielded from standard banking regulation. With the disappearance of the SIVs' funding sources, notably asset-backed commercial paper, banks had to bring over $136 billion-worth onto their books. That comes on top of over $160 billion, so far, of subprime-related write-downs, over a third of which has come at three banks: Citigroup, Merrill Lynch and UBS.

Though few bankers worked in structured finance, it was a huge earner, accounting for 20-30% of big investment banks' profits before the crisis, according to CreditSights, a financial-research firm. Banks such as Bear Stearns, Lehman Brothers and Morgan Stanley, which bought or built mortgage-origination businesses to fuel the securitisation machine, have rushed to close or pare them. Merrill, whose fees from CDOs alone peaked at $700m in 2006, said recently that it would stop packaging mortgages altogether.

Alongside the banks, the “gatekeepers” who were supposed to lend stability and credibility to the new originate-and-distribute model of finance have also been found wanting. Rating agencies' models underplayed the risk that loans from different lenders and regions could turn sour at the same time. Bond insurers, too, misjudged the risks lurking in CDOs. That failing has undermined the worth of their guarantees and strained their own credit ratings—and hence financial markets.

George Miller, the ASF's executive director, accepts that this crisis of confidence will lead to a degree of “re-intermediation” for a time, as some banks go back to balance-sheet lending. But he insists that it highlights the dangers of lax lending standards in a particular market rather than fundamental faults in securitisation itself.

A study by NERA, an economic consultancy, commissioned by the ASF before the crunch, offers some support for this view. Preliminary results, based on data from 1990 to 2006, suggest that increased securitisation leads to lower spreads in consumer credit and softens interest-rate shocks for banks, especially smaller ones. On the other hand, in a recent paper two economists at the University of Chicago's business school conclude that securitisation encouraged mortgage originators to lend to dodgy borrowers.

Stresses and strains

What is not in doubt is that the subprime crisis has exposed four deep flaws in the practice of securitisation. The first is that by severing the link between those who scrutinise borrowers and those who take the hit when they default, securitisation has fostered a lack of accountability.

A debate has been rumbling over how to ensure that lenders have more “skin in the game”. Some think they should set aside a sliver of capital even for loans they sell on. Andrew Davidson, a structured-finance consultant, suggests an “origination certificate”, guaranteeing the quality of the underwriting, issued by the lender and broker, which stays with the loan. Alex Pollock of the American Enterprise Institute thinks that securitisers should be required to guarantee the quality of their loan pools, as are America's government-sponsored mortgage giants, Fannie Mae and Freddie Mac. Others counter that most such exposures can be neutralised these days through derivatives markets.

The second flaw is the sheer lack of understanding of some instruments. Not long ago investors took too much on trust. They are now clamouring for more “transparency”. Some want a central trade-quoting facility for lumpy asset-backed products: regulators have approached the New York Stock Exchange. CME Group, which runs the world's largest futures exchange, is also looking to expand its clearing of over-the-counter securities.

Yet reams of information already accompany mortgage-backed securities sold in public markets. Even SIVs provide a steadier stream of data to investors than most of the banks backing them. So some interpret calls for greater disclosure as whimpering by investors who did not do their homework.

However, more information about the performance of loans after origination would help, particularly those in leveraged structures such as CDOs. This opens up opportunities: fewer banks were at the ASF conference this year, but more data-analytics firms turned up. Clayton, the largest mortgage-surveillance company, unveiled a partnership with Experian, an information-services firm, that will help mortgage-servicers to package subprime loans for modification under a plan backed by the ASF and America's Treasury. Later, it hopes to offer a swathe of data to buyers of structured products.

Understanding the underlying assets is, or should be, at the core of securitisation. Securitisation is really an arbitrage: with surplus collateral, assets can be bundled into an entity with a supercharged credit rating. But if investors fail to spot the jiggery-pokery with credit scores and the outright fraud that permeated the subprime market, that cushion of safety quickly disappears. Witness the speed with which losses have spread into supposedly safe, “super senior” tranches of CDOs.

This points to the third flaw: that some securities were poorly structured, often because their risks were not fully understood. The upper layers of a well-designed securitisation vehicle should be all but impervious to loss. But poorly structured deals, like those stuffed with subprime and marginally less iffy “Alt-A” loans in 2006 and early 2007, have crumbled as the weakness of the collateral becomes clear.

The fourth flaw was the market's over-reliance on ratings as a short cut to assessing risk. In the go-go years, people wrongly assumed that an AAA-rated mortgage bond—even one with a high yield—would never lose value. But the rating agencies, paid for their appraisals by the seller not the buyer, were compromised from the start. Moreover, their quantitative models appear to have ignored “fat-tail” risks—the possibility that large losses are likelier than standard statistical models predict.

Though the agencies do not have to suffer giant write-downs, they have paid a high price. Before the market imploded, almost half the revenue of Moody's, a leading agency, came from structured finance. Now the agencies are revising their rating criteria in a bid to head off tougher regulation. “Either deals get less complex or we have to find a better shorthand for measuring risk,” says Ron Borod of Brown Rudnick, a law firm. The rating agencies say they were never supposed to substitute for investors' own due diligence. That is disingenuous, given their past self-assuredness. Still, wise investors will take future ratings with a pinch of salt, as most hedge funds have long done.

As the market grapples with change, some is likely to be imposed from above. Separately, international regulators and the President's Working Group (comprising America's Treasury, the Federal Reserve and others) are looking into securitisation's part in the crisis. By co-operating over loan modifications, the ASF may have gained favour with the working group.

The industry is more worried about two bills in America's Congress. Securitisers can live with much of the one that has been passed by the House of Representatives. What alarms them is an “assignee liability” provision that would hold them partly responsible for lax lending by originators. This, they say, would send a chill through secondary markets, cutting credit to thousands of worthy borrowers. Precedent is on their side. Georgia introduced assignee liability, only to back-pedal after the state's subprime market started to seize up. Not all bankers are against it: in Las Vegas, Bianca Russo of JPMorgan Chase argued that some form of it was needed to counter the perception, if not the reality, that securitisation was harmful.

The other bill would allow bankruptcy judges to alter the terms of struggling borrowers' mortgages. The industry argues that this would be an intolerable violation of the sanctity of loan-pooling contracts. In addition, securitisers face probes by several state attorneys-general, the Internal Revenue Service, the Federal Bureau of Investigation, the Securities and Exchange Commission and the Justice Department, as well as lawsuits from investors and a rising number of stricken municipalities.

Bankers will tell you that the subprime meltdown was just that: the product of irresponsible lending to, and borrowing by, flaky consumers, not a broader crisis of securitisation. Maybe, but the severity of the credit crunch points to broader pain ahead. More will come from housing: much of the 30-40% of American home-equity loans that have been securitised looks wobbly, as does a growing chunk of the $800 billion of Alt-A paper outstanding. Loans for offices are an even bigger worry. The spread on the AAA tranche of an index tracking bonds backed by commercial mortgages has tripled since the turn of the year. New issuance is frozen.

Trouble is also brewing for securities tied to non-mortgage consumer assets, such as credit-card debt, car loans and student loans, which make up a good slice of the asset-backed market (see chart 3). Credit-card delinquencies are creeping up as the economy turns down. The sharp slowdown in card borrowing, reported recently by the Fed, will mean less raw material for securitisation. Standards for car loans dropped in 2006-07, though not as dramatically as they did for mortgages.

One ominous sign is that structured instruments tied to student loans are coming unstuck, although the loans typically carry a federal guarantee. Recent auctions of such securities by Citigroup, Goldman Sachs and others have failed. Normally the banks would have bought in whatever did not sell. But they have declined, because they dare not cram even more assets onto their already strained balance sheets.

Yet securities of these types should be more resilient than those tied to subprime loans. Their structures are tried and tested, having evolved, along with performance data in their markets, over many years. In contrast, subprime mortgages with only a short record were shoved into many-layered structures that depended on house prices holding up. “They started from the other end entirely, asking how can we create CDOs, backed by mortgage-backed securities, themselves backed by collateral with barely any history, and their stress tests assumed house prices would be stable and the loans in the pools uncorrelated,” says Mr Borod.

Encouragingly, credit-card receivables are still being bundled and sold. There are even shoots of hope in the mortgage market, thanks to a refinancing mini-boom in the wake of interest-rate cuts—though most new deals are backed by the giant agencies, Fannie Mae and Freddie Mac, not Wall Street (see chart 4).

Saunter down the strip

It is also worth remembering that securitisation has not been confined to consumer and corporate loans. In the past decade financial engineers have found ways to package and sell tobacco-settlement and mutual-fund fees, sports and fast-food franchise rights, life-insurance premiums, intellectual property, music royalties and much more. Hollywood studios use securitisation to help finance film-making. With intangible assets accounting for an ever-growing share of corporate value, this trend looks likely to continue.

That may be scant consolation to the banks whose bets have gone so spectacularly wrong. Their fingers are still being singed by mortgage-backed securities and CDOs that continue to burn. Those hoping for a recovery face a long wait, maybe 18 months or more for out-of-favour collateral such as non-agency mortgages. Some once-enthusiastic cheerleaders are turning gloomy: Bear Stearns said recently that its net short position on subprime loans and bonds had risen to $1 billion. Others are redeploying staff and capital to fee businesses that don't put a strain on the balance sheet, such as merger advice.

But it would be a mistake to write the obituary of structured finance. Even its sternest critics accept that securitisation has brought real economic benefits, and that it would be wrong to throw away the whole barrel because of a few subprime apples. Some students of financial innovation think the market will come back even more inventive after scorching its less attractive pastures. “As with past forest fires in the markets, we're likely to see incredible flora and fauna springing up in its wake,” says Andrew Lo, director of the Massachusetts Institute of Technology's Laboratory for Financial Engineering.

So it may just be a matter of hanging on. As any punter in Las Vegas will tell you, every losing streak ends eventually, if you can only stay solvent for long enough.

Beyond the Mortgage Crisis, a Persistent Problem of Cost

(WP) There's a growing problem in this region that we don't hear enough about: the continuously shrinking supply of affordable housing.

The problem is also worsening in other metropolitan areas with stable economies, escalating land and construction costs, and climbing real estate values.

The supply and affordability problem affects more than those at the bottom of the income pyramid. In Washington and elsewhere, it's increasingly difficult for middle-income households to find, buy and keep a home.

Now, as conditions in the housing and credit markets deteriorate, we may hear more about the supply of affordable housing, as opposed to the supply of affordable financing. Perhaps we will again consider the needs and methods for delivering housing, and the costs.

Attention has focused on the obvious, far-reaching financial story. Who has not read about the subprime mortgage debacle with its deluge of foreclosures and loss of wealth, about the intense pain inflicted on borrowers, lenders, investors, and housing-related businesses and workers?

Incredibly lax home-loan underwriting practices, the primary cause of the debacle, were intended to make the unaffordable affordable. Almost all the housing produced in recent years was affordable not because of subsidized land and construction costs but rather because home-financing standards went out the window.

Less obvious, and less frequently analyzed and reported, is the profoundly troubled relationship between real housing production costs, the cost of financing and household income.

This critical economic relationship was lucidly addressed this week in a Washington Post op-ed article, "Don't Blame Subprimes," by Michael Hill, president and chief executive of Emerge Homes, a luxury builder.

"Those bad loans were just a response to our real problem," the op-ed's subheadline proclaimed. "What's happening in the market today is not the bursting of a five-year bubble," Hill wrote, "but the bursting of a 40-year bubble" and "the incongruity between incomes and home pricing."

Hill cited sobering national statistics. Median household income was about half the median price of a home 40 years ago. Twenty years ago, the median home price was approximately three times median household income. During the past decade, the ratio of home price to income nationally reached 4 to 1.

In regional urban markets such as Washington, ratios are much worse, because local median home prices are substantially higher than national medians. "Try to find a single-family home in the D.C. area for the national median of $221,900," Hill wrote. Instead, he said, the median home price in metropolitan Washington is about eight times the median household income.

Hill concluded by suggesting a financing solution to the price-income incongruity: a new kind of "mortgage product," an alternative to the conventional, 30-year fixed-rate or adjustable-rate loan. He didn't offer details.

Innovative financing could help, but it would only partially close the price-income gap, especially considering how capital is generated, priced and allocated in today's worldwide markets.

The gap will remain wide unless we also address housing supply and production costs, which continue to rise and put most market-rate housing out of reach of millions of households. In fact, no matter how financing is structured, subsidies in some form will be needed for much of the middle class.

There was a time when Americans embraced national policies that recognized and tried to close this gap using below-market financing and affordable-housing production subsidies. But such federal policies were swept away after 1980, when Ronald Reagan was elected president and public attitudes about housing changed. Since then, progressive state and local jurisdictions have stepped up their efforts to foster production, often with limited money and mixed results.

For example, Montgomery County has sought to increase the supply of affordable housing by requiring developers of multi-unit residential projects to set aside a specified percentage of units as moderately priced dwellings, to be sold or rented at below-market prices. As compensation for subsidizing what are known as MPDUs, the developer is granted density increases.

