Intensifying pressure from the Obama Administration, legislators and housing advocacy groups forced Edward DeMarco, acting director of the Federal Housing Finance Agency, to reconsider his refusal to allow Fannie Mae and Freddie Mac to reduce the principal balances on the loans of struggling homeowners. But it didn’t make him change that unpopular position.
“We concluded that the potential benefit was too small and uncertain relative to the known and unknown costs and risks,” DeMarco said.
The agency, which oversees Fannie and Freddie, based its determination on an extensive analysis of the likely effects of principal reductions on borrowers, the GSEs, investors and taxpayers. That analysis showed that principal reduction was no more effective than other assistance alternatives in helping homeowners avoid foreclosure, and involved greater risks to and higher costs for taxpayers and the GSEs, DeMarco said.
Making no effort to disguise the Administration’s frustration, Treasury Secretary Tim Geithner disputed that conclusion, noting that several studies – including the FHFA’s own analysis — have demonstrated substantial potential savings for taxpayers and the GSEs from the principal reduction program the Administration has implemented.
A recent study by Amherst Securities comparing the effectiveness of different assistance programs found that the redefault rate for principal modifications was 12 percent after 12 months, compared with 23 percent for interest rate reductions and 30 percent for “capitalization” modifications, extending the loan term.
“Five years into the housing crisis, millions of homeowners are still struggling to stay in their homes and the legacy of the crisis continues to weigh on the market,” Geithner wrote in a letter to the independent regulator, adding, “You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis.”
DeMarco acknowledged that the agency’s study identified some scenarios under which taxpayers would benefit from the principal reduction program, but those projections assume more widespread buyer participation than is likely and fail to consider that the program targets buyers who are seriously underwater, for whom redefault risks are particularly high. He also cited “moral hazard” – the possibility that borrowers able to repay their loans will default “strategically” to reduce their loan — as a major concern and an argument against principal reductions.
The exchange between DeMarco and Geithner mirrors what has been an ongoing debate between advocates of principal reduction, who say it is essential to help the housing market and the economy recover, and critics who say the long-term negative implications – increasing taxpayer costs and discouraging mortgage investment – can’t be ignored.
Republicans, who share the latter view, applauded DeMarco’s decision, while Democrats, who support principal reductions, decried it. Sen. Bob Corker (R-TN) praised DeMarco for “[refusing] to bend to political pressures,” while Rep. Gary Peters (D-MI) blasted the FHFA for “turning its back on hundreds of thousands of underwater homeowners.”
Economist Paul Krugman, who has been among DeMarco’s most outspoken critics, was even more direct, arguing in his New York Times column, “This guy needs to go.”
NOTHING IN RESERVE
Most Americans would probably agree that it is important to have cash reserves available to cover an emergency, but only about half of them actually follow that advice. A recent survey by Bankrate.com found that 49 percent of the respondents lack sufficient savings to cover three months of expenses.
That’s worse than last year, when 46 percent were in the ‘no savings’ category, but much improved from 2006, when more than 60 percent of respondents lacked the resources to manage a short-term emergency. When it comes to a longer-term problem, however, the statistics remain grim. Only 25 percent of those surveyed said they had saved the equivalent of six months of expenses, which is the minimum cushion financial experts generally recommend.
Although most consumers lack the resources needed to see them through a financial rough spot, they are feeling better overall about their finances. Nearly a quarter said they are in better shape financially than they were a year ago and only 32 percent said they are “less comfortable” about their savings, compared to nearly half (47 percent) who expressed concern about their savings level a year ago.
Americans are also feeling a bit better about housing market. Nearly three quarters (73 percent) of the respondents to Fannie Mae’s monthly housing survey said they think this is a good time to buy a house, up slightly from 72 percent in May and 35 percent expect home prices to increase over the next 12 months – the best response ever to that question in this survey.
“While consumers remain cautious about the general economy, their attitudes toward the housing market continue to improve," Doug Duncan, Fannie Mae’s senior vice president and chief economist, said. Given that dichotomy between discouraging economic news and increasing optimism about housing, Duncan said, “one might ask whether consumers are increasingly seeing the current environment as a unique opportunity to buy a home, while prices remain depressed, rental costs are increasing, and interest rates are near historic lows.”
The Consumer Financial Protection Bureau (CFPB) has proposed a boat load of new rules designed to improve disclosure and promote fairness in the home mortgage market. The new rules build on continuing efforts by regulators to curb abusive mortgage lending practices, help borrowers shop more effectively for loans, and ensure that they understand the terms of the loans they receive. Among the key provisions:
· Within three days of receiving a loan application, lenders would have to give borrowers a detailed, three-page loan estimate, including the interest rate, how, if at all, the rate might change over the life of the loan, and the largest monthly payment possible.
