Save Subprime Borrowers, Not Bloated Bankers
By Dean Baker
t r u t h o u t | Columnist
Monday 20 August 2007
There is a simple and direct way in which the federal government can help out millions of moderate-income families struggling to keep their homes: They can simply change the rules on foreclosure to allow moderate-income homeowners the option to remain in their homes indefinitely as renters, paying the fair market rent.
This proposal would immediately give moderate-income homeowners a guarantee they would not be thrown out of the street because they cannot meet the terms of a predatory mortgage. It accomplishes this goal without requiring any elaborate new bureaucracy and without requiring a single dollar from the taxpayers. And this plan does not bail out the bankers, hedge funds, and other financial industry types who were speculating in mortgage debt.
Here's how the plan works: Currently, if a homeowner is not able to make their mortgage payments, the holder of the mortgage can go to court to place the house in foreclosure. This means, if the homeowner is not able to come up with back payments on the mortgage, or work out an acceptable arrangement with the mortgage holder, the bank or financial institution that holds the mortgage retakes ownership of the house and can have the homeowner evicted.
Under this security of housing proposal, the foreclosure process would be changed so the current homeowner would have the option to remain in their house as a renter paying the fair market rent. If a homeowner chose to go this route, the judge in the foreclosure proceeding would appoint an independent appraiser to determine the fair market rent for the house, in the same way a bank hires an appraiser to determine the value of the house before issuing a mortgage.
The former homeowner could then remain in their home as a renter for as long as they liked. The rent would be adjusted at regular intervals in step with the change of other rents in the area. There could even be an appeal process in which either party could request that the judge get a second appraisal, at the expense of the person complaining about the original appraisal. This should ensure the rent set for the house is fair. After the foreclosure, the mortgage holder would now own the house and be free to sell it to another person, but the former homeowner would still have the right to remain as a renter, regardless of who owned the house.
This program could be restricted to homes that cost less than the median house price for an area to ensure high income homeowners do not take advantage of it. The program would also only apply to people who lived in their homes, not investors. In short, it is a very simple and low-cost way to help moderate-income homebuyers. It does not give them any windfalls, but it can ensure they don't end up being thrown out on the street.
In contrast, the politicians are lining up with plans that ostensibly protect homeowners, but would most immediately benefit the mortgage holders who speculated in predatory mortgage debt. For example, one popular proposal being circulated in Congress would vastly expand the role of Fannie Mae and Freddie Mac, the government created mortgage intermediaries, in the mortgage market. This proposal would allow them to buy up hundreds of billions of dollars of subprime and other mortgages that the private sector does not want.
Of course, the private sector doesn't want these non-prime mortgages because the default rate is soaring. If Fannie Mae and Freddie Mac suddenly got in the market for this debt, those who are currently speculating in these mortgages stand to make a fortune. It's not clear the government's largess will necessarily benefit moderate-income homeowners facing foreclosure, but there is certainly a possibility some of the windfall will trickle down.
The point here is simple: We can design a mechanism that will directly benefit millions of moderate-income homeowners who are struggling to hang on to their homes; or, we can come up with schemes that will benefit the banks and hedge funds that speculated in mortgage debt. Place your bets.
The Dream of Home Ownership, Now a Nightmare
By Steve Lohr
Sunday 19 August 2007
New York - Three years ago, Martin and Jennifer Cossette bought into the dream of homeownership, the quintessentially American ideal of personal striving and family stability celebrated by politicians, promoted by Madison Avenue and financed by Wall Street.
The modest Cape Cod-style house, in Meriden, Connecticut, had three bedrooms and a backyard for their young son, Steven. Like so many families, they stretched to buy their first home. In the red-hot housing market at the time, they put no money down and got a mortgage for its entire $180,000 price.
They had qualms but too few, as reassuring lenders spoke of rising housing prices, falling interest rates and easy access to future loans.
