Martin D. Eakes

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Martin D. Eakes Subprime Mortgage
Loans Foreclosures and Policy Reversing the
Retreat on Civil Rights Conference October 19,
2007
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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 nations
  largest community development financial
  institutions.

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Overview

• Subprime and Foreclosure Data
• Existing Subprime Borrower Problem
• Federal Regulations and Legislation
• North Carolina legislation 1999 and 2007

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Subprime Growth
Source IMF Publications
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Subprime Share of All Mortgages (by origination
year)
Source IMF Publications
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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

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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.

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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

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(No Transcript)
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Cumulative Final Foreclosures for Subprime Loans
Made in 2000
Cumulative Foreclosures (as of May 2005)
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Final Foreclosures by Annual Loan Cohort (May
2005)
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Subprime Foreclosure Starts Now Drive MBA Overall
Foreclosure Starts
Source MBA
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Subprime Proportion of MBA Conventional
Foreclosure Starts
Source MBA
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State Housing Prices vs. Foreclosures
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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.

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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.

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Remaining Legal Issue 2nd liens

• 20 LTV second mortgage for 50 of 2006 loans
• 50 serviced by different servicer.
• Borrowers cant 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

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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.

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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.

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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
  debtors principal residence, or of holders of
  unsecured claims, or leave unaffected the rights
  of holders of any class of claims

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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.

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FRB Authority since 1994

• 15 USC 1639(l)(2)
• (l) DISCRETIONARY REGULATORY AUTHORITY OF
  BOARD.--
• (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.

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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

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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

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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

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Addendum Slides
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Subprime Foreclosure Over Time(20 Cohort FC
Rate 70 SP Refi Rate)
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Sensitivity to Refi Rate to Another Subprime Loan
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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.

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Example of 2-28, 200,000 ARM, No Change in Rates
Source CRL Calculations
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Ever Foreclosed, by Annual Loan Cohort