REFinBlog

Editor: David Reiss
Brooklyn Law School

July 28, 2016

Freddie and Fannie Nightmare Scenario

By David Reiss

male and female zombies

For a number of years, I have warned of the increased operational risk that results from leaving Fannie Mae and Freddie Mac in the limbo of their conservatorships. “Operational risk” refers to risks that a company faces from things like poor procedures, systems, policies and employee supervision.

The Inspector General of the Federal Housing Finance Agency has released three reports that address aspects of Fannie and Freddie’s operational risk (along with that of the Federal Home Loan Bank System). The three reports are:

The last of the three reports notes,

As the regulator of Fannie Mae and Freddie Mac (collectively, the Enterprises) and of the Federal Home Loan Banks (FHLBanks), the Federal Housing Finance Agency (FHFA) is tasked by statute to ensure that these entities operate safely and soundly so that they serve as a reliable source of liquidity and funding for housing finance and community investment. Examinations of its regulated entities are fundamental to FHFA’s supervisory mission.

FHFA has directed its Division of Enterprise Regulation (DER) to conduct supervisory activities of the Enterprises and its Division of Federal Home Loan Bank Regulation (DBR) to conduct these activities for the FHLBanks. When DER or DBR identifies a deficiency, it will classify the deficiency as a Matter Requiring Attention (MRA), a violation, or a recommendation. According to FHFA, MRAs are “the most serious supervisory matters.” FHFA requires the regulated entities to promptly remediate MRAs. Examiners are required to “check and document” the progress of MRA remediation.

In FHFA Office of Inspector General’s (OIG) 2016 Audit and Evaluation Plan, we explained our intent to focus our resources on programs and operations that pose the greatest financial, governance, and reputational risk to FHFA, the Enterprises, and the FHLBanks. One of the four areas we identified was FHFA’s rigor in its supervision of the Enterprises and the FHLBanks. According to FHFA, a key component of effective supervision is close oversight of efforts by an entity it regulates to correct identified supervisory concerns. This evaluation is one in a series of OIG reports that assess the robustness of FHFA’s policies, procedures, and practices governing its oversight of remediation of supervisory concerns by a regulated entity.

In this evaluation, we compared the MRA tracking systems used by two federal financial regulators and DBR to those used by the DER Fannie Mae and Freddie Mac examination teams. We found substantial weaknesses in DER’s tracking systems that limit significantly the utility of those systems as a tool to monitor the Enterprises’ efforts to remediate deficiencies giving rise to MRAs. We also reviewed a sample of open and closed MRAs issued to each Enterprise by DER to assess whether DER examiners performed independent assessments of the timeliness and adequacy of each Enterprise’s efforts to remediate the MRA. Our review found a lack of consistent independent analysis by DER examiners of the timeliness and adequacy of each Enterprise’s remedial efforts. (2)

My nightmare scenario is that Fannie and Freddie operations have slowly degraded as they have been left to linger in the limbo of conservatorship. This kind of degradation is not really observable from the outside and its effects are not known until something really bad happens. Maybe their hedging strategy is poorly designed, maybe their underwriting is allowed to become outdated, maybe too many employees lose their drive.

Eight years of conservatorship can do that to a company. When it happens, you can be sure that members of Congress will blame a whole host of people for this failure. But the blame will sit with Congress. Because Democrats and Republicans cannot come up with a reasonable compromise, we are left with two zombie organizations dominating our housing finance system.

Hopefully, I am wrong about this. Or maybe I am right about it but we dodge the bullet by some stroke of luck. But the longer we leave the two companies in this state, the more likely it is that things go bad and the taxpayer is left holding the bag once again.

 

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July 28, 2016 | Permalink | No Comments

July 27, 2016

Regulating Small Lenders

By David Reiss

photo by Doug Kerr

The Consumer Financial Protection Bureau is often subject to a lot of criticism for imposing a heavy regulatory burden on small community banks and credit unions (together, community lenders). A recent Government Accountability Office report, Community Lenders Remain Active under New Rules, but CFPB Needs More Complete Plans for Reviewing Rules, undermines that critique.

The GAO did this report at the request of Representative Hensarling (R-TX), the Financial Services Committee Chair, who sought to understand the impact of various rules promulgated under Dodd-Frank on community lenders and their customers. The report studied the impact of mortgage servicing and regulatory capital rules on community lenders’ participation in the mortgage servicing market. (Mortgage servicing refers to the business of receiving monthly mortgage payments and providing other services relating to outstanding mortgages on behalf of the owner of the mortgage, which in some cases may also be the servicer itself).

