Fed Pressured to Curtail Abusive Mortgage Practices

I am clearly showing my age. I am mystified watching both the Fed’s and the banking industry’s reluctance to tighten up on lending practices in subprime home loans.

One would think this situation would, handled correctly, represent an opportunity for bankers. They have lost share to mortgage brokers, who were more lightly regulated and appear, proportionately, to have been worse actors in the subprime market than banks. While any change it the rules would shrink the market (as would a return to common-sense lending practices), legislation could be crafted in a way to favor banks over independent mortgage brokers, who aren’t large enough in aggregate to lobby as effectively as the banking industry.

And the Fed’s hesitation to intervene is more puzzling. If they don’t intend to act, or intend only to do the bare minimum (more likely), you’d think they’d at least try to get out in front of this story and deliver whatever key messages they deem to be relevant. Instead, it seems they believe in profits uber alles but know that’s an unacceptable posture, so they’ll just hunker down and hope the industry lobbyists will keep the reformers at bay until this blows over.

But the subprime mess doesn’t appear to be going away any time soon. RealtyTrac announced a few days ago that foreclosures had spiked, and the Wall Street Journal reports other surveys are coming out with similar findings. Even the normally optimistic real estate industry sources expect the situation to worsen. And of course, the weakest borrowers are taking it on the chin:

A record number of homeowners entered the foreclosure process during the first quarter, topping the previous high set in the final quarter of 2006 and reflecting continued stress on the jittery housing market, according to a report released by the Mortgage Bankers Association.

The trade group’s chief economist, Doug Duncan, predicted that delinquencies would likely rise, peaking later in the year. He also said rising foreclosures probably wouldn’t peak until next year. “Our view is that we will probably see modest increases in delinquencies and foreclosures for the next couple of quarters,” Mr. Duncan said.

Seasonally adjusted, 0.58% of loans entered the foreclosure process last quarter, compared with 0.54% in the fourth quarter of 2006 and 0.41% in last year’s first quarter. The rates for the past two quarters are the highest in the survey’s 37-year history. The MBA reported that the spike in foreclosures was much steeper in California, Florida, Arizona and Nevada than in other areas. Mr. Duncan said some speculators are walking away from properties in the face of falling prices and higher borrowing costs.

The percentage of loans now in the foreclosure process rose to 1.28%, up from 0.98% a year earlier. That’s still well below the 1.51% recorded in the first quarter of 2002, in the wake of a brief recession.

Foreclosures were at an unusually low level at the height of the housing boom a few years ago because people who fell behind on payments generally could sell their houses for more than they owed, or could refinance into loans with easier terms. That has become far more difficult.

In a research note, economists at Goldman Sachs noted that the first-quarter data reported yesterday don’t fully reflect the effects of tighter credit, which started taking hold late in the quarter. The figures also don’t reflect the recent surge in interest rates, which will push up costs for borrowers with adjustable-rate mortgages. “So future reports are likely to show further deterioration, perhaps at a faster rate,” the Goldman report said.

One factor likely to restrain rises in the foreclosure rate, at least in the near term, is the willingness of many loan servicers — the firms responsible for collecting payments — to lower interest rates or stretch out payment schedules for some borrowers who fall behind. An April report from Credit Suisse mortgage analysts in New York forecast “an impending flood of loan modifications.” But these payment-lowering plans sometimes merely delay foreclosure rather than prevent it…

The delinquency rate on prime loans rose in the first quarter to 2.58% from 2.25% a year earlier. For subprime loans, the rate increased to 13.77% from 11.5%. Delinquency rates on prime adjustable-rate mortgages rose to 3.69% from 2.3% a year earlier. On subprime ARMs, the rate climbed to 15.75% from 12.02%.

We have noted before that the methodology used to classify subprime borrowers is badly flawed, and has the effect of considerably understating subprime delinquencies. For example, the widely touted 13-14% subprime delinquency level (as of a couple of months ago) is actually closer to 20-21%.

