Optimus sub-prime

Just before the Bush Administration announced its new mortgage-market plan, we got a visit from some activists who follow the issue closely and are proposing their own reform proposals. Paul Leonard, director of the Center for Responsible Lending, Kevin Stein, associate director of California Reinvestment Coalition, and Norma Paz Garcia, senior attorney at the west coast office of Consumers Union, are floating a range of proposals aimed at providing relief to borrowers on the verge of default.

Prime people in sub-prime loans

Kevin Stein: Almost everybody agrees that the lending that has occurred over the last few years has been bad. However we would define it. I would label it predatory. People would call it loose underwriting, lax underwriting. The regulators recognized this, the industry recognizes this. The GAO came out with a report a couple of weeks ago that you may have seen, and they count this as one of the few factors that explain what has happened: lax underwriting. Another factor that they identified is the ready access to Wall Street finance. And one of my favorite quotes is that quote from the guy who ran Ownit Mortgage Solutions, one of the first sub-prime lenders to go under, saying, They pay me more money, Wall Street pays me more money, to do a stated-income, no-verification loan. So what would you do? Everybody’s incentive was to sell bad products to consumers at every step of the way, from the brokers to the lenders to the Wall Street securitizers to the investors who may not have been as aware of what was happening, but they knew what they were interested in and they knew what rates of return they enjoyed, and none of this was kind of, a, I think a bargain that the consumers were taking.

Jon Healey: Was the rate of return predicated, that Wall Street was seeking, predicated on having people pay significantly higher interest rates than otherwise they would have in the marketplace?

Norma Paz Garcia: At least.

Paul Leonard: Yes, I mean you have through yield-spread premiums, which are essentially incentives that lenders are offering, essentially kickbacks from brokers to lenders, stated income all raise interest rates and again, that starts with the securities and the appetite for investors to have higher returns. And I think one of the most telling things is that you can look at these rate sheets, and I was pleasantly surprised that yesterday’s Wall Street Journal had a New Century rate sheet with a little mouseover where you could actually see these things, where we’ve actually been talking to people. Most consumers don’t actually see rate sheets by the way; they’re for the brokers. And so, again, most consumers I think don’t know what they can and can’t negotiate with their broker, what’s the best rate they can get or not. But the fact of the matter is with I think all of the rate sheets we’ve looked at, for any borrower of a fixed credit quality, you could get a lower interest rate on a fully documented, 30-year fixed-rate mortgage than you could on a stated-income 2/28 mortgage. And again, I’m not sure that’s a choice that is fully presented to borrowers in this circumstance. I don’t know, I haven’t been a shadow in the room for many of these conversations. But it strikes me that that’s a lower rate, and that’s for the life of the loan without any of the risks associated with...

Jon Healey: So even lower than the rate that they’d get for the first two years?

Paul Leonard: Yeah, it seems to me that that’s the most stunning indictment of the system.

Eryn Brown: Well that’s not for everybody though, that’s for some borrowers.

Paul Leonard: In sub-prime. That’s the standards on the sub-prime rate sheet.

Norma Paz Garcia: And all this goes back to is it really appropriate for the government to protect individuals from themselves? What we have found from talking to borrowers in these sorts of loans is that had they known what they were really getting into they would never have done it. And so this says to us that it’s, it’s more a situation where you have parties with unequal bargaining power and knowledge, and consumers who don’t understand the complexities of mortgages are often at the mercy of the advice of people they consider to be professionals: brokers, lenders. And when you go to a lender who’s saying one thing, and you believe that person, and you find yourself at the back end in a terrible position, what are you going to do? And this is really at the crux of the matter, you know, how much responsibility does each party take. And we believe in informed consumers and believe consumers should inform themselves, but at some point even really informed consumers understand all the complexities.

Paul Leonard: Not even the CEOs appear to have understood them...

Jon Healey: So in your view what is the percentage today of people who can afford to stay in a loan sans reset?

Paul Leonard: Without a reset?

Jon Healey: Uh huh.

Paul Leonard: Seventy percent of borrowers, at least a month ago, 70% of borrowers were current at reset.

No good deed goes unpunished

Kevin Stein: The conversation seems to be around loan modifications. And as far as modifying loans, that’s a determination that would be made, right, so that what we’re really I think all seeking are broad-scale loan modifications that would keep people in their homes, and this would be for people who cannot afford the reset, whatever the number would be.... I think there were two pieces to this: One is how culpable were the borrowers, I don’t know if we all come in at exactly the same place, but we place most of the blame on the industry for victimizing people who really had no idea and putting them into products they really could not afford. The other part is an earliery suggestion about government intervening on behalf of the consumer. But we feel that loan modification is pretty much a win-win situation. It keeps the borrower in the home, and if we’re talking about folks who were otherwise gonna be faced with unaffordable rate resets, then the investors win as well because collecting the same amount of money, which is not insignificant, is better than collecting nothing.

Jon Healey: The folk who don’t win though are those who went in with their eyes open, um, knew that they could handle the reset, hoped they wouldn’t get to that point, were expecting to be able to refi, after they developed some equity. They get caught in this, but they don’t get relief, because they can afford the reset. Meanwhile other people who haven’t been as financially prudent, they get relief? There was a story, I forget whether it was in our paper or not, but it was loaded with bitterness from these folk, saying: Look, I’m getting screwed but I’m gonna survive this, and I’m not getting help. These people are getting help. Where’s the justice there?

