Foreclosures and Consumers
| Citado como | Vol. 50 No. 2 Pg. 0008 |
| Páginas | 0008 |
| Año de Publicación | 2009 |
2009 Fall, Pg. 8. Foreclosures and Consumers
Volume 50, No. 2
Fall 2009
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
W.B. Yeats, The Second Coming, 1921
"Greed, for lack of a better word, is Good"
Gordon Gekko, "Wall Street"
I. CASE HISTORIES
In 2005, Karl and Wanda Hrbek(fn2 ) were in financial trouble. Karl, an engineer, had recently been laid off from a local business, which meant a loss of roughly $80,000 in annual income to his family. After an extended job search, Karl, 56, realized that his particular skills and salary requirements were not in sync with the current job market.
With savings running low and the COBRA deadline for health insurance approaching, the Hrbeks decided to try to turn a shared avocation - antique restoration - into a business. To secure start-up capital, they refinanced the mortgage on their home in April 2006, borrowing $310,000 against an appraised value of $375,000. The mortgage they were offered was particularly appealing because it featured a low introductory interest rate of 3.25 percent for one year, after jjj which the loan would reset to a level of 5.75 basis points over the three-month London Interbank Offered Rate ("LIBOR").(fn3 )
The Hrbeks did not know what LIBOR was. They could not know that the LIBOR rate in April 2007 would be 5.355 percent,(fn 4 )effectively raising their monthly interest rate to 11.105 percent. and raising their monthly principal and interest payment from $1,349.14 to $2,930.14. After the rate change, they could not afford payments and by December 2007 had fallen four payments behind . They contacted their loan servicer's workout department and negotiated a restructuring of their loan. The restructure allowed the Hrbeks to capitalize their arrearage, all late fees and attorney's fees in return for an upfront servicing fee of $2,000. The restructuring also extended the term of the loan to 40 years and deferred the additional principal to the end of the loan, allowing the Hrbeks to remain at their then operative interest rate of 10.9727 percent - but measured against a principal amount increased by $12,500 to $315,000. The effect of these transactions was to bring the Hrbeks current, but at a continuing payment level of $2,907.10.
The Hrbeks also could not know that beginning in 2007 and continuing throughout 2008, the broad failure of the subprime market would result in a depression of home values, with the result that, when they sought to refinance out of their current mortgage in December 2008, their house was appraised at $299,000. The Hrbeks were now "upside down" on their mortgage, meaning they owed more than the value of the mortgage - effectively preventing them from refinancing. Without any recourse to refinance, the Hrbek's situation spiraled downward. In February 2009, they lost their home of 17 years to foreclosure.
John Dubois, a 23-year-old construction worker, and Cathy Dubois, 25, a 2 5-year old secretary, never assumed that they would qualify for a home purchase loan on their joint income of $60,000 a year. But Cathy had a cousin who was working for a mortgage company and driving around in a $800 a month rented Mercedes who told them otherwise. The cousin came to their house one evening and took down all their important information, had them sign an application in blank, then left telling them he would take care of everything.
Three weeks later, they were approved for a "no money down" mortgage. Young, inexperienced and naive, they neither asked for nor received a copy of their application. They also did not understand until closing that they were in fact entering into two loans - a structure commonly known as an 80/20. Under this structure, 80 percent of the total loan value of $280,000 - that is, $224,000 -.was collateralized by a 30-year first mortgage on their home at a fixed 7.95 percent, while the remaining $56,000 was structured as a 15-year loan at 11.5 percent interest secured by a second mortgage on the same property. As structured, the two loans established a monthly payment of $1,635.83 on the first loan and $654.19 on the second for a total of $2290.02 per month, creating an annual payment stream (net of insurance and taxes) of $27,480.24 - just shy of 50 percent of their gross household income.
Inevitably, they missed payments and fell progressively further behind on both loans. When the young couple finally obtained a copy of their application from the loan servicer, they discovered that their income had been inflated, presumably by their cousin. They also found that, although their mortgage servicer had never changed, their first and second mortgages had each been sold into the secondary market, but to different purchasers as parts of two separate securitized trusts, each with a different managing trustee. Letters and phone calls to their loan servicer's "mortgage resolution" division resulted in multiple contacts with different individuals (almost never the same person twice), which resulted in considerable confusion and a seeming inability on the servicer's part to effectively coordinate discussions on the two loans. Without being able to obtain a coherent response from their servicers, the Dubois were forced to declare bankruptcy, in part because of the level of their debts, but also because it was the only venue by which they could achieve a coordinated resolution of their two mortgages.
The above histories are fairly typical examples of the frequently intractable situations faced by so-called "subprime" borrowers over the last several years. The complexities presented in these examples are not exaggerated for effect. The fact is that the so-called "subprime" mortgage market has been marked by the use of relatively complicated mortgage structures, which are then placed into a secondary market through mechanisms and instruments of increasing complexity. The result is that failures within this market have proven extremely difficult to address in any rational format. This piling of complication upon complexity - particularly with the added element of fraudulent inducement or construction - has resulted in a vastly irrational market that has proven almost impossible to regulate or correct by traditional means. It is no exaggeration to suggest that, from its inception, the subprime mortgage market was constructed for inevitable failure; and when markets suffer a widespread failure without an adequate resolution mechanism in place, the result is bound to be widespread dislocation and serious damage to some participants in that market.
In America in 2009, in the wake of the collapse of the subprime credit market, the people most likely to suffer damage have been, not at all surprisingly, the weakest " market participants." - the poor, the inexperienced, the unsophisticated borrowers to whom subprime mortgages have been sold in droves, and who have over the past several years experienced unprecedented rates of default. The story of this failure is being told in the small print of foreclosure notices in the back pages of papers all over the country.
II. SOME HISTORY
The so-called subprime mortgage crisis has been brewing in this economy since the enactment of the Financial Services Modernization Act of 1999 ("Gramm-Leach-Bliley") (fn 5 ) Among the principal provisions of the Act was the repeal of Depression-era restrictions(fn 6 ) on the capacity of depository banks to engage in broader financial activities, including the issuance and marketing of securities, and merchant banking. (fn 7 )The entry of large depository banks into the securities and merchant banking markets essentially poured billions of previously untapped dollars into those markets. Unsurprisingly, in retrospect, these newly liberated financial institutions gravitated toward financial products with which they had some experience and familiarity - particularly an emerging hybrid of traditional mortgages and securities created by packaging mortgages into securities. The concept of moving mortgages into a secondary market was far from new. Indeed, quasi-governmental entities such as Fannie and Freddie Mac had long provided liquidity to mortgage markets by providing a secondary market for individual mortgages. What changed after Gramm-Leach-Bliley was the emergence of a broad market for mortgages packaged together into mortgage-backed securities asprivate investment vehicles. Over time, the legal and financial structures of such packaged securities grew increasingly complex as investment bankers devised various risk-limitation strategies based primarily on mixing secured loans with differing risk profiles.(fn8 )
The large-scale expansion of the mortgage/security markets following enactment of Gramm-Leach-Bliley had a secondary effect of broadening demand for mortgages that could be packaged into saleable securities. This demand could only be satisfied by extending the mortgage market into non-traditional areas. Following the lead of the credit card industry, mortgage lenders began offering credit to increasingly less credit-worthy cohorts of customers, eventually creating a wide market for mortgages designed for individuals with less than impeccable credit histories -the subprime market.
The extension of credit to millions of lower income and higher risk individuals created an increased demand for housing purchases, which in turn fueled the precipitous rise in housing prices during the first decade of the 21st century - the so called...
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