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Testimony of the
American Homeowners Grassroots Alliance
Submitted to the
Senate Committee on Banking, Housing, and Urban Affairs
Hearing on
Mortgage Market Turmoil: Causes and Consequences
March 22, 2007
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The American Homeowners Grassroots
Alliance (AHGA) commends the Senate Committee on Banking, Housing, and
Urban Affairs for holding this hearing on Mortgage Market Turmoil:
Causes and Consequences. AHGA is an independent consumer advocacy
organization which focuses on policy issues that have a significant
economic impact on homeowners and home ownership. AHGA strongly supports
a stable and healthy mortgage marketplace that will enable the expansion
of U.S. home ownership. The current mortgage environment is causing
untold grief for many innocent homeowners, undermining the equity of the
nation’s 75 million homeowners, and threatening the ability of potential
future homeowners to take part in the American dream.
The current mortgage market turmoil has been caused by a number of
circumstances, most notably the greed of some companies that function
primarily as mortgage intermediaries. For many of them the lure of
substantial immediate profits outweighed the importance of sound
mortgage underwriting practices, ethical treatment of consumers, and/or
risk to their businesses’ viability. Some of the consequences in human
and economic terms have already become evident, and both the scope of
the problem and its long term impact on consumers and the economy will
largely be determined by the actions of Congress on a number of current
policy issues that will impact home values and mortgage lending
liquidity. Mortgage lending liquidity and home values are inextricably
tied to each other, and home values will be the single most important
factor in determining the severity and length of the current mortgage
market turmoil.
An outcome of the mortgage lending practices that have lead to the
current turmoil is that a large number of unsophisticated home buyers,
who were advised to take out types of mortgages they could not afford
over the last few years, now face mortgage foreclosure. The personal
tragedy suffered by homeowners who have lost or will lose their homes as
the result of poor guidance from mortgage brokers they had trusted, and
who knew better, must be prevented in the future. Appropriate steps must
be taken to assure that this scenario does not repeat itself. It is also
absolutely essential that other parallel steps be taken simultaneously
to assure continued liquidity in mortgage financing and mitigate the
potential impact of the problem.
A recent study by First American CoreLogic Inc predicted that in the
next six years, 13 percent of the 8.37 million adjustable-rate mortgages
(or 1.1 million mortgages) originated between 2004 and 2006 will
default, destroying $112 billion in home equity. The study, “Mortgage
Payment Reset: The Issue and the Impact," also projects that for each 1
percent increase in home values, 70,000 homes can be saved from
foreclosure, and conversely, that for each 1 percent decline in home
values another 70,000 homes will face foreclosure. In a more disturbing
report issued on March 20, "Dissecting the Mortgage Distress," BAS
analysts noted an excess supply of 800,000 existing homes currently on
the market, and predicted that another 300,000 new foreclosures will
soon be added to inventories. This will likely depress home values by
another 5% in 2007, according to the Bank of America subsidiary.
Former Federal Reserve Chairman Alan Greenspan and many other economists
believe that the current level of foreclosures can be absorbed into the
market with relatively little impact on home values. It is important to
note that many of those mortgages will reset in 2008, so the value of
homes next year will be extremely important in determining whether the
problem will worsen or improve. Actions of Congress in a number of
areas, including needed steps to prevent a recurrence of the recent
problems, can have a significant aggregate impact on home values. They
can range from a net positive effect, helping to further mitigate the
problem, to a net negative effect, which will increase the number of
foreclosures, the heartaches to foreclosed homeowners, and the threat to
the overall economy.
Some steps are already being taken by the private sector to minimize the
problems and prevent their recurrence. Many mortgage lenders and
servicers are working with homeowners to restructure mortgages in manner
that will be affordable to homeowners, and some have been willing to
forgive part of the mortgage balance. The latter makes it possible for
distressed homeowners to avoid bankruptcy and sell their homes, and
saves mortgage lenders much higher costs of foreclosure.
In addition lending standards have already been tightened by GSE’s and
other mortgage lenders. This step was obviously needed. Many of the
marginal mortgages that have been packaged and sold on the stock market
have ended up in the hands of deep pocketed international and domestic
investors who had the sophistication to understand the risks and deep
enough pockets to absorb the losses. This is fortunate because, unlike
the naïve home buyers who are also victims, there is neither any reason
nor any need to bail out sophisticated and wealthy mortgage investors.
