As thousands of homes are forfeited to banks each year, I continue to receive calls from constituents who cannot understand why financial institutions seem to prefer foreclosures and short sales on homes rather than to work with homeowners on loan modifications. Wouldn't banks stem their losses by negotiating refinance agreements with the homeowners?
Unfortunately, this is often not the case. Illustrating the law of unintended consequences, policies enacted by federal organizations that were meant to supply financial aid to lenders when they lost money to foreclosures have actually resulted in subsidizing and even incentivizing foreclosures. Reminiscent of the federal government's bank bailouts, the policies use taxpayer dollars.
A brief background on how we got into the current economic mess. First, the federal government demanded that housing loans be made more accessible, even to unqualified borrowers. Financial institutions such as thrift and commercial banks were required to lower their standards for qualifying home buyers. Next, as the housing boom continued and home prices rose astronomically, lenders got creative. Interest-only loans, negative amortization loans and jumbo loans requiring little or no down payment by the borrower became the norm. Finally, borrowers themselves contributed to the housing bust by participating in "liar loans" (with financial institutions fully complicit), where borrowers intentionally misrepresented income, and rather than verify the applicant's income or employment history, lenders simply took the applicant's word for it.
Fast-forward to 2010, and we are in a housing crisis that is destroying our economy. California is facing an unemployment rate of 12%, the state is facing a $19-billion budget shortfall, and the state is reeling from last year's 186,000 home foreclosures, including an all-time high rate of foreclosure in early 2009.
The crisis is aggravated by financial institutions whose goals are not necessarily to keep people in their homes. Regularly, when a person cannot afford to maintain his loan payments, financial lenders will either conduct a short sale or foreclose on the house, appearing to cut the losses. But why won't banks reduce their losses by working with homeowners to modify their loans?
The answer might surprise you.
The unfortunate reality is that some lenders are receiving incentives to foreclose, incentives that come from the taxpayer-funded Federal Deposit Insurance Corporation (FDIC). The FDIC has committed to more than 90 "shared-loss" agreements with financial institutions. In one case, the FDIC agreed to cover between 80% and 95% of a lender's losses due to foreclosure or short sale. Under this contract, the financial institution can actually turn a profit when combining the income of the short sales and the FDIC's funding. Therefore, there may be no motivation for the financial institution attempting a loan modification.
In addition, most of the home loans that were made during the housing boom have since been bundled together and sold off to investors, many of which are in foreign countries. The banks act only as loan servicers (money-collectors) and are paid regardless of whether or not a property goes into foreclosure. Furthermore, the bank must receive permission to modify the loan from the investors who now own the debt. Since investors are paid off in a pecking order, those on the low end are usually very reluctant to agree to accept a loan modification because this means they may get zero return on their investment. Why agree to a loan modification if the U.S. government will pay the difference on your loss?
This leaves the nation with two problems that have domino-effect consequences on the greater economy. First, millions of people are losing their homes because of foreclosures, and second, the government is using taxpayer dollars to incentivize banks' increasing use of foreclosure. Both cause a deterioration of American purchasing power. Less spending means that every other segment of the economy is experiencing decreased business, acting to exacerbate the nation's unemployment rate. This, in turn, accelerates the economic death spiral as a second round of unemployed and underemployed people can no longer afford their mortgage payments.
This cycle will not be willingly stopped by financial institutions. Instead, we must demand that the government stop incentivizing foolish financial behavior and stop using taxpayer dollars for giant bank bailouts and unwise shared-loss agreements.
JIM SILVA is an assemblyman covering the 67th district, which includes Huntington Beach.