Foreclosure Crisis Vexes US Govt

Source : The Business Times, October 28, 2008

Over 4m homeowners with a mortgage are at least one month behind on their payments as at end-June

(WASHINGTON) Each day from July through September, more than 2,700 Americans lost their homes in foreclosure. That number, up from 1,200 a day a year ago, is a sign that the mortgage industry and government programmes have done little to help troubled homeowners.

Sign of the times: The No1 reason people fall behind on their mortgage is loss of a job, or some source of income, perhaps from a divorce or death of a spouse. If a borrower is unemployed, lenders do not have many options but foreclosure

The mortgage market's troubles have proved to be far more serious and intractable than most in government or the private sector had predicted a year ago.

'We are behind the curve. We are falling behind,' Sheila Bair, head of the Federal Deposit Insurance Corp (FDIC), told a Senate hearing last week. 'There has been some progress, but it's not been enough, and we need to act. And we need to act quickly, and we need to act dramatically to have more wide-scale, systematic (loan) modifications. . .'

More than four million homeowners with a mortgage were at least one month behind on their payments at the end of June, according to the latest data from the Mortgage Bankers Association, and a record 500,000 had entered the foreclosure process.

So why is the foreclosure crisis so hard to fix? There are five main reasons: 1) Crashing home prices: A massive speculative bubble in housing prices caused millions of Americans to think of their homes as an investment, rather than a place to live.

Now prices are plummeting, especially in once-sizzling markets like California, Florida and Nevada. And the bleeding might not stop until the end of next year.

The median home price in the US dropped 9 per cent in September from a year ago to US$191,600, and is down 17 per cent from the peak in July 2006, the National Association of Realtors said last week. Already, 23 per cent of homeowners with a mortgage owe more on their loans than their homes are worth, and that figure is expected to rise to 28 per cent by this time next year, according to Moody's Economy.com.

2) Investor speculation: Plunging prices have had even more impact on investors than on homeowners because investors have less emotional attachment to a house. They are even more likely to walk away, especially if they have put little money into a property. Investors purchased one of every five homes last year, and almost one of every three when the market peaked in 2005, according to the Realtors trade group.

Now, more than 30 per cent of properties in the foreclosure process are owned by someone with a different address, indicating the home is likely owned by an investor, according to foreclosure listing service RealtyTrac Inc. Government programmes to help homeowners are specifically designed not to help such investors, though in reality it may be hard to weed them out.

3) Complex investments: Traditionally, lenders evaluated borrowers carefully because they held onto the mortgages for the life of the loan. That process started to change in the late 1980s, as Wall Street found new ways to package the loans into securities to sell to investors.

Investors were attracted to these new mortgage-backed securities because they paid better returns than government bonds.

At the beginning of this decade, the Federal Reserve started cutting interest rates to historic lows. So investors poured money into the US mortgage market, particularly into securities made up of high-interest mortgages made to borrowers with poor credit records.

The high-interest, risky mortgages, called 'sub-prime', boomed, from US$160 billion in new loans in 2001 to more than US$600 billion in both 2005 and 2006, according to Inside Mortgage Finance, a trade publication.

Lenders stopped worrying about the creditworthiness of borrowers and offered them ever-riskier mortgages. Most of those loans were made by commission-driven mortgage brokers, who had nothing to lose if the mortgage went bad because it had been resold. 'By the time it defaults, it's somebody else's headache,' said Barry Ritholtz, CEO of research firm FusionIQ.

4) Job losses: The No 1 reason people fall behind on their mortgage is loss of a job, or some source of income, perhaps from a divorce or death of a spouse. If a borrower is unemployed, lenders do not have many options but foreclosure.

Two years ago, about 36 per cent of mortgage delinquencies were caused by loss of income or unemployment, according to research by mortgage finance company Freddie Mac. But that number has risen to 45 per cent this year as the unemployment rate has ticked up to a five-year high of 6.1 per cent.

Jon Falen, 33, put his four-bedroom house in Olathe, Kansas on the market more than two years ago, after health problems forced him to leave his job as an air traffic controller. Mr Falen and his wife, now delinquent on their two home loans, are finally scheduled to sell their house next month. But there is a big catch: The buyer has agreed to pay only US$490,000, which is US$70,000 less than what the couple paid for it in 2002.

Making matters worse, Mr Falen and his wife owe US$675,000 to two lenders because they used their home equity to pay off student loans and remodelling expenses. Though Mr Falen and his family seem to have avoided becoming another foreclosure statistic by cashing out on retirement plans and dipping deeply into savings, he is chastened by the drawn-out experience.

5) Falling behind again: It's hard to fix something that keeps breaking. Roughly one-third of all sub-prime loans modified in the third quarter of last year were delinquent again within 10 months, according to a Credit Suisse report released this month.

Maria Martinez, 57, an administrative worker at the county jail in Stockton, California, is typical of homeowners who have gotten help, but not enough. She is three months behind on her mortgage, even after receiving a loan modification earlier this year.

Though Ms Martinez bought the house more than a decade ago for only US$76,000, she now owes about US$230,000 because she refinanced her home loan several times.

- So what has and should be done? The scale of the mortgage crisis became clear in July 2007 when Countrywide Financial, then the largest US mortgage lender, reported an unexpected surge in defaults in high-quality mortgages.

Three months later, the Bush administration announced a new mortgage industry coalition - dubbed the Hope Now alliance. The coalition had an 'aggressive plan to reach more homeowners and help them find a way to stay in their homes', Treasury Secretary Henry Paulson said at the time.

Faith Schwartz, the coalition's executive director, said the effort was never meant to be the only solution to the foreclosure crisis. She says there 'has been a tremendous effort' on the industry's part, noting that 1.9 million households have received letters urging them to call a housing counsellor.

Industry and government responses have also drawn fire from consumer advocates for being too slow and too narrow. The Federal Housing Administration (FHA), a government agency that backs loans to borrowers with weak credit, says it has helped about 400,000 borrowers refinance over the past year, though only about one per cent were behind on their loans.

This month, the FHA started the 'Hope for Homeowners' programme, included in legislation passed over the summer by Congress. It is designed to let another 400,000 troubled homeowners swap their mortgages for traditional 30-year fixed rate mortgages, but only if lenders agree to reduce the value of a loan and take a loss.

But there are still questions about how eager lenders will be to participate. Faced with public outrage that they passed a US$700 billion plan to rescue the financial industry, politicians in Washington are going to keep trying to find ways to fix the foreclosure crisis. One promising approach came this month when 11 states entered into a more than US$8 billion settlement with Countrywide Financial and its new parent Bank of America Corp.

The settlement, which goes into effect on Dec 1, is projected to help an estimated 400,000 Countrywide borrowers by allowing them to replace risky loans with ones at substantially lower interest rates.

And in Washington, the FDIC's Ms Bair has proposed a plan in which the government would provide guarantees for mortgages that have been reworked by banks, lowering payments to more affordable levels. All eyes now are on Ms Bair, Mr Paulson and other top officials to see if the government can craft a plan that gets at the heart of the global financial meltdown - the US foreclosure crisis. -- AP