Loan Mods Amidst Rising Interest Rates

photo by Chris Butterworth

The Urban Institute’s Laurie Goodman et al. have posted Government Loan Modifications: What Happens When Interest Rates Rise?. This brief is another product of the newly formed Mortgage Servicing Collaborative. This brief

examines the current loan modification product suite for government loans insured or guaranteed by the Federal Housing Administration (FHA), US Department of Veterans Affairs (VA), or the US Department of Agriculture (USDA). When a delinquent borrower with a government loan obtains a modification, the mortgage rate is typically reset to the prevailing market rate, which can be higher or lower than the original note rate. When the market rate is below the original rate, providing payment reduction becomes inherently easier and less expensive for the investor. Conversely, when market rates are above the note rate, providing payment reduction becomes more expensive and challenging, making it more difficult to cure the delinquency. This can result in more redefaults and foreclosures, larger losses for government insurers, and greater distress for borrowers, communities, and neighborhoods. In addition, most government mortgage borrowers are first-time homebuyers and minorities, who tend to have limited incomes and savings, making loan modifications all the more important. (1)

Given the recent upward trend in interest rates, this is more than a theoretical exercise. And indeed, the brief “explains why FHA, VA, and USDA borrowers who fall behind on their payments are unlikely to receive adequate payment relief when the market interest rate is higher than the original note rate. ” (3)

The brief outlines some options that could increase payment relief for those borrowers, including deploying a 40-year extended term and principal forbearance to reduce the monthly mortgage payment. The brief acknowledges that there are barriers to implementing the options it has identified but it also proposes ways to overcome those barriers.

As I had stated previously, the Mortgage Servicing Collaborative is providing sorely needed guidance through some of the darker corners of the mortgage market. This brief sheds some welcome light on an obscured problem that may cause trouble in the years to come.

Running The CFPB out of Town

photo by Gabriel Villena Fernández

My latest column for The Hill is America’s Consumer Financial Sheriff and The Horse it Rides Are under Fire. It reads,

Notwithstanding its name, the Financial Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs Act, or Financial Choice Act, will be terrible for consumers. It will gut the Consumer Financial Protection Bureau and return us to the Wild West days of the early 2000s where predatory lenders could prey on the elderly and the uneducated, knowing that there was no sheriff in town to stop ‘em.

The subprime boom of the early 2000s has receded in memory the past 15 years, but a recent Supreme Court decision reminds us of what that kind of predatory behavior could look like. In Bank of America Corp. v. Miami this year, the court ruled that a municipality could sue financial institutions for violations of the Fair Housing Act arising from predatory lending.

Miami alleged that the banks’ predatory lending led to a disproportionate increase in foreclosures and vacancies which decreased property tax revenues and increased the demand for municipal services. Miami alleged that those “‘predatory’ practices included, among others, excessively high interest rates, unjustified fees, teaser low-rate loans that overstated refinancing opportunities, large prepayment penalties, and — when default loomed — unjustified refusals to refinance or modify the loans.”

The Dodd-Frank Act was intended to address just those types of abusive practices. Dodd-Frank barred many of them from much of the mortgage market through its qualified mortgage and ability-to-repay rules. More importantly, Dodd-Frank created the Consumer Financial Protection Bureau. The CFPB was designed to be an independent regulator with broad authority to police financial institutions that engaged in all sorts of consumer credit transactions. The CFPB was the new sheriff in town. And like Wyatt Earp, it has been very effective at driving the bad guys out of Dodge.

The Financial Choice Act would bring the abusive practices of the subprime boom back to life. The act would gut the CFPB. Among other things, it would make the Director removable at will, unlike other financial institution regulators. It would take away the CFPB’s supervisory function of large banks, credit unions and other consumer finance institutions. It would take away the CFPB’s power to address unfair, deceptive, and abusive acts and practices. It would restrict the CFPB from monitoring the mortgage market and thereby responding to rapidly developing abusive practices.

The impacts on consumers will be immediate and harmful. The bad guys will know that the sheriff has been undercut by its masters, its guns loaded with blanks. The bad guys will re-enter the credit market with the sorts of products that brought about the subprime crisis: teaser rates that quickly morph into unaffordable payments, high costs and fees packed into credit products, and all sorts of terms that will result in exorbitant and unsustainable credit.

