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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Mortgage industry executives summoned to meet with Treasury Secretary Timothy Geithner last week agreed to do what they can to pick up the lagging mortgage modification pace. But they also complained that the expectations for speedy foreclosure relief were unrealistic given the complexity of the Obama Administration’s Home Affordable Modification Program (HAMP) program, the volume of modification requests, and the need for servicers to hire and train thousands of new employees.

Geithner told the officials from 25 mortgage servicing companies who attended the meeting that the Administration wants them to complete 500,000 modifications by November 1 – a stretch, based on current figures. Different reports calculate the modification totals differently, but none are impressive. According to the Treasury Department, servicers participating in HAMP have offered modifications to 325,000 eligible borrowers and completed between 131,000 and 160,000 restructurings, with the remainder still in various stages of the review process. Even the high end of that completed modification range represents a small percentage of the 3 million to 4 million troubled borrowers Administration officials say the program will help over the next three years.

The modification numbers also seriously lag foreclosure rates, which continue to rise. RealtyTrac reported 1.53 million foreclosures in the first six months of this year, with 1 in 84 homeowners receiving foreclosure notices. The company is predicting a total of 3.5 million foreclosures this year. The Center for Responsible Lending estimates that close to 9 million homeowners will lose their homes over the next three years.

“What these numbers suggest,” a Realty Trac spokesman told CNNMoney recently, “is that despite the intensity of the [foreclosure prevention efforts], we don’t have a handle on foreclosures yet.”

Industry critics contend that soaring foreclosures and administrative problems only partly explain the slow modification pace; it is not a lack of capacity , they say, but a lack of will that is making lenders and servicers reluctant to process and approve modifications. Although foreclosures may ultimately produce larger losses than modifications, they also take longer and delay the point at which lenders or investors must recognize the losses and write down the value of the assets — a strategy analysts describe as “extend and pretend.”

The delinquent loans also have value as a source of servicing income, an article in the New York Times noted recently. “Even when borrowers stop paying,” the Times reported, “mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue — fees for insurance, appraisals, title searches and legal services.”

Congressional leaders have echoed these complaints and voiced others. Sen. Christopher Dodd (D-CT), chairman of the Senate Banking Committee, has asked Administration officials to investigate allegations made at a recent hearing, that servicers are violating the requirements of HAMP by:

  • Demanding up-front payments from borrowers before the review of their loan files has been completed;
  • Rejecting modification requests if borrowers are not already in default. (The program specifically allows assistance to at-risk borrowers who have not-yet fallen behind on their payments); and
  • Initiating foreclosure actions before the case review has been completed.
  • “If true and widespread,” Dodd said in a letter to Geithner and HUD Secretary Shaun Donovan, “abuses of this kind threaten to undermine the effectiveness of the HAMP program and deny the relief on which so many homeowners are depending for their financial stability.”

JAWBONE TODAY – BLUDGEON TOMORROW

The Obama Administration has been using “jawboning” in the traditional political sense – trying to persuade lenders to modify more loans for more borrowers more quickly (see related item). But if those efforts don’t work, lawmakers may start swinging the jawbone instead of talking with it.

Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, suggested as much after last week’s meeting between Administration officials and mortgage industry executives. And there was nothing subtle about the message he delivered: If the industry doesn’t do a better job of preventing foreclosures, then Congress will consider “drastic legislative measures” to help struggling homeowners. The specific “drastic” measure he has in mind, Frank said, is the bankruptcy “cram down” legislation that would allow bankruptcy judges to restructure the terms of residential mortgage loans.

The House approved that bill this year but the Senate defeated it after the financial industry mounted a successful lobbying campaign against it. But the industry shouldn’t count on that result if the bill comes up again, Frank cautioned.

"People in the servicing industry and in the broader financial industry must understand that if this last effort to produce significant modifications fails, the argument for reviving the bankruptcy option will be extremely strong, and I think there is a substantial chance that the outcome will be different," he said in a press statement.

"I can assure all concerned that no legislation which we are asked to pass to facilitate the full return of the lending industry to the role it should be playing in the economy will pass out of the Financial Services Committee unless we see a significant increase in mortgage modifications and foreclosure-avoidance, or the legislation includes a bankruptcy provision for primary residences," he added.

WHY DO BORROWERS WALK?

This seems a reasonable and important question to ask, as delinquency rates and foreclosures continue to rise and home values continue to decline. Some analysts are suggesting that an increasing number of borrowers owing more on their mortgages than their homes are worth may decide it is in their economic interests to walk away from their loans, even if they are able to continue making the payments.

