The first in a series of three articles
Testimony of Paul Leonard
California Office Director
Center for Responsible Lending
Before the U.S. House of Representatives House Financial Services Committee
Subcommittee on Housing and Community Opportunity
November 30, 2007
[Editor’s note: This is an issue of great importance to the economic well being of California. As we reported last week, Democrats in Sacramento are proposing a package of legislation and the Governor, mayors around the state, and other elected officials are calling for action. Last Friday, U.S. House of Representative Maxine Waters of Los Angeles held hearings on what can be done to keep families in their homes and took expert testimony, including that of Mr. Leonard. Here is the first part of Mr. Leonard’s testimony. There will be two other installments published tomorrow and Thursday.]
First, I wish to thank Chairwoman Waters, Ranking Member Capito and Members of the Housing and Community Opportunity Committee for convening today’s hearing, and for inviting the Center for Responsible Lending to testify. The timing for this hearing, focusing on current borrowers, could not be better.
I am Paul Leonard, California Office Director of the Center for Responsible Lending (CRL). CRL is a not-for-profit, non-partisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL began as a coalition of groups in North Carolina that shared a concern about the rise of predatory lending in the late 1990s. Today CRL works closely with a broad range of civil rights, labor and consumer organizations at both the federal and the state level to provide for safe, sustainable and affordable homeownership. And I can honestly tell you that we look forward to working with you, Madam Chair, to make sure that every homebuyer has access to credit with fair prices and fees and adequate consumer safeguards.
CRL is an affiliate of Self-Help, which consists of a credit union and a non-profit loan fund. For the past 26 years, Self-Help has focused on creating ownership opportunities for low-wealth families, primarily through financing home loans.
Self-Help has provided over $5 billion of financing to over 55,000 low-wealth families, small businesses and nonprofit organizations in North Carolina and across the country, with an annual loan loss rate of under one percent. We are also a responsible subprime lender. In addition to making direct loans, Self-Help encourages sustainable loans to borrowers with blemished credit through a secondary market operation. We buy these loans from banks, hold on to the credit risk, and resell them to Fannie Mae. We have used the secondary market to provide $4.5 billion of financing to 50,000 families across the country, loans that have performed well and significantly increased these families’ wealth, giving many families their chance to rise into the middle class.
I want to make three main points today:
• First, California is the epicenter of the national foreclosure crisis.
• Second, while loan modifications hold the greatest promise for avoiding foreclosures and keeping people in their homes, the results to date have been disappointing.
• Third, broader changes are needed from industry and policymakers in order to assist the largest number of borrowers in avoiding foreclosure.
I. California is the Epicenter of the Subprime Foreclosure Crisis
Because of reckless lending practices in the subprime market and voracious investor demand for the resulting loans, 2.2 million families nationwide—and nearly 500,000 in California—have lost or will lose their homes to foreclosure, according to CRL estimates from last December. These foreclosures already are occurring in record numbers, and the worst is still ahead.
The cost of the subprime problem extends far beyond the families who lose their homes. Millions of other families—who diligently paid their mortgages—will be hurt by declines in property values spurred by nearby foreclosures and a weaker housing market. CRL’s recent report, Subprime Spillover found that nationwide foreclosures cost neighbors $223 billion, with average individual property value loss of $5,000. In California, that total number is $67 billion, with an average individual property value loss of more than $8,000. Three million Los Angeles County homeowners will lose $30 billion in property value as a result of neighboring foreclosures.
Foreclosure Data Are Ominous
Since the beginning of the year, hardly a week has gone by where new and increasingly ominous reports and press accounts of the mounting foreclosure crisis are not prominently featured on front pages across the state and the country.
• A panel at the Milken Institute’s prestigious State of the State conference debated the impact of the crisis on California’s economy. One economist predicted the housing crisis would lead California’s economy into recession. Panel members, including chief executives of KB Homes and Countrywide all agreed that housing prices in California would decline by at least 10 percent in the next 18 months. Rick Orlov, “Foreclosures, Housing Slump, Hurting California Economy.”
• Last month, DataQuick, an industry leading research firm, reported that California had the highest levels of defaults and foreclosures since it began tracking such data in 1988. Among the findings: California had nearly 25,000 foreclosures in the third quarter of 2007, a 600% increase over third quarter 2006 foreclosures, and 10,000 more foreclosures than the peak level of foreclosures in 1996. An additional 72,571 notices of default were filed during the quarter, on 68,746 residences (since some homes had more than one defaulting loan), another record. More than half of the default activity was concentrated in 293 zip codes running from Sacramento through the Central Valley, the Inland Empire and down to San Diego. Defaults reached record levels in 39 of the states and 58 of the counties.