None of it turned out that way. There were unforeseen expenses: a new furnace, stove and garage door. Bills mounted and credit card debt got out of hand. They refinanced in late 2005, folding other debts into the mortgage, but that proved to be only a stopgap.
Earlier this year, the Cossettes filed for bankruptcy under Chapter 13, used by wage earners who want to hold onto their homes. But the monthly payments on the $230,000 mortgage were $1,800, 40 percent higher than the first mortgage, and headed even higher. So they decided to let the house go.
"We were totally naive," said Cossette, a purchasing agent for a warehouse company.
Families like the Cossettes are the individual faces of the American credit crunch of 2007. The economic bite of the credit squeeze, which began with troubles in the market for higher-risk home loans, like the one made to the Cossettes, continued to intensify last week. Stock markets around the globe were pummeled by worries about the squeeze's ripple effect. Businesses and savers far removed from the housing fallout, from the shares of industrial companies to 401(k) retirement accounts, suffered losses.
Consumer confidence is slipping. Countrywide Financial, the nation's largest mortgage lender, was forced Thursday to tap $11.5 billion in emergency loans from 40 of the world's largest banks. The Federal Reserve took a dramatic step on Friday, cutting the rate it charges banks for loans to add liquidity and steady the financial markets. The Fed explained its move by saying that the risk to the economy from the credit squeeze had increased "appreciably."
The fallout extends from hedge fund managers to rank-and-file investors, but the most personally punishing setback is a family's losing its home.
About 1.7 million households will lose their homes to foreclosure this year and next, according to estimates by Moody's Economy.com.
That would be nearly double the number of the previous two years.
Looking at foreclosure warning signs like loan delinquency and default rates, which are spiking, Mark Zandi, chief economist of Economy.com, said the outlook was "very dark," largely because of the current "self-reinforcing downward cycle" of falling house prices, loan defaults and credit tightening that pushes house prices down further.
There are regional and local differences, to be sure. Problems tend to be more pronounced in a few Midwestern states with weak economies, like Michigan and Ohio, and states with the greatest concentration of subprime loans, like California, Florida and Nevada. "But the trouble is not just a few places. It's coast to coast now," Zandi said.
As the squeeze on homeowners becomes worse, the political debate over how to address the problem will intensify. Earlier this month, Senator Hillary Rodham Clinton, Democrat of New York, called for a crackdown on mortgage brokers who engage in so-called predatory lending, and for a $1 billion federal fund to help families avoid foreclosure.
Senators Christopher Dodd of Connecticut and Charles Schumer of New York, both Democrats, recently urged federal regulators to ease restrictions so that Fannie Mae and Freddie Mac, the two giant mortgage agencies, could buy more mortgages and mortgage-backed securities from lenders to add fresh capital to the home credit markets.
The lenders, then, would presumably have to use the new capital to refinance loans for borrowers facing default and foreclosure.
Congress is looking hard at changing the bankruptcy law so courts can restructure home loans as they do other personal loans like credit card debt. The goal, proponents say, would be to update the bankruptcy code in line with realities of the modern mortgage market.
In Chapter 13, a borrower's mortgage obligation remains intact. The most that a person gets is extra time to catch up on payments in arrears, but every nickel on the mortgage must be paid.
The bankruptcy code went through a major revision two years ago, in what was seen as a triumph for banks and other lenders. The revision made it harder for people to declare bankruptcy, especially a Chapter 7, or "straight bankruptcy," in which everything is liquidated, by setting tighter income and means tests to qualify. The 2005 amendments also set more stringent rules for writing down unsecured debt, notably credit card debt.
Protection for the mortgage lender has been unchanged since the Bankruptcy Reform Act of 1978. At the time, first-time home buyers paid about 20 percent of the value of the houses upfront, got fixed-rate mortgages, and the lenders were local bankers, serious, skeptical types who scrutinized borrowers. Homeowners agreed to mortgages they could afford. When they ran into financial troubles, it was typically because of some unforeseen event in their lives like the loss of a job, an illness or a divorce. The mortgage was rarely the problem.
