No, not those stress tests...the ones that show which major financial institutions are under capitalized under stressful economic times. But rather the tests consumers feel in these uncertain times.
A recent article in the Wall Street Journal on emergency 401k withdrawals got me to ask colleagues in the tax preparation world if this was in issue this year. By and large the answer as yes, and the stories they told profound.
One site here in Madison did taxes mostly for University employees as part of the IRS Volunteer Tax Assistance Program (VITA) and served low-income individuals. The thing about many VITA sites is the tax forms are not that complicated--few clients have to fill out schedules for small businesses or rental properties, or even Schedule A for itemized deductions. Getting through Child and Earned Income Tax credits is much of the work. But this year an employee with around $25,000 in income came in who had cashed out an 401k or IRA tax deferred account. It had at one point risen in value to more than $35,000--a lot for a low-wage worker under 40 years of age. Then by November/December has dropped to $14,000. For this client seeing this drop in value was too much. The media was talking about banks failing and scams where investors lost all of their money. This was not an FDIC insured account and the client feared the worst. The only defensive move in this client's mind was to get that money back ASAP before it was all gone.
He panicked. But it is not hard to put yourself in his shoes and realize in that context, if you don't believe markets will come back, and the media is buzzing about the collapse of the economy, you might have the same thoughts.
Of course finance theory tells us to ignore cyclical swings, dollar cost average, and invest for the long-run, especially for a retirement account that won't be needed for a decade or more. But knowing that and believing that when you and everyone around you is under stress is another matter.
This story is not that uncommon among VITA sites. Sometimes people sold for an emergency expense; some sold in a panic. Either way they sold at what now looks like a bottom of the market. Plus remember they have to pay all the deferred taxes on the initial IRA/401k contributions, plus a 10% penalty. In the anecdote above the client ended up owing about $4000 in taxes and penalties to pull out $14,000. Mind you $14,000 is still more than half his income. If there as an emergency use it might even avoid some tax implications. But most likely that money won't be reinvested at a reasonably long-run rate of return (eg it will go in a savings accounts versus an S&P 500 Index) and will lose value. Or even more likely it will be spent on everyday costs of living and consumption.
A lot of savings "policy" and programs aimed at boosting financial literacy or investing focus on getting in, but not what to do when the market drops 30% in less than one year. When it looks like the bottom is falling out people respond in predictable ways. One implication is that we need to better understand this consumer behavior under financial stress. Maybe this could lead to more supportive products and services to prevent people from letting today's stress get the better of their financial future. Financial insecurity comes from more than just a spreadsheet, but is a state of mind.
Saturday, May 9, 2009
Friday, April 24, 2009
Failures of Basic Financial Services
The Federal Reserve held a conference in April on research in community development. There were several papers on payday lending, tax refund anticipation loans, prepaid cards and other forms of credit. These non-traditional sources of loans may at first blush seem illogical: Why would someone borrow next week's paycheck for a $30 fee when that amounts to a 360% APR on an annual basis? Or borrow their tax refund in October at a cost of nearly $100 for $1500 in 5 months. Why opt out of checking accounts and use higher cost prepaid cards?
The answer it seems, at least in part, is that people are not well served by financial services and using what is available to as best they can. Jennifer Romich and colleagues followed a small group users of prepaid cards using details interviews. It turns out these consumers liked the limits on prepaid cards and generally eschewed conventional checking accounts because they had been burned in the past. Checking accounts have fees on low balance accounts, charges for check printing and from the perspective of these consumers, banks just seem to be out to get them. For people with just enough income to get by several checks may go out that come close to overdrawing the account. Banks generally will cash the largest check first, bouncing several smaller checks. Consumers see this as capricious and vindictive. So they opt out of the system entirely.
Angela Littwin used similar methods to look at high cost credit cards used by low-income women in Boston. In part because Boston has few short term payday loan options (regulations largely ban these loans), credit cards are a key source of credit. Low income families use credit cards as a form of an emergency fund. But they report being frustrated as the card issuer periodically 'gives' them more credit; they feel they would be better off without the option to borrow more. The author suggests new forms of credit cards with simple fees and low balances that the consumer affirmatively selects--and they can set limits on their own use.
Jeremy Tobacman and colleagues look at pay day loans and credit card use. The authors note many payday loan users actually have credit available on their credit cards, yet still use high cost payday loans. They also find that the use of a payday loan is a precursor to credit card default. Thus consumers may be using payday loans because they know they are in financial trouble. The costs of over charging a credit card and/or late fees or even carrying debt over time on a card are such that consumers are allocating their credit across all available options.
