The 2008 National Association of Regulatory Utility Commissioners (NARUC)
Collections Report came out this week. This association of state regulatory agencies surveys public utilities - 41 state agencies took part - to document payment problems experienced by residential energy consumers. The Summary Report is online, as well as a state by state tabulation. The headline is 1 in 5 consumers are behind. The share of utility bills that are behind is up a little bit between mid 2007 and mid 2008 (the survey took place earlier this year) and all evidence suggests things are worse now. Utilities may not cut off service in the winter and some sophisticated consumers might exploit this to pay off other bills first and pay utilities later...when spring comes and termination is threatened. Nevertheless the amount past due is also rising, as well as terminations and write offs, all of which are signs of distress.
The major policy at the federal level is LIHEAP (low income heating energy assistance program). This is about $5 billion block granted and distributed at the local level. This NARUC survey suggest less than 5% of gas consumers, and 2.5% of electric, get any help from this program.
Data from MortgageKeeper.org, which tracks what services mortgage default counselors are referring clients to, suggests as many as half of callers with referrals are looking for utility bill help. As winter sets in the trend is very predictable, especially in the Midwest.
There are only so many consumer dollars available to pay off monthly obligations. Proposals to boost LIHEAP or similar programs may have merit not only to help people in a recession but help prevent more mortgage defaults.
This issue highlights the need to better understand how many consumers manage their budgets. Financial education may help, but for some a pattern of trading off bills and late fees due to delinquencies may be rational and deliberate--but risky. Utility companies have robust data on payment patterns, including the form of payment (for example: money orders or cash = unbanked). Moreover utility company data offers information on consumers at all levels of income. Paying more attention to consumers in this market is likely to yield key proxy indicators of what is going on in the economy overall - yet another canary in the coal mine.
Friday, December 19, 2008
Monday, December 8, 2008
Tough Calls: A Mortgage Bailout
I spent a very interesting day and a half at the Fed last week at Housing and Mortgage Markets Conference. One idea that seems to be gaining momentum is that the Treasury (or FDIC, or FHA or all of these with the Fed) will start to buy pools of troubled loans with the idea of working out solutions to foreclosure. Now the FDIC has something like this with IndyMac- the FDIC took over this failing lender and is experimenting with modifications at scale. But for loans with interests across lots of private securities in the form or MBS (mortgage backed securities) this will not work. And this FDIC program is not getting strong response from borrowers because there is no principal reduction, and most are 'under water'. The FHA Hope for Homeowners (H4H) offers a solution, but lenders/investors must write down the principal balance and taking that loss is not attractive.
So the solution seems to be some method of buying pools, refinancing the loans into lower rate/lower balance mortgages, and then using FHA HFH insurance on the loans to make the loans something private lenders will hold. The result is the private MBS market comes back to life, borrowers who owe more than their home is worth will feel more secure and maybe ride out the house price drop, and home sales may stabilize. It makes some sense.
Problems? Many.
(1) It will be costly. Sure there is an upside if the government holds loans and performance improves. And with H4H any future appreciation of homes goes back to FHA and the Treasury (the borrower writes a check for 1/2 of any gain in value at sale or refinance). But there will be losses. And taxpayers in low foreclosure areas will be subsidizing those in high foreclosure areas with the aim of stabilizing 'national' credit and housing markets.
(2) Mechanism for purchase. How will Treasury pick which MBS pools to buy? It is unclear if the MBS pools have enough information available to make judgments about which pools will create the most bang for the buck. Since no other buyers in the MBS market have the ability to force mass loan modifications it is hard to imagine how pricing will work.
(3) Dealing with borrowers. How will they be contacted and lead into better loans? If deals are offered to all borrowers and borrowers opt in, some speculative borrowers who do not deserve it will latch on. While others will remain ignorant and miss out. Lots of issues remain here and judgments may end up being made about who deserves help. Further imagine sophisticated H4H borrowers who now see prices on the way up...there will be much gamesmanship in just when to sell or refinance to avoid a stiff appreciation penalty. And clearly borrowers who get their principal balance cut MUST pay some price for that...there is a strong moral hazard problem otherwise.
That said, of all the options on the table, this probably has the most merit. It seems very unlikely bankruptcy courts are a good route (timing, cost, volume, precedent, etc). And doing nothing will be very costly for the economy and credit markets. Foreclosure sales may run as high as 1 million out of the 4-5 million home sales this next year. 1 in 5 or 1 in 4 sales by some measures. Higher in some areas. We know forced sales like foreclosure depress home sales and prices (see this paper). It starts to add up fast.
One other theme I heard last week is that this housing market is actually quite normal. Most of the foreclosure problem is in CA, FL, NV and AZ. These states have been through boom and bust before. And the midwestern 'rust belt' is suffering but for a different reason - lack of jobs. It has been in a long term decline for quite a while. The rest of the country has pretty typical patterns in sales and prices for a recession. But because of the very high levels of consumer debt and the fact that that debt was sold and packaged as MBS and other forms of leveraged securities, and the fact that the housing market is moving at a national scale, unlike in past cycles, this one will be longer and deeper than before. There are signs the market will bottom out in 2009, based mostly in the CA, FL, NV, AZ markets' rapid tumble. But it will be a long flat bottom on the upturn, not a fast V-shaped recovery, mostly because credit markets are stuck but also the recession in jobs and investment will continue.
So, the outlook is not great. Policymakers have some tough calls to make. Doing nothing seems a poor course of action. Buying pools of MBS and boosting H4H (and investing in FHA infrastructure by the way) might just be the best available option if the details can be refined. With each passing week more research is coming out, lenders are reporting on new innovations and experiments and market participants are re-evaluating prices and information. The picture is getting clearer, and whatever happens it won't be cheap.
So the solution seems to be some method of buying pools, refinancing the loans into lower rate/lower balance mortgages, and then using FHA HFH insurance on the loans to make the loans something private lenders will hold. The result is the private MBS market comes back to life, borrowers who owe more than their home is worth will feel more secure and maybe ride out the house price drop, and home sales may stabilize. It makes some sense.
Problems? Many.
(1) It will be costly. Sure there is an upside if the government holds loans and performance improves. And with H4H any future appreciation of homes goes back to FHA and the Treasury (the borrower writes a check for 1/2 of any gain in value at sale or refinance). But there will be losses. And taxpayers in low foreclosure areas will be subsidizing those in high foreclosure areas with the aim of stabilizing 'national' credit and housing markets.
(2) Mechanism for purchase. How will Treasury pick which MBS pools to buy? It is unclear if the MBS pools have enough information available to make judgments about which pools will create the most bang for the buck. Since no other buyers in the MBS market have the ability to force mass loan modifications it is hard to imagine how pricing will work.
(3) Dealing with borrowers. How will they be contacted and lead into better loans? If deals are offered to all borrowers and borrowers opt in, some speculative borrowers who do not deserve it will latch on. While others will remain ignorant and miss out. Lots of issues remain here and judgments may end up being made about who deserves help. Further imagine sophisticated H4H borrowers who now see prices on the way up...there will be much gamesmanship in just when to sell or refinance to avoid a stiff appreciation penalty. And clearly borrowers who get their principal balance cut MUST pay some price for that...there is a strong moral hazard problem otherwise.
That said, of all the options on the table, this probably has the most merit. It seems very unlikely bankruptcy courts are a good route (timing, cost, volume, precedent, etc). And doing nothing will be very costly for the economy and credit markets. Foreclosure sales may run as high as 1 million out of the 4-5 million home sales this next year. 1 in 5 or 1 in 4 sales by some measures. Higher in some areas. We know forced sales like foreclosure depress home sales and prices (see this paper). It starts to add up fast.
One other theme I heard last week is that this housing market is actually quite normal. Most of the foreclosure problem is in CA, FL, NV and AZ. These states have been through boom and bust before. And the midwestern 'rust belt' is suffering but for a different reason - lack of jobs. It has been in a long term decline for quite a while. The rest of the country has pretty typical patterns in sales and prices for a recession. But because of the very high levels of consumer debt and the fact that that debt was sold and packaged as MBS and other forms of leveraged securities, and the fact that the housing market is moving at a national scale, unlike in past cycles, this one will be longer and deeper than before. There are signs the market will bottom out in 2009, based mostly in the CA, FL, NV, AZ markets' rapid tumble. But it will be a long flat bottom on the upturn, not a fast V-shaped recovery, mostly because credit markets are stuck but also the recession in jobs and investment will continue.
So, the outlook is not great. Policymakers have some tough calls to make. Doing nothing seems a poor course of action. Buying pools of MBS and boosting H4H (and investing in FHA infrastructure by the way) might just be the best available option if the details can be refined. With each passing week more research is coming out, lenders are reporting on new innovations and experiments and market participants are re-evaluating prices and information. The picture is getting clearer, and whatever happens it won't be cheap.
Sunday, November 30, 2008
FHA's Role in the Mortgage Market
The December 1 2008 issue of Business Week includes a cover article "The Subprime Wolves are Back". The theme of the piece is that former subprime mortgage brokers and mortgage bankers are now pushing FHA mortgage products. The article suggests FHA will create another $100 billion in taxpayer liabilities due to the higher levels of risk FHA is taking on.
It is a good piece and Business Week actually has done quite a bit of pro-consumer journalism on issues of consumer credit. The content and tone of this article raises is worrisome in several respects, however.
Remember FHA was created in the Depression to insure mortgage loans. FHA-approved lenders can make loans on which they can more or less count on FHA approving a mortgage insurance policy. FHA insurance covers most of any losses a lender might take on a foreclosed loan. The lender ends up paying about $3,000 in costs regardless, so it is not 100% insurance, but pretty close. FHA loans are also more costly to make due to added forms and regulatory processes. So this is not a free lunch for lenders.
