Counseling a Cure for Subprime Woes?
Earlier this month, the Illinois legislature passed a law (W$J - subscription required) requiring individuals seeking home loans to spend time with a mortgage counselor if the loan is non-traditional (e.g., pre-payment penalties or interest-only payment options). The goal of the legislation is alert borrowers to the tricks and traps that can be thrown into mortgage documents at the last minute by unscrupulous brokers.
A previous program was discontinued earlier this year after problems surfaced and allegations of racism arose. The success of this program will depend on whether its backers can win the public relations battle against actors in the mortgage industry who claim the law will dry up credit for affected borrowers. (This objection raises serious questions as to why such loans are suddenly unavailable when light scrutiny is applied.)
This law is a promising attempt to approach the predatory lending issue from the consumer side. Legitimate objections do exist to the legislation, but none of them merit scrapping this program before enough time has passed to evaluate its impact.
Mortgage counselors have expressed concern that they lack the resources to handle the influx of clients. Some combination of overtime pay or new hiring could suffice to resolve this short-term problem.
Allegations of racism will prove a more serious hurdle for the new law. While it may be the case that borrowers who are offered subprime rates and predatory loans (and are thus covered by the new law) may be disproportionately from minority groups, this does not make the law racist. Indeed, African-American legislators lobbied hard to ensure that their districts were included in the pilot program.
A potential decline in housing values in pilot program areas is another, related problem. If it materialized, the problem might proceed as follows: decreased loan availability would limit the number of potential buyers, depressing sale prices or preventing sales entirely. The solution to this problem is not to give up on educating borrowers, leaving them trapped in predatory mortgages for the sake of maintaining home prices. Instead, the legislature could follow up with careful scrutiny of lenders to ensure any decrease in loan availability is not discrimination-based and consider state support for loans on a short-term basis until the market can catch up to the new legislation. (Fannie Mae and Freddie Mac have been clamoring to help out with the subprime crisis at the federal level - perhaps they could be enlisted to help out in Illinois)
For those of you, who, like me, want to believe that increased education can help level the playing field between consumers and the financial services industry, stay tuned.
Education is good, but it's not the way to eliminate ripoffs. Ripoff loans should be illegal. Specifically, banks and corporations should be required by law to specify a maximum monthly payment on page one of every mortgage they write. They should be prohibited from issuing mortgages where the maximum payment is more than a third of the home owner's monthly income.
This is much bigger than protecting Mr. and Mrs. So-and-so from themselves. It's about not crashing the global economy.
Banks create money by the act of lending. Too much money causes inflation. Runaway inflation feeds back on itself, causing a bubble. Bursting bubbles halt lending, which contracts the money supply. Central banks have to issue emergency loans at lower rates, to desperately try and prevent the whole financial system from collapsing in a panic.
The activities of unregulated lenders, behaving like banks while ignoring the rules that keep banks open, should've never been allowed to begin with. Houses would be less expensive today.
August 23, 2007 2:16 PM | Reply | Permalink
A previous program was discontinued earlier this year after problems surfaced and allegations of racism arose.
Translation: Blacks have more problems with loans, and this program therefore began to affect blacks more than it did whites. As it would be racist to suggest that this has anythng to do with their own behavior, it was determined that the cause must be the racism of the program.
"You say I'm a dreamer. We're two of a kind. Looking for some perfect world that we both know that we'll never find." - Thompson Twins, "Hold Me Now"
August 23, 2007 2:37 PM | Reply | Permalink
I can't say that I like the idea of the government mandating that somebody seek professional counsel before making a financial decision. I mean, if we do it for a home loan, why not for buying your first commodities option?