The GAO found that community lenders “remained active in servicing mortgage loans under the” CFPB’s new mortgage-servicing rules. (n.p., front matter)

The report also described the small lender business model in some detail. Servicing activities

generated income and allowed them to maintain strong relationships with their customers. Some of these community lenders and industry associations noted that holding mortgage loans in portfolio and servicing these mortgage loans helped with overall profitability. For example, the servicing revenue can offset a reduction in income from originating loans when interest rates rise. Conversely, when interest rates decline, borrowers are more likely to prepay or refinance their mortgage loans, and servicing revenue may decline, while income from new mortgage loan originations might increase. (15)

Community lenders also claimed that ” they and their customers benefit from the close relationship maintained when these institutions service mortgages. . . . For example, representatives at one community bank told us that a customer who could not make a mortgage payment could meet directly with a bank representative to develop a payment plan.”  (16)

We often romanticize the small lenders (think, Bailey Brothers’ Building and Loan) and demonize the big banks (think, The Big Short). This report shows that the little guy is doing okay under Dodd-Frank, at least when it comes to servicing. It remains to be seen whether borrowers in the aggregate are better off with small lenders and their personal touch, but we will leave that discussion for another day.

 

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July 27, 2016 | Permalink | No Comments

July 26, 2016

Retiring with a Mortgage

By David Reiss

senior-golfing

MassMutual quoted me in Is it OK to Retire with a Mortgage? It opens,

The conventional wisdom is that you should pay off your mortgage before you retire. Yet, about 4.4 million retired homeowners still had a mortgage in 2011, according to an analysis of American Community Survey data by the Consumer Financial Protection Bureau (CFPB). More than half of them spend 30 percent or more of their income on housing and related expenses, a percentage that may be uncomfortably high even for working homeowners.

Not having to put such a large percentage — or any percentage — of your retirement income toward a monthly mortgage payment in retirement will certainly make it easier to meet your other expenses. But is it really so bad to have a mortgage payment during retirement?

“The logic behind the rule of thumb is that your income will go down in retirement, so it would be helpful if your monthly expenses went down significantly as well,” said David Reiss, a law professor who specializes in real estate and consumer financial services at Brooklyn Law School in New York. But if your income from Social Security and a pension (if you have one), and to some extent your assets (the nest egg you plan to draw on for additional retirement income), will be sufficient to make your monthly mortgage payment and meet your other expenses in retirement, there is no real reason that you have to get rid of the mortgage, he said. The key is that keeping your mortgage during retirement should be part of a plan and not a response to a crisis.

More Homeowners are Retiring with a Mortgage

More homeowners retired with a mortgage in 2011 than a decade earlier, according to the CFPB’s analysis of U.S. census data.1 They’re less likely to have their homes paid off because they’re purchasing later in life, making smaller down payments and tapping equity for other purchases.1 In fact, 36.6 percent of homeowners ages 65 to 74 and 21.2 percent homeowners age 75 and older (some of whom may not be retired yet) had mortgages or home equity loans in 2010, according to the Federal Reserve. The median balance was $79,000 for the 65 to 74 age group, and $58,000 for the 75 and up age group.

The CFPB points out two problems with carrying a mortgage during retirement: less accumulated net wealth and the possibility of foreclosure if retirees can’t make their mortgage payments. Foreclosure is harder to recover from when you’re older because you may not be able to return to the workforce to compensate for the loss and because you’re more likely to have health problems or cognitive impairments, the CFPB said.1

Having less accumulated net wealth is a problem, especially if most of your wealth consists of your home equity, which is less liquid than stocks, bonds and cash. Foreclosure is a serious problem if it happens to you, but the odds are slim: even in the aftermath of the housing crisis, in 2011, foreclosure rates were only 2.55 percent for homeowners 65 to 74 and 3.19 percent for homeowners 75 and older.