But FHA will allow smaller downpayments -as low as 3% - and will permit borrowers to receive loans even if they have less than perfect credit. FHA loans will allow a borrower to access credit sooner after bankruptcy (1-3 years) or a past foreclosure (3 years) than prime loans. FHA historically has not been credit score driven but few FHA loans go to borrowers with credit scores below 580. Borrowers pay an insurance premium - both at the close of the loan and as part of the monthly payment.
In the last decade FHA has generated far more in premiums than it paid out in claims. In 2000 the annual FHA 'surplus' was over $16 billion. Of course all of this went right into the Federal budget - like most programs there is no 'lockbox' for future liabilities. In some years the FHA actually paid out a mutual benefit payment to insureds - and there were many proposals to use the FHA surplus to cut premiums (which happened) or to set up a set-aside fund for affordable housing (which did not). Of course the rise of subprime cut into FHA's business. In 2006, before the bubble burst, policymakers were trying to re-invent FHA since its market share plummeted from about 1 in 5 loans to 1 in 20 loans. The current credit crisis has spawned some new FHA products - like Hope for Homeowners (H4H in HUD-speak). This product allows borrowers who owe more than their home is worth to refinance for a smaller loan, if the lender will write off the remainder. Loan volume has been slow, as you might imagine lenders are not eager to write off loan amounts. There's no free lunch here, either, since homebuyers share half of any future home price gains with FHA.
The Business Week article misses a few points in my opinion. First, FHA has always had issues with fraud. The Sopranos even based an episode on FHA fraud. Mortgage brokers continue to be a problem because they act without skin the the game. The FHA insurance is not the problem, although FHA may be slower to move against problematic lenders than private mortgage insurance companies (this is anecdotal - I have not seen evidence on this). The problem continues to be the structure of the brokerage regulatory structure where states have little ability to oversee individual brokers. FHA adds complexity to the transaction and may create a wedge that makes lenders and borrowers feel they can get away with shadier tactics, but FHA is not a problem by itself.
The second issue the article touches on but fails to detail is FHA's own capacity. The new administration will soon nominate a new FHA commissioner. Most of the recent commissioners of the last 2 decades have been very capable administrators who generally were not pure political appointees. This is a big agency and includes a majority of the staff of the entire department of HUD. It deserves a prominent role with other agencies at the table in addressing the credit crisis. And FHA's aging staff and systems need support, training and replacement.
Finally, the tone of this article suggests that low-income and credit blemished borrowers will all end up in foreclosure. Even among the worst books of business in subprime 2 out of 3 borrowers have not defaulted. FHA's standards are higher and as designed FHA really is supposed to be a credit backstop for smaller first mortgage loans for owner occupants trying to on their feet in the housing market. Some borrowers - especially borrowers from minority communities who historically mistrust banks - trust the FHA brand and prefer FHA insured loans. FHA charges a premium and based on audits these premiums should be able to cover any required payouts. Even if they don't and require a year or two of additional federal budget allocations, years of the FHA 'surplus' likely more than offsets any shortfall during this credit crisis.
It's easy to disparage a government program with ongoing liabilities, especially one involving mortgages. FHA single-family mortgage insurance is generally a good program. As the credit market tightens it is plain old mortgage insurance programs are becoming more important. Its more exotic (and temporary) programs like H4H remain small and mostly experimental. Hopefully FHA administrative capacity will be enhanced and the cases of fraud and lenders with a history of problems will be fixed in the near future. .
It is a good piece and Business Week actually has done quite a bit of pro-consumer journalism on issues of consumer credit. The content and tone of this article raises is worrisome in several respects, however.
Remember FHA was created in the Depression to insure mortgage loans. FHA-approved lenders can make loans on which they can more or less count on FHA approving a mortgage insurance policy. FHA insurance covers most of any losses a lender might take on a foreclosed loan. The lender ends up paying about $3,000 in costs regardless, so it is not 100% insurance, but pretty close. FHA loans are also more costly to make due to added forms and regulatory processes. So this is not a free lunch for lenders.
But FHA will allow smaller downpayments -as low as 3% - and will permit borrowers to receive loans even if they have less than perfect credit. FHA loans will allow a borrower to access credit sooner after bankruptcy (1-3 years) or a past foreclosure (3 years) than prime loans. FHA historically has not been credit score driven but few FHA loans go to borrowers with credit scores below 580. Borrowers pay an insurance premium - both at the close of the loan and as part of the monthly payment.
In the last decade FHA has generated far more in premiums than it paid out in claims. In 2000 the annual FHA 'surplus' was over $16 billion. Of course all of this went right into the Federal budget - like most programs there is no 'lockbox' for future liabilities. In some years the FHA actually paid out a mutual benefit payment to insureds - and there were many proposals to use the FHA surplus to cut premiums (which happened) or to set up a set-aside fund for affordable housing (which did not). Of course the rise of subprime cut into FHA's business. In 2006, before the bubble burst, policymakers were trying to re-invent FHA since its market share plummeted from about 1 in 5 loans to 1 in 20 loans. The current credit crisis has spawned some new FHA products - like Hope for Homeowners (H4H in HUD-speak). This product allows borrowers who owe more than their home is worth to refinance for a smaller loan, if the lender will write off the remainder. Loan volume has been slow, as you might imagine lenders are not eager to write off loan amounts. There's no free lunch here, either, since homebuyers share half of any future home price gains with FHA.
The Business Week article misses a few points in my opinion. First, FHA has always had issues with fraud. The Sopranos even based an episode on FHA fraud. Mortgage brokers continue to be a problem because they act without skin the the game. The FHA insurance is not the problem, although FHA may be slower to move against problematic lenders than private mortgage insurance companies (this is anecdotal - I have not seen evidence on this). The problem continues to be the structure of the brokerage regulatory structure where states have little ability to oversee individual brokers. FHA adds complexity to the transaction and may create a wedge that makes lenders and borrowers feel they can get away with shadier tactics, but FHA is not a problem by itself.
The second issue the article touches on but fails to detail is FHA's own capacity. The new administration will soon nominate a new FHA commissioner. Most of the recent commissioners of the last 2 decades have been very capable administrators who generally were not pure political appointees. This is a big agency and includes a majority of the staff of the entire department of HUD. It deserves a prominent role with other agencies at the table in addressing the credit crisis. And FHA's aging staff and systems need support, training and replacement.
Finally, the tone of this article suggests that low-income and credit blemished borrowers will all end up in foreclosure. Even among the worst books of business in subprime 2 out of 3 borrowers have not defaulted. FHA's standards are higher and as designed FHA really is supposed to be a credit backstop for smaller first mortgage loans for owner occupants trying to on their feet in the housing market. Some borrowers - especially borrowers from minority communities who historically mistrust banks - trust the FHA brand and prefer FHA insured loans. FHA charges a premium and based on audits these premiums should be able to cover any required payouts. Even if they don't and require a year or two of additional federal budget allocations, years of the FHA 'surplus' likely more than offsets any shortfall during this credit crisis.
It's easy to disparage a government program with ongoing liabilities, especially one involving mortgages. FHA single-family mortgage insurance is generally a good program. As the credit market tightens it is plain old mortgage insurance programs are becoming more important. Its more exotic (and temporary) programs like H4H remain small and mostly experimental. Hopefully FHA administrative capacity will be enhanced and the cases of fraud and lenders with a history of problems will be fixed in the near future. .
Wednesday, November 19, 2008
Health Insurance as a Personal Finance Issue?
(I don't keep up with law journals but seem to keep commenting on them.)
Christopher T. Robertson, Richard Egelhof, & Michael Hoke have a forthcoming an article "Get Sick, Get Out: The Medical Causes of Home Foreclosures" in the health law journal Health Matrix (issue 18 (2008): pps 65-105). The authors sent me a preview copy and it is intriguing.
They surveyed about 2,000 borrowers in 4 key states- California, Florida, New Jersey and Illinois. They pulled data from foreclosure filings with the goal of finding out what got borrowers into trouble. Only 7% of the valid addresses responded, or about 128 borrowers. Not a large sample and the authors concede there could be some bias introduced by low response rates. They do provide some evidence non-response bias is minimal and in any case I am not sure it casts too much doubt on key findings.
Prior studies suggest health problems are associated with financial problems. Overall, this study finds 7 out of 10 respondents had some medical issue in the last year prior to foreclosure being filed. Only 1 out of 3 borrowers blamed their default on rising mortgage payments (or ARM 'resets') and less than 16% said their loan was always unaffordable. Most were facing a combination of a drop in income and unexpected expenses. And most had equity in their home--the "underwater" mortgage story is not what they found even in CA & FL. Only 15% reported being upside down on their mortgage.
46% reported an injury or illness in their household as causing the default. 27% were prevented from working at all due to this and 23% cited high medical bills. Most (more than 2/3rds) had medical insurance, but uncovered costs ran $5,000 on average. Medical expenses eat up modest savings accounts in a hurry. For borrowers who cited medical bills as a cause of default, the average bill was $15,000. More than 1 in 4 used home equity to try to pay off medical debt.
The paper suggests a number of policy options, including staying foreclosure for medical emergencies (not unlike what was attempted post-Hurricane Katrina in certain areas - not related to health issues). It also highlights emergency 'bridge' grants or loans like those provided in some states, HEMAP in Pennsylvania being a leading example. It also suggests health care and consumer health care coverage may be a risk factor lenders and policymakers might need to take more seriously when considering mortgage markets and special mortgage programs for high-risk consumers.
The authors might be able to use some econometric techniques to produce more robust findings, especially related to non-responses. But overall it is a solid effort and suggests more inquiry into this issue is warranted.
Christopher T. Robertson, Richard Egelhof, & Michael Hoke have a forthcoming an article "Get Sick, Get Out: The Medical Causes of Home Foreclosures" in the health law journal Health Matrix (issue 18 (2008): pps 65-105). The authors sent me a preview copy and it is intriguing.
They surveyed about 2,000 borrowers in 4 key states- California, Florida, New Jersey and Illinois. They pulled data from foreclosure filings with the goal of finding out what got borrowers into trouble. Only 7% of the valid addresses responded, or about 128 borrowers. Not a large sample and the authors concede there could be some bias introduced by low response rates. They do provide some evidence non-response bias is minimal and in any case I am not sure it casts too much doubt on key findings.
