With the blueprint for resuscitating the banking industry, for better or worse, now in place, President Barack Obama has turned his attention to the housing market, announcing a $275 billion government effort to help as many as 9 million homeowners at risk of losing their homes.
In one possibly encouraging sign, the stock market did not tank immediately following the unveiling of the “Homeowner Affordability and Stability Plan” as it did two weeks before, after Treasury Secretary Timothy Geithner described the government’s revamped initiatives to aid the nation’s damaged banks.
The centerpieces of the housing plan are:
A standardized loan modification process with incentives to encourage lenders to restructure the mortgages of delinquent and at-risk borrowers; and
A new program targeting “credit-worthy” borrowers who are current on their payments but unable to refinance because declining home values have left them “upside down,” with mortgage balances that exceed the value of their properties. The program authorizes Fannie Mae and Freddie Mac (both operating under government conservatorship) to waive the 20 percent equity standard for a conventional mortgage and offer qualified homeowners loans of up to 105 percent of their current property value without the private mortgage insurance these loans would normally require.
The Fannie/Freddie plan could help as many as 5 million homeowners reduce their current mortgge rates, according to Administration estimates. The loan modification plan, with an estimated $75 billion price tag and a target of 3 million to 4 million at-risk borrowers, aims to substitute a standardized process for what is now a patchwork of modification programs. The Treasury Department is supposed to publish “clear guidelines” for the program this week, and one of the key details Treasury will have to specify is how lenders will define “at risk” borrowers eligible for loan modifications to exclude both borrowers who can afford their payments and those whose income will not support mortgage payments on any terms.
In his comments, Obama emphasized that those and other distinctions will be important. The housing plan, he said, “will not rescue the unscrupulous or irresponsible by throwing good taxpayer money after bad loans. It will not help speculators who took risky bets on a rising market and bought homes not to live in but to sell. It will not help dishonest lenders who acted irresponsibly, distorting facts and dismissing the fine print at the expense of buyers who did not know better. And it will not reward folks who bought homes they knew from the beginning they would never be able to afford.” The government program, he added, ‘will not save every home.”
Nor with the program be inexpensive, Obama acknowledged. “But preventing foreclosures will save the cost to families who lose their homes, to other homeowners, whose properties are devalued, and to our economy as a whole. Given the magnitude of these costs,” he added, “it is a price well worth paying.”
Initial reaction to the program was relatively positive, with predictable complaints from the left (it does too much to help banks and not enough to help homeowners) and on the right (it rewards lenders who made bad loans and borrowers who made bad decisions), but an impressive amount of support in between, with from industry executives and consumer advocates agreeing that the plan is far more ambitious and better-structured than previous initiatives and has a better chance to succeed.. “I think it will be much more successful,” Mark Zandi of Moody’s.com told the Los Angeles Times. “But I worry that it’s not going to be successful fast enough.”
On the other hand, Karen Shaw Petrou, managing director of Federal Financial Analytics pointed out, “We’ve tried a lot of other half-solutions that were quibbled and nibbled at…and we’ve wasted a year-and-a-half. This [plan] needed to be really big and far-reaching,” she told American Banker. “And I think [it] is. If this doesn’t work,” she added, “nothing will.”
AND NOW, AN IMPORTANT MESSAGE
The massive housing assistance plan that President Obama has unveiled includes a sizable and politically significant commitment to expand the financing and refinancing capacity of Fannie Mae and Freddie Mac, the weakened secondary mortgage market giants, now operating under federal conservatorship. In addition to increasing the regulatory limit on the size of their mortgage portfolios from $850 billion to $900 billion; calls for using remaining funds from the first iteration of the Toxic Asset Repurchase Plan (Tarp I) to purchase securities issued by the GSEs “so there is stability and liquidity in the marketplace;” and authorizes the Treasury Department to increase the purchase of preferred stock in the companies from $100 billion to $200 billion each, to provide the capital they need to ensure secondary market liquidity and “hold mortgage rates down.”
The promise of increased capital support does not represent a government estimate of future losses for the GSEs, Treasury Secretary Geithner emphasized in a press statement. The intent, rather, is “to provide assurance to market participants that Congress gave these companies a special purpose to support housing finance. Given the difficulties in the housing market today,” he added, “we stand firmly behind their ability to provide that support.”
The message the expanded government funding commitments convey about the GSEs may be as significant as the funding commitments themselves. Before crisis engulfed the financial markets, momentum was building to tighten regulatory oversight of Fannie and Freddie and restrict their activities. Geithner’s comments reflect a dramatic change both in tone and in policy direction.
“[The housing plan] draws Fannie and Freddie yet more tightly into the embrace of the federal government and shows their importance to housing policy,” an analysis in Financial Times observed. In its reliance on the GSEs, this analysis suggested, the plan moves “from the implicit [federal] guarantee of their debt,” which critics have deplored for years, “to the brink of making [the guarantee] explicit.”
CREDIT CARD FEARS
Seeing the shadow of impending regulation hovering over their business, credit card issuers are aggressively adding transaction fees, cutting credit lines and increasing interest rates before restrictive laws and regulations make it more difficult or impossible for them to do so.
Recent press reports noted a growing list of major issuers, Capital One, Citibank, and HSBC among them, that have recently increased interest rates on card balances and others (Chase) that have added annual fees and increased their minimum payment requirements. Many more issuers are reducing credit lines, reflecting concern about credit risks as consumers are hammered by the economic downturn.