Some retirement-age homeowners who haven’t paid off their mortgages undoubtedly would rather be debt free but couldn’t afford to retire their home loan sooner. But others might be putting the money that could have gone toward extra mortgage payments to a better use. (footnotes omitted)

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July 26, 2016 | Permalink | No Comments

July 25, 2016

Creating Safe and Healthy Living Environments

By David Reiss

photo by Will Keightley

The Center for American Progress has released Creating Safe and Healthy Living Environments for Low-Income Families. It opens,

A strong home is central to all of our daily lives. People in the United States spend about 70 percent of their time inside a residence. As the Federal Healthy Homes Work Group explained, “A home has a unique place in our everyday lives. Homes are where we start and end our day, where our children live and play, where friends and family gather to celebrate, and where we seek refuge and safety.” Understanding how fundamental homes are to everything we do, it is troubling that more than 30 million housing units in the United States have significant physical or health hazards, such as dilapidated structures, poor heating, damaged plumbing, gas leaks, or lead. Some estimates suggest that the direct and indirect health care costs associated with housing-related illness or injuries are in the billions of dollars. The condition of housing is even more important for children, the elderly, and people with disabilities who need housing structures that support their particular needs.

The condition and quality of a home is often influenced by the neighborhood in which it is located, underscoring how one’s health and life expectancy is determined more by ZIP code than genetic code. According to a recent report by Barbara Sard, vice president for housing policy at the Center for Budget and Policy Priorities, living in neighborhoods of “concentrated disadvantage”—which are characterized by high rates of racial segregation, unemployment, single-parent families, and exposure to neighborhood violence—can impair children’s cognitive development and school performance. Residents of poor neighborhoods also tend to experience health problems—including depression, asthma, diabetes, and heart disease—at higher-than-average rates. This is particularly troubling given that African American, American Indian and Alaskan Native, and Latino children are six to nine times more likely than white children to live in high-poverty communities.

The country’s affordable housing crisis is partially to blame for families and individuals tolerating substandard housing conditions and unhealthy neighborhoods. Half of all renters spend more than 30 percent of their income on housing—the threshold commonly deemed affordable—while 26 percent spend more than half their income on housing. While housing assistance programs such as public housing and the Housing Choice Voucher program, commonly referred to as Section 8, provide critical support to families struggling to meet housing costs, only one in four households eligible for rental assistance actually receives it due to limited federal funding. Furthermore, millions of Americans face evictions each year. As work by Harvard University sociologist Matthew Desmond has highlighted, eviction is not just a condition of poverty but a cause of it, trapping families in poverty, preventing them from accessing and maintaining safe housing or communities, and corresponding with higher rates of depression and suicide.

This report provides an overview of the conditions of the nation’s housing stock, barriers to accessing housing for people with disabilities, the effects that neighborhood safety has on families, and recommendations for improving these conditions. Given how central homes and communities are to people’s lives, federal and local leaders must work to ensure low-income families have access to living environments that are conducive to their success. (1-2, footnotes omitted)

There were rapid improvements in housing healthy and safety over the 20th century. Since the time of Jacob Riis’ How The Other Half Lives, we went from outhouses being common to the public subsidy of modern apartment buildings in cities and the suburbanization of the rest country.

As a result, many people do not realize the extent to which many households continue to live in substandard housing. Lead paint exposure is perhaps the most known of the  risks, but it is not the only one.

This CAP report also highlights the risks that neighborhoods can present to their residents. Being safe in your home does not mean that you are safe on your street, on your walk to school or on your daily commute.

The report provides provides a useful overview of the challenges that low-income households face, inside and out of their homes.

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July 25, 2016 | Permalink | No Comments

July 22, 2016

Wall Street’s New Toxic Transactions

By David Reiss

Toxic Real Estate

The National Consumer Law Center released a report, Toxic Transactions: How Land Installment Contracts Once Again Threaten Communities of Color. It describes land installment contracts as follows:

Land contracts are marketed as an alternative path to homeownership in credit-starved communities. The homebuyers entering into these transactions are disproportionately . . . people of color and living on limited income. Many are from immigrant communities.

These land contracts are built to fail, as sellers make more money by finding a way to cancel the contract so as to churn many successive would-be homeowners through the property. Since sellers have an incentive to churn the properties, their interests are exactly opposite to those of the buyers. This is a significant difference from the mainstream home purchase market, where generally the buyer and the seller both have the incentive to see the transaction succeed.

Reliable data about the prevalence of land contract sales is not readily available. According to the U.S. Census, 3.5 million people were buying a home through a land contract in 2009, the last year for which such data is available. But this number likely understates the prevalence of land contracts, as many contract buyers do not understand the nature of their transaction sufficiently to report it.

Evidence suggests that land contracts are making a resurgence in the wake of the foreclosure crisis. An investigative report by the Star Tribune found that land contract sales in the Twin Cities had increased 50% from 2007 to 2013. Recent reports from The New York Times and Bloomberg reveal growing interest from private equity-backed investors in using land contracts to turn a profit on the glut of foreclosed homes in blighted cities around the country.

