Empire Justice Center and the Subprime Mortgage Crisis

December 1, 2007

Author(s):  Barbara van Kerhove & Warren Wightman

Empire Justice Center has been at the forefront of local and statewide advocacy efforts to address the current subprime and non-traditional mortgage lending foreclosure crisis.  We have been working locally with the Greater Rochester Community Reinvestment Coalition (GRCRC)1 and the City of Rochester’s Foreclosure Task Force to determine the extent of foreclosures in Rochester and Monroe County and to develop options for homeowners at risk of foreclosure. We also represent clients with predatory loans and/or who are at risk of foreclosure.

Empire Justice Center, GRCRC and several GRCRC members belong to New Yorkers for Responsible Lending (NYRL), a state-wide coalition of more than 130 member organizations that promotes access to fair and affordable financial services and the preservation of assets for New Yorkers and their communities. Empire Justice and NYRL have asked the Governor to include funding in his executive budget to address foreclosures in New York State.  In addition, Empire Justice has testified at several public hearings and forums on the current crisis and has recommended actions for addressing it and for preventing it from recurring in the future.

This article summarizes our testimony and recommendations.2

Empire Justice Center convenes the Greater Rochester Community Reinvestment Coalition (GRCRC), consisting of over 30 organizations and individuals working to improve lending, investments and services to lower income and minority families and communities in the Rochester area.  Since it was established in 1993, the Coalition, along with Empire Justice Center, has released nine analyses of lending data on home mortgage and small business loans made public in compliance with the Home Mortgage Disclosure Act (HMDA) and the Community Reinvestment Act (CRA).  We have used the analyses to identify strengths and weaknesses in lending patterns and to generate ongoing discussion with the banks whose data we study.3

The Current Foreclosure Crisis

Home mortgage foreclosures are on the rise in New York State.  According to Realtytrac.com, 72,339 foreclosures have been filed in New York between January and August 2007.4  Nationally, since mid-2007 over 800,000 homeowners have entered foreclosure.5  The most recent RealtyTrac data shows that in New York State, four of the top 5 metro areas saw increases of 50 percent or more in the number of properties in foreclosure when compared to the third quarter of 2006.6 (See Table 1 for details).

How do we get a better handle on the extent of the current “mortgage mess” in New York communities?  Currently, the only way to determine the extent of subprime and non-traditional lending in our communities is through the publicly available HMDA mortgage lending data which includes information that lets us identify “high cost loans.”

The term “high cost loan” refers to a loan with an APR (annual percentage rate) exceeding a certain threshold when compared to the interest rate on a U.S. Treasury Security of the same maturity.  For first lien loans the threshold is 3 percent above Treasury rate; for subordinate lien loans the threshold is 5 percent above Treasury rate.  A 10 year first lien loan which is 3 percent higher than the yield of a 10 year US Treasury bill would therefore be shown in the HMDA data as a high cost loan.

It should be noted that these “high cost” loans do not comprise the entire universe of all subprime loans.  High cost loans, as defined here and captured in the publicly available HMDA data, make up only a subset of loans considered to be subprime or “non-traditional” home loans.  The broader category of loans that are potentially unaffordable, and which are causing the current foreclosure crisis, is much larger than is reflected in the HMDA data.

“Non-traditional” home loans, also called “exotic” loans, are those that break with long-standing practices in the lending markets by relaxing eligibility requirements, sometimes drastically.  Examples are mortgages that require no down payment, no proof of income, no loan-to-asset ratio restrictions, no payments on principal, and even “negative amortization” loans for which the principal balance increases over a substantial part of the loan’s term.

What can be gained, then, by looking at the high cost loans found in the HMDA data?  They are the best estimate we have of broader subprime and non-traditional lending trends, particularly in small geographies and in categories identified by borrower characteristics.  And, as we have been reading in the news over the past 10 months, it is in the subprime and non-traditional lending markets where the “mortgage meltdown” and the bulk of foreclosures is occurring.

According to a recent report in the Wall Street Journal, in 2006 there were more than 142,000 high cost loans made in New York State - 28 percent of all mortgages. Of the metropolitan areas examined, Nassau-Suffolk had the highest percentage - 30 percent.  This was followed by the New York-Wayne (NJ)-White Plains area and Glens Falls with 28 percent.7  (See Table 2 for high cost loans in New York Metropolitan Areas.)

In addition, over 80 subprime lenders have either filed for bankruptcy, been acquired, closed their doors, or have stopped making loans.8  Homeowners with loans from these lenders, and who are at risk of foreclosure, will find it much more difficult to work something out with lenders who are themselves in trouble.  And this is exactly the sector where more defaults are likely to occur - loans from subprime lenders.

