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What Can a City Do?

posted by Elizabeth Warren

Because subprime lending was not evenly spread around the country (or even around a state or city), individual neighborhoods are bearing the brunt of the meltdown.  When several homes in one community go into foreclosure, a neighborhood can rapidly shift from a safe, comfortable area with well-tended lawns to a place where no one wants to live.  Mayors are on the front lines in dealing with the fallout.

Like most academics, we at Credit Slips tend to talk about what the federal government could do to deal with the subprime crisis.  The feds have the power, if not the will, to make some big changes.  But what about mayors?  Can anything be done at the city level? This isn't an academic question, so put on your thinking caps and volunteer some ideas.  Here's mine: 

A mayor could appoint a Foreclosure Investigator.  Announce that any person anywhere in the city who has received a notice of foreclosure or similar document should immediately call the city officer who will investigate all the paperwork to make certain that every aspect of the mortgage and the mortgage foreclosure comply with the law--at no expense to the homeowner. 

This would be a powerful tool for three reasons:  1)  Many of the worst mortgages have bad documentation, illegal provisions, etc.  But if homeowners don't know that, and if they don't go to very good lawyers, the mortgage companies will foreclose and the homeowner's rights will be lost.  2) Even if the mortgage paperwork is in order, any push back from a homeowner makes is more likely that a deal can be negotiated to keep the homeowner in the house (if the homeowner really can afford it). A Foreclosure Investigator can inform the homeowner about a range of options. 3) If one city has the reputation as a lousy place to bring a foreclosure action, mortgage companies have lots to do right now, and they may put that city's foreclosures lower on their to-do lists.  I realize the last point simply externalizes the problem, but for a mayor working hard to save neighborhoods in his or her city, that may be an issue for another day.

What are your ideas?  What other tools are available?  If a highly motivated mayor asked you what to do, what would you suggest?

Comments

On some level, this suggestion is simply a free-legal-assistance proposal, which isn't all bad; although it is couched in terms that are far more troublesome. Our capital markets are the best in the world, and our mortgage market is the most competitive and lowest-cost in the world, because, among other things, we have enforceable security interests and a judicial system that will give lenders the benefit of their foreclosable-mortgage bargains. The right to be free of a bargained-for foreclosure comes at a cost to lenders and to the system. Those costs will ultimately have to be borne by other consumers and will cause an increase in the cost of mortgage finance for everyone. Why aren't lenders entitled to have a government-paid "investigation" of the misrepresentations made by consumers in their loan applications? Or do only consumers matter?

Some good points.

1. Lenders are entitled to "goverment paid investigations." They are part and parcel of criminal prosecutions.
2. Borrowers should be placed on the same footing as lenders. Lenders spend millions for contract provisions in their promissory notes that are favorable to lenders. Borrowers do not have that luxory.
3. No-one is trying to stop forclosures. Most are trying to stop enforcability of contrats of adhesion.
4. I would like to see, as a standard part of the contract, a non-assignability clause. If I go to a bank to get a mortgage, I want that bank to service the mortgage and I want a veto over the transfer of the mortgage service provider. If a borrower cannot transfer the obligation, why should a lender be able to transfer the note?

In Colorado, the biggest response has been at the state level (a natural because most real estate market regulations takes place at that level of government) which has changed the foreclosure laws effective 1.1.08 (mostly to reduce redemption periods in favor of cure periods), regulated mortgage brokers, and used regulatory authority to prohibit many pre-payment penalties.

Colorado also has a well used foreclosure hotline. Workouts tend to be more common than legally binding legal objections in those cases. The hotlines help interrupt debtor paralysis.

The best known city actor in the foreclosure and post-foreclosure market is Detroit which has aggressively condemned abandoned properties, but it is worth noting that Detroit isn't much better off for its efforts.

For most cities, I suspect that aggressive code enforcement in the troubled neighborhoods, with a focus on absentee landlords, would encourage lenders to maintain them, and to quickly lease properties or resell them to new owner-occupants. Foreclosing banks are quite capable of responding to clearly conveyed incentives.

Cities are already taking action to force lenders and investors to internalize the external costs of foreclosure. Business Week features a story on Buffalo's housing code enforcement actions against lenders in connection with properties in foreclosure, even before the lenders take title. Today's Times reports on Baltimore's lawsuit to stop foreclosures by Wells Fargo based on the racial disparities in its lending and pricing. More cities will be taking similar actions to stop foreclosures and force loan holders to deal with REO responsibly. Increasing the cost of foreclosure by internalizing formerly external costs may make mortgages a little less cheap. On the other hand it may create a market incentive to make mortgages less risky.