One other paper from the conference that is relevant to this discussion is by Peter Tufano and colleagues. They look at income tax filings and clients using advance refund loans. They then track how clients use their refunds among those who took their refund on a stored value card. The #1 item for which the funds were used? Groceries. For many the purchase happened immediately--within a few days. Less than 10% appeared to buy big items or consumer durables (the stereotype of buying a flat screen TV).
These are all insightful papers and deserve more attention than the few sentences offered here. The overall picture these papers paint is that consumers do make mistakes and suffer from mis-information. But they also are doing the best they can with the tools they have available. And it seems many see mainstream banking-- checking accounts and credit cards-- as more trouble than they are worth. Non-traditional users of these accounts are slapped with fees and charges on a regular basis making even a high-cost payday loan a cheaper alternative. It is also clear these products all interact, as consumer trade off one form for another--probably not something regulators pay attention to. Moreover as financial services consolidates and firms look to raise more revenue from basic transactional and small credit services, it seems likely more consumers on the fringe will opt out of mainstream services.
New products and markets are developing to better serve this population. So long as they offer transparent pricing, consumers are likely to be better off for it. A better understanding of the landscape of consumer services in this segment is clearly needed.
The answer it seems, at least in part, is that people are not well served by financial services and using what is available to as best they can. Jennifer Romich and colleagues followed a small group users of prepaid cards using details interviews. It turns out these consumers liked the limits on prepaid cards and generally eschewed conventional checking accounts because they had been burned in the past. Checking accounts have fees on low balance accounts, charges for check printing and from the perspective of these consumers, banks just seem to be out to get them. For people with just enough income to get by several checks may go out that come close to overdrawing the account. Banks generally will cash the largest check first, bouncing several smaller checks. Consumers see this as capricious and vindictive. So they opt out of the system entirely.
Angela Littwin used similar methods to look at high cost credit cards used by low-income women in Boston. In part because Boston has few short term payday loan options (regulations largely ban these loans), credit cards are a key source of credit. Low income families use credit cards as a form of an emergency fund. But they report being frustrated as the card issuer periodically 'gives' them more credit; they feel they would be better off without the option to borrow more. The author suggests new forms of credit cards with simple fees and low balances that the consumer affirmatively selects--and they can set limits on their own use.
Jeremy Tobacman and colleagues look at pay day loans and credit card use. The authors note many payday loan users actually have credit available on their credit cards, yet still use high cost payday loans. They also find that the use of a payday loan is a precursor to credit card default. Thus consumers may be using payday loans because they know they are in financial trouble. The costs of over charging a credit card and/or late fees or even carrying debt over time on a card are such that consumers are allocating their credit across all available options.
One other paper from the conference that is relevant to this discussion is by Peter Tufano and colleagues. They look at income tax filings and clients using advance refund loans. They then track how clients use their refunds among those who took their refund on a stored value card. The #1 item for which the funds were used? Groceries. For many the purchase happened immediately--within a few days. Less than 10% appeared to buy big items or consumer durables (the stereotype of buying a flat screen TV).
These are all insightful papers and deserve more attention than the few sentences offered here. The overall picture these papers paint is that consumers do make mistakes and suffer from mis-information. But they also are doing the best they can with the tools they have available. And it seems many see mainstream banking-- checking accounts and credit cards-- as more trouble than they are worth. Non-traditional users of these accounts are slapped with fees and charges on a regular basis making even a high-cost payday loan a cheaper alternative. It is also clear these products all interact, as consumer trade off one form for another--probably not something regulators pay attention to. Moreover as financial services consolidates and firms look to raise more revenue from basic transactional and small credit services, it seems likely more consumers on the fringe will opt out of mainstream services.
New products and markets are developing to better serve this population. So long as they offer transparent pricing, consumers are likely to be better off for it. A better understanding of the landscape of consumer services in this segment is clearly needed.
Sunday, April 12, 2009
Why so few loan mods?
The HASP effort from the Treasury/White House/HUD has been in play for over a month now. By some measures, lenders are beginning to use the program and at the least there are refinances being made through Fannie and Freddie for loans with loan to value ratios of 80-105% of appraised values ("shallow under water" loans).
In the last week we heard that FHA loans are performing poorly. This created headlines about an FHA 'bailout'...which is not quite right. FHA charges a premium and has generally added to the Federal revenues every year due to a surplus of premiums paid over payouts (there is no "lock box" for Federal programs). In many ways this has been a tax on homebuyers which returned billions to the Treasury. Due to a slew of loans in 2005-2007 where downpayments were gifted by sellers (a blueprint for disaster to all who watched it happen), FHA has a book of loans that is doing lousy. That program has ended and FHA volume overall is robust. FHA may need, for the first time in history, a subsidy for its premiums. Or it could simply to raise its current premiums. But this is not quite a collapse of an otherwise pretty good program.
But the news on loan mods is more modest. Still lenders are slow to get mods approved and seem to still end up doing more foreclosures than alternatives. New data will soon be out from HOPE NOW and some state programs to see if or how fast things are changing.