· Lenders would have to disclose any potential risks related to the loan the borrower is obtaining and highlight components of the loan, such as prepayment penalties, borrowers would want to avoid.
· Lenders must provide a closing form, at least three days before the closing, with more detailed information about likely closing costs.
"When making what is likely the biggest purchase of their life, consumers should be looking at paperwork that clearly lays out the terms of the deal," Richard Cordray, the director of the bureau, said in a press statement.
The proposed rules drew rare praise from both consumer advocates and financial industry executives. Consumer groups said the revamped disclosure forms do a much better job of highlighting and explaining loan details to borrowers. Kathleen Day, a spokesman for the Center for Responsible Lending, noted the “more prominent disclosure on prepayment penalties” as a significant improvement.
David Stevens, president of the Mortgage Bankers Association, said the association also supports clearer disclosures for consumers and credited the CFPB for taking a major step in that direction. But he expressed concern that the short (90-day) comment period may not be long enough to permit a thorough review of the 1,000-page document.
The rules have their share of critics, however. The Independent Bankers Association has asked the CFPB to exempt smaller banks that do relatively few mortgages from the new disclosure requirements. Republican lawmakers, who opposed the creation of the new agency and have tried to restrict its reach, have criticized the length and complexity of the proposed rules.
A memo prepared by staff of the House Small Business Committee complained that the proposed rules are “as long as War and Peace but probably not as interesting to read, and about as indecipherable as if you were an English speaker trying to read the novel in Russian.”
Responding to that criticism at a recent hearing, Cordray noted that the actual rules represent “only a small portion” of the 1000-page document. “Much of it is the kind of explanation, procedure, detail, analysis that Congress has told us they want to require before we write a rule.”
WHAT BORROWERS WANT
The CFPB’s focus on loan disclosure (see related item) appears to be well-placed. When asked in a recent survey what was most important to them in an on-line mortgage search process, most said it was “truth” — as in, accurate and complete disclosure of all the loan costs.
More than 25 percent of the consumers responding to this Harris Interactive survey cited disclosure as their top priority; almost as many (20 percent) said their primary concern was the ability to obtain loan information anonymously, without identifying themselves to the loan originator, while 16 percent cited the ability to compare rates and fees easily. Ten percent said they wanted “protection from unsolicited loan officers.”
“It’s revealing that across the age spectrum, so many online users cite full disclosure of fees and privacy as their top priorities,” said Rick Allen, chief operating officer of Mortgage Marvel, which commissioned the survey.
The responses revealed some interesting age- and gender-related differences, however. For example, men were more concerned than women about accurate disclosure of fees, while women were more concerned than men about being able to obtain loan information without disclosing personal information.
A RISING EQUITY TIDE
Rising home prices are boosting equity positions, pulling some underwater borrowers out of the financial depths and into beak-even or better positions for the first time in years. Price gains erased the negative equity of more than 700,000 homeowners in the first quarter, according to a CoreLogic report, which tallied 11.4 million mortgage borrowers still under water – down from 12.1 million in the final quarter of last year. Of the borrowers who still owe more on their homes than their outstanding loan balance, nearly 2 million were facing a gap of only 5 percent, the report found.
"This is a meaningful improvement that is driven by quickly improving outlooks in some of the hardest hit markets," Mark Fleming, CoreLogic's chief economist, told CNN-Money. While the still sluggish economic recovery will prevent dramatic improvement in the housing market, Fleming acknowledged, “reducing the number of underwater households is an important step toward reducing future mortgage default risk,"
Also boding well in the risk management area, a new credit scoring model identifies many more consumers as good credit risks. The model, developed jointly by Fair Isaac Corp. (FICO) and CoreLogic, combines traditional credit information gleaned from credit card companies and other financial sources, with data collected from public records, including short-term installment loans, rental payment history, and real estate information. This additional information creates “a more precise score and picture of the borrower,” Tim Grace, vice president of CoreLogic, said in a press statement.
Using the new model, the number of consumers with the highest credit score (800 to 850) nearly doubles, to 44 percent – about matching the decline in the second tier (700 to 799). Nearly 70 percent of consumers end up with higher credit scores under this model, but less than 1 percent are pushed above 700 – the cutting off point many mortgage lenders use in qualifying borrowers.
On the other hand, Grace told Business Week, the new model is 10 percent more accurate in predicting defaults for the highest-risk borrowers, making it, not a substitute for the traditional FICO credit score, but a useful addition to it.