Bankruptcy Filings Rising Faster Than Expected
In March 2009, data from Automated Access to Court Electronic Records (AACER) report there were almost 131,000 total U.S. bankruptcy filings for a rate of 5,945 filings per business day. That is a 9.2% increase from February and a year-over-year increase of 38.1%. It also is a 17.0% increase from November 2008, just before the annual dip in filings during December and January.
Anyway you look at it, bankruptcy filings are rising dramatically. The 9% growth in March may not sound like much, but it is an annualized growth of 280%, meaning annual filings would almost triple if they grew 9% each month. The rate of increase also seems to be rising. It took us thirteen months to go from 3,000 filings per day to 4,000 and another nine months to go from 4,000 filings per day to 5,000. In March, we almost broke the 6,000 filings per day figure. If we go over 6,000 filings per day in April, as we appear poised to do, it will have taken only six months to break that new plateau.
With the March data, that gives us one calendar quarter of 2009 filings, and I am comfortable to start making some projections for the entire calendar year. In 2009, we will have:
- 1,326,000 filings if bankruptcy filings continue for the rest of the year at the same daily rate (5,303 per day) as they have averaged for the first three months of 2009
- 1,447,000 filings if bankruptcy filings continue at the same daily rate (5,9455 per day) as they have averaged for March
- 1,476,000 filings if bankruptcy filings for the remaining nine months of 2009 constitute the same proportion of total filings as the last nine months of 200 constituted for total filings that year (about 78.1%)
Those figures would represent a 22% – 32% increase in bankruptcy filings this year. My prediction of 1.4 million filings in 2009 is starting to look a little low. Indeed, if the rate of increase keeps rising, we could see 1.5 million filings, although I think a figure of 1.45 million is more likely. Of course, if the bankruptcy mortgage modification legislation passes, then filings will be much higher (easily more than 1.6 million).
The March 2009 figures have returned us almost to the level before the 2005 law became effective. When I said that the last time, a reader questioned the accuracy of the statement. The graph to the right shows the filing rate per day since 2004 (as far back as I have data). The thin red line is provided as a visual reference to compare the current filing rate to past filing rates. The spike off the top of the chart is for a data point of 31,520 filings per day in October 2005, when people rushed to file to beat the effective date of the onerous 2005 bankruptcy law.
In all the back and forth about subprime mortgages, most news reports miss a central fact: Many of the families that have subprime mortgage could have paid a mortgage with less onerous terms. For examples, some families who were sold teaser rate mortgages that escalated from 2.9% to 12.9% may be in trouble even though they could have made payments on 7.9% mortgages. Other families were told they qualified for $400,000 mortgages, which they could not manage once the introductory rates ended, but they could have managed $200,000 mortgages. Practices like yield spread premiums encouraged mortgage brokers to steer others to subprime mortgages that they couldn’t pay when their credit qualified them for prime that they could have paid. In other words, the loan product itself caused part of the problem, not just the fact that the loan was made to someone with low income or damaged credit.
Sharp businesspeople like Herb and Marion Sandler and Martin Eakes built strong companies lending money to people of modest means, many of whom had credit trouble. But they didn’t put their borrowers into loans they couldn’t afford. The whole idea behind their lending model was to put them in loans they could afford–and to keep the default rates low.
A significant part of the problem in the subprime market is not simply that too many dollars were put into the hands of working families and people with bad credit. The problem is that too many exploding products–products that were designed from the beginning to become unaffordable–were sold around the country.
The Senate Banking Committee has invited representatives from the top five subprime lending companies to “explain their lending practices in the subprime mortgage market” at a hearing scheduled for tomorrow, March 22. With all the recent focus on teaser rates and no document loans, the one-way adjustable rate mortgage (ARM) probably won’t get much attention. An analysis of the actual terms of recent ARM loans, however, shows that one-way ARMs are yet another example of how subprime lenders stack the deck against borrowers.
In its simplest form an adjustable rate mortgage is one in which the interest rate for the loan is pegged to an “index” and for which the interest rate is adjusted at set intervals (e.g., 6 months, 1 year, etc.). If the index increases, the borrower’s interest rate increases, if the index declines, the borrower’s interest rate goes down. The floating rate structure of the ARM allows lenders and borrowers to share the interest rate risk. In exchange for assuming some of this risk, borrowers generally receive lower initial interest rates. This economic reward for risk-sharing is the justification for ARM loans–at least in theory.
