Monday, June 29, 2009

Foreclosure Crisis: Help is NOT on the Way

Some beleaguered California homeowners are in a world of financial pain. Daily news stories recount tales of job losses, missed mortgages payments, foreclosure notices, and families in crisis.

Falling real estate prices only exacerbate the problems: owners find themselves increasingly upside down, and increasingly unmotivated to hold on to their piece of the American dream.

In spite of the Obama Administration’s efforts to stem the housing crisis, the problem only seems to be snowballing, as prolonged job losses and falling prices increase the gravity of the problem. Radical solutions may be required to get this country on solid economic footing once again.

Two disturbing trends illustrate how the status quo is not working.

First, bankruptcies in Southern California have skyrocketed.

Second, the government’s efforts to modify loans for homeowners in distress – and to prevent future foreclosures – are proving ineffective.

The Los Angeles Times today reported on bankruptcy statistics: “Bankruptcies Surge in Southern California.”

Going legally broke has made a big comeback -- especially in the Los Angeles area -- despite a mid-decade revision to the U.S. Bankruptcy Code intended to curb filings.

The number of Southern Californians seeking bankruptcy protection nearly doubled in 2008 from 2007 in the U.S. Bankruptcy Court's seven-county California Central District, by far the biggest increase in the nation.

Bankruptcy is still booming. Personal filings from January through April, the most recent month available, rose 75% in the Central District compared with the year-earlier period.

Bankruptcy experts attribute the growth mainly to the mortgage meltdown, which hit the region's adventuresome borrowers particularly hard. Add soaring credit card debt and medical expenses, and people who never thought they'd see a bankruptcy courtroom are lining up with petitions in hand.

"It's real estate," said Encino bankruptcy attorney David S. Hagen, who conducts free seminars for homeowners organized by the nonprofit Neighborhood Legal Services.

"People got sold a bill of goods on some kind of nontraditional mortgage and thought they could change it when the worth of their house went up. But the worth went down and the payments went up," he said. "They start to live off of their credit cards."

With the bankruptcy goes the foreclosure. So, what is the government doing to help these homeowners in distress?

With much fanfare, the Obama Administration rolled out its Making Home Affordable Program to help homeowners unable to make payments by allowing them to refinance or to obtain loan modifications so they can stay in their homes.

Sounds great. But what are the results? According to a New York Times article “Paper Avalanche Buries Plan To Stem Foreclosures", the government gets a definitive ‘F’.

Ms. Montenegro, an intern at a local company that seeks loan modifications, dials Washington Mutual to check on the status of an application for a homeowner whose income has plummeted. Syrupy-voiced customer service representatives chide her for landing in the wrong department. She learns that the documents her company sent in have simply vanished — for the third time since November.

“I don’t know what happened,” says a customer service officer who identifies himself as Chris. “I don’t know if there was a glitch in the system, whether it was transferred from one call center to the other.”

Think of the documents as being part of a pile massing inside the bank, Chris suggests. “This pile is not going to be moved forward at any point in time.”

Ms. Montenegro and her colleagues suffer these sorts of excruciating exchanges all day long. It is a potent indication of the difficulties afflicting the $75 billion taxpayer-financed program created by the Obama administration in an effort to avoid foreclosure for as many as four million distressed homeowners.

Under the plan, the government offers mortgage companies $1,000 for each loan they agree to modify, then another $1,000 a year for up to three years.

Hanging in the balance is more than the fate of individual homeowners. The administration portrays its mortgage program as a crucial piece of its broader effort to restore vigor to the economy. If the effort fails, foreclosures will continue to surge and home prices will probably keep falling, sowing fresh losses in the financial system and threatening to crimp credit anew for businesses and households.

Yet in the four months since the Treasury Department announced the program, millions of new homeowners have slipped into delinquency and foreclosure.

The administration still does not know how many mortgages have been modified under the program. In a recent interview, Mr. Barr estimated the number at “over 50,000.”

Distressed homeowners are finding themselves doing battle with huge financial institutions which seem to be doing everything in their power to say “no” to loan modifications.

The tales of lost paperwork, uninformed customer service representatives, and a lack of accountability for the banks run rampant. Homeowners on the brink of foreclosure seem to be pushed to foreclosure as they unsuccessfully navigate the loan modification maze that was intended to help them.

The task of “Making Home Affordable” is challenging for several reasons.