I'm more in favor of suitability laws for mortgages. Just like with a stock investment, if somebody sells you a mortgage that is clearly unsuitable for you (and you can convince a judge and jury of that) then you should be able to sue for a lot of money.
thosethingswesay.blogspot.com
August 23, 2007 5:22 PM | Reply | Permalink
Minor side issue, at best. At worst, inane and putting the burden on the victims. People with money don't feel pressed for credit, don't feel pressed to take out more loans, and have investment advisors and lawyers who can scan the fine print. Surely it'd be easy to insist on loan agreements that don't take a CPA to locate situations in which (surprise!) you suddenly owe a lot of money rather than consumer education. It'd be a lot cheaper expenditure of public funds, more effective, and simply fairer as well.
John
http://www.haberarts.com/
August 23, 2007 5:34 PM | Reply | Permalink
The intent is good and, generally speaking, I am pro-education pretty much across the board. However, informing the public in this situation would be but a drop in the bucket. For one, a home purchase is an emotional purchase. By the time contracts are in front of a home buyer, they have already mentally unpacked, decorated, planted flowers. Even if the possibility of an unaffordable monthly payment was made plainly visible, they would find a way to rationalize the decision and go ahead (that is why they are sitting there, looking at a high-risk loan agreement in the first place).
If the goal is to prevent a repeat of this exercise, in my opinion, we need to look slightly higher up the food chain. The quality of mortgage products sold to consumers is directly proportional to the risk assumed by the lender. It is human nature - you take better care of property if you buy it than if you rent it. Lenders were not "buying" these mortgages, they were "renting" and so they didn't take good enough care of the merchandise. The Enron-style creation of wholesale value was a natural consequence of mortgage lenders spreading the risk. If regulation is in order, it would be effective to target the practice of bundling and selling mortgages as investment products. Make lenders own their products rather than rent.
August 23, 2007 5:48 PM | Reply | Permalink
I agree, just mandating that the maximum possible payment be disclosed on the front page would help more than counseling.
Pretty simple. Mandate the following clause in 16pt bold with a signature line below it:
"Your on-time monthly payment under this loan can be as much as $XX,XXX per month. Any verbal or written assurances to the contrary are false."
August 23, 2007 7:42 PM | Reply | Permalink
Yes, yes, and again yes. English doesn't have to be obtuse to be precise. My analogy would be the "Terms of Use" agreement we all tick off as having read and understood when we download and install new software. It looks like English (a bit), and probably is English (of a sort), but I doubt it would pass muster for comprehension in any introductory English class in college.
I suspect this is deliberate. And I think it deliberate in terms of mortgages and other sorts of loan agreements, as well.
aMike
August 24, 2007 4:15 AM | Reply | Permalink
We already know that mortgage brokers steer blacks and other minorities toward high-priced sub-prime mortgages more often than they do whites with the same credit scores. So the racism starts way earlier than any counseling program.
I do agree that there's something suspicious to lenders who say, "If you educate buyers about our product, they're less likely to buy, and that's bad." There will probably be a drop in sale prices (or a smaller increase as a result), but propping up bubbles really isn't a good idea anyway.
August 24, 2007 7:14 AM | Reply | Permalink
you should be able to sue for a lot of money
I think this fact emphasizes why "professional counseling" is important! When people are about to make the biggest financial committment of their life I don't see a few hours of "going through the numbers" as a bad decision. Don't "smart people" hire a building inspector too?
As I've noted here in the past, I enjoyed my "defensive driving course" and, subsequently, I understood that "how I drive" controls my "margin of safety!"
BTW: how do you expect the poor-- who get into mortgage trouble, to sue? I think that 12,000+ loan people were laid off last month and a lot of loan businesses have gone bust too!
why not for buying your first commodities option?
the husband of my mother's friend lost his savings through "stock market investments." i.e. just like people thought that homes prices could only go up, he thought that stocks could only go up.
As a financial conservative, I surprised my financial advisor a few months ago by shifting a large portion of my 401k funds into bond and income funds a few months back.
He recently sent me an email and "made up with me." ;-) i.e. While my stock funds have gone down 9%, my bond and income funds have been earning 7 to 8 percent APR.
To boldly go...
August 24, 2007 7:28 AM | Reply | Permalink
My understanding, the first time I saw this story months ago, was that the lenders themselves had orchestrated the cry of "raciscm!" and found other ways to scuttle the program. Certainly has the ring of truth, doesn't it.