Prior studies suggest health problems are associated with financial problems. Overall, this study finds 7 out of 10 respondents had some medical issue in the last year prior to foreclosure being filed. Only 1 out of 3 borrowers blamed their default on rising mortgage payments (or ARM 'resets') and less than 16% said their loan was always unaffordable. Most were facing a combination of a drop in income and unexpected expenses. And most had equity in their home--the "underwater" mortgage story is not what they found even in CA & FL. Only 15% reported being upside down on their mortgage.
46% reported an injury or illness in their household as causing the default. 27% were prevented from working at all due to this and 23% cited high medical bills. Most (more than 2/3rds) had medical insurance, but uncovered costs ran $5,000 on average. Medical expenses eat up modest savings accounts in a hurry. For borrowers who cited medical bills as a cause of default, the average bill was $15,000. More than 1 in 4 used home equity to try to pay off medical debt.
The paper suggests a number of policy options, including staying foreclosure for medical emergencies (not unlike what was attempted post-Hurricane Katrina in certain areas - not related to health issues). It also highlights emergency 'bridge' grants or loans like those provided in some states, HEMAP in Pennsylvania being a leading example. It also suggests health care and consumer health care coverage may be a risk factor lenders and policymakers might need to take more seriously when considering mortgage markets and special mortgage programs for high-risk consumers.
The authors might be able to use some econometric techniques to produce more robust findings, especially related to non-responses. But overall it is a solid effort and suggests more inquiry into this issue is warranted.
Friday, November 14, 2008
Mortgage Disclosures, Another Round
HUD has announced a new RESPA (real estate settlement procedures act) regulation. RESPA reforms have been discussed for decades. HUD proposed various reforms to RESPA in the last 8 years each time beaten back by trade groups, other policy priorities or just plain old poor execution. The current change intends to strengthen the Good Faith Estimate (GFE) provided to mortgage loan applicants at or near the time of the first application for a loan. And then to beef up disclosures provided at the closing table. It initially even included a proposal to actually read a script to would-be borrowers about the terms of the loan.
Disclosure can work...if a policy goal is to have borrowers re-think their loan options and shop around or even exit the market. In theory more shopping around results in borrowers finding lower cost options and being better informed. Of course it might also just take up time and energy and gain the borrower little in lowered costs for their efforts. It is hard to say what the 'optimal' amount of shopping should be, although lots of pundits seem to like to make these assumptions lately.
The GFE has long been a problem. Lenders claim that it may be weeks or months from application to closing. It is impossible to say for sure what the interest rate and terms will be for a loan in the future. There is some validity to this. HUD now says the GFE must be within 10% of actual. That is probably a good step, but the GFE is vague and still probably not ideal for comparison shopping. Nor does is suggest/promote shopping. And the consumer really has no way to judge the relative cost of the loan offer compared to what else may be out there.
At the closing table the new RESPA rule requires 3 pages of disclosures about loan terms, prepayment and other penalties, and other conditions. There are several problems with disclosures at the loan closing. First, at this point the borrower has invested time and energy in the deal and basically just wants to sign the loan. Walking away is costly (in terms of opportunity costs at least). Second, there are a number of forms, contracts and disclosures required at closing, especially if the loan closing is simultaneous with a home purchase. Whether the form is written or read aloud, it probably would not have much effect on behavior.
It is interesting to note that the Federal Reserve also has disclosure authority under the Truth in Lending Act (TILA) as well as HOEPA (Home Owner Equity Protection Act). Apparently HUD and the Fed have been working separately on changes to TILA and RESPA changes. HOEPA only applies to high cost loans. My own research on aspects of HOEPA loans suggests a warning " YOU MAY LOSE YOUR HOME" provided at least 3 days before the closing, can be an effective mechanism if a goal is to encourage borrowers to walk away from a loan offer.
The problem borrowers have is judging what is a good deal. For a borrower with perfect credit, scanning the web or a local paper may provide a sense of the best APR available and then look for no fees or points (or the lowest). But what if you don't know if you have good credit? What if you know you have a 600 credit score? It is less clear what the going rate might be. Attempts to standardize pricing have been sporadic at best. One innovative experiment is MortgageGrader.com which offers the equivalent of a blue book guide for mortgages. Perhaps more lenders will follow this model as mortgage lenders consolidate and become more cautious about lending and fear being accused of taking advantage of confused borrowers.
So where does this leave HUD's RESPA reform? It is the right direction, for sure, but short of what consumers would ideally have in a legally mandated disclosure. At the very least the APR, fees and terms of the loan should be provided 3-5 business days before the closing and require a signature from the borrower acknowledging receipt and understanding. The disclosure might also make clear the borrower should shop around for the best terms and conditions, and ideally even suggest sources of information on current interest rates, such as a government website with current rates by credit score (which does not yet exist). Some time of warning about the risks of a loan, including foreclosure, also should be explicit. I suspect some new formats of disclosure may emerge too, such as web-based or video-based information.
The Fed and HUD, and maybe FTC as well, are likely to keep trying to make consumer disclosures better in the next year. There is not a great deal of research in this arena - at least not recent research. Let's hope policymakers are able to come up with sensible solutions in any case.
Disclosure can work...if a policy goal is to have borrowers re-think their loan options and shop around or even exit the market. In theory more shopping around results in borrowers finding lower cost options and being better informed. Of course it might also just take up time and energy and gain the borrower little in lowered costs for their efforts. It is hard to say what the 'optimal' amount of shopping should be, although lots of pundits seem to like to make these assumptions lately.
The GFE has long been a problem. Lenders claim that it may be weeks or months from application to closing. It is impossible to say for sure what the interest rate and terms will be for a loan in the future. There is some validity to this. HUD now says the GFE must be within 10% of actual. That is probably a good step, but the GFE is vague and still probably not ideal for comparison shopping. Nor does is suggest/promote shopping. And the consumer really has no way to judge the relative cost of the loan offer compared to what else may be out there.
At the closing table the new RESPA rule requires 3 pages of disclosures about loan terms, prepayment and other penalties, and other conditions. There are several problems with disclosures at the loan closing. First, at this point the borrower has invested time and energy in the deal and basically just wants to sign the loan. Walking away is costly (in terms of opportunity costs at least). Second, there are a number of forms, contracts and disclosures required at closing, especially if the loan closing is simultaneous with a home purchase. Whether the form is written or read aloud, it probably would not have much effect on behavior.
It is interesting to note that the Federal Reserve also has disclosure authority under the Truth in Lending Act (TILA) as well as HOEPA (Home Owner Equity Protection Act). Apparently HUD and the Fed have been working separately on changes to TILA and RESPA changes. HOEPA only applies to high cost loans. My own research on aspects of HOEPA loans suggests a warning " YOU MAY LOSE YOUR HOME" provided at least 3 days before the closing, can be an effective mechanism if a goal is to encourage borrowers to walk away from a loan offer.
The problem borrowers have is judging what is a good deal. For a borrower with perfect credit, scanning the web or a local paper may provide a sense of the best APR available and then look for no fees or points (or the lowest). But what if you don't know if you have good credit? What if you know you have a 600 credit score? It is less clear what the going rate might be. Attempts to standardize pricing have been sporadic at best. One innovative experiment is MortgageGrader.com which offers the equivalent of a blue book guide for mortgages. Perhaps more lenders will follow this model as mortgage lenders consolidate and become more cautious about lending and fear being accused of taking advantage of confused borrowers.
So where does this leave HUD's RESPA reform? It is the right direction, for sure, but short of what consumers would ideally have in a legally mandated disclosure. At the very least the APR, fees and terms of the loan should be provided 3-5 business days before the closing and require a signature from the borrower acknowledging receipt and understanding. The disclosure might also make clear the borrower should shop around for the best terms and conditions, and ideally even suggest sources of information on current interest rates, such as a government website with current rates by credit score (which does not yet exist). Some time of warning about the risks of a loan, including foreclosure, also should be explicit. I suspect some new formats of disclosure may emerge too, such as web-based or video-based information.
The Fed and HUD, and maybe FTC as well, are likely to keep trying to make consumer disclosures better in the next year. There is not a great deal of research in this arena - at least not recent research. Let's hope policymakers are able to come up with sensible solutions in any case.
Sunday, November 2, 2008
State Foreclosure Laws and Default Counseling
With rising levels of home mortgage foreclosure filings, policymakers are increasingly exploring how public programs and processes can be designed to prevent families from losing their homes.
In a recent paper with Chris Herbert and Ken Lam of Abt Associates, we explore the extent to which consumers may benefit from three types of state foreclosure polices: (1) judicial foreclosure proceedings, (2) rights of redemption, and (3) statewide foreclosure prevention initiatives. We also test how voluntary efforts of lenders to promote third party default counseling may also benefit consumers, as well as how these efforts may be more powerful in states with each state policy.
We used data on 32,000 borrowers in default from one national lender during the 15 month period of January 2007 through March 2008.
In general judicial proceedings, rights of redemption and state foreclosure interventions have little effect on the cure rate or foreclosure avoidance in the period we examined. Although we found weak effects of state policies in general, the direction was inconclusive. Loans in states with judicial proceedings may benefit consumers by allowing more opportunities for borrower-lender contact, but may also be associated with worsening loan outcomes such as foreclosure filings. No state policy was associated with either an increase or a decrease in borrowers losing their homes to foreclosure.
Lender voluntary offers of telephone-based default counseling are associated with about a 12% reduction in days delinquent. This is a promising finding suggesting promoting consumers to call a hotline might actually help consumers (we created a control group using a group of borrowers not offered counseling --so technically we can report on the offer of counseling not the actual receipt of it).
The more interesting finding is that when offers of counseling are implemented in states with foreclosure prevention policies or programs, borrower-lender contact rates are about 12% higher and rates of foreclosure filings 30% lower than when implemented in states without such policies.
