Whose Fault is the Foreclosure Mess Anyway? Part II

In 1953 my grandmother went through a divorce at a time when very few people living in middle America got divorces.  Abandoned by her husband at about thirty years of age, she and her three young children (all under the age of 10) moved back to the tiny town of Parsons, Kansas, where her parents and siblings lived.  My grandmother moved in with her mother and father and got a job in town which barely covered the expenses for herself and and her children.  After a short time, she realized that she needed a loan from the local bank in order to make ends meet.

My grandmother did not have credit or any collateral, but she hoped that her family's long-time presence in the community would help her in securing the small loan she needed.  When she talked to the banker, she told him that her father would be willing to co-sign for her for the loan.  The banker's only question was, "Who is your father?"

"Harlan Stringer," replied my grandmother.

"In that case, I don't need a co-signer," replied the banker.  "I know your father.  If you don't pay this money back, he will, whether he co-signed for it or not."  She left the bank with the money, which she did pay back in full from her meager wages.

My great-grandparents were fairly typical of Depression-era families.  They never had any extra money, but they raised a garden and a cow which allowed them to feed their own six children plus six extra children from town every night.  (Each of their children had instructions to bring home one classmate from school each night for dinner, but to rotate the children so that all of the classmates could come out to the farm and eat.  Children who lived in town often went hungry, so it was important that the invitations be extended to everyone since the Stringers raised their own food so they always had plenty to eat.)  My great-grandfather eventually went to work for the railroad, and after he retired he stayed home and kept the garden, raised and sold chickens and fished.  At that point, my great-grandmother got a job in town where she worked until well into her seventies.

They had no expectation of wealth--no concept of winning the lottery or some contest that would bring a windfall into their lives.  They expected to work for whatever they received and to pay for whatever they owned.  They did not borrow money carelessly, because their sense of honor required that debts had to be paid--even if the debt were for an adult child who had borrowed the money because of a personal crisis but could not afford to repay the loan. 

We hear a lot of comparisons today between our present day crisis, "The Great Recession," and the "The Great Depression" but I really don't think that it is fair to compare our society with the generation from 70 years ago who weathered that storm.  The Depression-era generation was not as sophisticated as we are today and not nearly as well educated or well traveled, but they had a sense of values that our generation cannot begin to understand.

Yesterday, I said that I thought there were two seldom mentioned culprits in the foreclosure mess, and that Culprit A had helped to create Culprit B.  Culprit A, in my opinion, is the Making Home Affordable Program and all of the companion programs that play on homeowners' desires and needs and encourage them to apply for modifications they will not get.  But Culprit B is the borrowers themselves and the  "I am entitled to something for nothing" mindset that touches every facet of our society today.  No discussion of the foreclosure problem is complete without acknowledging that a big part of the problem is individuals who refuse to take responsibility for their actions.

As we listen to the media coverage of the furor over foreclosures, we hear a lot about how banks may not have fully reviewed the documents, or how the MERS system allows lenders to transfer deeds without re-recording them, but we hear very little about the fact that the average foreclosure is taking over 460 days to consummate.  We hear a lot about declining values as a reason for borrowers to practice strategic default and allow a house to be sold on a short sale, but we do not hear much about the fact that the same borrower was making the payment on the house and living in it before the home devalued.  If we discount arm resets (which can be a serious problem for homeowners who can no longer make the new higher payment), what can possibly be a good justification for stopping making a house payment just because the home devalued?  If the payment has not adjusted and there is no loss of employment or drop in income, then the borrower is making the same payment that he always was on the same house he had been living in prior to the market crash.  The equity will return at some point. 

The reason that loan modifications have been able to take advantage of so many people and put so many Americans in a position to lose their homes is that as a society, we want to be taken advantage of.  We want to believe that we should have our payment modified, we should have the principal balance we owed on the house reduced, and we really are entitled to the lowest possible interest rate whether we actually qualify for it or not.  If "life is not blowing us kisses" then we need to find someone to blame and hold responsible.  We can always hire an attorney to tell a judge that we did not understand what we were signing, or that we were tricked or misled.  And if all of that fails, we have the option of living in our home for over a year without making a house payment until the bank can finally sell it.  And we feel righteous in doing so, because after all, it is not our fault that we signed a note for something we could not afford in the first place.

Today, we do not have a point of reference for a man who valued his word so much that he would pay a bill he clearly did not owe for his daughter, particularly when paying that debt he had not signed for would have worked a genuine financial hardship on him. But his attitudes about money and personal integrity obviously influenced his own family.  My grandmother, who today is 89 years old, understood that no magician was going to come along and fix all of her problems.  In a couple of years, she met and married my mother's step father, who was in the army. She saved money carefully, and when he got out of the military they paid cash for their first home in the Kansas countryside.  After they got too old to live there, they bought a house in town which they also paid cash for. She and her new husband never made much money, but through an extremely thrifty lifestyle, she saved enough money to be comfortably self-sufficient in her old age. Her funeral arrangements are fully paid for so that even in death she will not leave behind any unpaid bills.

As a society, we will get out of "The Great Recession".  This round of foreclosures will finish and the homes will be resold.  New laws will tighten credit standards for quite a while, although experience teaches that credit standards are often cyclical and over time will tend to loosen up again.  But for our country to avoid another problem like the one we are in today, we need more than new regulations or financial reform bills, or reviews of foreclosures.  We need a return to personal integrity as individuals that demands that we repay  what we borrow, and that we borrow only what we are able to repay.

