Building Sustainable Homeownership:
Responsible Lending and Informed Consumer Choice
Federal Reserve Bank of Philadelphia
10 Independence Mall, Philadelphia, Pennsylvania 19106
June 9, 2006
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Pages 1-25 | 26-50 | 51-75 | 76-100 | 101-125 | 126-150 | 151-175 | 176-200 | 201-221
| Transcript | Line | Page |
|---|---|---|
| gotten a prime loan as opposed to a subprime loan, | 1 | 51 |
| where their credit score fell. But the credit | 2 | 51 |
| score is not the sole determinant of how you make | 3 | 51 |
| the credit decision. | 4 | 51 |
| The underlying part of the discussion, | 5 | 51 |
| is that's, sort of, an implicit assumption that | 6 | 51 |
| every lender has, what an economist would call, | 7 | 51 |
| the same objective and the same appetite for risk | 8 | 51 |
| and they have the same appetite for product | 9 | 51 |
| diversification or assets in the portfolio. | 10 | 51 |
| That's an invalid assumption. When we have 8 to | 11 | 51 |
| 9000 banks out there, each of whom has there | 12 | 51 |
| specific stockholders' interest in how much risk | 13 | 51 |
| they want to take in what kind of areas. The idea | 14 | 51 |
| that two separate institutions would look at the | 15 | 51 |
| same borrower and come to exactly the same | 16 | 51 |
| conclusion is probably not accurate. Although, on | 17 | 51 |
| broad averages, across the entire population of | 18 | 51 |
| lending institutions, it will come to the central | 19 | 51 |
| tendency decision. | 20 | 51 |
| MR. ZORN: This is, sort of, an | 21 | 51 |
| interesting experiment, but we had a couple | 22 | 51 |
| hundred thousand loans, which are the combination | 23 | 51 |
| of prime lenders, who have reported rate | 24 | 51 |
| spreads -- that is, loans from prime lenders with | 1 | 52 |
| reported rate spreads, loans from what we | 2 | 52 |
| identified as subprime lenders, that were not | 3 | 52 |
| reported rate spreads. Then you look at the micro | 4 | 52 |
| score distributions of those two sets of | 5 | 52 |
| borrowers, they're right on top of each other. | 6 | 52 |
| GOVERNOR OLSON: Bring that to a | 7 | 52 |
| conclusion. What did you learn from that? | 8 | 52 |
| MR. ZORN: I learned, isn't life funny. | 9 | 52 |
| What I think would be the initially -- I also | 10 | 52 |
| learned that rate spread doesn't really tell you | 11 | 52 |
| everything you want to learn about price, for | 12 | 52 |
| reasons that everybody knows, but in some sense, | 13 | 52 |
| what we thought we were doing when we first did | 14 | 52 |
| this, was, we looked at what are the higher cost, | 15 | 52 |
| higher risk loans being made by prime lenders, how | 16 | 52 |
| do they look compared to the lower risk loans of | 17 | 52 |
| subprime lenders. And the answer is, from micro | 18 | 52 |
| score distribution tests, almost identical. So, | 19 | 52 |
| that is, this gets to the point -- it comes back | 20 | 52 |
| to that. This is 2005 origination. | 21 | 52 |
| GOVERNOR OLSON: Janice, we've been | 22 | 52 |
| discussing at the macro level, now let me come | 23 | 52 |
| back and ask -- part of what we're getting at here | 24 | 52 |
| is the shopping, if you will. I think your | 1 | 53 |
| perspective would be very interesting in this | 2 | 53 |
| sense. The mortgage product and the mortgage | 3 | 53 |
| industry is open to an enormous amount of scrutiny | 4 | 53 |
| because of the information available. The product | 5 | 53 |
| is publicly identified, in many respects, the many | 6 | 53 |
| characteristics, but there is a tremendous amount | 7 | 53 |
| of other shopping for financial products that | 8 | 53 |
| don't receive that kind of scrutiny, and I'm sure | 9 | 53 |
| the same asymmetry exists, in terms of knowledge, | 10 | 53 |
| but also some of the same confusion. But where do | 11 | 53 |
