Bailout blues

Today, Camerota, chairman of the California Mortgage Bankers Assn., and Leonard, California office director for the Center for Responsible Lending, discuss calls for government relief of mortgage defaults. Previously they focused on building homeownership, the ethics of lending, the scale of the sub-prime crisis and proposed solutions.

Don’t encourage bad behavior
By Robert Camerota

In our headline-reading, 24-hour-news-cycle, short-attention-span world, government bailouts often seem to be the pat answer to market or corporate declines. Whether it is the airlines, railroads or governments themselves in financial trouble, the suggested solution is far too often a bailout. Now we are hearing from some that it’s time for a government bailout of the sub-prime mortgage industry and its borrowers.

For all that is wrong with a government bailout in response to the sub-prime cooling, it is first and foremost unfair to taxpayers, who aren’t at fault and shouldn’t bear another unnecessary burden. With rising interest rates and uncertainty in other markets, the last thing we need is to hit the taxpayer yet again.

Bailing out borrowers also bails out lenders and their investors. It is irresponsible for government to adjust market forces artificially (for an example, see how well price fixing has worked when it was tried). With that in mind, it is important to realize that one of the most crucial forces in the lending industry is risk and, specifically, the risk of loss. Retaining the inherent risk of loss ensures that consumers, lenders and investors don’t systematically make irresponsible decisions. From lenders evaluating a potential borrower’s creditworthiness to investors gauging the reliability and strength of a particular lender and the loans it is originating, the risk of loss is a critical component to the lending industry.

In our current situation, the threat of loss (lenders typically lose 20% to 40% of the loan value if the home is foreclosed) gives lenders incentive to be more credit-conscious, work with homeowners to restructure loans, offer low-cost refinances or otherwise work with their borrowers. If investors, lenders and borrowers who pushed the envelope too far, stretched themselves too much or sank too much money into certain products are bailed out by the government, the risk of loss fades. And the bad news is we won’t see the effects right away, but down the road, during the next upswing in the market as individuals who are tempted by the quick buck will have no fear — why would they, if they are convinced by experience that the government will clean up the mess afterward?

Once again, I am convinced that the lending industry has taken tangible steps to self-correct and assist borrowers by providing education, counseling, increased borrower communication and a commitment to work with our government and nonprofit partners on issues such as fraud and identity theft. These steps, taken without government mandate, send a clear signal that lenders understand the problems and that con artists and predatory lenders have no place in our industry.

In closing out this week, I’d like again to thank the Los Angeles Times for hosting this debate. I’d also like to thank you, Paul, for a spirited exchange. I think one message that readers can take away from this is that while industry and consumer advocates may disagree on certain issues, we both are committed to increasing opportunities for homeownership for all Americans.

Robert A. Camerota is chairman of the California Mortgage Bankers Assn. and is currently the senior vice president and managing director of the consumer lending operations group for GMAC-ResCap.

Move people up to prime
By Paul Leonard

Robert, once again there’s much we agree on, but some important differences too.

First, we agree that it’s not government’s role to “bail out” bad loans. We agree that to preserve the market consequences of making bad loans, lenders or investors don’t deserve a publicly financed bailout.

That said, we don’t think the market will necessarily minimize foreclosures, a goal that has a number of policy benefits. The first is simply to keep many families in their homes, a laudable goal by itself. But it’s not just the families who are harmed by foreclosures. Foreclosures dramatically contribute to downward pressure on housing prices, most immediately in neighborhoods with concentrations of foreclosures, but also marketwide. Many believe the decline in housing prices and the loss of consumer spending associated with the cashing out of equity could tip our national economy into recession.

Some sub-prime borrowers at risk of default and foreclosure will have built up enough equity to be able to refinance — many will be able to move into prime-quality loans. Remember, many of those who are in sub-prime loans have prime-loan credit but have been steered into sub-prime loans to benefit the broker or lender. Now is the time for many to graduate into lower-cost, prime-quality loans.

The best outcome for those sub-prime borrowers who face steep payment increases they can’t afford is for the lenders to restructure the loans to make them affordable for the long term. As you indicate, lenders do have strong financial incentives to avoid costly foreclosures by modifying the terms of the existing loans. While lenders have a range of so-called “loss mitigation” tools at their disposal, their priority is to maximize returns, not necessarily to minimize foreclosures. To maximize profits, lenders will want to offer the lowest possible concessions to borrowers, generally to delay the unaffordable jump in mortgage payments for a year or two.

We believe that many borrowers need to have their loans converted to long-term, fixed-rate affordable loans. The federal regulators have now made it clear through recent guidance: The market alone will not ensure that fairly priced and sustainable financing will be offered. Rather than simply delaying another unaffordable payment increase, we think servicers should be held to the same standards for loan modifications that they are for new loans. When loans are modified, borrowers should be able to afford their loans over the long term at the so-called fully indexed rate, not just the current payment level. Public agencies should be monitoring and holding lenders accountable for affordability outcomes from foreclosure-avoidance efforts.

In an encouraging bit of news, Federal Reserve Chairman Ben Bernanke this week indicated that the Fed is planning on issuing new regulations at the end of the year to ensure that borrowers are better informed and better protected in today’s complex mortgage market. These regulations will cover all mortgage originators, not just banks and credit unions.

If anything is clear from the distress of the last few months, it is that we can’t simply let the “market” regulate itself. Regulators, at both the state and federal level, must pay careful attention to emerging problems in the mortgage market, and intervene when necessary. So too should our legislators, particularly when regulators are not responsive.

I too would like to thank the Los Angeles Times and the California Mortgage Bankers Assn. for the opportunity to exchange our ideas about these important issues. I’ve enjoyed it immensely and certainly learned a thing or two. I hope our readers have as well.

Paul Leonard is the director of the California office of the Center for Responsible Lending.