A recent paper by Christopher Foote, Kristopher Gerardi, Lorenz Goette and Paul Willen on the Boston Fed website (Public Policy Discussion Paper P09-2) with the pithy title "REDUCING FORECLOSURES" has some interesting implications.
The authors argue that loans originated with high mortgage payments relative to income, or at so at "unaffordable levels," are not the main reason that borrowers default. They suggest it is actually household income shocks such as a job loss or income reduction, combined with a declining house price market.
Because investors usually gain more from foreclosures than modifications, the system is set up to pursue foreclosure options even if the borrower may be able to maintain a modified loan. They argue that PSA and securitization agreements are not the barrier to servicers often suggested, and that investors are not putting legal pressure against mods as much as simply are economically better off foreclosing. It would be better for society, borrowers, neighborhoods, etc for more mods to be made, but probably not for specific investors facing a trade off between forms of losses. Both a mod and foreclosure mean a loss. Mods may just prolong the problem in too many cases.
The authors conclude that mods may need to be re-directed. Rather than reducing payments below 31% of income for 5 years across the board, as in the HASP, a better approach would be to focus on the trigger event to get the borrower through until a better income level is achievable, then revert to the prior terms.
It is a nicely written paper and engages a useful discussion of what we ought to consider affordable or "sustainable" lending. It should be noted they do not find income to mortgage payment ratios are not unimportant, just that income:payment at the time the loans is made is not a main driver of default. From other data we know mods that reduce payments tend to perform better over time. In fact the authors repeat this finding. But the situation each borrower is in varies, as does the availability of data on changes in income over time.
One proposal put forth by Steve Malpezzi and colleagues at the Center for Real Estate at the University of Wisconsin Business School is that unemployment benefits could include a temporary housing voucher which pays any amount over 30% of income for making housing payments. The result is a bit like a short term insurance contract against default.
It seems unlikely there will be much momentum for HASP II or even another round of foreclosure prevention policies in the near term. But as housing policy is designed going forward, better attention to what happens when housing and labor markets fall at the same time at scale will be a hard learned lesson.
In the last week we heard that FHA loans are performing poorly. This created headlines about an FHA 'bailout'...which is not quite right. FHA charges a premium and has generally added to the Federal revenues every year due to a surplus of premiums paid over payouts (there is no "lock box" for Federal programs). In many ways this has been a tax on homebuyers which returned billions to the Treasury. Due to a slew of loans in 2005-2007 where downpayments were gifted by sellers (a blueprint for disaster to all who watched it happen), FHA has a book of loans that is doing lousy. That program has ended and FHA volume overall is robust. FHA may need, for the first time in history, a subsidy for its premiums. Or it could simply to raise its current premiums. But this is not quite a collapse of an otherwise pretty good program.
But the news on loan mods is more modest. Still lenders are slow to get mods approved and seem to still end up doing more foreclosures than alternatives. New data will soon be out from HOPE NOW and some state programs to see if or how fast things are changing.
A recent paper by Christopher Foote, Kristopher Gerardi, Lorenz Goette and Paul Willen on the Boston Fed website (Public Policy Discussion Paper P09-2) with the pithy title "REDUCING FORECLOSURES" has some interesting implications.
The authors argue that loans originated with high mortgage payments relative to income, or at so at "unaffordable levels," are not the main reason that borrowers default. They suggest it is actually household income shocks such as a job loss or income reduction, combined with a declining house price market.
Because investors usually gain more from foreclosures than modifications, the system is set up to pursue foreclosure options even if the borrower may be able to maintain a modified loan. They argue that PSA and securitization agreements are not the barrier to servicers often suggested, and that investors are not putting legal pressure against mods as much as simply are economically better off foreclosing. It would be better for society, borrowers, neighborhoods, etc for more mods to be made, but probably not for specific investors facing a trade off between forms of losses. Both a mod and foreclosure mean a loss. Mods may just prolong the problem in too many cases.
The authors conclude that mods may need to be re-directed. Rather than reducing payments below 31% of income for 5 years across the board, as in the HASP, a better approach would be to focus on the trigger event to get the borrower through until a better income level is achievable, then revert to the prior terms.
It is a nicely written paper and engages a useful discussion of what we ought to consider affordable or "sustainable" lending. It should be noted they do not find income to mortgage payment ratios are not unimportant, just that income:payment at the time the loans is made is not a main driver of default. From other data we know mods that reduce payments tend to perform better over time. In fact the authors repeat this finding. But the situation each borrower is in varies, as does the availability of data on changes in income over time.
One proposal put forth by Steve Malpezzi and colleagues at the Center for Real Estate at the University of Wisconsin Business School is that unemployment benefits could include a temporary housing voucher which pays any amount over 30% of income for making housing payments. The result is a bit like a short term insurance contract against default.