| you see -- how does this product differ, for | 12 | 53 |
| example, from the sale of life insurance or other | 13 | 53 |
| consumer products, or perhaps, even, other | 14 | 53 |
| consumer products that are not financial products | 15 | 53 |
| in terms of A, the marketing or the assistance, or | 16 | 53 |
| the shopping process in the community? | 17 | 53 |
| MS. BOWDLER: I think there's some | 18 | 53 |
| differences and some similarities. Let me start | 19 | 53 |
| there. One of the biggest differences is that | 20 | 53 |
| when you're shopping for a mortgage or when you're | 21 | 53 |
| not shopping for a mortgage, but obtaining a | 22 | 53 |
| mortgage -- | 23 | 53 |
| GOVERNOR OLSON: The mortgage shops for | 24 | 53 |
| you. | 1 | 54 |
| MS. BOWDLER: When the mortgage shops | 2 | 54 |
| for me, it's a much bigger decision, and I think | 3 | 54 |
| people are very aware of that fact, and for that | 4 | 54 |
| reason seek out more counsel, going back to points | 5 | 54 |
| that I think all of us have made, that this | 6 | 54 |
| shopping is much more relationship based. And I | 7 | 54 |
| think that financial products that rely on | 8 | 54 |
| brokers, in general, and there's a lot of other | 9 | 54 |
| financial products, such as insurance or stocks | 10 | 54 |
| and securities, that rely on that market | 11 | 54 |
| intermediary function, are shopped for very | 12 | 54 |
| similarly, based on relationships and less on the | 13 | 54 |
| actual product. Other consumer products say, | 14 | 54 |
| remittances, which we know there's a lot of | 15 | 54 |
| financial abuse there, heavily used in the Latino | 16 | 54 |
| community, that's more geographic. | 17 | 54 |
| GOVERNOR OLSON: What do you mean by | 18 | 54 |
| "geographic"? | 19 | 54 |
| MS. BOWDLER: Whatever's closest or | 20 | 54 |
| more convenient. So if it's on your way home from | 21 | 54 |
| work, or if it's close to your house or where you | 22 | 54 |
| grocery shop, than that tends to be more | 23 | 54 |
| geographic. | 24 | 54 |
| MS. BRAUNSTEIN: And mortgages are not | 1 | 55 |
| -- you don't think people are going to the folks | 2 | 55 |
| who are either in the neighborhood or marketing | 3 | 55 |
| the neighborhood? | 4 | 55 |
| MS. BOWDLER: I think they do. But | 5 | 55 |
| here, I think that relationships are much more | 6 | 55 |
| important. For example, just to pick up on your | 7 | 55 |
| question from earlier, you asked if there wasn't | 8 | 55 |
| some self selection into the subprime market, | 9 | 55 |
| based on people's perception of their own credit | 10 | 55 |
| score. I don't think people make that kind of | 11 | 55 |
| decision. I don't think people think to | 12 | 55 |
| themselves, especially in the Latino community, | 13 | 55 |
| I'm a subprime borrower, I need to go find a | 14 | 55 |
| subprime lender. That calculation doesn't happen. | 15 | 55 |
| What happens is, that they know a | 16 | 55 |
| bilingual or bicultural broker because their | 17 | 55 |
| sister or their family member, or they go to the | 18 | 55 |
| same church, or they somehow know each other from | 19 | 55 |
| some other social connection. So it could be that | 20 | 55 |
| they also happen to be in the same neighborhood, | 21 | 55 |
| but I don't think that's always true. For banking | 22 | 55 |
| that's more true, but for shopping for a mortgage, | 23 | 55 |
| I think it's less true. | 24 | 55 |
| MS. BRAUNSTEIN: Have you found, and | 1 | 56 |
| any of you can address this, but I know Janice, | 2 | 56 |
| you said that when you looked at the newspapers | 3 | 56 |
| and listened to the radio ads, that there were | 4 | 56 |
| some subprime lenders that were marketing, but | 5 | 56 |
| they were marketing subprime products. To me, | 6 | 56 |