First, the program is intended only for loans backed by Fannie Mae or Freddie Mac (although some banks have “extended” the modification option to loans not backed by these government agencies).

Second, the loan servicer the borrower negotiates with is often not the “investor” that holds the loan, i.e., this is not even a direct negotiation.

Third, the lender which made the loan (e.g., Washington Mutual or EMC) may no longer exist, and the borrower must negotiate with the new owner of these orphaned loans (e.g. Chase) who never even originated them.

Fourth, if there are first and second loans on the property, the borrower finds themselves caught between two parties that may have conflicting interest.

Fifth, some lenders are not even participating in the “Making Home Affordable” program – it is voluntary, not mandatory.

Sixth, the loan modification proposed to the borrower may be inadequate to keep them in their home and may not address a core issue – that the home is so seriously “underwater” that there’s little incentive for the homeowner to stay in the home.

Update July 3, 2009: HARP (Home Affordable Refinance Plan) has increased the loan-to-value limit from 105% to 125% for "underwater" homeowners who want to refinance a 1st loan.

In spite of the huge bailouts of the financial institutions, they seem entirely unmotivated to help the distressed homeowners who desperately need their assistance.

The bottom line is, foreclosures keep rising, prices keep falling and the Obama Administration seems to have helped the banks but not the homeowners. These financial institutions may be “too big to fail.” But homeowners – who are at the root of any recovery – are being allowed to fail, and are causing the housing crisis to grow worse.

So, what is the solution? How can we possibly get out of this quagmire? We believe that two measures are required.

First, the Federal government must define standards and practices for loan modifications and enforce them on financial institutions. They become mandatory and not voluntary; they must occur within a specified period of time; and they must address the financial need of the homeowner.

Second, the government must face the reality that the biggest problem of the loan modification puzzle that no one has addressed is that millions of homeowners are “underwater”. They have no equity in their homes, and they may not have any equity for years or perhaps decades.

Their best option becomes to walk away. Although it may be unpopular, one option proposed is that the government must find away of writing off the “underwater” portion of the loan and returning the homeowner, with a loan modification, to a point of at least neutral equity.

Tom Petruno of The Los Angeles Times ran a provocative article, “Mortgage Forgiveness May be Next”. Although this measure will be wildly unpopular, the proposal addresses the core problem of the current economic meltdown:

Government and private-lender attempts to stem the home foreclosure crisis so far have mostly focused on loan modifications or refinancing -- giving borrowers a temporary or permanent reduction in their monthly payments.

But some housing experts say the next wave of help will have to address the core problem for many homeowners: negative equity.

This camp believes that there is no alternative but outright forgiveness of a substantial chunk of mortgage debt for many people who are underwater in their homes and at risk of foreclosure.

If your mortgage is worth significantly more than your house, your incentive to walk away may rise even if your monthly payment goes down. The decision to walk becomes a matter of simple math: If you have no hope of having an equity stake in the home for years to come -- if ever -- trading your mortgage payment for a much cheaper rent payment may be an economic no-brainer.

For many taxpayers, this is a big pill to swallow – bailing out those borrowers who took the most risk – and maybe bought an SUV or paid for college tuitions as they refinanced up to 100% of the inflated value of a property.

It becomes another example of moral hazard, rewarding those who took the most risk, got themselves into trouble, and now get bailed out. These homeowners get the house – the SUV, the college tuition – and the obliteration of their negative equity.

Comments on the Los Angeles Times' LA Land Real Estate Blog are nearly uniform in their response: outrage. One writer, Raffi, commented:

Seriously, when did it become such a casual topic for the government to refund gamblers (er, homebuyers) losses? When did it become such a problem for housing to be affordable? What happened to pretending this is a free market economy? What is going on?

Is this America?????????

The argument goes, if the issue of “negative equity” is not addressed, homeowners who are not underwater will see the values of their equity continue to decline.

It’s clear the Obama Administration needs to go back to its economic toolkit and revisit its approach to the foreclosure crisis. Bankruptcies and foreclosures continue to mount. Banks are creating logjams for borrowers seeking loan workouts. Homes are seriously underwater in many parts of the country, and homeowners will continue to “walk” through short sales or foreclosures.

There are no easy solutions. But the legislators who were so quick to bail out the banks seem to have abandoned those most in need -- their constituents.