It seems unlikely there will be much momentum for HASP II or even another round of foreclosure prevention policies in the near term. But as housing policy is designed going forward, better attention to what happens when housing and labor markets fall at the same time at scale will be a hard learned lesson.
Saturday, March 28, 2009
Solutions to Foreclosure: Looking Across the Atlantic
The US is not alone in having a housing crisis. Many European and other nations also had a house price run up and bust--many with some forms of expanded high risk lending. The UK has a more homogeneous housing market and also experienced a downturn like the current episode in the early 1990s.
In the UK the foreclosure is called repossession and operates on a national basis as opposed to the US with its state laws administered by county clerks. While lenders generally offer the same workout/modification options to borrowers in default as in the US, if the problem is not resolved then the lender seeks remedy in the courts. The court can grant immediate possession to the lender, but the most common outcome of the judicial process is a ‘suspended possession order’. In short, the debtor puts a proposal to the court to repay arrears over a stated period. If the court considers this acceptable, irrespective of the lender’s willingness to accept the offer, possession of the property is granted to the lender but with the order suspended so long as the payments are made. No further action can be taken by the lender unless the debtor misses a payment.
There are a number of common themes in policy responses in both countries. In UK during 2008 there were a series of policy announcements aimed at reducing levels of repossessions. Four major initiatives include:
(1) the Support for Mortgage Interest scheme, which amended the welfare benefits system to provide improved support to home-buyers with mortgages who lose their jobs;
(2) the Homeowner Mortgage Support Scheme, providing ‘mortgage holidays’ for home buyers who may suffer a temporary fall in income, but are expected to recover at a later date;
(3) the Mortgage Rescue Scheme enabling homeowners facing repossession to remain in their home through a shared equity scheme, whereby a Registered Social Landlord or RSL) will provide an equity loan enabling the householders' mortgage repayments to be reduced; and a related program, and
(4) the Government Mortgage to Rent Scheme whereby the RSL will clear the secured debt completely and the applicant will then become a rent paying tenant of the RSL.
In September 2008 the UK government packaged these and other programs and then announced a ‘Billion pound package for housing’.
Like the US, the UK has increased funding for borrower counseling. In November 2008 it was announced that “£15.85 million ($22) to extend free debt advice [is] to be made available to all consumers across the country” . This builds on expansion of the “debt advice sector” since around 2004, although different to the US, this expansion was initially separate from housing issues and was located in the Government’s anti-poverty agenda (reducing indebtedness). This led to a 2004 action plan for tackling (over) indebtedness (Department of Trade and Industry 2004). The action plan was updated annually and the importance of debt advice has remained a consistent theme. In the 2007 report included: “Free and impartial debt advice is a vital safety net for many vulnerable consumers, improving their ability to manage financial commitments and stave off far more costly consequences” (Department for Business, Enterprise and Regulatory Reform, 2007: 62). In the initial 2004 action plan on indebtedness £45 million ($63) was allocated to increase the supply of free face to face debt advice. While unpacking different spending announcements is complex, somewhere in the region of £80 million ($112) is now committed by the UK Government to increase capacity through to 2011 (Department for Business, Enterprise and Regulatory Reform 2007). As in the US, support is provided both for face-to-face and telephone counseling services.
In the US about $200 million was provided on 2008 as part of the National Foreclosure Mitigation Counseling Program. In addition HUD provides about $50 million for housing counseling, some portion of which is directed towards housing debt.
Like the US, the UK policy response is perhaps far less than the need. For example, in the UK the Mortgage Rescue Scheme applies only in some local areas, and it is estimated it will help just 6,000 households over two years. Both the Support for Mortgage Interest Scheme and Homeowner Mortgage Support Scheme are based on such complex qualifying rules. This is parallel with US experience such as with the FHA Hope For Homeowners program. Congress made the terms strict, in order to prevent the appearance of abuse, including a requirement that 50 percent of any future gain in the home’s value would go to the government—which reduced incentives for use.
A recent Survey by ACORN suggests the US HASP program may more success. In this survey three-quarters of the top lenders say they will participate in the program. Of course, as unemployment rates keep going up no modification could help those homeowners without income to be able to remain in place.
Both countries are engaging in a range of policy experiments. Neither has great data to build on, nor the time to develop pilots before trying new ideas. But stronger research comparing each county’s experience has the potential to help develop better responses in both.