| that raised a question. If a borrower goes into a | 7 | 56 |
| prime lender, even though they're responding to an | 8 | 56 |
| ad for a subprime product, and when the | 9 | 56 |
| underwriting takes place, if that lender finds | 10 | 56 |
| that this person actually could qualify for a | 11 | 56 |
| prime product, is that kind of referral going on | 12 | 56 |
| or are they just given the subprime product they | 13 | 56 |
| walked in from the ad where they walked in the | 14 | 56 |
| door? Do you have any knowledge of whether that's | 15 | 56 |
| happening, and any of you can go about this if you | 16 | 56 |
| know that that's happening in your member | 17 | 56 |
| institutions. | 18 | 56 |
| MS. BOWDLER: I'm going to make a | 19 | 56 |
| guess. Research came out recently from the | 20 | 56 |
| Consumer Federation, that I think the number -- | 21 | 56 |
| don't quote me on the number -- somewhere around | 22 | 56 |
| 40 percent, that payment option mortgages were 40 | 23 | 56 |
| percent of the loans last year. So there's been a | 24 | 56 |
| dramatic increase. I might have that statistical | 1 | 57 |
| data, but I think we'd all agree that there's been | 2 | 57 |
| a dramatic increase in those mortgages. | 3 | 57 |
| Now, I was part of an FTC panel a | 4 | 57 |
| couple of weeks ago, where a prime lender | 5 | 57 |
| presented and explained to us that his | 6 | 57 |
| underwriting standards for underwriting a payment | 7 | 57 |
| option mortgage was to underwrite a consumer at | 8 | 57 |
| the rate that he expected the loan to jump to in | 9 | 57 |
| that first year. So if you got a 1 percent rate | 10 | 57 |
| for the first month or maybe six months, however | 11 | 57 |
| that product was structured, and in that year, if | 12 | 57 |
| they expected that the product would go to 7 | 13 | 57 |
| percent, they underwrote to 7 percent. | 14 | 57 |
| So my question would be, if that person | 15 | 57 |
| is an underwritable for 7 percent, all other | 16 | 57 |
| things being equal, how do they end up in a | 17 | 57 |
| payment option mortgage versus your standard | 18 | 57 |
| 30-year fixed for even a fully amortizing ARM. | 19 | 57 |
| And the only conclusion there is, it's more | 20 | 57 |
| profitable to be in a payment option mortgage than | 21 | 57 |
| it is to be in a 30-year fixed. I think profit | 22 | 57 |
| motivation is very natural and important in this | 23 | 57 |
| market to do what they need to do, but it tells me | 24 | 57 |
| that we need some more accountability to offset | 1 | 58 |
| those motivations. | 2 | 58 |
| MR. DUNCAN: I was actually at the same | 3 | 58 |
| FTC thing, and you're right about the | 4 | 58 |
| underwriting. I think the initial question was | 5 | 58 |
| whether or not the consumer could qualify for a | 6 | 58 |
| different loan, and the lender explained that they | 7 | 58 |
| underwrote at a fully fixed rate so that even if | 8 | 58 |
| there was negative amortization, the increase to | 9 | 58 |
| the maximum over a three-year period, would be a | 10 | 58 |
| 14 percent increase in the payment from the | 11 | 58 |
| qualifying level. Then the question was, whether | 12 | 58 |
| the consumer chose the 1 percent teaser rate | 13 | 58 |
| because they had other use for those funds in the | 14 | 58 |
| interim, and if they managed that loan they were | 15 | 58 |
| well-positioned to make the payments. | 16 | 58 |
| It's not true today that all lenders | 17 | 58 |
| have a specific referral process, but many lenders | 18 | 58 |
| have a specific referral process internally. So | 19 | 58 |
| that if a borrower were to come in, selling to us | 20 | 58 |
| as a subprime and after the qualification process | 21 | 58 |
| were complete, they were determined to be eligible | 22 | 58 |
| for a prime loan, they would be referred to a | 23 | 58 |