But the county's policy is flawed. Developers have had the option of buying out of the MPDU requirement by contributing money to an affordable-housing fund, intended to finance housing to be developed in the future at other sites. The fund has grown, but the number of MPDUs not provided by developers has far outstripped the number of MPDUs produced by the fund.

The county's goals are noble, and the private-public policy is sound. But even if the flaws are eliminated, the county will never close its affordability gap without more direct subsidy and more county-sponsored housing production.

It's telling that in Europe, publicly financed housing is called "social housing," while here we typically call it low- or moderate-income housing.

The European term expresses the civic purpose of affordable housing, which in many European cities is built by government and inhabited mostly by the middle class. In contrast, American terminology stigmatizes such housing by describing the limited economic means of its occupants.

Perhaps someday we will come to believe that it wouldn't be un-American to build publicly financed social housing to ensure that America's workers have a decent place to live.

Proposals on Servicers Are Only a First Step

(Jack Guttentag in the WP) In my last two articles, I examined the Federal Reserve Board's proposals for tightening mortgage underwriting requirements and for limiting mortgage broker charges to borrowers. These are long-standing regulatory concerns.

In contrast, the Fed seems to have discovered mortgage servicing abuses only recently. The regulatory proposals are weak, but they are a good first step.

One proposal would require that servicers credit payments on the days payments are received. Another would require servicers to provide accurate payoff statements within a reasonable time to borrowers who intend to pay off their loans. Both are fair, clear and not onerous for the lender.

A third proposal would prohibit servicers from imposing late fees or delinquency charges when scheduled payments are received on time but do not include previous late charges. This rule would eliminate the practice of "pyramiding late fees," in which servicers continue to charge late fees until all previous late fees have been paid.

But the proposal does not cover a worse type of pyramiding. When a scheduled payment is received on time but the escrow payment is short, the practice is to place the entire payment in a suspense account, charge the borrower a late fee and send a delinquency notice to the credit bureaus.

If the servicer does not send out monthly statements, which many do not, the borrower will be in the dark. The next month's regular mortgage payment will also be deposited into the suspense account, and the borrower will incur a second late charge and a second 30-day delinquency report. At this point, the account may go to collection, and the borrower may find himself dunned for a list of fees, with failure to pay possibly resulting in foreclosure.

The Fed's proposed rule against pyramiding late fees should be broadened to require that monthly payments received on time be credited when only escrow portions are deficient.

Another regulatory proposal "would require a servicer to provide to a consumer upon request a schedule of all specific fees and charges that may be imposed in connection with the servicing of the consumer's account . . . and an explanation of each." The fees and charges covered include those of third parties that are passed on to borrowers.

Because servicing does not involve third-party fees until a loan goes into collection, that proposal is relevant mainly to borrowers who get behind in their payments and are referred to their servicers' collection departments. At that point, a borrower will be billed for such things as a broker's price opinion, property inspection and legal services.

Borrowers in trouble need protection, but requiring that their servicers provide them with a list of charges is not going to help when there is no standard that such charges must meet. What could help is mandatory disclosure combined with a rule that servicers cannot mark up the prices charged by third parties or profit from them in any way.

Conspicuous by omission from this proposal is that information be provided to all borrowers, so they can keep themselves out of trouble. The single most important step that regulators could take to curb servicing abuses is to require monthly statements that show everything that has transpired during the month -- and that are comprehensible as well as comprehensive.

I mentioned borrowers whose monthly payments are not credited because the escrow portions of their payments are deficient. If a borrower does not receive a monthly statement that shows this, the problem can snowball until the borrower ends up in collection.

Consider as well the Fed's proposal to require that servicers credit payments on the day they are received. Who is going to monitor the roughly 50 million home-mortgage payments that are made every month to assure compliance? The only ones who possibly can are the 50 million borrowers, who know when their payments were made and have a financial interest in receiving timely credit. But without access to monthly statements, borrowers are severely handicapped.

The Fed also ignores other important abuses:

Some servicers cripple the ability of borrowers to refinance profitably by not reporting good payment records to the credit bureaus. Servicers should be required to report payment histories on all accounts.

Some servicers purchase servicing contracts and convert the mortgages to different interest-accrual schedules if the notes do not explicitly prevent it. If a borrower did not negotiate such a schedule at origination, a later conversion is unconscionable. Such conversions should be prohibited.

Some servicers cover up abusive practices by selling the servicing to another firm without forwarding evidence of the abuses -- that is, the prior servicing record. When servicing is transferred, the purchasing firm should be required to obtain and hold the complete file.

Mortgage Insurer Tightens Up

(WP) First it was the lenders. Now it's the mortgage insurers. Entire product lines are being yanked, potentially squeezing large numbers of home buyers and refinancers out of the marketplace.

On Feb. 6, the oldest and largest private insurer of home loans -- MGIC -- issued a bombshell warning that in much of the country, it would no longer provide coverage on cash-out refinancings; reduced-documentation loans; mortgages with down payments less than 5 percent; loans for rental houses and other non-owner-occupied investor properties; and mortgages with negative amortization features, such as payment-option loans.

The bans, which take effect March 3, cover a number of markets, including the District and its suburbs. Four whole states are on the list -- Arizona, California, Florida and Nevada -- and about two dozen metropolitan areas. Among them, in addition to the Washington area: Atlanta; Baltimore; Boston; Chicago; Denver; Detroit; Minneapolis; the Long Island and New Jersey suburbs of New York; Portland, Ore.; and Tacoma, Wash.

MGIC also tightened eligibility standards nationwide on a number of low-down-payment loan categories:

Home buyers who seek mortgages with less than 5 percent down must have minimum FICO credit scores of 680, up from the previous 620.

Cash-out refinancings on all non-owner-occupied rental or investment properties no longer will be eligible for insurance, no matter how high the borrower's credit scores.

Borrowers who seek to use reduced documentation plans must now make minimum down payments of 10 percent, have FICO scores of 660 or higher and be able to demonstrate that at least 50 percent of their annual income is from self-employment. The income restriction is intended to discourage "stated income" applications from people who could readily furnish pay stubs or W-2 tax forms but choose not to do so.

All buyers of condominiums in declining markets will need to come up with 10 percent down payments. Buyers of single-family homes in those areas with less than 10 percent down payments will need FICOs of 680 or higher.

Milwaukee-based MGIC is a giant in the industry with nearly $200 billion in insurance coverage in force on 1.3 million mortgages. The company this week reported that it lost almost $1.5 billion in the last three months of 2007, and that it is exploring ways to raise more capital.

Like other private mortgage underwriters, MGIC provides lenders protection against losses on low-down-payment loans -- those with less than 20 percent borrower equity. Competitors are expected to adopt their own versions of at least some of MGIC's cutbacks in coming weeks.

Private mortgage insurers played a key role during the housing boom of 2001-05 by helping millions of people with modest incomes and marginal credit to purchase homes with minimal down payments. But now the industry is facing rising claims on loans that went sour.

MGIC's retrenchment parallels recent moves by other mortgage market players, from investors Fannie Mae and Freddie Mac to regional banks. Most of them are restricting the hyper-creative financing that powered the boom -- zero-down, no-documentation, minimum-payment plans and speculator loans -- especially in markets where appreciation rates and prices spiraled off the charts. Essentially, the industry is saying: We were willing to go with the flow when all the arrows were pointing up during the boom years, but that party is over.

What are the cutbacks likely to mean in practical terms? They could be felt almost immediately by buyers who can't come up with substantial down payments. They will need higher FICO scores. They may also find certain types of loans -- for vacation condos and small-scale rental investment properties, to cite just two -- unavailable.

The major bright spot still left for purchasers seeking a home with low down payments: the Federal Housing Administration. The FHA's insurance program has no connection with private insurance. Borrowers can still put 3 percent down and qualify for a fixed-rate, 30-year FHA loan that comes with consumer-friendly credit, debt-ratio and other underwriting terms.

The new federal economic stimulus package raises the maximum mortgage amounts for the FHA -- great news for high-cost areas including California, the Northeast, Florida and the Mid-Atlantic states. Pending congressional legislation would even sweeten the deal by reducing minimum down payments well below 3 percent.

On the flip side, the FHA is a little old-fashioned in some respects. Be prepared to document your income, assets and debts. And don't even think about payment-option plans, interest-only, negative amortization and other funny-money techniques that were all the rage a few years ago.

Jumbo Help: New Rule Could Mean Rate Relief on Big Loans

(WP) Anna Galloway keeps a watchful eye on interest rates and stays in touch with her mortgage broker because she is eager to refinance the "jumbo" loan on her Charles County home.

"But I haven't even bothered to try to refinance yet because I know the jumbo rates are too high right now," said Galloway, 37, a D.C. legal secretary. "I'm just waiting and watching for any sign that the interest rates will drop."

That drop may be coming soon.

The economic stimulus package that President Bush signed this week includes provisions aimed at pulling those rates down and reinvigorating a part of the mortgage market still stunned by problems with subprime borrowers that surfaced last year.

Jumbo mortgages -- those that exceed $417,000 -- got expensive as the credit crisis worsened. Rattled investors stopped buying them. Lenders responded by raising rates. And plenty of people in high-cost areas such as Washington got shut out of the housing market or, like Galloway, lost their chance to refinance into cheaper loans.

As part of the stimulus package, the mortgage giants Fannie Mae and Freddie Mac will be allowed to buy or guarantee mortgages up to $729,750 for single-family homes. That's up from the previous $417,000 cap, which was tied to the average home price nationwide. The amount would vary so that the most expensive areas would qualify for bigger loans. The stimulus package also increases the limits for loans insured by the Federal Housing Administration.

The idea is that investor appetite for these larger loans will grow if they have backing from Fannie Mae and Freddie Mac. The two companies are federally chartered, which means many investors treat their loans as if they have the government's implicit guarantee. Fannie Mae and Freddie Mac mortgages are about the only ones investors are buying these days, which is why policymakers wanted jumbos added to the mix.

Mortgage industry experts said the change should encourage lenders to lower jumbo rates. But they disagree on how low and on whether the benefits will be widespread enough to bolster the housing and mortgage markets, especially because the higher caps will be in place for a limited period, through the end of this year.

"The most we can say right now is that there will be some opportunity for some borrowers to achieve perhaps some interest-rate relief on their jumbo mortgages," said Keith Gumbinger, a vice president at HSH Associates, a mortgage research firm.

A lot of the details have not yet been determined. Under the new plan, the Fannie Mae and Freddie Mac loan limits will be set to 125 percent of the median home price in every metropolitan statistical area. Within these parameters, the limit cannot drop below $417,000 or exceed $729,750.

The Department of Housing and Urban Development is in charge of calculating the limits; it's expected to tell lenders next month what the limits are in various areas. It will take several more weeks before Fannie Mae and Freddie Mac can begin to purchase the loans; first they must sort through internal logistical and operational issues.

Many analysts expect limits to increase in about 20 metropolitan areas, mostly pricey markets on the East and West coasts. Federal regulators declined to comment on what they expect the loan limit to be in the Washington area, or on what geographic definition of the region they will use.

But the Stanford Group Company, a policy research firm in the District, estimated that if the cap is based on median prices compiled by the National Association of Realtors, locally it would be about $500,000 and would apply to an area that extends into West Virginia.

"While not every American is going to get to enjoy a higher loan limit, what makes this program exciting is that those who need the assistance the most are going to get it," said Jaret Seiberg, an analyst at Stanford Group. "There are markets where the average home price is well below $417,000, so they do not need any kind of boost."

Lower rates would help Galloway, the Charles County homeowner. She owes about $448,000 on her house. She has an adjustable-rate mortgage and wants to refinance before that loan resets, possibly to a higher level.

But just as she was about to get a new loan, the jumbo rates started climbing and never stopped. In the past, lenders charged about 0.25 percentage point more for 30-year, fixed-rate jumbo loans than they did for smaller loans that conform to Fannie Mae and Freddie Mac standards. But the spread has widened since August to nearly a full percentage point, according to HSH Associates.

Last week, the rates on conforming loans averaged 5.77 percent, while those on jumbo loans averaged 6.7 percent.

Although the aim of the changes is to reduce that gap, investors have become so skittish about jumbos that there's no telling how they will react if the large loans are mixed in with more traditional conforming loans, several industry analysts said.

Why should the average consumer care how investors react?

Because when Fannie Mae and Freddie Mac buy these loans from lenders, they sell them to investors on the secondary market.

If investors feel that the larger loans inject too much risk into the pool of mortgages offered to them, they will demand a higher yield, which translates to higher rates for borrowers, said Ajay Rajadhyaksha, head of U.S. fixed-income strategy at Barclays Capital.

The perceived risk is not a creditworthiness issue, Rajadhyaksha said. Rather, it's the jumbo borrowers' well-documented fondness for refinancing when rates drop, which forces investors to reinvest the money at a lower rate.

"The investor will still be wary of [jumbo loans] even if they come with a Fannie or Freddie guarantee," Rajadhyaksha said. He said he expects the spread between existing jumbos and conforming loans to return to about 0.25 percentage points.

Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University, said the spread could narrow from about a percentage point to 0.50 to 0.75. "That can be a pretty big number because we're talking about markets with expensive homes."