The implications of these findings suggest state policy efforts at preventing foreclosure may be enhanced by coordination with financial institutions and counseling providers. So states with high foreclosure rates which offer media campaigns, refinance pools, grants and other initiatives combined with lender offers of default counseling may prove most successful.
The paper will be presented at a couple of conferences in the coming weeks, and likely improved with the comments of discussants. In the meantime a draft version is online.
In a recent paper with Chris Herbert and Ken Lam of Abt Associates, we explore the extent to which consumers may benefit from three types of state foreclosure polices: (1) judicial foreclosure proceedings, (2) rights of redemption, and (3) statewide foreclosure prevention initiatives. We also test how voluntary efforts of lenders to promote third party default counseling may also benefit consumers, as well as how these efforts may be more powerful in states with each state policy.
We used data on 32,000 borrowers in default from one national lender during the 15 month period of January 2007 through March 2008.
In general judicial proceedings, rights of redemption and state foreclosure interventions have little effect on the cure rate or foreclosure avoidance in the period we examined. Although we found weak effects of state policies in general, the direction was inconclusive. Loans in states with judicial proceedings may benefit consumers by allowing more opportunities for borrower-lender contact, but may also be associated with worsening loan outcomes such as foreclosure filings. No state policy was associated with either an increase or a decrease in borrowers losing their homes to foreclosure.
Lender voluntary offers of telephone-based default counseling are associated with about a 12% reduction in days delinquent. This is a promising finding suggesting promoting consumers to call a hotline might actually help consumers (we created a control group using a group of borrowers not offered counseling --so technically we can report on the offer of counseling not the actual receipt of it).
The more interesting finding is that when offers of counseling are implemented in states with foreclosure prevention policies or programs, borrower-lender contact rates are about 12% higher and rates of foreclosure filings 30% lower than when implemented in states without such policies.
The implications of these findings suggest state policy efforts at preventing foreclosure may be enhanced by coordination with financial institutions and counseling providers. So states with high foreclosure rates which offer media campaigns, refinance pools, grants and other initiatives combined with lender offers of default counseling may prove most successful.
The paper will be presented at a couple of conferences in the coming weeks, and likely improved with the comments of discussants. In the meantime a draft version is online.
Foreclosures and Consumer Perceptions
In March 328 owners and renters in greater Chicago answered a set of questions about their willingness to invest in housing. In August 349 renters in greater San Francisco did the same. For each respondent we collected a zip code, allowing a matching of the 'neighborhood' foreclosure rate to the respondent. The result? No surprise, foreclosures weaken consumers' enthusiasm for buying or maintaining a home.
We asked "How many people who buy a home this year will lose it in a foreclosure?". The mean answer was between 35 and 38 in both cities--quite a bit higher than reality (the most pessimistic estimate is 20/100 could lose their home). In both areas each percentage point increase in foreclosure rates (say from 2% to 3%) results in consumers perceiving about a 6/100 increase in the risk of foreclosure. This is controlling for age, income, race, language and other factors. It also includes fixed effects to account for any unobserved characteristics of the zip code.
Among owners in Chicago (owners were not included in the San Fran sample), an increase in foreclosure rates was associated with a 5% decrease in willingness to invest in a $5,000 home repair or improvement. In San Francisco each percentage point boost in foreclosure rates was associated with a 10% drop in agreement with the idea that owning a home is better than renting in general. Renters also show about an 8% reduction in willingness to buy a home in 6 or 12 months for each point rise in foreclosure rates (although not in 36 months).
The general finding is that owners in high foreclosure areas, even controlling for the other factors you might expect to influence opinions, are report a lower level of willingness to maintain their homes. Meanwhile renters in higher foreclosure areas have a reduced willingness to buy a home at least in the short (under 2 years) run. This has the potential to create a negative feedback loop where high foreclosure areas have lower levels of investment in housing, which undermine home values and could result in more foreclosures on the margin.
The current policy debates about rescuing lenders versus borrowers, and the allocation of subsidies to buy/renovate/demolish foreclosed properties should heed these results. Foreclosures do not happen in isolation and the ripple effects of an additional foreclosure on a neighborhood should not be underestimated.
We asked "How many people who buy a home this year will lose it in a foreclosure?". The mean answer was between 35 and 38 in both cities--quite a bit higher than reality (the most pessimistic estimate is 20/100 could lose their home). In both areas each percentage point increase in foreclosure rates (say from 2% to 3%) results in consumers perceiving about a 6/100 increase in the risk of foreclosure. This is controlling for age, income, race, language and other factors. It also includes fixed effects to account for any unobserved characteristics of the zip code.
Among owners in Chicago (owners were not included in the San Fran sample), an increase in foreclosure rates was associated with a 5% decrease in willingness to invest in a $5,000 home repair or improvement. In San Francisco each percentage point boost in foreclosure rates was associated with a 10% drop in agreement with the idea that owning a home is better than renting in general. Renters also show about an 8% reduction in willingness to buy a home in 6 or 12 months for each point rise in foreclosure rates (although not in 36 months).
The general finding is that owners in high foreclosure areas, even controlling for the other factors you might expect to influence opinions, are report a lower level of willingness to maintain their homes. Meanwhile renters in higher foreclosure areas have a reduced willingness to buy a home at least in the short (under 2 years) run. This has the potential to create a negative feedback loop where high foreclosure areas have lower levels of investment in housing, which undermine home values and could result in more foreclosures on the margin.
The current policy debates about rescuing lenders versus borrowers, and the allocation of subsidies to buy/renovate/demolish foreclosed properties should heed these results. Foreclosures do not happen in isolation and the ripple effects of an additional foreclosure on a neighborhood should not be underestimated.
Thursday, October 30, 2008
Foreclosure Patterns
Below is a map of foreclosure patterns per household. The extent of the problem is clear in places in red -like FL and CA.
Why does this matter if you are not being foreclosed on? Because it shakes confidence in the entire housing market. Surveys I ran in CA and IL show that neighborhoods with higher foreclosure rates have scared consumers. Even controlling for income, education, race and other factors, including neighborhood factors, renters in high foreclosure areas are more cautions about buying a home and see the risk of foreclosure as being higher. Homeowners are less likely to take on a home improvement or repair. The collateral damage can be significant.
I will post more on this issue in the coming days, but this map (pulled from foreclosurepulse.com) tells quite a story...
Why does this matter if you are not being foreclosed on? Because it shakes confidence in the entire housing market. Surveys I ran in CA and IL show that neighborhoods with higher foreclosure rates have scared consumers. Even controlling for income, education, race and other factors, including neighborhood factors, renters in high foreclosure areas are more cautions about buying a home and see the risk of foreclosure as being higher. Homeowners are less likely to take on a home improvement or repair. The collateral damage can be significant.
I will post more on this issue in the coming days, but this map (pulled from foreclosurepulse.com) tells quite a story...
Sunday, October 5, 2008
Subprime Myths
The consumer implications of the current mortgage crisis offer rich material for commentary. Nevertheless I feel compelled to comment first on some of the 'facts' that are often thrown about this ‘subprime mortgage crisis.’
1) The problem is too many poor people became first-time homeowners. And 'poor' means lower-income and minority families. It is true homeownership rates hit record highs in the last decade. It is also true much of the growth in ownership came from younger households - Gen Y and Gen X. Much of what happened was pure demographics, however. Demographers in the 90s predicted a boom in homebuying even before it started. Gen X has a tendency to do things later (get education, settle down, have a family, etc) and Gen Y to do things faster. Right there you have the makings of a boom (plus Gen Y is quite large a birth cohort). These groups also tend to be lower-income by virtue of being younger and have a larger percentage of non-white members with higher birth rates than average. The result: more minority homebuyers. The market catered to these buyers with low-downpayment loans. Then, as house prices shot up, offered multiple varieties of home equity loans to provide extra cash to these households to make consumer purchases or pay off credit cards. When house prices dropped, these same households lack the deeper pockets of older age cohorts and also greater job instability. It is true these households entering the market put upward pressure on house prices at the entry level and this cascaded on up the housing value pyramid. But these buyers are not speculators nor more risky in terms of non-payment of loans.
2) Government policies like the Community Reinvestment Act (CRA) caused the speculative bubble and created subprime loans. This one seems to be getting a lot of play. Let's be clear about what CRA is. It was created in the 1970s because banks took deposits from large groups of people who they would never make loans to. And from areas where they would not make loans ('redlining' certain areas as unqualified for a loan). CRA is all-in-all a pretty weak provision. A lot of bankers and economists hate CRA because it forces banks to make certain loans. But in reality a poor CRA rating creates a slight case of bad PR and may slow down a bank's ability to take over another bank, or be taken over, but that's about all. Importantly, CRA is only applied to depositories. Nearly all subprime lenders were not depositories, but went right to capital markets. So the growth of subprime was all OUTSIDE of the scope of CRA. One could argue that because banks largely ignored borrowers with poor credit, subprime filled that vacuum. Had CRA encouraged more innovations, more careful loans by CRA-covered banks might have been offered and made to those borrowers who ended up in subprime loans.