| prime channel. | 24 | 58 |
| The reason for that is, the comment | 1 | 59 |
| that I made earlier, about the increased | 2 | 59 |
| competition in the subprime arena, if you went | 3 | 59 |
| back ten years ago you would have a lot of | 4 | 59 |
| independent finance companies. Today it's | 5 | 59 |
| migrated to many more subsidiaries and diversified | 6 | 59 |
| financial service companies, which have more | 7 | 59 |
| serious capital investments and reputational | 8 | 59 |
| investments in the industry, and those | 9 | 59 |
| institutions are subject to CRA rules and things | 10 | 59 |
| like that, and are much more sensitive about the | 11 | 59 |
| proper classification of borrowers according to | 12 | 59 |
| their regulations. | 13 | 59 |
| MS. BOWDLER: If I could just add one | 14 | 59 |
| thing to that. We've heard similar things from | 15 | 59 |
| financial institutions that have both prime and | 16 | 59 |
| subprime ARMs, or subsidiaries within their | 17 | 59 |
| structure, that there is this referral method to | 18 | 59 |
| refer up and not just refer down. And we have | 19 | 59 |
| partnerships with several -- several lenders | 20 | 59 |
| through our housing counseling network that meet | 21 | 59 |
| with lenders on a regular basis and ask them all | 22 | 59 |
| for example loans where that's happened, and for | 23 | 59 |
| documentation on policies of exactly how that's | 24 | 59 |
| supposed to work, and I have yet to see it. So I | 1 | 60 |
| think there are policies out there that, just like | 2 | 60 |
| the nontraditional credit company products, I just | 3 | 60 |
| don't know that they're used. | 4 | 60 |
| GOVERNOR OLSON: In fairness, we did | 5 | 60 |
| hear on Wednesday in Chicago from a panelist where | 6 | 60 |
| that partnership did work, so we know it does, | 7 | 60 |
| although I'm sure that there are gaps. | 8 | 60 |
| Let me come back to one other element | 9 | 60 |
| that is really critical to the subprime question. | 10 | 60 |
| Is the significant change that's taken place in | 11 | 60 |
| the last four years in the secondary market, | 12 | 60 |
| especially secondary markets' appetites now for | 13 | 60 |
| the nontraditional product -- let me pose it, make | 14 | 60 |
| my point, and then have anybody -- Ira, you've | 15 | 60 |
| already referred to Adam Smith, so if you want to | 16 | 60 |
| comment on this as well you're welcome to. | 17 | 60 |
| In my early experience the subprime | 18 | 60 |
| market was geared toward taking the conforming | 19 | 60 |
| product and that was the product that was | 20 | 60 |
| available in the secondary market. In recent | 21 | 60 |
| years, and I think a combination of flat yield | 22 | 60 |
| curve, very liquid secondary market and a shift, | 23 | 60 |
| therefore, in investors looking for a risk premium | 24 | 60 |
| as opposed to a term premium, there has been a lot | 1 | 61 |
| of appetite for that, for the nontraditional | 2 | 61 |
| product. And it's not clear to us that the | 3 | 61 |
| underwriting standards in the secondary market | 4 | 61 |
| brackets are as tight as it is with the conforming | 5 | 61 |
| product. | 6 | 61 |
| It comes back to a point we were | 7 | 61 |
| talking about earlier, we may have lost some of | 8 | 61 |
| the discipline of the underwriting process at the | 9 | 61 |
| point in which the application is taken, because | 10 | 61 |
| of the fact that we've had this explosion of | 11 | 61 |
| interest in the secondary market of the | 12 | 61 |
| nontraditional product. I'd be interested in any | 13 | 61 |
| of your comments about that. | 14 | 61 |
| MR. ZORN: I would make a personal | 15 | 61 |
| statement, not speaking for any of the people | 16 | 61 |
| paying my salary. I, personally, believe credit | 17 | 61 |
| spreads in the subprime market are too low. | 18 | 61 |
