The
Social Toll Of The US
Home Mortgage Crisis
Part 1
By Andre Damon
31 August, 2007
WSWS.org
The following is the first in a two-part series.
Home
foreclosures in the US have reached near-epidemic scope and scale. In
Detroit, there was one foreclosure filing for every 97 households in
July alone, according to RealtyTrac.com, the largest database of foreclosed
properties. Michigan, Georgia and California each saw about one foreclosure
action per 300 households in only the last month, while Nevada continued
to hold the top statewide foreclosure rate of one per 200 households
during the same period.
If trends seen during the
first six months of 2007 continue, cities like Detroit, Las Vegas and
Riverside/San Bernardino, Stockton and Sacramento in California will
see one foreclosure action per 15 households this year. Nationwide in
2006 there were 1.26 million foreclosure filings—including default
notices, auction sale notices and bank repossessions—and RealtyTrac
expects over 2 million in 2007.
The rapid rise in foreclosures
was triggered by a slowdown in the growth of housing prices—deflation
of the bubble that had been growing for 12 years and ballooned from
2001 through 2005. Although fluctuations in the housing market are difficult
to track, a recent Standard & Poor’s/Case-Shiller survey of
20 cities found that single-family home prices fell by 2.8 percent from
May 2006 through May 2007.
According to the index, May
marked the fifth consecutive month of falling prices following 13 months
of slowing price growth. “At a national level, declines in home
price returns are showing no signs of a slowdown or turnaround,”
Robert Shiller, an economist connected with the survey, told the Associated
Press. The same is true of foreclosure rates, which increased by 9 percent
from June to July and by 93 percent over the same period, according
to figures from RealtyTrac.com.
The recent bout of foreclosures
precipitated a credit crisis throughout the US and international economy
as investors dumped securities possibly exposed to bad mortgage debt
in mid-August. In an effort to prevent a panic, the Federal Reserve
moved to provide cheap credit to banks against a broad range of collateral.
However, the longer-term financial impact of the housing crisis, not
to mention the recessionary implications of a systemic downturn in the
housing market, remains to be seen.
A foreclosure occurs when
a borrower is consistently delinquent in paying his or her mortgage.
A default notice is sent out, and, if the borrower is unable to sell
the property, refinance his loan, or resume regular payments within
an allotted timeframe, the lender repossesses the property, along with
any equity the borrower may have in it.
In theory, foreclosure should
be an absolute last resort, because the borrower loses his or her entire
stake in the property, not to mention the disastrous effects on the
borrower’s credit ratings. In a period of rising home prices it
is both possible and desirable to avoid foreclosure by selling or refinancing.
When home prices fall, however, it is more difficult to avoid foreclosure.
If a house decreases in value by more than the value of the homeowner’s
equity, the borrower will be left to pay the difference if he or she
wishes to sell or refinance. In such a case, foreclosure may be the
only way out for a borrower who cannot afford the monthly payments and
does not have sufficient savings to cover the cost of refinancing.
One would expect a decrease
in home prices, as seen this year, to bring with it some rise in foreclosures.
The current foreclosure rate, however, is unexpectedly large, given
the relatively small decline in prices. Furthermore, foreclosure rates
increased sharply in 2005, correlating roughly with the beginning of
the home price growth downturn, not with the actual downturn of prices,
which started around of the beginning of 2007.
The high foreclosure rate
must be understood in terms of both short-term and long-term trends.
In the first place, the stage of the housing boom lasting from 2001
to 2005, which saw a 20-30 percent increase in real housing prices,
also saw a massive increase in speculation, predatory lending and outright
fraud, which led to large numbers of people taking out unaffordable
mortgages.
Speculation and fraud
From 2001 to 2005, lenders
loosened their standards and gave every incentive for mortgage brokers
to prioritize the quantity of money loaned out over borrowers’
ability to pay it back. This not only gave an impetus to the growth
of the sub-prime mortgage sector, but also led to the proliferation
of “exotic” (i.e., speculative) loans to people who would
otherwise qualify for standard debt instruments if the size of their
mortgage were smaller.
Foremost among the “exotic”
retail debt instruments popularized during the recent housing bubble
is the adjustable rate mortgage or ARM, in which the borrower pays a
relatively low interest rate for several years (typically three to five
years), after which the rate bounces back. Adjustable-rate mortgages
reached a record-high 37 percent of the mortgage market in 2005.
Another risky mortgage instrument
that has grown popular in recent years is the interest-only loan. Such
mortgages accounted for less than 5 percent of the jumbo loans—those
totaling over $417,000—taken out in 2004. By the second quarter
of 2005, this figure had grown to 25 percent. A borrower who takes out
an interest-only loan delays paying off any of the principal for a period
of several years, after which monthly payments increase and the normal
amortization process begins. The borrower then owns no more or less
equity than was owned at the beginning of the loan.
By contrast, negative-amortization
loans, in which a borrower pays less than the accruing interest, have
also grown increasingly prevalent. Borrowers who take out such loans
collect negative equity; that is, they owe more money after several
years of mortgage payments than when they first took out their mortgages.
As an “alternative” to interest-only and negative-amortization
loans, California lenders began marketing 50-year mortgages for the
first time in 2006.