3) Fannie Mae and Freddie Mac fueled the subprime market into excess. This is another popular line in the OpEd pages. Fannie and Freddie (the GSEs) are huge political targets. Republicans have always argued against their public-private structure, while Democrats benefited from the GSE’s largess. The GSEs are complicated and there is logic to their existence, but their implicit guarantee structure was clearly flawed. These entities were established to create a mortgage market, but within a set of guidelines. GSEs buy whole loans from banks and then split out the cash flow to investors who buy into a security (MBS). GSE guidelines focused on 80% loan to value ratio loans- so borrowers had a fat downpayment or mortgage insurance. And GSEs also had high credit standards. So they did not make subprime loans. One of the flaws of the GSE model is they could borrow at very low rates - close to Treasury rates - and then lend at higher rates. So the GSEs would not just buy and package loans, they would also buy their own securities as well as other MBS on the market. By law they could not take on much risk - so they bought the AAA-rated top level tranches. This meant they got paid first even if there were more defaults in the pool of loans underlying the MBS than expected. Lots of investors bought these top-tiers of MBS on subprime loans - insurance companies, pension funds and foreign governments. In general these top tiers of these MBS issues are still paying as expected...an often overlooked fact. But the value of these securities has plummeted since no investor wants them. Much like the homebuyer who owes more on their home than it can be sold in the market, the GSEs were sitting on investments worth far less than their book value. The whole mortgage market was around $12 billion. Subprime about $1 billion. The GSEs were about involved in abut 20% of the overall mortgage market and bought the AAA pieces of between 25% and 40% of all subprime MBS. So they did provide capital to the subprime market, and at a higher rate than they provided to the overall market (this varies by year however). Between the I-Banks, commercial banks and sovereign funds, subprime MBS would have grown during the housing bubble, even without the GSEs. The GSEs fueled the fire, but hardly caused subprime lenders to take on more risks...remember someone else bought the riskier lower-tranches of MBS for the GSEs to buy the top rated tranches.
4) The Clinton/Bush Administration pushed too many people into buying homes. Nearly every president since Hoover has promoted homeownership. It is the 'American Dream' after all. Clinton and Bush had homeownership goals, but these goals were very close to what demographers predicted would happen anyway. On net these programs amounted to some homebuyer education (averaging $30-50 million per year, which is not much at a national scale) and some special programs serving a few thousand families annually. All of this was more PR than substance. And amounted to little especially relative to the massive $60-80 billion in tax breaks offered to homeowners annually.
Foreclosures today are mostly (a) people who have refinanced and taken out cash (b) people who bought at the peak of the housing bubble (c) speculators--mostly in California, Florida, Arizona and Nevada. In all cases they are in troubled because we had a housing bubble and they owe more than their home is worth. My guess from data I have from one major lender is true speculators, meaning people buying property to rent or flip, account for less than 10% of foreclosures. Peak bubble buyers who took out purchase loans worth more than the house was ever worth are less than a quarter. The remainder are people who used their equity to pay off other debt and now owe more than the house is worth. Think of the mortgage like the coral reef - it collects the toxins in household consumption behavior. All the credit card and other debt winds up there.
So who's fault is the current mess? Lenders offered easy credit, thanks in part to over-reliance on technology for underwriting loans. Wall Street thought MBS carried little risk and plowed cheap money into the market. The GSEs were certainly sloppy in their management and accounting for the risk and value of investments in MBS. But at the street, mortgage brokers, real estate agents, appraisers and buyers and sellers all bought into the notion that house prices could only go up and never would go down everywhere at once. They were wrong. Prices are likely to go down 25-30% from their peak, if not more. Even classic 20% downpayment loans are in trouble. This is not just a subprime problem anymore.
1) The problem is too many poor people became first-time homeowners. And 'poor' means lower-income and minority families. It is true homeownership rates hit record highs in the last decade. It is also true much of the growth in ownership came from younger households - Gen Y and Gen X. Much of what happened was pure demographics, however. Demographers in the 90s predicted a boom in homebuying even before it started. Gen X has a tendency to do things later (get education, settle down, have a family, etc) and Gen Y to do things faster. Right there you have the makings of a boom (plus Gen Y is quite large a birth cohort). These groups also tend to be lower-income by virtue of being younger and have a larger percentage of non-white members with higher birth rates than average. The result: more minority homebuyers. The market catered to these buyers with low-downpayment loans. Then, as house prices shot up, offered multiple varieties of home equity loans to provide extra cash to these households to make consumer purchases or pay off credit cards. When house prices dropped, these same households lack the deeper pockets of older age cohorts and also greater job instability. It is true these households entering the market put upward pressure on house prices at the entry level and this cascaded on up the housing value pyramid. But these buyers are not speculators nor more risky in terms of non-payment of loans.
2) Government policies like the Community Reinvestment Act (CRA) caused the speculative bubble and created subprime loans. This one seems to be getting a lot of play. Let's be clear about what CRA is. It was created in the 1970s because banks took deposits from large groups of people who they would never make loans to. And from areas where they would not make loans ('redlining' certain areas as unqualified for a loan). CRA is all-in-all a pretty weak provision. A lot of bankers and economists hate CRA because it forces banks to make certain loans. But in reality a poor CRA rating creates a slight case of bad PR and may slow down a bank's ability to take over another bank, or be taken over, but that's about all. Importantly, CRA is only applied to depositories. Nearly all subprime lenders were not depositories, but went right to capital markets. So the growth of subprime was all OUTSIDE of the scope of CRA. One could argue that because banks largely ignored borrowers with poor credit, subprime filled that vacuum. Had CRA encouraged more innovations, more careful loans by CRA-covered banks might have been offered and made to those borrowers who ended up in subprime loans.
3) Fannie Mae and Freddie Mac fueled the subprime market into excess. This is another popular line in the OpEd pages. Fannie and Freddie (the GSEs) are huge political targets. Republicans have always argued against their public-private structure, while Democrats benefited from the GSE’s largess. The GSEs are complicated and there is logic to their existence, but their implicit guarantee structure was clearly flawed. These entities were established to create a mortgage market, but within a set of guidelines. GSEs buy whole loans from banks and then split out the cash flow to investors who buy into a security (MBS). GSE guidelines focused on 80% loan to value ratio loans- so borrowers had a fat downpayment or mortgage insurance. And GSEs also had high credit standards. So they did not make subprime loans. One of the flaws of the GSE model is they could borrow at very low rates - close to Treasury rates - and then lend at higher rates. So the GSEs would not just buy and package loans, they would also buy their own securities as well as other MBS on the market. By law they could not take on much risk - so they bought the AAA-rated top level tranches. This meant they got paid first even if there were more defaults in the pool of loans underlying the MBS than expected. Lots of investors bought these top-tiers of MBS on subprime loans - insurance companies, pension funds and foreign governments. In general these top tiers of these MBS issues are still paying as expected...an often overlooked fact. But the value of these securities has plummeted since no investor wants them. Much like the homebuyer who owes more on their home than it can be sold in the market, the GSEs were sitting on investments worth far less than their book value. The whole mortgage market was around $12 billion. Subprime about $1 billion. The GSEs were about involved in abut 20% of the overall mortgage market and bought the AAA pieces of between 25% and 40% of all subprime MBS. So they did provide capital to the subprime market, and at a higher rate than they provided to the overall market (this varies by year however). Between the I-Banks, commercial banks and sovereign funds, subprime MBS would have grown during the housing bubble, even without the GSEs. The GSEs fueled the fire, but hardly caused subprime lenders to take on more risks...remember someone else bought the riskier lower-tranches of MBS for the GSEs to buy the top rated tranches.
4) The Clinton/Bush Administration pushed too many people into buying homes. Nearly every president since Hoover has promoted homeownership. It is the 'American Dream' after all. Clinton and Bush had homeownership goals, but these goals were very close to what demographers predicted would happen anyway. On net these programs amounted to some homebuyer education (averaging $30-50 million per year, which is not much at a national scale) and some special programs serving a few thousand families annually. All of this was more PR than substance. And amounted to little especially relative to the massive $60-80 billion in tax breaks offered to homeowners annually.
Foreclosures today are mostly (a) people who have refinanced and taken out cash (b) people who bought at the peak of the housing bubble (c) speculators--mostly in California, Florida, Arizona and Nevada. In all cases they are in troubled because we had a housing bubble and they owe more than their home is worth. My guess from data I have from one major lender is true speculators, meaning people buying property to rent or flip, account for less than 10% of foreclosures. Peak bubble buyers who took out purchase loans worth more than the house was ever worth are less than a quarter. The remainder are people who used their equity to pay off other debt and now owe more than the house is worth. Think of the mortgage like the coral reef - it collects the toxins in household consumption behavior. All the credit card and other debt winds up there.
So who's fault is the current mess? Lenders offered easy credit, thanks in part to over-reliance on technology for underwriting loans. Wall Street thought MBS carried little risk and plowed cheap money into the market. The GSEs were certainly sloppy in their management and accounting for the risk and value of investments in MBS. But at the street, mortgage brokers, real estate agents, appraisers and buyers and sellers all bought into the notion that house prices could only go up and never would go down everywhere at once. They were wrong. Prices are likely to go down 25-30% from their peak, if not more. Even classic 20% downpayment loans are in trouble. This is not just a subprime problem anymore.
Wednesday, September 24, 2008
The Subprime Solution
I just picked up Robert Shiller's Subprime Solution. It is a quick read and I highly recommend it. Despite its title, I am not sure the book presents a perfect prescription for policymakers today. Shiller obviously wrote the book before the fatal issues with the GSE's, AIG and I-banks emerged. His main proposal is to re-establish the Home Owner's Loan Corporation to buy up distressed assets...an idea that has been tossed around for at least a year. But there is a lot to like about this book.
First, Shiller provides a nice background on the run up in house prices. In general research has been focused on asset bubbles for quite some time. He wrote Irrational Exuberance on the tech stock bubble (also a recommended read). Subprime Solution echoes many of the ideas of that book - that markets and economists tend to forget that psychology matters. People get caught up in a frenzy and start to believe prices can only go up (or if prices go down, it won't happen all at once or as much as what can and does happen). It is a compelling and easy to read description of the evidence. Too often we read the popular press blame the foreclosure crisis on the Fed keeping interest rates low, or, my personal favorite, Community Reinvestment Act lending (never mind almost all subprime lenders were not covered by CRA). He offers a simple explanation of a speculative bubble that fueled homeowners, bankers, Wall Street, ratings agencies and even policymakers. I think this is mostly right and not well understood.