The losses by both investors and mortgage holders who have been burned
in the recent turmoil will provide them a strong disincentive to not
make the same mistake again. Bailing them out would only lessen their
resolve to avoid the same mistakes in the future.
The real victims are the homeowners who were talked into mortgages they
shouldn’t have accepted and now face foreclosure. Of course foreclosures
occur even in the best of times. Some home buyers who finance their
homes with fixed rate conventional mortgage lose their jobs or
experience other unanticipated personal tragedies that often lead to
foreclosure of their home. No doubt many subprime borrowers also
experienced personal traumas, and there is nothing Congress can or
should do in either case.
However, some of the subprime home buyers who bought at the top of the
market and now face foreclosure might be able to afford a conventional
mortgage on their home today at their home’s foreclosure auction price.
We recommend that Congress study the possibility of establishing a
guarantee type program that would allow threatened subprime borrowers to
buy their own homes at foreclosure auctions, using traditional mortgage
financing methods in those cases where the auction price is low enough
that the homeowner could afford to refinance the home in that manner. In
cases where lenders are unwilling or unable to work out a solution with
a homeowner, this could save the homes for some homeowners.
One way such a program might work is that if the homeowner who is
threatened with foreclosure would be prequalified by a government
approved lender for a conventional mortgage up to a certain amount based
on the homeowner’s current income and assets. Government backing would
be essential as homeowners facing foreclosure would understandably
otherwise have a very difficult time qualifying for any mortgage from
any lender. The homeowner could then use the government-backed guarantee
to bid up to that amount for their home at a foreclosure auction. This
program would help homeowners who had been put in the wrong kind of
mortgage stay in their home and would also mitigate further declines in
home values. In addition it would offer some help to mortgage holders
(an additional higher bid on the foreclosed property) while avoiding the
counterproductive problems of direct lender subsidies.
A pernicious problem is that many mortgage brokers have had, and still
have, insufficient incentives to discourage them from putting naïve home
buyers in unsuitable mortgages. Mandatory disclosures on subprime and
other risky loans is a partial solution, which we endorse. More funding
for consumer education and counseling is another partial solution that
we also endorse. Unfortunately, the professional entry standards for
mortgage brokers is very low. Until those standards are raised, the
ability of mortgage brokers to effectively educate consumers will remain
inadequate, and the incentive of mortgage brokers to protect their
investment of time and money necessary to be professionally licensed
will remain inadequate to offset the temptations of the quick money to
be had by putting consumers into unsuitable mortgages.
Therefore, a key part of the solution must be to substantially increase
the professional entry standards for qualification as a mortgage broker.
The mortgage brokerage industry has obviously not addressed this need,
which must be addressed quickly. It is unlikely that this problem can be
addressed quickly or effectively at the state level. In the real estate
services sector research by the Consumer Federation of America has
identified a significant amount of regulatory capture at the state
level. State real estate commissions and boards are often dominated by
traditional real estate brokers, and those organizations rarely propose
substantially strengthening entry standards despite much evidence
supporting that need, and much sentiment within the real estate services
profession for strengthening entry standards. A similar threat of
regulatory capture would exist at the state level for mortgage broker
entry standards, and the results could be uneven and take a long time to
materialize. For this reason we recommend that Congress set a reasonable
but substantial national minimum standard for entry into the mortgage
brokerage profession which states may have the option to strengthen, but
not reduce.
We urge the committee to be very wary of disallowing certain types of
home financing and/or mandating minimum qualifications for specific
types of home financing at this time. If Congress errs on the side of
being overly restrictive, such standards may substantially diminish the
availability of mortgages, particularly to first time buyers and those
with blemished credit histories. An outcome of such restrictions could
very likely be further declines in home values and as a result, far more
foreclosures. If this Committee feels such restrictions may be needed,
it would be better to initially take a very small step in this
direction, to be followed by stronger measures later if the
aforementioned recommendations do not sufficiently reduce abusive
mortgage lending practices.
Members of this committee and other members of Congress need to be
mindful of other current policy issues that will impact home values.
They are critical to maintaining the values of American homes, which in
turn will play a major role in the recovery from the mortgage market
turmoil. One of the most important is the regulation of the GSE’s. GSEs
have had their own problems, and it is appropriate that some
restrictions be imposed to prevent the recurrence of past abuses.
At the same time the GSEs are also major players in providing mortgage
liquidity. A study of GSEs by former OMB Director James Miller estimated
that lower mortgage interest rates available through GSEs save American
homeowners between $16 and $21 billion in housing costs every year.