Few states have laws addressing the problems with land installment contracts, and the state laws on the books are generally insufficient to protect consumers. The Consumer Financial Protection Bureau (CFPB) has the mandate to regulate and prevent unfair and deceptive practices in the consumer mortgage marketplace, but has not yet used this authority to address the problems with land installment contracts. (1-2, footnotes omitted)

This report shines light on this disturbing development in the housing market and describes the history of predatory land contracts in communities of color since the 1930s. It also shows how their use was abetted by credit discrimination: communities of color were redlined by mainstream lenders who were following policies set by the Federal Housing Administration and other government agencies.

The report describes how these contracts give the illusion of home ownership:

  • They are structured to fail so that the seller can resell the property to another unsuspecting buyer.
  • They shift the burden of major repairs to the buyer, without exposing the seller to claims that the homes breach the warranty of habitability that a landlord could face from a tenant.
  • They often have purchase prices that are far in excess of comparable properties on the regular home purchase market, a fact that is often masked by the way that land contract payments are structured.
  • The properties often have title problems, like unsatisfied mortgages, that would not have passed muster in a traditional sale of a house.
  • They often are structured to avoid consumer protection statutes that had been enacted in response to previous problems with land contracts.

The report identifies Wall Street firms, like Apollo Global Management, that are funding these businesses. It also proposes a variety of regulatory fixes, not least of which is to have the CFPB take an active role in this shadowy corner of the housing market.

This is all to the good, but I really have to wonder if we are stuck just treating the symptoms of income and wealth inequality. Just as it is hard to imagine how we could regulate ourselves out of the problems faced by tenants that were described in Matthew Desmond’s Evicted, it is hard to imagine that we can easily rid low-income communities of bottom feeders who prey on dreams of homeownership with one scheme or another. It is good, of course, that the National Consumer Law Center is working on this issue, but perhaps we all need to reach for bigger solutions at the same time that we try to stamp out this type of abusive behavior.

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July 22, 2016 | Permalink | No Comments

July 21, 2016

Dual Agency Explained

By David Reiss

photo by Richard P J Lambert

Trulia quoted me in What Is Dual Agency? (And Why You Should Beware). It opens,

Home sellers and homebuyers are two sides of a complementary transaction. Should they each have their own agent, or is one agent enough? The answer: It depends.

You’ve probably heard the phrase “You can’t have your cake and eat it too.” But if you’ve ever puzzled over it’s meaning, here’s a hint: If you eat your cake now, you won’t have any left over to look forward to eating later. In other words, sometimes a person is forced to make a choice between two good options. In the real estate world, dual agency breaks the cake rule: If your real estate agent also represents the sellers of the home you want to buy, you don’t necessarily need to ditch them. In many cases, you can keep your agent and get the house too — if you want to, that is.

Whether you’re buying a home in Providence, RI, or Tampa, FL, it’s typical for one agent to represent the seller and another agent to represent the buyer. With dual agency, one agent works for both the buyer and seller — and keeps the full commission. Dual agency also occurs when agents from the same brokerage represent each party. But like enjoying a huge slice of cake and in return getting a bellyache, there are definitely pros and cons to agreeing to dual agency.

Pro: Streamlined communication

Because one real estate agent or brokerage represents the buyer and the seller, the agent doesn’t need to wait every time communication needs to happen between the parties. Streamlined communication often creates a smoother transaction. “You are in charge of both sides, including paperwork, scheduling, and deadlines,” says Mindy Jensen, a Colorado agent and community manager of BiggerPockets.com. “We’ve all been involved in a sale with an agent who didn’t respond in a timely manner, missed deadlines, and in general did not perform their duties as they should have. For us control freaks, dual agency can seem like a great thing.”

Con: No advice

Because a dual agent is working in a potential conflict-of-interest situation — one client (the seller) wants to get as high a price as possible, while the other client (the buyer) wants to pay as little as possible — the agent can’t take sides or give advice. Bruce Ailion, an Atlanta, GA, real estate agent and attorney, compares dual agency to having one attorney representing both husband and wife in a divorce. “The parties’ interests are adverse and are best represented by independent professionals,” he says.

The agent in a dual agency situation becomes, instead of a coach, more of a referee. “The agent cannot disclose confidential information to either party and has to act in a neutral position during the transaction,” says Emily Matles, a New York, NY, agent with Douglas Elliman. Matthew Berger, another New York, NY, agent with Douglas Elliman, says: “When the listing agent steps into the role of dual agent, they cannot give advice to the seller nor the buyer.” On the other hand, when you have an independent agent, “You are more likely to get the benefits of being a principal getting fiduciary benefits,” Ailion says.