For instance, a half-percentage-point drop in the rate on a $500,000 mortgage shaves about $200 off monthly payments, said Retsinas, who serves on Freddie's board.

But even if rates drop, not everyone will be able to take advantage of them, Retsinas said. Potential borrowers with less-than-stellar credit will be turned away from any kind of loan these days, as will people who owe more on their mortgages than their homes are worth.

Galloway said that she fits the profile of an on-time borrower lenders want to work with and that she can't wait to see what the new loan limits might mean for her family.

Galloway and her husband have four children, ages 8 to 18, and the oldest is headed to college.

"At this point, I'll take any savings I can get," she said.

Subprime Lawsuits: The Lerach Connection

(Felix Salmon) Remember those subprime class-action suits? Well now Navigant Consulting has put together another league table - not of the most-sued companies but rather of the law firms filing the most suits. Amir Efrati has the lowdown:

Wannabe securities class-actions brought by investors of mortgage-backed securities and others made up about one-fifth of the filings, or more than 60 suits, and it's perhaps no surprise to learn that San Diego-based plaintiffs powerhouse Coughlin Stoia Geller Rudman & Robbins LLP filed the most-more than a dozen.

Who are Coughlin Stoia? There might be a bit more name recognition if I told you they're the former Lerach Coughlin Stoia Geller Rudman & Robbins. As in Bill Lerach, the man shortly to spend two years behind bars for his conspiracy to obstruct justice.

Wasn't Lerach at Milberg Weiss Bershad Hynes & Lerach, you ask? Well, yes, he was, until 2004, when Lerach and some other west-coast Milberg lawyers split off and formed their own competitor, Lerach Coughlin Stoia.

Interestingly, it's Lerach's old law firm, Milberg Weiss, which has suffered the most from his indictment and conviction. His new firm, Coughlin Stoia (no Lerach there any more), seems to be going as strong as ever.

Jumbo conforming won't be part of TBA trades (SIFMA)

(Housing Wire) Confirming what sources had suggested for the past week, The Securities Industry and Financial Markets Association (SIFMA) said Friday that it will keep newly-conforming jumbo mortgages out of the to-be-announced market. The decision means newly-eligible conforming borrowers aren’t likely to get all of the GSE rate benefits that had been touted by many primary market participants.

“Jumbo borrowers [will] only get the benefit of guarantee in market, while the prepayment hickey and higher GSE guarantee fees are tacked onto their rate,” said one source via email earlier this week.

The economic stimulus package signed into law by President Bush this past Wednesday boosts the GSE conforming limit to as much as $729,750 through the end of this year, and also raises FHA lending limits to the same level for high-cost areas.

“SIFMA views this methodology as the most expeditious and least disruptive option currently available to facilitate securitization and secondary market activity for the higher balance loans, bringing added liquidity and rate relief to higher balance loan borrowers while not imposing additional costs or impairing the liquidity for loans falling within the pre-existing loan limits,” said Sean Davy, managing director of SIFMA’s MBS and securitized products division.

The TBA market facilitates the forward trading of MBS issued by the GSEs and Ginnie Mae by creating parameters under which mortgage pools can be considered fungible and thus do not need to be explicitly known at the time a trade is initiated – hence the name “to be announced.” The TBA market is the most liquid, and consequently the most important secondary market for mortgage loans.

SIFMA said its decision was made to ensure “the continued liquidity and smooth functioning of the current conforming loan market.”

Many industry insiders had said that including the newly-conforming jumbo loans in TBA trades would essentially raise conforming rates for all borrowers, while potentially gumming up the one part of the mortgage secondary market that is still working.

For more information, visit http://www.sifma.org.

Will servicers be the next victims of the credit crunch?

(Housing Wire) Reuters’ Al Yoon hits it out of the park today on the trouble that likely lies ahead for many of the nation’s servicing shops, both large and small:

“If they are not careful, servicers may be the next in line” to follow dozens of failed mortgage lenders, said Rick Smith, chief executive officer of Marix Servicing LLC in Phoenix, Arizona. “They are not getting more loans, but need twice as many people. How long can you operate at a negative cost of service?”

Servicers of subprime loans, such as Ocwen Financial Corp., are in the worst predicament since the companies must send payments to investors of mortgage-backed bonds created out of pools of home loans even if homeowners are delinquent, analysts said.

Ocwen, for the record, has a much-coveted servicing contract from the VA; and, of course, it’s not just Ocwen that’s having to provide advances — every servicer faces this problem. And that should provide some pause to a part of the mortgage industry that operates on pretty thin margins to begin with; doubly so when we hear broad public commitments to increasing loss mitigation from six of the nation’s largest financial institutions. Each of the big six has a sizeable servicing portfolio of its own.

But while all servicers will face this new sort of crunch, it is particularly firms like Ocwen — stand-alone servicing shops that aren’t married to a deep-pocketed bank — that are most likely to be sent reeling by a flood of troubled borrowers. While servicers are likely to eventually recoup most of their advances, the time horizon on collecting those repayments is increasing exponentially as REO inventory continues to pile up and goes unsold for months on end.

Which leads us to what could end up being the single largest inflection point in the servicing industry’s history. This is an industry — particularly in default management — that has long operated under cost mandates moreso than any sort of real value proposition:

“There are a lot of actions (by servicers) that are cost-minimizing and not performance-maximizing,” Rod Dubitsky, a managing director at Credit Suisse, said on an American Securitization Forum panel, the nation’s biggest bond lobbying group, in Las Vegas last week.

Reuters cites Marix in particular, a new-entrant into the servicing space, as a servicer looking to differentiate by paying the bucks needed to bulk up loss mitigation. The company is putting a focus on loss mit specialists instead of bulking up call center staff as part of a way to win servicing contracts from frustrated investors, according to Reuters.

But it’s not just loss mitigation that’s being put under the microscope now that the number of distressed borrowers is rising; foreclosure and REO management also face similar strains, as many servicers outsourced these two areas during the housing boom in an effort to keep costs as low as possible.

As the volume of defaults have continued to rise dramatically, servicers are now finding themselves increasingly reliant on an often unregulated and patchwork network of vendors to ensure that foreclosures are properly processed, evictions are managed properly, and so forth. Some servicing executives I’ve spoken to recently have said they’re having to rethink their operating strategy. “We can’t be held hostage by fact that one of our vendors is the weakest link,” said one executive, who asked not to be named.

Reuters quotes Bear Stearns’ Tom Marano as saying that “servicing is going to be the focus…of how we get out of all this,” and I agree. But, as the Reuters story highlights, I’d suspect that more than a few servicers will be rethinking the rules of the game needed to get there.

Conforming limits boosted

(Housing Wire) President Bush on Wednesday signed H.R. 5140, the Economic Stimulus Act of 2008, making official a temporary boost to both conforming and FHA loan limits. The new law boosts the GSE conforming limit to as much as $729,750 through the end of this year, and also raises FHA lending limits to the same level for high-cost areas.

“I know many Americans are worried about meeting their mortgages,” President Bush said prior to signing the bill. “My administration is working to address this problem.” Bush cited HOPE NOW and the recently announced “Project Lifeline” initiative as examples of ongoing work by the administration to address the housing crisis.

A White House-produced fact sheet covering the new growth package is available here.

The U.S. Department of Housing and Urban Development now has 30 days to publish a database of house prices that will be essential in determining which markets get access to the new ‘jumbo conforming’ or ‘expanded FHA’ loan products.

Of course, that could prove to be bit of a problem in and of itself, given that HUD doesn’t currently gather or publish home price data. Bankrate’s Holden Lewis was on this right from the start; he and I had chatted briefly on the matter when Congress first passed the bill:

The Office of Federal Housing Enterprise Oversight, or OFHEO, compiles periodic indexes of home prices. Fannie Mae and Freddie Mac use the OFHEO data each November to update the next year’s conforming limit.

The Federal Housing Finance Board and the National Association of Realtors both collect and publish home prices. The FHA takes information from both entities to calculate the FHA limits for each metro area.

Congress could have pegged the conforming and FHA limits to data collected by OFHEO, the Federal Housing Finance Board or the Realtors. But it didn’t. Instead, the law says: “The secretary of Housing and Urban Development shall publish the median house prices and mortgage principal obligation limits … for all areas as soon as practicable.” The law gives HUD 30 days to publish the database of house prices.

The simplest solution would be for HUD to use the same house price information it uses to calculate FHA loan limits. But a HUD spokesman says: “We have not yet determined if the same data will be used to make the new calculations.”

That leaves lenders in the dark until HUD makes a decision.

While price designations aren’t yet known, a few industry sources close to the process have suggested that the new conforming limits won’t be as broadly applied as many might expect; just 15 counties in California might be designated as eligible for the loan limit increase, for example.

That’s not the only grey area out there, of course — there’s also the as-of-yet unclear issue of TBA trading in the secondary market that will need to be settled, something HW has covered often recently. (The unconfirmed word from our sources today is still that SIFMA wants to keep the new ‘jumbo conforming’ loans out of TBA pools.)

It’s also unclear exactly how the GSEs will price the newly-conforming loans, given that neither Fannie nor Freddie have experience underwriting within the jumbo mortgage market.

Similarly, it isn’t exactly clear what the initial underwriting criteria will be, although most expect it to at least sit close to existing ‘traditional conforming’ guidelines — if not ending up more restrictive. “OFHEO has already gone on record saying that jumbo loans are more risky, so I wouldn’t be surprised if the underwriting guidelines end up being tighter than what you’d see for usual conforming products,” said one executive at a large lender, who asked not to be identified.

Americans Selling Homes See Prices Go Below Mortgage (Update2)

(Bloomberg) -- When Mary Kamanu paid $409,000 for a house in Folsom, California, she never imagined that three years later it would be worth about 20 percent less and she would have to pay the bank more than $80,000 just to sell the place.

``I'm completely upside-down on my mortgage, like a lot of people,'' said Kamanu, who wants to move 12 miles away to live with her fiancé in a suburb of Sacramento. ``I know I'm going to have to come up with a big chunk of change.''

By the end of this year as many as 15 million U.S. households may owe more on their mortgages than their homes are worth, according to an estimate from Jan Hatzius, chief U.S. economist of New York-based Goldman Sachs Group Inc. That may fuel an increase in foreclosures, erode prices, and increase mortgage bond losses, he said in a Feb. 1 report.

``If borrowers who are underwater go into foreclosure, the properties are likely to be sold at discount prices and will further depress the price of housing,'' said Robert Engle, a Nobel laureate in economics who teaches at New York University's Stern School of Business in Manhattan. ``It becomes a spiral.''

Thirty-nine percent of people who purchased a home two years ago already owe more than they can sell it for, according to a Feb. 12 report from Zillow.com, a real estate data service. Only 3.2 percent who bought five years ago are in that situation, the report said.

Prices Fall

Almost half of the borrowers who took out subprime mortgages in the last two years won't have any equity left if home prices drop an additional 10 percent, New York-based UBS AG analysts led by Laurie Goodman wrote in a report yesterday.

Home prices probably will decline 4.5 percent this year and 2.6 percent next year after falling 2.2 percent in 2007, according to Fannie Mae, the world's largest mortgage buyer. New foreclosures averaged about 2,900 a day in the fourth quarter, double the pace of a year earlier, according to RealtyTrac Inc., an Irvine, California-based real estate data company.

Cities in California, Ohio, Florida and Michigan accounted for three-quarters of the 20 U.S. metropolitan areas with the most foreclosures in 2007, RealtyTrac said in a report today.

``If people owe more on their mortgage than their house is worth, a substantial number of them will give their keys back,'' said Kenneth Rosen, head of the University of California's Fisher Center for Real Estate and Urban Economics.

No Options

Refinancing won't be an option for homeowners with negative equity who have mortgage rates that are spiking, he said. About a third of U.S. borrowers have adjustable-rate home loans, according to the Federal Housing Finance Board in Washington.

``They will lack refinancing ability, and will obviously be under financial strain as their rates adjust,'' Rosen said. ``We're going to see credit card delinquencies rise and car loan delinquencies rise as a result.''

As many as 5 million U.S. homeowners may have mortgages that exceed the value of their homes by the end of this year, according to estimates from Rosen. He said he expects a 16 percent decline in home prices from 2006 to 2009, compared with Hatzius' estimate of a 22 percent drop.

Falling prices and rising foreclosures are a threat to an already slowing economy since many homeowners used their equity to finance purchases such as cars or computers.

Sunset Wedding

U.S. property owners took out about $318 billion of equity from their homes in 2006 by refinancing home loans, according to Freddie Mac, the world's second-largest mortgage buying company. Add to that $146.2 billion lent in home equity lines of credit, according to the Federal Reserve.

In all, $2.2 trillion of home equity has been liquidated since 2001, which was the first of five years of record-setting house prices and sales.

Kamanu refinanced her house in May 2007 and owes $415,000 on her mortgage. Homes in her neighborhood now sell for about $330,000, she said. The median home price in California dropped 17 percent from a year earlier in December, according to the state's association of Realtors.

Kamanu said she doesn't want to put her life on hold until the housing market improves. She's planning a sunset wedding later this year on the beach at Folsom Lake, about half a mile from her property, even as she waits for a buyer.

