FCIC Final Report, Part 5, Chapter 22, The Aftershocks - The Foreclosure Crisis

8/7/2019 FCIC Final Report, Part 5, Chapter 22, The Aftershocks - The Foreclosure Crisis

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22

THE FORECLOSURE CRISIS

CONTENTS

Foreclosures on the rise: Hard to talk about any recovery ...............................

Initiatives to stem foreclosures: Persistently disregard ......................................

Flaws in the process: Speculation and worst-case scenarios ............................

Neighborhood effects: Im not leaving..............................................................

FORECLOSURES ON THE RISE:

HARD TO TALK ABOUT ANY RECOVERY

Since the housing bubble burst, about our million amilies have lost their homes tooreclosure and another our and a hal million have slipped into the oreclosureprocess or are seriously behind on their mortgage payments. When the economicdamage fnally abates, oreclosures may total between million and more than million, according to various estimates. The oreclosure epidemic has hurt amiliesand undermined home values in entire zip codes, strained school systems as well as

community support services, and depleted state coers. Even i the economy begansuddenly booming the country would need years to recover.Prior to , the oreclosure rate was historically less than . But the trend

since the housing market collapsed has been dramatic: In , . o all houses, or out o , received at least one oreclosure fling. In the all o , in every outstanding residential mortgage loans in the United States was at least one paymentpast due but not yet in oreclosurean ominous warning that this wave may not havecrested. Distressed sales account or the majority o home sales in cities around thecountry, including Las Vegas, Phoenix, Sacramento, and Riverside, Caliornia.

Returning to the , borrowers whose loans were pooled into CMLTI -NC: by September , many had moved or refnanced their mortgages; by thatpoint, , had entered oreclosure (mostly in Florida and Caliornia), and hadstarted loan modifcations. O the , still active loans then, were seriously

past due in their payments or currently in oreclosure.

The causes o oreclosures have been analyzed by many academics and govern-ment agencies. Two events are typically necessary or a mortgage deault. First,monthly payments become unaordable owing to unemployment or other fnancial


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THE FORECLOSURE CR I S I S

hardship, or because mortgage payments increase. And second (in the opinion omany, now the more important actor), the homes value becomes less than the debt

owedin other words, the borrower has negative equity.The evidence is irreutable, Laurie Goodman, a senior managing director with

Amherst Securities, told Congress in : Negative equity is the most importantpredictor o deault. When the borrower has negative equity, unemployment acts asone o many possible catalysts, increasing the probability o deault.

Ater alling rom their peak in to the spring o , home prices haverebounded somewhat, but improvements are uneven across regions. Nationwide,. million households, or . o those with mortgages, owe more on their mort-gages than the market value o their house (see fgure .). In Nevada, o homeswith mortgages are under water, the highest rate in the country; in Caliornia, therate is .

Given the extraordinary prevalence and extent o negative equity, the phenomenono strategic deaults has also been on the rise: homeowners purposeully walk awayrom mortgage obligations when they perceive that their homes are worth less thanwhat they owe and they believe that the value will not be going up anytime soon.

By the all o , three states particularly hard hit by oreclosuresCaliornia,Florida, and Nevadareported some recent improvement in the initiation o oreclo-sures, but in November Nevadas rate was still fve times higher than the national av-erage. Foreclosure starts climbed in states rom their levels a year earlier, with thelargest increases in Washington State (which has . unemployment), Indiana(. unemployment), and South Carolina (. unemployment), according to theMortgage Bankers Association.

In Ohio, the city o Cleveland and surrounding Cuyahoga County are bulldozingblocks o abandoned houses down to the dirt with the aim o creating a northeasternOhio bank o land preserved or the uture. To do this, authorities seize blighted

properties or unpaid taxes, and they take donations o homes rom the Departmento Housing and Urban Development, Fannie Mae, and some private lenders. Now,the county fnds itsel under increasing duress, having endured , oreclosures in. Ater years o high unemployment and a ragile economy, the fnancial crisistook vulnerable residents and shoved them over the edge o the cli, Jim Rokakis,Cuyahogas treasurer, told the Commission.

