This article first appeared in the St. Louis Beacon: October 10, 2008 - Three alarming facts about failing home loans are worrying Karen Wallensak of Catholic Charities who works with troubled homeowners on the front lines of the foreclosure crisis.
Wallensak, executive director of the agency's Housing Resource Center in St. Louis, speaks in a calm, reassuring voice even when she is delivering bad news, such as her expectation that the mortgage crisis has "legs" that will carry it into the next decade. Catholic Charities is one of the local nonprofit agencies that make up the St. Louis Alliance for Homeownership Preservation that provides free counseling to troubled homeowners.
"These are gloomy times,'' Wallensak said. "I don't think anything the federal government has proposed is going to mitigate this. From what I'm seeing, there are still waves of foreclosures that are going to ripple through our country and our community here in St. Louis for up to another three years."
Worry No. 1:
In July, the number of prime loans in foreclosure moved ahead of the number of sub-prime loans in foreclosure. (The terms prime and sub-prime refer to the credit histories of the borrowers; sub-prime loans were generally made to people with less-than-perfect credit ratings.)
In July, 105,000 prime borrowers and 92,000 sub-prime borrowers entered into some stage of foreclosure, according to statistics compiled by HOPE NOW, a coalition formed by the lending industry that operates a national hotline for homeowners facing foreclosure. The number of prime borrowers facing foreclosures was about double the number recorded in July 2007.
"In July, sub-prime became old news in the mortgage crisis," Wallensak said. "Part of that is just the impact of the economy. People are losing jobs, the cost of living is going up and folks who were on the edge and a paycheck away from disaster -- and that describes probably two-thirds of Americans, whether they're affluent or not -- this is just toppling them right over the cliff."
Worry No. 2:
About 3 million "Alt-A" mortgages have just started to re-set, with monthly mortgage payments increasing by as much as 150 percent. Alt-A loans, which stands for Alternative A-paper, include a variety of "creative financing'' products that fall somewhere between prime (A loans) and sub-prime (B loans) and account for an estimated $1 trillion in loans. Nationwide, 16 percent of Alt-A loans made since January 2006 are at least 60 days behind in payments, according to statistics compiled by Bloomberg News.
In many cases, Alt-A loans required only minimum payments that were far lower than even the monthly interest on the loan. The difference between this minimum and what was actually owed was tacked onto the loan principal. Every month, the principal amount grew, and, in most cases, homeowners have little or no equity in the property.
"Many of these loans have gigantic re-sets. About one-third of them are what are called the pick-a-pay adjustable rate mortgages, where people could pick what they wanted to pay,'' Wallensak said.
Alt-A loans were often sold to people who could not have afforded the monthly payments of a conventional loan -- with the idea that they could refinance before the loans re-set. But the tight credit market and falling housing prices closed that escape hatch.
"What makes these loans so scary is that so many of them were what they called no-documentation loans or what we call 'liar loans' where people did not have to verify their incomes," Wallensak said.
In 2006, the Mortgage Asset Research Institute reviewed 100 samples of no-documentation loans, comparing the "stated income" with IRS income forms. The group warned that actual income was overstated by more than 50 percent in nearly 60 percent of the loan samples.
"These loans were very lucrative for mortgage brokers. If they made them and sold them they got paid a handsome fee," Wallensak said. "Some of the biggest entities that bought up these loans -- Freddie Mac, Fannie Mae, Wachovia, Lehman Brothers -- shall I continue the list?"
Worry No. 3:
Sub-prime borrowers with adjustable rage mortgages who received some type of loan modification during the first half of 2007 were again 90 days or more behind in their payments by the end of March 2008, according to a report by Moody's Investors Service.
Wallensak attributes the rate of failure to the fact that lenders insisted on repayment plans rather than renegotiating the terms of the failed mortgages.
"During 2007, there were many foreclosures happening, and loan servicers primarily were not willing to modify loans. They just wanted to be paid back," she said.
In most cases, these repayment plans allowed borrowers to make up missed payments and late penalties over a period of time, by adding an agreed amount to their monthly payments. Homeowners, who were already hard-pressed to make their original mortgage payments, were unable to sustain these higher amounts.
"So, we have perhaps a second wave of people coming who already received help once and who were not able to make good on the repayment plan they thought would work," Wallensak said.
A slow-moving trickle
Wallensak's worries, shared by other housing counselors, add up to a gloomy bottom line: While the $700 billion taxpayer bailout of Wall Street's troubled financial institutions is trickling down through the economic stratosphere, the flood of foreclosures will continue on Main Street -- pushed along by the free-falling stock market, loss of jobs and rising food and fuel prices.
In August alone, 303,879 properties in the United States were in some stage of foreclosure, according to Realtytrac.com. Missouri ranked 15th with 3,755 foreclosures, while Illinois was ninth with 10,757.
"That 'trickle down' hasn't trickled yet,'' said Chris Krehmeyer, executive director of Beyond Housing, another nonprofit in the St. Louis homeownership alliance.
Krehmeyer said the massive bailout has yet to provide relief for individual homeowners. Although he credited Sen. John McCain for at least making an attempt to address the needs of individual homeowners with his rescue plan announced during Tuesday's presidential debate, Krehmeyer has reservations about its effectiveness. He said the McCain plan doesn't get at a critical issue -- loan pooling -- that has prevented individual homeowners from negotiating better loan terms with their mortgage servicers.
Risky mortgages were packaged, securitized and sold in pools to reduce financial risk to investors, who even now are unwilling to negotiate substantial loan modifications, the housing counselors say. What's needed are reductions in principal -- in light of falling housing prices -- and lower interest rates to replace ballooning adjustable rate mortgages.
