Consequences of the Crisis

Assessing the Legacy of the Great Financial Tempest
   Monday: Banking   |   Tuesday: Housing   |   Weds: Wall St.   |   Thursday: The Fed   |   Friday: Consumers

Consequences of the Crisis: Housing

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Michael Calhoun
President of The Center for Responsible Lending
Tuesday, September 15, 2009; 12:00 PM

On Monday, Sept. 15, 2008, investment banking firm Lehman Brothers filed for bankruptcy protection, kicking off a week of massive shifts on Wall Street that was the beginning of the largest financial crisis in recent memory.

Michael Calhoun, president of the Center for Responsible Lending, was online Tuesday, Sept. 15 at Noon ET to discuss the effect the financial crisis has had on the housing market, the government's foreclosure prevention efforts and where troubled borrowers stand now.

How have you been affected by the downturn in the housing market? Have the government's foreclosure prevention programs helped you? We want to hear your stories.

A transcript follows.

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Mike Calhoun: Hi I'm Mike Calhoun, president of the Center for Responsible Lending, and I'm happy to be here and to answer questions about the current financial crisis and proposals for reform. Fire away.

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Rockville, Md.: Mr. Calhoun, I was just reading conservative columnist Thomas Sowell's recent book the Mortgage Boom and Bust, and while I may not have every fact exact, he says something along the lines of the following:

In the late 90s, a major study found the African-American mortgage applicants were turned down 17% of the time while whites were denied 11%, for traditional prime loans. This was widely reported in the press as "Blacks 60% more likely to be denied than whites," and became a major story about alleged lending discrimination. Largely missed was the fact that black and white borrowers (i.e. those that had been approved) had about the same delinquency and foreclosure rates, implying that they were being treated the same, everything else being equal.

The acceptance disparity, however, motivated an initiative to increase minority homeownership, with the result that blacks were now being accepted for more loans, but at higher risk. The result was that during the housing boom blacks and whites were being accepted about equally, but due to higher risk, the loan nonperformance rate became differential by race.

Was giving minorities loans they couldn't keep up worth doing?

Mike Calhoun: There have been many suggestions and assertions that a significant cause of the mortgage melt down was minority families being given loans when they could not afford to own a home. Our studies show this to be false. First, only 10% of subprime loans went to first time homeowners; 60% were refinancings of the same house, and the rest were existing homeowners moving from one house to another. Second, minority loans made up only a small part of even the subprime market. Most important, many minority borrowers were pushed into loans with much higher interest rates than they qualified for and risky terms. This generated lots of fees for the industry but caused more foreclosures. While certainly there were loans given to borrowers of all races that put borrowers in over their heads, the overall crisis was primarily a case of junk loans, not unqualified borrowers.

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Laurel, Md.: Mike, maybe this isn't the kind of question you are searching for, but it does sort of involve the mortgage crisis. My husband and I have been looking for a house to take advantage of the $8,000 credit. A lot of the homes in our price range are short sales. What is the benefit of a short sale, to either the bank or the owner of the home? To me, it seems like the bank must be losing tons of money by doing short sales; getting your short-sale contract approved takes months, a foreclosure contract approval does not take as long. How does it benefit the owner of the home to go into a short sale vs. foreclosure?

Mike Calhoun: Short sales are when house is will sell for less than the amount owed on the existing loan. A lender agrees to let the borrower sell the house at a price the lender agrees to, and the lender releases its remaining lien on the house so that the buyer gets clear title. Often, but not always, the lender will release the borrower in default from any remaining debt. (This is something borrowers facing foreclosure should check very carefully with their lender, as some borrowers still end up owing the bank a lot of money after a short sell.) The advantage to the bank is that it avoids the cost and delay of foreclosure. The advantage for the borrowers is that they avoid having a foreclosure on their credit record, and hopefully have made sure the bank will not still come after them for the remainder of the loan.

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New York: The government's efforts to stem foreclosures is clearly not working. Can't the president simply declare a foreclosure moratorium until a more effective program is developed? Thanks for the chat.

