Strategic Default Penalties Threaten Struggling Homeowners

Minnesota Independent

 

Last week, Fannie Mae, the government-sponsored enterprise that buys up mortgage contracts from loan originators to keep the housing market liquid, announced new penalties for homeowners who strategically default.

“Defaulting borrowers who walk away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure,” the company announced, adding that the policy goes into effect this Thursday, July 1. “Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.”

The new provisions mean that if you strategically default, you likely cannot get a conforming mortgage for seven years. And if you strategically default in some areas, Fannie Mae will come after you in court.

But the Fannie Mae rule — one of several new provisions aimed at penalizing strategic defaulters — raises the possibility that the government and loan servicers might imminently begin targeting an economically vulnerable population, one characterized by housing insecurity and joblessness. It brings up the immediate concern — for both defaulting homeowners and the agencies trying to keep them paying — of how to distinguish “strategic” defaulters from those defaulting because they have no choice. And the data shows that those considering default are by most metrics in financial straits, whether solvent or not.

Consider, for instance, the situation of Charlene Mueller-Holden of Newark, Del. Mueller-Holden is a wife and the mother of two young boys, ages three and six. She lost her $60,000-a-year job as an instructional designer in January 2008. Two and a half years later she has not found a job, despite persistent searching.

“My family is slowly starting to lose the things that everyone takes for granted — a roof over our head and food on the table,” she says. “I was living the American dream. I did everything that everyone tells you to do. I had a great 401k, life insurance and five months’ [worth of] bills sitting in the bank in case of an emergency,” she notes.

The family lives in a modest three-bedroom. After Mueller-Holden exhausted her $1,200-a-month unemployment benefits and the family traded in for a cheaper car, exhausted its savings and tapped its retirement accounts, it has still had trouble keeping up on the mortgage. Her husband brings home around $1,800 a month — the family’s only source of income now. The $1,046.73 monthly mortgage payment started eating up 60 percent of the family’s income. Given food, gas and utilities — plus the cost of keeping the kids clothed and unexpected car repairs — the Mueller-Holdens became hard-up. They refinanced their mortgage under the Home Affordable Modification Plan, seeking to bring the payment down to a sustainable level. Their new payment? $1008.77 — 56 percent of their monthly income. And the balance on the mortgage increased.

“This year my husband’s overtime has been cut out and his hourly salary has been cut and now we are just grateful he has a job,” Mueller-Holden says. “We are beyond struggling. Each month I have to go through our bills to see which one might be able to wait, because we have to buy bread and peanut butter so the kids have something to eat. No more vegetables, no more fresh fruit. No new or used clothes for them this year.”

According to Mueller-Holden, it is not a question of whether the family will default on the mortgage if she does not find work, and fast. It is a question of when and how. The family’s credit score is already seriously tarnished. “I used to have an 820,” Mueller-Holden, says, referring to her FICO score. Imminent default and the six- or twelve-month period before actual foreclosure would provide some relief. No other federal program or bank refinancing initiative will. Indeed, the government itself is on the verge of penalizing strategic defaulters. The FHA Reform Act passed by the House but not yet taken up by the Senate excludes strategic defaulters from receiving Federal Housing Administration-backed loans — a provision included with bipartisan backing, including from most Republicans and Rep. Barney Frank (D-Mass.), the head of the House Financial Services Committee.

The question confronting Mueller-Holdens and the millions of other homeowners facing default is this: How will Fannie Mae and other entities going after defaulters decide what “strategic” default really is? Will they qualify? Will the government or their bank come after them, even when they are on the verge of poverty?

Certainly, over the course of the recession, strategic default has emerged as a phenomenon, with a few particularly famous cases of families pulling the plug on the mortgage and heading to Disney World. The most cited study of strategic default, from credit firm Experian and consulting firm Oliver Wyman, found that as many as 588,000 families strategically defaulted nationwide in 2008 — mostly prime and subprime borrowers in the “sand states” worst hit by declines in home values. Experian and Oliver Wyman deemed people defaulters strategic if they went from having “perfect payment histories” to stopping paying the mortgage entirely, intentionally and suddenly. (All in all, more than three million homeowners received foreclosure filings from banks that year, and banks repossessed 850,000 houses.) But a more recent study by the Federal Reserve showed that four in five strategic defaulters walked away only when deeply underwater, and generally after an “income shock,” such as job loss.