                                                                   
   

Whose Fault is the Foreclosure Mess Anyway?

After a week of spreading moratoriums on foreclosures throughout the country, and calls by Nancy Pelosi and Barney Frank to have a federal moratorium on foreclosures, we see common sense and reality beginning to weigh in on this issue.  According to the Washington Post,  federal regulators today urged lenders to get to work reviewing paperwork on foreclosures, to file new documents if the documents that are part of their current files are found to be in error, and to continue with foreclosures as quickly as possible if no problems are found.  This is an unusually practical approach for the federal government to be taking, and it is  absolutely necessary to prevent a complete crash of the real estate financing system.

I promised in last week's post that we would take a look at who is really responsible for the foreclosure mess.  Obviously, a complete list would take a long time to compile.  Poorly underwritten lending products are one culprit.  Joblessness is another--without employment, Americans cannot make their mortgage payments.  And as long as unemployment hovers just under 10% we are going to see continuing problems with foreclosures. 

However, I believe that there are two other contributors to the foreclosure problem we have today who receive much less publicity.  In fact, I believe that contributor A helped create contributor B.  And that is what I want to talk about today.

What is contributor A?  The Making Home Affordable Program and the entire system of loan modifications as proposed by the Obama administration has exacerbated the foreclosure problem by 1. encouraging Americans to believe that they may be entitled to a lower payment, 2. by misrepresenting what modification means in real terms, 3. by putting homeowners in jeopardy of losing their homes if they do not complete the process, which many fail to do.

Consider this: a Huffington Post article entitled Extend and Pretend: The Obama Administration's Failed Foreclosure Program, posted 08/4/2010, took an in-depth look at HAMP.  The stated goal of HAMP according to a speech made by the President in February of 2009 and quoted in the Huffington Post article, was to "enable as many as three to four million homeowners to modify the terms of their mortgages to avoid foreclosure."   As of August 4, 2010,  approximately 1.2  million homeowners had applied for loan modifications under the Making Home Affordable Program, but  only about 400,000 people received a permanent modification.  About 529,000 people were denied and the rest were still waiting for an answer.

So what does a program that is designed to reduce monthly payments and help homeowners stay in their homes have to do with the current foreclosure crisis?  Plenty.  For one thing, homeowners who applied for the Making Home Affordable Program were put on a trial modification which temporarily reduced their payments while the loan servicer determined whether they qualified to receive a permanent modification.  The purpose of the modification was to reduce the mortgage payment to 31% of the home owner's income to make it easier for the homeowner to stay in the house.  The problem was ( and is) that home owner's have to be able to document income and assets and to qualify for the relief offered under the program.  And even though the qualification process is supposed to take three months, for many borrowers it drags on and on. The Huffington Post article tells the story of Bea and Terry Garwood who applied to Chase for relief under the HAMP program in April of 2009 and had their mortgage payment reduced during the HAMP trial.  However, after almost a year of waiting, they were told this past March that they did not qualify for modification after all and they were being kicked out of the program.  At that point, they owed Chase $12,000--the difference in the payment they had been making and the actual payment on the house.  Borrowers kicked out of the HAMP program also owe the servicer late fees in addition to the principal and interest that has been deferred during the trial modification.

A borrower who is struggling making his or her payments might continue to struggle to do so while looking for a job or trying to cut expenses.  But a homeowner who has been lured into HAMP and then rejected from the program generally cannot come up with thousands of dollars additional in order to bring the note current after paying a reduced payment every month in the form of a trial modification.  So a program that is supposed to save homeowners from foreclosure by reducing their payments actually endangers their homes if they do not qualify for a permanent modification.

But HAMP also puts borrowers in a position where they ultimately owe more than they did when  they started.  Since HAMP does not reduce principal--it just lowers the payment,for five years--the borrower still owes the full amount of the mortgage, but he will owe that mortgage over a longer period of time, and with home prices continuing to decline, even borrowers who successfully complete HAMP trial modifications may conclude that continuing to make the house payment on a property that is depreciating just is not worth it.  Some statistics show that as many as 70% of borrowers who receive a HAMP modification will end up in foreclosure anyway because they cannot afford the mortgage payment.

As far as I know there are no studies directly linking HAMP modifications to foreclosures.  However, the Huffington Post did have some interesting statistics:  Since the implementation of HAMP,  1.2 million homeowners have applied for the program, 389,000 have been approved, and banks have foreclosed on nearly 1.1 million borrowers (almost three times the number of those receiving permanent modifications.)

The point of the Huffington Post article is that HAMP, while unsuccessful, was necessary to delay foreclosures so that housing prices could rise.   But it is my belief that many of those who are losing their homes today might not be doing so at all if HAMP had not been introduced.  If HAMP were a private initiative rather than a government-based one, it would now be decried as the worst form of predatory lending--a program which offered false hope to struggling homeowners while burdening them with debt they could not pay and then resulting in the loss of their homes.

As the U.S. now faces the foreclosure crisis head on, we need to begin to take a long hard look at the long- term consequences of our actions.  Today's encouragement from regulators to proceed with processing foreclosures is one major step in the right direction.  We need to stop delaying the inevitable and start dealing with reality.  And we need to stop promising homeowners help that we know is not coming.  For many of these homeowners, the only way they can actually Make Home Affordable is to move out and get into a new place that they can actually afford.