Employment Cooling, Housing Slipping as Fed Continues to Combat Inflation

The nation’s red hot labor market cooled a bit in August, indicating that the Federal Reserve’s inflation-fighting efforts may be having the desired effect. But Fed officials aren’t declaring victory yet. Far from it.

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Two customer satisfaction surveys convey different messages to credit unions.  One sends accolades while the other sounds a cautionary note.

The accolades come from the “Bank and Credit Union Satisfaction Survey” conducted annually by Prime Performance, which again ranked credit unions and small banks well ahead of large banks.  Of the more than 6000 bank and credit union customers surveyed in May, 88 percent of those dealing with credit unions and the same percentage of small bank customers were satisfied with the service they received, compared with only 78 percent of large bank customers.  Eighty five percent of credit union customers and 81 percent of small bank customers said they would recommend their financial institutions to others; only 69 percent of large bank customers shared their enthusiasm.

“The public is already wary of large banks and totally rejects the ‘too-big-to-fail’ attitude that contributed to the recent recession,” Jim Miller, president of Prime Performance, said in a press release.  “Small [financial institutions] get rave reviews from their customers and offer a friendlier and more trustworthy banking experience at a time when all of us need to see smiling faces and to hear warm greetings everywhere we do business.”

The personalized service credit unions and small banks offer gives them an additional edge as the public image of large banks has soured, Miller suggested.  “For the first time since banking deregulation in the 1980s,” he said, “we have a David-and-Goliath situation where David has the tactical advantage.”  Small banks and credit unions “now have their best chance in years to gain market share and net income at the expense of their bigger competitors,” he predicted.
An expanded array of products and services is enabling credit unions to compete more effectively with banks, but that strength may also be undermining their customer satisfaction levels.  That is the cautionary note found in the American Customer Satisfaction Index, which reflected a 5 percent decline for credit unions. Their 2010 ranking (80) still placed them well ahead of banks, at 76, but several large banks moved up this year.  Citigroup and Bank of America Corp. both gained 2 percent as credit unions moved in the opposite direction. 

“The difficulties in managing rapid growth are partly to blame, as regulators have allowed credit unions to expand offerings to include more mortgage and investment banking activity,” ACSI analysts explained in their survey report.  “Financial losses by several individual credit unions have [also] taken a toll. Since credit unions can’t raise capital by selling stock,” the report notes, “the only recourse to recover losses is through cost-cutting, which usually leads to less customer service, or raising fees, which leads to higher customer cost.”  Both trends will shave points from customer satisfaction levels, the report said. 

Prime Targets

In the effort to affix blame for the implosion of the financial and housing markets, Fannie Mae and Freddie Mac have emerged as popular targets, propelled into the negative spotlight by their size, their dominance of the secondary mortgage market, and their position as wards of the federal government.  Critics, who blame the two Government Services Enterprises (GSEs) in part for creating the crisis, now say they are also partly responsible for the foreclosure fiasco that has erupted in its wake.

A recent Washington Post article leveled the most recent charge, suggesting that the effort to control their portfolio losses led Fannie and Freddie to pressure servicers to foreclose as quickly as possible, resulting in the flawed foreclosures that are being scrutinized by lawmakers, regulators and attorneys for homeowners who have lost, or are in the process of losing, their homes.

The Federal Housing Finance Agency, which regulates Fannie and Freddie, reported that servicers initiated 339,000 foreclosures on their mortgages in the third quarter, 23 percent more than in the same period last year and the most the agency has ever reported. 

“Fannie and Freddie, the largest mortgage companies, shaped the practices being challenged in courtrooms around the country,” the Post article said.  “They picked law firms that could foreclose fast and paid them based on how many foreclosures they could process.  Speed was essential,” according to this report, ‘because delays cost the companies money and, after they were taken over by the government two years ago, meant losses for taxpayers, too.”

Spokesmen for both Fannie and Freddie insisted that they have tried to ensure that foreclosures conducted on their behalf were handled properly, but the article contends that both companies continued working with law firms (the article focuses on one Florida firm in particular) after their practices had been questioned by regulators and attorneys. 

“Given that just a handful of law firms are handling foreclosures for over half the nation’s mortgages, it’s no wonder the paperwork problem has spread so widely,” Rep. Judy Biggert (R-IL), told the Post.  (The article notes that Biggert raised questions about the GSEs and the foreclosure practices they were condoning long before the issue exploded in the media.)  “Many Americans may be losing their homes,” Biggert said, “because of a system that was set up to send foreclosures through law firms that were the quickest, cheapest, and least reliable.”

Studying Foreclosures

Record foreclosures are clearly wrecking havoc on personal finances, home prices and neighborhood stability.  But look on the bright side; the trend is providing a mother lode of research material for economists and social scientists.  Two recent examples focused on the impact foreclosures have on, respectively, consumer credit scores and defaults on second mortgages. 

It is no surprise that a foreclosure damages a consumer’s credit rating – a lot and for a long time.  Somewhat more surprising, and a bit counterintuitive, is the evidence  in the first of these studies that borrowers who start with lower credit scores recover more quickly than those who had stronger financials before a foreclosure. 