Yet the mortgage often is the financial culprit these days. That is particularly true of lending in the subprime market of zero-down loans with terms fixed for two years and then floating rates, arranged by aggressive national mortgage brokers and bankers who earn lucrative fees.
"The bankruptcy law was written for a different world, and we want to give the bankruptcy courts, and creditors, more flexible tools to work with borrowers to save their homes," said Senator Richard Durbin of Illinois.
In September, Durbin, the Democratic whip, plans to propose amendments to the bankruptcy code, in a bill called the Helping Families Avoid Foreclosure Act. It would, among other things, permit writing down loans and stretching out payment terms.
Some bankruptcy experts agree that it is time to change the law.
"Our bankruptcy laws are not well designed to deal with a massive wave of mortgage foreclosures," said Elizabeth Warren, a professor at Harvard Law School. In particular, Warren said, bankruptcy courts should be able to rewrite mortgages in line with market conditions.
The banking industry, which pushed hard for the tougher bankruptcy law in 2005, wants no easing up now.
For people struggling to hold onto their homes, the path to financial peril usually began with bad loans. Bad choices often made matters worse.
That is the story Neil Crane hears and sees every day in Connecticut, a state that closely tracks the national trends in mortgage loan delinquencies and defaults. Crane, a lawyer in Hamden, Connecticut, has been handling personal bankruptcies for 25 years. Business is brisk. His office takes on 30 new cases a month, a 50 percent increase in the last year and a half.
His clients, including the Cossettes, are families typically with household incomes of $65,000 to $90,000 a year. In the past, Crane said, it was usually the loss of a job, a lengthy illness or another unexpected setback that pushed people into bankruptcy.
"But what we see now are people who refinanced to pay existing bills, with the encouragement of lenders, on very poor terms that only worsened their problems," he said. "If you sat in at the mortgage closing, you could have predicted the bankruptcy."
Joseph and Lu-Ann Horn bought their 1,200-square-foot, or 111-square-meter, three-bedroom home in South Windsor, Connecticut, in 2002, paying for nearly all of it with a $150,000 loan. The mortgage was a 30-year loan with a fixed rate of 7.5 percent. Two years later, they decided to refinance to pay off their truck and their credit card debt and to buy a $4,000 motorcycle.
The new mortgage was for $198,000, at a fixed rate of about 8 percent for two years and variable rates afterward. The monthly payment was about $1,600. The mortgage broker, Joseph Horn said, told them not to worry about the variable rate because they could refinance in two years and lock in a fixed rate again.
"They basically put us in a loan that they knew we couldn't pay," Horn said. "We never should have done it."
When the fixed rate expired last year, the Horns found no willing lenders. The interest rate has jumped and the monthly payments rose to nearly $2,200, Lu-Ann Horn said. "It just goes up and up," she said.
Jospeh Horn, 34, is a truck driver, and Lu-Ann Horn, 39, is an assistant manager in a fast-food restaurant. They make about $70,000 a year, but with two children and other expenses they fell behind on the mortgage. They have been served with foreclosure papers, and have filed for Chapter 13. "We're fighting to hold onto the house now," Lu-Ann Horn said.
For Sue Ellis, 47, a nurse in Northford, Connecticut, the road to bankruptcy began with a home improvement project six years ago. "If I had it to do over again, I never would have redone my kitchen," she said.
The first refinancing added $40,000 to her original mortgage of $140,000 on the small ranch house she bought in 1997. She was a single parent and wanted to have a backyard for her two children. The monthly payment on the original mortgage was about $850.
Ellis has since remarried, and she and her husband, Robert, a salesman at an industrial equipment company, make about $85,000 a year. But the higher mortgage and other bills led to two more refinancings, in 2003 and 2005, each to pay off about $40,000 in credit card debt. "We were using credit cards to pay the bills and then we refinanced to pay off the credit cards," she said. "It's a vicious cycle."