Second, Shiller offers a wide ranging set of longer-term priorities. While this section reads as a bit of a grab bag, there are some great nuggets here. What I am most struck by is his emphasis on consumers. He discusses improvements to the 'information infrastructure' which will help prevent future problems. Number one is "comprehensive financial advice," especially for lower-income consumers. This might include subsidized fee-only financial planning (an idea EARN is working on in San Francisco, along with a handful of other nonprofits in other areas) or even new technologies. He also talks about using learnings from behavioral finance, such as relying more on default options in mortgage product promotion, and continuously adjustable mortgage contracts which in effect modify themselves as housing or economic conditions change over time. He also provides a critique of too low FDIC and SPIC deposit insurance coverage. All in all a nice collection of ideas.
Shiller concludes by plugging ideas he has worked on for a decade or more, including home equity insurance (he even notes his experiment in Syracuse NY run with Neighborhood Reinvestment Corporation) and options markets consumers can use to hedge drops in real estate prices.
Shiller's general theme in Subprime Solution is the Great Depression spurred the creation of bold social experiments - many of which still exist and play a vital role in the economy - like FHA and FDIC deposit insurance. He thinks today's crisis should result in a similar response. Time will tell if he is correct, but kudos for writing such a timely and accessible summary of policy options today, and for keeping consumer behavior at the center of the debate.
First, Shiller provides a nice background on the run up in house prices. In general research has been focused on asset bubbles for quite some time. He wrote Irrational Exuberance on the tech stock bubble (also a recommended read). Subprime Solution echoes many of the ideas of that book - that markets and economists tend to forget that psychology matters. People get caught up in a frenzy and start to believe prices can only go up (or if prices go down, it won't happen all at once or as much as what can and does happen). It is a compelling and easy to read description of the evidence. Too often we read the popular press blame the foreclosure crisis on the Fed keeping interest rates low, or, my personal favorite, Community Reinvestment Act lending (never mind almost all subprime lenders were not covered by CRA). He offers a simple explanation of a speculative bubble that fueled homeowners, bankers, Wall Street, ratings agencies and even policymakers. I think this is mostly right and not well understood.
Second, Shiller offers a wide ranging set of longer-term priorities. While this section reads as a bit of a grab bag, there are some great nuggets here. What I am most struck by is his emphasis on consumers. He discusses improvements to the 'information infrastructure' which will help prevent future problems. Number one is "comprehensive financial advice," especially for lower-income consumers. This might include subsidized fee-only financial planning (an idea EARN is working on in San Francisco, along with a handful of other nonprofits in other areas) or even new technologies. He also talks about using learnings from behavioral finance, such as relying more on default options in mortgage product promotion, and continuously adjustable mortgage contracts which in effect modify themselves as housing or economic conditions change over time. He also provides a critique of too low FDIC and SPIC deposit insurance coverage. All in all a nice collection of ideas.
Shiller concludes by plugging ideas he has worked on for a decade or more, including home equity insurance (he even notes his experiment in Syracuse NY run with Neighborhood Reinvestment Corporation) and options markets consumers can use to hedge drops in real estate prices.
Shiller's general theme in Subprime Solution is the Great Depression spurred the creation of bold social experiments - many of which still exist and play a vital role in the economy - like FHA and FDIC deposit insurance. He thinks today's crisis should result in a similar response. Time will tell if he is correct, but kudos for writing such a timely and accessible summary of policy options today, and for keeping consumer behavior at the center of the debate.
Monday, September 22, 2008
A New Structure for Financial Insitutions, and Regulators?
Today we hear news many old line investment banks are reorganizing as commercial banks or bank holding companies. No long ago (like a year) commercial banks were considered too old school for modern capital markets. Now being regulated as a bank means ready access to the historically little-used Federal Reserve's cash drawer. Given the sense among investors that investment banks lack liquidity or ready access to capital, just having the option to tap the Fed's money may be viewed as a plus.
This just highlights our fractured regulatory system. In 1999 decades old restrictions on blending banking, insurance and investing functions were repealed. Yet the regulatory system remained a mix of mortgage lending compliance, capital ratios for depositories, lighter oversight of some holding companies and then the SEC for Wall Street. It seems the market might actually appreciate one set of rules which serve to reduce overall financial institution risk taking and also make information more transparent across firms. Commonly applied asset ratios means the former investment bank will need to have more cash and liquid assets and will not longer be able to place huge bets by borrowing or swapping liabilities.
During the S&L crisis of the 1980s (which rolled into the 1990s) there were some changes in the structure and functions of the bank regulators --to review this includes: the OTS (part of Treasury focused on thrifts or S&Ls), OCC ('national' banks), FDIC (state chartered but also broader functions related to deposit insurance), the Fed or 'FRB' (holding companies and commercial banks), HUD (a grab bag of institions doing mortgage lending including many former subprime institutions) and NCUA (credit unions).
In the last year the Federal Reserve has been clarified as the super-regulator. In general the regulatory agencies seem to be getting along (except maybe the SEC ). But as policymakers mull their chocies this week it is time to re-examine a more modern system of regulation with one agency outside of the executive branch to work with Treasury as needed.
In the process the community/public/consumer affairs function hopefully can be strenthened. Likewise the commitment to fair lending and community reinvestment can be affirmed. The UK's Financial Services Authority used to be a model to look towards, but the breakdown related to Northern Rock last year might suggest even the FSA model did not go far enough (the FSA lacked the Fed's market mechanism--that stayed with central bank).
In the 1990s financial instututions would shop around altering their charter or aquisitions to find a regulatory agency they felt best met their needs. In hindsight a standardize higher regulatory bar would have been a better approach. One could imagine the FDIC as the insurance agency, as well as expert in taking over failing banks. The FDIC could assess safety and soundness risk and be ready to jump in when firm-level instability looked immenient. The Fed could then take the OCC, OTS and NCUA under its wing, taking on safety and soundness as well as consumer affairs and fair lending.
Most likely there will be resistence to changes and agencies won't willingly give up power. With mega-bank instutitions like Bank of America, Citi, JPMorgan/Chase, and now Goldman and Morgan Stanley under the Fed's purview, the odds are more in favor of the Fed being the achitect of the regulatory structure going forward. Regardless, let's hope the new structure includes a robust consumer perspective in addition to making investors feel more secure about putting money into institutions.
This just highlights our fractured regulatory system. In 1999 decades old restrictions on blending banking, insurance and investing functions were repealed. Yet the regulatory system remained a mix of mortgage lending compliance, capital ratios for depositories, lighter oversight of some holding companies and then the SEC for Wall Street. It seems the market might actually appreciate one set of rules which serve to reduce overall financial institution risk taking and also make information more transparent across firms. Commonly applied asset ratios means the former investment bank will need to have more cash and liquid assets and will not longer be able to place huge bets by borrowing or swapping liabilities.
During the S&L crisis of the 1980s (which rolled into the 1990s) there were some changes in the structure and functions of the bank regulators --to review this includes: the OTS (part of Treasury focused on thrifts or S&Ls), OCC ('national' banks), FDIC (state chartered but also broader functions related to deposit insurance), the Fed or 'FRB' (holding companies and commercial banks), HUD (a grab bag of institions doing mortgage lending including many former subprime institutions) and NCUA (credit unions).
In the last year the Federal Reserve has been clarified as the super-regulator. In general the regulatory agencies seem to be getting along (except maybe the SEC ). But as policymakers mull their chocies this week it is time to re-examine a more modern system of regulation with one agency outside of the executive branch to work with Treasury as needed.
In the process the community/public/consumer affairs function hopefully can be strenthened. Likewise the commitment to fair lending and community reinvestment can be affirmed. The UK's Financial Services Authority used to be a model to look towards, but the breakdown related to Northern Rock last year might suggest even the FSA model did not go far enough (the FSA lacked the Fed's market mechanism--that stayed with central bank).
In the 1990s financial instututions would shop around altering their charter or aquisitions to find a regulatory agency they felt best met their needs. In hindsight a standardize higher regulatory bar would have been a better approach. One could imagine the FDIC as the insurance agency, as well as expert in taking over failing banks. The FDIC could assess safety and soundness risk and be ready to jump in when firm-level instability looked immenient. The Fed could then take the OCC, OTS and NCUA under its wing, taking on safety and soundness as well as consumer affairs and fair lending.
Most likely there will be resistence to changes and agencies won't willingly give up power. With mega-bank instutitions like Bank of America, Citi, JPMorgan/Chase, and now Goldman and Morgan Stanley under the Fed's purview, the odds are more in favor of the Fed being the achitect of the regulatory structure going forward. Regardless, let's hope the new structure includes a robust consumer perspective in addition to making investors feel more secure about putting money into institutions.
Sunday, September 14, 2008
Fannie and Freddie: Implications for Consumer Policy?
The news from Wall Street just keeps coming. I have been drafting thoughts on current events and then constantly revising them as more information comes out. It looks like AIG will have access to an infusion of public capital, but at a cost to shareholders and management, much like Fannie Mae and Freddie Mac. But the issues are very different.
Fannie and Freddie - the government sponsored enterprises (GSEs) - were created as a public-private enterprises. They have historically played a key role in buying whole mortgages from banks, allowing banks to make more mortgage loans. This secondary market function was an innovation and has helped the banking system overall.
The public part of the GSE mission has been widely debated for years. Investors always believed there was an implicit government backing for Fannie and Freddie. Investors behaved like GSE securities were 'almost' like Treasury securities. This gave the GSEs access to lower cost capital and ultimately allowed for lower interest rates on mortgages. How much lower? There have been several studies. The most objective study (arguably) is from the Fed (in the Alan Greenspan era) and suggests about 25 basis points lower interest rates on conforming mortgages. That is one-quarter of 1 percentage point of interest. Not that much for a consumer to notice, really, but it is something from the view of capital markets.
The other function of the GSEs that is less discussed is as a 'backstop' in the capital markets for mortgages available to the middle class. A few years ago many argued banks had direct access to Wall Street and the GSE function was outdated. But as we have just seen, investor capital moves globally in seconds. As confidence in mortgages and financial institutions weakens, investors pull out rapidly. For some lenders there would be no more capital to make another mortgage loan without access to a stablized secondary market. A consumer who is in need of cash to pay for an unexpected expense might not be able to take out a home equity loan. Someone moving might not be able to sell their home because no cash buyers exist. It gets ugly fast.