In the UK the foreclosure is called repossession and operates on a national basis as opposed to the US with its state laws administered by county clerks. While lenders generally offer the same workout/modification options to borrowers in default as in the US, if the problem is not resolved then the lender seeks remedy in the courts. The court can grant immediate possession to the lender, but the most common outcome of the judicial process is a ‘suspended possession order’. In short, the debtor puts a proposal to the court to repay arrears over a stated period. If the court considers this acceptable, irrespective of the lender’s willingness to accept the offer, possession of the property is granted to the lender but with the order suspended so long as the payments are made. No further action can be taken by the lender unless the debtor misses a payment.
There are a number of common themes in policy responses in both countries. In UK during 2008 there were a series of policy announcements aimed at reducing levels of repossessions. Four major initiatives include:
(1) the Support for Mortgage Interest scheme, which amended the welfare benefits system to provide improved support to home-buyers with mortgages who lose their jobs;
(2) the Homeowner Mortgage Support Scheme, providing ‘mortgage holidays’ for home buyers who may suffer a temporary fall in income, but are expected to recover at a later date;
(3) the Mortgage Rescue Scheme enabling homeowners facing repossession to remain in their home through a shared equity scheme, whereby a Registered Social Landlord or RSL) will provide an equity loan enabling the householders' mortgage repayments to be reduced; and a related program, and
(4) the Government Mortgage to Rent Scheme whereby the RSL will clear the secured debt completely and the applicant will then become a rent paying tenant of the RSL.
In September 2008 the UK government packaged these and other programs and then announced a ‘Billion pound package for housing’.
Like the US, the UK has increased funding for borrower counseling. In November 2008 it was announced that “£15.85 million ($22) to extend free debt advice [is] to be made available to all consumers across the country” . This builds on expansion of the “debt advice sector” since around 2004, although different to the US, this expansion was initially separate from housing issues and was located in the Government’s anti-poverty agenda (reducing indebtedness). This led to a 2004 action plan for tackling (over) indebtedness (Department of Trade and Industry 2004). The action plan was updated annually and the importance of debt advice has remained a consistent theme. In the 2007 report included: “Free and impartial debt advice is a vital safety net for many vulnerable consumers, improving their ability to manage financial commitments and stave off far more costly consequences” (Department for Business, Enterprise and Regulatory Reform, 2007: 62). In the initial 2004 action plan on indebtedness £45 million ($63) was allocated to increase the supply of free face to face debt advice. While unpacking different spending announcements is complex, somewhere in the region of £80 million ($112) is now committed by the UK Government to increase capacity through to 2011 (Department for Business, Enterprise and Regulatory Reform 2007). As in the US, support is provided both for face-to-face and telephone counseling services.
In the US about $200 million was provided on 2008 as part of the National Foreclosure Mitigation Counseling Program. In addition HUD provides about $50 million for housing counseling, some portion of which is directed towards housing debt.
Like the US, the UK policy response is perhaps far less than the need. For example, in the UK the Mortgage Rescue Scheme applies only in some local areas, and it is estimated it will help just 6,000 households over two years. Both the Support for Mortgage Interest Scheme and Homeowner Mortgage Support Scheme are based on such complex qualifying rules. This is parallel with US experience such as with the FHA Hope For Homeowners program. Congress made the terms strict, in order to prevent the appearance of abuse, including a requirement that 50 percent of any future gain in the home’s value would go to the government—which reduced incentives for use.
A recent Survey by ACORN suggests the US HASP program may more success. In this survey three-quarters of the top lenders say they will participate in the program. Of course, as unemployment rates keep going up no modification could help those homeowners without income to be able to remain in place.
Both countries are engaging in a range of policy experiments. Neither has great data to build on, nor the time to develop pilots before trying new ideas. But stronger research comparing each county’s experience has the potential to help develop better responses in both.
Tuesday, March 3, 2009
Homeowner Affordability and Stability
It seems no one likes any ideas being put forth on any economic issue these days. The alternative of just letting banks, companies and homeowners just 'go under' is increasingly argued to be the optimal long-run choice. But doing nothing is a choice too. Certainly some will be worse off if nothing is done. And some maybe better off if something is done. So now we get into debates about who pays the costs and who gets the benefits, and if plan A has more impact than plan B. But doing nothing no longer seems to be a politically or economically viable choice.
Today we learn the details of the HAS plan - that is the Homeowner Affordability and Stability plan first announced in February by the Treasury Dept. The HAS plan is the newest iteration of foreclosure prevention. Round I was largely voluntary efforts by industry and resulted in some good press and the creation of a national hotline for borrowers in trouble. Round II stepped up the voluntary efforts, layered on some FHA loan products (which ended up being almost un-usable), money for foreclosure counseling and a few regulatory moves around the margin. In the end a few people in default were helped but it would be hard to prove there as much impact, beyond the efforts of the FDIC to offer loan modifications to borrowers of loans from the failed bank Indy Mac, which the FDIC itself took over.
