Carolina Reid with Center for Responsible Lending #256


This week Bruce is joined once again 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, especially in the area of affordable housing.

In their last interview, Bruce and Carolina had just broached on the subject of the need for a down payment. Shelia Bair stated as she was leaving office, “If people put down 20%, it makes perfect sense that they are going to have a better payment history.” Based on that assumption, we’re going down the road of Dodd-Frank and making it mandatory for a 20% down payment before we’re able to receive the best rate loan. Bruce believes the timing of this is disastrous. Shelia agreed, and she also does not think that 20% down payment is necessary in order to ensure that borrowers stay in their homes and receive responsible loan products. Carolina said they have a history of providing no down payment or very low down payment loans with very high success rates. The questions are how you underwrite these loans, what kind of product features do these loans have, and if you have really considered the borrower’s ability to repay the loan over the long term. There is evidence from city programs and state affordable housing programs and other programs like the Community Advantage Program, which has run out of self-help and is affiliated with CRL and a CRA motivated lending program and has very low foreclosure rates. We have also seen the aforementioned in an FHA loan, although historically FHA foreclosure rates have been slightly higher than the market overall. Over this most recent time period, they have actually performed quite well compared to the Alt-A and the negative amortization as well as the other risky loan products that were originated during the subprime boom.

Bruce believed they were probably not a big participant in the years that Carolina covered. In California they would have been non-existent, but they are certainly going to have their fair share of 2009 foreclosures. The deal is not so much the down payment as much as the negative equity, which has not really been discussed. The majority of the country’s problems are really located in areas that had ridiculous prices rises and then ridiculous price declines. Bruce wondered if the negative equity was really the driving force to most of the foreclosures. Carolina was uncertain and said there is some debate among economists about what actually caused the foreclosure crisis. Once prices start to decline, it becomes really hard to come up with an alternative of exiting your home if you are having payment difficulties other than foreclosure, whether it is because you cannot resell or do not have enough equity. However, it is a big part of the problem now and is certainly hurting homeowners, particularly homeowners who have lost their jobs or otherwise financially struggling due to the recession. It is one thing to have a negative equity position; but if you’re attached to the real estate industry then the odds of you making the same money that you were making in 2006 is very unlikely. If you are in the lending business and are paid a point-to-loan, you are now making a loan at half of the price and a lot less transaction. Even if you are employed, you are not as fully employed as you once were. Carolina said she believes families are really struggling right now because the after effects of the recession have gone on so long and unemployment still remains so high that even people who had considerable savings have burned through that. This has made it increasingly difficult for them to make their mortgage payments. Bruce said there is also acceptability right now to not making your payment that is definitely taking hold.

When The Norris Group buys foreclosure property, they have seen that the average length of people have been in the property for two years or more and have therefore been making payments for a couple years. There is a study that says if your circle of people starts performing strategic foreclosures, then there is pressure. You may be sitting next to your cousin, who is on vacation on a cruise ship, and he may be thinking, “The only reason this is possible for me to take this vacation is I stopped making that payment.” You begin feeling the urge to join the party. Carolina is not sure of the extent to which this may be a real problem across the state. In the many interviews she has done she has found that borrowers are really committed to making their mortgage payments, and they feel a real obligation to that with a real sense of self-worth about being able to make that payment and that commitment. Carolina said she wishes we had a way to empirically tease out which of the stories is the strongest, but there are probably just as many borrowers who are actually desperately trying to make their payments. Bruce believes if it was a lot more, you would have a gigantic foreclosure percentage. Bruce said he is dealing with the most foreclosures ever, but we are still not talking 10%. There are a lot of people upside-down making payments on things they know is over encumbered because it is the way they have been taught to be built.

One example of a group is there was an owner of a head shrunk fund in New York who owned a home in a real nice area in Orange County on a cul-de-sac. There were twelve houses, and he was the only one making his payment in the whole cul-de-sac. They actually had meetings every month with the eleven other people to discuss how it was going. This was considered a neighborhood strategic default, which Bruce had never heard of prior. Bruce also wondered about NSP funds. We have this foreclosure crisis, and the County of Riverside has their share of funds. The Norris Group met with the city and tried to figure out a way to work with them, but they could not really come up with something. Therefore, Bruce wondered how successful the NSP fund program has been and whether it was a wise expenditure of money. Carolina believed it was and that it was not a very big expenditure of money in terms of the housing market. We have to remember that it was a program that was developed in a period of crisis, so therefore there were a lot of mistakes made both in terms of initial program design and program implementation. Several municipalities and other areas that received NSP funds really struggled with the capacity to deploy those funds; but in other places they really have worked in the way they were intended and really helped to support non-profits and city governments in both purchasing distressed properties and returning them to productive use and affordable homeownership programs. Carolina believes there are a lot of examples of really innovating approaches to NSP implementation that maybe are not at the scale we would like them to be at but are certainly making a difference at the local level.

