Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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“The Hustle” sounds like a 1970s disco dance, but it refers to what the Department of Justice (DOJ) describes as a “particularly brazen” fraud designed by Countrywide Mortgage, for which, Bank of America, which purchased the erstwhile mortgage giant, is being sued.

The civil fraud suit alleges that Countrywide intentionally short-circuited loan reviews that were intended to detect fraud and shoddy underwriting in order to speed the approval and sale of loans to Fannie Mae and Freddie Mac. That process (which the suit contends continued after B of A acquired Countrywide), and an incentive structure linked exclusively to the number of loans originated but not their quality, resulted in loan “defect” rates nine times the industry norm, causing more than $1 billion in losses, according to the complaint.

“Countrywide and Bank of America systematically removed every check in favor of its own balance,” sheet, Preet Bharara, U.S. attorney for the Southern District of New York, said in a press statement. “This lawsuit should send another clear message that reckless lending practices will not be tolerated,” he added.

Separately, Bhara’s office has accused Wells Fargo of intentionally misleading the Federal Housing Administration about the quality of loans insured by that agency, through “longstanding and reckless” lending practices spanning more than a decade. The suit is seeking hundreds of millions of dollars in damages to compensate the FHA for its losses on failed loans.

(Wells Fargo and Bank of America have both paid multi-million dollar settlements to resolve DOJ allegations that they illegally charged higher interest rates to minority mage borrowers. The payments - $335 million for B of A and $125 million in penalties plus $50 million in assistance funds for Wells – are the largest and second largest- fair lending settlements negotiated to date.)

The suits against Bank of America and Wells Fargo are the latest in a string of legal actions targeting financial institutions involved directly or indirectly in lending excesses that triggered the mortgage market meltdown and the recession resulting from it.

  • Citigroup, Flagstar Bancorp and Deutsche Bank have settled civil fraud cases for $158.3 million, $132.8 million and $202.3 million, respectively.
  • The federal mortgage task force created to coordinate actions related to the financial meltdown has sued Bear Stearns & Company (now owned by JPMorgan Chase), for “widespread misconduct” in the packaging and sale of mortgage-backed securities.
  • The Massachusetts attorney general sued Morgan Stanley for its financial backing of New Century, a now defunct mortgage lender. The company agreed to pay $102 million to settle that claim. The American Civil Liberties Union has recently filed a separate suit against Morgan Stanley, accusing the investment bank of pressuring Century financial to make questionable loans targeting low-income minority borrowers.

Financial institutions have generally been settling these actions out of court -- paying sizable financial penalties but neither admitting nor denying guilt – but some are beginning to fight back. Wells Fargo for example, has thus far refused to settle the DOJ suit, arguing that the multi-billion-dollar settlement the nation’s largest financial institutions negotiated with federal and state officials earlier this year, should have largely cleared the liability slate. Jamie Dimon, chief executive of JPMorgan, has also complained publicly about being sued for actions by Bear Stearns, which his bank purchased at the request of the Federal Reserve during the height of the financial meltdown.

Those complaints have drawn a sympathetic response from an unlikely source — Rep. Barney Frank (D-MA) — the ranking Democrat on the House Financial Services Committee. Hardly known as a cheerleader for the financial industry, Frank has urged federal and state officials not to prosecute financial institutions for the actions of smaller institutions they purchased at the behest of government agencies struggling to contain the financial crisis.

In a statement issued earlier this month, Frank noted JPMorgan as a case in point. “The decision now to prosecute J.P. Morgan Chase because of activities undertaken by Bear Stearns before the takeover unfortunately fits the description of allowing no good deed to go unpunished,” a characterization that, he said, applies equally to Bank of America’s acquisition of Merrill Lynch, but not to that bank’s purchase of Countrywide. “I am aware of no federal urging that led CEO Ken Lewis of Bank of America to take over Countrywide, and it is entirely appropriate for the bank to be pursued on that ac,” Frank stated.

Frank emphasized that he was not suggesting “there should be impunity for those in various financial institutions who misbehave,” but the remedy, he said, should be “to pursue those individuals rather than the institutions for which they worked.”

Although the Justice Department did not comment directly on Frank’s argument, a spokesman for the New York Attorney General’s Office dismissed it, telling reporters, "It would be the ultimate legal loophole if accountability for billions of dollars’ worth of fraud upon taxpayers and investors could simply disappear into the ether because ownership of a company changed hands."

SHIFTING DYNAMICS

If you push on one end of a balloon filled with water, it will bulge at another point. The housing market works the same way. When the housing market was booming, homeownership rates soared and rental demand sagged. Now, the reverse is true. The collapse of the housing market depressed ownership rates at one end but boosted rental demand at the other. The rental population grew by nearly 5 million while the population of homeowner households shrank by more than 1.5 million, according to data compiled by the Mortgage Bankers Association. Now it appears that trend may be changing once again.