Fannie Mae did not respond to repeated requests for clarification about how hard-up homeowners will need to be before they can default without the new penalties. Thus far, none of the housing experts reached by TWI knew the definition either. The FHA Reform Act that might institute federal penalties for some defaulters instructs the Department of Housing and Urban Development to figure it out. But Mike Konczal of the Roosevelt Institute points to the strictures used by one subprime lender in the 1990s: post-mortgage income of less than $400 a month per family member.

By that standard, Fannie Mae would let homeowners like the Mueller-Holdens off of the hook. They live on just $790 a month after taxes and mortgage payments, but before utilities and all other expenses. (Additionally, they attempted to ameliorate their situation through a HAMP refinancing that ultimately proved useless, as Fannie requests hard-hit borrowers do.) But they exemplify the 5.5 million Americans currently in the foreclosure pipeline. A majority have suffered an “income shock,” like job loss. For many, their mortgage is eating up more than half of their post-tax income.

And now, they have Fannie to worry about.

Bankruptcies Up 32% To 1.4 Million On The Year

AP

RALEIGH — U.S. consumers and businesses are filing for bankruptcy at a pace that made 2009 the seventh-worst year on record, with more than 1.4 million petitions submitted, an Associated Press tally showed Monday.

The AP gathered data from the nation's 90 bankruptcy districts and found 1.43 million filings, an increase of 32% from 2008. There were 116,000 recorded bankruptcies in December, up 22% from the same month a year before.

While experts believe some of the increase is due to a natural recovery as consumers and attorneys become accustomed to a recent overhaul of bankruptcy laws, the numbers indicate clear correlations to recession-weary regions. Arizona saw the fastest increase, a jump of 77% from the year before, followed by Wyoming (60%), Nevada (59%) and California (58%).

Emile Harmon, who owns a law firm in Tempe, Ariz., said the firm has doubled its staff to handle the surge in bankruptcy filings. The lawyers have been steadily shifting away from their other areas of business, civil lawsuits and divorce cases.

"Bankruptcy is kind of swallowing the whole practice." Harmon said. "There's little time to do other stuff."

There's also no sign that things are slowing down. Harmon said bankruptcies have been coming in waves, first with those 18 months ago who had adjustable-rate mortages, then with those who lost their jobs due to the housing downturn. Now he's finding wealthy individuals and business owners who have finally succumbed to lower incomes and shrinking home values.

"A lot of the people we see were in a really good financial position two years ago," Harmon said. "People really look at you and say, 'I can't believe I'm here."'

For three years, filings have been steadily rising back toward levels reached early in the decade before Congress overhauled the nation's bankruptcy laws. The 2005 alterations made bankruptcy filings more cumbersome, a move that followed fears from lenders that some consumers were abusing the system to wipe away debts.

Bankruptcies surged to slightly more than 2 million in 2005 as consumers rushed to file before the new law took effect but then plummeted to 600,000 in 2006. They've been climbing ever since and in 2009 became the seventh-highest year on record, behind only the years 1998 and 2001-2005.

The 2005 spike had been preceded by a steady climb from 1.5 million in 2001 to 1.6 million in 2005.

John Pottow, a bankruptcy professor at the University of Michigan, said the return to the highs of earlier this decade illustrates the failures of the 2005 overhaul bill. He said the measure largely made filings more costly and time-consuming by forcing consumers to undergo a paperwork-heavy test to determine eligibility for Chapter 7 bankruptcy and adding liability for attorneys who provide help.

"It never made sense in the first place that you could change the laws and make all these bankruptcies go away," said Pottow, who would like to see the 2005 law changes repealed. "If people are encountering financial distress, you can only scare them away for so long before they come back again."