"We only have a small percentage of loans that are going south, but it is dramatic and it is significant and higher than in years past," Krehmeyer said. "We need to figure out from a securities standpoint how to get at these loans -- how do we stop as many as possible from going under. We're still going to have a lot of people losing their homes, but is there any way we can minimize that damage? I've not heard anyone put up a macro solution."
Eric Madkins, director of housing and foreclosure intervention for the Urban League of Metropolitan St. Louis, says that while the government and financial institutions concentrate on unclogging the banking system so money again begins to flow, troubled borrowers won't see any relief until public policy is changed.
"On Main Street, until lenders and servicers of these loans look for ways to perform loss mitigation -- whether it is reductions in principal or taking borrowers out of adjustable rate mortgages and placing them into fixed mortgages -- the problem will persist,'' Madkins said.
He adds that evaluating troubled mortgages is going to be an enormous task, amplified by the fact that the properties will have declined in value.
Economist Jack Strauss of St. Louis University said the government has tremendous latitude and could, in fact, cut through the tangled financial web of loan pools to intervene on behalf of homeowners.
Strauss said the government could take several actions, including freezing interest rates on re-setting adjustable rate mortgages.
Plans, such as McCain's, to buy troubled loans have historical precedence, both during the Depression and in other countries, Strauss said. But he believes that lenders should be forced to accept a loss of at least 10 to 15 percent to keep taxpayers from bearing the full cost of the rescue. Strauss said few lenders would fight such a write-down because they lose two or three times that amount when properties go into foreclosure.
"There is no winner here. But even the banks would be better off because nobody wins in a foreclosure,'' said Strauss, who is the director of the Simon Center for Regional Economic Forecasting at SLU.
Strauss believes that Congress could also help homeowners by rewriting federal bankruptcy laws to give judges the ability to force loan modifications.
Making matters worse
In the meantime, the worsening economy is adding more families to the foreclosure rolls, Madkins said.
"We are seeing families that are facing foreclosure not because they bought a house that was far beyond their means and had bad credit. These families have prime -- not sub-prime -- mortgages and are facing foreclosure due to unemployment, layoffs or under-employment. To stay afloat, the head of the household has to take a job that pays less than the original job," he said.
Because of declining home values, refinancing is no longer a solution for these homeowners, and they quickly run out of options if lenders aren't willing to work with them.
The counselors agree that the need far outweighs any available help.
For example, the Federal Housing Administration has just rolled out the Hope for Homeowners loan program to refinance mortgages for about 400,000 borrowers across the country.
"But there are millions of homes facing foreclosure, so it's going to help some people, no doubt, but for most who are in foreclosure now or near to that point, I don't see anything on the horizon that's going to be of great help," Wallensak said.
The sad reality is that by the time the crisis wanes, analysts predict that more than 2 million American families will have lost their homes.
"And some of that is because so many people simply don't have the income to sustain the mortgage. And if that's the case, there's little that can be done," Wallensak said.
Wallensak cited the case of a tradesman who works in the now-suffering construction industry who asked for help because he was falling behind on his mortgage once more -- after having negotiated a repayment plan with his lender. The principal on his loan is $300,000, and his mortgage had been $2,600 a month. He was now paying $3,700 a month.
"He makes about $30,000 a year, and I said, 'Excuse me, sir, how can you possibly afford a $2,600 loan payment on $30,000, and he said, 'Well, I did lots of side jobs' -- which weren't reported to the IRS. And he had gotten a no-doc loan and didn't have to declare his income," she said.
Wallensak said that though the case was not typical of the people she normally hears from, she expects to see more of them as Alt-A loans fail.
"That's what is going to be washing up on the beach -- borrowers with more affluent incomes who have gotten loans they truly couldn't afford from the first moment," Wallensak said. "And I'll have to tell them, 'Unless your lender can modify the loan so you can afford it on your current income, we can not help.' "
Wallensak adds that those types of loans have contributed to a public backlash about the foreclosure crisis.
"A lot of folks ask me, 'Why should I help bail out people who were careless or used bad judgment or didn't tell the truth? But the case I just described is not common among our clients. Our clients usually have a lower income and may have made some mistake in judgment, but really a lot of times they just got a bad loan they didn't deserve," she said.
Wallensak said the agencies have a responsibility to be honest with homeowners whose budgets simply can't sustain an unaffordable mortgage. The agencies have limited funds to assist homeowners and are careful to spend that money where it can have a real effect.
"We are that gut check for the homeowner," she said.
Wallensak urges struggling homeowners to contact a housing counselor because even when no financial assistance is available, the agencies can assist them in planning their next moves.
Help in the meantime
Local housing counselors agree that state and federal officials could take some steps to ease the pain of homeowners, if even temporarily. For example, a 90-day moratorium on foreclosures could give homeowners a chance to seek remedies -- or at least consider options.
They say state legislators could help by changing Missouri from a non-judicial foreclosure state, where no court action is required, to a judicial state, such as Illinois, where the process is court-administered. The change would lengthen the foreclosure process, which can take as little as 60 days in Missouri, giving homeowners more time to seek a solution. In Illinois, foreclosures can take a year.
Other actions include stronger oversight of mortgage brokers and the lending industry.
"If there is anything this has shown is there is a place for regulation," Wallensak said. "Allowing the mortgage industry to run amok with no oversight leads to disaster. I don't want to over-regulate, but I think some responsible oversight of the mortgage lending industry is called for. And if we don't learn that much from this crisis, then I would just throw up my hands."