Economists at Northwestern University, the University of Chicago and the European University Institute, analyzed the factors that lead some borrowers to default “strategically” (by choice), or decline to do so, and found a clear economic link to those decisions. Of the 2000 homeowners they interviewed (1,000 couples), all said they would continue making their payments if their equity shortfall was below 10 percent of their home value, but given a 50 percent negative gap between their mortgage and their home value, 17 percent said they would walk away from their obligation.

Although most of the respondents (81 percent) agreed that defaulting intentionally would be “morally wrong,” those pangs of conscience diminished as negative equity increased. At $50,000 under water, 7 percent of those who saw a moral impediment to walking away from a loan said they would do so anyway; at $100,000 that number increased to 22 percent and at $200,000 economics overcame conscience for 37 percent.

For those who saw no moral imperative to pay if they could, 20 percent would default at $50,000 in negative equity, 41 percent at $100,000 and 59 percent at $200,000.

Long tenure in a home reduced the likelihood of strategic defaults, but exposure to others who default increased the risk. The authors identified a “contagion effect,” – noting that homeowners are more likely to default themselves if they know someone who has defaulted or are in neighborhoods where the foreclosure rate is high.

Owners who think strategic defaults are wrong are 77 percent less likely to default than those who are not constrained by conscience; but within the conscience-stricken group, those who know someone who has defaulted are 82 percent more likely to follow suit, according to this study. When the foreclosure rate in an owner’s neighborhood reaches 16 percent, every one percentage point increase above that doubles the probability of strategic defaults, the study found.

The implications of these findings are somewhat disturbing, the authors note, suggesting the possibility of “vicious circles, where an initial shock of foreclosure leads to a reduction in the value of houses (which increases the percentage of people with negative equity) and reduces the social constraints to default, both factors that lead to more defaults and foreclosures [in the future].”

MORE TRUTH-IN-LENDING

The Federal Reserve Board (Fed) has proposed for comment revised Truth-in-Lending regulations that would expand the consumer disclosure requirements for closed-end mortgage and open-end home equity lines of credit (HELOCs) and generally strengthen protections for loans secured by a primary residence. The Fed proposal would also go beyond existing requirements (including the Department of Housing and Urban Development’s revised RESPA regulations) and prohibit all compensation for mortgage brokers and loan officers that is linked to the interest rate of a loan.

Emphasizing the Fed’s new-found commitment to consumer protection, Fed Chairman Ben Bernanke said the proposed regulations provide the “proper tools” consumers need to determine “whether a particular mortgage loan is appropriate for their circumstances. It is often said that a home is a family’s most important asset,” Bernanke added, “and it is the Fed’s responsibility to see that borrowers receive the information they need to protect that asset.”

The Fed’s proposal, open for a 120-day comment period, would require lenders to give borrowers more streamlined and (the Fed suggests) more useful disclosures, including a one-page document, provided at application for both mortgages and HELOCs, detailing the questions borrowers should ask about both types of loans. For mortgages, the proposed regulations, among other new mandates, would also require lenders to highlight risky features and revise the APR calculation to include fees and other settlement costs, which are currently excluded from that figure. This would make the APR a “better measure” of total loan costs, the Fed proposal says.

New requirements for HELOCs include: Providing within three days after receiving an application, disclosures “specifically tailored to the actual credit terms” for which the borrower qualifies. The rules would also would prohibit lenders from terminating an account for delinquency unless payments are at least 30 days’ overdue, require them to provide more detailed information explaining why a credit line is reduced or suspended and to inform borrowers of their right to request reinstatement and respond “promptly” to reinstatement requests.

A major component of the Fed proposal – and a feature attracting considerable industry attention – is the proposed ban on compensation linked to the interest rate or other terms of the loan. This provision would effectively ban both yield spread premiums paid to mortgage brokers and “overages” paid to loan officers, making it more restrictive than HUD’s RESPA regulations (slated to take effect January 1 of next year), which don’t affect overages or other incentive payments to bank loan officers and don’t ban YSPs. The RESPA rules, instead, require that YSPs paid to mortgage brokers be credited against the borrower’s closing costs.

The National Association of Mortgage Brokers (NAMB), which has threatened to sue HUD for singling out mortgage brokers with RESPA’s YSP disclosure requirements, applauded this aspect of the Fed’s TILA proposal. The broader restriction on rate-based compensation recognizes “that all competitors in the mortgage market receive indirect compensation inside the mortgage rate,” the trade group noted in a press statement. “For too long,” the statement adds, “hidden payments, known as ‘overages’ and ‘service release payments’ paid by Wall Street to lenders have gone undisclosed to consumers.”