| GOVERNOR OLSON: Another way to say | 19 | 61 |
| that is that they haven't fully priced in the risk | 20 | 61 |
| associated with this product. | 21 | 61 |
| MR. ZORN: Correct. | 22 | 61 |
| MR. DUNCAN: I think the root question | 23 | 61 |
| is whether, in global capital markets, credit | 24 | 61 |
| spreads are appropriate. In the U.S. -- by | 1 | 62 |
| "appropriate", I mean, reflecting historical | 2 | 62 |
| norms. And I think most people, including, back | 3 | 62 |
| in Chairman Greenspan's tenure, when he | 4 | 62 |
| reintroduced us to the word conundrum. I think | 5 | 62 |
| that was a part of what he was expressing. In a | 6 | 62 |
| market which is very efficient and where capital | 7 | 62 |
| explosions relate to demand on capital, whatever | 8 | 62 |
| those measurements are, they will be passed | 9 | 62 |
| through ultimately -- | 10 | 62 |
| GOVERNOR OLSON: In the mornings, when | 11 | 62 |
| I'm a macro economist, I think that's a wonderful | 12 | 62 |
| thing. Because what it means is, we have reduced | 13 | 62 |
| the price, to the consumer, of that product. In | 14 | 62 |
| the afternoon, when I'm looking at consumer | 15 | 62 |
| interest, I see the other side of it, which is to | 16 | 62 |
| say that there is a relaxation of the underwriting | 17 | 62 |
| and it may have put people in products for which | 18 | 62 |
| they are ill-suited. And in the macro world, we | 19 | 62 |
| have a significant dispersion of risk exposures, | 20 | 62 |
| now, in pricing, appropriately or inappropriately. | 21 | 62 |
| When it comes back to the individual consumer, | 22 | 62 |
| then it becomes, in that context, irrelevant, | 23 | 62 |
| because you've got a consumer in a product where | 24 | 62 |
| they don't belong. | 1 | 63 |
| I think this is an area where all of us | 2 | 63 |
| need to recognize that explosion, that plethora of | 3 | 63 |
| opportunity, is causing some people to be in | 4 | 63 |
| inappropriate products, perhaps, and I'd be | 5 | 63 |
| interested in any reaction as to how we can deal | 6 | 63 |
| with that fundamental issue. | 7 | 63 |
| MR. GOLDSTEIN: My observation, if I | 8 | 63 |
| could, is that you're exactly correct, that there | 9 | 63 |
| are a massive number of people who are in products | 10 | 63 |
| that are entirely inappropriate for them, if, for | 11 | 63 |
| no other reason than, that they don't understand. | 12 | 63 |
| They don't know what's going to happen to them a | 13 | 63 |
| year out, two years out, three years out. | 14 | 63 |
| I'll give you a quick story. The | 15 | 63 |
| sheriff of Philadelphia announced that the number | 16 | 63 |
| of sheriff sales was going down, and he was | 17 | 63 |
| pleased to announce that 2005 had substantially | 18 | 63 |
| less than 2004. And part of his announcement was, | 19 | 63 |
| he wanted to have some borrowers, some people who | 20 | 63 |
| had been in trouble, talk about how they had their | 21 | 63 |
| circumstance remedied, and they were not subject | 22 | 63 |
| to having their home sold at the auction block in | 23 | 63 |
| Philadelphia where hundreds of homes are sold on a | 24 | 63 |
| monthly basis. This is somebody who was in deep, | 1 | 64 |
| deep, deep trouble, and it took months of | 2 | 64 |
| intensive effort by local housing counseling, and | 3 | 64 |
| in the end, when she was trying to express what | 4 | 64 |
| happened to her, she could neither express what | 5 | 64 |
| happened to her nor how she got out of trouble, | 6 | 64 |
| only that she was helped. | 7 | 64 |
| So after months of very intensive work | 8 | 64 |
| between her and a housing counselor, her situation | 9 | 64 |
| was so complicated that she could still not | 10 | 64 |
| understand what she had to do. | 11 | 64 |
| MR. CHANIN: I want to return to this | 12 | 64 |