Relying on Luck

She said she's willing to sell the three-bedroom, two-bath, 1,272-square foot house fully furnished and include two wide- screen televisions to entice a buyer. The home has a fireplace and a two-car garage.

``I'm hearing it might be a year or two before the housing market comes back, and I can't wait that long,'' said Kamanu, 38. ``I'm relying on luck, hoping that someone will come along and fall in love with the house, like I did.''

Real estate assets represent about one-third of the net worth of U.S. households, said Michael Darda, chief economist of MKM Partners in Greenwich, Connecticut. In 2006, Americans owned $20.5 trillion in homes, compared with $6.3 trillion in corporate equities, according to Federal Reserve data.

``The decline in home prices will cause a ding in household balance sheets,'' said Darda.

Declining values may keep many people from trading up. Owners with fixed-rate mortgages probably will ride out the slump without moving, even if they have a growing family and need more room, said David Berson, chief economist at PMI Group Inc. in Walnut Creek, California. They won't be spending much for clothes or dishwashers or Disneyland vacations, he said.

Values in `Freefall'

``Economists call it a negative wealth effect,'' said Berson, the former chief economist of Fannie Mae. ``When housing values go down, people tend to stay put, save more and spend less.''

The economy probably will shrink 0.5 percent in the current quarter and 1 percent more in the second quarter as the real estate decline takes its toll, said Hatzius. An economic recession began in late 2007 and will last until at least July, he forecasts.

``All aspects of residential real estate remain in freefall,'' said Hatzius. ``At present, there is no sign of a bottom.''

Ricardo Fornos is part of that plunge. He's trying to sell his two-bedroom, two-bath condominium in Davie, Florida, near the Miami Dolphin football team's practice field at Nova Southeastern University. Fornos paid $190,000 two years ago and now expects he may get $165,000 for it.

With a mortgage of $171,000, Fornos said he may have to pay as much as $20,000 to sell the property after covering the broker's fee and the buyer's closing costs.

Fornos, 50, is eager to get out now before prices worsen. In December, the median price for a condominium declined 8 percent from a year ago and sales dropped 31 percent, the Florida Association of Realtors said.

``It comes to the point where you have to decide: Do I want to take a big loss now or an even bigger loss later?'' he said.

Downpayment in arrears

Last March, I wrote about a couple that had to bring $20 thousand to escrow to sell their home: Escrow to Seller: "Bring Money". Since they bought the condo with no money down, this was a downpayment in arrears.

Today, with house prices falling even more, they would have to bring $80 thousand or more to escrow, or arrange a short sale with the lender, or just walk away and suffer the consequences.

Bloomberg has an article on this phenomenon: Americans Selling Homes See Prices Go Below Mortgage (hat tip SC)

When Mary Kamanu paid $409,000 for a house in Folsom, California, she never imagined that three years later it would be worth about 20 percent less and she would have to pay the bank more than $80,000 just to sell the place.

``I'm completely upside-down on my mortgage, like a lot of people,'' said Kamanu, who wants to move 12 miles away to live with her fiancé in a suburb of Sacramento. ``I know I'm going to have to come up with a big chunk of change.''

This sounds like another "no money down" purchase with a 20% down payment in arrears.

And the nation's highest 2007 foreclosure rate goes to...

(Housing Wire) For all of the attention California and Florida have been getting during the recent housing bust — and rightfully so — the nation’s highest foreclosure rate isn’t in either former housing hotspot. It’s in none other that Detroit, Michigan, which has seen its economy decimated by continuing woes in the U.S. automobile industry.

Detroit registered the highest foreclosure rate among the nation’s 100 largest metro areas during 2007, according to a report released Wednesday, with close to 5 percent of its households entering some stage of foreclosure during the year — 4.8 times the national average, and up from about 3 percent in 2006. A total of 72,616 foreclosure filings on 41,273 properties were reported in the Detroit metro area in 2007, up 68 percent from 2006, according to foreclosure listing service RealtyTrac.

Not that California or Florida, however, were all that far behind. Fifteen of the metro areas with the top 20 metro foreclosure rates were located in just four states: California with six, Ohio with four, Florida with three and Michigan with two.

Overall, the rate of foreclosures nationwide increased nearly 80 percent from 2006 levels, according to RealtyTrac.

“As expected, the number of properties entering some stage of foreclosure in 2007 was up in the vast majority of the nation’s 100 largest metro areas, with 86 metros reporting increases from 2006,” said James J. Saccacio, chief executive officer of RealtyTrac. “Most of the metro areas with the highest foreclosure rates were either cities like Stockton and Las Vegas, which experienced meteoric growth and unsustainable price appreciation over the past few years, or cities like Detroit, which are undergoing a more widespread economic downturn along with higher unemployment rates.”

Stockton in particular has been hard hit, with 4.86 percent of its households entering some stage of foreclosure during the year, RealtyTrac said. A total of 22,184 foreclosure filings on 10,608 properties were reported in the metro area in 2007, up 271 percent from 2006.

Other California metros with foreclosure rates in the top 20 were Riverside-San Bernardino at No. 4, Sacramento at No. 5, Bakersfield at No. 7, Fresno at No. 14 and Oakland at No. 16.

Las Vegas posted the third highest metro foreclosure rate among the 100 largest metropolitan areas in 2007, RealtyTrac said, with 4.2 percent of households entering foreclosure in 2007.

For more information, visit http://www.realtytrac.com.

Will the Mortgage Industry Fix the Mortgage Mess Itself? A Look at Project Lifeline

(Credit Slips) The mortgage industry has been arguing against bankruptcy reform legislation that would permit the court-supervised modification of single-family principal home mortgages in bankruptcy. The industry argues that permitting mortgage modification in bankruptcy would result in higher interest rates and that its private efforts will solve the problem. In an earlier post and in a working paper, I have shown that we are unlikely to see higher interest rates as a result of allowing bankruptcy modification. Here, though, I want to take issue with the mortgage industry’s claim that its private efforts will solve the problem.

Hopefully the mortgage industry is correct about this. But there is good reason to doubt the efficacy of the industry’s efforts. To date, the mortgage industry’s efforts to fix the foreclosure crisis have been a lot of sizzle, but not much steak. Unfortunately, this seems to be the case with Project Lifeline, the latest half-measure to come out of the mortgage industry. As I explain below, the very structure of Project Lifeline means that homeowners in a significant number of states will be unable to take advantage of Project Lifeline's meager offering because it will kick in only after their homes have been sold in foreclosure.

The mortgage industry’s efforts at cleaning up the foreclosure mess have been coordinated through a private consortium of the largest mortgage servicers, called the HOPE NOW Alliance, which provides a clearing house for homeowners to reach servicers to attempt to work out deals on troubled mortgages. The HOPE NOW Alliance’s most recent effort, called Project Lifeline, was rolled out today with much hoopla. Project Lifeline is likely to have have very little impact. Despite its endorsement by the Treasury and HUD Secretaries, Project Lifeline is a voluntary private program of the six largest mortgage servicers under which they will pause foreclosure proceedings for up to 30 days for a certain limited group of homeowners who contact them and provide updated financial information. In order to qualify for the Project Lifeline pause, a loan must (among other things) be 90-days delinquent and not have a foreclosure sale scheduled within 30 days. That means that there cannot be a sale scheduled within 120 days of the first missed payment. The problem is that many foreclosures are completed within this 120-window.

By the time a homeowner can qualify for Project Lifeline, there may be no home left to save. Are mortgage servicers this clueless about foreclosure law or is the point of Project Lifeline simply to sandbag other reform efforts?

Most servicers start foreclosure proceedings when mortgage loans are 60-days delinquent. The time it takes from the beginning of foreclosure proceedings to a sale varies significantly from state to state, but in many states, it can easily be completed within another 60 days. For example, in Maryland, my state of residence, it takes a minimum of 16 days. If I read Michigan law correctly, the sale can occur within 22 days. In Texas the foreclosure sale can be accomplished in 42 days. If servicers are efficient about foreclosures, there are many states (at least 17 and quite possibly more) in which no homeowners would be able to qualify for the Project Lifeline pause.

For those homeowners who do qualify for the pause, it’s worth noting that it is not a guaranteed 30-day pause, but a pause of up to 30 days, during which the servicer is not obliged to do anything. Assuming servicers attempt to work out the loan in good faith, we still shouldn’t be particularly optimistic about the outcomes given the past track record of mortgage servicers and the HOPE NOW Alliance. In the last half of 2007 some 869,000 workouts occurred. But 75% of those were repayment plans. Repayment plans just mean that arrearage is allowed to be paid out over time going forward. But there is no change to the terms of the mortgage. The monthly payments actually go up because in addition to the usual monthly payment, there is also the arrearage to be repaid. If the monthly payment was unaffordable before, a repayment plan actually makes things worse.

Even of the 25% of workouts that resulted in modifications of loan terms, we have no way of knowing whether these modifications were qualitatively sufficient to provide long-term solutions. Given the large number of mortgages in foreclosure from failed workouts (29% of foreclosures nationally!), it would appear that many were insufficient. It tells a lot about the HOPE NOW Alliance members’ mindset that they entitled their statistics on the number of mortgage modifications and repayment plans as “mortgage loss mitigation statistics.” (See pp. 12-16). Servicers are likely to lowball loan modification offers. As long as this happens, we are unlikely to see the mortgage industry fix the mess it wrought.

So let’s consider a few possibilities. If the mortgage industry’s efforts are unsuccessful, then we really need to have a fallback plan or else we’re looking at a foreclosure epidemic of unprecedented proportions. Permitting mortgage modification in bankruptcy would provide such a fallback.

On the other hand, if the industry's efforts are successful, then what harm is there in permitting modification of mortgages in bankruptcy? No one files a Chapter 13 petition for fun--that's 3 or 5 years of living on a court-supervised, IRS-devised budget. There simply is no moral hazard issue here.

Finally, permitting modification of mortgages in bankruptcy might actually facilitate the private work outs of delinquent mortgages because it would push servicers to offer modification terms closer to what a homeowner could get in bankruptcy. It’s hard to see what the possible downside is to permitting mortgage modification in bankruptcy—it would make bankruptcy treatment of mortgages like all other secured debts (at least pre-BAPCPA), would have little or no effect on interest rates, would not create moral hazard problems, and might facilitate private deal-making. We should see bankruptcy reform as a counterpart, rather than an alternative, to private mortgage loan workouts.

Hope Now = False Hope

(Naked Capitalism) The Hope Now Alliance, a plan brokered by Treasury Secretary Hank Paulson to get mortgage servicers to freeze introductory ARM rates for a narrowly-defined set of subprime borrowers, was roundly attacked by many borrower advocate groups. Their estimates of how many people it would help ranged from 15,000 to 145,00, and were attacked by the Administration.

Looks like the critics are being proven correct. From the Wall Street Journal in "Earlier Subprime Rescue Falters":

In the past two months, the 1-888-995-HOPE hotline received roughly 176,000 calls, according to the nonprofit Homeownership Preservation Foundation, which operates the hotline. During that time, hotline counselors recommended a workout for 9,975 borrowers -- and told an additional 4,410 people to "seriously consider selling their home," the group says. Another 12,113 borrowers were referred for in-person counseling and services such as job-placement help.

The beginning of the article says only 36,000 borrowers received counseling. So what happened to the other 140,000?

And no one is promising a big spike up:

Faith Schwartz, executive director of the Hope Now Alliance, a coalition of mortgage companies, investors and credit counselors, said she expects the number of borrowers benefiting from the rate freeze to "inch up."

If this is all the official shill is willing to promise, I wouldn't get my hopes up.

Tiitke insurers hit with price fixing suit in New York

(Housing Wire) Title insurers are being harshly scrutinized in the wake of the housing boom — no question about it. The Wall Street Journal reports on a price-fixing case recently filed in federal court in Brooklyn:

In the latest legal challenge, an antitrust suit … accuses the four firms that dominate title insurance nationwide of illegally fixing prices in New York state. Although insurance firms have limited immunity from antitrust claims because state regulators approve their rates, the suit accuses title firms of concealing improper costs underlying their rate requests …

The New York suit, which seeks to represent all home buyers in the state, says consumers were forced to pay hundreds of millions of dollars in extra closing costs.

The four firms named in the suit are Fidelity National Title, First American, LandAmerica Financial and Stewart Title Insurance. The Journal reports on the allegations, which claim that while New York regulators review title insurance rates, the rates provided for review hide referral fees and other kickbacks that prop up the cost of title insurance:

“They’re gaming the regulatory system,” said Gordon Schnell, a lawyer representing the four named plaintiffs. “Especially in New York, where the firms set their rates collectively, that’s a violation of the antitrust laws.” The suit cites a 2006 state hearing in which regulators conceded they can’t adequately review agents’ commissions, which make up 85% of rates.

Industry representatives have said all four firms will fight the allegations vigorously in court, according to the Journal.

Allegations of illegal kickbacks are nothing new to the title industry — First American paid $10 million last January, and Stewart $1 million in August, to settle charges of kickbacks with the California Department of Insurance. Fidelity National’s default management outsourcing businesses were recently the subject of a class-action lawsuit alleging forced and illegal kickbacks involving its network of foreclosure attorneys.

