Along with other community and housing groups, the National Community Reinvestment Coalition has been pushing the White House and Congress to require banks to reduce mortgage principals to stop foreclosures. Doing so will help revive the economy, protect neighborhood property values and, most importantly, keep families in their homes.
In 2007, when we first proposed mandatory mortgage principal reduction as a way to prevent massive foreclosures, government officials took a pass and the financial media expressed doubts. Financial institutions could never be forced to write down mortgages, they said then. Three years later, with at least another 9 to 11 million foreclosures staring us in the face and Wall Street, banks and their servicers making feeble efforts to stem the tide of foreclosures, the idea has taken on some currency with economists and, thankfully, states' Attorneys General.
Without comparison, the states' Attorneys General have been the aggressor in making banks do the right thing. While a proposed victims' fund is not a bad idea, it should be viewed as only one remedy. The problem of how lenders and servicers are treating and have treated borrowers needs to be fixed.
About 4.5 million mortgages are seriously delinquent or already in foreclosure today. Wall Street analysts expect another 11 million filings. Housing experts estimate foreclosures occurring between 2009 and 2012 will result in $1.8 trillion in lost wealth, an average loss of over $20,000 for each of the almost 92 million homes impacted by the foreclosure crisis.
Not only has the federal government not pressured lenders and servicers to reduce mortgage principals, its own programs have dismal results. An OCC/OTS report found that Fannie and Freddie, both in government conservatorship, have negotiated ZERO principal reductions. Treasury and HUD's partnership with banks through the HAMP effort has been a failure. Of over 7 million foreclosure filings, only 6% have resulted in permanent loan modifications under HAMP. Only 1 percent of its miniscule 470,000 permanent loan modifications included a principal reduction, the rest tinkered with interest rates and payment plans, steps that are unlikely to keep anywhere from 30 to 50 percent of these loans from re-defaulting.
Paul S. Willen, a senior economist at the Federal Reserve Bank of Boston, recently offered two solutions: "Require banks to modify loans, basically imposing the cost on them; or pay banks to modify loans, imposing the cost on taxpayers."
My vote is on option one. But, how exactly would it work? Below are NCRC's answers to some of the questions raised about our proposal:
Would potentially every homeowner be eligible for a mortgage reduction? If not, who would be?
Not every homeowner would be eligible, only those that can demonstrate economic hardship, a salary reduction, a divorce, a death in the family, or that they were the victim of an abusive loan that saddled them with inflated debt. Homeowners living in high foreclosure neighborhoods also should be eligible, given that they are likely to be underwater, meaning they owe more on their mortgage than their home is worth.
Won't this approach encourage homeowners to stop paying their mortgages so they can qualify for a mortgage reduction?
Homeowners would have to prove an economic hardship. This means there must be a legitimate reason why they can't pay their mortgages. We are not suggesting that any and every homeowner would qualify for a mortgage reduction.
Why should anyone, regardless of his or her situation, get "bailed out" of a mortgage?
The economic crisis we are facing is a direct result of the actions of Wall Street investment banks and a handful of financial institutions that took advantage of a mortgage pipeline that was not adequately monitored and regulated by the responsible government agencies. The result from the foreclosure crisis is that even homeowners current on their mortgages suffer from lower property values, contributing to a growing number of homeowners underwater on their loans. Every new foreclosure causes loss of value in neighboring homes; we all lose as foreclosures continue to pile up.
Also, the federal government is guaranteeing the vast majority of loans held in portfolios now by Fannie Mae, Freddie Mac and the FHA. As a result, it's in every taxpayer's interest to keep homeowners paying their mortgages. Otherwise, taxpayers end up paying for the loss anyway.
The Administration says it can't make Fannie and Freddie reduce mortgage principals.