Rep. Jeb Hensarling (R-Texas), chairman of the House Financial Services Committee, is the chief proponent of the Financial Choice Act. Hensarling claims that Dodd-Frank and the CFPB place massive burdens on consumer credit providers. That is not the case. Interest rates remain near all-time lows. Consumer credit markets have many providers. Credit availability has eased up significantly since the financial crisis

One only needs to look at his top donors to see how the Financial Choice Act lines up with the interests of those consumer credit companies that are paying for his re-election campaign. These top donors include people affiliated to Wells Fargo, Bank of America, JPMorgan Chase, Capital One Financial, Discover Financial Services, and the American Bankers Association, among many others.

Dodd-Frank implemented regulations that work very well in the consumer credit markets. It created a regulator, the CFPB, that has been very effective at keeping the bad guys out of those markets. The Financial Choice Act will seriously weaken the CFPB. When vulnerable consumers cry out for help, Hensarling would heave the CFPB over its saddle and let its horse slowly trot it out of town.

Banks v. Cities

The Supreme Court issued a decision in Bank of America Corp. v. Miami, 581 U.S. __ (2017). The decision was a mixed result for the parties.  On the one hand, the Court ruled that a municipality could sue financial institutions for violations of the Fair Housing Act arising from predatory lending. Miami alleged that the banks’ predatory lending led to a disproportionate increase in foreclosures and vacancies which decreased property tax revenues and increased the demand for municipal services. On the other hand, the Court held that Miami had not shown that the banks’ actions were directly related to injuries asserted by Miami. As a result, the Court remanded the case to the Eleventh Circuit to determine whether that in fact was the case. This case could have big consequences for how lenders and others and other big players in the housing industry develop their business plans.

For the purposes of this post, I want to focus on the banks’ activities of the banks that Miami alleged they engaged in during the early 2000s. It is important to remember the kinds of problems that communities faced before the financial crisis and before the Dodd-Frank Act authorized the creation of the Consumer Financial Protection Bureau. As President Trump and Chairman Hensarling (R-TX) of the House Financial Services Committee continue their assault on consumer protection regulation, we should understand the Wild West environment that preceded our current regulatory environment. Miami’s complaints charge that

the Banks discriminatorily imposed more onerous, and indeed “predatory,” conditions on loans made to minority borrowers than to similarly situated nonminority borrowers. Those “predatory” practices included, among others, excessively high interest rates, unjustified fees, teaser low-rate loans that overstated refinancing opportunities, large prepayment penalties, and—when default loomed—unjustified refusals to refinance or modify the loans. Due to the discriminatory nature of the Banks’ practices, default and foreclosure rates among minority borrowers were higher than among otherwise similar white borrowers and were concentrated in minority neighborhoods. Higher foreclosure rates lowered property values and diminished property-tax revenue. Higher foreclosure rates—especially when accompanied by vacancies—also increased demand for municipal services, such as police, fire, and building and code enforcement services, all needed “to remedy blight and unsafe and dangerous conditions” that the foreclosures and vacancies generate. The complaints describe statistical analyses that trace the City’s financial losses to the Banks’ discriminatory practices. (3-4, citations omitted)

Excessively high interest rates, unjustified fees, teaser interest rates and large prepayment penalties were all hallmarks of the subprime mortgage market in the early 2000s. The Supreme Court has ruled that such activities may arise to violations of the Fair Housing Act when they are targeted at minority communities.

Dodd-Frank has barred many such loan terms from a large swath of the mortgage market through its Qualified Mortgage and Ability-to-Repay rules. Trump and Hensarling want to bring those loan terms back to the mortgage market in the name of lifting regulatory burdens from financial institutions.

What’s worse, the  burden of regulation on the banks or the burden of predatory lending on the borrowers? I’d go with the latter.

Nonbank Servicers Pose Risks for Homeowners

Christy Goldsmith Romero, Special Inspector General for the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP)

SIGTARP Special Inspector General Romero

The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) has released its Quarterly Report to Congress (April 27, 2016). The Report focuses on how nonbank servicers raise risks for homeowners participating in the Home Affordable Modification Program (HAMP) of the Troubled Asset Relief Program (TARP). (65) The report states that

Mortgage servicers are the single largest factor in determining whether homeowners applying for, or participating in, TARP’s signature foreclosure prevention program HAMP are given a fair shot, and whether the program runs effectively and efficiently. This is because Treasury has contracted with mortgage servicers to play a predominant role in HAMP, by making the day-to-day decisions related to HAMP that have enormous implications for homeowners seeking relief. Mortgage servicers decide whether homeowners are eligible for HAMP, whether homeowners get a trial run in the program, and whether that trial run should result in the servicer permanently modifying the homeowners’ mortgages. Mortgage servicers decide how the mortgage will be modified, such as whether a homeowner will get a lower interest rate, and if so, what rate. Mortgage servicers decide how much the homeowner will have to pay each month. Mortgage servicers also apply payments they receive, and they make decisions on whether a homeowner should be terminated from the program. Because of this outsized role, all mortgage servicers are required to comply with HAMP rules, and federal laws. Following HAMP rules and federal laws is necessary to protect homeowners from harm.