Kenneth Brevort, a senior economist at the Federal Reserve Board and Cheryl Cooper, a research associate at the Urban Institute, studied “The Credit Experiences of Individuals Following Foreclosure” by analyzing the anonymous credit scores of about 370,000 consumers who had suffered foreclosures.  They found that borrowers with pre-foreclosure scores of 680 suffered an 85-point decline, on average, while those with scores of 780 lost nearly 160 points. 

The declines for both groups resulted because of spill-over delinquencies on other loans – credit cards, auto loans, etc.   But the declines were steeper for those with higher scores, who also recovered more slowly. After two years, only 10 percent of prime borrowers had restored their scores to pre-delinquency levels, and only 40 percent had fully recovered after 7 years. Sub-prime borrowers fared much better.  After two years, more than 60 percent had repaired the damage to their credit scores and after 7 years, the recovery rate was 94 percent.  

The researchers don’t have a definitive explanation for the difference, but one possibility they suggest is that foreclosure “may change prime borrowers’ perception of creditworthiness,” making them more likely than they were before to default on other loans.  Having a lower credit score in itself “may reduce the incentive to make on-time payments,” the study notes. 

In the second of these studies, researchers at the Federal Reserve Bank of Philadelphia offer an intriguing explanation of why second lien holders have resisted pressure to modify those loans in order to make modifications of first mortgages viable for lenders and borrowers.  This study found that 20 percent of borrowers who entered foreclosure on their first mortgage often continued making payments on the second, and 40 percent of borrowers receiving loan modifications kept their equity loans current. 

One likely reason, the authors suggest: In order to qualify for some loan modifications, borrowers must first default on their primary mortgage, creating an incentive to default on one loan, but not on the other. On the contrary, the study points out, borrowers have a strong incentive to remain current on their second liens (primarily home equity lines of credit), in order to preserve access to their credit lines. Supporting this theory, the larger the credit line, the less likely borrowers were to default.  Interestingly, this study found that 90 percent of credit lines were not adjusted following a foreclosure; a few (3 percent to 6 percent) were actually increased.

Other studies have focused on the rise in “strategic defaults” by owners with negative equity.  But this study suggests that borrowers may be overlooking an even more effective strategy.  A second lien behind a first mortgage that already exceeds the value of the property is virtually worthless.  So borrowers could default on the second lien, possibly generating enough revenue to remain current on the first mortgage, without much risk that the lender will foreclose on the second. 

“The data indicate, however, that most borrowers rarely engage in this strategy,” the study says, “even though it appears to be viable.” 

Appearances Still Count

A book’s cover may not tell you much about its contents, but home sellers would be wise to focus on the first impression their properties make on prospective buyers.  Curb appeal remains a critical factor in home purchases, often determining not whether buyers purchase a home, but whether they even actively consider it. 

The National Association of Realtors’ annual “Cost vs. Value” analysis of remodeling expenditures rated exterior projects among the most cost-effective sellers can undertake.   Based on the value recovered in a sale, 9 of the 10 most cost-effective projects in this year’s analysis were exterior renovations.  Topping that list:  Steel entry door replacement, which returned 102.1 percent of the cost – the only project to fully pay for itself.  Replacement of a garage door with a mid-range upgrade returned an estimated 83.9 percent, on average.  Siding and window replacements returned an average of more than 70 percent, while upscale fiber cement siding returned as much as 80 percent of the cost.

“Curb appeal remains king,” NAR President Ron Phipps said in a press release summarizing the latest analysis.  “It’s the first thing people notice when looking for a home and it also demonstrates pride of ownership,” he said.

Too Much Caution -- And Too Little?

The devastating recession has made Americans on the whole, more cautious and risk-averse.  And the possibility that this change may be permanent is cause for concern, economist Robert Samuelson believes.  Consumers are shedding debt and “erecting protections against unpredicted adversities,” he observed, while corporate executives are hoarding cash.

“All of this may seem a prudent reaction to the follies that fostered the financial crisis,” Samuelson wrote in a recent Washington Post column.  “But where does prudence stop and paranoia start?”

“….The Great Recession’s most worrisome legacy could be this common allergy towers risk-taking,” Samuelson warns.  “Having underestimated risks in the bubble years, we may overestimate them now.” While this reaction to the past may be understandable, he notes, it could also “burden the future.”
If there is reason to suspect that consumers and businesses have been overly chastened by their experience, there may also be reason to fear that lenders have not been sufficiently chastened by theirs. 

“Credit card offers are surging again after a three-year slowdown,” the New York Times reported recently.  Lenders are once again offering cards to “high-risk” borrowers, although they appear to be exercising more discretion than in the past - slicing and dicing borrower credit profiles to distinguish between those who defaulted on mortgages “strategically” or who suffered temporary income disruptions because of job losses, and “distressed borrowers,” who lack the capacity to repay their loans.  

While lenders may be focusing more on risk management, they are, nonetheless, offering new credit sooner to previously distressed borrowers, as they seek to rebuild their tattered credit card lines.  The “rehabilitation” of borrowers with damaged credit is occurring faster than in the past, the Times suggests, because “lenders cannot afford to wait.”