August 24, 2007 7:32 AM | Reply | Permalink
My analogy would be the "Terms of Use" agreement...
each time a microsoft engineer is asked about the EULA, the employee notes that only the company's lawyers are able to interpret the EULA... so, if highly trained employees can't understand their own EULA, the "normal user" clearly can't be responsible for them. that's why I don't read them and what I'd tell a judge.
as far as I can tell, microsoft's lawyers use the EULA to enforce agreements via other lawyers and it's not clear that their EULA's would hold up in court if challenged.
the same is true with today's mortgages and credit cards and it's only time before many peopler realize that their obligations can't be met.
I doubt we'll get much regulation on this since the public pension funds, private pension funds, 401ks, endowments, etc... all depend on being able to financially rape people...
I tend to think of these things as a defacto "national sales tax" that socializes the cost of things onto the masses.
To boldly go...
August 24, 2007 8:07 AM | Reply | Permalink
if you've read chomsky, you probably remember his point that governments do things under the claim of humanitarian actions... corporations do the same thing by claiming that they are philanthropic-- even though customers foot that bill and companies write off philanthropy as a business expense.
Of course, Iraq is a prime example this because we're told that "we're over there for the good of the Iraqi people."
In general, because governments misuse good will so much, I've become more libertarian....
To boldly go...
August 24, 2007 8:18 AM | Reply | Permalink
Even if the possibility of an unaffordable monthly payment was made plainly visible, they would find a way to rationalize the decision and go ahead
to me, this is OK if they write down, in their own words, that they're buying something that's unaffordable.
that way, the buyer can't point fingers at someone else later and claim that they were tricked.
we need to look slightly higher up the food chain.
while this might sound tempting, it doesn't address the issues of option ARM's, under which buyers don't build equity, or the situation where a lost job would force bankruptcy.
if people became worried about overextending themselves, home prices would come down. homeowners, however, wouldn't like this because they'd be under negative equity and expected nesteggs would be much smaller.
however, bubbles do pop and this one might too! i.e. it's scarey to think that the NASDAQ lost 75% of it's value (I think) in 2000.
And, if you've never seen the graph of how the land values in Japan plunged (SEE GRAPH) it's quite dramatic, I promise! If that happens here, watch out!
Make lenders own their products rather than rent.
I think that they do this to get around the fractional reserve requirement. If banks couldn't sell their mortgages and debt to wallstreet then their businesses would die when they hit the fractional reserve limits.
Of course, they could offer 10% interest to attract cash into savings accounts but who would want the 15% mortgages and what would that do to home prices!
Interest rates aren't low because the banks are kind! Instead, they found a way to get cheap money! To transition to your rules, there would be a lot of pain.
To boldly go...
August 24, 2007 8:46 AM | Reply | Permalink
It's interesting that it's always the "mortgage broker" who is demonized whenever the sub-prime mortgage crisis is discussed; but no one ever mentions the misleading tv and internet ads. Mortgage bankers (who perform the same function as a broker, but funds their own loans, and then sells the loan to a mortgage company) do not have to show their borrowers how much money they make on each loan; BROKERS do. Brokers usually represent "prime" as well as "sub-prime" lenders, and can provide the best terms for which a borrower qualifies. Direct marketing lenders usually only offer sub-prime terms, regardless of the borrower's qualifications.
So, thanks all you well-meaning pudnits & bloggers, for helping to perpeutate the myth that it's the "broker" who screws over the client; sending the message that borrowers shouldn't patronize a local mortgage brokerage where they can sit face-to-face with a person (who is heavily regulated, and generally licensed by the state), to get a mortgage. Go online, call the 800 number on your screen,or respond to the latest mailer promising "you are pre-approved!!!", to get your home loan from a faceless nameless entity that doesn't have to answer to anyone about how they do business. And, God forbid that the Lenders (ie big corporations) might be to blame, in any way; it's always the Broker's fault...