Using the Budget to Keep New Yorkers Out of Foreclosure

Building on and Existing Model that Works

Across the state there exists a network of housing default counselors and legal services attorneys that already work with homeowners at risk of foreclosure.

By working with the homeowner, the lender and, in more difficult cases with a legal services or private attorney, these housing counselors have a successful history of helping borrowers regain control of their household finances, maintain their property and help stave off the decline of local neighborhoods.

After intense one-on-one financial analysis and counseling, a successful home rescue allows the housing default counselor to provide one of the following three services:

1. Direct negotiation with the lender to seek a reasonable and affordable solution to allow the borrower to stay in his or her home
2. Referral of the borrower to a consumer attorney when the affordable solution is not one the lender is willing to provide, or when the borrower needs legal intervention
3. Referral of the borrower to a refinance program when options 1 and 2 are not feasible.

This model has been proven to work in communities across the state.  For example, Rochester and Monroe County have a very successful foreclosure prevention program at The Housing Council. In 2006, of the 608 defaulting borrowers who received counseling, 90 percent were successful in avoiding foreclosure.

Despite the fact that mortgage foreclosure filings increased in Monroe County between 2004 and 2006, foreclosure sales continued to decline, a decline that goes back to 2002.  We believe that this consistent decrease in the number of foreclosure sales in Monroe County is due to the counseling provided homeowners at The Housing Council - backed up by legal assistance such as that provided by Empire Justice.

A program like The Housing Council’s could be enhanced and replicated throughout New York with appropriate funding and products.  Our first recommendation to the Governor, therefore, was to:

1. Fund Housing Counseling and Education. Provide $5 million in funding to the New York State Banking Department for distribution to:

• HUD-approved housing counseling agencies with demonstrated capacity to deliver post-purchase, foreclosure prevention counseling
• Legal services attorneys
• Not-for-profit organizations that provide foreclosure preventive outreach and education

Governor Spitzer and Attorney General Cuomo should be commended for their recent decision to provide $2 million in funds to match private grants to not-for-profit counselors and civil legal services organizations that provide counseling and legal assistance to homeowners facing delinquency and foreclosure.  This money will help build on an existing model that is already working in New York State.

We urged the Governor to get this program off the ground as soon as possible using the guidelines described above and to encourage banks, community foundations and other grant-making entities to make private funds available to the counseling agencies.

We also asked the Governor to increase the funding so that the total available is at least $5 million.

Helping Other Agencies Work with Homeowners

While there are several counseling agencies in New York State with the demonstrated capacity to provide foreclosure prevention counseling and legal assistance, our work on Rochester’s Foreclosure Task Force suggests there are several areas in New York State where homeowners in default and foreclosure will not be able to find the quality assistance they need.  Therefore, our second recommendation was to:

2. Fund Training and Technical Assistance for Foreclosure Prevention and Legal Assistance. Provide $2 million in funding to non-profit housing counseling agencies and civil legal services providers.  Training in best practices and effective techniques in combination with direct individual assistance with difficult cases will result in dramatically more efficient advocacy on behalf of homeowners.

This funding will also help to keep advocates up to date on changes in the law, industry practices and new opportunities for homeowners at risk of losing their homes. The Division of Housing and Community Renewal should develop an RFP process to ensure that the organizations providing the training and individual technical assistance have demonstrated success in working with, and representing, clients in default or foreclosure, and/or dealing with the problems caused by predatory loan practices.

Helping Homeowners Who Are Not Eligible for Existing Assistance Programs

When default counseling and legal assistance is not sufficient to help borrowers keep their homes because lenders are not willing to negotiate affordable mortgage payments, because the loans do not have illegal terms a lawyer can litigate, or because the homeowners are not eligible for other loan assistance, such as the SONYMA “Keep the Dream” program or Treasury Secretary Paulson’s “Hope Now Alliance” plan, the borrowers must have other options that will allow refinancing out of the unaffordable loans. We asked the Governor to provide such an option by including in the budget a:

3. State Foreclosure Fund. Provide $100 million to establish a foreclosure remediation fund to assist individuals facing foreclosure who are not eligible for public or private loan assistance. The fund would be implemented using sound eligibility criteria, and serve individuals who received an unaffordable loan on their primary residence and now face foreclosure.

Understanding Foreclosures

The current foreclosure crisis makes it clear that New Yorkers, the New York State Banking Department and the Attorney General need a better understanding of the extent of foreclosures in communities across the state. In New York, foreclosure data are currently available only at the county level, and for most counties are not available online. One must either purchase the data from private vendors, or undergo laborious data collection at county clerks’ offices. There is no state repository for this data, which should be gathered and made available for analysis and use by state officials and the public. Therefore, we urged the Governor to include in the budget:

Funding for Foreclosure Data Collection. Require the Banking Department to collect foreclosure data from counties throughout the state, create a public repository for this data, and adequately fund this process.  This will help the Banking Department and Attorney General identify communities and mortgage originators that are disproportionately represented in the foreclosure data and act swiftly to address the problems.