Now consider another factoid: if you believe Lewis Ranieri, half the subprime borrowers would have qualified for conventional loans (and Tanta at Calculated Risk, who looked into the question, didn’t find anything that would disprove Ranieri’s view). The fact that they were steered towards subprimes means they paid souped-up fees and are burdened with excessive interest rates.

But by definition, those borrowers, even if they were saddled with subprime loans, were stronger financially and hence in a better position to service the loan. But even a few of them could have gotten into trouble (job loss, medical emergency). So let’s assume that 90% of the delinquents were “natural” subprime borrowers, and 10% were prime borrowers steered into subprimes.

If we assume 50% of the subprime loans went to “natural” subprime borrowers and the overall delinquency rate is 20%, you get an effective delinquency rate of 38% among “natural” subprime borrowers, the ones who would allegedly be hurt if they were denied access to this product. And these delinquency figures are expected to get worse, perhaps considerably worse.

Given the absolute train wreck this product has been, I am amazed that anyone with an ounce of intellectual integrity can stand up and oppose reform. Oh, but I forgot. I am talking about the real estate industry.

As you can see from the article below, the reforms proposed are very tame. If the banking industry was smart, it would gamely try to defend its reputation and accept the reforms, fast, before conditions deteriorate. The longer it waits, the worse the facts on the ground will become.

From MarketWatch, “Heat on Fed to ban abusive mortgage practices“:

The heat is turning up on the Federal Reserve to ban an array of abusive mortgage lending practices that hurt consumers.

Practices for subprime borrowers such as prepayment penalties and stated income loans could be further regulated, state bank regulators said at a Thursday hearing. Such practices are at the root of problems in the subprime market, observers say.

“Market forces alone will not protect our most vulnerable homeowners,” said Mark Pearce, deputy commissioner of banks in North Carolina. “State and federal government must use the right tools at the right times to keep pace with changes in the marketplace.”

Steven Antonakes, Massachusetts’s commissioner of banks, said he would “strongly urge”the Fed to promote uniform mortgage rules across all the states.

Thursday’s hearing focused on how the Fed could address concerns about “abusive” lending practices in the mortgage market and whether it should prohibit specific “unfair” or “deceptive” mortgage and refinancing practices under authority of the Home Ownership and Equity Protection Act of 1994.

HOEPA covers higher-cost loans — typically for lower-income borrowers, or those with a blemished credit history — which have made headlines in recent months due to increasing delinquencies. The act gives the Fed real muscle, enabling it to regulate all lenders.

Americans will lose up to $164 billion in home-based wealth due to foreclosures in the subprime mortgage market, according to a study from the Center for Responsible Lending, a nonprofit research and policy organization.

Yet many financial industry participants are less than eager to have new rules dictating how lending would work.

Michael Decker, senior managing director of research and public policy with the Securities Industry and Financial Markets, testified at the hearing about the need to take a measured approach and use caution to make sure that any regulation or legislation does not hurt the ability to legitimately serve subprime borrowers.

“We oppose banning particular loan products or particular loan features, as borrowers are best served by the freedom to choose what best suits their needs,” he said.

Some consumer advocates are concerned that subprime borrowers who obtain mortgages do not fully understand all of the associated costs, and that no amount of disclosure would be enough.

Here are actions that consumer-advocacy groups support the Fed making mandatory:

Fully documenting a borrower’s ability to repay the home loan
The escrow of property taxes and hazard insurance
Verifying all sources of a borrower’s income
Getting rid of prepayment penalties

Sen. Chris Dodd, D-Conn., chairman of the banking, housing and urban affairs committee, said in a Thursday statement that the Fed has a clear duty under HOEPA to extend “substantive” protections to subprime borrowers.

“I urge the board to fulfill its duty as quickly as is reasonably possible,” he said.
On Wednesday, Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said he thinks federal agencies aren’t adequately staffed or even structured to provide consumer protection in financial services. He also said the Fed should use its consumer-protection power or lose it.

Next week the Consumer Advisory Council, which advises the board about its responsibilities under the Consumer Credit Protection Act, will meet to discuss HOEPA and other topics.

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