But the New York suit represents a new tack on an old issue, with borrowers directly bringing an antitrust suit against the large title insurers.

It’s worth noting that the law firm representing the plaintiffs here is Constantine Cannon LLP — the same law firm that won a $3 billion antitrust settlement on behalf of Wal-Mart against Visa and MasterCard in 2003. Their involvement likely signals an ability and willingness to go toe-to-toe with some pretty deep pockets.

Project Lifeline: More smole and mirrors?

(Naked Capitalism) We didn't think much of the New Hope Alliance, the program brokered by the Treasury Department to rescue subprime borrowers facing resets. The program's criteria targeted those who were already paying fairly high initial interest rates with very little to no equity in their house at the time of closing. In other words, this group already was likely to be in negative equity territory due to the decline in the housing market; in many cases, it would make more sense for them to renege on the mortgage. So who really benefits from that program?

The New Hope program was also widely faulted for being largely cosmetic, since it would help relatively few homeowners (although the tally of who has supposedly been helped is sufficiently creative so as to make the program appear as if it is indeed accomplishing something). The new program to be announced at the Treasury tomorrow, Project Lifeline, looks like even more of the same.

The Associated Press provides a nice summary:

The plan will allow seriously overdue homeowners to suspend foreclosures for 30 days while lenders try to work out more affordable loans are worked out.

On a pilot basis, the plan will involve six of the largest mortgage lenders, in hopes that more lenders will sign on. The participants are Bank of America Corp., Citigroup Inc., Countrywide Financial Corp., JPMorgan Chase & Co., Washington Mutual Inc. and Wells Fargo & Co.

This verges on silly; the banks can do this on their own without the fanfare of a name and an the grandstanding of the Treasury.

And fittingly, the media isn't taking it all that seriously. The Wall Street Journal (at least as of this hour) does not have the story in its first page news summary and the article itself featured only negative comments:

Martin Eakes, chief executive of the Center for Responsible Lending, a nonprofit research group based in Washington that frequently bashes the mortgage industry, said moves announced so far have been "baby steps." He said lenders should move more aggressively to reduce loan balances to current home values and make monthly payments affordable. He acknowledged, however, that servicers of loans -- the firms that collect payments and handle foreclosures -- face the risk of lawsuits from investors that own loans if those investors believe borrowers have been given overly generous terms.

Bruce Marks, chief executive of Neighborhood Assistance Corp. of America, a Boston-based nonprofit that works with distressed homeowners, dismissed Project Lifeline as a "PR stunt." He said it already should have been automatic for loan servicers to pause foreclosure proceedings for homeowners seeking to qualify for a more affordable loan.

While the New York Times has a page one story on the underlying problem, "Mortgage Crisis Spreads Past Subprime Loans," it does not mention the new plan until the second page. Even then, it intimates that its real aim is to reduce the number of borrowers who decide to walk from their homes. In other words, the initiative may be more for the benefit of the industry than the consumer:

Bank of America, Citigroup, Countrywide Financial, JPMorgan Chase, Washington Mutual and Wells Fargo are expected to announce on Tuesday at the Treasury Department that they will offer both prime and subprime borrowers who are more than three months behind a chance to halt foreclosure proceedings for 30 days and work out new loan terms.

In a conference call with analysts in December, Kenneth Lewis, the chief executive of Bank of America, said more borrowers appear to be giving up on their homes as prices fall, noting a “change in social attitudes toward default.”

“You don’t mind making a $2,000 payment when the house is going up” in value, said Steve Walsh, a mortgage broker in Scottsdale, Arizona, who has seen several clients walk away from their homes because they couldn’t refinance or sell. “When it’s going down, it becomes a weight around your neck, it becomes an anchor.”

The Lifeline program is so cosmetic that it is difficult to think that it's intended to address the change in attitudes among overextended borrowers. But the fact that the Times presents that as a motivating factor is telling.

Update 3:00 AM: Bloomberg's story has some choice quotes:

Paulson, who as recently as last month opposed a moratorium on foreclosures, is pushing lenders to go beyond earlier pledges to freeze subprime interest rates for five years...

``There is this huge disconnect between what is being represented by the industry and what is being experienced on the ground,'' said Kevin Stein, associate director of the California Reinvestment Coalition, a San Francisco-based housing activist group. ``Borrowers are falling through the cracks while more and more of these press releases come out. It's clearly not enough.''...

``This is good, but we've seen this over and over again,'' said Kathleen Day, a spokeswoman for the Center for Responsible Lending in Washington. ``The fact that they keep having to roll out subsequent rescue plans every few weeks underscores that each plan is inadequate.''

Mortgage Workouts Shifting Into Higher Gear

(American Banker) Hammered by bad publicity and rising foreclosures, the financial services industry is moving toward broader loan workout efforts.

The Hope Now alliance and the Treasury Department are expected to announce today a voluntary freeze on certain foreclosures and a broader outreach effort to delinquent subprime borrowers, sources said. Countrywide Financial Corp., meanwhile, struck its own deal with a community group Monday to help more than just subprime hybrid mortgage borrowers.

The Countrywide deal and the prospective Treasury announcement underscored an understanding in the industry that efforts to date have been insufficient to stem subprime problems, observers said.

"There's going to be a need for assistance for a wide swath of loans much broader than subprime," said Brian Chappelle, a partner at Potomac Partners. "I do see it going broader because the problem is broader."

The loan modification efforts underway have come under broad fire from lawmakers, the media, and consumer groups that have said they come too late and are too narrow.

This has prompted a flurry of hints from Treasury officials that they would broaden the Hope Now plan, which currently offers five-year interest rate freezes on a narrow segment of subprime hybrid adjustable-rate mortgages. Consumer groups have also detected a change at lenders and servicers.

"We're seeing a lot more, and we're finalizing discussions and agreements with a number of servicers," said Bruce Marks, the chief executive of Neighborhood Assistance Corporation of America.

Still, it was unclear how much impact today's planned Treasury announcement would have.
At a press conference with Treasury Secretary Henry Paulson, Hope Now members, including Bank of America Corp. and JPMorgan Chase & Co., are expected to announce a plan, dubbed Project Lifeline,

The plan, which has been in the works for two months, has been softened to ask servicers to "consider" the foreclosure freeze, not to require it, as the initial language said, according to sources.

Mr. Marks said the plan's voluntary nature undercuts its effectiveness. "There's no set restructuring," he said.
"It's a public relations gimmick... It's no different than what servicers or lenders do today. Until they require it, then this is not a significant event."

Some economists agreed it may do little to alleviate the problems.
"The various efforts to help hard-pressed homeowners remain in their homes … are very laudable but threaten to be overwhelmed by plunging housing values and rising unemployment in an increasing number of areas across the country," said Mark Zandi, the chief economist and a co-founder of Moody's Economy.com Inc. "Mortgage defaults and foreclosures will continue to increase until mortgage credit begins to flow more freely and the job market stabilizes."

The plan is also expected to call for outreach to more delinquent subprime borrowers. The current loan modification plan was limited to current borrowers facing an interest rate reset they could not afford.

Steve Bartlett, the president of the Financial Services Roundtable, said the expanded plan, too, might be added to later.

"It's an expansion, and I think you'll see further expansion," he said. "This is a massive area. This is the largest and most pressing economic problem in the world today."

Certain Hope Now members, including the Calabasas, Calif.-based Countrywide, have also announced their own separate initiatives.

The thrift company said Monday that it would partner with the Association of Community Organizations for Reform Now to work with all subprime loans, not just hybrid adjustable rate mortgages.

The company also pledged to rework loans for borrowers across various stages of delinquency, not just those that are current on payments.

Joseph Mason, an associate professor of finance at Drexel University's LeBow College of Business and a former Office of Comptroller of the Currency economist, said the Countrywide announcement shows that the industry is not relying on Hope Now to figure out modifications.

"The industry is still trying to stay one step ahead of Hope Now," he said.

DR Horton "UnAuction Event"

(Housing Wire) Home builder D.R. Horton is advertising it’s “UnAuction event,” which as best I can tell is like having a foreclosure auction without the foreclosure. “Auction prices without the hassle!” is the tagline on the promotional Web site just launched to promote the event.

Covering 23 neighborhoods in Southern California, the “unauction” will offer discounts of up to 50 percent on unsold inventory homes. (Read that number again: a 50 percent discount on new homes). And just where are these values to be had? Kern County. Ventura County. San Bernardino County. Riverside County. Imperial County.

For the uninitiated to California’s geography, all are in the so-called Inland Empire — the area of the state that’s been hardest hit during the ongoing housing slump.

This story gives me a chance, BTW, to relay a sidenote from the flight home last week after ASF 2008. I ended up sitting in coach across from a gentleman who bought four beers during the three hour flight from Las Vegas to Dallas; well-dressed, wearing a grey suit. Upon landing, he pulled his luggage out from underneath the seat, which sported his full name and title as a very senior executive at D.R. Horton.

When he noticed I was scanning his luggage tag, what was his response? To turn the tag over and hope nobody saw his name, his title, or who he worked for. That, ladies and gentlemen, is what has become of the nation’s homebuilders. A sign of the times, I guess.

HOPE NOW isn't enough: Countrywide and ACORN partner on loss mitigation

(Housing Wire) On the heels of the HOPE NOW subprime ARM rate freeze — a program that, like FHASecure before it, seems to be having little impact on the mortgage crisis — Countrywide Financial Corp. said Monday that it had established a wider and more comprehensive set of subprime borrower workout standards in partnership with consumer-activist group ACORN (the Association of Community Organizations for Reform Now).

In a joint statement, both organizations said the new standards went well beyond the Bush administration-backed HOPE NOW agreement introduced in December.

As part of the agreement, Countrywide will introduce new workout programs for borrowers with all types of subprime loans, not just hybrid adjustable rate mortgages with pending rate resets. Further, the agreement addresses home retention options and procedures for borrowers in various stages of mortgage delinquency, and not just borrowers who are current in their payments.

Critics have suggested that the original HOPE NOW agreement is too narrow in its scope, and that it would be unlikely to help many troubled subprime borrowers — especially those already delinquent on their payments. The ASF circulated a memorandum last week suggesting as much, and the Countrywide/ACORN partnership illustrates that the nation’s largest servicer isn’t waiting for industry-wide discussion on the issue.

“Countrywide and ACORN share the belief that no subprime borrower who has demonstrated the ability and willingness to make payments should face foreclosure,” said Maude Hurd, national president of ACORN. “We hope others in the mortgage servicing industry will adopt similar practices.”

The agreement respects investor interests, Countrywide said, by ensuring that investor returns are protected by the workout options offered to borrowers.

“Countrywide is eager to work with borrowers, whether they are facing rate resets or some other type of financial difficulty,” said Michael Gross, managing director of loan administration for Countrywide. He said the new workout plan offers “investors in the loans a more attractive alternative than foreclosure.”

The lender said that it is currently working with 100,000 additional borrowers in an attempt to find what it called an “affordable workout solution.”

Bankruptcy cram-down would deliver $17M benefit to government

(Housing Wire) According to a cost estimate released Thursday by the Congressional Budget Office, enactment of a bill seeking to amend federal bankruptcy law to allow for principal cram-downs on primary residences would deliver $17 million in cost savings and additional revenues to the federal government.

The CBO estimated that HR 3609, the Emergency Home Ownership and Mortgage Equity Protection Act of 2007, would reduce direct spending by $10 million and increase government revenue by $7 million between 2009 and 2018. The report also estimates that while the bill would add to court costs, the CBO believes that such costs “would not be significant.”

While costs to the public sector aren’t expected to be signficant — and, indeed, the bill is expected to benefit the federal government — costs to the private sector may be. The CBO said that while the bill would impose additional costs on businesses, it was unclear if the aggregate costs of complying with the bill’s provisions would exceed a dollar threshold set by the Unfunded Mandates Reform Act, or UMRA.

UMRA was put into place in 1995 to ensure that Congressional leaders do not enact bills that place a costly burden on state-level agencies or private-sector parties without associated funding support.

The CBO said that it could not estimate the cost of private-sector mandates “because of uncertainty about the number of bankruptcy plans that would be modified and how these changes would affect holders of secured claims.”

The debate over whether bankruptcy cram-downs should be allowed has been an intense one; the fact that the proposed bill is likely to drive incremental revenue for the government, while costing the private sector an indeterminable amount of money, is likely to be an area of contention as the bill is debated at varying Congressional levels in the months ahead.

The complete report by the Congressional Budget Office is available here.

OFHEO to publish monthly HPA data

(Housing Wire) The Office of Federal Housing Enterprise Oversight said yesterday that it will begin publishing a monthly housing price index, according to a report by Reuters.

The news agency reported that Edward DeMarco, deputy director of OFHEO, told attendees at the New York Society of Security Analysts forum Thursday that the agency would move to move to a monthly reporting format beginning in March.

OFHEO’s HPI data has previously been published only on a quarterly basis.

Reuters’ coverage also had some input on market trends from DeMarco:

“For subprime loans, the seriously delinquent rate is now approaching levels of the 2001 recession,” DeMarco said. “The difference, of course, is that there are now over two times more subprime loans outstanding than there were in 2001.”