Substantially restricting GSE’s ability to provide affordable mortgages
would undermine home values. Restrictions on GSE lending ability would
put more homeowners at risk of foreclosure and, given the current market
conditions, is also against the best interest of mortgage lenders as
well. Both homeowners and mortgage lenders will suffer to the tune of an
estimated 70,000 additional foreclosures for every 1% drop in home
values if the ability of GSEs to contribute to the maintenance of
mortgage liquidity and home values is undermined.
Recent House legislation that will require GSEs to devote more financial
resources to helping the economically disadvantaged buy homes will be
very beneficial to strengthening home values. The GSE reform legislation
will refocus GSEs on one of the most important components of their
mission which will also offset any new lending restrictions contained in
other legislation that will limit the accessibility of mortgage
financing to homeowners.
Most importantly the House GSE reform legislation does not require
arbitrary restrictions on the ability of GSEs to support more mortgage
lending so long as prudent guidelines are followed. Some mortgage
lenders have recommended restrictions on the size of GSE portfolios, but
such recommendations would limit mortgage liquidity and thereby
undermine home values, lead to more foreclosures, and undermine the
economy. For that reason arbitrary restrictions on the size of GSE
portfolios are not only against the best interests of homeowners but
also, given the state of the mortgage marketplace, against the best
interests of all other mortgage lenders as well. Given the expected
continued pressure from the GSE’s commercial competitors, we believe
that the legislation could be improved by language prohibiting any
restriction on GSE lending ability so long as sound financial practices
are followed.
There are a number of other concurrent steps that Congress should take
to improve mortgage liquidity and home affordability. This will help
offset the current problems and prevent more foreclosures in the future.
The Federal Home Administration (FHA) could play a stronger role in
funding mortgages if some of the restrictions and regulatory red tape on
its programs are lifted. AHGA supported changes proposed by FHA include
eliminating FHA’s statutory 3% minimum cash down payment requirement and
offering down payment flexibility; increasing the FHA loan limits; and
allowing FHA to use risk-based pricing.
Late last year Congress passed legislation allowing for the deduction
for private mortgage insurance by home buyers who earn less than
$100,000 annually. This new deduction lowers the effective cost of home
ownership which will also help maintain home values. For that reason it
should be made permanent (it expires at the end of 2007) in order to
help maintain home values. Hearings by the House Financial Services
Committee last year on title insurance revealed that only 2-4% of title
insurance premiums are paid out in claims. Congressional action to
reduce abuses identified in those hearings has a substantial potential
for reducing consumer transaction costs and thereby contributing to the
stabilization of home values. Another House Financial Services Committee
hearing (and a GAO study) last year on the real estate services sector
revealed that home sellers are often forced to pay for real estate
services they neither want nor need. If Congress acts to remove
unnecessary costs from home sale transactions, allow home buyers to save
money though such steps as real estate commission rebates (currently
prohibited in some states) it would further help stabilize home prices
and limit the impact of the current mortgage turmoil.
Eliminating real estate market inefficiencies through precisely targeted
surgical reforms of real estate lending and services marketplace,
combined with improved consumer education, disclosure, home ownership
tax incentives, and the elimination of unnecessary transaction costs
will enable homeowners, mortgage lenders, and the economy to weather the
current mortgage turmoil quickly. We urge the Senate Banking Committee
and other oversight committees to act quickly and decisively to take the
following steps to reduce the impact of the mortgage market turmoil:
● Fund consumer education and require specific clear plain English
disclosure of the inherent risks of certain types of mortgages to all
consumers contemplating those mortgages.
● Impose substantially higher entry level requirements for mortgage
brokers that may be further strengthened, but not reduced, at the state
level.
● Be cautious and minimalist in any initial restrictions on types of
mortgages that may be offered, because the restrictions could undermine
home values and drive up foreclosures.
● Be cautious and minimalist in the regulation of GSEs, in particular
avoiding imposition of restrictions on their loan portfolios which could
also undermine home values and drive up foreclosures.
● Look for additional ways to increase mortgage liquidity through such
vehicles as an expanded role for FHA and other entities.
● Reduce the costs of home ownership through such steps as permanently
extending the mortgage insurance tax deduction.
● Reduce the transaction costs of home purchase/sale through such steps
as reform of the title insurance industry and the elimination of state
prohibition of real estate commission rebates, and state mandated
requirements on home sellers to pay for services they neither want nor
need.
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