Preventing New Predatory Practices and Future Foreclosure Crises

The recommendations outlined above will help stem the current foreclosure crisis, but action is needed to address the new crop of subprime and nontraditional home loan products and new abuses that continue to develop. The loans we are seeing today, and the foreclosure crisis before us, are the result of these new exotic products, coupled with a very hard sell of subprime and nontraditional loans not only to low- and moderate-income Americans but to middle-income Americans as well.

The successful anti-predatory lending law New York passed in 2002 needs to be updated. Therefore, we continue to urge the New York State Legislature to:

PASS THE NEW YORK STATE RESPONSIBLE LENDING ACT OF 2007.  (A.8972A)

To combat this new wave of lending, we need to enact the New York State Responsible Lending Act of 2007 (“Responsible Lending Act”) into law.  This legislation will do several things:

First, the Responsible Lending Act will mandate that lenders make loans that people can afford. Lenders will be required to verify borrowers’ income. Responsible lenders do this without question.  This requirement is not only for the sake of homeowners, but is also a matter for the market. It will help to level the playing field for the benefit of the ethical lenders who should be doing the lending.

Secondly, the Responsible Lending Act will get rid of practices in the subprime and nontraditional loan market which allow brokers and lenders to make it appear to the borrower that their loan is affordable when in fact, it is not.

One ploy to create the façade of affordability is failing to escrow for property taxes and insurance.  Borrowers are deceived by being shown a monthly payment that appears lower than their current payment, but which does not contain an escrow for taxes and insurance.

Another tactic is to schedule balloon payments in the future which make the monthly payments lower than if the loan was amortized regularly over the 30 year loan term.  One adjustable rate mortgage Empire Justice recently reviewed had the borrower making $3,000 to $5,000 in monthly payments on a $487,000 loan.  However, at the end of the 30 year term, the borrower would still owe $325,000!

The Responsible Lending Act also addresses a third scheme, loans that negatively amortize – meaning that the principal balance actually increases over time. The payment the borrower is required to make is less than a fully amortized payment of principal and interest, causing the loan to increase over time and costing the borrower considerably more in interest while gaining no equity in the home.

Finally, and probably most important, the Responsible Lending Act provides consumers with basic protections so that mortgage brokers will be working in their best interests.  Mortgage brokers can be helpful to borrowers, assisting them in working through the process to obtain  loans that meet their needs. The majority of mortgage brokers in our state probably do operate under this principle simply because of their business and personal integrity. Unfortunately it is apparent that a significant number of unscrupulous brokers act primarily in their personal interests and have no qualms about taking advantage of their clients. Most brokers are compensated in ways that incentivize them to push clients into costlier loans—both in terms of loan size and interest rates. Again, it is a matter of leveling the playing field so that the honest brokers who do try to assist homeowners can thrive.

Federal Preemption of state laws governing lending

The courts have determined that federal laws and regulations override state laws governing nationally chartered banks, and even the subsidiaries of national banks that are located in another state. So, why should New York pass a law that could be preempted? Empire Justice Center has been very much involved in the formulation of the Responsible Lending Act. We believe a New York statute would significantly impact subprime and nontraditional home mortgage lending.

First, the Responsible Lending Act would in fact apply to most subprime and nontraditional home loans—such as those made through mortgage brokers and independent mortgage bankers. Secondly, although following the preemption ruling of the Office of the Comptroller of the Currency (OCC) in 2003, Banking Law 6-L did not technically apply to nationally chartered banks, the law still affected the lending practices of these banks. We did not see a split in some banks making those loans while others could not.  We believe this was because no bank wanted to be seen as violating the spirit of a law that regulated the most egregious practices within the industry. We anticipate the 2007 Responsible Lending Act to similarly raise the bar for lending practices across the board.  

End Notes

1.  See below for more information on GRCRC.
2.  Complete versions of the testimony can be found on the Empire Justice Center website at:  http://www.empirejustice.org/policy-advocacy/testimony/
3.  The HMDA and CRA small business lending data for each previous calendar year is publicly available from the Federal Financial Institutions Council under the aegis of the Federal Reserve Board.
4.  http://www.realtytrac.com
5.  http://www.nytimes.com
6.  http://www.realtytrac.com
7.  http://online.wsj.com/article/SB119205925519455321.html
8.  http://online.wsj.com/public/resources/documents/info-subprimeloans0706-sort.html

Supporting Documents: