Saturday, December 20, 2008

States Help, Hurt When it Comes to Mortgages

By Paul Jackson in the Housing Wire:

State legislatures are stepping up their response to the nation’s housing crisis, according to research released today by the Pew Center on the States — but that response appears to be mixed in terms of its effectiveness and focus, according to a review of the study’s findings by HousingWire.

In terms of reforming lending practices, the Pew study found that between January and October 2008, eight states passed legislation tightening high-cost loan regulations since April, bringing the total number of states with predatory lending regulations to 32. Washington was the only state that had no previous restrictions against predatory lending to pass legislation; the other seven states — Connecticut, Kentucky, Maine, Maryland, Minnesota, New York and Pennsylvania — strengthened existing laws.

Six states — Connecticut, Illinois, Kentucky, Maryland, New York and Washington — passed legislation requiring the lender to take into account the borrower’s best interest when recommending a mortgage, such as verifying a borrower’s ability to repay a loan. Today, 15 states have such laws.

Prolonging the pain
The Pew data, however, makes it clear that states are focusing their efforts much more towards the reactionary here; the number of states tweaking the foreclosure process in an effort to halt borrower defaults dwarfs any of the efforts this year to limit predatory lending practices.

Through October, a whopping twenty-one states have adopted foreclosure intervention laws. Three states — California, Michigan and New Jersey — introduced loan modification programs; six states — California, Connecticut, Illinois, Maryland, Michigan and Washington — created refinance programs; and 17 states enacted legislation against mortgage fraud or rescue scams. In all, 34 states now have foreclosure intervention laws, Pew said.

Nine states — California, Colorado, Connecticut, Maryland, Massachusetts, New York, North Carolina, Pennsylvania and Virginia — have either instituted a moratorium on foreclosures or increased the number of days before a notice of default must be issued to a borrower. Consumer advocates argue that such delays can help borrowers find solutions; critics have argued such delays merely stall a foreclosure that was going to take place anyway.

It’s worth considering the case of Massachusetts: initial foreclosure filings in the state soared 465 percent between August to September, after being much lower than normal in June, July and August. That temporary lull happened after a new law took effect in May requiring lenders to give homeowners a 90-day right to cure notice before initiating foreclosure. A similar trend now appears to be playing out in California, as well.

“Several states, including, Illinois, Maryland and Ohio, have been aggressive in their efforts to help homeowners plagued by foreclosures,” said Kil Huh, a project director with the Pew Center on the States who led the research. “As the economic challenges from the housing crisis continue to play out in communities across the country, our research shows that states are looking to each other for a way out of this debacle.”

Drawing the wrong conclusions
Here’s the thing that is undisputed: nobody wants to see a foreclosure. But it’s applying that sentiment that has become problematic in the current crisis — just how far are we willing to go to extend that sort of logic?

After all, a good number of borrowers speculated on home price appreciation in recent years, and still others committed outright fraud in order to obtain loans, as unpopular as it may be to suggest that now. Do we simply forgive their bad actions, arguing that their actions were the fault of a system that enabled it? Or do we focus on reforming the system instead? Or both? Do we allow those who made bad choices to suffer the unfortunate consequences of their decisions? Or do we believe that their choices were not their own? Answers to these questions aren’t easy to reach consensus on, as the current crisis has clearly shown.

But it’s important to understand the answers any particular organization has selected to these sort of questions when reading their interpretation of any data. And at Pew, it’s clear what lens they’ve selected.

“Homeowners and communities reeling from historically high rates of foreclosure need assistance,” said Susan Urahn, managing director of the Pew Center on the States. “States are taking steps in the right direction — but they can’t go it alone. They need the federal government to do more to build on state efforts to help homeowners keep their homes and prevent more troubling loans from being made.”

The idea that federal legislators need to “do more” has long been a rallying cry of various consumer advocacy groups, even before the current crisis took shape. But there are valid reasons people lose their homes, too. It’s the often unfortunate other half of the coin in the business of secured lending: the security pledged by borrowers is pledged in exchange for a promise to perform as agreed. In secured lending, the collateral is what matters — its value, as well as the ability to seize it should doing so become needed to protect a creditor’s interest.

Which means that the business of servicing a loan isn’t always pretty. In fact, it means that servicing can often pit a creditor directly against a borrower — who would, all else being equal, prefer not to lose whatever collateral they had pledged — but it’s nonetheless also the function that separates home lending from a credit card or other unsecured consumer loan.

Think of the current mortgage market like you might think of an episode of food poisoning: the lending process put the toxic food into the belly of the American consumer. A decision to forestall the exit of that toxic material, on the logic that all food is nourishment for the body, will likely end up doing much more harm than good, and could go so far as to kill the already sick patient. But that’s what we’re now seeing take place; toxic loans put into the system, and the idea that home ownership represents “the American Dream,” to be preserved at any cost.

By lumping much-needed lending reform together with foreclosure prevention efforts, the researchers at Pew are confusing the decision to make the loans with the actions that are really needed to help the system recover. It’s the functional equivalent of indicting a person’s gut for reacting to a restaurant’s decision to plate moldy food, and the consumer’s decision to ingest it.

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