A weak economy, sluggish job creation rates, the financial battering the recession delivered to household balance sheets and uncertainty about both the economic outlook and home price trends have combined to keep many potential homebuyers out of the market since the downturn began, because they lacked the confidence, the financial capacity, or both to purchase homes. But the continuing economic recovery - -slow, but consistent – rising home prices and record low interest rates are beginning to offset those negatives.

The homeownership rate stood at 65.5 percent in the third quarter, down from 66.3 percent a year ago and well below the record 70 percent before the market crashed, but unchanged from the second quarter, indicating to some analysts that the downward spiral is ending.

Homebuilders, sensing that shift, have accelerated construction plans, starting work on new homes at an annualized rate of more than 870,000 in September – the best performance in four years. Market dynamics have pushed rental prices up (as rental demand has increased), while pushing home prices down, making ownership less costly than renting in many markets.

“This has been a year of steady growth in the percentage of consumers with positive home price expectations," Doug Duncan, senior vice president and chief economist of Fannie Mae, said in a recent report. "Increasing household formation, encouraged by an improving labor market, is adding additional momentum to the housing recovery and putting upward pressure on rental price expectations. Expected increases in both owning and renting costs may encourage more consumers to buy and add further strength to the housing recovery already under way."

FORECLOSURE DAMAGE

There’s no evidence that foreclosures are contagious; just because your neighbors lose their home doesn’t mean you will suffer the same fate. But it does mean that the value of your property will almost certainly suffer. A recent study by the Center for Responsible Lending quantified the impact.

The study, Collateral Damage: The Spillover Costs of Foreclosures,” estimated that foreclosures nationally reduced the value of neighboring properties by a combined total of nearly $2 trillion, with half those losses on properties in minority neighborhoods.

Neighboring foreclosures reduced household wealth by an average of about $21,000 per household– the equivalent of about 7 percent of the value of the homes, the study found. In minority neighborhoods, the average loss was $37,000 or 13 percent of the average median value of homes the report, “

“CRL’s report is troubling evidence of how much the economic costs of foreclosures are spilling over into communities all over America,” Wade Henderson, president and CEO of the Leadership Conference on Civil and Human Rights, said in the CRL press release. “Communities of color – which have been targeted for years by predatory lenders, and abused for years by mortgage servicers – have been practically drowning,” he added. “Until policymakers get serious about reducing foreclosures and restoring meaningful home ownership in all communities, a full economic recovery will likely remain out of reach.”

CHANGING THEIR POLICIES

The regulatory pushback on force-placed insurance is forcing insurers and lenders to alter their approach to this traditionally profitable business in significant ways.

Mortgage contracts typically give lenders the right to ‘force place’ property insurance if borrowers fail to obtain or maintain it. But insurers and lenders have been under fire from regulators and consumer advocates critical of the high cost of the insurance the commissions banks earn on those policies and the lack of incentive to find competitive prices on the policies. An investigative report by American Banker found that force-p-laced premiums industry-wide were as much as 10 times the cost of policies purchased voluntarily.

One major provider of this insurance, Assurant, has announced plans to create more “flexible” policies – read that, lower-cost premiums linked more clearly to industry losses. One of the largest issuers of force-placed insurance, Assurance also agreed recently to reduce premiums by more than 30 percent in California, one of several states where regulators are scrutinizing the pricing structure.

The New York Department of Financial Services, which regulates insurers in that state, has been studying force-placed insurance and is expected to release a report on the issue before the end of this year. The Comptroller of the Currency has also expressed interest in the issue and Fannie Mae announced recently that it intended to establish a relationship with an insurance company to control the issuance and pricing of force-placed policies on loans Fannie has purchased.

A DISCORDANT NOTE

In the continuing symphony of good news about the housing market, a recent announcement from Fannie Mae has sounded a somewhat discordant note. As part of a continuing effort to reduce its exposure to default risks, the GSE is tightening some of its underwriting guidelines. Among other changes, Fannie Mae will now require condominium buyers putting less than 20 percent down to provide detailed financial information about the community association. Previously, only borrower making down payments of 10 percent of less were required to provide that additional documentation.

A few months ago, Fannie decided to reduce the maximum loan-to-value ratios for some adjustable rate mortgages to 90 percent (previous limit went up to 97 percent for some loans) and to increase minimum credit scores (from 620 to 640) for ARMs that aren’t processed through its Desktop Underwriter program. The new rules also limit the discretion lenders had to accept scores as much as 40 points below the minimums if borrowers had offsetting strengths in other areas.

Another change will now require self-employed borrowers to provide a minimum of two years rather than one year of business and personal tax returns - a move that, some industry executives say, will make it more difficult for many prospective home buyers, recovering now from hard financial times, to qualify.