Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Consumer advocates are assailing a Federal Reserve proposal that would scale back (opponents say “eviscerate) the right of borrowers to rescind a loan found to have predatory characteristics. Attorneys have successfully used the right of rescission, which can be exercised for up to three years after a loan is originated, to extricate borrowers from high-cost loans on which payments have adjusted beyond the consumers’ ability to repay.

The Fed’s proposal, amending the Truth-in-Lending Act, would require borrowers to repay their outstanding loan balance before the lender rescinds the loan and cancels the lien. Under the existing regulatory framework, lenders that do not challenge a rescission demand cancel the lien first, giving borrowers a defense against foreclosure and enabling them to refinance and then repay the loan. The Fed’s proposed change would close that escape hatch for most borrowers, who can’t repay the loan until they refinance.

Requiring them to pay first amounts to “verdict first, trial later,” Kathleen Keest, senior policy counsel for the Center for Responsible Lending, told the McClatchy News Service. “It basically puts the cart before the horse,” she added.

Barry Zigas, director of housing and credit policy at the Consumer Federation of America, agreed. “None of us is quite sure what purpose is being served by this proposal or what prompted it.”

The Federal Register notice outlining the proposal says it is designed “to ensure a clearer and more equitable process for resolving rescission claims raised in court proceedings.” The change is also consistent with what most courts already require, the notice points out.

Fed officials have declined to comment further on the proposal until the comment period ends, December 23.

CREDIT CARD CONCERNS

Credit card delinquency rates are declining. For those inclined toward optimism, this provides further evidence that consumer finances s and the economy are recovering. For those who prefer the ‘half-empty’ perspective, the decline indicates that consumers aren’t using credit cards as much because prior defaults, poor current finances, or both, have made it impossible for them to qualify for credit.

Whatever the explanation, the card delinquency rate declined by nearly 1 percent (0.83 percent) in the third quarter, according to a quarterly analysis by TransUnion, nearly 10 percent below the second quarter rate and almost 25 percent below the year-ago figure.

A separate analysis by Moody’s Investor Service found the same downward trend in charge-offs, which fell to 8.79 percent in October, their lowest level since January, 2009, even though the employment rate has been rising. Analysts attribute that unusual disconnect (between employment and delinquencies) to the “can’t-get-any-worse” situation of unemployed consumers, who have already defaulted on their cards and can’t continue using them.

“You can only charge off once,” Richard Fairbank, chief executive of Capital One, told investors at a recent conference. “Someone who’s been unemployed for three years, I can pretty much guarantee that they said goodbye long ago to their…credit card.”

The decline in credit card delinquencies may also reflect a shift in consumer priorities. A recent study by Filene Research found that an increasing number of financially troubled borrowers are opting to make their credit card payments first, falling behind or defaulting on their mortgages instead. This indicates that the “stigma” attached to foreclosure has declined (possibly because foreclosures have become so widespread), and that many consumers are making a “rational” decision to maintain access to credit, the research report, by Ethan Cohen-Cole, a professor at the Robert H. Smith School of Business at the University of Maryland, suggests.

“These findings could lead to new, member-friendly lending practices,” a summary of the study, says. “For example, credit unions that provide lines of credit or credit cards to stressed borrowers may actually find some improvement in the performance of these loans, in the event of a mortgage delinquency.”

Although card usage has declined overall (80 million consumers did not have an active, general-purpose credit card last year, according to the TransUnion report), national credit card debt outstanding actually increased in the third quarter for the first time in six quarters, inching up by .28 percent, but still nearly 12 percent below the year-ago level.

“Consumers who do not have a [general-purpose] credit card still have a need for other payment vehicles, a fact which is beginning to attract significant attention from credit and debt providers alike,” Ezra Becker, vice president of research and consulting at TransUnion, said in that company’s recent report.

“The drop in the savings rate [reported for the third quarter] coupled with the drop in the number of active cardholders, might led one to infer that consumers are shifting their focus away from a pure savings mindset,” Becker noted, a shift that could point toward “increased non-credit spending, such as through debt or checking transactions.”

JOINING THE CHASE

Investors are joining the growing throngs chasing loan originators and syndicators, demanding compensation from them for flawed foreclosure procedures.

In one of many recently filed or threatened suits, shareholders have sued Lender Processing Services for fraud, alleging that the company’s officers “made materially false and misleading statements” failing to disclose that the company “had been engaging in deceptive document execution and preparation related to foreclosure proceedings.”