Perhaps of greatest concern, DataQuick reported an alarming jump in the percentage of defaults that could not avoid foreclosure. In the third quarter of 2007, 54.1% of defaults ended in foreclosure, as compared to only 19.1 percent in 2006. “Record California Foreclosure Activity,” DataQuick News Release. October 26, 2007.
• RealtyTrac, another private foreclosure tracking firm, reported on Nov. 29 that California’s foreclosure rate of one filing for every 258 households ranked second among the states. According to RealtyTrac, California’s reported foreclosure filings totaled 50,401 in October 2007, more than triple the number reported in October 2006
“U.S. Foreclosure Activity Increases 2 Percent in October,” Realty Trac News Release. November 29, 2007.
• The Legislative Analyst in California is now projecting $10 billion in budget deficits, in part due to slower revenue growth associated with the housing downturn.
Subprime loans have and will continue to represent the largest and far disproportionate share of California’s foreclosures. Recent data from the mortgage banking industry shows that while subprime loans represent 15 percent of outstanding mortgages in California, they account for a stunning 68 percent of recent foreclosures in the second quarter of 2007. Unpublished Banc of America Securities Data. August 1, 2007.
Delinquencies are rapidly growing among subprime ARMs. In just 6 months, the 60-day delinquency rate for subprime ARMs nearly doubled from 11.1 percent in February 2007 to 19.4 percent in July 2007. Unpublished Banc of America Securities Data. August 1, 2007.
The Human Toll
These reports provide the factual foundations. Other stories have presented the human toll of foreclosures:
• The San Francisco Chronicle’s account of a 44-year-old Chinese speaker with Parkinson’s disease. The subject had his home sold out from under him because of his failure to stay current on a $20,000 second mortgage, even though he had plenty of equity in his $500,000 home, was current on his first mortgage, and owed only $94,000 on it. Countrywide Financial, the foreclosing lender, was the lender on both his first and second mortgages.
Countrywide and the foreclosure investors who purchased the home were able to unwind the sale and return the home to the borrower after the initial story ran. Before the story the investors had offered to sell the property back for $500,000 after buying it for only $194,000. Carolyn Said, “Face of foreclosure crisis – Chinese-speaking Parkinson’s sufferer,” San Francisco Chronicle, October 27, 2007.
The Orange County Register’s account of how one block in Santa Ana was ravaged by subprime loans and foreclosures, many involving Hispanic borrowers who did not fully understand the terms of their mortgages and had been misled or cheated by brokers. John Gittelsohn and Ronald Campbell, “Street of broken dreams: Foreclosures and forced sales mar West Camile Street,” Orange County Register. August 12, 2007.
• The Los Angeles Times’ account of Steve and Mona Breidenstein of Santa Maria who spent eight months attempting to contact Countrywide Financial in order to convert their adjustable rate mortgage to a fixed-rate loan—well before the scheduled mortgage reset. Countrywide refused to show any interest in helping them, and until the Times ran the story, Countrywide did not offer the Breidensteins any option beyond selling their home. E. Scott Reckard, “Giving borrowers a break: Prodded by politicians and foreclosures, some lenders are willing to modify terms to help homeowners,” Los Angeles Times. October 4, 2007.
These accounts have vividly captured the human and neighborhood costs of foreclosures. They also suggest an industry that responds to press coverage on individual stories, while leaving intact a system that is too often failing to treat borrowers fairly.
The Worst is Still to Come
It is important to recognize that while the rate of subprime foreclosures is alarming today, the worst is still ahead. As the chart below shows, a large majority of these rate resets will occur later this year and throughout 2008, peaking in October 2008. E. Scott Reckard, “Giving borrowers a break: Prodded by politicians and foreclosures, some lenders are willing to modify terms to help homeowners,” Los Angeles Times. October 4, 2007.
Source: CRL calculations, based on Banc of America Securities data
The most immediate problems arise due to subprime ARMs. However, California and the nation will also be confronting a large pool of “payment option ARMs” that have significant payment resets. These loans provide borrowers with at least three payment options each month: a fully amortizing payment, an interest only payment, and a minimum payment, which is less than the full amount of interest. The difference between the minimum payment and the full amount of interest due is added into the principal balance of the loan, so that the balance of the loan grows. This is called “negative amortization.” When the principal balance reaches a certain threshold, usually 115% – 125% of the original, the loan recasts and requires the borrower to make a fully amortizing payment on the larger loan balance. Studies have shown that many of these payment option ARMs were originated with lax underwriting standards and stated income features, leading many borrowers to make minimum payment and leading to unaffordable payments when the loan recasts.
The chart below, from Credit Suisse, shows that there will be another spike in Option ARM resets that occurs between 2009 and 2011.