There has been widespread criticism of how the GSEs have been treated. This summer's announcement that Treasury has the power to take over the GSEs, but no one at Treasury thought they would need to use it had a destabilizing effect. Investors were not comfortable with being in limbo- "maybe the government will take over and maybe that means shareholders are wiped out." In a market with extremely low tolerance for uncertainty, investors ran from Fannie and Freddie. As these firms had losses on the lending side they needed capital, but no investor was willing to go there. In the end Treasury had no choice. Fannie and Freddie shares still exist, but are worth just pennies.
So now what? With all the news about Lehman and AIG, we have not heard much on Fannie and Freddie the last few days. Key staff are heading for the exits, and that is troubling. But the GSE market function is still working. Mortgage rates are somewhat stable. Local lenders can still operate.
How will the GSEs look in the future? We don't know how Treasury will proceed. The clean-up alone will take a while. One view is to spilt them up into 5-6 smaller secondary market firms to buy loans. The Federal Home Loan Banks played a bit of this game a few years back. It is not clear more smaller firms helps overall, and there will always be returns to scale such that consolidation could make economic sense. Firms could specialize by type of loan or region, but that presents problems in terms of concentrated risk.
Regardless of the institutional structure, the public-private GSE structure needs review. The government guarantee needs to be priced and made into legal contracts. The affordable housing function of the GSEs should continue at least as long as the GSEs have some federal support and probably longer. If banks are required to make lending balance deposits under the Community Reinvestment Act, then there must be a vibrant secondary market to support this function. It is hard to imagine a completely private mortgage secondary market. In fact the 3rd GSE - Ginnie Mae - is essentially a department of HUD and facilitates the secondary market for mortgages insured by FHA/VA mortgage insurance. This is going to be complex to sort out.
Unfortunatelty election year politics are caught up in all of this. Most policymakers don't have a full understanding of the issues involved. Career staff at Treasury and HUD, as well as the Fed, will have their hands full for quite some time. Consumer advocates need to be as well informed as possible and make sure lending markets are stable and capital keeps flowing especially for the market segments least well served by the financial market--working families in older urban areas and rural markets--as well as immigrants and minorities with no connections to the financial sector. These consumers are going to continue to be first-time homebuyers, especially as home prices come back down to more affordable levels.
A recent survey I helped run in California and Illinois shows moderate income renters are as interested in buying a home as ever. They see prices coming down and want to own a home. But they also see the risks, and want to be well-educated how to buy a home and find a mortgage loan (in fact they tend to substantially over-estimate the risks of foreclosure--we'll save that for another post). The majority have doubts any lender will offer them a loan. Reading the current press and watching the media, no wonder.
Fannie and Freddie - the government sponsored enterprises (GSEs) - were created as a public-private enterprises. They have historically played a key role in buying whole mortgages from banks, allowing banks to make more mortgage loans. This secondary market function was an innovation and has helped the banking system overall.
The public part of the GSE mission has been widely debated for years. Investors always believed there was an implicit government backing for Fannie and Freddie. Investors behaved like GSE securities were 'almost' like Treasury securities. This gave the GSEs access to lower cost capital and ultimately allowed for lower interest rates on mortgages. How much lower? There have been several studies. The most objective study (arguably) is from the Fed (in the Alan Greenspan era) and suggests about 25 basis points lower interest rates on conforming mortgages. That is one-quarter of 1 percentage point of interest. Not that much for a consumer to notice, really, but it is something from the view of capital markets.
The other function of the GSEs that is less discussed is as a 'backstop' in the capital markets for mortgages available to the middle class. A few years ago many argued banks had direct access to Wall Street and the GSE function was outdated. But as we have just seen, investor capital moves globally in seconds. As confidence in mortgages and financial institutions weakens, investors pull out rapidly. For some lenders there would be no more capital to make another mortgage loan without access to a stablized secondary market. A consumer who is in need of cash to pay for an unexpected expense might not be able to take out a home equity loan. Someone moving might not be able to sell their home because no cash buyers exist. It gets ugly fast.
There has been widespread criticism of how the GSEs have been treated. This summer's announcement that Treasury has the power to take over the GSEs, but no one at Treasury thought they would need to use it had a destabilizing effect. Investors were not comfortable with being in limbo- "maybe the government will take over and maybe that means shareholders are wiped out." In a market with extremely low tolerance for uncertainty, investors ran from Fannie and Freddie. As these firms had losses on the lending side they needed capital, but no investor was willing to go there. In the end Treasury had no choice. Fannie and Freddie shares still exist, but are worth just pennies.
So now what? With all the news about Lehman and AIG, we have not heard much on Fannie and Freddie the last few days. Key staff are heading for the exits, and that is troubling. But the GSE market function is still working. Mortgage rates are somewhat stable. Local lenders can still operate.
How will the GSEs look in the future? We don't know how Treasury will proceed. The clean-up alone will take a while. One view is to spilt them up into 5-6 smaller secondary market firms to buy loans. The Federal Home Loan Banks played a bit of this game a few years back. It is not clear more smaller firms helps overall, and there will always be returns to scale such that consolidation could make economic sense. Firms could specialize by type of loan or region, but that presents problems in terms of concentrated risk.
Regardless of the institutional structure, the public-private GSE structure needs review. The government guarantee needs to be priced and made into legal contracts. The affordable housing function of the GSEs should continue at least as long as the GSEs have some federal support and probably longer. If banks are required to make lending balance deposits under the Community Reinvestment Act, then there must be a vibrant secondary market to support this function. It is hard to imagine a completely private mortgage secondary market. In fact the 3rd GSE - Ginnie Mae - is essentially a department of HUD and facilitates the secondary market for mortgages insured by FHA/VA mortgage insurance. This is going to be complex to sort out.
Unfortunatelty election year politics are caught up in all of this. Most policymakers don't have a full understanding of the issues involved. Career staff at Treasury and HUD, as well as the Fed, will have their hands full for quite some time. Consumer advocates need to be as well informed as possible and make sure lending markets are stable and capital keeps flowing especially for the market segments least well served by the financial market--working families in older urban areas and rural markets--as well as immigrants and minorities with no connections to the financial sector. These consumers are going to continue to be first-time homebuyers, especially as home prices come back down to more affordable levels.
A recent survey I helped run in California and Illinois shows moderate income renters are as interested in buying a home as ever. They see prices coming down and want to own a home. But they also see the risks, and want to be well-educated how to buy a home and find a mortgage loan (in fact they tend to substantially over-estimate the risks of foreclosure--we'll save that for another post). The majority have doubts any lender will offer them a loan. Reading the current press and watching the media, no wonder.
Friday, August 29, 2008
Financial Literacy is a Failure?
In recent weeks the writings of law professor Lauren Willis have become much more widely distributed, in part thanks to a short piece in Money magazine. (see: http://money.cnn.com/2008/08/25/pf/teaching_money.moneymag/index.htm)
Professor Willis has at least 2 law review articles suggesting in essence that the financial market is too complex for the average consumer and only prescriptive legislation regulating consumer financial products will prevent consumers from taking on higher risk or cost products than necessary.
One 2006 Maryland Law Review article is titled: Decisionmaking & the Limits of Disclosure: The Problem of Predatory Lending and another 2008 in the Iowa Law Review Against Financial Literacy Education. Those who toil on consumer education topics might find the titles alone a little alarming. The articles are worth a read and certainly are serving to provoke discussion.
A few points are worth remembering.
First, regulation and education are complements, not substitutes. Policymakers can, and in fact do, regulate the terms of some products while also supporting consumer education.
Second, from a legal scholar's point of view regulation provides an absolute and highly standardized way to present a solution to a social problem. Economists tend to a bit more skeptical--if there is consumer demand the market will develop a work around almost before the ink is dry on a new law. The markets evolve so fast product regulation is more like a game of whack-a-mole.
Third, Professor Willis is correct much of the data on financial education and disclosure shows non-significant effects, and when findings are significant, plagued by selection bias--that is the consumers most likely to get information are the most motivated and successful even in the absence of education or disclosure. But this points more to failures in research methods and design than in public policy. As a society we do seem to believe education has value; there is not reason to think education only works in certain domains. Moreover, some research is carefully done and shows financial literacy education and disclosures are effective at statistically significant levels. There is not enough research in the field (so says the researcher) on financial education and disclosures, and far too little research on how to deliver information to consumers or when the ideal times to do so might be.
Consumer decisions in financial markets are more complicated than in the past: for example defined pensions are now more likely to be consumer-directed retirement accounts and fixed rate mortgages now come in multiple adjustable rate flavors. Consumers have the capacity to navigate this marketplace without resorting to high cost advisers. Before throwing out the concept of consumer education maybe policymakers need to take a fresh look at what is being attempted and how it can be improved.
Professor Willis has at least 2 law review articles suggesting in essence that the financial market is too complex for the average consumer and only prescriptive legislation regulating consumer financial products will prevent consumers from taking on higher risk or cost products than necessary.
One 2006 Maryland Law Review article is titled: Decisionmaking & the Limits of Disclosure: The Problem of Predatory Lending and another 2008 in the Iowa Law Review Against Financial Literacy Education. Those who toil on consumer education topics might find the titles alone a little alarming. The articles are worth a read and certainly are serving to provoke discussion.
A few points are worth remembering.
First, regulation and education are complements, not substitutes. Policymakers can, and in fact do, regulate the terms of some products while also supporting consumer education.
Second, from a legal scholar's point of view regulation provides an absolute and highly standardized way to present a solution to a social problem. Economists tend to a bit more skeptical--if there is consumer demand the market will develop a work around almost before the ink is dry on a new law. The markets evolve so fast product regulation is more like a game of whack-a-mole.