The HAS plan has a number of components, some of which are quite vague if not innovative. But it boils down to 2 main efforts: (1) refinance underwater loans held by Fannie Mae and Freddie Mac and (2) facilitate loan modifications for borrowers "at risk".
Fannie and Freddie are under government conservatorship. They require government subsidy to operate at this point and seem willing to take on the risky proposition of refinancing borrowers who owe more than their home is worth. The catch is the borrower also has to have high payment ratios such that affording the mortgage is in question; just being in a declining home value market is not enough. It looks like the implementation of this will also require some indications of (a) hardship like job loss or income reduction and (b) re-underwriting the loan to prove the borrower can actually pay going forward. It is likely many will apply and only a fraction will qualify. And remember by definition Freddie and Fannie borrowers are better credit quality, not subprime or in the category of various 'exotic' loans.
The danger is making the rules too narrow and then no borrowers are helped. (See "Hope For Homeowners" the FHA refinance product which is the poster child of protecting a program from abuse by making the terms so strict no one could use it.) On the other end is making the program so easy to qualify for that a high share of these newly refinanced loans default. Or worse from a PR perspective, some 'undeserving' borrowers get a deal. When the guy in Miami with 3 condos slips through and gets a loan it will be sure to be in the press.
The second part of HAS is not refinancing loans but modifying the terms of existing loans. This relies on the efforts of private lenders. It is voluntary on the lenders' part, but in reality every major mortgage lender is depending on TARP or some other form of government support, so not taking part in HAS would be a poor move politically. Again details are forthcoming, but here are some components:
- payments to servicers to make mods. This addresses a major problem in the market. Even if the lender and borrower may be better off with a modified loan, the servicer may be financially better off pushing foreclosure. $1,500 may not be enough to change the calculus, but it at least forces a second look at modification options.
- cost sharing for lowering payments. Lenders are required to take a hit by lowering interest rates and/or principal to get payments to 38% of income, then split the cost with Treasury of getting payments down to 31%.
- incentives for performance. Borrowers who agree to a mod can get up to $1000 per year for 5 years for principal reduction. Not a huge amount but perhaps again it lines up borrowers to make an extra effort.
- opportunity to re-capture some revenue later. After 5 years the modification can start to increase interest rates and payments as economic conditions improve. This could prove to be a problem if the economy stays soft. Let's all hope 5 years is not overly optimistic. One could imagine this date being pushed back if so.
- insurance against further home value declines. This is the most cutting edge and least well defined. Basically FDIC insures the lender in case home values drop more and the home goes further under water.
The Treasury is releasing guidelines for modifications. The idea is to again focus on borrowers with hardships, either in foreclosure or at risk of it. Payments will be lowered and in some cases principal forgiven. This will be a 'new' kind of modification in many ways. The press has jumped on data from the OCC that shows 50% or more of mods re-default. But mods in 2008 often increased monthly payments and/or principal, so this should not be a big surprise. Alan White's recent data suggest the types of mods proposed here will perform much better, with short-run defaults of 20% or less.
Will all of this work? Compared to what? We have learned a lot in the last few months and the HAS incorporates some important lessons. A major issue remains investors in securities. There is no legal consensus on how loan terms being re-written filter up to how securities divide up losses in principal and interest payments. Lenders and servicers may still fail to offer mods because of fear of legal issues with investors.
In the short run we can count on consumers being confused. Phone lines and websites to lenders will be overwhelmed. The HOPE hotline and housing counselors like will see a deluge of clients looking to understand what they can do. It is unlikely servicers--who are already grossly over their capacity to deal with loan workouts--will smoothly launch HAS mods. And then the process for administering government subsidy to lenders/servicers on a loan by loan basis has the potential to become a bureaucratic mess (FHA has done it for years; many lenders and FHA employees will debate both sides of how well this works).
Given a stream of strongly negative data on the housing, employment and banking front, the bottom of this crisis may not yet be in sight. Let's hope HAS has more impact than its predecessors.
Update: Here are the details... More detailed than many expected... The new piece is documenting 'hardship' which clearly intends to avoid 'underserving' borrowers from getting help. Also a "1-strike and you are out" for re-default. And, an emphasis on using the FHA Hope for Homeowners loan program. Now let's watch the implementation...
Today we learn the details of the HAS plan - that is the Homeowner Affordability and Stability plan first announced in February by the Treasury Dept. The HAS plan is the newest iteration of foreclosure prevention. Round I was largely voluntary efforts by industry and resulted in some good press and the creation of a national hotline for borrowers in trouble. Round II stepped up the voluntary efforts, layered on some FHA loan products (which ended up being almost un-usable), money for foreclosure counseling and a few regulatory moves around the margin. In the end a few people in default were helped but it would be hard to prove there as much impact, beyond the efforts of the FDIC to offer loan modifications to borrowers of loans from the failed bank Indy Mac, which the FDIC itself took over.