Considerably less enthusiastic about the Fed’s approach, the Mortgage Bankers Association (MBA) said the “broad restrictions” on compensation for mortgage brokers and loan originators “will require considerable analysis…Our goal,” an MBA press statement said, “is to ensure that potential borrowers have a crystal clear understanding of their loan without making the process more burdensome than it has to be for either the borrower or the lender.”

NAMB also stopped short of endorsing the entire TILA proposal, noting that the organization looks forward to working with the Fed “to improve [the] proposed rule [for] the benefit of consumers.” NAMB has also joined the MBA and other real estate industry trade groups in urging HUD to withdraw its revised RESPA regulations and work with the Fed to develop uniform mortgage disclosure requirements.

In announcing the TILA proposal, Bernanke said the Fed is working with HUD to make the Fed’s disclosures “compatible and complementary” with HUD’s RESPA reforms, suggesting the possibility that a single disclosure form may result from those discussions.

But HUD officials have thus far insisted that they intend to make the new RESPA rules effective, as planned, January 1 of next year, despite pressure from lawmakers, requests from trade groups and the threat of litigation from NAMB, among others. The agency has bent a little, withdrawing one provision — a definition of “required use” that would have prohibited builders from offering homebuyers discounts or other incentives linked to their use of mortgage and title companies affiliated with the builder.

The National Association of Home Builders had filed a law suit challenging that restriction. In withdrawing the provision, HUD officials said they intended to develop a “more effective” definition that would accomplish the intent: Enabling consumer to shop for homes and mortgages without the influence of “disingenuous discounts and incentives.”

DELAY AND DEBATE

Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, has decided to delay the committee’s mark-up of legislation creating the Consumer Financial Protection Agency (CFPA) – a centerpiece of the Obama Administration’s proposed overhaul of the nation’s financial regulatory system.

The committee’s crammed ‘to-do’ list before Congress adjourns for its summer recess in August was one reason for putting off consideration of the CFPA measure until September, but not the only one, Frank admitted. The delay, he said, will also give supporters of the legislation a chance to counter the fierce lobbying campaign the banking industry has mounted against it. The bill “has become somewhat more controversial than [I] expected,” Frank told reporters recently. “I didn’t expect [the bankers] to cheer for this,” he added. “But I’ve been disappointed at the energy they’re putting into fighting it.”

“They’ve hired three lobbyists for each one of us,” Rep. Maxine Waters (D-CA), a member of the Financial Services Committee, agreed. “They’re running up and down these halls, trying to convince people the agency isn’t needed,” she told the Washington Post.

As outlined in the Administration’s proposal, the CFPA would strip consumer protection responsibility from federal bank regulators and transfer it to a new agency, with sweeping authority to establish and enforce regulations covering a broad spectrum of financial products and services.

Scott Talbott, chief lobbyist for the Financial Services Roundtable, thinks the decision to delay consideration of the measure will work in the industry’s favor. “We hope the extra time will be used to engage in a discussion about the best way to protect consumers,” he told reporters recently. “That’s where the debate should be.”

Frank’s response: Be careful what you wish for. The debate over the CFPA will likely focus on whether financial institutions have done a good job of protecting consumers, he noted during his recent press conference, “and frankly, if I were the bankers, I would not invite [that discussion]. But a national debate is what they want, and I think that’s what we will have.”

Although industry lobbyists concede that they probably will not be able to block the CFPA legislation, they think they have a good chance of weakening it. Consumer groups say they are ready for the battle. They have created a 200-member coalition of state and local consumer advocacy organizations – Americans for Financial Reform — to lobby for the legislation, and come up with a $5 million budget to finance their campaign. That’s small change compared with the banking industry’s lobbying resources, but sufficient, consumer groups think, to convey their central message: The CFPA legislation is pro-consumer and its opponents are not.

Offering a preview of the debate that will intensify in the coming months, consumer groups have a dismissed opposition to the CFPA as efforts to “sustain the status quo,” while critics have warned that the agency will reduce consumer choices and stifle industry innovation. Making that point, Rep. Jeb Hensarling (R-TX) described the CFPA proposal as “one of the greatest assaults on economic liberty in my lifetime. It says to the American people, ‘you are simply too ignorant or too dumb to be trusted with economic freedom.”

From the other side, consumer advocates insist that the agency will provide in the financial services area protection consumers need and receive in other areas. “We regulate toasters to make sure they don’t catch fire,” USPIRG’s Mierzwinski asserted. “We’re not banning toasters,” he told reporters. “We’re just saying they have to be safe.”