| issue of shopping, which is, if not a solution, | 13 | 64 |
| part of a solution to this issue of people -- | 14 | 64 |
| where they're getting a suitable product or | 15 | 64 |
| looking into suitable products. Obviously, one of | 16 | 64 |
| the issues that we will have to deal with is, | 17 | 64 |
| trying to make the disclosures more comprehensible | 18 | 64 |
| to people and also make them simpler, which is no | 19 | 64 |
| small task given the complexity of these products. | 20 | 64 |
| Aside from that small issue, is the | 21 | 64 |
| question of how do we ensure or try to ensure that | 22 | 64 |
| the consumers do shop and, if you will, don't | 23 | 64 |
| evolve into this notion of a trusted relationship | 24 | 64 |
| in relying on someone who may not provide all of | 1 | 65 |
| the information that, ideally, the consumer should | 2 | 65 |
| get from this person. | 3 | 65 |
| So do you have suggestions that we can | 4 | 65 |
| use or think about, of, how do we get people to | 5 | 65 |
| shop more so for these products and make sure we | 6 | 65 |
| get the product that best suits their needs? | 7 | 65 |
| MR. GOLDSTEIN: One possibility, I | 8 | 65 |
| think that the data from mortgages bankers these | 9 | 65 |
| days and from mortgages brokers suggest, probably, | 10 | 65 |
| an excess of two-thirds of mortgages that are | 11 | 65 |
| originated, originated through brokers. And one | 12 | 65 |
| way to ensure a wide review of that market is to | 13 | 65 |
| look to, not only incentivize borrowers to shop -- | 14 | 65 |
| there are clearly incentives for borrowers to | 15 | 65 |
| shop, because if they do it properly, they'll end | 16 | 65 |
| up with a better product. But to incentivize or | 17 | 65 |
| regulate brokers, so that they're truly shopping | 18 | 65 |
| and acting on behalf of the borrowers themselves. | 19 | 65 |
| So if a broker, like the one I | 20 | 65 |
| described or others that we've had relationships | 21 | 65 |
| and contacts with, if they're only taking their | 22 | 65 |
| customer to one lender or two lenders, it's not a | 23 | 65 |
| matter of the consumer's shopping behavior, in a | 24 | 65 |
| way, it's more a matter of the broker's shopping | 1 | 66 |
| behavior. | 2 | 66 |
| MS. BOWDLER: I think that's right. I | 3 | 66 |
| think it would be a mistake to assume, and I don't | 4 | 66 |
| think anybody here has suggested this, but a | 5 | 66 |
| perfectly educated borrower is going to regulate | 6 | 66 |
| the market. It's not going to happen. So, even | 7 | 66 |
| the most astute borrower who shops, is still going | 8 | 66 |
| to have missed steps if there's not some | 9 | 66 |
| protection or suitability standard to back them | 10 | 66 |
| up. | 11 | 66 |
| So, the mortgage market is not -- | 12 | 66 |
| you're not going to have loan officers or brokers | 13 | 66 |
| telling families, your situation isn't quite | 14 | 66 |
| right, you need to wait a year and come back. | 15 | 66 |
| Well, I have this other product; it's a little | 16 | 66 |
| more expensive, I can get you in right now. | 17 | 66 |
| That's always going to be the answer. So, there | 18 | 66 |
| needs to be something to offset that. | 19 | 66 |
| MR. COLLINS: Doug, if you could go | 20 | 66 |
| back to some of the statistics you cited in your | 21 | 66 |
| opening comments around foreclosures. I think you | 22 | 66 |
| had numbers for 2001 and 2005, but at the same | 23 | 66 |
| time, you stated that there's a lot of conversions | 24 | 66 |
| in the prime and subprime markets, and a lot of | 1 | 67 |
| advances in the marketplace since 2001. How do | 2 | 67 |
| you see the outcomes of the decisions today, as | 3 | 67 |
| the Governor's indicated, do you have a good sense | 4 | 67 |
| of whether or not those numbers are comparable? | 5 | 67 |
