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Moratorium Would Be Disaster

Moody's Economy.com, FBR comment

April 12, 2007


photo of Coco Salazar

The temporary ban on subprime loan foreclosures proposed by civil rights and consumer advocacy groups would be a disaster for the mortgage market. Instead, government sponsored enterprises, the Federal Housing Administration and individual states should step in.

The Leadership Conference on Civil Rights, the National Fair Housing Alliance and the Center for Responsible Lending recently issued an announcement requesting that mortgage lenders, servicers and investors implement an immediate six-month moratorium on foreclosures resulting from "reckless and unaffordable" subprime loans.

"Exploding" hybrid adjustable-rate mortgages have been the predominant loan type marketed by subprime lenders in recent years and, along with other exotic loans, "have been a driving force in massive foreclosures occurring today," the groups said. Overall, subprime loans represent 13 percent of the overall mortgage market but account for over 60 percent of new foreclosure filings, according to the announcement.

"The subprime market has invented a new barrier: dangerous loans disguised as opportunities," said Shanna L. Smith, president and CEO of the National Fair Housing Alliance, in the written statement. "Wall Street must also take responsibility for securitizing these dangerous loans especially after scholarly reports, consumer advocates and civil rights groups warned about the lack of suitability and the harm of these exotic loans."

The moratorium on foreclosures is urgent and the six-month period will be "time for the industry to work with the groups to establish benchmarks and set long-term goals for easing the foreclosure crisis and to assist borrowers," according to the groups.

"Homeowners saddled with defective loans need relief," said Mike Calhoun, president of the Center for Responsible Lending, in the written statement. "Those responsible for these mortgages have a duty to fix the broken product they sold just like anyone else. The industry must work quickly."

But the industry is exercising all options possible and each loan needs to be addressed individually between the lender and the borrower because each is an individual transaction and situation, John M. Robbins, chairman of the Mortgage Bankers Association, responded in an announcement.

"The industry wants to take every possible step to avoid foreclosure," Robbins said. "Lenders are already using a number of tools to help financially-stretched borrowers stay in their homes, including forbearance, payment plans and various other options."

Nonetheless, "forbearance is certainly an effective tool in some cases, but it is not a sustainable long term solution," the MBA executive continued. "If we have learned one thing coming out of the Katrina and Rita disasters, it is that blanket policies rarely have the desired blanket effects."

"The current troubles in the subprime market have already begun to create a 'credit crunch' affecting consumers who are experiencing financial difficulties face difficulties qualifying to refinance into a better loan, Robbins added. "They are trapped and we are doing everything we can to help them, including looking at new products designed to help troubled borrowers," such as special "rescue products" Freddie Mac and others have recently opened doors to create.

Celia Chen, Moody's Economy.com director of housing economics, said a foreclosure moratorium would be a "drastic measure" that would "have the effect of disrupting the credit flow."

And while the impact of foreclosures would be delayed, it is unclear whether borrowers will be in a better financial situation after the moratorium, she added.

One measure that would help is empowering the Federal Housing Administration and government-sponsored enterprises to expand lending to borrowers, Chen said. Increasing their funding capabilities and less restrictive qualifying income ratios would allow some borrowers, such as those that "slightly delinquent," to refinance into new loans.

A moratorium would be "highly destructive to our entire system of mortgage finance," Michael Youngblood, portfolio manager and managing director of research for FBR Investment Management Inc., told MortgageDaily.com. The moratorium would undoubtedly lead to sharply higher mortgage interest rates, a severe rationing of credit, and would undermine existing property values.

"Our entire system of mortgage finance depends upon lenders' ability to sell or securitize the loans that they originate," Youngblood explained. "The moratorium that is being proposed would oblige every servicer to remit monthly payments of principal and interest to securities holders when they have no related cash flow coming to them for borrowers. This could, given the precarious state of many subprime lenders and servicers, defectively force them into bankruptcy."

"The proposal is impractical and potentially destructive to securitization, which is an output of mortgage lending," he continued. "An enormous financial burden is being imposed upon parties contrary to all existing practices and contractual arrangements."

"It's the equivalent of dropping a neutron bomb on our mortgage and housing markets," Youngblood said.

Youngblood additionally said the extent of the subprime problem seems to have been "greatly exaggerated." As of yearend 2006, it is estimated that subprime loans outstanding comprised $1 trillion of the total $11 trillion home mortgage market. Of the subprime share, only 10.5 percent of the loans are in default and the rate is expected to peak late this year at around 11 percent.

"The current system of mortgage finance is fully capable of handling the number of subprime loans that are currently in default and likely to be in default by yearend 2007," the researcher said.

The groups are "ignoring the horse beating the cart," Youngblood added. "If in fact the concerned parties wanted to benefit homeowners, they would turn their focus away from servicers who are already dealing with the problem of defaults, using the loss mitigation techniques that have been in place since 1996, and would petition the Fed to lower short-term interest rates. If the Fed was to reduce the fed funds rate to 1 percent all of these issues would go away."

He suggested the best solution for now was to let the mortgage finance system to work and for any states that bear the burden of a weak local economy and elevated levels of default rates to consider measures like Ohio.

At yearend 2006, Ohio had the nation's highest foreclosure inventory across all mortgages at 3.38 percent, DBRS reported. The inventory for subprime mortgages was at 11.32 percent and the delinquency rate stood at 19.6 percent.

Consequently, the Ohio Housing and Finance Authority unveiled a pilot refinance program to help borrowers who may be impacted by a loss of employment, divorce or payment shock from certain mortgages, including ARMs or interest-only loans.

The Opportunity Loan program, as it is dubbed, will provide qualifying borrowers with a 30-year fixed-rate loan. The program also offers a 20-year fixed second-lien mortgage of up to 4 percent of the appraised home value to assist with closing costs and other charges such as, first mortgage payoff, including late fees or attorney fees, according to the finance authority's Web site.

"It seems to me that the state of Ohio is taking the lead in the measure to provide relief to its citizens," Youngblood said. Measures like Ohio's "supplements the system of housing finance. It focuses on the areas where the need is greatest and it avoids any permanent damage on our very successful system of mortgage finance."

Coco Salazar is an associate editor and staff writer for MortgageDaily.com.

e-mail: [email protected]

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