August 24, 2007 10:24 AM | Reply | Permalink
I agree. that's why I think that a certified and licensed economic advisor would be a good solution. the client doesn't have to take the advice of the advisor but then the client should sign a sworn statement that they know better!
that way, the buyer cannot blame someone else for their own misunderstanding and the seller won't have to send out two messages: one that markets the house and one that tries to say no.
To boldly go...
August 24, 2007 11:11 AM | Reply | Permalink
The intent is good but the proposal is at odds with 4 decades of evidence that the secondary market in mortgages - which, by the way, was first created by government policy - has been critical to the expansion of home finance. I don't know how old you are, but in the late 1970's - early 80's, much of the home finance industry conducted business as you suggest and was nearly destroyed when interest rates rose and the industry's funding costs exceeded the interest rate on the mortgages they were holding. There would be very few institutions in existence today with balance sheets strong enough to hold a sizable portion of the mortgages they originate so it would be very disruptive. Moreover, those mortgage-backed securities are often a big part of pension funds' assets. So don't throw the baby out with the bathwater just because once every blue moon a subset of borrowers - many of whom have obtained the loans by fraudulently overstating their income, by the way - shows up in the media.
August 24, 2007 11:19 AM | Reply | Permalink
I am pretty cynical about disclosure and counseling laws as solutions for consumer problems. I don't believe consumer economic decisions are made in an economically rational manner. For example, subprime lending tends to cluster in certain neighborhoods where through word of mouth or whatever people realize that all of a sudden home financing is easy and cheap - if you "know how to fill out the forms" and, by the way, this broker "knows how to fill out the forms." "You can buy a house with no money down just like I did" and "then you can sell it at a profit and move to that new neighborhood like I did." Are you going to believe a stranger who types on a calculator and tells you that you can't, or your peers who, with your own eyes, you can see moving to a new neighborhood - especially when it's no money down, so what's the downside? It's herd behavior, just like on Wall Street.
Plus the counseling process can be coopted. The lenders/brokers will have their own and they will steer consumers to those.
I don't like incremental solutions because they're incremental but not solutions. I like big, clean, clear ones. Either a strong usury law, strong rules regarding maximum debt-to-income ratios or minimum down payments (which I know have no chance of success politically because there are too many special interest groups on both the left and the right against these) or let the real world teach its own lessons.
August 24, 2007 11:47 AM | Reply | Permalink
Plus the counseling process can be coopted.
why? make licensing and bonding requirements. the counselor would have to document why he/she concluded that the client could afford the asset.
example: when someone buys a house, someone checks to see if there are leins on the house, etc... the counselor would be doing the same thing for the buyer.
Either a strong usury law, strong rules regarding maximum debt-to-income ratios or minimum down payments
all of these have problems!
strong usury laws: that demands a "cheap supply of money." cash might flow elsewhere if the reward is bigger.
strong rules regarding maximum debt-to-income ratios: impossible because debt/income ratios change dynamically.
minimum down payments doable but doesn't mortgage insurance cover this? maybe making insurance a requirement, until 25% equity is met, might be just as effective. I think you can insure your house now to guarantee a certain resale price. by requiring insurance, you make people understand the risks they're taking in fianacial terms.
To boldly go...
August 24, 2007 1:27 PM | Reply | Permalink
57 makes a very good point. Without the ability to securitize loan pools and sell them, lenders would not be able to offer the low rates (historically speaking) on even so called "A paper" mortgages.
There is no doubt that there has been fraud, and abuse.
But...
There is also no shortage of consumers who dived in to negative amortization mortgage products knowing the risks, but ignoring the advice of their parents and grandparents who told them "If it sounds too good to be true, it probably is."
I speak from experience trying to explain to potential clients why the lender down the street has NO plans to loan them money for ANY period of time at 1.95%. Especially at a time when Fed Funds (the overnight lending rate for banks) is at 4.25%.
August 24, 2007 5:45 PM | Reply | Permalink