“We’re all hearing, and certainly the books of the two enterprises are showing, that delinquences are spreading to other parts of the real estate market,” he added.

In other words: it’s a housing leverage problem now.

OFHEO: GSE reform is "critical"

(Housing Wire) In remarks delivered today to the Senate Banking, Housing and Urban Affairs Committee, Office of Federal Housing Enterprice Oversight director James Lockhart said that the need for GSE reform was “critical” as Congress considers raising the conforming limit as part of a pending economic stimulus package.

“Given the tremendous stresses on the mortgage markets, the American people cannot afford to have Fannie Mae, Freddie Mac, or the 12 FHLBanks incapable of serving their mission,” Lockhart said.

click to see larger version

Lockhart’s not kidding — I’d suspect even many mortgage market participants would be surprised to see just how big the GSEs really are; the graph to the right shows GSE debt relative to the entire public debt of the United States.

Lockhart pressed Senate committee members to couple any increase in the conforming loan limit with “quick enactment of comprehensive GSE reform,” citing many of the challenges that have been reported on by HW in the past, including the new capital needed to successfully operate in jumbo lending.

“Underwriting them [jumbos] successfully will require new models and systems to ensure safe and sound implementation,” Lockhart said.

The OFHEO director outlined a key reform measure, suggesting that a new regulator for the housing GSEs be established. “We need a stronger, single and unified regulator for the housing GSEs,” Lockhart said. “That regulator needs to have all the powers of the bank regulators and more given the Enterprises size, systemic importance, and GSE status.”

“We have this strange budget mixture where we are funded by Freddie Mac and Fannie Mae, but yet we are appropriated by Congress as if we were funded by taxpayers,” he said.

“In only two of our fifteen years has OFHEO known how much money we had to spend when the year started. Uncertain funding levels and the resulting under-staffing is not the way to run a regulator.”

Lockhart’s full testimony is available here.

Schumer vows a full court press on mortgage industry regulation

(Housing Wire) Senator Charles Schumer (D-NY) is making more than his fair share of headlines today by cranking up the heat on the mortgage industry at a Reuters-sponsored Regulation Summit in Washington.

Beyond suggesting that the GSEs need to consider so-called partial charge-offs for ‘underwater’ borrowers facing difficulty making their mortgage payments, Schumer also vowed Wednesday to pass federal regulation of mortgage brokers, and said that a formal investigation on rating agencies may be in the offing.

From Reuters’ coverage of its own event:

“We will get that passed this year. There will be regulation of mortgage brokers, as there should be, at the federal level,” said Sen. Charles Schumer, a New York Democrat and chairman of Congress’ Joint Economic Committee.

He also called for reform of credit rating agencies. “I am seriously looking at, and our committee is going to hold hearings, on the credit rating agencies …

“Maybe the structure should change. There’s a built-in conflict of interest,” Schumer said in remarks at the Reuters Regulation Summit in Washington.

HW readers know that rating agencies — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — have been taking plenty of heat as of late from investors and regulators alike. A recent proposal earlier this week by Moody’s to alter how it rates structured finance issuances, part of an attempt to rebuild investor confidence, has led to plenty of eye-rolling among various commentators. Late Wednesday the Wall Street Journal reported that Standard & Poor’s is set to release its own plan aimed at countering conflict of interest claims.

A Senate bill targeting federal regulation of mortgage brokers was introduced late last year by Senator Chris Dodd (D-CT) — the Homeownership Preservation and Protection Act (S 2452) — which would, among other provisions, prohibit the use of yield spread premium on all non-traditional mortgages as well as estalish a fiduciary relationship between brokers and borrowers.

It’s unclear if the current Senate bill has bipartisan support or not; it has been referred to the Senate Committee on Banking, Housing, and Urban Affairs for markup.

Loss mitigation lacking for seriously delinquent borrowers

(Housing Wire) Seven out of ten seriously delinquent borrowers are not tracking towards a loss mitigation solution, according to a report released today by the Conference of State Bank Supervisors, who said that a rising number of loan delinquencies are outpacing gains in loss mitigation efforts.

The State Foreclosure Prevention Working Group, a task force organized last summer by Iowa AG Tom Miller, said that while servicers have increased staffing and pushed creative outreach efforts, a large gap remains between homeowners most in need of loss mitigation and the number currently receiving assistance.

The working group comprises representatives of the Attorneys General of 11 states (Arizona, California, Colorado, Iowa, Illinois, Massachusetts, Michigan, New York, North Carolina, Ohio and Texas), two state banking departments (New York and North Carolina), and the Conference of State Bank Supervisors.

In line with a report issued late Wednesday by the HOPE NOW industry consortium, the CSBS report did find that servicers have increased their use of loan modifications — among delinquent borrowers in contact with their servicers, 45 percent are working on executing a loan modification. “Servicers are increasing their use of longer-term changes to the mortgage loan, versus their earlier reliance on short term repayment or forbearance agreements,” the organization said in a press statement.

Interestingly, the report also suggested that the largest contributor to loan resolution was homeowners helping themselves: the State Bank Supervisors said their analysis found that it was actions by homeonwers — many of whom caught up on back payments — and not the actions of servicers that actually prevented the majority of foreclosures.

The report also noted that the refinancing option “has nearly evaporated.”

“Despite recent interest rate cuts, the mortgage industry will not be able to refinance its way out of this crisis absent dramatic changes in loan products of a reversal in home price declines,” the CSBS group said.

The full report is available here.

Bankruptcy Cramdowns

(Housing Wire) Tomorrow at 1:30 US EST, a couple of academics from Georgetown and Columbia will be holding a press conference touting their own study, which they claim “debunks interest-rate claims made by the Mortgage Bankers Association.”

The MBA has claimed that allowing cram-downs in Ch. 13 bankruptcy proceedings could add as much as two points to mortgage rates.

Adam Levitin, an associate professor of law at Georgetown, and Joshua Goodman, an economics doctoral candidate at Columbia, have authored a study that they claim proves that allowing modifications in Ch.13 bankruptcy proceedings would not result in an interest rate spike.

A recent working draft of the study, as with most academic papers, is already available (dated January 28, 2008).

As an ex-academic — HW readers may or may not know that it wasn’t too long ago that I was a Ph.D. student myself — I can’t help but comment.

I think the authors’ data — despite to Levitin’s bellowing to the contrary — surprisingly lends credence to the idea that altering bankruptcy law to permit cram-downs will, in fact, serve to raise mortgage rates.

Study 1: historical interest rates
In the first study, the authors performed a series of regression-based analyses on historical interest rate data, and included a variable intended to capture the effect of ’strip-downs.’ The data used was from the time period of 1988 to 1993, a time period when strip-downs/cram-downs were allowed — the idea here being that it is possible to tease out any effect of cram-downs in historical mortgage rate data.

The finding was that allowing ’strip-downs’ raised the median interest rate by 11 to 15 basis points, with the latter figure representing a statistically significant effect on a lagged six-month basis. This is seen as a “small” effect by the authors, and not a sizeable change to mortgage rates.

The regressions also lead the authors to conclude that allowing cram-downs did not affect the proportion of Ch. 13 filings relative to Ch. 7 — this is an important point in the analysis that I’ll get back to.

Study 2: rate survey
The authors pulled current mortgage rates, PMI fees and GSE delivery fees on single-family primary residences, investor properties, vacation homes, and multi-family residences in an effort to ascertain whether or not current rates diverged where cram-downs were allowed under current bankruptcy law.

While rates/fees generally diverged significantly between primary residences and investor properties, the authors found no such disparity between primary residences and other property types subject to cram-down risk. Thus, the authors concluded that cram-down risk could not explain the divergence between primary residences and investor properties.

Debunking the debunking
Let’s start with study one. I’ve noted in some earlier commentary that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has had a dramatic impact on the bankruptcy landscape. In particular, the prevalence of Ch.13 filings has shot up dramatically since the enactment of the Act, while overall bankruptcy filings have dropped.

In the paper, the authors manage to test whether strip-down rulings have a bigger effect on mortgage rates in states where Ch. 13 filings are more prevalent. What they find is statistical relevance suggesting that every 10 percentage point rise in the proportion of filers using Ch. 13 leads to an additional 17 basis point increase in mortgage rates when strip-downs are allowed.

This ‘prevalence effect’ comes over and above the 10-15 bp rise found as a so-called main effect of allowing cram-downs.

It’s a finding that is sadly relegated to nearly zero discussion and cited as something to consider for “future work,” when in truth it should have been the focus of much further analysis.

While the authors do say they found no evidence in the historical data to suggest that allowing cram-downs drove more borrowers to file Ch.13, they completely failed to account for the so-called “means test” established under section 707(b) on the 2005 Act. That test, by its very definition, makes Ch.13 filings more prevalent.

The fact that the authors were able to find strong evidence of a ‘prevalence effect’ at all using historical data suggests that allowing cram-downs now — in a post-BAPCPA world — would have a pretty dramatic impact on overall mortgage rates. The failure to consider this has to throw the entire study’s conclusions into doubt.

But that’s not all — let’s take a peek at study two.

The authors find uniform evidence of higher rates and points for investor properties, as compared to single-family primary residences; but no such divergence exists for vacation homes and multifamily residences.

The conclusion, and associated footnote:

Because investor properties share the same bankruptcy modification risk as vacation homes and multifamily residences, the mortgage rate premium on investor properties cannot be attributed to bankruptcy modification risk.

[footnote] It is not surprising that vacation homes have the same rates as single-family principal residences. Vacation homes reputedly have lower default rates because typically only well-heeled buyers purchase them. They do not have tenant risks such as vacancy, non-payment, or damage, and they are typically well-maintained because of the pride of ownership factor.

What is “bankruptcy modification risk,” exactly? The authors don’t define it explicitly, but I can assure you that investor homes and vacation homes absolutely do not face the same risk of being modified as part of a Ch.13 bankruptcy — simply because vacation homes are less likely to default and/or be subject to a borrower bankruptcy to begin with. (It’s in the authors’ own footnote, for crying out loud.)

I should note here that I’m not defending the 200 basis point figure generated by the MBA per se; what I’ve said all along is that allowing cram-downs will have a meaningful impact on mortgage rates.

That could be a rise of 90 basis points, and not 200 bps; but given today’s market, that’s still the sort of rise that should be seen as problematic for borrowers.

Papers Show Wachovia Knew of Thefts

(NYT) Last spring, Wachovia bank was accused in a lawsuit of allowing fraudulent telemarketers to use the bank’s accounts to steal millions of dollars from unsuspecting victims. When asked about the suit, bank executives said they had been unaware of the thefts.

But newly released documents from that lawsuit now show that Wachovia had long known about allegations of fraud and that the bank, in fact, solicited business from companies it knew had been accused of telemarketing crimes.

Internal Wachovia e-mail, for example, show that high-ranking employees at the nation’s fourth-largest bank frequently warned colleagues about telemarketing frauds routed through its accounts.

Documents also show that Wachovia was alerted by other banks and federal agencies about ongoing deceptions, but that it continued to provide banking services to multiple companies that helped steal as much as $400 million from unsuspecting victims.

“YIKES!!!!” wrote one Wachovia executive in 2005, warning colleagues that an account used by telemarketers had drawn 4,500 complaints in just two months. “DOUBLE YIKES!!!!” she added. “There is more, but nothing more that I want to put into a note.”

However, Wachovia continued processing fraudulent transactions for that account and others, partly because the bank charged fraud artists a large fee every time a victim spotted a bogus transaction and demanded their money back. One company alone paid Wachovia about $1.5 million over 11 months, according to investigators.

“We are making a ton of money from them,” wrote Linda Pera, a Wachovia executive, in 2005 about a company that was later accused by federal prosecutors of helping steal up to $142 million.

Ms. Pera left Wachovia in 2006, and could not be located.
Lawyers pursuing the lawsuit against Wachovia, which was filed in a Pennsylvania federal court on behalf of a woman named Mary Faloney and other apparent victims, have asked a judge to declare the case a class action, which could expand it to as many as 500,000 plaintiffs.

The lawsuit alleges that Wachovia accepted fraudulent, unsigned checks that withdrew funds from the accounts of victims, often elderly. Wachovia forwarded those checks to other banks that were unaware of the frauds, which in turn sent money to the swindlers.

A judge is expected to rule on the class action request by this summer. Wachovia, in court filings, has denied the suit’s allegations. The company declined to comment on the pending litigation.

However, Wachovia’s senior vice president for risk management, Alan Chudoba, said that the bank introduced reforms aimed at telemarketing frauds last summer. Those changes, which came about after an article in The New York Times last May reported that thieves had used Wachovia accounts, include greater scrutiny of accounts used by telemarketers and stronger fraud protections.

In a statement, Wachovia said: “Earning the trust of our customers is at the heart of what we do every day and we regret this situation occurred. We took this issue very seriously, and senior management, led by C.E.O. Ken Thompson, was actively involved in directing aggressive steps to correct the processes related to this situation. We are confident that the changes we’ve implemented will help protect our customers.”

