Prof gives foreclosure testimony to Congress

Wed, September 17, 2008 |

A Valparaiso University law professor who is an expert on predatory mortgage lending and mortgage foreclosures gave testimony today, Sept. 17, to the U.S. House Committee on Financial Services on the government's response to the foreclosure crisis.

Alan White, an assistant professor in Valparaiso's School of Law, testified during the committee's hearing on "The Implementation of the HOPE for Homeowners Program and a Review of Foreclosure Mitigation Efforts."

During his testimony, White summarized his findings on mortgage modifications during the last 12 months, suggested the need for a federal role in gathering and reporting information on mortgage foreclosure and workouts, and offered observations on why mortgage servicers are not modifying mortgages more aggressively.

To address the lack of information about whether the Administration's plan to rely on voluntary industry-led measures is working, White collected data on approximately 4,300 mortgage modifications from monthly remittance reports prepared by mortgage servicers for investors.

"The first striking finding is that in 98 percent of the modifications, the principal balance is not being significantly reduced, and in about half the cases the balance is increasing," White said. "This is very troubling, given the decline in home values, and the fact that many of these homeowners already owe more than their house is worth. Even if their short-term payment problem is resolved, the long-term incentives for homeowners with negative equity are not good."

The second striking finding, White said, is that nearly half of the loan modifications did not reduce the monthly payment amount.

"These truly are short-term solutions, which may be quite appropriate for homeowners who faced temporary difficulties, but are not useful in the more common situation where the monthly payment was unaffordable from the origination of the loan," he said.

According to White's research, three types of loan modifications are commonly being used by subprime servicers. The first type – the teaser-freezer plan which converts adjustable-rate mortgages to fixed-rate, at least temporarily – appears to have been relatively uncommon. The second type of loan modification is an interest rate reduction, associated with a payment reduction, and usually with no significant change in the principal debt. White's research shows those modifications account for half of the cases.

"These interest rate concessions can produce large monthly savings, and certainly can ease homeowners' cash flow problems, while not impairing investors' return of principal," White said. "On the other hand, the average rate after reduction, for loan modifications with rate reductions, was more than 6.7 percent, and the negative equity problem remains for these families."

The third type of loan modification, accounting for about a quarter of all modifications, is a capitalization of unpaid interest arrears and reamortization of the increased principal. In this arrangement, the interest portion of missed payments gets added to the loan balance.

"These recasting agreements result in a higher principal balance, and a higher monthly payment, and leave the interest rate unchanged," White said. "In some cases, reducing the interest rate mitigates this effect, but that does not seem to be a modification package that is commonly offered."

His findings cast uncertainty on whether the current efforts to solve the foreclosure crisis are working.

"If the problems to be solved are first, excessive total mortgage debt, and second, payments that are not affordable, the first problem is almost never being solved and the second is being redressed in only about half of the modifications offered," White said.

At the same time, he noted that the loss severities on completed foreclosures have increased from about 30 percent to nearly 40 percent in the past year, meaning investors are doing worse and worse by choosing the foreclosure option.

White also testified that the number and type of modifications varies tremendously from one servicer to another. One servicer, for example, modified 2 percent of delinquent mortgages in a pool, while another servicer modified 56 percent of delinquent mortgages in one of its pools.

Though White said there is not much reliable data on how well borrowers do after their loans are modified, industry estimates on re-default rates run at about 35 to 40 percent.

"While this seems high, it means that more than half of these homeowners are able to maintain their new payments, even without any significant principal reductions, and often without even a payment reduction," he said. "It seems intuitively obvious that more generous loan restructuring would produce better success rates."

During his testimony, White also called for the Federal Reserve Board or another regulator to conduct a monthly survey of mortgage servicing that would tell the public how many delinquencies and new foreclosures there are, how many foreclosure sales were completed, how many new modification and repayment agreements were made, and other details. That information, he said, could inform future policy initiatives and stabilize capital markets by allowing investors to better gauge the extent of losses and loss mitigation efforts.

The nationalization of Fannie Mae and Freddie Mac also offers a tremendous opportunity to change servicer psychology, White said.

White is serving a three-year term as a member of the Federal Reserve Board of Governors Consumer Advisory Committee and earlier this year his paper "The Case for Banning Subprime Mortgages" ranked as the most downloaded article on the Social Science Research Network's "Law and Society" list.

About Alan White

White joined Valparaiso's law faculty last year after serving as supervising attorney for Community Legal Services Inc., which provides legal services to low-income consumers in Philadelphia. From 2000 to 2003 he served as a fellow and consultant at the National Consumer Law Center, where he wrote manuals on truth in lending, student loans and consumer bankruptcy, and presented testimony to the Federal Reserve Board on predatory mortgage lending and research on mortgage foreclosures. In 2004, he was named National Association of Consumer Advocates' Consumer Attorney of the Year. White helped produce the DVD "Defending Foreclosures, Saving Homes," featuring speakers at a March conference he organized, who presented the latest developments in foreclosure and bankruptcy, loss mitigation and mortgage servicer practices.