Today, her mortgage debt is $260,000, and her monthly payments are $2,400. The value of her house, said Crane, her lawyer, is about $200,000. Ellis is a month behind in her mortgage payment and is not in foreclosure yet. But she has also accumulated more than $20,000 in credit card debt, and she is filing for Chapter 13 bankruptcy.
For people in Chapter 13 and facing foreclosure, the struggle to hold onto a home will be an uphill battle. Bankruptcy buys a few months of relief from creditors. Crane urges his clients to use the breathing room to build up a small cushion of savings and to pare back all expenses. Life's small frills - restaurant meals, movies, - are jettisoned. Brown-bag lunches can save a few dollars a day.
The goal, Crane said, is to establish 12 months of timely mortgage payments and then, with court approval, refinance into a lower-interest, fixed-rate mortgage - and to take advantage of any new federal or state programs to help homeowners.
For Cossette, 37, who is now a renter, homeownership no longer has much allure. "You put your life's sweat into a piece of real estate that may or may not go up in value," he said. "So I don't have a house. That's O.K. with me."
Cossette said he may never again own a house. He would not consider buying, unless he could put 20 percent down, he said. His experience with the home lending system has left him understandably jaded, and he has a suggestion for policy makers.
"Hopefully, they will make it harder for people to buy houses in the long run," Cossette said. "Maybe others can learn from this."
After the Pain of Foreclosure, a Big Tax Bill
By Geraldine Fabrikant
The New York Times
Monday 20 August 2007
Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could no longer make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom house for sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, county records show.
Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a new start. He married and moved in with his wife, Denise.
But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. The letter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes, as well as penalties and late fees. The couple had a month to challenge the charges.
For those who struggle to pay their bills, who watch their housing payments rise out of reach with their adjustable-rate mortgages, who lose a job or who fall victim to illness, losing one's home can feel like hitting bottom. But one more financial indignity may await as the fallout from the great housing boom ripples across the United States.
"Getting that tax bill," Mrs. Stout recalled, "my first thought was that I needed to see my family doctor to help me with my stress, because we had a big mortgage and other debt and then here came the I.R.S. saying we owe this."
Notices of unpaid taxes, unanticipated and little understood, will probably multiply as more people fall behind on their mortgages, said Ellen Harnick, senior policy counsel at the Center for Responsible Lending, a nonpartisan research and policy center in Durham, N.C.
Foreclosure is one way that beleaguered homeowners can fall into this tax trap. The other is when homeowners are forced to sell their homes for less than the value of the mortgage. If the lender forgives that difference, they are liable for income taxes on that amount.
The 1099 shortfall, as it is called, stems from an Internal Revenue Service policy that treats forgiven debt of all types as income even if the taxpayer has nothing tangible to show for it, unless the debt is canceled through bankruptcy.
The Center for Responsible Lending expects that 20 percent of the home loans made in 2005 and 2006 to people with weak credit, commonly called subprime loans, will end in foreclosure. Because so little money was required as a down payment during the boom, the value of many of these houses may be less than what is owed.
Some people in this predicament are fighting the I.R.S. and winning. Sometimes, lower payments can be negotiated with the I.R.S., tax experts say.
In other cases, bankruptcy or a claim of insolvency can eliminate the tax burden. Sometimes, the bills are sent out erroneously, as banks fail to keep track of home values and what price the properties ultimately sell for.
"The tax laws are far too complex for borrowers to understand," said Kurt Eggert, a professor at Chapman University School of Law, noting that there are distinctions between selling a house for less than the loan amount and losing one in foreclosure. He says it is crucial to get expert tax advice to sort through the bewildering complications.
The whole concept can be counterintuitive. "Your home has declined in value and you lose it," Mr. Eggert said. "Then the I.R.S. says you owe tens of thousands in taxes because you got a windfall when the debt was forgiven."