In practice, the one-way ARM, which is ubiquitous in the subprime market, only adjusts upwards from the initial rate. By the terms of the note the interest rate can never drop below the initial rate even if the index goes down. As a result, borrowers, not Wall Street, bear the brunt of any interest rate volatility.
Preliminary data from an empirical project (funded by the National Conference of Bankruptcy Judge’s Endowment for Education) that I am currently working on with Professor Katie Porter confirms the widespread use of one-way ARMs among homeowners in bankrutpcy. As part of the project, which looks at the intersection of bankruptcy and homeownership, we coded information about debtors’ notes and mortgages when such loan information was available. Among ARM loans in the sample-to-date, more than 85% of these loans put no risk of interest rate change on the lender because the initial interest rate and the floor interest rate (the lowest rate permitted by the note) were identicial.
Some have likened ARMs to a gamble: the borrower wins if interest rates go down and loses if the interest rates go up. The realities of recent subprime lending practices show that Wall Street is like every winning gambling house—it is has effectively stacked the deck so that the house always wins. With one-way ARMs, consumers don’t get a fair deal, no matter how you cut the deck.
Wall Street is watching closely to see what, if any, “ripple effect” the problems in the subprime market will have on other credit markets. It is also watching to see what effect the market meltdown will have on subprime servicing. Financial troubles, staff layoffs and potentially higher servicing costs on defaulting loans have led to concerns that servicing quality may decline.
SUBPRIME SERVICING QUALITY MAY DECLINE!! This is really bad news for homeowners in bankruptcy where mortgage loan servicing is already abysmal. Of course, according to servicers and their attorneys it’s not really their fault. It’s those darn pesky computers that keep giving them incorrect information.
We’re all watching the subprime mortgage meltdown and the ancillary predictions about whether it will drag the economy directly into a recession. But I’m losing sleep over a very different concern: What if there’s no recession because the rating agencies don’t tell the truth?
The emblem of the subprime mortgage meltdown has been Liar’s Loans–high-interest mortgage loans for which the borrowers could fill in any numbers, and the mortgage companies wouldn’t check. In other words, bad information. Now, from Gretchen Morgenson at the New York Times, comes a paragraph that makes me wonder if Liar’s Ratings are coming next:
Nevertheless, some investors wonder whether the rating agencies have the stomach to downgrade these securities because of the selling stampede that would follow. Many mortgage buyers cannot hold securities that are rated below investment grade — insurance companies are an example. So if the securities were downgraded, forced selling would ensue, further pressuring an already beleaguered market.
I get the part about the stampede, but I’m enough of a market purist to believe that when quality fails, the rating agencies MUST downgrade. If they do not, then ratings are not giving a genuine mark of the quality of securities. At that point, all confidence in the American markets will dissolve.
The Center for American progress has released a new report addressing the policy consequences of the rising foreclosure rate. From Boom to Bust: Helping Families Prepare for the Rise in Subprime Mortgage Foreclosures is written by CAP analyst Almas Sayeed and is certainly timely in light of recently released figures showing that more than 1.2 million foreclosure cases were filed in 2006. Of course, not all of these foreclosure filings caused families to lose their houses, and the theme of the CAP’s Boom to Bust report is that there is still time to implement public policies at the state and federal level to help families who are dealing with unaffordable mortgages. The report provides a helpful survey of different state-level foreclosure rescue programs. Many of us working on bankruptcy, including bankruptcy practitioners who often file homeowners in Chapter 13 cases, would be well served to know more about these programs and consider them as alternatives for clients facing foreclosure.
This report makes a nice segue for me to let Credit Slips readers know that next week’s guest blogger will be Tara Twomey, a current adjunct at Stanford Law and former clinical instructor at Harvard Law School. Tara is in the thick of BAPCPA case law as a consultant to NACBA and the NCLC but her interest in bankruptcy grew out of years of representing clients facing foreclosure. She’s an expert on consumer real estate lending, and I hope that she’ll share some of her foreclosure-defense expertise with Credit Slips.
I’m celebrating the close of data collection in my current empirical project, which studies the intersection of homeownership and bankruptcy. With funding from the National Conference of Bankruptcy Judge’s Endowment for Education, my co-investigator, Tara Twomey, and I have data on more than 1500 Chapter 13 bankruptcy cases filed by homeowners in 2006. The particular twist of this project is its focus on examining the mortgagees’ proofs of claims and that actual loan documents. Most past research on consumer bankruptcy has focused on the debtor’s schedules.