-Alan White

Allan, if the lenders couldn't sell or transfer their paper it would raise the cost for everyone. The secondary mortgage market is why rates are as low as they are. The mortgage market imploded because no one wanted to buy the paper, so lenders couldn't make additional loans because they had no way to get older loans off their books and bring in additional revenue.

He who has the gold, makes the rules. If borrowers want all these rights as you state, they need to pay a premium for the loans or start buying houses in cash.

Russ,

I know that. I don't like that I have no choice in the matter. Where both parties are on equal footing, everything is negotiable. If I want to go to my local bank with an understanding that my local bank and only my local bank (unless it goes insolvent) will service the loan, it should be allowed. If my local bank says it will cost an extra 2%, I will have to consider whether it is worth the cost.

The secondary mortgage market is also why there is a crisis. Those who rated the securities did not do a proper risk assessment. Those who bought the securities relied (perhaps turning a blind eye) on the risk assessments. Many of the securities were not worth the paper they were written on. And those that might be salvaged cannot be because no-one knows who owns the notes.

I followed this link over from Calculated Risk where your posting was given prominence...

http://calculatedrisk.blogspot.com/2008/01/foreclosure-investigator.html

Here is my take (cross posted). In short - I think a 'Foreclosure Czar' is a terrible idea...

::::

Mayors need to focus on the job of mayoring... keep the streets plowed & clean... make sure the police dept. is arresting the hookers, pimps and pushers (which can tear a neighborhood with vacant homes to pieces in a hurry)... make sure city sets the best example by maintaining its own property (parks, roads, buildings) and then enforce ordinances on private property for up keep, mowing, snow shoveling, junk & abandoned vehicles... Do all that (and it is no small task) and it will do a lot to see that the properties inside the city's domain retain as much value as is possible given market conditions. An environment like that is likely to see new buyers eventually replace those who have been foreclosed... plus give incentive to those not yet foreclosed upon to not walk away.

They have their plates full - they don't need another serving of problems, especially ones where they can have little positive effect.

dryfly | 01.09.08 - 11:13 am | #

::::

There is nothing more a mayor can do except make sure his/her city is a wonderful place to live... build it (then maintain it) and they will come.

Dryfly didn't say this, but there is an extensive discussion of this proposal over at http://calculatedrisk.blogspot.com/2008/01/foreclosure-investigator.html

You need to click on the comments separately to read them. There are about 50+ comments so far (and growing). Tanta also responds favorably to some of the comments (more favorably than Dryfly).

CalculatedRisk is an excellent place to read about the growing and mortgage crisis. While Creditslips tends to be more liberal/progressive/academic, CR has many working assessors, mortgage brokers and investors, with many more goldbugs and Ron Paul lovers than you'd find on CreditSlips. This diversity of opinion and experience is an asset, not a liability.

I'm not dissing the folks on this blog-- American Prospect is one of my favorite magazines. It's just that all of us in America tends to stick to our own silos too much- left, right and center.

If we're throwing out ideas on municipal intervention, how does this fit in with Van Jone's proposal that we create "work that needs to be done for those that need work" and retrofit America's housing stock to be more climate-friendly. Might this also tie in?

Elizabeth,

My question would be, what would the Foreclosure Investigator do if they found that the original loan application had falsehoods in it? Would they refer the case to someone to prosecute for fraud? If not, why not? As a government official wouldn't they be obligated to report crimes that they uncovered? (Lieing on loan docs is a crime in most all states.) And if the Foreclosure Investigator would report misrepresentation on the original loan docs, that would mean that a lot of people who are in foreclosure would want to avoid this investigator at all costs.

Your post seems to assume that all the foreclosures that are the result of banks taking advantage of people, but ignores that many people got their homes through falsifying loan docs. A sad but true aspect of this problem, particularly in the sub-prime arena.

I posted some responses on calculatedrisk where I first read about this.

"A well thought out and implemented plan akin to what Warren suggests could provide benefits in several ways.

Localizing the issue could take some heat off the FED."

"Consumers may actually learn something that they can carry with them for life.
Fraud or questionable practices would be better quantified after some time.
It could slow the deterioration of cities, neighborhoods etc down and, if enough municipalities ran with a version of this, help nationally as well. Perhaps the floor would be found sooner as a result. This may allow for a quicker and broader economic recovery (probably still years though).
Also, in my experience if a consumer pushes back, even in the slightest way, the % of getting closer to a win/win solution increases drastically."

"I could be very wrong but my impression of foreclosure firms is that they are paper mills.
As soon as something happens in a file that is not SOP, the cogs slow down.
Slowing down a runaway freight train before impact will create less damage.

Also, the speculators will continue to bail in large quantities. Upside down depreciating assets can do that.
I believe the vast majority of folks that will seek help will be people that want to live in the home.