While these actions are intended in part to get ahead of credit card reform initiatives (regulations issued by the Federal Reserve take effect in July and both the House and Senate are considering measures that go beyond the Fed’s rules), they may have the unintended effect of bolstering arguments that restrictions should be tighter and consumer protections stronger than those enacted or proposed.
Some analysts also have warned that cutting credit limits and other issuer actions designed to reduce credit risks might have the opposite effect, encouraging borrowers to charge to their limit and then walk away from cards they no longer view as useful to them.
“You reduce the credit line to the balance they have, so it becomes a useless card at that point,” Rick Wittwer, who has overseen collections for large card issuers, told American Banker. “It pushes them into delinquency when they weren’t there before,” Wittwer, a managing partner at Virtual Point capital Corp., noted.
Reducing credit limits also infuriates good customers, and may lead them to take their credit card business elsewhere, leaving issuers with a larger ratio of high-risk customers on their books. “In some ways, it rates adverse selection,” Richard Fairbank, chairman and president of Capital One Financial Corp. said at a recent conference, reported by American Banker. “The bad guys,” he added, “already have your money.”
FANNING THE CREDIT CARD FIRES
Adding more fuel to the regulatory fires burning around credit cards (see above), the Center for Responsible Lending (CRL) has published two studies chronicling and decrying practices the Federal Reserve’s newly approved credit card regulations target. The studies, announced almost simultaneously with the publication of the final rules (which take effect in July), assess the use of penalty rates and the allocation of monthly payments to higher-cost balances, describing both practices as “deceptive and abusive” and dismissing industry arguments supporting them as “making no economic sense.
Credit card issuers intentionally use “complex” pricing policies that “exploit borrowers’ lack of information,” the CRL contends, noting as particularly confusing, the differences between introductory teaser rates, rates on purchases and rates charged for cash advances. “Only 3 percent of Americans understand these differences well enough to be able to make the least costly decision” about their payments, the consumer advocacy group asserts in its summary of the study results.
The study of penalty pricing – higher rates triggered by missed or late payments – found that 11 percent of consumers have been placed in the “penalty box,” but more than half are not aware of it and “issuers do not go out of their way” to inform consumers of the pricing shift. The higher rates have a significant impact on credit costs, however, adding $1,800 annually to the interest charges paid by a family with an average credit card debt of $10,678, according to the CRL study.
Lenders have been deriving an increasing amount of revenue from penalty fees, which, the study notes, increased by 67 percent between 2003 and 2007, as issuers included the penalty rates in 94 percent of all new credit card solicitations in 2008, up from 82 percent in 2003.
The study of payment allocation practices was equally critical of the industry, describing the allocation of payments to lower-rate balances first as “harmful to borrowers, highly deceptive and inconsistent with risk-based pricing,” which is the industry’s argument for using this approach. In fact the study contends, the practice “distorts” risk-based pricing, because it is the lower-risk consumers, not those posing greater risks, who end up paying higher rates. Issuers use this approach anyway, the study suggests, because it allows them to raise effective card rates without altering the stated rate; takes advantage of consumers’ “known tendencies to overvalue the present and over-discount the future,” and capitalizes on the “excessive optimism” of consumers, which leads them to ignore the higher credit costs or understate their impact.
The Fed regulations require lenders to choose one of two payment allocation methods, and that represents an improvement, the CRL says, but it does not go far enough, because most consumers cannot effectively compare different pricing strategies. Instead, the organization suggests, regulators should require all lenders to use a single pricing standard – preferably one that allocates payments to higher-cost balances first, “because this would save consumers the most money and is most consistent with risk-based pricing.”
The battle to turn back the revised Real Estate Settlement Procedures Act (RESPA) regulations continues. The Department of Housing and Urban Development (HUD) has refused industry requests to withdraw and rethink the regulations, designed to make residential mortgage disclosures clearer and more useful to home buyers. But with a new Administration in place (the regulations were developed during the Bush Administration) industry executives are hoping for a different response. A letter signed by eight industry trade groups repeats their request that HUD coordinate its RESPA rules with revisions the Federal Reserve is drafting for the Truth-in-Lending Act disclosures.
“Considering that RESPA and TILA rules are so interrelated, successive disclosure changes, first by one agency and then the other, would be unnecessarily costly for the industry at a time when the industry can ill-afford the costs, and would confuse consumers rather than providing greater clarity,” the letter says.
The “daunting array” of disclosures consumers receive are disparate, uncoordinated, confusing, and consequently, too often ignored,” the letter continues. Administration officials have indicated plans to carefully review all Bush-era regulations and RESPA, the industry trade groups argue, should be on that list.
The organizations signing the letter included: The American Bankers Association, the American Escrow Association, the American Financial Services Association, the Consumer Bankers Association, the Consumer Mortgage Coalition, the Housing Policy Council of the Financial Services Roundtable, the Independent Community Bankers of America, and the Mortgge Bankers Association. Notable by their absence: the National Association of Realtors, the Real Estate Services Providers Council, and the American Land Title Association, all of which have participated in joint expressions of industry opposition to RESPA in the past.
HUD has not yet responded to the recent letter, but the Department of Justice picked up where the former Administration left off and has asked a U.S. District Court to dismiss a suit filed by the National Association of Mortgage Brokers, challenging the new RESPA rules. NAMB contends that the rules, which require up-front disclosure of the fees lenders pay brokers for originating higher-rate loans, would create a “permanent disadvantage” for brokers, because other loan originators are not required to disclose their compensation.
NAMB officials said they were not surprised by the DOJ position and indicated that HUD still has time to rethink the rules before they take effect, in January of next year