Third, Professor Willis is correct much of the data on financial education and disclosure shows non-significant effects, and when findings are significant, plagued by selection bias--that is the consumers most likely to get information are the most motivated and successful even in the absence of education or disclosure. But this points more to failures in research methods and design than in public policy. As a society we do seem to believe education has value; there is not reason to think education only works in certain domains. Moreover, some research is carefully done and shows financial literacy education and disclosures are effective at statistically significant levels. There is not enough research in the field (so says the researcher) on financial education and disclosures, and far too little research on how to deliver information to consumers or when the ideal times to do so might be.
Consumer decisions in financial markets are more complicated than in the past: for example defined pensions are now more likely to be consumer-directed retirement accounts and fixed rate mortgages now come in multiple adjustable rate flavors. Consumers have the capacity to navigate this marketplace without resorting to high cost advisers. Before throwing out the concept of consumer education maybe policymakers need to take a fresh look at what is being attempted and how it can be improved.
Thursday, August 28, 2008
Back to school
The thousands of new college students descending on campuses nationally are a keen reminder of how consumers can quickly become mired in credit card debt. College freshman are the target of credit card marketers for several reasons. This is a key time when consumer sign up for cards--many for their first card. Students are also typically cash strapped, thus likely to run a balance and pay interest.
College campuses have a range of policies--some actively work with companies and gain revenue from the marketing of credit cards. Others restrict access to campus property or regulate if card offers are tied to gifts or incentives.
For many students a credit card is a useful tool. Students tend to have expenses related to getting set up to learn (computer books etc) and as such going into debt to invest in future educational gains might make sense. Late night pizzas...not so much. Surveys sponsored by student lender Nellie Mae show more than 3 out of 4 undergraduates have at least one card. Those with cards on average owe more than $2,150. Most get their card their freshman year and many accumulate more than one card.
My own research shows few students look at mandated card disclosures unless directed. They are easily misled to think the introductory teaser APR is the actual APR. Almost none will look at details such as a default rate which might be three times the normal APR if the student defaults on any loan of any kind.
Thankfully most student credit cards have low balance limits. Some students may need these kinds of offers--and to make a few mistakes--to learn some hard financial lessons.
Campuses that limit offers to certain areas might be on the right path. Certainly students seeking a card can find one, but impulse applications at the bookstore might not be as prudent. Limiting free T-shirts, iPods or other features makes sense too--these may become a distraction from the actual terms and conditions of the card.
But most of all students need to learn, after all, and there is more most campuses can do. Simple brochures and email messages are a good start, as are workshops or seminars on financial topics. One small survey I conducted with undergraduates at Cornell University, where many students came from affluent backgrounds, showed more than two-thirds of students would attend a workshop on credit and financial management if it was offered at a convenient time and place.
Parents, or course, play a key role. My surveys show 87% of undergraduates say they learned about financial management from their parents. The number two source: the internet, at 40%. About one-third of the students I surveyed expect their parents to pay their bills for them and another third pay their own bills but have asked their parents for help in the past.
Parents with college students might consider having a regular conversation about credit card debt and budgeting with their kids. When they apply for a card ask questions about the APR and ask them what they think that means. Ask them to tell you about other fees--such as for using the card at an ATM to get a cash advance. All this will focus attention on costly features and details. And let them know your expectations about their spending. Even if you are willing to bail them out in an emergency, be sure they understand you are not a co-signer and the card is their responsibility. Since the majority of students use credit cards for convenience a low balance should be just fine for most students (often $500-1,000, or the cost of an unexpected plane ticket or emergency car repair). Beware that the card issuer may offer increased balance limits over time. Parents can discourage students from taking larger limits and make sure the student knows a larger limit just means larger bills.
With the proper tools, information and support, most students will do just fine with their first foray into the credit market. But parents and university administrators need to pay attention too.
Highlights of Student Credit Card Survey
Cornell University, Spring 2008 (n=182)
Use of Disclosures:
Use of Cards:
Attitudes:
College campuses have a range of policies--some actively work with companies and gain revenue from the marketing of credit cards. Others restrict access to campus property or regulate if card offers are tied to gifts or incentives.
For many students a credit card is a useful tool. Students tend to have expenses related to getting set up to learn (computer books etc) and as such going into debt to invest in future educational gains might make sense. Late night pizzas...not so much. Surveys sponsored by student lender Nellie Mae show more than 3 out of 4 undergraduates have at least one card. Those with cards on average owe more than $2,150. Most get their card their freshman year and many accumulate more than one card.
My own research shows few students look at mandated card disclosures unless directed. They are easily misled to think the introductory teaser APR is the actual APR. Almost none will look at details such as a default rate which might be three times the normal APR if the student defaults on any loan of any kind.
Thankfully most student credit cards have low balance limits. Some students may need these kinds of offers--and to make a few mistakes--to learn some hard financial lessons.
Campuses that limit offers to certain areas might be on the right path. Certainly students seeking a card can find one, but impulse applications at the bookstore might not be as prudent. Limiting free T-shirts, iPods or other features makes sense too--these may become a distraction from the actual terms and conditions of the card.
But most of all students need to learn, after all, and there is more most campuses can do. Simple brochures and email messages are a good start, as are workshops or seminars on financial topics. One small survey I conducted with undergraduates at Cornell University, where many students came from affluent backgrounds, showed more than two-thirds of students would attend a workshop on credit and financial management if it was offered at a convenient time and place.
Parents, or course, play a key role. My surveys show 87% of undergraduates say they learned about financial management from their parents. The number two source: the internet, at 40%. About one-third of the students I surveyed expect their parents to pay their bills for them and another third pay their own bills but have asked their parents for help in the past.
Parents with college students might consider having a regular conversation about credit card debt and budgeting with their kids. When they apply for a card ask questions about the APR and ask them what they think that means. Ask them to tell you about other fees--such as for using the card at an ATM to get a cash advance. All this will focus attention on costly features and details. And let them know your expectations about their spending. Even if you are willing to bail them out in an emergency, be sure they understand you are not a co-signer and the card is their responsibility. Since the majority of students use credit cards for convenience a low balance should be just fine for most students (often $500-1,000, or the cost of an unexpected plane ticket or emergency car repair). Beware that the card issuer may offer increased balance limits over time. Parents can discourage students from taking larger limits and make sure the student knows a larger limit just means larger bills.
With the proper tools, information and support, most students will do just fine with their first foray into the credit market. But parents and university administrators need to pay attention too.
Highlights of Student Credit Card Survey
Cornell University, Spring 2008 (n=182)
Use of Disclosures:
- 40% incorrectly identified the APR as the 'teaser' balance transfer rate
- 32% incorrectly identified APR as not changing or varying
- 40% incorrectly identified late payment fees
- 33% did not understand 'default rate' changes with late payments on other credit cards
Use of Cards:
- 55% used cards for convenience and always paid off the balance
- 15% carried a balance of $1,000 or more
- 20% paid a late payment fee in last 12 months
- 35% report using their card more when they feel stressed
- 75% report it is "very easy" or "easy" to get a credit card
- 10% reported ever being denied for a credit card
- 25% report getting credit card offers in the mail at least weekly
- Most popular marketing features: rewards or bonuses for making charges
- Least popular marketing features: free t-shirts or discounts for signing up
Attitudes:
- 69% report being "very likely" or "likely" to attend a seminar on personal financial management offered on campus at a convenient time
- 36% report "next to my student loan my credit card debt is nothing"
Saturday, August 23, 2008
New Forms of Credit Disclosures?
Economist Richard Thaler and law professor Cass Sunstein ran an article in the Wall Street Journal suggesting policy makers re-look at consumer disclosures for credit products (and even cell phones). The authors mostly promoted themes from their new book "Nudge: Improving Decisions about Health, Wealth and Happiness." But in general they have a good point -- too often disclosures and consumer information strategies are dismissed. Would better disclosures have avoided the current subprime mortgage default problem? Surely not. But at least at the margin some consumers would have had more information.
I have some research in process showing that states requiring a signed "YOU MAY LOSE YOUR HOME" statement on disclosure forms for very high cost loans reduces the probability a consumer will go through with a loan offer from a lender. The effect is not large, but not zero either.
Thaler and Sunstein wrote "the Fed can substantially improve its proposal by requiring credit issuers to disclose relevant information electronically in a standardized, machine-readable format. In one simple stroke, new disclosure requirements would dramatically improve the current situation."
The key to their solution is that 3rd party providers will create a market to supply consumers with easy to read reports and recommended actions--much like investment tracking firms like Morningstar do in the mutual fund market.
They argue "electronic disclosure will merely supplement the current written disclosure requirements...the electronic disclosure we are advocating would make it much easier for nonprofit groups to help the poor make better choices because they could have all the information they need right on a computer."
Would it work? It is hard to say for certain, but at least this suggests technology can enhance paper and pen information disclosures. Before deciding consumer disclosures are a failure, policy makers ought to explore how disclosures--many of which are regulated by a hodgepodge of agencies and using forms dating back to the 70s--can be modernized and refined to better impact consumer behavior.
I agree with Thaler and Sunstein when they wrote"Some politicians have clamored for banning some types of mortgages, especially in the subprime market, but low-income or high-risk borrowers are often the ones that can particularly benefit from financial innovation." Product bans such as they fear are probably unlikely to happen, and in fact the private market has shut down most risky lending on its own. It seems likely these products will return, however. It may take a few years but $1000 downpayments, low credit scores and high debt to income ratios will be common again in the mortgage market before long. In the meantime, exploring better ways to communicate the terms, costs and risks of products to consumers should be a high priority. The Federal Reserve Board and FTC have some research efforts under way on the wording of disclosures, but more testing of innovations such as Thaler and Sunstein discuss has merit.
See the full op-ed at:
http://online.wsj.com/services/article/S B121858695060335079-search.html
Friday, August 15, 2008
Welcome
I am new to blogging but decided with all of the current events in consumer finance policy I should take a crack at posting interesting research, policy debates, articles and other information as it comes up. Thanks for looking!
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