Part of our inquiry is the accuracy of mortgagees’ proofs of claim, including what types of supporting documentation are attached to the claim form as required by Rule 3001 and whether arrearage amounts are detailed. This element of the project took its inspiration from the multiple recent judicial decisions in which bankruptcy judges express consternation and even anger at mortgage companies’ inability to explain the amounts requested on proofs of claims. If you haven’t seen this line of cases, here are a few very recent examples: In re Allen (Bankr. S.D.Tx. 1/9/07) and In re Sanders (Bankr. D. Mass. 1/23/07).
As the project moves forward and we finish coding and cleaning the data, I’ll post some of our findings. In the meantime, I’d love to hear from CreditSlips readers on either side of the aisle, so to speak. What is the extent of documentation/detail required by Rule 3001 in your district? How do those who represent mortgage lenders/servicers prepare their proofs of claims and document the amount owing? What are the difficulties that they face in getting accurate information about the loan? For debtors’ attorneys, how frequently do you object to mortgagee proofs of claims? What is your internal process, if any, for verifying or having debtors verify the mortgagees’ proof of claim?
From an editorial that urged Congress to focus on the 90% of subprime loans that aren’t currently in serious default to a how-to foreclosure sale primer aimed at potential buyers, The Wall Street Journal could have masqueraded as the Mortgage Bankers Association newsletter last week. The most interesting piece was the front-page announcement that HSBC underestimated by $1.76 billion the amount that it needs to set aside to cover bad debts, including subprime mortgages gone awry. The article was titled Faulty Assumptions, and contained an acknowledgement by HSBC that “FICO scores are less effective or ineffective” in assessing the risk in subprime loans in a low-interest rate environment. If HSBC (and its predecessor on these loans, Household Financial) can’t figure out whether buyers can repay non-traditional or subprime loans with a team of 150 PhDs on the task and incredibly sophisticated models at their disposal, how is the subprime borrower supposed to decide if buying the home is a good risk for their individual family? The 2003 Fannie Mae National Housing Study reported that 59% of the population believes that housing lenders are required to give borrowers the best possible rates on loans; I’m betting that an equally large percentage of consumers relies on their broker’s or banker’s assessment of how much they can ‘afford’ to borrow or their suggestions of a particular financing arrangement. The misestimation about the risks of subprime loans is bad news for HSBC shareholders who may lose their shirts on the stock. The real pain of such mistakes will fall on HSBC subprime customers who will lose their homes. Unlike HSBC shareholders, such individuals can’t easily hedge the risk of homeownership.
Imagine if instead of the warnings on cigarette packages, tobacco companies were required to insert a small pamphlet containing facts and figures about smoking. It would be written in plain English, but the information could still be primarily technical. It would encourage purchasers to ask themselves questions like, “Is smoking the right choice for you?”
That is what the Federal Reserve has done in its recent update to its Consumer Handbook on Adjustable-Rate Mortgages. The new handbook includes many welcome warnings about the risks of ARMs. It cautions consumers that their mortgage payments may increase dramatically, that most brokers are not required to find them the best deal, that interest-rate caps do not provide complete protection from rate increases, that pre-payment penalties can prevent them from refinancing or selling their homes, and that minimum payment plans can result in consumers owing more money than they originally borrowed.
But simply providing the right information is not enough. The handbook needs to warn consumers that taking out adjustable-rate mortgages they cannot afford could lead to them losing their homes. (Not once does the handbook mention the f-word, foreclosure.) And it needs to drive that message home in such a way that consumers will grasp the message on a psychological level. It needs to do the equivalent of the thetruth.com ad I saw on TV this weekend where a “singing cowboy” “sings” “you don’t always die from tobacco” through a hole in his throat.
More on Ownit (cf. last night’s post), from a former student who knows this stuff far more intimately than I do (though not directly involved in the Ownit BK, I am advised):
These days, what happens is that the lender makes a loan, packages with a lot of other loans and sells the package to Wall Street. But, the sale has a put back for “EPDs” (early payment defaults) and “FPDs” (first payment defaults). All the sub prime lenders are getting squeezed because what Wall Street will pay them for the loans isn’t enough over what it cost them to book the loan (competition is fierce). Then they get hit with their repurchase obligations and they are all losing money big time. Sometimes its bad underwriting but often it is just plain old garden variety fraud by brokers, sponsors, appraisers and/or borrowers. Going to take some time before the industry can right itself. As for the borrowers, when the mortgage company sell the loans the servicing rights (which are worth a lot of money) are transferred to a different, often unrelated, entity. I would suspect that the Ownit borrowers will see no interruption in receipt of that monthly payment statement.
