Moving to curb the rise in “strategic defaults,” Fannie Mae intends to impose a seven-year ban on new mortgage loans for borrowers who walk away from mortgages they could potentially afford to repay. The new rules, announced last month, require borrowers to negotiate “in good faith” with their lenders to obtain an affordable repayment plan.
In addition to restricting access to future mortgage credit, Fannie also intends to pursue strategic defaulters personally in jurisdictions where the law puts other assets, in addition to the home securing the mortgage, within a creditor’s reach.
“Walking away from a mortgage is bad for borrowers and bad for communities and our approach is meant to deter [this] disturbing trend,” Terence Edwards, Fannie’s executive vice president for credit portfolio management, said in a press statement.
Freddie Mac has not implemented a similar policy, but a spokesman told reporters the company “will take a close look” at it. “We’ll consider it in light of current market conditions in order to manage our risk as effectively as possible,” Brad German told the Associated Press.
Fannie and Freddie are both struggling with record delinquencies while playing a critical role in the Obama Administration’s foreclosure prevention efforts. Severely weakened by loan losses and earlier accounting scandals, the two secondary market lynchpins have been operating under federal receivership since September of 2008.
While industry analysts and many legislators have slammed the companies for overly lax underwriting standards in the past, some critics have also questioned Fannie’s attempt to, in their words, “punish” strategic defaulters. Critics say the new rules will be difficult to enforce, unpopular with the public, and not terribly effective, in any event.
“How are they going to do this, and for what result?”Grant Stern, president of Morningside Mortgage Corporation, asked in an interview with the New York Times. “So they can find the people who have a little money left after their house crashed and take it away from them?”
Lou Barnes, a Colorado mortgage broker and columnist, echoed that view. “Fannie wants to lock people up in a jail of negative net worth for much of the rest of their lives,” Barnes told the Times. “They’re bringing back the debtor’s prison.”
Fannie’s new rules reflect growing lender concern about the increasing number of borrowers who appear to be defaulting not because they can no longer afford to make their mortgage payments, but because they have decided it is in their financial interests to walk away from a loan that now exceeds the depressed value of their home.
According to some industry estimates, nearly 25 percent of owners with mortgages --about 11 million households-- were underwater on their loans. A recent study by Experian and Oliver Wyman, a consulting firm, estimated that nearly 19 percent of all mortgage defaults last year were “strategic.”
A separate study by the Federal Reserve found, not surprisingly, that the higher the level of their negative equity, the more likely borrowers are to “walk away.” According to that study, when negative equity approaches 50 percent and the prospects for significant price appreciation appear slim, half of defaults are strategic.
The Experian study found some evidence that mortgage delinquencies generally and strategic defaults particularly may have peaked in the fourth quarter of 2008. But that conclusion is “heavily contingent” on continued stabilizing of home prices -- a prospect that appears less likely in the near term, analysts say, in light of recent employment reports indicating that new job formation is slower and weaker than they had expected.
TAX CREDIT REPRIEVE
Beating the deadline buzzer-- barely -- Congress approved a three-month extension of the homebuyer tax credit program, giving buyers until September 30 to complete purchases that will be eligible for credits of up to $8,000 for first-time buyers and $6,500 for owners who sell their existing residences and purchase another.
The original June 30 deadline would have caught an estimated 180,000 buyers short of the finish line, unable to close on homes they had selected and committed to buy. The House approved the deadline extension easily on a 409-5 vote, but the measure’s fate was uncertain in the Senate, where lawmakers had added the credit extension to a broader bill extending unemployment benefits that lacked the votes required for passage. With the tax credit deadline looming, the Democratic leadership introduced a stand-alone measure extending the tax credit deadline, which the Senate passed by unanimous consent in one of its final acts before adjourning for the July 4th recess.
The National Association of Realtors led the campaign to extend the credit deadline, arguing that many buyers taking advantage of the program were purchasing foreclosed homes or engaged in short sales, which take longer to complete than conventional purchases. (Only buyers who have signed purchase and sale agreements will be able to take advantage of the new deadline.)
“We owe this to the people who have essentially followed the rules, who are caught by a closing date,” Rep. Sander Levin (D-MI), chairman of the House Ways and Means Committee, said before that body approved the extension.
Despite the lopsided House vote and the unanimous consent in the Senate, the push to extend the tax credit deadline encountered stiff resistance from critics of the tax credit, who argued that the program has distorted the housing market, accelerating purchases that would have been made anyway without doing much to encourage additional sales.
A Treasury Department report indicating that prison inmates illegally claimed more than $9 million in credits while in prison, following earlier reports of fraud and abuse in the program, created additional resistance in the Senate, but in the end, not enough to prevent final approval of the deadline extension.
LOYALTY REWARDS
Loyalty pays. That is the not terribly surprising but nonetheless reassuring conclusion of a recent study by TransUnion, finding that consumers who have multiple accounts with a financial institution perform better – with fewer delinquency problems – than customers with fewer relationships.
