TIGHTENING CREDIT AND THE CHANGING FINANCIAL MARKET Mike Calhoun

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TIGHTENING CREDIT AND THE CHANGING FINANCIAL
MARKETMike Calhoun

• NeighborWorks
• Atlanta, Georgia February 18, 2009

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Center for Responsible Lending

• 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 nations
  largest community development financial
  institutions.
• Over 5 billion of financing to 55,000 low-wealth
  families, small businesses and non-profits.

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CHRONOLOGY OF THE CRISIS

• Unsustainable mortgage products and practices
• A lending bubble that inflated the housing bubble
• Securitization of these loans into AAA securities
  and derivatives
• Leverage of investments that amplified gains and
  risks
• Loss of market confidence
• Deleveraging as asset values fall
• Foreclosures creating more downward home values

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The Products That Got Us Into this Mess Subprime
Home Loan Traits

• Typically hybrid ARMs with built-in payment shock
• Most carry large prepayment penalties for refi
  prior to first interest rate adjustment
• No escrows for taxes or insurance prompts
  further refis
• Typically refinance loans
• Typically broker-originated
• Up-front fees far higher than in prime market
• Debt-to-income ratios can rise as high as 55
• Underwritten to introductory rate no
  expectation that borrower could afford the loan
  after rate adjustment

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Unnecessary Losses Most HomeownersSold SP Loans
Qualified for Better Loans

• A Wall Street Journal Study found that 60 of
  borrowers who received SP loans in 2006 had
  credit scores high enough to qualify for prime
  loans.
• Even those who did not qualify for prime loans
  could have received 30 year fixed rate SP loans
  with payments similar to and often lower than the
  exotic arm loan they received.

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Chairman Bernankes Conclusion

• Fed. Reserve Chairman Ben Bernanke
• Although the high rate of delinquency has a
  number of causes, it seems clear that unfair or
  deceptive acts and practices by lenders resulted
  in the extension of many loans, particularly
  high-cost loans, that were inappropriate for or
  misled the borrower.
• (July 14, 2008 Statement)
• (www.federalreserve.gov/newsevents/press/bcreg/ber
  nankeregz20080714.htm)

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How did this happen?Market Incentives

• The big demand was not so much on the part of
  the borrowers as it was on the part of the
  suppliers who were giving loans which really most
  people couldn't afford. (Alan Greenspan to
  Newsweek, The Oracle Reveals All, (9/24/2007)
  pp.32-3)
• Yield Spread Premiums paying brokers to put
  borrowers into loans with higher rates than they
  qualify for.
• The market is paying me to do a
  no-income-verification loan more than it is
  paying me to do the full documentation loans
  What would you do?(CEO of Ownit Mortgage to The
  New York Times (1/26/2007) pp. C1, C4.
• Why would lenders make these loans? Because
  investors continued to buy the loans. (Mortgage
  Bankers Assn Chief Economist to CNN Money.com
  (2/20/2008))

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WHATS COMING?Current Foreclosure Forecasts
Subprime

• 2 million homeowners with subprime mortgages will
  lose their homes to foreclosure, most by year-end
  2009.
• This is in addition to the 700,000 homes with
  subprime loans currently in foreclosure or REO.
• (Source Credit Suisse, Foreclosure Trends
  4/23/08)

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Racial Impact of Subprime Loans
Higher cost (subprime) 1st lien loans 2005 HMDA
Data
of higher of total loans
cost loans to group African
American 388,471 52 Latino 375,889 40 Whit
e 1,214,003 19
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Troubles Move Beyond Subprime

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Alt-A Loans

• Made to credit-worthy borrowers with some element
  of added risk, e.g.
• Reduced borrower income and asset documentation
• Debt-to-income ratios above Fannie/Freddie
  guidelines
• Credit history with some problems (e.g., low
  scores or delinquencies, but no recent
  charge-offs or bankruptcy)
• High loan-to-value ratios

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Next Wave of Foreclosures Payment Option ARMs

• Affords low monthly payments by allowing
  borrowers several payment options each month
• 75 of POARM borrowers make lowest payment
• based on low teaser rate in effect for 1 month or
  1 day
• includes no principal and less than all of
  interest owed
• Interest shortfall is added to loan balance
• After 5 years, or when loan balance hits 115 of
  original loan, payments sharply increase
• Eligibility often was based on initial low
  payment

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2nd Wave Alt-A and Option ARMs
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NEXT WAVE OF MORTGAGE DEFAULTS
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Foreclosure Forecast Total Market

• 10 to 13 million mortgage loans will fall into
  foreclosure over the next 5 years.
• For the market as a whole, 1 out of every 6
  homeowners who currently has a mortgage faces
  losing their home to foreclosure.

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Ever Increasing Leverage

• Mortgage Backed Securities (MBS) are securities
  backed by pools of mortgages.
• Collateralized Mortgage Obligations (CMOs) are
  securities backed by pools of MBS, and are often
  highly leveraged.
• Some CMOs are backed by pools of CMOs.

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Foreclosures Vicious Cycle

• Home price declines lead to foreclosures
• Foreclosures flood already oversaturated home
  market with more inventory, depressing home
  prices further, and leading to even more
  foreclosures

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Impact On Consumer Finances
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Current Policy Responses

• Voluntary Loan Modifications and Treasury Dept.
  Modification Program
• Hope for Homeowners Program
• Funds for recycling of foreclosed properties

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Existing Obstacles to Voluntary Modifications

• Insufficient Servicer Staffing
• Misaligned Financial Incentives for Servicers
• Fear of Investor Lawsuits
• Pooling and Servicing Agreement Limitations
• Second Mortgages

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Additional Policy Responses

• Foreclosure Deferment
• Court-supervised Loan Modifications (bankruptcy
  reform)
• Additional Consumer Protections for future loans

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Conclusion

• Foreclosures pulled the economy into deep
  recession and the economic crisis will not be
  resolved until preventable foreclosures are
  stopped.
• Bankruptcy reform is an essential element of any
  successful foreclosure prevention program and is
  needed immediately.
• Protections for future mortgages must establish a
  floor of consumer protections and must address
  the incentives that have rewarded the making of
  bad loans.

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Breakout Sessions

• A. Exploring Lease-Purchase as a Community
  Stabilization Strategy Gwinnett
• B. New Approaches to Financing and Credit
  Scoring Cherokee
• C. Maximize Your Technology How Innovative
  Tools Can Improve Your Service Delivery Henry
• D. Counseling Challenges and Successes in
  Response to Market Changes - Forsythe