Some advocates cautiously applaud the bank’s efforts.
“This could be very good news for millions of consumers,” said Kathleen Keest with the Center for Responsible Lending, a group working to eliminate abusive financial practices.

“But reforms tend to happen quickly in the light of publicity, followed by backsliding when the spotlight fades,” Ms. Keest added.

One of the lawyers handing the Pennsylvania suit said Wachovia should do more. “I don’t understand why, like other banks, Wachovia simply doesn’t have a policy to avoid any business related to telemarketers,” said Howard Langer, of the firm Langer, Grogan and Diver.

A Wachovia spokeswoman said the bank was not currently working with any telemarketers, would review any future clients who do work with telemarketers, and would reject any client solely focused on telemarketing.

In the last three years, government agencies have sued several companies accused of routing telemarketing thefts through at least nine banks, including Wachovia, the largest company named in those lawsuits.

However, Wachovia and most other banks accused of involvement in similar frauds have never been publicly fined or prosecuted by federal regulators for aiding telemarketing criminals.

So some victims have turned to private lawsuits.
The Pennsylvania suit against Wachovia alleges that the bank’s involvement with telemarketing thefts dates to October 2003, when Wachovia was warned by another bank that a Wachovia client named AmeriNet had tried to process more than $100,000 in improper withdrawals.

AmeriNet was a “payment processor,” a company that creates unsigned checks on behalf of telemarketers to withdraw funds automatically from customer accounts. Such checks, once widely used by businesses collecting monthly fees, are legal if customers approve the transactions.

However, a Wachovia executive wrote to colleagues, evidence suggested AmeriNet was creating unapproved checks.
“Keep in mind historically, telemarketing is an easy way to money launder and commit fraud. To knowingly bank a customer who is perpetrating fraud places the bank at great exposure,” wrote that executive, Tim Brady, according to documents that are part of the lawsuit.

Mr. Brady, who did not return phone calls, recommended closing the AmeriNet account in 2003, according to that e-mail message. But Wachovia continued working with the company until 2005, when AmeriNet paid $50,000 to settle complaints filed by the attorneys general of five states. Wachovia was not named in those complaints.

In late 2003, a Wachovia executive announced to colleagues via e-mail that her unit, because of AmeriNet, had seen “an increase in our annual revenue projection.”

Wachovia declined to comment on those e-mail messages, citing pending litigation.
Wachovia also worked with other payment processors, according to court documents. In 2004, Wachovia held a lunch for the owner of a payment processor that the bank knew had drawn thousands of previous complaints.

“It is important that our relationship is firm and in good standing” with the owner of that company, Your Money Access, wrote the Wachovia executive, Ms. Pera, to colleagues. Your Money Access was sued last year by the Federal Trade Commission and seven states on suspicion of helping to steal up to $69 million.

There were other internal warnings, as well.
In 2005, a Wachovia fraud investigator wrote to colleagues that 79 percent of the checks submitted by one Wachovia client, Suntasia, had been returned in August because of unauthorized withdrawals and other problems. Regulators say return rates in excess of 2.5 percent is evidence of potential fraud.

“I have good reason to believe that all of the deposited items are unauthorized drafts,” wrote the fraud investigator, Bill McCann in a 2005 e-mail message.

But Wachovia continued doing business with Suntasia until last year, when the company was shut down by a court order, according to the lawsuit.

Wachovia declined to comment on Mr. McCann’s e-mail. Mr. McCann declined to return calls.
Moreover, executives at other banks, including Bank of America, Wells Fargo, Citizens Bank, the Social Security Administration and the Justice Department Federal Credit Union also warned Wachovia multiple times that its accounts were being used for fraud, according to the lawsuit against the bank.

In 2006, an executive at Citizens Bank wrote via e-mail that thieves were routing unauthorized checks through Wachovia that stole from Citizens account holders.

“We have spoken to many of our customers who have been victimized by this scam,” wrote the Citizens executive, according to court documents. “We would appreciate it if you would shut down accounts of any customers of yours that may be engaging in improper activity.”

But Wachovia kept that account open until it was frozen by a federal court a few weeks later, as part of a government lawsuit against the client.

A Wachovia spokeswoman said that in every case where a bank complained, an investigation was opened and that some accounts were closed.

But court records show that many of those accounts stayed open for years after the complaints were received.
Last June, after Wachovia’s involvement with telemarketing thefts was reported by The Times, Congressional lawmakers, including Representative Edward J. Markey, Democrat of Massachusetts and senior member of the House Energy and Commerce Committee, asked five regulatory agencies to answer questions regarding the unsigned checking system that fraud artists used. Senator Tom Harkin, Democrat of Iowa, also asked the Senate Banking Committee to investigate the issue.

Many of those agencies responded by saying they lacked jurisdiction. “Clearly, more needs to be done to prevent fraud in this area,” Mr. Markey said in a statement. A spokeswoman for Mr. Harkin said lawmakers were considering hearings.

Other regulators say the banks are to blame.
“These types of crimes only are possible because banks tolerate them,” said the United States attorney in Philadelphia, Patrick L. Meehan, who prosecuted a payment processor accused of using Wachovia accounts to steal more than $100 million.

“Who knows how many other crimes like this are occurring every day without anyone realizing it?” Mr. Meehan said.

Housing Wire ASF report

(Housing Wire) Some odd-n-ends from Monday, as day two of ASF 2008 looms. We’ll start with some pertinent quotes from the experts:

• Jon Bottorff, managing director at HSBC Finance, during a session on mortgage origination, on walk-aways: “We’ve attracted a lot of borrowers who are really renters … It is disheartening as a servicer to see the willingness [to walk away] … [borrowers] simply don’t care.” Bottorff wants to see the mortgage industry “get back to the classic homeowner” who has a vested interest in staying in their home.
• Peter DiMartino, senior managing director at Bear Stearns & Co.: “The one thing we need to get past is the monoline issue.” DiMartino said that the crisis affecting bond insurers is the single largest issue keeping investor confidence at bay.
• Merrill Lynch senior director Sarbashis Ghosh, in a session on RMBS research: “It’s not a subprime problem, it’s a housing leverage problem … we have people with a mortgage who simply cannot afford to make their payments.” Ghosh suggested the solution was “to address the question of leverage,” and went so far as to suggest something like a food stamp program to help borrowers with payments.
• Glenn Schultz, managing director at Wachovia Securities: “[We] need more of a heart-of-the-problem solution … any [government-led] solution will not be able to be put into place in time to help troubled borrowers.”

By far, the most frequented exhibitor booth at the show has been the one hosted by Wilmington Finance. The reason? Guitar Hero 3.

Whoever planned the booth had the brilliant idea of offering conference goers the opportunity to be virtual rock stars — and, as anyone who has ever met any of Wall Street’s finest knows, the chance to be bigger than life is proving to be an irresistable draw. I spent a few minutes watching one player absolutely butcher the Rolling Stones’ “Paint it Black.”

The industry dinner on Monday night was well-planned and even more expertly executed. A special private show by the Blue Man Group — not to mention free-flowing alcohol — had nearly every attendee planted in their seat for at least two hours.

The BMG show itself? I was very pleasantly surprised. It’s worth noting, BTW, that the rock-star motif continued onward, with the BMG show focusing on “what it takes to be a rock star.”

Protecting Homeowners and Sustaining Home Ownership

Governor Randal S. Krosner at the American Securitization Forum 2008 Conference, Las Vegas, Nevada (February 4, 2008)

The mortgage market has long been a source of strength in the U.S. economy, but it is facing significant challenges, especially in the subprime segment that serves consumers who have shorter or weaker credit records. As of November, the most recent month for which data are available, about 20 percent of subprime adjustable-rate mortgages (ARMs) were ninety or more days delinquent, twice the level one year earlier.¹ More than 171,000 foreclosures were started on these mortgages in the third quarter, up 36 percent from the previous quarter.² The significance of the problems with subprime loan performance is evident in the unusually high rate of defaults within a few months of loan origination, known as early payment defaults. In November, nearly 7 percent of subprime ARMs originated in the previous six months were already ninety or more days delinquent, twice the rate of the year before and nearly four times the rate two years earlier.³

These problems have many causes, but the role of abusive lending practices is of particular concern. Such practices have led many people into homeownership that they cannot sustain, hurting their families as well as their neighbors and communities. Practices that have hurt consumers have also undermined the confidence of investors and contributed to a virtual shutdown of the subprime market. As a result, it is difficult for many borrowers, especially those with shorter or weaker credit records, to obtain home loans.

These events have highlighted the shared interest of mortgage borrowers, their communities, lenders, and investors in protecting borrowers from abusive practices and preserving their choices. Abusive loans that strip their equity or cause them to lose their homes must not be tolerated. Protecting borrowers with responsible underwriting standards also protects the integrity and proper functioning of the mortgage market by increasing investor confidence. In other words, effective consumer protection can reduce uncertainty about the underwriting standards of, and hence, the value of, loans in mortgage-backed securities, thereby helping to revive and strengthen mortgage securities markets. In this way, effective consumer protection produces a complementary benefit for consumers by making more capital available to meet their needs. Similarly, systematic efforts to keep borrowers who may have trouble meeting their loan obligations in their homes on a sustainable basis, by providing more certainty to the market, can have the complementary benefit of ensuring the flow of capital for potential borrowers.

With these principles in mind, I will discuss current initiatives to mitigate foreclosures. Then I will spend most of my time discussing the Board's recent initiative in proposing new regulations to prevent abuse, unfairness, and deception in residential mortgage lending.

Preventing Unnecessary Foreclosures
About one-and-a-half million adjustable-rate subprime mortgages are scheduled to have their interest rates reset this year--significantly more than in 2007--and another one-half million in 2009. While many borrowers facing reset will be able to make the higher payment, many will not. As rates reset, it is important that we take steps to protect homeowners, communities, the mortgage market, and the economy from the adverse consequences of unnecessary defaults and foreclosures.

Given the high cost of foreclosures to lenders and investors and the disruption and distress that foreclosure can cause to consumers, their families, and their communities, it is in everyone's interest to avoid foreclosures whenever other viable options exist. With large numbers of borrowers facing potential repayment problems, it is in the interest of borrowers and investors alike for the industry to develop prudent loan modification programs and other assistance to help borrowers on a systematic and sustainable basis.

The American Securitization Forum (ASF) and the Hope Now Alliance have recognized this interest and have taken leading roles in streamlining the process for refinancing and modifying subprime adjustable-rate mortgages. I have been an active proponent of such streamlined systematic approaches to reduce transactions costs and to help mitigate foreclosure risk, and I strongly encourage market participants to adopt and to implement these fast-track modification proposals as quickly as possible. The efforts by ASF and Hope Now have helped accelerate loan modifications in the last quarter, according to recently released data. I applaud these efforts but more must be done as the number of households facing resets increases. Challenges remain, for example, with respect to ongoing constraints on servicing capacity to expedite work outs. Servicers must undertake the investment to overcome the capacity challenges and provide transparent and timely measures of the results.

A systematic and prudent effort to avoid unnecessary foreclosures has many benefits. Many borrowers with subprime ARMs, for example, have been able to strengthen their credit records by making timely payments so far. It would be very unfortunate if some of these borrowers faced foreclosure when their payments increased merely because servicers lacked the capacity to reach them in time with a sustainable alternative. The solid credit history would be lost and, consequently, financing options would be reduced. Loan-by-loan modifications can help some, but they require substantial time and effort. Where appropriate, an efficient, systematic approach lets servicers reach more of these borrowers and prevent more foreclosures.

Furthermore, as noted above, standards for dealing with problem loans may help make more capital available for potential borrowers. By providing more certainty to the mortgage market, clear and consistent standards can help ensure the flow of credit to potential borrowers.

While much has been done to prevent avoidable foreclosures, more still needs to be done. For our part, the Federal Reserve has been working with financial institutions and community groups around the country to address the challenges posed by problem loans. For instance, we have been providing community coalitions, counseling agencies, fellow regulators, and others with detailed analyses identifying neighborhoods at high risk of foreclosures. In addition, all twelve of the Federal Reserve Banks have also been working with an array of stakeholders to address these challenges on the local and regional levels.

There are also efforts under way on the international level to develop responses to recent financial market turmoil. I represent the Board on the Financial Stability Forum, which has established a working group to diagnose causes of recent events and make recommendations.

The Board's Proposal
I will now focus on the Board's recent proposal for stricter regulations prohibiting abusive and deceptive practices in the mortgage market under authority of the Home Ownership and Equity Protection Act (HOEPA). This proposal is intended to protect consumers and to preserve consumer choice by targeting protections to borrowers who face the most risk. The proposed regulations are designed to protect consumers from excessive layering of risk even as the practices that increase risk may change. We have sought to ensure that these standards are clear for lenders to reduce unintended consequences for consumers. Though clear, the standards are intended to be not overly prescriptive, so as to preserve access to responsible credit while amply protecting consumers. Our proposal is also comprehensive, covering most mortgage loans with certain protections and the entire subprime market with certain more specific regulations. While comprehensive, the proposal would focus protections where the risks are greatest and preserve consumers' access to responsible credit.

