The Treasury Department has received its first report card – actually two report cards -- on the management of the financial industry bail-out program (TARP). And the grades on both were poor. Both the Government Accountability Office and the Congressional panel overseeing the program found much to criticize in Treasury’s design, administration, implementation and evaluation of the $700 billion program.
On a laundry-list of problems and shortcomings, the report, by the Government Accountability Office (GAO) cited as most troubling:
The “effective management structure” and “essential system of internal control” needed to administer the program remain incomplete.
The agents and contractors Treasury has hired to run the program have not produced the conflict-of-interest guidelines required by TARP’s enabling statute, and Treasury hasn’t developed procedures for monitoring those conflicts.
Treasury has not yet fully staffed the Office of Financial Stability (responsible for managing TARP), hiring only 48 of the 200 full-time employees anticiapted. Inadequate staffing creates “a heightened risk that the interests of the government and taxpayers may not be adequately protected and that the program objectives may not be achieved in an efficient and effective manner,” the report notes.
Strong oversight of the program clear communication of its goals and effective measurement of its progress are particularly important, GAO said, in light of Treasury’s recent decision to shift TARP’s focus from purchasing toxic assets to infusing capital directly into financial institutions. While acknowledging that it is too soon to evaluate the program, the GAO said, “without a strong oversight and monitoring function, Treasury’s ability to help ensure an appropriate level of accountability and transparency will be limited.”
The Congressional oversight panel made a similar point: “American taxpayers need to know that their money is having a tangible effect on improving financial stability, credit availability, and the economy as a whole,” the panel said in its first report on TARP’s progress. As a first step, the report suggested, “Treasury needs to provide a detailed assessment of whether the finds it has spent so far have had any effect — for better or worse — in these areas.”
Legislators, who have been increasingly critical of Treasury’s management of the bail-out program, have intensified their criticism. The GAO report provided “bad news and worse news,” Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, said in a press statement. “The bad news was confirmation…that Treasury has no way to measure whether taxpayer funds invested in banks are being used in accordance with the purpose of the law, to increase lending. The much worse news,” he said, “is Treasury’s response that it does not even have the intention of doing so.” The department’s position, Frank added, “comes very close to telling the institutions that they will be free to use the funds as they wish.”
Frank’s criticism, echoed by other senior legislators, indicates that Treasury Secretary Henry Paulson can expect stiff resistance if he seeks Congressional approval to tap the second half of the $700 billion in TARP funds. “I would be a very hard person to convince that this crowd deserves to have their hands on the next $350 billion,” Sen. Christopher Dodd (D-CT), chairman of the Senate Banking Committee, told reporters recently. “I am through giving this crowd (the Bush Administration) money to play with.”
Most analysts agree that the only TARP proposal likely to fly in Congress is one that calls for using at least some of the funds to help homeowners avoid foreclosure. Congressional leaders – Republicans as well as Democrats — have told Paulson they won’t consider a TARP funding request unless he submits a detailed report outlining how he plans to use the funds.
Still, most agree that events on the ground could alter the Congressional mood. “I wouldn’t take all these comments [about blocking additional TARP funding] at face value, “Tom Gallagher, head of policy research at Washington-based International Strategy and Investment Group, told Bloomberg News. Congress quickly approved TARP when the financial markets froze after the failure of Lehman Brothers, and a similar response is likely, he said, if another financial crisis looms.
MORE NEGATIVE BENCHMARKS
Delinquency and foreclosure rates continue to hit negative milestones. The most recent, reported by the Mortgage Bankers Association (MBA): One in ten homeowners were either behind on their mortgage payments or in foreclosure in the third quarter of this year. Late mortgage payments and loans in foreclosure both reached 29-year highs of nearly 7 percent and close to 3 percent, respectively. For prime loans, the delinquency and foreclosure rate was 5.9 percent; for subprime, the rate was approximately 33 percent.
New foreclosures filed actually declined slightly to 1007 percent from 1.08 percent in the second quarter. But that is actually a negative indicator, according to the MBA, reflecting the temporary foreclosure moratoria several states have imposed. When those relief periods end, foreclosure rates will spike anew, MBA analysts warn.
Illustrating that point, loans delinquent for 90 days or more jumped by 45 basis points to 2.2 percent (another record), suggesting to Mark Vitner, a managing director and senior economist at Wachovia Corp., that the mortgage crisis “is far worse than most people realize.”
Another troubling statistic is the large number of seriously delinquent properties (40 percent) that are also vacant. That concerns Jay Brinkman, the MBA’s chief economist, because it suggests that efforts to prevent foreclosures are keeping many properties “at a standstill,” depressing sales and “artificially” lowering foreclosure rates. Another definitely bad sign, Brinkman told American Banker: delinquency rates have traditionally been a leading indicator of future foreclosure rates.
The MBA economist agrees that the recent statistics suggest that despite government and private efforts to stem the foreclosure tide (see related items below), the mortgage crisis is deepening.
Until recently, Brinkman said, he has attributed the delinquency and foreclosure problems largely to a combination of “overbuilding, improper underwriting and speculation. But now,” he told American Banker, “we have to factor in job losses due to the recession,” and job losses, he noted, “are mounting. We have not gone into past recessions with the housing market as weak as it is now,” Brinkman noted, “so it is likely that a much higher percentage of delinquencies caused by job losses will go to foreclosure than we have seen in the past.”