Mike Calhoun: It is clear that more needs to be done to slow the flood of preventable foreclosures. These foreclosures are depressing the housing market and are a significant drag on the overall economy. To date, all of the efforts have been attempts to entice lenders into modifying loans. Two additional effective steps, that would not cost taxpayers a cent, are: (1) require lenders to review loans for modifications and meet with borrowers BEFORE they are allowed to begin foreclosure; and (2) allow judges to modify home loans under strict limitations, just as they are able to do for all other debts (including the debt of the lenders who made these loans.) Presently, loans on primary homes can not be modified, but loans on everything else, including second homes and yachts, can be modified.

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Apopka, Fla.: What other options are there if your lender does not want to refinance your adjustable rate mortgage? Lender only wants to modify loan for one year. Does not want to re-write. Do I foreclose? Do I short sale and buy back?

Mike Calhoun: Many have asked what options are there to lower their home payments. First, the government has taken steps to lower overall interest rates, and mortgage rates are at very low levels. If you are able to refinance, this is a good time to check this out. If your house is worth less than your loan balance (you are underwater) you still may be able to refinance to a lower rate and a more stable loan. Loans that are presently insured by Fannie Mae or Freddie Mac are generally eligible for refinancing up to 125% of the current value. You will need to be able to show that you can make the new payments. Finally, you can approach your current loan servicer/lender, but this is often hard. Since loans are typically packaged into securities and sold to investors, it is often hard for borrowers to find anyone with the authority to talk to them about modifying their loan.

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Centreville, Va.: Is anything being done to discourage lawyers that advise clients to run up credit card debt before they file bankruptcy? Along those lines, the commercials for companies that will negotiate your $100,000 IRS obligation to a $5,000 settlement are sickening. This is money these people had and simply failed to provide to the IRS as their fair share. There's something about a company bragging that they can help you skirt your obligation to your fellow taxpayers that makes me want to run home and take a shower.

Mike Calhoun: The bankruptcy laws were tightened considerably in 2005, and one of the changes was to make it very hard to avoid paying for recent credit card debt. Most people file for bankruptcy because of illness and uninsured medical bills. I agree that encouraging people to avoid their debts, especially taxes, when they can afford to pay them is a problem. What usually happens with these debt settlement companies, though, is they take a big upfront fee from the consumer and then deliver little or nothing in return.

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Washington, DC: If judges could modify the principal of a mortgage loan in bankruptcy, that would cause banks to have to raise interest rates (to something more like auto, credit card or personal loans, which have higher interest rates because of the risk of loan modification in bankruptcy). Isn't it already hard enough to afford a home without forcing banks to increase mortgage rates? Essentially choosing to help people who purchased or refinanced homes in the last five years at the expense of those now renting?

Mike Calhoun: History shows that allowing judges to modify home loans, just like they have the authority to modify all other loans, would not cause an increase in interest rates on home loans. From 1978 to 1992, judges were allowed to modify home loans in much of the country, because judges differed over whether this was allowed under the bankruptcy law. This was changed in 1992 when the Supreme Court ruled they could not. During the many years when loans were modified in some areas but not in others, there was no difference in the interest rate or other terms of the loans. In addition, we faced this same type of crisis in the mid 1980s when farm land prices collapsed. Congress responded by allowing loans on farmhouses and farmland to be modified, and it helped reduce that crisis. That law remains in effect today, and farm loans are readily available. Finally, under the bankruptcy code, even if a loan is modified, the borrower has to pay the full present value of the home and a market interest rate to be eligible for the modification, and then they have to make timely payments for the next 5 years or the modification is revoked. There are lots of safeguards to make sure this would not be abused.

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Fairfax, Va.: Is law enforcement pursuing the homeowners that trash their house on the way out? This has happened several times in my neighborhood - shrubs pulled up, stairs removed, laminate flooring taken, even doors removed. This seems illegal and causes the house to sit for much longer while repairs are made, or the house is sold for an even lower amount. This seems criminal to me.

Mike Calhoun: This has been problem, though often the damage is done by salvagers or vandals. The borrower is on the hook to the bank for any damage they do to the home. Another problem has been banks abandoning homes after they foreclose on them. All of this shows why foreclosures hurt everyone, and we should try to reduce preventable foreclosures.

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New York: I heard a recent report on NPR that discussed how banks are turning down many homeowners who actually qualified for the federal mortgage relief program. In fact, a few minutes after an applicant was turned down by phone, the NPR reporter pointed out, correctly, that she should have been approved. What is being done about this problem? Thanks.