My correspondent calls attention to a hobbyhorse of mine: who owns the assigned intangibles? While I admit it can get dicy in detail, I’ve always harped on the point that the “owner” is the one who bears the risk of decline in value. The point can be critical in a bankruptcy, on the issue of who owns the incoming payment stream–does the trustee get it for distribution pro rata, or do the individual components go to individual assignees? Cf. Bear v. CoBen, 829 F.2d 705 (9th Cir. 1986), All these “putbacks” seem to make a pretty clear case that the loss remains with the transferor Ownit (i.e., or his trustee) in this case. Congress may have mooted the point by all those special-interest rules for securitizations: perhaps I should hop on a plane and pop over to Washington, so I can listen to Douglas Baird’s presentation at the AALS tomorrow.
“I’m tired of worry about my debts,” goes the old story, “now you worry about them.”
In trying to understand the plight of borrowers in any prospective subprime lender meltdown, we may have failed to focus on the fact that for every unpaid loan, there is an unpaid lender. Evidence of this point comes from the apparent collapse of Ownit Mortgage Solutions Inc. which filed for Chapter 11 in Van Nuys last Friday. The LA Times says:
Ownit grew rapidly over the last few years, becoming a top 20 lender nationally in the sub-prime niche, but the closely held company turned unprofitable as interest rates and homes prices rose and competition for a shrinking customer base intensified.
Interest rates? Competition? I wonder if somebody got spun here. Much deeper in the story, the reporter adds that “by far the biggest portion of the debt resulted from soured mortgages,” which sounds to me like “we made a lot of lunatic loans that we never should have made in the first place.”
In any event, is fascinating to speculate on what, if anything will be the implications of a failure like this for the harassed borrower. It used to be that for the debtor, news of your lender’s bankruptcy was the best you could hope for: you’d be dealing with a trustee with a limited warchest; records would get misplaced or simply forgotten; and in any event, during a general unravelling, the last thing the creditor wanted was to take the property back.
I haven’t any idea whether this is what is happening here; it may be a different story altogether, or it may be that I am just fighting the last war –our mantra these days seems to be that securitization has rewritten the rule book, and this may be the place where we find out what the new rules look like.
Paranoid further thought: now I am really getting beyond myself, but bear with me. Deep in the story, we are also told that, in addition to sour mortgages, “glitches in recording payments and other technical problems also played a role.” Hello, technical problems? Glitches? Glitches? I am old enough to remember any number of mortgage-lender meltdowns that came unmasked as outright Ponzi schemes, riven with fraud from top to bottom. Yes, yes, I am getting way beyond the evidence here, but I am wondering if this might turn out to be a case that only a lawyer could love.
I feel the urge to showcase a `couple of blogs that may not have surfaced so far on the radar of CreditSlips readers.
I mostly bypass the specialized bankruptcy blogs: there are so many and it is kind of like counting bees—you never know which ones you have already counted.. Most readers will have their own views on specific items among the proliferation of commercial marketing blogs created by law firms and others, many of which are mediocre and some of which are butt awful. One difficulty that particularly seems to affect the good ones is that the proprietors seem to be discovering that it is a lot of work. Thus the ABI BAPCPA blog started strong but hasn’t surfaced a new post October. The same fate may be overtaking the Bankruptcy Litigation Blog, or maybe he is just taking a long holiday. One apparent survivor that perhaps does deserve mention is The Bankruptcy Lawyers Blog (no apostrophe?), if only because it succeeded in getting the phrase “Illinois … Professor” into the headline of two separate posts, for two separate professors (Lawless and Tabb). BLB does mostly consumer BAPCPA. For business BK, there is straightforward stuff at In the (Red).
But further afield–how many readers have ventured far enough afield to find The Housing Bubble Blog? As one who has lived through nine of the last four recessions, I find it riveting: of course if the market ever does turn up, these guys will be perhaps the last to know. Absolutely do not overlook the slide show.
Or, if that isn’t enough, allow me to introduce The Payday Loan Industry Watch—not quite a blog, but they’ve got an RSS news feed and Podcasts, along with a direct link for your payday borrowing needs. And finally, if none of this provides life in tooth and claw, try I Am Facing Foreclosure (good news: his Bible reading is up to 138 chapters, but no word on whether this includes Chapter 11).