In a spring survey, o the responding mayors ranked the prevalence ononprime or subprime mortgages as either frst or second on a list o actors causingoreclosures in their cities. Almost all the mayors, , said they expected the ore-closure problems to stay the same or worsen in their cities over the next year.

There has been no meaningul decline in the inventory o distressed propertiesound in the housing market, Guy Cecala, the chie executive and publisher o InsideMortgage Finance Publications, told a congressional panel overseeing the Troubled

Asset Relie Program in October . It is hard to talk about any recovery o thehousing market when the share o distressed property transactions remains close to percent.


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Underwater Mortgages

SHARE OF LOANS WITH NEGATIVE EQUITY, THIRD QUARTER 2010

SOURCE: CoreLogic

>50%

3049

1529

014

NAME

NY MA

CT

RI

PA NJ

DE

DC

MD

OH

VA

SC

NCTN

AL GA

AK

TX

HI

ND

SD

IA

MN

OR

WA

ID

UT

CO

NM

MT

MO

AROK

KS

NE

LA

MS

WY

WV

WI

IL IN

KY

AZ

NV

MI

CA

FL

VT

NH

U.S. average23%

Many mortgage holders find themselves underwater; that is, owing morethan their homes are worth. This is particularly true in Arizona, California,

Florida, Michigan, and Nevada.

Figure .

F INANCIAL CR I S I S INQUIRY COMMISS ION REPORT

There was a undamental change in our fnancial services sector that really is thereason were in this crisis, this economic crisis, and is the reason were seeing and willsee in total probably beore were done, between and million oreclosure flingsin this country, John Taylor, the president and CEO o the National CommunityReinvestment Coalition, explained to the FCIC. And by the way, a ew hundred

thousand people, even a million people going into oreclosure, you can kind o blameand say, Well they should have known better. But [or] million American ami-lies cant all be wrong. They cant all be greedy and they cant all be stupid.


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INITIATIVES TO STEM FORECLOSURES:

PERSISTENTLY DISREGARD

The same system that was so ecient at creating millions o mortgage loans over thepast decade has been ineective at resolving problems in the housing market, includ-ing the eorts o homeowners to modiy their mortgages. As mortgage problemsmounted, the ederal and state governments responded with fnancial incentives toencourage banks to adjust interest rates, spread loan payments over longer terms, orsimply write down mortgage debts. But to date, ederal auditors and independentconsumer watchdogs have given the ederal governments and the banks mortgagemodifcation programs poor grades.

The Home Aordable Modifcation Program (HAMP) is alling short o the to million amilies targeted or help by the end o . (The programs resources comerom the ederal TARP unds.) As o December , HAMP has resulted in the per-manent modifcation o only , mortgages. Meanwhile, the banks report thatthey have independently approved . million loan alterations o various kinds, al-though many o these modifcations simply roll missed payments into a new mort-gage and thus result in higher monthly payments.

The eectiveness o state mortgage modifcation and oreclosure assistance pro-grams is unclear. Some are just getting started. New Jersey, or instance, will begin a million HomeKeeper Program in , to oer some residents who ace oreclo-sure because o unemployment or substantial underemployment a deerred-payment,no-interest loan so that they can continue making payments on their mortgages.

During a series o hearings in communities around the country aected by thehousing crisis, the Commission heard rom many witnesses about the extraordinarydiculties they had encountered in seeking to modiy their mortgages and stay intheir homes. Borrowers who have been paying down mortgages or years and have

built up substantial equity are especially susceptible to being turned down or loanmodifcations, because the lender would preer that they simply sell their homes.Kirsten Keee, a senior sta attorney with the Empire Justice Center in Albany, NewYork, brought this issue to regulators attention in March . Speaking to the Fed-eral Reserve Boards Consumer Advisory Council in Washington, Keee identifedtrends among borrowers in New York who tried to qualiy or the governmentsHAMP program. We are also routinely hearing that olks who have a lot o equityare . . . being denied HAMP modifcations, she said. Diane Thompson, rom theNational Consumer Law Center, testifed to the United States Senate Committee onBanking, Housing, and Urban Aairs in November about the challenges o theprogram. She stated, Only a very ew o the potentially eligible borrowers have beenable to obtain permanent modifcations. Advocates continue to report that borrowersare denied improperly or HAMP . . . and that some servicers persistently disregard

HAMP applications.

