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This week Bruce is joined by Carolina Reid. Carolina joined the Center for Responsible Lending in August 2011 as a senior researcher working out of the Center’s California office. Before coming to CRL, Carolina served as the research manager for the Community Development Department for the Federal Reserve Bank of San Francisco. At the Fed, she published a substantial number of journal articles, working papers, and policy reports on the Community Reinvestment Act, the Foreclosure Crisis, Access to Credit, the role of anti-predatory lending laws. She also helped build the capacity of local stakeholders, including banks, nonprofits, and local governments, to undertake community development activities.
One of Carolina’s reports stated, “For decades, owning a home has been the most accessible way to build wealth and gain a foothold in the middle class, especially for lower income and/or middle income borrowers of color. This crisis threatens to undo decades of social, economic, and educational progress.” Therefore, whoever thought of the title “Lost Ground” chose a very meaningful title. The title was also a play on a previous report the Center for Responsible Lending published called “Losing Ground,” where they predicted the scale of the foreclosure crisis was related to subprime lending. Five years into the crisis, they thought it would be interesting to revisit this and see what we know now. Right now, we know that we are only about halfway through the crisis, which was a surprise in terms of how many borrowers are still delinquent or in some stage of the foreclosure process. We know that although the majority of borrowers that have been affected have been white families as well as higher income or middle income families, a disproportionate share of the foreclosure crisis has fallen on communities of color. Bruce wondered if it was possible that the lending programs were an attempt to get the people that had not had a chance to own a home to own one. This probably would have naturally been a higher percentage of families of color.
In “The Lost Ground,” the latest report CRL put out, they looked carefully at what led to the differential foreclosure rates among communities of color, borrowers of color, and they found it was very closely tied to the loan products that they received. It’s not necessarily that people were lending to the wrong kinds of borrowers, but rather they were offering borrowers the wrong kinds of loan products. These loan products had risky features, such as teaser adjustable interest rates, prepayment penalties. Some of the option ARMs and amortization loans that were really common between the 2004 and 2007 lending period really have much higher foreclosure rates than loans that are proven to build equity and wealth for families, such as the 30-year fixed rate mortgages. These were the years that the subprime product and all the creative loans had their peak. Bruce said that they buy foreclosures at the courthouse steps, and he believes the majority are two years of loans from 2006 and 2007.
In the report CRL just released, they were looking at loans that only originated between 2004 and 2008 at the height of the subprime lending boom. They were working with a sample of 27 million loans, and they also took special attention to try and make sure the loans they were representing had a wide coverage of the mortgage market. They looked at subprime, prime, and Alt A loans. They therefore have broad market coverage in these results. In the 2009 report, “The Untold Cost of Subprime Lending,” a very important question was asked, which was, “How did borrowers decide on which loan product to accept, and how knowledgeable were they about the loan terms?” This was a question that was not answered in the 2009 report. Carolina said she did not have an answer for this, but she did know that brokers, with their incentives to steer borrowers into more expensive loans, had a big role in it. However, she is still not sure of the mechanisms by which certain borrowers went to brokers and others may not have gone to brokers. CRL knows the loans were complicated, and borrowers did not shop around for a mortgage the way others may shop around for other product and therefore cost-compare. This put them in a more vulnerable position to get a product that was not well-suited to their circumstances. The also were probably given a product that was much more expensive than the loan that they actually might have qualified for based on their credit score.
One of the things Bruce recalled during that timeframe was he could not get on the radio without hearing about a loan program. It seems you would have been exposed to at least the teaser program on radio, called on it, and found out you didn’t qualify. It would seem at the time you would have known there was a shift in what you were going to be able to receive. This confused Bruce in a way in that it seemed like there would have been a natural exposure to at least a competitive product, or people were dealing with other people they felt so comfortable with that they had blind trust. Bruce wondered if CRL ever did a study on this and from whom loans were obtained from as well as there being so much trust they did not realize that they were taking advantage of the spread premium. Carolina answered that when she was on the Federal Reserve, she did a study that interviewed borrowers to develop a better understanding of why different borrowers received different kinds of loan products. She expressed with her own views that she discovered people did have a lot of trust in both brokers and lenders as being the professionals and trusted advisors who would put them into a responsible loan product or a loan product that was well-suited to their financial circumstances. What the borrowers did not understand was that these brokers had a financial incentive to spear them into a more expensive loan. There was not much evidence of shopping around, and it was very different to hear a radio ad than to actually know, given your own financial circumstances and credit score, how you might qualify. Carolina believes it is also important to distinguish between lending programs that were run through non-profits and other affordable homeownership programs where we have seen extremely low foreclosure rates and the lending products that were being pushed by the private market over the specific time period.