Brinkman is currently predicting that lenders will initiate 2.2 million foreclosure actions this year. “Absent a recession, the 2009 number would likely have fallen by several hundred thousand,” he noted, “but the effects of job losses and general deterioration make the 20089 outlook worse, particularly if mortgage problems become more widespread.”
As loan delinquency and foreclosure rates continue to mount, lawmakers and consumer advocates are increasing the pressure on lenders to modify the loans of struggling borrowers more quickly and on a much larger scale. But a recent study suggests that modifications may not be as effective as advocates assume. The study, by the Office of the Comptroller of the Currency, found that more than one-third of the borrowers whose loans were modified in the first quarter defaulted again within a month and more than half were in default within six months of receiving what were, presumably, more favorable repayment terms.
“The results, I confess, were somewhat surprising, and I say that not in a good way,” Comptroller of the Currency John Dugan said, during a panel discussion at a National Housing Forum sponsored by the Office of Thrift Supervision (OTS). Dugan said the OCC analysis, detailed in the agency’s third quarter “Mortgage Metrics Report,” does not explain why the modification results to date have been so poor. “Is it because the modifications did not reduce monthly payments enough to be truly affordable to the borrowers? Is it because consumers replaced lower mortgage payments with increased credit card debt? Is it because the mortgages were so badly underwritten that the borrowers simply could not afford them, even with reduced monthly payments? Or is it a combination of these and other factors?” The explanation, Dugan said, “has important ramifications for the foreclosure crisis and how policymakers should address loan modifications, as they surely will in the coming weeks and months.”
Speaking on the same panel, Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC), acknowledged that “the quality of [the modifications] is not what it should be.” But Bair and others have also emphasized that modifications must give borrowers permanent relief in the form of a reduction in their principal balance. Many modifications extend payment times or defer a portion of the payments without actually reducing the borrower’s debt burden.
A recent study by Credit Suisse highlighted that problem. The study analyzed the recent loan modification efforts of 19 servicers, finding that 30 percent of the borrowers whose loans were restructured in the fourth quarter of last year defaulted again within 8 months. Within that group, nearly half (44 percent) of the borrowers receiving traditional modifications (reduced interest rates or extended loan terms) defaulted, compared with only 23 percent of those who received principal reductions.
A study by Alan White, an assistant professor at the Valparaiso University School of Law, produced similar results. The servicers White studied forgave an average of $1,914 in unpaid interest on each loan, but increased the principal balance by an average of $11,200 on 72 percent of the loans modified. “We’re going backwards,” White told American Banker. “The voluntary modifications are putting people under water more than they already are, and those terms are contributing to the failure rate.”
Ocwen Financial, a West Palm Beach institution highlighted in the Credit Suisse study, has offered principal reductions to more borrowers, with promising results. Only 12 percent of the delinquent borrowers whose principal balances were reduced in April were delinquent five months later, compared with 22 percent who received less aggressive modifications. Those results are preliminary but still “encouraging,” according to Rod Dubitsky, head of asset-backed securities research for Credit Suisse, who oversaw the study. “There are still some lingering concerns [about principal reduction-modifications],” Dubitsky told American Banker, “But in six months, what Ocwen is doing could become standard operating procedure.”
Stricter underwriting standards – a reaction (some say, an overreaction) to the underwriting lapses responsible for the subprime debacle – have made it demonstrably more difficult for prospective home buyers to obtain loans. This has produced two results: A sharp reduction in loan originations and a sharp increase in the incidence of mortgage fraud, as borrowers try to overcome loan approval obstacles.
The Mortgage Asset Research Institute reports that incidents of mortgage fraud increased by 45 percent in the second quarter compared with the same period a year ago, with most of the reports involving the “misstatement” of financial information. Falsifying bank statements (by editing them on-line) and “doctoring” pay stubs were among the most common strategies noted in the report. Florida was responsible for nearly 22 percent of the second quarter fraud reports, followed by California and Illinois. The Mortgage Bankers Association estimates that fraud cost mortgage lenders close to $1 billion over the last decade. Other studies have identified fraud as a factor in between 30 percent and 50 percent of the subprime mortgage defaults.
FIRST WE SHOOT THE ECONOMISTS
Shakespeare suggested that we should shoot lawyers first. But a Latvian university professor has discovered that economists can become a prime target of those inclined to shoot the messengers delivering unwelcome financial news. The Wall Street Journal reports that Dmitrijs Smirnovs, a 32-year-old university lecturer, was detained by Latvia’s Security Police after telling local newspaper reporters that the condition of both Latvia’s banks and the country’s currency was precarious. “All I can advise is this,” Smirnovs told the reporters. “First, don’t keep money in banks. Second, don’t keep money in lats.”
When his comments were published, Smirnovs was detained by the security police, who seized his computer and questioned him for two days. Although he was not arrested, Smirnovs was ordered not to leave the country and warned not to continue spreading “untruthful information.”
Smirnovs told the Journal that he will “certainly be more careful” about expressing his views in the future. But he also pointed out that the tactics of the Latvian security agents have proven to be counterproductive. Before his detention, Smirnovs noted, hardly anyone was aware of the country’s financial problems. Now, thanks to the national and international publicity he’s received, “everybody knows who I am and what I think.”