Today, the Joint Economic Committee held a hearing entitled “Current Trends in Foreclosures and What More Can Be Done to Prevent Them.” Testifying before the Committee were:
- Joseph Mason, Louisiana Bankers Association, Professor of Finance, Louisiana State University
- Susan M. Wachter, Professor Financial Management, The Wharton School, University of Pennsylvania
- William Shear, Director, Financial Markets & Community Investment, United States Government Accountability Office (GAO)
- Keith Ernst, Director of Research, Center for Responsible Lending (CLR)
Dr. Mason argued that “regulators can ... do a great service to both the industry and borrowers in today’s financial climate by insisting that servicers report adequate information to assess not only the success of the major modification initiatives, but also performance overall.” He stated that proving servicer value has become crucial to the market as a whole and noted that there are several reasons why servicers are currently facing difficulties with borrowers, including: (1) the modification of loans is expensive; (2) arrearages diminish profits, (3) the value of loan servicing contracts decline when loans default, (4) an increase of fees are only a partial fix, since such practices have been viewed as per se predatory, and (5) when servicers are threatened, talented employees will leave, which will have an adverse affect on the qualify of servicing. Dr. Mason further noted that major drawback of the current approach is the use of modification to skew the system. He cited the State Foreclosure Prevention Working Group’s February 2008 report which acknowledged that “senior bondholders fear that some servicers, primarily those affiliated with the seller, may have incentives to implement unsustainable repayment plans to depress or defer the recognition of losses in the loan pool in order to allow the release of overcollateralization to the servicer.” Dr. Mason therefore concluded that substantial improvements to servicer reporting are necessary to support the appropriate modification policies.
Dr. Wachter began by stating that, according to the Mortgage Bankers Association, the foreclosure rate is 400%, the highest since the Great Depression. Dr. Wachter noted that “while the initial source of the problem was recklessly underwritten nontraditional mortgages, the asset bubble this created ... has been and is now a problem for all who borrowed for homes in the years 2003 and beyond.” She argued that the “crisis will abate when home prices stop falling,” and also noted the critical importance of controlling the growing unemployment rate and keeping mortgage rates affordable.
Dr. Shear presented some of the results of a GAO report released at the hearing entitled Characteristics and Performance of Nonprime Mortgages and discussed (1) the trends in loan and borrower characteristics of nonprime mortgages originated from 2000 through 2007; (2) the performance of these mortgages by market segment, product type and geographic location; and (3) the performance of nonprime loan cohorts. Dr. Shear noted that the subprime and Alt-A mortgages originated from 2000 to 2007 had characteristics which are associated with higher likelihoods of default and foreclosure, including adjustable interest rates, deficient documentation of borrower income and assets and higher borrower debt burdens. As a result, “approximately 1.6 million of the 14.4 million nonprime loans originated from 2000 through 2007 had completed the foreclosure process, [and], of the 5.2 million loans [still active], almost one-quarter were seriously delinquent.” Dr. Shear further noted that the mortgages originated between 2004 and 2007 accounted for the majority of the troubled loans. As of March 31, 2009, 92% of the subprime loans and 98% of the Alt-A loans originated during 2004 to 2007 were seriously delinquent. He also noted that cumulative foreclosure rates reveal that “the percentage of mortgages completing the foreclosure process increased for each successive loan cohort,” and concluded that this trend was, at least, partially attributable to the decline in home prices and deterioration in credit quality.
Mr. Ernst began by emphasizing that “in light of what has happened, it is more essential than ever that Congress take immediate, strong steps to prevent foreclosures and bar the return of abusive, unsustainable lending that otherwise might once again fundamentally disrupt our economy.” The CLR recommended several steps to both mitigate foreclosure rates and avert a similar financial crisis in the future, including (1) the creation of a Consumer Financial Protection Agency as proposed in H.R. 3126; (2) legislation requiring sound underwriting practices and preventing abusive loan practices as proposed under H.R. 1728; (3) ensuring that the Administration’s foreclosure prevention efforts work effectively; (4) lifting the ban on judicial loan modifications of principal residence mortgages. Mr. Ernst noted that the creation of a Consumer Financial Protection Agency would “restore consumer confidence, stabilize the markets and put us back on the road to economic growth.” In particular, he noted that H.R. 3126 included the essential elements to an effective consumer protection agency, including rule-making authority to discourage abusive acts and practices, strong enforcement tools against violators and supervisory authority over financial institutions. Mr. Ernst also encouraged the passage of H.R. 1728 because it would establish bright-line standards to encourage safer loans, provide more certainty for originators and ban yield spread premiums, a major cause of the financial crisis. Finally, Mr. Ernst encouraged further action in saving the homes of families facing foreclosure. He argued that the Treasury’s Home Affordable Modification Program (HAMP) should be strengthened by (1) requiring servicers to consider a consumer for modification before proceeding with foreclosure action, and (2) instituting a deferment program to avoid foreclosure until the HAMP transitions into an more effective program. He also supported the lifting of the ban on judicial modification of primary residence mortgages because it “carries zero cost to the U.S. taxpayer [and] has been estimated to potentially help more than a million families stuck in bad loans to keep their homes.” He argued, however, that strict limits must be established to control judicial modifications, including the use of commercially reasonable interest rates, loan terms not in excess of 40 years and that the property value be in excess of the loan’s principal balance.