Competing incentives may encourage banks to view oreclosure as quicker,cleaner, and oten cheaper than modiying the terms o existing mortgages.


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For them, oreclosure is a prudent response to deault because, the data suggest,many borrowers who receive temporary or permanent orgiveness on their terms

will slide into deault again. Also, servicers may receive substantial ees or guid-ing a mortgage through the oreclosure process, creating an incentive to deny amodiication.

Frequently, theres another complication to attempting a oreclosure or modii-cation: the second mortgages that were layered onto irst mortgages. The irstmortgages were commonly sold by banks into the securitization machine. Thesecond mortgages were oten retained by the same lenders who typically servicethe mortgage: that is, they process the monthly payments and provide customerservice to borrowers. I a irst mortgage is modiied or oreclosed on, the entire

value o the second mortgage may be wiped out. Under these circumstances,the lender holding that second lien has an incentive to delay a modiication intoa new loan that would make the mortgage payments more aordable to theborrower.

The countrys leading banks now hold on their books more than billion insecond mortgages. To the extent the banks have reported these loans as perorming,the loans have not been marked down on their books. The actual value o these sec-ond mortgages could be much less than their billion-plus reported value. Thedanger o uture losses is sel-evident. Some rustrated frst-lien investors have suedservicers, asserting they are not protecting investors fnancial interests. Instead, theyclaim that because the servicer is holding the second lien, the servicers are lookingater their own balance sheets by encouraging borrowers to keep up the payments ontheir second mortgage when they cannot aord to make payments on both obliga-tions. According to Laurie Goodman, or mortgage modifcations to work, the hold-ers o the second mortgages will have to accept some lossesa potentially expensiveproposition.

A number o other obstacles have made modifcations dicult. For example,there are competing interests among various investors in a mortgage-backed security.Proceeds rom a oreclosure may be enough to pay o the investors holding the high-est-rated tranches o securities, while the holders o the lower tranches would likelybe wiped out. As a result, the holders o the lower-rated tranches might preer a mod-ifcation, i it produced more cash ow than a oreclosure.

Other eorts in the private and public sectors to address the oreclosure crisishave ocused on encouraging short sales. In theory, short sales should help borrow-ers, neighborhoods, and lenders. Borrowers avoid oreclosure; neighborhoodsavoid vacant, dilapidated homes that encourage crime; and lenders avoid some othe costs o oreclosure. Nonetheless, such deals requently stall because the processis cumbersome, demands coordination, and eats up resources. For example, lenderscan be reluctant to sign o on the buyers bid because they are not sure that the

home is being sold at the highest possible price. In addition, when there are twomortgages, the holders o the irst and second mortgages must both agree to theresolution.


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FLAWS IN THE PROCESS:

SPECULATION AND WORSTCASE SC ENARIOS

In , additional issues have come to the ore, as problems with individual oreclo-sures have revealed systemic aws in how lenders documented and processed mort-gages or securitization. Legal experts and consumer advocates told the Commissionthat procedural and documentation problems with oreclosure have been laid out incourt cases and academic studies or years, but were ignored until the number ooreclosures rose so dramatically.

All o the nations state attorneys general banded together in the all o toinvestigate oreclosure irregularities, identiy possible solutions, and explore poten-tial redress or borrowers who were harmed by improper oreclosures. For example,lenders have relied on robo-signers who substituted speed or accuracy by signing,and sometimes backdating, hundreds o adavits claiming personal knowledge oacts about mortgages that they did not actually know to be true. One such robo-signer, Jerey Stephan o GMAC, said that he signed , adavits in a monthroughly per minute, in a -hour workweekmaking it highly unlikely that he

verifed payment histories in each individual case o oreclosure. In addition, anumber o court cases have been fled alleging invalid notarizations, orged signa-tures, backdated mortgage paperwork, and ailure to demonstrate having legal stand-ing to oreclosethat is, being the entity with the right to repossess a home.