Bruce wondered why it is felt that the private investor would not be able to take on the inventory and provide a completely perfect house for these types of programs. It is not that the end buyer is getting a big discount, but he is getting a fixed-up home in a neighborhood area that has some challenges. In some places, they really are working to use NSP funds to turn them into permanently affordable homes through community land trusts. There is a very innovative program out of Boston Community Capital that tries to keep the distressed borrower in their home using NSP funds, but the best NSP funds usually go beyond this. There are a lot of investors out there who are not necessarily as responsible as others are. The idea behind NSP is trying to keep some of the wealth and some of the equity that exists in the home within community hands rather than in investor hands. Carolina does not see this as competition with other investors, but rather a very nice way to promote affordable housing within locally hard-hit areas. One of the challenges for NSP funds is they do have to compete with investors, and they did not end up with as many properties as they thought. This is one example of where you do not know when you are in the middle of a crisis, and people thought there would be plenty of properties that they would have been able to quickly acquire them. However, this turned out to not be true.

The delinquencies in California tripled in about a twelve month period, and foreclosures declined during the time period when delinquencies went from 3.4% to 11%, and foreclosures went from 1 ½% to .8%. Lenders stopped foreclosing. Carolina said they had problems with inventory even as early as 2009, but during that specific timeframe in 2008 they stopped. The reason they stopped in 2008 was when The Norris Group was buying REOs at the time, the lenders were receiving about $.18 on the dollar on their loan amount because there was so much inventory that the price was hammered to death. They stopped foreclosing on the inventory for a combination of reasons, such as they were capable of being fined by the city and prices were sinking because they had 16 months of inventory that was now down to 5 or 6. However, it is not churning in the background, and this is part of what Carolina’s report is saying that we are not finished with any of this.

One of the discrepancies that is a little scary is that we have already foreclosed on 2.3 million and have a little over 3 million to come, and in addition there was a wildcard statement that there was another report saying there was probably 10 million more to come. Bruce wondered where they obtained this figure, and Carolina said a lot of it was in the difference of measurement. The bigger figure, which was the 10 million, included the borrowers who were current but were significantly underwater. The estimate, therefore, was for borrowers who may still become delinquent, which CRL does not include. The estimate also included estimates of short sales, which CRL also does not assess in their reports. However, short sales are definitely gaining momentum in our world, so as far as the investor world they see that there is a shift. If you look at the California Association of Realtors’ figures, the short sales have already passed the number of REO sales in the counties of Orange and L.A. Riverside and San Bernardino are gaining momentum and you also have a fair amount of properties that will not necessarily go to the NSP stage because they are lowering the opening bids at the trustee sales to move the properties before they become an REO. Therefore, they are preventing as many REOs as they can, and there are also bulk deals where they are selling the notes in bulk to where people then have a chance to get a workout done because the new owner of the note owes a lot less than the face value of the note. In the $600,000 example Bruce used before, they might go buy the note for $350,000, and they would be in a great position to sit down with the owner to make a deal.

One thing that is a little aggravating is we never make a differentiation on the person that is upside down on how they got to that point. It’s the idea that one size fits all. So one person is upside down, but you had refinanced your way there and had pulled out $300,000. Or, in another example, someone’s application may have not been true. There is never a mention that when we are talking about a loan modification program we look at some of those categories and say we should not do it. Carolina agreed saying people got underwater under a multiple different ways, and the more careful studies do look at this. One of the things we are plagued by in this research is the lack of data that really helps us to combine all the different factors that went into both the loan origination decision and the outcome, particularly where borrowers are now given changes in house prices.