Non-banks who service mortgages have increased their participation in HAMP, and now play a larger role in HAMP than bank servicers, but that was not always the case.

*     *      *

HAMP and its related programs have become a lucrative business and reliable source of income for non-bank servicers. Treasury pays mortgage servicers for every homeowner who receives a permanent mortgage modification in HAMP. Nonbank mortgage servicers have received $1.1 billion in Federal TARP dollars from Treasury through the HAMP program.

As non-bank servicers increase their role in HAMP, the risk to homeowners has also increased. Non-bank servicers have less federal regulation than banks that service mortgages. Some of the largest non-bank servicers have already been found to have violated laws in their treatment of homeowners, and have been the subject of enforcement actions by the federal or a state government. Some of the largest non-bank servicers also have been found to have violated HAMP’s rules in their treatment of homeowners. This increased risk to homeowners must be met with increased oversight to ensure that homeowners are treated fairly, and that HAMP and its related programs are effective and efficient. (65, notes removed)

Regulators and other government agencies have been taking a hard look at servicers recently (take a look at this and this). It is important for federal regulators to get their oversight of servicers right because they can and do cause mountains of misery for homeowners when things goes wrong.

Principal-ed Forgiveness

photo by Vic

The Federal Housing Finance Agency announced a new program to implement principal reduction for seriously delinquent, underwater homeowners who meet the following criteria:

  • Are owner-occupants.
  • Are at least 90 days delinquent as of March 1, 2016.
  • Have an unpaid principal balance of $250,000 or less.
  • Have a mark-to-market loan-to-value ratio of more than 115% after capitalization. (1)

The program’s “modification terms include capitalization of outstanding arrearages, an interest rate reduction down to the current market rate, an extension of the loan term to 40 years, and forbearance of principal and/or arrearages up to a certain amount to be converted later to forgiveness.” (1) Once the borrower completes three timely payments, the principal forbearance amount can be forgiven.

This program can help just a small proportion of homeowners who have been underwater on their mortgages. Most importantly, it is being implemented years after the foreclosure crisis swamped the nation’s housing markets. But as can be seen from the criteria above, it is targeted just to homeowners with below-average principal balances on their mortgages and who are severely underwater. There are all sorts of political reasons that principal reduction was not a key component of the post-crisis housing finance reform agenda. But it is worth asking now — should we deploy it more quickly in the next crisis? What would be the principled reasons for doing that?

Many argued that principal forgiveness would reward homeowners for making bad, even immoral, decisions. With the benefit of hindsight, it would have been better to put that questions aside and ask what the best policy option for the country would have been. If outstanding principal balances could have been aligned more closely to the new normal of the post-financial crisis economy, the recovery could have proceeded more quickly.

Now would be the time for the FHFA to implement regulations to deal with the next great recession. If principal forgiveness makes sense under certain conditions, let’s identify them now and then have an easier time of it down the road.

Road to GSE Reform

photo by Antonio Correa

A bevy of housing finance big shots have issued a white paper, A More Promising Road to GSE Reform. The main objective of the proposal

is to migrate those components of today’s system that work well into a system that is no longer impaired by the components that do not, with as little disruption as possible. To do this, our proposal would merge Fannie and Freddie to form a single government corporation, which would handle all of the operations that those two institutions perform today, providing an explicit federal guarantee on mortgage-backed securities while syndicating all noncatastrophic credit risk into the private market. This would facilitate a deep, broad and competitive primary and secondary mortgage market; limit the taxpayer’s risk to where it is absolutely necessary; ensure broad access to the system for borrowers in all communities; and ensure a level playing field for lenders of all sizes.

The government corporation, which here we will call the National Mortgage Reinsurance Corporation, or NMRC, would perform the same functions as do Fannie and Freddie today. The NMRC would purchase conforming single-family and multifamily mortgage loans from originating lenders or aggregators, and issue securities backed by these loans through a single issuing platform that the NMRC owns and operates. It would guarantee the timely payment of principal and interest on the securities and perform master servicing responsibilities on the underlying loans, including setting and enforcing servicing and loan modification policies and practices. It would ensure access to credit in historically underserved communities through compliance with existing affordable-housing goals and duty-to-serve requirements. And it would provide equal footing to all lenders, large and small, by maintaining a “cash window” for mortgage purchases.