Bruce said this was probably the only time in history where the lenders themselves did not care if the loan was ever repaid because they did not own it very long. This is an astonishing piece of history we will probably never get to relive. It’s clear that there was not much incentive to make responsible, safe loans over this time period; and it has had devastating consequences for borrowers. This is one of the things about people who are losing their homes. 2.3 million people have already lost their home in foreclosure, and Bruce wondered what percentage of these people put down a down payment as well as what percentage of the people did a refinance and pulled out money. Carolina did not know the percentages off the top of her head, but there have been studies done off of this. CRL did look at the same patterns within the data for lost ground, and they found that when they looked at the patterns for people who put down a down payment and people who did not put down a down payment, they found there was not much difference in terms of who had marketed the most risky loan products. This included the relationship between the loan products and their ultimate status at the end. This could include whether or not they were in foreclosure. However, they know now that it is quite important it is to document somebody’s income and assets, which is part of the loan underwriting process. There were different terms for the risky loans and higher interest, but this was because the lenders were not documenting certain things.
A lot of the people have lost their homes in foreclosure, and Bruce wondered how many of them have actually lost money. If we looked into it, we may find a great many people did not have a down payment, they have now been in the home for two years not making a payment, or they have extracted equity in the meantime. We are concentrating on a group of people that lost their property. As an example of what could happen in Riverside where home values have declined by 50%, you could have somebody who borrowed $600,000 on a $600,000 home without a down payment. This was very easy to do. If they still owe $600, but the house is worth $300, and a next door neighbor put down 50% but owes $300 on a $300 grand house and has literally $300,000 of after tax dollars disappear from his life, then these people who we don’t talk about have probably been more damaged than the people we do. The negative spillover effects of foreclosure on surrounding neighbors is huge and on the market as a whole. There are plenty of borrowers who are still in their homes and have seen their equity erode as well as their wealth in their homes. This is one of the reasons we are pushing so hard to try and stabilize the housing market through foreclosure prevention just to stop all this downward slide of house prices.
Bruce said the reason we are not halfway through the foreclosure process is because we have delayed on foreclosing. Somebody who was foreclosed on fairly quickly in 2008 is literally re-emerging as a buyer in 2011 and 2012 because the system allows them to re-buy in three years after a foreclosure and get an FHA loan. For this gigantic group of people who we have not even stopped the credit damage, they are not going to be buyers until around 2015-2016. One of the problems and unintended consequences is your market does not heal really fast when you prevent people from actually losing a property. Carolina believes one of the reasons it is important to stop foreclosures is because of the negative spillover effects on neighborhoods. The neighborhoods that have been hit by the most foreclosures tend to be lower income neighborhoods and tend to be neighborhoods with high concentrations of minority households. These were neighborhoods that were starting to improve and a lot were invested in in terms of community development, but now they have received a big shock. The community there has been really hard hit by this process. The other real reason is there may be a few borrowers who are coming out of the foreclosure process and doing just fine a few years down the road, but most of the research shows a financial shock like that can actually have devastating consequences, not only in terms of rebuilding their credit score and regaining financial stability, then more generally the lost accumulation of wealth potential over the time period.
Carolina said she is not as sanguine as Bruce is about doing a foreclosure quickly is going to be the best thing for borrowers or neighborhoods. She agreed we cannot prevent every foreclosure, but in a lot of cases improved servicer practices would help encourage loan modifications for borrowers who can and do want to stay in their homes. We have good evidence that effective loan modifications do reduce the risk of subsequent default, and this is probably in everybody’s interest. This includes not only the borrower but also the investor in the neighborhood.
Bruce went on to talk about loan modifications. These have a fail rate of about 50% depending on when they were done. If you created a loan product with a 50% failure rate, you would not be calling this a success. However, Carolina disagreed in that she said the failure rates are the re-default rates that were calculated on loan modifications that actually did not necessarily reduce the payment. It did not help the borrower, so it was not surprising that the loan re-defaulted. She found that loans that do actually reduce monthly payments, particularly loans that help reduce them such as principle burden, have an excellent record for not going back into default very easily.