Mike Calhoun: The Treasury Department is looking at ways to improve the modification process. At minimum, borrowers should be told the detailed reasons they were denied and be given a way to correct and appeal this. Also, lenders should be required to go through the modification process before they foreclose, this would give them more incentive to get it right.

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Chantilly, Va.: Hi Mike,

My dad lost his job a year ago, and was the primary breadwinner. My sister and I have been supporting my parents since. Sis and I are both just starting respective careers, and will eventually want to buy our own houses/have families, but will be unable to afford to do so with the current level of support provided to parents. We contacted the mortgage company for a modification. They approved it, and said we should get a letter in the mail in 30-40 days. After much run around, they finally called, after 2 months, to say we were denied because the house value is not lower than the loan amount. My question: why is President Obama not addressing situations such as mine? I'm sure there are several people providing significant financial support to others. Where is our relief?

Mike Calhoun: You should look into whether you are eligible for a refinancing under the Obama plan for folks who's mortgages are guaranteed by Fannie Mae or Freddie Mac.

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Washington, DC: Regardless of the kind of loans that were applied for and approved, do you think that if lenders spent some time to explain how a mortgage works, how credit works, etc., along w/fees, then people would be better educated about the mortgage and lending process?

Mike Calhoun: Sometimes and sometimes not. The Fed just did a study using focus groups and found that even if prepayment penalties----which in most cases are merely kickbacks to brokers for steering borrowers into a more expensive mortgage than they need--are explained, consumers still didn't understand the conflict of interest the pose. Disclosure certainly helps but it's not enough. Would we say an assault is okay if the perpetrator warns the victim? No, and what amounts to financial assault shouldn't be allowed just because it was disclosed. Some products and features are just wrong----enrolling consumers automatically in high-cost debit card overdraft fee programs for example---ought not to be permitted.

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Springfield, Va.: My son and his wife purchased a home 3 years ago and made all payments except last month's on time as they were expecting their second child and the payment was late. Additionally, their mortgage was an ARM which has gone up significantly, and you know where this is going, the house is not worth as much as it was when they bought it. They took the ARM as it was the only way they could buy a home at that time. They want to do the right thing but are getting killed by the higher payments. Their mortgage company will not forfeit the late payment and say that there is nothing they can do for them as far as refinancing. What do these young people do?

Mike Calhoun: they should try to get an explanation from the lender about why they are eligible for a refinancing, and they should explore if they are or will be eligible for a loan modification to get monthly payments down to an amount they can afford.

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Princeton, N.J.: In April I received a letter from my bank, Wachovia, stating they had arbitrarily reduced the value of my house by about 50% from its 2004 appraisal. They refused to say how they came up with this number, and refused to accept an impartial appraisal. I think the sole reason was to reduce my ability to borrow more funds (this is a line of credit). It is actions like these that make people upset with the ways the TARP funds are not being used.

Mike Calhoun: Without knowing the details I can't give you specific advice, but lenders can limit credit lines for just about any reason. This is the kind of problem that the consumer financial protection agency proposed by the Obama administration would address.

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Baltimore: What is out there for people who can still afford their mortgage but do not have the 20% to refinance at a lower rate. The house bought in 2006 has lost more than 20% of its value...

Mike Calhoun: you may be eligible for a refinancing under the Obama plan. Go to www.makinghomeaffordable.gov and see.

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Fairfax County, Va.: I have negative $80,000 equity in my home. I'd like to refinance to a lower interest rate which will lower my payments. I'm still not clear on the issue where a judge can (or cannot) modify a home loan for someone who is underwater on their mortgage and their lender is unwilling to help. How do I approach a judge about this?

Mike Calhoun: Right now a bankruptcy judge can modify a mortgage on a vacation home, a commercial property or a yacht but not on a person's mortgage on his primary residence. That makes no sense. Allowing bankruptcy judges to modify these mortgages by reducing the principal to a fair market value---which is at least what the lender would get in foreclosure anyway---would help everyone. it would allow mass loan modifications quickly ---which would cut down on the spillover effect, namely the drop in price each neighboring home sees when it's next to a foreclosed property. And it's the only solution to the current foreclosure problem that wouldn't cost taxpayers a dime. But special interests blocked this provision in the Senate earlier this year but lawmakers are beginning to talk about this again because it just makes common sense.