Two numbers summarize US consumer protection policies for financial products: 1) The SEC is considering a modification of a rule so that hedge funds cannot sell their high-risk investment devices to 98.7% of all Americans. 2) An estimated one in five recent subprime home mortgage borrowers will lose their homes. There it is: When you might lose your investment in stocks, the SEC imposes suitability rules that prevent brokers from selling high-risk products to all but the most sophisticated investors. But when you could lose your home in a refinancing, federal regulatory agencies have largely left consumer to the wolves.
Investors get protection because the government decided a long time ago that there would be more confidence in the market if the repeat players (the brokers) bore some obligations to their customers not to steer them to high risk investments. Over time, the market has evidently agreed and regulations to protect consumer investors have been strengthened. But high risk mortgages reflect the opposite mindset. The home is the largest single investment the typical middle class family will ever make, but it’s “buyer beware” in the subprime mortgage market.
Undoubtedly, any debate over a predatory lending bill in Congress will have to address the question: who should bear the costs of abusive lending? Right now, borrowers, their neighbors and their towns bear most of these costs. In contrast, the secondary market, which finances abusive loans through securitization, successfully insulates investors from most of the risks of predatory lending. This imbalance needs to change.
There are a number of rationales for imposing assignee liability on the trusts that hold securitized predatory loans. We mention a few here. It costs less for trusts and investment banks — as part of securitizations — to screen loans for predatory terms than it collectively costs borrowers to hire attorneys to review their loan transactions. One study by the Center for Responsible Lending (see http://www.responsiblelending.org) estimated that automated review of loan files cost less than one dollar per file and manual review cost $43, or about three percent of origination costs.
Last year marked the tenth anniversary of Freddie Mac’s Loan Prospector, the first statistically-based automated underwriting (AU) system for home mortgages. Shortly after Loan Prospector made its debut, Fannie Mae rolled out its own AU system, Desktop Underwriter. By 2002, about two-thirds of all home mortgages were originated through Loan Prospector, Desktop Underwriter, or proprietary AU systems.
Automated underwriting has many benefits, not the least of which is faster loan decisions and lower origination costs. Loan Prospector and Desktop Underwriter have also spurred greater flexibility in mortgage terms and underwriting standards. Previously, under manual underwriting, any major negative often resulted in a “knock-out,” regardless of the applicant’s other strengths. In contrast, the GSEs’ AU systems weight negative and compensating factors for risk and then offset the negative factors with the compensating factors as appropriate. The resulting flexibility has been especially important for minorities and lower-income borrowers, many of whom could not qualify for home loans under older, stricter manual underwriting standards.
Since last year, reporters and researchers have been publishing reports on the new Home Mortgage Disclosure Act (HMDA) pricing data that find that blacks and Hispanics pay more than whites for subprime home loans. Industry dismisses these reports because the findings do not establish causation. While this is a legitimate criticism, the real problem is the mortgage industry’s refusal to provide — and the government’s refusal to require — the reporting of credit score data that would permit more nuanced analyses, including whether race, credit risk, or something else drives the observed differences in the price that people of color pay for mortgage loans.
Why don’t lenders want to make credit score data available? We asked a representative from a reputable lender that question and his response was, “Why don’t I just lie down in the middle of the road and make it easier for you?” He was concerned that the data would open the door to fair lending lawsuits, which, as he rightly pointed out, have to be defended even if the lawsuits are not substantiated. In addition, he expressed concern about borrowers’ privacy. Arguably, it would be possible to identify property using HMDA data and then learn the borrowers’ credit scores.
With last month’s elections and the Democrats’ upcoming control in Congress, predatory home mortgages are back in the spotlight. Congressman Barney Frank, the incoming chair of the House Financial Services Committee, has made clear that a federal anti-predatory lending law is high on his agenda, and industry representatives and consumer activists are scurrying to draft bills. Given the recent attention on the Hill, we decided to devote our guest entries this week to residential mortgages. Our heartfelt thanks go to Bob Lawless and his colleagues at Credit Slips for inviting us to make a guest appearance.
Today, we focus on a persistent myth: that if subprime customers just comparison-shopped, they would not end up with predatory loans. In our humble view, no matter how smart customers are, it is impossible – totally impossible – for them to engage in informed comparison-shopping in the subprime market. Policymakers have a hard time grasping this fact because it is so easy to comparison-shop in the prime market. However, price revelation works differently in the subprime market, making meaningful comparison-shopping impossible.