Mortgage brokers sought to
convince borrowers—especially in states with ballooning housing
markets—that real estate was a no-loss commodity; that borrowing
money on unfavorable terms for properties they could not afford (i.e.,
highly leveraged speculation) in hopes that prices would continue to
grow represented a sound “investment” strategy.
Various hucksters sprung
up in seminars, infomercials and TV shows such as “Flip this House,”
encouraging people to “get rich on other people’s money”
by means of leveraged speculation in real estate. Some people succeeded
in this enterprise until they were washed out by the market slowdown,
which hit highly speculative markets, like Florida and California, faster
than the rest of the country.
One Florida Keys real estate
broker told the Financial Times, “People were buying places figuring
they would put in a new kitchen and then flip them. It was greed. We
were all in the same game.” Dorothea Sandland, an agent for Remax,
told the newspaper, “A lot of buyers took out second mortgages,
risky loans or even special bonds because they thought they could get
rid of the property very quickly.” She continued, “I’m
looking at condos coming to market that were bought for $259,000 when
there are brand new ones next door selling for $180,000.”
The great majority of people
who were affected by the foreclosure crisis, however, were simply looking
to buy homes under conditions where home prices had been continually
increasing while their wages or salaries remained stagnant or decreased.
Lenders turned a blind eye as brokers, rewarded by the size of the contracts,
convinced borrowers to take out loans they could not possibly repay
if housing prices stopped growing. In many cases, brokers reverted to
outright fraud, lying about property values, hiding the real terms of
the contracts they put forward, and charging exorbitant fees. A recent
FBI report noted “a strong correlation between mortgage fraud
and loans which result in default or foreclosure.”
Carol Trowell, an Associate
Broker at Century 21 DuPont Realtors in Detroit, blamed much of the
problem on irresponsible brokers. She told the WSWS, “There was
a lot of fraud, jacked up appraisals, people starting off at extremely
high rates.”
But brokers weren’t
the only ones defrauding homeowners. In one recent case, Charlotte,
North Carolina homebuyers sued the construction company Beazer Homes,
alleging that its lending arm misconstrued their financial information
to qualify them for government-backed mortgages they could not afford.
According to a local newspaper, some sections of the city with Beazer-built
homes have foreclosure rates of over 20 percent, while the statewide
rate is around 3 percent.
Even the lenders that did
not engage in outright fraud sought to sign up as many buyers with bad
credit and low incomes as possible, taking advantage of these borrowers’
inability to get standard loans to charge extra fees and higher interest
rates. In a period of housing price growth, this makes sense; if housing
prices never fall, borrowers can sell or refinance instead of foreclosing.
As far as lenders are concerned, the benefits of charging higher interest
rates are not offset by increased risk in the short term.
However, this strategy falls
apart as soon as the housing market cools down. As early as 2005, borrowers
began defaulting in record numbers, and as home prices began tumbling,
so did lenders specializing in sub-prime and “exotic” mortgages.
One such lender, New Century Financial, filed for Chapter 11 bankruptcy
in April of this year, and American Home Mortgage, the tenth largest
retail mortgage lender in the US, folded in August.
Countrywide Financial, which
had a 2005 net income five times greater than that of New Century, barely
avoided collapse in mid-August when the Fed lowered its discount rate
and a consortium of 40 banks offered the company an $11.5 billion emergency
credit line. According to a recent survey by Fannie Mae, the average
foreclosure costs the lender approximately $60,000, despite the fact
that the borrower loses his or her entire stake in the property.
Lenders’ difficulty
with obtaining credit, fueled by concerns over the viability of mortgage-backed
securities, seems to have precipitated a general reversal of previous
lending policies. In a survey of large lending institutions conducted
by the Federal Reserve, 67 percent of the lenders surveyed said they
had raised their lending standards for sub-prime mortgages, and 47 percent
said they had raised their minimum qualifications for adjustable rate
mortgages. Higher qualification standards translate into greater difficulty
refinancing, which in turn puts borrowers with adjustable rate mortgages
in an even more precarious situation.
Under conditions of rising
real estate prices and easy credit, borrowers retain the ability to
sell or refinance if payments prove too high after the introductory
period. But since banks are tightening their lending standards, it has
become even more difficult for borrowers with sub-prime and exotic mortgages
to refinance, even if their home prices have not decreased significantly.
Between falling home prices
and difficulty refinancing, borrowers who were maneuvered into taking
out risky mortgages find it ever more difficult to avoid foreclosure.
Even up to a year ago, some nine out of ten borrowers who fell behind
on their monthly payments succeeded in avoiding foreclosure by selling
their houses or refinancing, according to property analysis firm DataQuick.
By contrast, less than half do so now. “Refinancing is no longer
easily or automatically available, even for those with good credit,
and some of those who cannot refinance are losing their homes,”
noted Jim Saccacio, chairman and CEO of RealtyTrac.com.
Predatory lending practices,
speculation and widespread fraud cannot, however, fully account for
the scale of the foreclosure crisis. Rather, the ultimate causes lie
in long-term trends; the stagnation of wages, the lack of affordable
housing and the growing indebtedness of American households.
To be continued
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