Mr. Stout has suffered doubly from the downturn in the housing market. He earned $65,000 last year as a salesman for a roofing company. But last winter, his job was cut from a salaried position to an hourly one. Then his hours were reduced, as construction demand eased. Through July he had earned only $25,000, said his lawyer, Stephen G. Doherty, of Bennett & Doherty in Doylestown, Pa., putting him on pace for a pay cut over all this year.
Mr. Doherty set out to appeal the Stouts' tax bill by arguing that Wells Fargo got the home as collateral so the family did not reap a benefit. The Stouts and their lawyer also hoped to show that Wells Fargo was able to sell the house for far more than $1. Finally, they contended that penalties were inappropriate because they did not receive a tax notice in 2005 or 2006.
After a reporter inquired about the Stout matter, Wells Fargo Home Mortgage said last week that it had reviewed the Stouts' tax documents and was filing a corrected 1099 tax form to show that no debt had been canceled, because the fair market value of the home was actually more than Mr. Stout had owed.
Mr. Doherty, the Stouts' lawyer, pointed out that the acquiring lender, in this case Wells Fargo, has some leeway in valuing a house. The fair market value can be the high bid at a sheriff's sale, or an alternative valuation.
In this case, Wells Fargo's about-face was tied to an appraisal that Mr. Doherty says he believes was completed before the sale. It set the value of the house at $132,844, eliminating the Stouts' liability. (Lenders do periodic appraisals once a property is in default, Mr. Doherty said.)
The Stouts found in county records that Wells Fargo had sold the house to U.S. Bank for $106,000 - the same amount Mr. Stout had owed - in March 2006. The house was resold that month for $140,000.
An I.R.S. spokesman would not comment on the Stout matter or how the agency applies the tax rules on forgiven debt, but referred to a document on the I.R.S.'s policies.
Diane Thompson, a lawyer in Godfrey, Ill., for the National Consumer Law Center, says the tax can be a real hardship for some people.
She recalled a client who owed $39,000 to her lender and got a tax bill after her house was sold in foreclosure for $10,000. Ms. Thompson appealed to tax authorities, contending that her client, a part-time waitress, was broke because her debts were greater than her assets.
"If you can prove you are insolvent, the I.R.S. does not treat the forgiveness of debt as income," Ms. Thompson said. Her client did not have to pay.
Lawyers may also be able to show that the original loan process was so flawed that the borrower is not liable for taxes. Indeed, during the real estate bubble, lenders and mortgage brokers sometimes encouraged homeowners to borrow more based on inflated home values.
Such was the case with Agnes Mouser, a 65-year-old widow who works in the records department in a Houston prison. In 2000, she sought to pay off her credit-card debt with a loan from Beneficial Finance, which sent an appraiser to assess the value of her home.
"A real nice young man came out to see me," Mrs. Mouser recalled. "He could have been my grandson."
That appraiser compared her 1977 mobile home with two new standard homes with two-car garages. Using those homes as benchmarks, Beneficial agreed to lend $34,730 on her home, valued at $43,500, in 2000. Mrs. Mouser's loan carried an interest rate of 14.88 percent, and she paid 7 points, or $2,431, at closing to get that rate, along with $270 to Beneficial for the appraisal.
A spokeswoman for HSBC, the parent company of Beneficial, said it did not comment on matters involving specific customers.
In 2003, when Mrs. Mouser could not meet the payments, she contacted Ira D. Joffe, a lawyer in Houston. He found that her property was valued by the county at $19,970, less than half of what Beneficial had estimated.
"I promised to depose the appraiser's Seeing Eye dog if there was a lawsuit," Mr. Joffe recalled telling Beneficial.
Beneficial released the lien. But then Mrs. Mouser got a tax bill for $10,000, or the amount owed on the $29,566 that Beneficial had treated as a canceled loan.
"The tax bill scared her to death," Mr. Joffe recalled. "It took a letter from an accountant and two letters from me to get the I.R.S. to go away."