While every state saw a rise in bankruptcies, Alaska (up 12%), Nebraska (12%) and North Dakota (14%) performed best.

Banks Getting TARP Funds Not Paying It Forward
Story from the Wall Street Journal

The largest bank recipients of U.S. government aid are offering less credit to businesses and consumers, the Treasury Department said Wednesday, reflecting and exacerbating the tenuous state of the current economic environment.

In a monthly snapshot of lending by the 21 largest banks receiving Troubled Asset Relief Program funds, the Treasury said credit being offered fell 2.2% across all commercial-lending and consumer-lending categories in February, compared with the prior month.

Particularly problematic: continued deterioration in commercial real estate and general business lending, as well as the credit being made available for auto and alternative student loans.

The lone bright spot remained home loans, with consumers eager to take advantage of record-low interest rates to refinance their home, business, or church mortgages.

The Treasury said 16 of the 18 banks surveyed increased mortgage originations in February, resulting in a 35% increase in mortgage lending from January levels.

The February decline in lending adds to pressure on the Obama administration's efforts to restart the still-fragile credit markets.

The Treasury has committed $95 billion in TARP funds for new programs to boost consumer and business lending, though they are either just getting started or are still in the development phase.

The report suggests that jawboning by federal officials for banks to use TARP funds to boost lending is having a limited effect.

The Treasury blamed the decrease on the broader economic weakness, including low consumer confidence, high unemployment and a decrease in U.S. exports.

It also said lending would have been lower absent the nearly $200 billion in capital injections the government has provided to about 550 banks.

Banks' diminished appetites for lending are forcing businesses and consumers alike to curb their spending, which risks prolonging the U.S. economic recession.

Demanding New Collateral

Dan Carl, who owns a handful of businesses including several car dealerships in Michigan, said Fifth Third Bancorp, Cincinnati, refused to renew some of his company's credit lines when they came due earlier this month. On other loans, Fifth Third raised interest rates and demanded Mr. Carl's firm put up additional collateral.

The lack of affordable credit was one factor prompting Mr. Carl's company to recently lay off 20% of the work force and close at least one dealership.

Lenders such as Fifth Third are punishing "the good customers to make up for the banks' mistakes," he said.

Fifth Third received $3.45 billion through TARP.

It made $634 million of new commercial and industrial loans in February, down from $785 million in January and $1.3 billion in December, according to the bank's filing with the Treasury Department.

"Demand for Small Business credit is still relatively stable but showing signs of weakening as application volume is starting to slow," Fifth Third said in its filing.

Fifth Third's Response

Fifth Third spokeswoman Stephanie Honan said the bank won't comment on specific customers.

In reviewing loans, she said, Fifth Third considers overall economic conditions and "any changes to the customer's business environment."

Overall, she said, the bank tries "to balance our commitment to our customers with safe and responsible lending practices."

The banking industry's lending pullback was particularly severe with consumer credit.

In February, according to the Treasury report, originations of new U.S. credit-card accounts fell 2.7%.

That number likely understates the magnitude of the retrenchment. Many banks have been slashing borrowing limits on cards, especially for customers who rarely approach their limits.

By reducing the credit lines, the banks can free up space on their balance sheets. But the move risks infuriating consumers.

Bank of America Corp., which received $45 billion through TARP and has the industry's largest U.S. card portfolio, said in its submission to the Treasury that credit-card loan balances and new account originations declined in February "due to continued reduction of exposure on long term inactive customers and line reductions on high risk accounts."

Bank of America recently informed longtime customer James S. Jensen that the interest rate on his credit card would leap into the double-digits, even though he had never been late on a payment.

Canceling His Account

"I could borrow on the street for less than this," says Mr. Jensen, a 61-year-old vice president at Navistar Truck Group in Warrenville, Ill.

Mr. Jensen says he is canceling his Bank of America card as a result.

Bank of America spokeswoman Betty Riess said the Charlotte, N.C., bank is "taking a more aggressive look at accounts to control risk given the current environment."