The Mortgage Bankers Association recently released its semi-annual survey on home loan originations. The press release reports that interest-only loans and payment-option loans continue to grow. In the first half of this year, 26% of all mortgage loan originations (based on dollar volume) were interest-only loans. Another 15% of dollar volume were “payment-option” adjustable-rate loans.
The Mortgage Bankers Association press release refers to these loans as “so-called ‘non-traditional’ products. Others have labeled them “exotic” mortgages. It strikes me that these labels minimize the extent to which these loans dominate today’s home lending economy. Interest-only and payment-option loans are too common to be marginalized as “exotic,” and given the increasing frequency of these loans in recent years, American homebuyers have arguably already created new traditions. Perhaps we should label them what they are–risky. Terminology matters to consumer perception. Consider the trend toward renaming no-documentation mortgages. Originally called “NINA loans” (nice, friendly-sounding acronym for no-income/no-asset), they are now often mocked as “liar’s loans” (making clear the potential for deception).
Federal regulators recently released a report about interest-only and payment-option mortgages, querying consumers “Are they for you?” The brochure offers three examples of consumers who may benefit from an interest-only or payment-option home loan: people who are certain their income will increase (about to graduate from law school, perhaps?); people who have substantial equity in their house and will invest elsewhere the money that they would put toward principal payments; and people who have irregular income (such as commissions) and want flexibility in making their payments. Frankly, I’m not sure about the wisdom of these risky home loans even if you fall into these categories. I do know that the population falling into these categories is not nearly big enough to account for the 2006 originations.
Mark Whitehouse reports in this Monday’s Wall Street Journal about the rising number of defaulting homeowners hitting the skids as those once-darling floating rate/interest-only loans start to rise (the current lull by the Fed notwithstanding). What’s the silver lining? Why the propitious news for derivatives traders who have gobbled up new contracts that hedge against sub-prime mortgage defaults! Yes, that’s right, the good news is you can make a buck on the foreclose of that guy down the street. I guess at least someone’s figured out how to bet on the Don’t Come Line in the crapshoot of life.
Per our running discussion of mortgage credit, the Federal Reserve and others have just released “Interest-Only Mortgage Payments and Payment-Option ARMs — Are They For You? . . .
The Denver Post just published a fourth article in its well-researched series on foreclosures in Colorado. The articles focus on the extreme conditions in Colorado – the state with the highest foreclosure rate in the nation – but many of its themes apply across the across the county. The series tells of recently-built neighborhoods in which one-fourth of the homes have been foreclosed. It discusses the increasing proportion of interest-only and adjustable-rate mortgages, which account for an astonishing 43.6 percent of mortgages in Colorado. The national rate of 26.7 percent may seem small in comparison, but it too has skyrocketed in recent years. (In 2001, fewer than 2 percent of home loans were interest-only mortgages. Adjustable-rate mortgages accounted for about 14 percent of the market as recently as 2003.)
The Post also did some original empirical research of its own, and the results suggest that the state’s rates of foreclosures and its rates of high-risk mortgages are not unrelated. The newspaper studied all the foreclosure notices filed this August in three Colorado counties which have been particularly hard hit by the foreclosure boom. Of the nearly 1,000 notices it examined, it found that, when excluding mortgages based on certain federally insured loans that require a small down payment, over seventy percent of the underlying loans were no-money-down. This means that the families became homeowners with no equity in their homes.
This series also tells a Colorado version of a story that has been documented nationally by the Consumer Bankruptcy Project. The families in the Post articles take on mortgages with payments that are barely affordable when times are good. When something goes wrong, these families are forced into foreclosure. Here that “something” ranges from divorce to surgery following a car accident to pay cuts to neighborhood covenants that required the new owner to landscape the property. The Post’s research comports with the Consumer Bankruptcy Projects national findings in one other key respect. Although a negative life event may be the immediate catalyst that sends a family into crisis, it is the family’s underlying financial structure – too much debt, too few assets (in this case, home equity) – that leaves it so vulnerable in the first place. As the reporters wrote in the most recent article in the series: “In interviews with dozens of homeowners in foreclosure, The Post found that life events such as job loss, medical problems and divorce often precipitate a default. But lack of equity, which gives homeowners options when they face financial problems, was a factor in nearly all cases.”