The NMRC would differ from Fannie and Freddie, however, in several important respects. It would be required to transfer all noncatastrophic credit risk on the securities that it issues to a broad range of private entities. Its mortgage-backed securities would be backed by the full faith and credit of the U.S. government, for which it would charge an explicit guarantee fee, or g-fee, sufficient to cover any risk that the government takes. And while the NMRC would maintain a modest portfolio with which to manage distressed loans and aggregate single- and multifamily loans for securitization, it cannot use that portfolio for investment purposes. Most importantly, as a government corporation, the NMRC would be motivated neither by profit nor market share, but by a mandate to balance broad access to credit with the safety and soundness of the mortgage market. (2-3, footnotes omitted)

The authors of the white paper are

  • Jim Parrott, former Obama Administration housing policy guru
  • Lewis Ranieri, a Wall Street godfather of the securitized mortgage market
  • Gene Sperling,  Obama Administration National Economic Advisor
  • Mark Zandi, Moody’s Analytics chief economist
  • Barry Zigas, Director of Housing Policy at Consumer Federation of America

While I think the proposal has a lot going for it, I think that the lack of former Republican government officials as co-authors is telling. Members of Congress, such as Chair of the House Financial Services Committee Jeb Hensaerling  (R-TX), have taken extreme positions that leave little room for the level of government involvement contemplated in this white paper. So, I would say that the proposal has a low likelihood of success in the current political environment.

That being said, the proposal is worth considering because we’ll have to take Fannie and Freddie out of their current state of limbo at some point in the future. The proposal builds on on current developments that have been led by Fannie and Freddie’s regulator and conservator, the Federal Housing Finance Agency. The FHFA has required Fannie and Freddie to develop a Common Securitization Platform that is a step in the direction of a merger of the two entities. Moreover, the FHFA’s mandate that Fannie and Freddie’s experiment with risk-sharing is a step in the direction of the proposal’s syndication of “all noncatastrophic credit risk.” Finally, the fact that the two companies have remained in conservatorship for so long can be taken as a sign of their ultimate nationalization.

In some ways, I read this white paper not as a proposal to spur legislative action, but rather as a prediction of where we will end up if Congress does not act and leaves the important decisions in the hands of the FHFA. And it would not be a bad result — better than what existed before the financial crisis and better than what we have now.

Final Accounting for National Mortgage Settlement

Attributed to Jacopo de' Barbari

Luca Pacioli, A Founding Father of Accounting

Joseph Smith, the Monitor of the National Mortgage Settlement, has issued his Final Compliance Update. He writes,

I have filed a set of five compliance reports with the United States District Court for the District of Columbia as Monitor of the National Mortgage Settlement (NMS or Settlement). The following report summarizes these reports, which detail my review of each servicer’s performance on the Settlement’s servicing reforms. This report includes:

• An overview of the process through which my team and I have reviewed the servicers’ work.

• Summaries of each servicer’s performance for the third quarter 2015.

Pursuant to the Settlement, the requirement to comply with the servicing standards ended for Bank of America, Chase, Citi, Ditech and Wells Fargo as of the end of the third quarter 2015. Accordingly, this is my last report under the NMS for these servicers. Like all mortgage servicers, they are still required to follow servicing-related rules issued by the Consumer Financial Protection Bureau (CFPB). (2)

Smith concludes,

The Settlement has improved the way these servicers treat distressed borrowers, and, under its consumer relief requirements, the banks provided more than 640,000 borrowers with $51 billion in debt forgiveness, loan modifications, short sale assistance and refinancing at a time when families and the market were subject to distress and uncertainty.

I believe the Settlement has contributed towards the rebuilding of public trust and confidence in the mortgage market and hope that it will inform future regulation of financial institutions and markets. I look forward to further discussions on these topics among policymakers, consumer advocates and mortgage servicers. (13)

I have blogged about the Monitor’s earlier reports and have been somewhat unhappy with them. Of course, his primary audience is the District Court to which he is submitting these reports. But I do not believe that the the reports have “contributed towards the rebuilding of public trust and confidence in the mortgage market” all that much. The final accounting should be accurate, but it should also be understandable to more than a select few.

The reports have been opaque and have not give the public (even the pretty well-informed members of the public, like me) much information with which to contextualize their findings. I hope that future settlements like this take into account the need to explain the findings of decision makers and court-appointed monitors so that the public can have a better sense of whether justice was truly done.