The HAS plan has a number of components, some of which are quite vague if not innovative. But it boils down to 2 main efforts: (1) refinance underwater loans held by Fannie Mae and Freddie Mac and (2) facilitate loan modifications for borrowers "at risk".
Fannie and Freddie are under government conservatorship. They require government subsidy to operate at this point and seem willing to take on the risky proposition of refinancing borrowers who owe more than their home is worth. The catch is the borrower also has to have high payment ratios such that affording the mortgage is in question; just being in a declining home value market is not enough. It looks like the implementation of this will also require some indications of (a) hardship like job loss or income reduction and (b) re-underwriting the loan to prove the borrower can actually pay going forward. It is likely many will apply and only a fraction will qualify. And remember by definition Freddie and Fannie borrowers are better credit quality, not subprime or in the category of various 'exotic' loans.
The danger is making the rules too narrow and then no borrowers are helped. (See "Hope For Homeowners" the FHA refinance product which is the poster child of protecting a program from abuse by making the terms so strict no one could use it.) On the other end is making the program so easy to qualify for that a high share of these newly refinanced loans default. Or worse from a PR perspective, some 'undeserving' borrowers get a deal. When the guy in Miami with 3 condos slips through and gets a loan it will be sure to be in the press.
The second part of HAS is not refinancing loans but modifying the terms of existing loans. This relies on the efforts of private lenders. It is voluntary on the lenders' part, but in reality every major mortgage lender is depending on TARP or some other form of government support, so not taking part in HAS would be a poor move politically. Again details are forthcoming, but here are some components:
- payments to servicers to make mods. This addresses a major problem in the market. Even if the lender and borrower may be better off with a modified loan, the servicer may be financially better off pushing foreclosure. $1,500 may not be enough to change the calculus, but it at least forces a second look at modification options.
- cost sharing for lowering payments. Lenders are required to take a hit by lowering interest rates and/or principal to get payments to 38% of income, then split the cost with Treasury of getting payments down to 31%.
- incentives for performance. Borrowers who agree to a mod can get up to $1000 per year for 5 years for principal reduction. Not a huge amount but perhaps again it lines up borrowers to make an extra effort.
- opportunity to re-capture some revenue later. After 5 years the modification can start to increase interest rates and payments as economic conditions improve. This could prove to be a problem if the economy stays soft. Let's all hope 5 years is not overly optimistic. One could imagine this date being pushed back if so.
- insurance against further home value declines. This is the most cutting edge and least well defined. Basically FDIC insures the lender in case home values drop more and the home goes further under water.
The Treasury is releasing guidelines for modifications. The idea is to again focus on borrowers with hardships, either in foreclosure or at risk of it. Payments will be lowered and in some cases principal forgiven. This will be a 'new' kind of modification in many ways. The press has jumped on data from the OCC that shows 50% or more of mods re-default. But mods in 2008 often increased monthly payments and/or principal, so this should not be a big surprise. Alan White's recent data suggest the types of mods proposed here will perform much better, with short-run defaults of 20% or less.
Will all of this work? Compared to what? We have learned a lot in the last few months and the HAS incorporates some important lessons. A major issue remains investors in securities. There is no legal consensus on how loan terms being re-written filter up to how securities divide up losses in principal and interest payments. Lenders and servicers may still fail to offer mods because of fear of legal issues with investors.
In the short run we can count on consumers being confused. Phone lines and websites to lenders will be overwhelmed. The HOPE hotline and housing counselors like will see a deluge of clients looking to understand what they can do. It is unlikely servicers--who are already grossly over their capacity to deal with loan workouts--will smoothly launch HAS mods. And then the process for administering government subsidy to lenders/servicers on a loan by loan basis has the potential to become a bureaucratic mess (FHA has done it for years; many lenders and FHA employees will debate both sides of how well this works).
Given a stream of strongly negative data on the housing, employment and banking front, the bottom of this crisis may not yet be in sight. Let's hope HAS has more impact than its predecessors.
Update: Here are the details... More detailed than many expected... The new piece is documenting 'hardship' which clearly intends to avoid 'underserving' borrowers from getting help. Also a "1-strike and you are out" for re-default. And, an emphasis on using the FHA Hope for Homeowners loan program. Now let's watch the implementation...
Wednesday, February 11, 2009
Foreclosure Mediation
A number of states and localities--OH, CT, NY, Philly among them--are experimenting with foreclosure mediation as an alternative way to settle foreclosure disputes. Of course from a lender's perspective there is no dispute--the contract was broken and foreclosure is the avenue to seek remedy. But the reality is foreclosure takes a long time and is costly to the lender and borrower. Some share of borrowers could remain in the loan if the loan terms are modified. How the modifications happen really matters, and mediation prior to foreclosure could help make that happen.
