What Really Caused the Foreclosure Crisis

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What Really Caused the Foreclosure Crisis? Asset
Funders Network Webinar November 5, 2008 Debbie
Goldstein Center for Responsible Lending
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Key drivers of foreclosure crisis

• Wall Street demanded volume
• Originators developed risky products, reckless
  underwriting, and incentives to push borrowers
  into unaffordable loans
• Policymakers didnt do enough to curb abuses

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Subprime Alt-A Market Share
Source Freddie Mac
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Wall Street Demand

• The big demand was not so much on the part of
  the borrowers as it was on the part of the
  suppliers who were giving loans which most people
  couldnt afford. We created something which was
  unsustainable. And it eventually broke. If it
  werent for securitization, the subprime loan
  market would have been very significantly less
  than it is in size. Alan Greenspan, Newsweek
  (9/2007)
• The market is paying me to do a
  no-income-verification loan more than it is
  paying me to do the full documentation loans.
  What would you do? Mortgage originator, NY Times

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Dangerous Products, Reckless Underwriting

• 2006 loan traits
• 2/3 ARMs, typical implicit payment shock gt 25
• Focus on monthly payment failure to underwrite
  based on fully indexed rate, fully amortizing
  payment
• Layered risk 50 of 2006 subprime were 80/20
  LTV with piggyback 2nd liens
• Average homeowner equity of 14, FICO 620
• 2/3 do not escrow for taxes and insurance
• 42 low or no documentation of income and/or
  assets

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Incentives Prepayment penalties and yield
spread premiums

• YSPs Incentives for steering to higher cost
  loans
• gt70 of subprime have prepay penalties only 2
  in prime
• Fail to reduce interest rate
• Trap borrowers in subprime loans
• Strip equity upon refinance
• Increase likelihood of foreclosure

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No and Low-Doc Proportions
Source Fitch Ratings, Li Ernst
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Inadequate Regulation

• Recent activity
• 1994 HOEPA
• State laws and preemption
• Limited federal regulation or enforcement
• 9/29/2006 Final Guidance on Nontraditional
  Mortgage Product Risks
• 6/27/2007 Statement on Subprime Mortgage Lending
  
• 7/14/2008 FRB Final HOEPA Rule on mortgage
  lending

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Real Change in US Housing Prices
86
-25
Sources Standard Poors SP Case-Shiller Home
Price Indices, BLS
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Aggregate Debt-to-Income on U.S. Home Loans at
Origination
Source FFIEC, HMDA Data
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Exits are Cut Off
Source McDash Analytics
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Not all home loans are equal
Brokered subprime ARM with prepay penalty 5.1
times more likely to default
Source Ding, Quercia, Ratcliffe, Li (October
2008)
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Broader context of mortgage crisis

• Crisis will eclipse Hurricane Katrina as a net
  drain on homeownership and wealth.
• In December 2006 Losing Ground study, CRL
  predicted that 1.1 million households holding
  subprime mortgages in 2005-2006 would lose their
  homes. Since that time, the numbers have
  continued to climb spurred by declining home
  values and economic instability.
• CRL now predicts that there will be 2.3M
  foreclosures annually (subprime 1.2M of these).
• Credit Suisse 6.5 million foreclosures over next
  5 years.

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Losses Spread Beyond Investors and Borrowers

• Neighboring homes to lose value 40.6 million
• Total associated depreciation 352 billion
• Avg. cost per home affected 8,667
• Avg. community cost per foreclosure 242,000

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Responding to the Crisis

• Policy interventions fall along two lines
• Helping borrowers and neighborhoods avert damage
  from foreclosures
• Adopting standards that protect future borrowers