There are consumer attorneys out there. Low income legal does not have to absorb the storm.
An enterprising consumer advocate practice could bring on some qualified staff and charge low cost fees for their own paper mill that would slow this down."

There are a number nonprofit resources available to address the needs of homeowners with unaffordable mortgages. These, of course, are underfunded and understaffed, but it is also my experience that resources such as these are under-utilized (a great example of this would be the Earned Income Tax Credit).

Perhaps I am somewhat dovetailing with CRN when I suggest that enterprising individuals and nonprofits should be welcoming the attention that this crisis has brought to them. In Atlanta affordable housing has been a cause that receives a very large amount of funding over the last year or so. What the nonprofit sector should embrace is a more synergistic approach to achieving their goals.

I would suggest that the city should not create a new position so much as those nonprofits in the areas of economic development, fair housing, financial literacy, microfinance, etc. should be identifying partnerships and funding sources that will effectively address this need.

I have a lot of confidence that existing laws vigorously enforced will address satisfactorily the vast amount of legitimate complaints. We have had numerous housing-related crises before and there are ample laws already on the subject. So, the call to adopt a process like the original poster suggested makes sense if we then leave the issue alone and move on. If you have this process but then you have other processes, like bankruptcy, that are going to fall in a sequence, than adding this layer doesn't make a lot of sense. Let's get to the bankruptcy instead. Or if a state or city adopts this but the federal level adopts other laws to address the problem, let's have the federal laws preempt this process. A patchwork of wellintentioned laws is suboptimal in a nationwide economy. It's a lot like credit care regulation. Sure, it protects some people but it raises the costs of credit to those who don't need protection because they manage credit better. Cost shifting and loss shifting from the imprudent to the prudent may be one's preference as to how a society should function but it's far from evident that they are in the best interest of the country as a whole over the long term.

To help alleviate the growing number of foreclosures, I would like to see some type of solution where lenders partnered with the Foreclosure Investigator or designated city contact. Lenders could focus on those cities that have the highest numbers of foreclosures, e.g., greater than 2% of the national average of homes in foreclosure. They could offer some type of incentive back to the cities if they are able to reduce the current number of foreclosures by a certain percent of the city’s current foreclosure number, say 25% and 50%. For example in the Detroit metro area, the approximate number of foreclosures as of Q3 2007 was 10, 316. If the city reduced that number by 25% to 2,579 of the 10, 316, and the city recouped 1% back on each of those 2,579 homes that didn’t go into foreclosure - it would be an incentive back of $66, 512 for meeting that reduction. The money the cities receive back from the lender for reducing foreclosures could be used towards low income housing or neighborhood improvement programs to rebuild those areas impacted.

While a partnering solution would not help everyone, it could help offset the rising numbers of foreclosures. Partnering alternatives would help keep more homes out of foreclosure, not drive to as many bankruptcies as a result of home mortgage issues and help rebuild communities. It would be a win since the average cost to a lender to foreclose is approximately $60,000 per home, cities would still be collecting property taxes and there would be reduced legal costs for lenders and borrowers.

It’s time for alternatives that offer sustainability for both lenders and cities.

A couple of thoughts:
1. As to Allan and Russ's discussion, I think it is unlikely a lender will ever have an enforceable non-assignability clause in their loan documents because the lender's regulator will never permit it. From a safety and soundness perspective, the regulator will require assets to be as liquid as possible (a mortgage payment stream is a huge asset). Giving every borrower the ability to block an assignment when the lender is or has gone under will prevent the regulator from doing its job: keep the lender afloat or sell the assets so the insurance fund takes the least hit possible.
2. No lender spends millions on residential mortgage documents. The vast majority of US lenders use the out-of-the-box form Notes and Mortgages created jointly by FreddieMac and FannieMae. And in order to sell to them (and many other buyers of loans on the secondary market), the terms cannot be changed. Some changes may be permitted, but they are strictly limited. It is arguable whether the Frddie/Fannie forms favor the lender or consumer (and that probably means they are balanced). Rates and costs may be negotiable, but the actual loan terms geernally are not. And even rates may not be negotiable due to the need to sell the loan ont he secondary market.
3. I think the city forclosure investigator is an interesting idea, but could be legally problematic if nto set up properly. If the investigator reviews the loan documents and finds something he/she thinks to be illegal and tells the borrower that, then there is a chance that person is practicing law without a license. Giving an opinion something is illegal is generally the practise of law under most state's definition. If the investigator is not an attorney and is being paid for providing the opinion, that is generally UPL. I then suppose this investigator would need to be set up to report to the city's Legal Department and not the Public Works or Community Development department.
4. And, if the investigator finds a borrower has lied on their loan application, that is almost definitely illegal under Federal law no matter what state law is. So the question about what a state/city employee must do to report illegal activity is not an academic question but a live question!

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