Norma Paz Garcia: Well is it a question really of being not as careful or not being fully able to appreciate the situation. I don’t think there’s a complete answer to your question. I think that overall the goal should be to keep as many people in their homes as possible. And whatever we need to do to get there is something we ought to do to get there is something we ought to consider. And that’s why we’re looking very carefully at the proposals from the governor and the Assembly leadership. There are clearly going to be some losers in this, but that doesn’t matter how we slice the pie, someone’s going to lose. The question is what can we do to keep people in their homes, to keep the economy going, to keep the governments funded with property tax payments; I mean the impact on local governments here is tremendous, and now they say that the state budget is being impacted as well. I hear what you’re saying, but there’s a bigger picture.

If loan modifications make sense, why aren’t lenders doing them now?

Paul Leonard: Internally you don’t get paid for doing a modification. Fear of investor lawsuits is a real problem...

Jon Healey: That’s because if you modify the loan you are...

Eryn Brown: ...the return is not what was promised?

Paul Leonard: Not only that, but the, not all the investors have the same stake. And so there’s not a sort of, the servicer is required to be maximizing present value for the investors as an entire class, but one investor may be disadvantaged more than others depending where they are in the waterfall. So um, there is concern, and clearly in the context of the conversations that are happening in Washington now, the investors are still planting their flag and saying we’re not so sure about this modification, you know, we don’t want to give up the right to sue the servicers who are not looking out for our interests.

I would add a couple more. One is that the servicers are overwhelmed. It’s just been bigger, particularly the loss mitigation operations have really been the weak stepchild of these organizations, and they’re not the biggest profit center. So it’s been hard for them to gear up to the extent that they should. Um, and then finally there are some conflicting incentives around the first and second mortgage holders, and getting some consensus around the first and second mortgage holder, whether their interests are not aligned. So there are internally a whole bunch of reasons why there haven’t been as many modifications as we would like to see, given the overwhelming economic rationale for borrowers, the neighbors whose homes are being devalued, for the government as a whole and for the marketplace. Because we would argue that the losses should be internalized within the system as opposed to having a big government bailout come in.

Cut interest or cut principle?

Jon Healey: Are any of you advocating pushing rates down as part of these modifications?

Paul Leonard: We are. Where it makes economic sense. I mean, we would like to see some transparency in the process where the economic interests are really sort of represented. So where the default and where it’s not easier to foreclose, causing a bigger loss than would be economically optimal — and I would argue that that’s not happening today — and so in some communities further writedowns make sense, in some places principle reductions make sense. And it’s perfectly economically rational because it’s still sort of better than the foreclosure consequence.

Sheep and goats: Who should get relief?

Norma Paz Garcia: You know, there’s a large universe of people who could benefit from relief but not everyone’s going to get it. There will be some losers. We were trying to figure out, Consumer’s Union was trying to figure out how to define that universe of who should get relief. You know, some of the things we’ve looked at is, you know, who should get properties that are owner-occupied, so we’re not propping up income-producing properties for some real estate portfolio. Because the goal here is to keep people in their role as a homeowner. We’re also looking at providing relief to people who could afford their mortgage before the reset but can no longer afford it once the mortgage resets to a higher interest rate. So that might be one of the criteria. Another, we’re looking at...

Tim Cavanaugh: And that would include — people who can’t afford once it resets we’re not just talking about owner-occupied, right? You’d have to meet all of these criteria?

Norma Paz Garcia: Yes. It should be restricted to owner-occupied only. Then we can start looking at these other factors. One of the other areas we looked at, and I mentioned this briefly, is there are a lot of people who ended up in sub-prime but really are prime borrowers. If the person could have qualified for a prime loan at the time that they were given a sub-prime loan or were steered into that sub-prime loan then maybe they ought to get relief...

Tim Cavanaugh: Then why can’t they get it now? Why can’t they just go to their lender and say: Here, I got a credit score of 780 and you should, you know, get me into a 7% loan right now.

Paul Leonard: I don’t know if you — I’m sorry, I was about to be flip.

Tim Cavanaugh: No, that’s OK, be flip.

Norma Paz Garcia: Part of the problem is people are upside-down in their loans.

Paul Leonard: That’s part, and part of the problem is the markets have shut down. I mean there is a huge credit crunch right now, you know, that there are 100 lenders have gone out of business. The largest lender in the whole country, Countrywide, in the sector, is now only doing conforming loans. The investor, the secondary market has essentially come to a grinding halt. So we’re in a very unique point in time where the secondary markets have shut down and there’s a serious lack of liquidity, putting a premium on jumbo loans that is well above our historical standard, and making sub-prime lending virtually non-existence.

Tim Cavanaugh: Premium on a jumbo loan: you mean you’re going to be paying a much higher interest rate on a jumbo loan now than you would on a conforming loan?

Paul Leonard: Correct. What was historically been a quarter of a point is now three-quarters of a point.

Tim Cavanaugh: When we’ve seen, in our own county, houses increase five-fold since 1995....

Jon Healey: Hoo, right on!

Tim Cavanaugh: ... why is that such a bad thing?

Paul Leonard: You asked the question about somebody’s ability to refinance a loan. And the answer is that there’s a credit crunch on right now.

Tim Cavanaugh: You’re right, I’m sorry to go off on a tangent, but...

Paul Leonard: I mean I’d like to get back to that.

Tim Cavanaugh: ...it’s My Dinner With Paul. One topic after another.

Norma Paz Garcia: Also if you’ve fallen behind in your mortgage chances are your credit score has taken a dip. That’s going to make it harder to refinance at a favorable rate. So when you have all these things coming together at the same time that doesn’t bode well for consumers.

Paul Leonard: Yeah, nobody’s making the argument, at least I don’t, that oh great, the California housing run-up has been the greatest thing ever.