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Fairfax, Va.: Mr. Calhoun, I am becoming increasingly frustrated that responsible consumers are being left behind while a variety of rewards are offered to people who are reckless with their finances. I would like to refinance my mortgage and lower my credit card interest rates. I have been told by the banks that because I have never missed a mortgage payment or credit card payment (over 20 years), there is nothing they can do for me. Shouldn't the finance industry be rewarding folks like me who will provide them with long-term consistent profits rather than reaching out to my neighbors who continue to spend money they don't have and simply look for new ways to do it?

Mike Calhoun: People who face foreclosure are in dire circumstances, have exhausted savings, including retirement funds, and in many cases were given an predatory loan. In most cases these folks are not being rewarded but given a chance to stay in their home at a reasonable market rate and that helps everyone, including you because every foreclosure results in a drop in surrounding property values, which in turn erodes the tax base for funding schools, hospitals etc. Keeping as many people in their homes is better for everyone.

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Bristow, Va.: Have the people that got us into this housing mess, been replaced yet?

Mike Calhoun: the Wall street and banking firms that sparked this crisis and have been bailed out by the taxpayer are still spending heaps of money to lobby against reforms that would protect consumers and taxpayers, notably the Consumer Financial Protection Agency that's pending before Congress right now

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San Rafael, Calif.: Why do lenders refuse to reduce mortgage loan principals? Isn't it better than losing a lot by foreclosing and selling at very low market prices?

Mike Calhoun: It certainly does seem perplexing, doesn't it? Some of the problem is clearly a problem with servicer capacity -- they do not have the staff and systems in place to deal with the demand. Some of the problem stems from the way that servicers receive compensation, because in many cases they make more money for themselves by foreclosing than by fixing the loan, even if that result would be better for both the homeowner and investor. In many cases, banks do not want to reflect the loss on their books now, so they will do anything to put off the loss until later, even if the ultimate recovery is lower. The proposal to permit bankruptcy judges to modify principal residence mortgages would have helped this problem significantly, but that proposal was blocked in the Senate by the banking special interest groups.

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Atlanta: There's an awful lot of attention being paid to the role of predatory lending in the crisis (think subprime loans), but the fact is that mortgage fraud (or bank robbery without a gun, if you prefer) was rampant and is one of the root causes of the meltdown. Is anybody doing anything to systemically stop this threat?

Mike Calhoun: Much of the mortgage fraud in the subprime market was perpetrated by the mortgage broker or lender rather than by the borrower. In particular, the push to sell no-documentation loans permitted brokers and lenders to sell mortgages to people who clearly could not afford them. This push came from Wall Street, which had an insatiable appetite for more risky mortgages to bundle into securities. This problem can be solved both by common-sense rules and by realigning the incentives in the mortgage market. Congress is considering both mortgage reform and the creation of a Consumer Financial Protection agency that would help prevent problems like this in the future.

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Laurel, Md.: During the housing boom, when politicians, lenders and the news media were trumpeting the news that minority homeownership had skyrocketed, a story came out (I think from your organization, but I'm not sure) that minority borrowers were more likely to be approved for loans if their broker was of their same ethnicity. Now that we know a lot of people, especially minorities, got loans that either they shouldn't have, or shouldn't have been given at the terms offered, we don't hear much about the ethnic affinity angle any more.

Where I live in Prince Georges County, affinity marketing was a significant component of minority mortgage lending. Why doesn't this angle get more discussion?

Mike Calhoun: Many lenders targeted communities of color, in some cases through "affinity" marketing. What's more, brokers were given financial incentives to steer people to loans that were more expensive than they would have qualified for. One excuse for this behavior was to open up more opportunities for homeownership, but only 10% of subprime borrowers were actually first-time homebuyers. The Obama Administration has proposed creating a Consumer Financial Protection Agency that would be able to address these practices in the future.

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Mike Calhoun: I am over the hour-long time-limit for this conversation. Thank you so much for your excellent and thought-provoking questions, and I'm sorry I did not get to answer them all. Please visit www.responsiblelending.org for more information.

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