Professor Mann’s proposed study is, as usual, interesting and thought-provoking. (I confess to finding it somewhat exhibitionist to engage in a public dialogue with a colleague, awkwardly having to use the third person, but I guess that what a “blog” is all about.) In any event, what I would counsel Professor Mann to consider as he pursues this project is the role of denial in the psychology of distressed debtors. While his study is not designed to gather this sort of data specifically — that is more the domain of co-blogger Professor Thorne — it occurs that readers of this blog might have helpful anecdotal data to share with Professor Mann regarding his intuition that a bankruptcy filing comes in response to external legal prompting, and my related intuition that that passivity in turn stems from a denial of the seriousness of the debtor’s affairs until objective forces conspire to make such denial no longer tenable.
In today’s New York Times, Vikas Bajaj and David Leonhardt offered a creative explanation for how home sales could be slowing and inventories building while home prices continued to nudge upwards: incentives. They report that in a weakening market sellers are giving rebates on prices, either in goods, services or outright cash. In other words, the records may show that the house sold for $350,000, but the effective price was $343,000.
The reasons for this ruse are partly psychological (individual sellers who think: “I don’t want to lower the price!”) and partly economic (builders who think: “I don’t want the people who already signed contracts for homes in this subdivision to know that the new guys can get in for lower prices.”)
Back in the day (say, 1972) when the median first-time home buyer coughed up an 18% downpayment, a few bucks of incentives probably wouldn’t have mattered. But with the median first time homebuyer today making a ZERO down payment, a little rebate means the mortgage starts out in the red. Bajaj and Leonhardt note at the end of the article that the mortgage companies try to police the rebates, but c’mon, does anyone think that really happens? Besides, by keeping the prices high, the comparables stay high as well, giving everyone an inflated appraisal on which to base that 100% financing.
Here’s one more little piece of evidence why everyone on this list should be selling their mortgage-backed securities (if anyone on this list ever had any mortgage-backed securities): The valuation numbers are phony. Maybe just a little phony in this case, but at 100% financing, a even a little bit phony is going to come out of the investor’s hide.
As housing values continue to deflate, those of us who teach mortgage foreclosure law will have many attentive students.
An earlier post by co-blogger Melissa Jacoby (Turning Stucco Into Sand) commented on homeowners who file bankruptcy. That demographic seems likely to grow in light of rising interest rates and falling home prices. New mortgage products, including interest-only loans and adjustable rate mortgages in which the initial rate is the floor, leave consumers bearing all the risk of these market fluctuations. Higher loan to value ratios are positively correlated with foreclosure, and yet today’s first-time home-buyers put down only 3 percent when they purchase a house.
What do these trends mean for financial advisers, educators, advocates, and even parents who are concerned with ensuring financial success and security for today’s young people? While more research is certainly needed, an article in USA Today offers one possible answer—rent! (“For Some, Renting Makes More Sense”, 1A, Aug. 10, 2006) The traditional advice to buy a home as soon as possible and stop “throwing away money on rent” may need to yield to the costs and risks of modern mortgages. The USA Today article examines the gap between the median mortgage payment and the median rent in several housing markets. It finds that many consumers would have a couple of thousand extra dollars each month if they rented. The national gap between mortgage payment and rent was calculated at $816 monthly. If families put this money into tax-advantaged retirement programs or into an emergency fund would they be better protected from financial failure? Is a home no longer the best way to achieve financial security? Does the government do too much to promote homeownership at the expense of urging and enabling families to save for retirement, purchase insurance, or save?
By the way, the Wall Street Journal had an interesting piece on Tuesday on NINA mortgages (no income/no asset verification) loans and some of the “red flags” created by that lending product. (‘Stated Income’ Home Mortgages Raise Red Flags, Wall Street Journal, D2, August 22, 2006).
I once received a pink flyer from a major bank that said in bold letters “Turn your stucco into sand,” while the inside of the flyer advertised home equity loans for purposes of taking beach vacations. This was supposed to be an enticement, but with this stucco-into-sand imagery, it seemed more like a warning about the consequences of using home equity, leaving people to make their own choices. I’m starting to wonder whether the bankruptcy system needs a similar warning. First, studies by Cheryl Long and Aparna Mathur suggest that there generally are longer-term home-owning consequences to filing for bankruptcy. Second, some homeowners file for bankruptcy primarily to save their homes from foreclosure — presumably because their lenders/servicers will not agree to a workout with a borrower they believe cannot or will not sustain the mortgage, but possibly for other reasons. These filers use chapter 13 bankruptcy, which not only stops a foreclosure but allows them to cure a default over time over the objection of the lender/servicer. The administrative costs alone of chapter 13 to the homeowner probably add up to at least one or two mortgage payments, or, if homeownership is not to be, then a few months of rent in a new home. But I’ve seen no evidence that chapter 13 turns out to save homes in the long term, or that it is any more successful than other anti-foreclosure interventions. We’ll get help figuring this out once real estate finance experts recognize chapter 13 for what it is – a federal mortgagor protection device, albeit of unknown efficacy, that overrides many of the state real estate laws they have spent considerable time analyzing.