Regulators, congressional leaders and the White House need to stop talking like they don't have the power to stem the foreclosure crisis. They have more than the bully pulpit; they have tremendous leverage. Freddie, Fannie, FHA, and the Federal Reserve are the secondary market today. They hold the vast majority of loans being made. They have the power to force the industry to write down principal and prevent unnecessary foreclosures by refusing to guarantee or buy more loans. In the case of the Federal Reserve, they could cut off the ability to borrow money. Thankfully, the states' Attorneys General are moving in this direction, but they will need these entities' cooperation.
Fannie and Freddie are in conservatorship, and the federal government is in control as the major shareholder. They can demand today that Fannie and Freddie engage in a principle write-down effort under the Home Affordable Refinance Program (HARP) to ensure that millions of households, where the principal bread winner is still employed, can be have a mortgage that is sustainable and allows them to continue to be a responsible homeowner.
Had many homeowners had a mortgage that matched their ability-to-pay in the first place, we wouldn't be in this mess. Unscrupulous lenders trapped millions of homeowners in loans that were unsustainable. But Fannie and Freddie could ensure that abusive lending doesn't result in foreclosure for huge numbers of households by refinancing loans for homeowners in a way that matches their ability-to-pay.
What can we do about homeowners underwater?
If homeowners are underwater as a result of an abusive loan or because foreclosures have driven down property values in their neighborhoods, then they should be considered for a mortgage reduction. To those who complain that principal reduction is a "moral hazard," they should consider that by not stabilizing the housing market, we are harming everyone's property values. The real moral hazard is allowing everyone to pay the price for the misdeeds of lenders and servicers.
Wouldn't mortgage reduction break the banks, causing more economic disruption?
Because of the taxpayer-funded bailout, most banks are profitable, and they have increased their capital reserves. Yet, the Congressional Oversight Panel warns that actions by the largest financial institutions may "threaten the still fragile economy," and the "danger is sufficient enough" to warrant grave concern and action. Mortgage reduction will not break the banks, but a failure to solve the foreclosure crisis imperils our economic recovery and could plunge us into a deeper recession for months to come.
Legally, how can government make the banks reduce mortgage principals?
Government can mandate and encourage mortgage reduction in several ways. First, as I stated earlier, government is guaranteeing the vast majority of loans held in portfolios now by Fannie Mae, Freddie Mac and the FHA. There is no private market for loans. Lenders have nowhere else to turn to sell the mortgage loans they are making now. These government agencies could refuse to purchase loans from banks that will not reduce mortgage principals for qualified borrowers. Right now, Fannie Mae and Freddie Mac are refusing to reduce principal while some banks are, though not at the level that is needed.
Second, the Federal Reserve, which holds over a $1 trillion in loans, could do the same and could close its borrowing window to banks that are not making a concerted effort to reduce principals. Third, some academics argue the federal government's eminent domain authority grants it the power to mandate mortgage reduction. In the same way that taking property to widen a highway is in the community's interest, saving homes from foreclosure protects the larger community from economic deterioration. And, finally, our nation's leaders could be pressuring banks from the bully pulpit much more than they have to date.
What about the servicers and their fee structure?
It is not only the banks and Fannie and Freddie that are at fault. Servicers process loan payments and foreclosures on behalf of lenders and investors. Some of the largest are HomeEq Servicing, Litton Loan Servicing, LLP, Nationstar Mortgage, Saxon Mortgage Services, and Select Portfolio Servicing.
They often have incentives to refrain from modifications since they are paid based on outstanding loan amounts. In addition, their staffing levels and expertise are no match for the magnitude of the foreclosure crisis. Since the Obama Administration's program to-date has relied upon the voluntary actions of servicers and other financial institutions, it has failed to dramatically alter the financial incentives and staffing inadequacies of the servicers.
This idea really sounds like big government taking over the banks.
The truth is that Wall Street and their financial institutions have taken over the government by influencing elections, and spending massive amounts of money to lobby Congress. No one is suggesting that government take over Wall Street or the banks but they, along with independent mortgage companies, mortgage servicers and mortgage brokers, created the housing bubble that resulted in the greatest economic turmoil in this country since the Great Depression. Requiring them to be part of the solution isn't asking too much; it is their responsibility to do so.