The problem o legal standing arose because the rapid growth o mortgage securi-tization outpaced the ability o the legal and fnancial system to accurately recordwho owns the mortgage. During the securitization process, loans were sold multipletimes. To speed up processing, the fnancial industry created Mortgage ElectronicRegistration Systems, Inc. (MERS), an organization made up o , mortgagelenders. It tracks changes in servicing rights and ownership interests in mortgage

loans. MERS is designated as the mortgagee o record on behal o its members, astatus that is meant to give it the legal right to oreclose i the borrower ails to pay theloan. MERS has registered million mortgages since launching in and had million loans outstanding as o November .

The standing o MERS or its designees to oreclose has been called into questionby courts and academics, however. In a hearing beore the House Judiciary Com-mittee on the oreclosure crisis, New York State Supreme Court Justice F. DanaWinslow testifed that standing has become such a pervasive issue that I requentlyuse the term presumptive mortgagee in oreclosure to describe MERS. Because omultiple unrecorded transers o the legal ownership o the [m]ortgage, it is unclearwhether MERS continued to be the mortgagee ater subsequent sales o the loan, ac-cording to Winslow. Moreover, courts have held that MERS does not own the un-derlying note and thereore cannot transer the note or the deed o trust, or oreclose

upon the property.

Winslow also highlighted other defciencies in MERS standing, many involvingsloppy paperwork: the ailure to produce the correct promissory notes in court during


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oreclosure proceedings; gaps in the chain o title, including printouts o the title thathave diered substantially rom inormation provided previously; retroactive assign-

ments o notes and mortgages in an eort to clean up the paperwork problems romearlier years; questionable signatures on assignments and adavits attestingto the ownership o the note and mortgage; and questionable notary stamps onassignments.

On November , , a bankruptcy court ruled that the Bank o New Yorkcould not oreclose on a loan it had purchased rom Countrywide, because MERShad ailed to endorse or deliver the note to the Bank o New York as required by thepooling and servicing agreement. This ruling could have urther implications, be-cause it was customary or Countrywide to maintain possession o the note and re-lated loan documents when loans were securitized.

Across the market, some mortgage securities holders have sued the issuers othose securities, demanding that the issuers rescind their purchases. I the legalchallenges succeed, investors that own mortgage-backed securities could orce the is-suers to buy them back at the original pricepossibly with interest. The issuerswould then be the owners o the securities and would bear the risk o loss.

The Congressional Oversight Panel, in a report issued in November , said itis on the lookout or such risks: I documentation problems prove to be pervasiveand, more importantly, throw into doubt the ownership o not only oreclosed prop-erties but also pooled mortgages, the consequences could be severe. This sentimentwas echoed by University o Iowa law proessor Katherine Porter who has studiedoreclosures and the law: It is lack o knowledge o how widespread the problemsmay be that is turning the allegations into a crisis. Lack o knowledge eeds specula-tion and worst-case scenarios. Adam Levitin, a Georgetown University associateproessor o law, has estimated that the claims could be in the trillions o dollars, ren-dering major U.S. banks insolvent.

NEIGHBORHOOD EFFEC TS: IM NOT LEAVING

For the millions o Americans who paid their bills, never ipped a house, and hadnever heard o a CDO, the fnancial crisis has been long, bewildering, and painul. Acrisis that started with a housing boom that became a bubble has come back ull cir-cle to orests o or sale signsbut this time attracting ew buyers. Stores have shut-tered; employers have cut jobs; hopes have ed. Too many Americans today fndthemselves in suburban ghost towns or urban wastelands, where properties are va-cant and construction cranes do not lit a thing or months.

Renters, who never bought into the madness, are also among the victims aslenders seize property ater landlords deault on loans. Renters can lose the roo overtheir heads as well as their security deposits. In Minneapolis, as many as o

buildings with oreclosures in and were renter-occupied, according to sta-tistics cited in testimony by Deputy Assistant Secretary Erika Poethig rom the U.S.Department o Housing and Urban Development to the House o RepresentativesSubcommittee on Housing and Community Opportunity.