The NYT ran a story that connects two dots—the housing bust and a slowing economy. Because housing has been a big employer, as new home construction comes a standstill, the effects will reverberate through the economy. Thus comes the answer to a question I’ve heard many times: So long as I’m not strung out on some crazy mortgage, why should I care if the housing market implodes? Because it affects the whole economy.
Now let’s add a third dot to the picture—the impact of an effectively unregulated home mortgage market. Over the past five years, lenders have sold billions of dollars of mortgages that are designed to go into eventual default because the borrowers cannot possibly afford to pay them. These so-called “creative mortgage products” have two powerful effects: They fueled the boom, pouring more money into an overheated housing market. Now they will accelerate the bust, pushing more people out of their homes through distressed sales, thereby accelerating price collapses on the way down. In other words, a housing bust doesn’t just happen. Regulators who won’t regulate have an effect as well.
Note the irony: Much of the middle class takes the hit either way. When the housing market exploded, houses became unaffordable in many cities. Last week we talked about firefighters and teachers who cannot afford to live in many cities. (“Great news—get a second job,” said a federal reserve economist.) Families took on terrible risks to try to get a home before they were completely closed out.
Now Vikas Babjas and David Leonhardt describe who will be hurt most by the housing implosion: people who work in the real estate industry. “On average, real-estate jobs pay somewhat less — about 7 percent less a year on average — than those in other parts of the economy. But real estate has also been one of the only industries creating good jobs for workers without college degrees in recent years, especially in construction and contracting work.” A big chunk of the middle class crumbles away.
Housing prices rise and fall for many reasons. The effects of interest rates are widely appreciated, but mortgage rules—or lack of rules—play an important part too. A boom and bust in housing may be hard to avert, but better regulation of home mortgage would have moderated the rise in housing prices as well as the subsequent contraction in the economy when housing cools off.
Regulation has become a dirty word, but many middle class people will pay a steep price for poor oversight of mortgage lending.
The New York Times ran a front page story yesterday about re-refinancing. Families now facing the end of the teaser rates on their adjustable-rate mortgages can’t make the payments when the rates re-adjust, so they are taking out another adjustable rate mortgage—with another teaser rate. They stay alive for another two years. And what happens when that one comes due? Evidently they are following the Scarlet O’Hara plan to worry about that tomorrow.
The obvious problem is that if housing prices level out, these families will have no options at all. No more teaser rates because the value of the home won’t back up the mortgage. They will have rented homes for two years or four years that they could not afford, and they will lose everything they invested and more. If the amount owed on the home is more than the outstanding loan balance when the music stops, the homeowner will face bad credit ratings and bankruptcy.
The Times article does not emphasize how expensive this re-refinancing is. Closing costs and fees all get lumped back in to increase the outstanding balance. Keep in mind that these buyers couldn’t make market-based payments on the old, lower balance. The odds of making those payments on the new, higher balance are worse than those in any Las Vegas gambling parlor.
In the industry, these mortgages are called 2/28s. The numbers refer to the teaser period (the 2) and the real payout period with the higher-than-market interest rates (the 28). How can the “2” be profitable for the lender, if the debtor re-fi’s the loan without paying the high 28 period? Many of these loans carry a pre-payment penalty, along with up-front fees and closing costs that make them instantly profitable. Even if the debtor refi’s immediately, the amount paid off includes all these costs, making the effective interest rate for the “2” ten or twenty times higher than the stated interest rate. In the 2/28 game, the lender nearly always wins.
Could re-refinancing be the knife that will cleave what is left of the middle class? There will be those who have fixed-rate mortgages, who pay off their homes, and who have something for retirement or savings if a catastrophe hits. And then there will be those who live in houses, paying high rent, always vulnerable to rate hikes, flat real estate markets, job layoffs, etc. That last group will nominally be called “homeowners” just like the first, but they won’t really be. They will play the 2/28 game until they go bust.