Our effort to produce robust, clear, and comprehensive rules was based on a rigorous analysis of available qualitative and quantitative data. We have put this proposal out for public comment until April 8 and eagerly seek suggestions to be able to craft the best possible final rule.

Comprehensive Scope
Let me say more about the comprehensive scope of this proposal. It would apply stricter regulations to higher-priced mortgage loans, which we have defined broadly. We were particularly interested in ensuring that protections remain strong over time as loan products and lending practices change. Our analysis of the data suggested that the troubles in the mortgage market generally arise not from a single practice in isolation, but instead from the complex ways that risk factors and underwriting practices can affect each other, sometimes called "risk layering." Therefore, we have proposed using a loan's annual percentage rate, or APR, to determine whether the loan is covered by stricter regulations.⁴ Because the APR is closely correlated to risk, the proposed protections would cover loans with higher risks rather than single out particular risk factors or underwriting practices.

With the APR thresholds we have proposed, we expect that the new protections would cover the entire subprime mortgage market and the riskier end of the "near prime" market, the latter also known as the "alt-A" market. Covering part of the alt-A market would anticipate possible actions by lenders to avoid restrictions on subprime loans priced near the threshold. It would also address real risks to consumers in the alt-A segment. This segment grew very rapidly, and it layered risks, such as undocumented income, on top of other risks, such as nontraditional loan structures allowing borrowers to defer paying principal and interest.

Our public hearings and our analysis identified problems not just in higher-priced loans, however, but in the broader mortgage market. Thus, our proposal addresses unfair or deceptive practices for the vast majority of mortgage loans secured by a consumer's primary home. Areas targeted this broadly include broker steering, appraisal coercion, unwarranted servicing fees, and deceptive advertising. I'll touch on broker steering toward the end of my remarks.

Robust Approach to Affordability
Extending credit that borrowers can afford to repay is a fundamental pillar of responsible lending. Across the whole range of higher-priced mortgage loans, our proposal offers three rules that, working in combination, would help ensure that borrowers can afford their payments. First is a requirement that a lender maintain responsible underwriting practices that genuinely assess borrowers' ability to repay. This general requirement would be complemented by a specific requirement to verify borrowers' income and assets. A third rule would require lenders to escrow property taxes and homeowners insurance to help borrowers meet these obligations.

This robust approach to affordability would help ensure that the subprime market promotes sustainable homeownership. Just as important, it would also help protect consumers from abuse. When the law requires that monthly payments be affordable, then consumers are less vulnerable to abusive refinancings that strip equity. When the law imposes a responsible underwriting standard on all lenders, then irresponsible actors who would strip borrowers' equity are easier to keep out of the market. Clear lending standards have the further advantages of increasing investor confidence in the mortgage market and helping to revive the flow of credit flow to consumers with shorter or weaker credit records.

Assessment of Repayment Ability
Now I want to discuss the major elements of our proposed regulations for higher-priced loans in a little more depth, starting with the requirement to assess repayment ability. The regulations would prohibit a lender from engaging in a pattern or practice of making higher-priced loans based on the value of the borrower's house rather than on the borrower's ability to repay from income, or from assets other than the house. This prohibition is intentionally broad to capture all risks to loan performance and the different ways that these risks can be layered. Moreover, the proposal avoids prescribing quantitative underwriting requirements. For example, the proposal would prohibit a pattern or practice of disregarding the ratio of applicants' income to their debt, but it does not prescribe a maximum ratio because the appropriate number depends heavily on other risk factors, which vary from loan to loan.

At the same time, the proposal does offer specifics. For example, it would create a presumption that a lender had violated the regulations if it engaged in a pattern or practice of failing to underwrite at the fully-indexed rate.⁵ This presumption is derived from the subprime guidance the agencies issued last year.

It bears emphasis, however, that our proposed regulations would be more robust and comprehensive than the guidance. The regulations would apply to all mortgage lenders, including independent mortgage companies. Guidance, in contrast, does not ensure uniformity of coverage. Moreover, the regulations would be legally enforceable by supervisory and enforcement agencies. Just as important, the regulations, unlike the guidance, would be legally enforceable by consumers. Borrowers who brought timely actions could recover statutory damages for violations, above and beyond any actual damages they suffered.

The proposed requirement to assess repayment ability is intended to protect consumers from abusive practices while maintaining their access to responsible credit. We recognize that satisfying both objectives at the same time is a challenge. The proposed rule's potential for consumer actions, coupled with its careful avoidance of prescribing quantitative underwriting thresholds, could raise compliance and litigation risk. In turn, this could raise the cost of credit for higher-risk borrowers or limit the availability of responsible credit. That is why we have proposed prohibiting a "pattern or practice" of disregarding repayment ability rather than attaching a risk of legal liability to every individual loan that does not perform. This approach is meant to preserve choices for borrowers with shorter or weaker credit records while protecting them from lenders who have a practice of disregarding repayment ability or are found to exhibit a pattern of unaffordable loans.

We anticipate vigorous comment on our proposed approach and have specifically solicited suggestions for its implementation.

Income Verification
When we looked closely at why so many borrowers had mortgages that they struggled to repay so soon after taking out the loan, the prevalence of "stated-income" lending was a clear culprit. Substantial anecdotal evidence indicates that failing to verify income invited fraud. Moreover, when we looked at the loan-level data we saw a clear correlation between "low-doc" or "no-doc" lending and performance problems, particularly early payment defaults.

That is why we have proposed to complement a broad requirement to assess repayment ability with a specific requirement to verify the income or assets a lender relies on to make a credit decision. We recognize that stated-income lending may have a proper place when not layered on top of too many other risks. Indeed, stated income lending and "no/low-doc" lending are defining features of the alt-A market, which has long served borrowers with good credit scores who seek some underwriting flexibility. We would target the verification requirement to higher-priced loans, including the higher-priced end of the alt-A market, where the risks of stated-income lending could be layered on top of too many other risks. This targeting is intended to maintain consumer access to responsible credit.

The proposal identifies standard documents that would be acceptable, such as W-2 forms. It also allows, however, any third party documents that provide reasonably reliable evidence of income. This rule is meant to preserve consumer choice by allowing the market to identify credible nontraditional documentation of consumer income--for example, check-cashing receipts. In that regard, the proposal responds to input we gathered through the HOEPA hearing I chaired last June. Several panelists spoke of the fact that some consumers may have access to only nonstandard documents and others, such as self-employed entrepreneurs, may have some difficulty documenting their income. To help ensure that the proposal preserves access to credit for the full range of consumers, we have sought public comment on this issue.

Escrows for Taxes and Insurance
Another part of our proposal for higher-priced loans--a requirement to escrow taxes and insurance--would also help ensure that borrowers can afford their payments. Escrowing has become standard practice in the prime market, and the case for making it standard in the subprime market, too, appears compelling. Consumers with shorter or weaker credit histories may be less likely to appreciate the sizable burden that taxes and insurance can add to the cost of homeownership, or more vulnerable to being misled by payment quotes that leave out these amounts. Moreover, when we looked at the data, we saw in the unusually high level of early payment defaults possible evidence that the lack of escrows hurt consumers who did not have experience paying property tax and insurance bills.

We have proposed to address the problem with a requirement to escrow taxes and insurance on higher-priced loans, accompanied by a limited allowance for opt-out. We wanted the regulations to prevent irresponsible efforts to encourage borrowers to opt out. So the rule would not permit opt-out at the closing table, but instead would require that twelve months pass before a consumer may opt out. In this respect the proposal is intended to preserve consumer choice while protecting consumers from unaffordable mortgage obligations.

Prepayment Penalties
Having discussed the rules that would promote affordability, I want to say a word about our proposed rule on prepayment penalties. These penalties can take a toll on consumers who have riskier loans, and many consumers may not even be aware their loans have a penalty. Accordingly, we have proposed a ban on prepayment penalties in circumstances of a high degree of risk to the consumer, and we are also addressing transparency concerns.

The proposed rule would ban prepayment penalties where they are most likely to prevent a consumer from refinancing a loan that has a particularly burdensome payment. Specifically, a penalty would be prohibited where the borrower's debt-to-income ratio exceeds 50 percent, and a penalty would have to expire before a loan's payment could increase. The rule would also ban prepayment penalties where they are more likely to be part of a "loan flipping" scheme--specifically, where a lender or its affiliate refinances the lender's own loan.

An approach tailored to the degree of risk to the consumer appears to us to be in the best interest of consumers overall. Banning penalties altogether could cause all borrowers, including those who do not prepay, to bear the full cost of investors' prepayment risk. That result would raise questions of fairness, and it could reduce consumer choice.

We share concerns, however, that consumers often do not knowingly choose loans with penalties. We are tackling those concerns head-on. Through rigorous consumer testing, we are developing a new disclosure for prepayment penalties to improve consumer awareness and understanding. This should empower consumers to make better informed choices and improve competition.

Steering
I have so far discussed the elements of our proposal that would seek to ensure that underwriting practices and loan terms on higher-priced loans do not present unwarranted risks to consumers. There is another potential source of risk to consumers that I want to address that is related to "steering"--the risk that when they use the services of a mortgage broker, they do not appreciate the extent to which the broker's interests may diverge from the consumer's interests because of "yield spread premiums."⁶

The growth of the market for brokerage services has no doubt increased competition in the market for mortgage loans, to the benefit of consumers. Moreover, the yield spread premium, a payment from a lender to a broker based on the loan's interest rate, is sometimes the best way for a consumer to fund the cost of a broker's services. However, when a lender pays a broker for a loan that has a higher rate, that payment can create a conflict of interest between the broker and the consumer. This conflict is problematic if the consumer does not know it exists or assumes, incorrectly, that the broker is obligated to put the consumer's interests first. In such cases, the consumer cannot protect his or her own interests, and competition for loans and for brokerage services does not work effectively.

Therefore, we have proposed to prohibit a lender, for both prime and subprime loans, from paying a broker any more than the consumer had expressly agreed that the broker would receive. This agreement must be executed up-front, before the consumer has submitted an application and become invested in closing the deal. The combination of stricter regulation and better disclosure that we are proposing should help reduce a broker's incentive to steer a consumer to a higher rate, empower consumers to shop and negotiate among brokers, and preserve consumers' option to use the services of a broker.

Better and Earlier Information for Consumers
Lastly, to protect consumers and promote competition, our proposed regulation would prohibit misleading mortgage advertising and require that consumers receive loan-specific disclosures early in the application process, when they can use the information to shop more effectively. We recognize, however, that we face a challenge in ensuring that disclosures for mortgage loans remain effective. We have begun a comprehensive program of rigorous consumer testing of potential improvements to current disclosures.

Conclusion
There are more elements of our comprehensive proposal that I do not have time today to discuss, such as a prohibition against coercing appraisers and restrictions on unwarranted servicing fees. We anticipate vigorous public comment on this proposal, and once we have carefully considered all the input we receive, we will move expeditiously to a final rule. As I noted at the outset, effective consumer protection can help to restore confidence in the mortgage markets and help to preserve the flow of capital to consumers who wish to purchase a home.

It is not too early to emphasize that the effectiveness of the final rule will depend critically on effective enforcement. The Federal Reserve will do its part to ensure compliance among the institutions it supervises. We also have been instrumental in launching a pilot project with other federal and state agencies to conduct consumer compliance reviews of non-depository lenders and other industry participants. I am sure we will be aided in these efforts by a new system for registering and tracking mortgage brokers recently launched by the Conference of State Bank Supervisors.

While we work to build effective consumer protections and enforcement regimes for future consumers, we will also continue our efforts, and encourage the initiatives many others are undertaking, to limit unnecessary foreclosures for consumers who are hurting now.

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Footnotes

1. Board staff calculation based on data from First American LoanPerformance. Return to text

2. Board staff calculation based on data from the Mortgage Bankers Association. Return to text

3. Board staff calculation based on data from First American LoanPerformance. Return to text

4. Under the proposal, a “higher-priced mortgage loan” would have an APR that exceeds the yield on comparable Treasury securities by three or more percentage points for first-lien loans, or five or more percentage points for subordinate-lien loans. Return to text

5. On an adjustable-rate mortgage, the fully-indexed rate is the sum of the value of the applicable index as of loan origination and the margin specified in the loan agreement. For example, a typical 2/28 mortgage issued in 2006 might have a fully-indexed rate of 11.37. This assumes that the mortgage was linked to the six-month LIBOR, that LIBOR was at its 2006 average value of 5.37 percent, and that the mortgage had a margin of six percentage points. Return to text

6. A “yield spread premium” is the present dollar value of the difference between the lowest interest rate the wholesale lender would have accepted on a particular transaction and the interest rate the broker actually obtained for the lender. This dollar amount is usually paid to the mortgage broker. It may also be applied to other loan-related costs, but the Board’s proposal concerns only the amount paid to the broker. Return to text

Credit Booms and Lending Standards: Evidence From The Subprime Mortgage Market

By Giovanni Dell'Ariccia , Deniz Igan , Luc Laeven

This paper studies the relationship between the recent boom and current delinquencies in the subprime mortgage market. Specifically, we analyze the extent to which this relationship can be explained by a decrease in lending standards that is unrelated to improvements in underlying economic fundamentals. We find evidence of a