#157 Spring 2009 — Foreclosure Crisis

The Continued Importance of Fair Lending in the Age of Obama

Housing discrimination continues to plague the market, as does the myth that the housing crisis resulted from extending homeownership and home mortgage credit to historically underserved groups: minority families. Even with the Obama administration's Homeowner Affordability and Stability Plan and, within that, the Making Home Affordable program, minority groups continue to suffer ongoing discrimination and fair housing violations.

Home Mortgage Policies Under Obama

Looking at the Homeowner Affordability and Stability Plan, and within that, the Making Home Affordable program, we see $200 billion of additional support to Fannie Mae and Freddie Mac to enable a healthy level of activity in their secondary market operations and to keep the flow of home mortgage credit going for new home purchases and refinances. It also includes a $75 billion loan modification program and a refinancing program for homeowners underwater; both programs are voluntary. The loan modification program is expected to assist four million homeowners, and the refinancing program some five million homeowners. Furthermore, judicial modifications of mortgages might be possible through bankruptcy courts if the legislation to change the bankruptcy law passes.

The 2010 budget proposed by the administration has increased funding for the U.S. Department of Housing and Urban Development to combat home mortgage fraud and predatory practices, and for fair housing enforcement. However, these are fairly modest proposals.

In addition, mammoth interventions by the government in the financial sector are expected to keep borrowing costs low, including mortgage interest rates. Under the financial rescue plan (or TARP), certain real estate mortgage-backed securities will be bought, and the government also plans to help private investors buy these toxic assets (now known in this administration as “legacy assets”).

A series of “shock and awe” measures from the Federal Reserve Board, such as its decision to purchase long-term U.S. Treasuries bonds (for the first time in more than 40 years), are also expected to bolster the flow of credit in the economy and keep borrowing costs low. Such measures will indirectly help some homeowners to refinance to more affordable rates and also encourage new home buying.

A main drawback of the Obama housing plan is that it’s a one-size-fits-all approach and does not get to the heart of the reasons why a homeowner might be in foreclosure. While it acknowledges “dishonest lenders who acted irresponsibly,” and lenders who distorted facts, the plan does not show any special accommodation to homeowners who were victims of fraudulent lending practices, such as those whose homes were overvaluated by appraisers whose interests were closely aligned to those of the lender or broker. In these cases, a sound housing plan would take these homes’ principal values and automatically reset them to reflect the correct market value at the time of the home purchase. Subsequently, the current refinancing program parameter of 105 percent of current market value may be applied. (Under the refinancing program, homeowners can refinance if their outstanding mortgage debt is no more than 105 percent of the current of the home).

In addition, the Obama housing plan makes no mention of anti-fraud prosecutions against lenders, brokers and servicers, and it should. Vigorous anti-fraud prosecution and seeking compensatory and punitive damages from the offending parties needs to be an important part of a sound housing plan. While such prosecutions can be launched at the state level by state attorneys general, the federal plan needs to forcefully stipulate that this is one strategy for providing relief to homeowners in distress. A federal program could help provide immediate relief to the victims of fraud, while the court cases are pending.

The Obama housing plan does not offer any guidelines to specifically help lower income families and families who were victims of lending discrimination. In the absence of such guidelines, it’s reasonable to expect that a good deal of “creaming” will occur following the program’s implementation, i.e., increased eligibility for loan modifications for better-off homeowners, because the program parameters favor higher income families. It is obvious that the 31 percent standard for the loan modification part of the housing plan (lenders will receive a subsidy if they can bring down the monthly payments to that level) can be more easily achieved for higher income homeowners; hence, they might be the ones who receive the most workouts under the plan. Also, homeowners who are only modestly underwater or not yet underwater will be helped by the refinancing provision, and not those whose home values have fallen far below the value of their mortgage. Only loans backed by Fannie Mae and Freddie Mac are eligible for refinancing under the Obama plan and this will leave out most of the subprime loans affected by plunging home values.

The housing plan lacks progressivity in the subsidy it offers, and only its full implementation will reveal how regressive it might turn out to be.

The Kirwan Institute’s john powell has suggested using a policy of targeted universalism in public policy; that is, even as programs are specified in universal terms, there should be a targeting of each program that takes into account the “differential situatedness” of groups in American society. In the case of a government rescue plan for homeowners at risk of foreclosure, a strong case can be made for targeting victims of abusive lending practices because these practices contributed to the mortgage delinquencies in the first place. The negligence of Congress to enact new legislation and of government agencies to enforce existing regulations to curb abusive and irresponsible lending over the past 10 years is palpable. This provides another rationale for targeting the housing rescue plan to victims of abusive lending practices.

It will be important for the government to track the flow of TARP funds and any new credit creation to minority neighborhoods and to other historically underserved groups. At the time of this writing, there has yet to be an announcement from the administration of a plan to engage in such tracking. Housing policy and civil rights advocates must demand this. Surprisingly little is known about the uses that the TARP funds have been put to. It is not clear how much of the funds have been applied for, creating new credit flows and in which sectors. We don’t know if the financial institutions receiving the monies from the government will agree to track actual households (by minority status) and regions that these funds will flow to. The Kirwan Institute has provided a model for tracking the flow of the economic stimulus funds to communities of color. Tracking households and neighborhoods can be done using GIS mapping techniques.

According to a range of experts, including professionals who work in the field with home mortgage-seekers, the flow of mortgage credit has slowed down in recent months, and new lending is largely available only to borrowers with unblemished credit, those who make a sizeable down payment, and those with steady income. Professionals from the field also report that minority households and minority neighborhoods are the hardest hit when they seek home mortgage loans because they encounter a presumption of being risky borrowers. In other words, we may already be seeing a return to the old-fashioned lending discrimination in the form of outright denial of loan applications for equally qualified minority applicants.

The current housing and economic crisis has occurred because abusive lending practices were allowed in home mortgage markets. When the victims of these practices were predominantly minority families, Congress failed to curb these abusive practices about which it had received detailed testimony on multiple occasions. The federal regulations during this period had intervened to prevent states from enforcing their own consumer protection laws that would have prevented some of the abusive lending. Now the problems have spilled over to non-minority communities, as well as into the prime lending sector. Dr. Martin Luther King, Jr. said that the quality of justice is indivisible and “injustice anywhere is a threat to justice everywhere.” These words ring so true in the present context. The unjust lending practices could not be restricted to certain segments — they are in all sectors, and pose a threat to justice everywhere.

Moving forward, we have to work to prevent market misbehavior even if we feel that it can be contained within a particular segment of the market. The rest of America must not look the other way, when credit card companies, mortgage brokers and lenders, and other actors are fleecing particular consumers in the financial system. Recent history has taught us that such misbehavior, when proven to be highly profitable, eventually finds its way to other segments of consumers as well, and becomes a threat to everyone.

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