Bruce read a recent document that said facing the foreclosure crisis requires servicers to make reasonable modification. Bruce wondered if the word “requires” can be translated to mean requiring principle loan reductions. However, Carolina does not believe this to be the case. We all believe that principle reduction would go a long way to help stabilize the housing market in general. There are still some conservative economists who are calling for principle reduction, which everybody sees as a necessary step. However, the word “require” here refers to making sure that servicers clean up their practices and pursue modifications more responsibly than they have in the past and eliminate abusive practices such as duel tracking and modification at the same time as a foreclosure.
Bruce agreed because he said it was very frustrating for them who bought properties at the courthouse steps. When you legitimately buy property here, but then you go to someone’s door and they are in shock because they were told that they had a loan mod in progress, then this is awkward for everyone. They are not trying to short-circuit the system, but they are trying to make a living buying and rehabbing properties. You have people who have been told one thing by one department, but you have another department not even knowing the conversation occurred. This is not right. If you know the history, then this is the Great Depression at least of real estate. We have never had anything like this since the Great Depression where prices have fallen not 5% a year but sometimes 5% a month in the worst hit areas until you could have a 50% equity cushion and have no cushion inside of 18 months. This is a ridiculous price dive.
One of the things that we have to be careful of is the unintended consequences of policies that a lender looks at and says he did not know they could do it; but now that he does know it, his lending policies going forward will be different. Your goal is not to make the foreclosure rate 0 in the future because that would probably eliminate a lot of people from potential ownership that would in fact make a payment. One of the things that CRL has been doing research on is to show that you do not have to return to an incredibly restrictive environment to be able to promote healthy lending and a healthy housing market. You can eliminate the most abusive products, then get down to an acceptable foreclosure rate without necessarily excluding borrowers who would otherwise be qualified from access to credit. We have used a term “unprecedented,” which really has a duel meaning. It means what we did before made sense when we did not have one of these events. We just have to go back and do whatever we did prior to 2000. If we look at the data, we actually find that, in terms of expansion of homeownership rates and expansion of homeownership rates for lower income and minority households, we saw homeownership rates for them expand more during the early 1990 periods than we did in 2003 and 2004 onwards. The sub-prime boom actually helped to reduce the homeownership rate among those groups, so the riskiest lending did nothing to expand access to opportunity in the way we would like it to expand.
In the ‘80s and ‘90s, there was a lot of attention paid to making sure that we do not restrict lending on purpose. This would have increased the ownership rate and the provision of affordable homeownership programs that offered borrowers with lower incomes and wealth the ability to access homeownership through a mortgage that was a 30-year fixed rate mortgage with reasonable monthly payments well within the borrowers’ ability to repay the loan over the long term. Bruce said the whole state of California is virtually an affordable program. However, in relationship to people’s incomes, house prices in California still remain high. It has definitely become more affordable in certain areas, the Inland Empire and the Central Valley being among some of the hardest hit in the country. We have to remember that over that late 1990 and early 2000 time period, house prices were so far above anybody’s annual growth in terms of their income that we’re not even at stable levels yet. Bruce said he would agree with this on price, but not on payment because if you combine a median price decline of $600 to below 3 and a decline to 4%, that monthly payment that emerges is very often less than rent.
There is a report produced by Cal Poly Pomona that is a really good report for people who do research because it is not median price or Case-Shiller. They actually have taken the time to appraise about 1,000 California properties every 6 months for decades. It is literally one house appraised in 1970 for one price and 2011 for another price. This is pretty neat because you can go backwards and see the price increase or decrease. What Bruce did was he took Lancaster, which is certainly one of the hardest hit areas. He took the compilation of properties and over the 20 year period from 1990 this group of properties lost 11% in real value. But interest rates in 1990 were 10%, so if you are a buyer in 2011 you get an 11% price discount, a 60% interest discount, and you’re making more money in the area. The payment that emerges for that buyer is $.29 on the dollar of the equivalent in 1990. This is the all-time monthly sale for ownership, and you have to consider interest rate because it is probably the biggest piece and one of the most economically beneficial for people that have lower income or are just beginning because it locks in their housing cost at fixed rate for a long time. This is one of the things in which we are missing the boat. One of the things Carolina intentionally did not point out was the need for a down payment, making a very big difference in the outcome of the loan. The best performing loan for probably the last 40 years is a VA, no down loan. This has the best payment history and the least damage for foreclosure. It would be a perfect time to have a nothing-down loan program right now, as this would help the people who don’t have a down payment but a payment they can afford. There would not be any harm in it, and it would be very successful. CRL has found that down payment matters somewhat, but it does not necessarily explain foreclosures to the extent that some people would say it does.
Tune in next week for part 2 of our interview with Carolina Reid.
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