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For children, a repossessed housewhether rented or boughtis destabilizing.The impact o oreclosures on children around the country has been enormous. One-

third o the children who experienced homelessness ater the fnancial crisis did sobecause o oreclosures o the housing that their parents owned or were renting, ac-cording to a recent study. One school ocial in Nevada told the Commission aboutthe signifcant challenges to the educational system created by the economic crisis.

All around, the demand rom people who need help is outstripping communityresources. Coast to coast, communities are trying to stretch housing aid budgets tohelp people displaced by oreclosures. In Nevada, or example, Clark County, whichcontains . million people living in and around Las Vegas, was orced to cut its Fi-nancial Housing Assistance program, despite the clear needs in the community. GailBurks, the president and chie executive o the Nevada Fair Housing Center, told theCommission that her group fnds that many they counsel through the oreclosureprocess are in despair. Its very stressul. There are times that the couples we arehelping end up divorcing, sometimes beore the process is over. . . . Weve also seenthreats o suicide.

And the stories continue. Karen Mann, the appraiser rom Discovery Bay, Cali-ornia, testifed to the Commission about her amilys circumstances. Her daughterand son-in-law refnanced their mortgage into an adjustable-rate mortgage. Whenthe time came or the rate to adjust upward, new fnancial troubles made the pay-ments more than the amily could aord. Because the market value o the home wasnearly equal to their mortgage debt, the amilys attempts to get the mortgage modi-fed were ruitless. They lined up a buyer or a short sale, but the deal was nixed.Then, when medical problems created yet another challenge, the couple and theirour children moved in with Mann. The children were relocated to new schools,and the adults dealt with the pain and emotional suering while they were trying torebuild their lives, Mann said. The couple fled or bankruptcy. Two months ater

the bankruptcy was completed, the lender asked them i they wanted to modiytheir mortgage.

In Cape Coral, Florida, Dawn Hunt and her husband, a mailman, and their twochildren live in an attractive ranch-style home they bought or about , morethan a decade ago. It was a quiet, -year-old subdivision where most o the residentswere homeowners. In and , builders rushed to the area and threw updozens o new homes on empty lots. Homebuilder Comort Homes o Florida LLCbroke ground or a house across the street rom the Hunts, but did not complete it.This all, the house sat vacant, an empty shell. No stucco was ever applied to the con-crete block exterior, and the house had no interior walls. A wasp nest decorated theelectrical box near the ront door. The untended grass had grown our eet high.Sharp sand spurs in the brush made it dicult to approach the property. Two doorsdown rom the Hunts, another house was also vacant, let empty when a amily split

up and moved a year earlier. They abandoned a car in the garage. The roo leaked,and a blue plastic tarp put in place to keep the rain out now aps in the breeze. TheHunts called the police ater vandals broke into the house one night; intruders havebeen back twice more in the daylight.


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Now o the homes in the Hunts neighborhood are in deault, are in the ore-closure process, or have been taken back by the bank. Most o the other houses in

the community are occupied by renters whose absentee landlords bought the houseswhen the homeowners lost their homes to their banks. The Hunts house has losttwo-thirds o its value rom the peak o the market. Nonetheless, even though theneighborhood is not as lovely as it used to be, Dawn Hunt told the FCIC, Im notleaving.

COMMISSION CONCLUSIONS ON CHAPTER 22

The Commission concludes the unchecked increase in the complexity o mort-gages and securitization has made it more dicult to solve problems in the

mortgage market. This complexity has created powerul competing interests, in-cluding those o the holders o frst and second mortgages and o mortgage servicers; has reduced transparency or policy makers, regulators, fnancialinstitutions, and homeowners; and has impeded mortgage modifcations. Theresulting disputes and inaction have caused pain largely borne by individualhomeowners and created urther uncertainty about the health o the housingmarket and fnancial institutions.

FCIC Final Report, Part 5, Chapter 22, The Aftershocks - The Foreclosure Crisis

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