Commentary on the HUD's Report on the Foreclosure Crisis to Congress

Interested in reading the HUD's nitty-gritty analysis of the foreclosure crisis? It's definitely a detailed read, but very informative. In a nutshell (from the Executive Summary of the report); the analysis and report covers:

This study of the root causes of the current extremely high levels of defaults and foreclosures among residential mortgages represents the final report to Congress by the Secretary of the Department of Housing and Urban Development (HUD) pursuant to Section 1517 of the Housing and Economic Recovery Act (HERA) of 2008 (P.L. 110-289). The problems in the mortgage market are routinely referred to as a “foreclosure crisis” because the level of defaults and foreclosures greatly exceed previous peak levels in the post-war era and, as a result, have drawn comparisons to the levels of distress experienced in the Great Depression. This report contains a review of the academic literature and industry press on the root causes of the current foreclosure crisis, data and analysis of trends in the market, and policy responses and recommended actions to mitigate the current crisis and help prevent similar crises from occurring in the future.

The most interesting things about this report aren't so much what is in the rear view mirror (i.e. how it happenedl; a big part of the report) but the recommendations the Secretary makes for mitigating the crisis. (HINT: some of them involves short sales and HAFA, surprise!). Many of the recommendations involve loan modification and trying to keep people in their homes, but most of those programs have met with failure, such as HOPE for Homeowners:

In July 2008, Congress authorized FHA, under the Housing and Economic Recovery Act of 2008, to insure up to $300 billion in loans via a new program: HOPE for Homeowners. Although some lenders have expressed interest in the program, as of July 2009 the program had insured only one loan

$300 billion insurance plan for one loan? There's a success story! The report goes on to mention that loan repayment options typically don't work, (i.e. adding on additional payments or creating subsequent loans for delinquent balances) because those additional loans typically represent added debt burden to the homeowner that simply adds more debt to an already unsustainable situation. Loan workouts, on the other hand, have had some success; however even the majority of those are only a temporary stop-gap; the borrowers often re-default on the modified loans.

Even as the number of modifications increases, larger numbers of recently modified loans are now redefaulting. In large part, this performance reflects the fact that most loan modifications to date do not reduce monthly payments. White (2008) found that voluntary loan modifications of subprime borrowers completed through August 2008 typically increased a borrower’s principal debt and virtually none involved a reduction in principal owed.

Based on the tremendous success of those programs (tongue-in-cheek), the government then released additional plans (Making Home Affordable and Home Affordable Modification Program (HAMP)) to make loan modifications that actually do reduce monthly payments and keep struggling homeowners current on their loans. Despite government incentives, many lenders have still been wary to actually adjust downward interest rates:

To date, many servicers have been reluctant to offer interest rate and principal write-downs even when such modifications could avoid lengthy and costly foreclosure costs. In part this reflects concerns that existing pooling and servicing agreements (PSAs, or the legal agreements that govern the servicer’s authority to engage in loan modifications on behalf of the collection of investors with interests in any single mortgage-backed security pool) may limit ability of servicers to engage in loan modification activities.

Regardless, even many who do receive actual relief on their monthly payments, it still is not enough to overcome the debt burden they are facing, especially when many of the borrowers have lost jobs as well. Does it really matter if your payment goes from $2000 a month to $1700 per month if you just lost your job that was production $4,000 per month in income?

The report then continues on to discuss additional potential ways to mitigate the crisis. Some of these include educating borrowers that they shouldn't borrow more than they can afford. (Apparently, this is something you need to teach people!)

To begin with, there is a clear need to enhance the ability of consumers to make appropriate choices in the mortgage market. Recent research on consumer behavior provides growing evidence that many consumers took out mortgages that they did not understand or that were not suitable for their needs. In particular, there is ample evidence that consumers are often overwhelmed by aggressive mortgage sales and marketing efforts that exploit various consumer decision making weaknesses.

The government is even going so far as to consider "trusted advisory" program where there would be individuals who would provide service to borrowers to educate them on the loans they are taking out, as a "mitigator" to the "overwhelming predatory marketing" of the banks.

In the face of this marketing onslaught, many community groups and counseling organizations are expanding their capacity to act as a “buyer’s broker” to help clients search for the best mortgages while earning a small fee for offering this service like any other mortgage broker. Building on this concept, there have been calls for the government to help establish a national network of “trusted advisors,” independent of mortgage providers who are available on demand to review loan documents, educate borrowers, and advise them of the suitability of their loan to their circumstances.

The report continues to suggest that banning specific mortgage types will not be sufficient since the mortgage industry can create new products quicker than they can be banned. A big point is the suggestion of banning Yield Spread Premiums (YSP) which is effectively a broker's bonus for writing a mortgage at a higher rate (i.e. ban any payment tied into loan terms). This would be handled via Truth in Lending Act revisions.

They recommend limiting or banning yield spread premiums, which provide brokers and loan officers with incentives to sell borrowers higher priced loans, and prepayment penalties, which lock borrowers into high-priced loans and expose them to high fees if they need to refinance or sell their homes. A proposed revision to Regulation Z, the regulation which implements the Truth In Lending Act, would ban yield spread premiums and lender loan officer compensation related to loan terms. There are also proposals to develop new standards for truth in lending so that mortgage brokers and lenders do not have incentives to get around disclosure rules. Under this approach, federal regulators would evaluate whether a creditor’s disclosure was objectively unreasonable, in that the disclosure would fail to communicate effectively the key terms and risks of the mortgage to the typical borrower.

I think disclosure is critically important, so Truth in Lending is great. The ambiguity and recourse of this isn't clear, though - what happens after a loan is written? 5 years down the road? Does a borrower have recourse to go after the lender if they feel disclosure wasn't sufficient? Other commentators have noted as well that banning the Yield Spread Premium would reduce competition and encourage monopolies with the banks. Yield spread premium is thought to automatically be mitigated by competition. The suggestion by many is rather than banning it, disclose it instead to the end borrower. Currently, this does not need to be disclosed.

The report continues on to say that creative solutions can help both homeowners and investors,since pre-foreclosure resolutions can be more profitable than by letting a loan go into foreclosure.

Finally, the recent mortgage crisis has exposed a range of shortcomings with the approaches that have been used in the past by many mortgage servicers, including the tendency to push less costly (to the servicer) repayment plans and short-term modifications rather than aggressively pursue options that may benefit both borrowers (by helping them stay in their homes with an affordable monthly payment) and investors (by finding resolutions that have a higher expected return than a foreclosure)..[].....Some have also called for imposing a duty to engage in loss mitigation efforts before initiating foreclosure actions.

So, an interesting article overall. The above snippets only cover the executive summary, the full report goes into much more detail on each of these topics and much more, so if you are feeling brave and have an afternoon to burn, go ahead and open it up! There are some good charges and analysis going backwards as well that discuss the root of the problem, which I largely skipped in this commentary.

What are your thoughts? Is the result of this too much government intervention? To little? Just right? What other mitigating actions is the HUD not thinking of?

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