The study looked at the correlation between the number of accounts consumers hold and the number of accounts on which payments are delinquent. The inverse relationship (the more accounts, the fewer delinquencies), present in all types of accounts, was most dramatic for first mortgages. Borrowers with one relationship had a 30-day or worse delinquency rate of 4.8 percent, compared with 4 percent for borrowers with 2 relationships, 2.8 percent for 2 relationships and 2.3 percent for 4 relationships. For borrowers with 5 or more relationships, the delinquency rate fell to 1.9 percent.
The correlation for credit cards dropped from 2.7 percent for borrowers with 1 relationship to 2.1 percent for 3 relationships and 1.6 percent for 5 or more. For auto loans, the delinquency rate fell from 2 percent for 1 relationship to 0.6 percent for 5 or more.
“There is a clear, consistent, and quantifiable increase in customer value associated with loyalty,” Ezra Becker, the study’s author and director of consulting and strategy in TransUnion’s financial services business unit, said.
Equally important, the “loyalty effect” the study identified held across income and credit score lines, suggesting that credit scores are not the predictor of customer loyalty that industry executives assume them to be.
The study’s findings hold important messages for both financial institutions and consumers, Becker suggested. “It behooves financial institutions to understand how their marketing acquisition efforts and product offers to current customers impact delinquencies and write-offs throughout their operations,” he said.
For consumers, Becker added, the “loyalty effect” suggests “possible benefits that might be obtained by demonstrating loyalty to a particular financial institution. Credit relationships work best, he said, “when both the lender and borrower view the deal as a partnership.”
AFTER THE GLUT-- A HOUSING SHORTGAGE?
If you thought the bulging inventories of unsold homes were creating problems, just wait until the industry has to deal with the acute housing shortage that some experts are predicting. That seems a little like worrying about flood risks in the middle of a 10-year drought, but some analysts argue that the current dearth of new home will create a severe supply-demand imbalance when the economic recovery strengthens and the housing market begins to rebound.
For now, the lingering high unemployment rate and poor job prospects are curbing household formation rates as more single individuals are doubling and tripling up or returning to live with their parents. The Census Department reports that only 398,000 new households were formed in 2009, startlingly below the 1.3 million annual average that has prevailed in recent years. But James Gaines, a real estate economist with Texas A&M University, thinks the depressed household formation rate is temporary and “artificial,” masking pent-up demand that will surface in spades, he predicts, when the economy recovers.
Those who see the large overhang of unsold homes as a continuing disincentive for new construction assume that all those “for sale” homes are desirable. In fact, James told CNN-Money, “many…may not be habitable or are in locations where nobody wants to live.”
Gaines appears to hold a minority view, however. Most analysts are far less optimistic about the near term housing recovery prospects. The inventory statistics actually understate the overhang, Nicholas Retsinas, director of Harvard’s Joint Center for Housing Studies noted in the CNN-Money report. Many more homes, he noted, are vacant but not net included in the ‘for sale’ figures. “The housing market hasn’t been this way before,” Retsinas insisted. “The gravity of the problem is deeper and the challenges different. You have to get through that inventory.”
Even if Gaines is right about the pent-up demand for new construction, industry executives say, he is wrong about the ability of builders to respond quickly to it. Lack of financing is a huge problem for many builders, Jerry Howard, CEO of the National Association of Home Builders (NAHB), told CNN-Money. The ongoing downturn has also thinned the ranks of builders, leaving fewer to respond when demand strengthens.
ANOTHER ARBITRATIN BOOST
The US Supreme Court, which hasn’t missed many opportunities in recent years to strengthen mandatory arbitration provisions in consumer contracts, took advantage of another one recently, affirming that arbitrators, not the courts, should determine whether an arbitration requirement is “unconscionable.”
That decision (Rent-A-Center, West v. Jackson) came in a suit challenging the arbitration requirement in an employment contract. The plaintiff, Jackson, sued his employer for discrimination after he was fired from his job as an account manager. The employment agreement Jackson had signed gave the arbitrator the exclusive right to resolve any disputes about the arbitration provision.
The lower courts rejected Jackson’s discrimination claim. A divided (5-4) High Court found that he had failed to challenge the arbitration “delegation” provision in the lower courts, raising the issue for the first time in his Supreme Court appeal, when “it was too late and we will not consider it,” Justice Antonin Scalia wrote in the majority opinion.
Writing for the minority, Justice John Paul Stevens said the majority decision puts in an arbitrator’s hands “gateway” issues that the courts should decide. These issues raise fundamental questions, such as the enforceability and legality of an arbitration agreement, that “the parties are not likely to have thought they had agreed an arbitrator would decide,” Justice Stevens.
The Chamber of Commerce, which filed an amicus brief for Rent-A-Center, said the High Court decision will appropriately curb the increase in consumer suits challenging arbitration provisions of all kinds as “unconscionable.” Consumer advocates said the decision unfairly limits the ability of consumers to fight unreasonable arbitration requirements.