The suit, filed by a public pension fund, seeks class action status, claiming that LPS falsely inflated its stock price by withholding negative information and making false statements in press releases and news reports. The suit cites, among other examples, statements from company officials dismissing as “immaterial” reports that employees had improperly processed thousands of foreclosures.

In another case pitting investors against a mortgage lender, a federal district court has ruled that executives at BankAtlantic Bancorp Inc. misled investors about the risks in its loan portfolio. That decision, in one of only a few class action securities fraud cases to go to trial, has rattled financial industry executives, in part, because the court rejected a standard defense – that financial institutions were victims of a market melt-down they didn’t cause and could not foresee.

Depending on how many investors join the action, claims against BankAtlantic could total “tens of millions of dollars,” attorneys representing the investors have estimated.

BankAtlantic officials termed the decision “disappointing” and said they plan to appeal it.

“If this outcome is allowed to stand, it would take public companies back to the day before Congress passed the Securities Litigation Reform Act,” which severely restricted the ability of investors to sue companies for fraud, Alan Levan, chairman and CEO of BankAtlantic, said in a press statement. “We will pursue every avenue to set this verdict aside and are confident of success in that endeavor,” he added.

TARGETING SECOND MORTGAGES

The possibility that investors will demand reimbursement for flawed foreclosures (see above) isn’t the only headache plaguing loan servicers. Financial industry regulators and some legislators are pressuring them to modify second mortgages, which have created a major impediment to foreclosure prevention programs based on the rewriting of first mortgage loans.

Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC) recently echoed a demand consumer advocates have been making for the past two years, telling a Senate Banking Committee hearing that servicers “should be required to take a meaningful write-down of any second lien if a first mortgge loan is modified or approved for a short sale.”

Some legislators are also embracing this argument, among them, Sen. Bob Corker (R-TN), who complained at the same hearing that investors “in many cases are putting their interests ahead of the first mortgage holder, which really inverts and greatly changes property rights.”

The confusion of interests that has emerged as foreclosures have swamped the housing market has also led to calls for national foreclosure standards. Testifying at the Banking Committee hearing, Federal Reserve Gov. Daniel Tarullo said national standards are needed to stabilize the mortgge market and ensure fair treatment for homeowners. “The system as it is now simply was not developed with a large number of foreclosures in mind,” Tarullo said, adding, “we do need more of a national effort to impose standards on everybody.”

Addressing that point in her testimony, Bair said that while an FDIC review triggered by revelations of flawed foreclosure procedures did not reveal any “immediate systemic risk” to the financial system, “the clear potential is there. We remain concerned about the ramifications of deficiencies in foreclosure documentation among the largest servicers.”

Bair said stricter regulation of foreclosures and rules defining “safe” mortgages could avoid the conflicts between investor and servicers that are impeding foreclosure remediation efforts today. The development of these regulations would also “provide a unique opportunity to better align the incentives of servicers with those of mortgage pool investors,” she suggested.

UNCOMMON INDICTORS

The financial press focuses endlessly on signals conveyed by leading, lagging and other common economic indicators. But some analysts rely on less mainstream, even slightly offbeat, information to inform their forecasts. For example, one retail analyst watches sales of a certain brand of bra at Victoria’s Secret to tell him whether economic forces are pushing up or down. If women purchase these very pricey items for themselves, they are probably willing to buy other luxury items, John Morris, a retail analyst at BMO Capital Markets, reasons.

A recent Associated Press article reporting this unusual indicator noted several others, among them, the way retailers advertise promotions. Company-wide discounts and hand-scrawled easels outside of stores indicate that the discounts are unplanned – a sign that sales are worse than anticipated. Strong sales of big-ticket items, on the other hand, are an obvious indicator that times are getting better, as is the reliance on credit to pay for them.

For collectors of unusual indicators how about car leases – as a predictor of home sales? LeaseTrader.com, which maintains a database of third party car leases, reported recently that 43 percent of Realtors backed out of car leases in 2010 - -down from 63 percent who terminated their leases early in 2008, and an indicator, this report suggests, that the housing market is strengthening.

“Never mind economic outlooks or market statistics telling us that things are terrible,” says Christine Ricciardi, in an article on housingwire.com reporting the auto leasing analysis. “Forget about low interest rates as a sign of nonexistent demand. Things are good enough that the head honchos on Wall Street no longer have to give up their pretty toys to pay their bills.” But it is also possible this trend doesn’t say anything at all about the housing market, Ricciardi concedes. “Maybe this is just the backlog of Realtors and financial execs who didn’t deleverage in 2008.”