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Martin D. Eakes Subprime Mortgage Loans Foreclosures and Policy Reversing the Retreat on Civil Rights Conference October 19, 2007 About CRL

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Martin D. Eakes

Subprime Mortgage Loans

Foreclosures and Policy

Reversing the Retreat on Civil Rights Conference

October 19, 2007

about crl
About CRL
  • Nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices.
  • Affiliated with Self-Help, one of the nation’s largest community development financial institutions.
  • Subprime and Foreclosure Data
  • Existing Subprime Borrower Problem
  • Federal Regulations and Legislation
  • North Carolina legislation 1999 and 2007
subprime growth
Subprime Growth

Source: IMF Publications

key subprime facts
Key Subprime Facts
  • 7.5 million borrowers; $1.4 trillion loans outstanding
  • 3 million subprime loans each year in 2005 and 2006
  • 1 in 5 subprime loans from 2005 and 2006 will end in lost home.
  • 57% of 2005 subprime loans not bank-affiliated
  • 72% of subprime as exploding ARMs (Lehman,2004)
    • Rates jump from 8% to 12%
    • Monthly payments up 30% or more in 3rd year
    • $600 billion rate reset in next two years
  • 70% lack escrows, which leads to “flipping”
  • 70% of subprime have prepay penalties; only 2% in prime
  • 50% utilize stated income for “ability to repay”
  • 50% of 2006 subprime were “80/20” LTV with piggyback 2nd liens
neighborhood loss direct loan loss
Neighborhood Loss > Direct Loan Loss
  • 1.5% lost value for neighborhood spillover effect within 1/8 mile of foreclosed home.
  • $3,000 loss per neighbor x 50 neighbors = $150k of lost neighborhood value.
  • $3,000 lost property tax revenues per year for schools at 2% rate.
  • For 2 million lost homes, $300B neighborhood wealth & $6B local taxes lost.
higher cost 1 st lien total loans 2005 hmda
Higher cost 1st lien total loans2005 HMDA

# Higher cost % of total

  • African American 388,471 52%
  • Latino 375,889 40%
  • White 1,214,003 19%
cumulative final foreclosures for subprime loans made in 2000
Cumulative Final Foreclosures for Subprime Loans Made in 2000

Cumulative Foreclosures (as of May 2005)

helping borrowers keep their homes
Helping Borrowers Keep Their Homes
  • 40% Refinance existing loans to prime, fixed-rate loans (GSEs, FHA).
  • 20% Loan modifications by extending initial rate.
  • 20% Loan modifications by reducing rate or balance by up to 50%, the est. liquidation loss.
  • 10% Speculative or investor loans.
  • 10% Borrowers where feasible assistance will not be enough.
solved legal issues for loan mods
“Solved” Legal Issues for Loan Mods
  • Pooling and servicing agreements (PSA) generally permit loan modifications.
  • REMIC rules for pass-through tax treatment permit modifications of loans in default or where default is reasonably foreseeable.
  • FAS 140 for QSPE treatment permits loan modification for home loans that are delinquent or where default is reasonably foreseeable.
remaining legal issue 2 nd liens
Remaining Legal Issue: 2nd liens
  • 20% LTV second mortgage for 50%+ of 2006 loans
    • 50% serviced by different servicer.
    • Borrowers can’t handle negotiations with two different servicers.
    • 1st lender will not modify loan if substantial benefit flows to 2nd.
    • 2nd lender will not modify if 100% loss.
    • Foreclosure cuts off 2nd, but borrower loses home.
    • Need federal amendment to modify home loan in bankruptcy
remaining legal issue servicer liability
Remaining Legal Issue: Servicer Liability
  • Servicer liability for conflicting investor demands
  • Example: Mod deferring loss favors residual holder if excess yield account released, but hurts senior bondholders.
  • New PSAs include safe-harbor language that loan servicers serve the best interests of boldholders as a group.
  • Will be greater problem in 2008 when modifications could reach 30% of outstanding securitization pools.
  • Discrimination liability possible if servicer modification guidelines are discretionary, and non-objective.
  • Foreclosure is legally the easiest servicer action.
foreclosure solutions
Foreclosure Solutions
  • Need federal bankruptcy amendment to allow judicial mod of home loans, as for all other personal assets, including 2nd homes, farms, land, commercial real estate, boats, and furniture.
  • Automated, standardized loan modifications by loan servicers. 1% currently is pathetic. (Moodys)
  • Funding for legal representation of borrowers.
  • Lease-purchase program to redeploy REOs.
bankruptcy tweak
Bankruptcy Tweak
  • section 1322 of the Bankruptcy Code should be amended as follows:
  • 1322 Contents of plan
  • . . . .
  • (b) Subject to subsections (a) and (c) of this section, the plan may –
  • (2) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims;
three different policy problems
Three Different Policy Problems
  • 1. Future subprime borrowers and loans
    • Joint banking guidance for “Nontraditional Mortgage” loans – October 2006
    • Joint banking guidance for Subprime mortgage loans –July 2007.
    • Federal Reserve rules under HOEPA – Fall 2007.
    • Federal legislation (Watt-Miller-Frank, Bachus, Schumer)
  • 2. Foreclosure of existing subprime borrowers.
  • 3. Liquidity and investor markets melt-down.
frb authority since 1994
FRB Authority since 1994

15 USC 1639(l)(2)


(2) PROHIBITIONS.--The Board, by regulation or order, shall prohibit acts or practices in connection with--

  • mortgage loans that the Board finds to be unfair, deceptive, or designed to evade the provisions of this section; and
  • refinancing of mortgage loans that the Board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.
frb action needed for subprime
FRB Action Needed for Subprime
  • Prohibit prepayment penalties
  • Prohibit yield spread premiums to brokers
  • Require escrows for taxes and insurance
  • Require ability to repay at fully indexed rate
  • Prohibit “stated income” loans
  • Require lender due diligence of brokers such that lender responsible for broker acts or misrepresentations for loans delivered to lender
north carolina 1999 legislation
North Carolina – 1999 Legislation
  • For all home loans
    • Prohibited single-premium credit insurance
    • Prohibited prepay penalties for loans up to $150k
    • Prohibited “flipping” where net tangible benefit of refinancing less than fees charged
  • “High cost” loan defined as 5% points and fees
    • Prohibits financing of up-front fees
    • Counseling required
north carolina 2007 legislation
North Carolina – 2007 Legislation
  • Definition of Subprime as “rate spread” loans
    • Consensus by Banks, credit unions, mortgage banks, finance companies, consumer and civil rights groups
    • HMDA trigger of Treasury + 300 bps for 1st liens OR
    • Freddie survey rate + 175 bps (fixes “flight to quality” problem and inverted yield curve ARM problem)
  • Prohibits subprime prepay penalties
  • Prohibits subprime stated income loans
  • Requires ability to repay at fully indexed rate
  • Includes yield spreads in 5% “high cost” definition as in Georgia, New Jersey, New Mexico, Mass, and other states
loan features carry risk
Loan Features Carry Risk
  • Among subprime loans originated in 2000, after controlling for credit score:
    • ARMs had 72% greater risk of foreclosure than FRM.
    • Balloons had 36% greater risk than FRM.
    • Prepayment penalties associated with 52% greater risk.
    • Low/no doc loans with 29% greater risk.
    • Purchase money with 29% greater risk than refinance.