Bruce wondered what the next few years will be like for housing, and if when Carolina looks at the information if she is looking at it on a national basis or California specific. Carolina answered saying she is looking at national data, and she thinks the policy choices that we make now stand to make a real difference in what happens, how many people are affected, what neighborhoods are affected, and how long this downturn is really going to last. We do not need to throw up our hands at this point, but instead we need to continue thinking creatively about solutions. We also need to really understand that there are things we know we can fix, such as servicer behavior as well as aligning servicers and improving their servicing practices. We also need to get creative on the policy front in terms of reducing foreclosures and delinquencies as well as stabilizing housing markets.

Bruce wondered what ramifications happen, because it seems inevitable that we are going to have a decline of homeownership as we resolve this next pile of properties. He wondered what societal benefits has there really been having the biggest percentage of people ever owning their own home and what this has meant to cities and neighborhoods in the way of stability. Carolina answered that she has never been one who has been for getting the U.S. homeownership rate as high as possible, and she is not sure this is the goal for which we should be striving. Instead, we need to minimize homeownership gaps between different groups and making sure that where there are barriers to homeownership we should be able to overcome with prudent public policy. We should hope to overcome these because it remains true that owning a home is the best source of wealth for all families but particularly for low income and minority families. This is true partly because it is a savings mechanism and also because it is such a nicely leveraged asset. As Bruce said before, we know how to do this well. During the 1980s and 1990s, we really did help to increase homeownership rates among those groups of people and close the homeownership gap in a way that was responsible and actually promoted stability for both neighborhoods and families. Therefore, we should not lose sight of this goal.

Bruce believes homeownership is very important to our country. He was married at 17, so he was on the other side of the equation at that point. He remembered when he and Marsha bought their home after saving for two years, which at the time was only $750 a month; Bruce had the grant deed recorded in his name when he did not have a dime of equity. However, on the Saturday that followed he was able to mow his own grass, and he could tell you it felt like he was a man. It was then engrained in him that part of being an American is you are able to call the shots within your own yard. Bruce would really not like there to be policies that dictate big down payments and are so restrictive that you eliminate a lot of people from that privilege. It really does not make much sense. The pull of homeownership is strong among all different groups. People really do want to become homeowners to a large degree, and Carolina believes the evidence is very strong that when done responsibly it is good for wealth building, for communities, and families, particularly children in terms of later life outcomes. Therefore, when done right it really can be a very great way of expanding access to opportunity.

Bruce Norris and Sean O’Toole had the opportunity to go to Washington to talk to Fannie Mae and FHA about some of the solutions that they talked about at I Survived Real Estate at the Nixon Library. One of the things they talked about was the nothing down loan program and its ability to maybe move to another owner without formal qualification. That idea came from the early 80s when Bruce became an investor. To become a full-time investor, Bruce refinanced his house at 17 ½% fixed. He almost owned it free and clear. However, about 60% of real estate transactions in California between 1981 and 1983 were accomplished by not needing a new loan. They were allowed to take over the existing loans in a term called “Subject To.” You literally did not fill out paperwork from the lender and get approved. All you had to do was make sure the loan payment was current and you sent it one sheet of paper that says to take one person’s name off and put on another name.

If in the next two years we could have a program where you had nothing down, qualified people getting a VA loan and who could make the payment, and also made the loan transferrable to another owner someday; then that would be a very big benefit. The reason is because this low interest environment that we are enjoying right now will not always be there, but it is a huge savings. For the people who can get in now, especially the beginning group or the people who have not had a bigger share of ownership, to receive a 4% mortgage rate is bragging rights for 30 years. The housing cost would also be so low compared to their neighbor over time that they have a lot of spendable money. This would be a very big difference in their life, so hopefully we will not become so restrictive with our policies that we eliminate the chance to own homes for a good percentage of our people.

It is important to realize that owning a home is still an earned privilege. Sometimes we cross over to where it has become a right, and this is something that shows with people who are not making their payments. They have the mindset that they really deserve their house anyway, even if they cannot make the payments. These kinds of people are not in the communities that Carolina has been working in, but she can imagine if you ran into these people it would be frustrating. They do not realize that the bill is being passed onto others.

Carolina has been working for the Center for Responsible Lending for only a few months, but for the upcoming year they will be doing some more research on qualified residential mortgage, both working with definitions and trying to show that a 20% down payment is not necessarily in everybody’s best interest. They also hope to look a little bit at neighborhoods, neighborhood stabilization, and see what is happening in different places, particularly hard-hit areas in California.

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