Pro: There must be full disclosure

Whether you’re a seller or a buyer, there’s nothing to fear about dual agency: If you don’t consent to the practice, it won’t happen. “The dual-agent broker must ensure that both parties know of the arrangement and consent to it,” says David Reiss, professor of law at Brooklyn Law School. His advice: “Home sellers should review the terms of the listing agreement before they sign it to see if dual agency is being contemplated.”

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July 21, 2016 | Permalink | No Comments

July 20, 2016

The Republican Housing Platform

By David Reiss

photo by DonkeyHotey

The Republican Party adopted its platform earlier this week.  The short housing platform is worth reading in its entirety:

Responsible Homeownership and Rental Opportunities

Homeownership expands personal liberty, builds communities, and helps Americans create wealth. “The American Dream” is not a stale slogan. It is the lived reality that expresses the aspirations of all our people. It means a decent place to live, a safe place to raise kids, a welcoming place to retire. It bespeaks the quiet pride of those who work hard to shelter their family and, in the process, create caring neighborhoods.

The Great Recession devastated the housing market. U.S. taxpayers paid billions to rescue Freddie Mac and Fannie Mae, the latter managed and controlled by senior officials from the Carter and Clinton Administrations, and to cover the losses of the poorly-managed Federal Housing Administration. Millions lost their homes, millions more lost value in their homes.

More than six million households had to move from homeownership to renting. Rental costs escalated so that today nearly 12 million families spend more than 50 percent of their incomes just on rent. The national homeownership rate has sharply fallen and the rate for minority households and young adults has plummeted. So many remain unemployed or underemployed, and for the lucky ones with jobs, rising rents make it harder to save for a mortgage.

There is a growing sense that our national standard of living will never be as high as it was in the past. We understand that pessimism but do not share it, for we believe that sound public policies can restore growth to our economy, vigor to the housing market, and hope to those who are now on the margins of prosperity.

Our goal is to advance responsible homeownership while guarding against the abuses that led to the housing collapse. We must scale back the federal role in the housing market, promote responsibility on the part of borrowers and lenders, and avoid future taxpayer bailouts. Reforms should provide clear and prudent underwriting standards and guidelines on predatory lending and acceptable lending practices. Compliance with regulatory standards should constitute a legal safe harbor to guard against opportunistic litigation by trial lawyers.

We call for a comprehensive review of federal regulations, especially those dealing with the environment, that make it harder and more costly for Americans to rent, buy, or sell homes.

For nine years, Fannie Mae and Freddie Mac have been in conservatorship and the current Administration and Democrats have prevented any effort to reform them. Their corrupt business model lets shareholders and executives reap huge profits while the taxpayers cover all loses. The utility of both agencies should be reconsidered as a Republican administration clears away the jumble of subsidies and controls that complicate and distort home-buying.

The Federal Housing Administration, which provides taxpayer-backed guarantees in the mortgage market, should no longer support high-income individuals, and the public should not be financially exposed by risks taken by FHA officials. We will end the government mandates that required Fannie Mae, Freddie Mac, and federally-insured banks to satisfy lending quotas to specific groups. Discrimination should have no place in the mortgage industry.

Zoning decisions have always been, and must remain, under local control. The current Administration is trying to seize control of the zoning process through its Affirmatively Furthering Fair Housing regulation. It threatens to undermine zoning laws in order to socially engineer every community in the country. While the federal government has a legitimate role in enforcing non-discrimination laws, this regulation has nothing to do with proven or alleged discrimination and everything to do with hostility to the self-government of citizens. (4)

Here are some of the policy proposals that I think it gets right: abolishing Fannie and Freddie in their current form as hybrid public/private corporations; implementing regulation that promotes responsible underwriting and protects against predatory lending; and banning discrimination in the credit markets.

There is a lot of coded language in the platform, however. And that coded language may be inconsistent with some of those goals. For instance, the opposition to the Obama Administration’s attempts to reduce de facto segregation in the housing markets through such initiatives as the Affirmatively Furthering Fair Housing regulation undercuts the claim that the party opposes discrimination in the housing market.

It will be a long, strange trip to the November election. The direction of federal housing policy must be counted as one of important issues at stake.

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July 20, 2016 | Permalink | No Comments