The mediator is a 3rd party, typically someone with legal training but outside the courts. Both sides (borrower and lender) have to make good faith efforts. Using a 3rd party a solution (modification or sale of home w/o foreclosure) could be found. It saves money and the potential harm to neighboring properties, not to mention the borrower and his or her credit record.
How would it work? Lenders could be required to offer mediation before foreclosure can proceed. Borrowers have a time limit to respond. Then the mediation has some limited time to be completed. Ideally the loan is restructured to avoid foreclosure or the borrower buys time to market and sell the home privately.
The critique of mediation is borrowers may be at a disadvantage. It is becoming clear not all loan mods are the same. A loan mod that moves fees to the final payment in 20 years and lowers the interest rate for a few years has less than a 50-50 shot at success. A mod with principal reduction has better odds - maybe as much as 80% will succeed. Mediation may result in naive borrowers agreeing to mods with weak terms and few net gains. One could imagine discretion on the part of lenders resulting in disparate impacts by race, income, location or in all three dimensions.
Enter the role of education and counseling. Prior to the mediation the borrower has to so some homework. Ohio's program has such a requirement. How well borrowers can be trained to explore their options is an open question, but it beats going in unarmed with a sophisticated lender.
There are lots of problems - like dealing with high volumes of foreclosure filings, getting borrowers to pay attention at all, compensating mediators and counselors, getting lenders/servicers to create mods that really can succeed given investor and legal issues with mortgage securities--just to name a few.
To be sure, if a mortgage cram down bankruptcy provision is passed at the Federal level, lenders may seek alternatives such as mediation with open arms. And anything that attempts to get the borrower to take action before the auction is socially valuable, even if the mediation does not result in a mod. Given the slow pace to restructuring individual mortgages we have seen so far, the mediation approach may have potential.
The mediator is a 3rd party, typically someone with legal training but outside the courts. Both sides (borrower and lender) have to make good faith efforts. Using a 3rd party a solution (modification or sale of home w/o foreclosure) could be found. It saves money and the potential harm to neighboring properties, not to mention the borrower and his or her credit record.
How would it work? Lenders could be required to offer mediation before foreclosure can proceed. Borrowers have a time limit to respond. Then the mediation has some limited time to be completed. Ideally the loan is restructured to avoid foreclosure or the borrower buys time to market and sell the home privately.
The critique of mediation is borrowers may be at a disadvantage. It is becoming clear not all loan mods are the same. A loan mod that moves fees to the final payment in 20 years and lowers the interest rate for a few years has less than a 50-50 shot at success. A mod with principal reduction has better odds - maybe as much as 80% will succeed. Mediation may result in naive borrowers agreeing to mods with weak terms and few net gains. One could imagine discretion on the part of lenders resulting in disparate impacts by race, income, location or in all three dimensions.
Enter the role of education and counseling. Prior to the mediation the borrower has to so some homework. Ohio's program has such a requirement. How well borrowers can be trained to explore their options is an open question, but it beats going in unarmed with a sophisticated lender.
There are lots of problems - like dealing with high volumes of foreclosure filings, getting borrowers to pay attention at all, compensating mediators and counselors, getting lenders/servicers to create mods that really can succeed given investor and legal issues with mortgage securities--just to name a few.
To be sure, if a mortgage cram down bankruptcy provision is passed at the Federal level, lenders may seek alternatives such as mediation with open arms. And anything that attempts to get the borrower to take action before the auction is socially valuable, even if the mediation does not result in a mod. Given the slow pace to restructuring individual mortgages we have seen so far, the mediation approach may have potential.
More Incentives to Borrow
The stimulus package contains so much it is hard to parse it all out. But there are several provisions to encourage consumer borrowing - notably to buy a first home and a car. The first-time buyer tax credit for homebuyers is actually an oldie but goodie. Every economic slowdown the Home Builders and allies promote such a credit. The tax deduction for 1 years worth of car loan--and deduction of sales tax for an auto purchase is a new one. Certainly it makes borrowing to buy a car more attractive, especially if you can pay off the loan in year two and avoid all that non-tax advantaged interest. Will consumers take the bait? Will lenders gin up loan volumes, or just make loans to prime credit borrowers? Don't be suprised if consumers and lenders still are conservative. If not, then the lessons of the last two years will have been too quickly lost. Ideally lending will return slowly and carefully on both the supply and demand side. There could be a real danger to an artificial boom...another lesson which may all to quickly be forgotten. We'll just have to wait and see.
Follow up: for fun (and sadly true):
http://www.hulu.com/watch/1389/saturday-night-live-dont-buy-stuff
Follow up: for fun (and sadly true):
http://www.hulu.com/watch/1389/saturday-night-live-dont-buy-stuff
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