| MR. DUNCAN: Sure. We surveyed | 6 | 67 |
| delinquencies, about 42 million loans at this | 7 | 67 |
| point in our data base, on a quarterly basis, and | 8 | 67 |
| we have been, for about the last year, suggesting | 9 | 67 |
| that there were about four reasons that we should | 10 | 67 |
| expect to see delinquencies in foreclosure rates | 11 | 67 |
| rise. | 12 | 67 |
| Those four reasons are: First, any | 13 | 67 |
| loan peaks in its probability of delinquency in | 14 | 67 |
| three to five years of its life and less than half | 15 | 67 |
| of all loans outstanding today are more than three | 16 | 67 |
| years old. So this puts an upward pressure on | 17 | 67 |
| delinquencies. | 18 | 67 |
| The second thing is that, as after | 19 | 67 |
| every re-fi, after this re-fi we've seen an ARM | 20 | 67 |
| boom, and that's because of the way the yield | 21 | 67 |
| curve works, long rates rise and short rates stay | 22 | 67 |
| low so consumers shift into ARMs. Then when the | 23 | 67 |
| short end of the yield curve comes up, then they | 24 | 67 |
| shift back to fixed-rate products. That's been | 1 | 68 |
| underway for the last couple of quarters. This | 2 | 68 |
| ARM process was extended because of the production | 3 | 68 |
| of the new loans that you referred to, various | 4 | 68 |
| alternative adjustable processes. ARM loans | 5 | 68 |
| always have a higher delinquency rate than | 6 | 68 |
| fixed-rate loans, so the market expects that. | 7 | 68 |
| The third factor is the growth of the | 8 | 68 |
| subprime market, which we're talking about here. | 9 | 68 |
| Relative to the total portfolio, subprime has | 10 | 68 |
| grown faster because of those things I talked | 11 | 68 |
| about earlier, lowering the cost hurdles. All | 12 | 68 |
| three of these forces will combine with what has | 13 | 68 |
| been recently rising interest rates to put upward | 14 | 68 |
| pressure on delinquency. | 15 | 68 |
| The primary factor operating in the | 16 | 68 |
| other direction is the single most important | 17 | 68 |
| factor in predicting foreclosure or delinquency | 18 | 68 |
| foreclosure, which is employment. As the | 19 | 68 |
| economy's been adding two million jobs, roughly, | 20 | 68 |
| per year for the last two and a half years or so, | 21 | 68 |
| that puts downward pressure on foreclosure. | 22 | 68 |
| This is the number one, most important | 23 | 68 |
| thing, employment and real income growth. If we | 24 | 68 |
| were to see a significant climb in employment, we | 1 | 69 |
| would see a different behavior in delinquencies, | 2 | 69 |
| but we do expect, over the next couple of years, | 3 | 69 |
| modest rises in delinquencies, and we saw it in | 4 | 69 |
| the fourth quarter, modest rise in delinquencies. | 5 | 69 |
| They went from, in the third quarter, 4.40 percent | 6 | 69 |
| to 4.70 percent delinquent, but we put a caveat in | 7 | 69 |
| there because .157 of that increase was Katrina. | 8 | 69 |
| If we stripped that out, it went from 4.40 to | 9 | 69 |
| 4.45. The way we stripped it out, we just said, | 10 | 69 |
| what if they stayed constant at the same rate of | 11 | 69 |
| increases as every other state. So, as we've been | 12 | 69 |
| suggesting, we will expect to see modest rises in | 13 | 69 |
| delinquencies. | 14 | 69 |
| One other thing to think about is, as | 15 | 69 |
| we're trying to determine whether we're at the | 16 | 69 |
| cusp of a slow down, whether monetary policies are | 17 | 69 |
| properly positioned, it's also the place where the | 18 | 69 |
| yield curve has been flat, and that's the | 19 | 69 |
| inflexion point for the mortgage bracket, where | 20 | 69 |
| underwriting stresses are the most difficult in | 21 | 69 |
| terms of predicting into the macro economic | 22 | 69 |
| environment. So we would expect to see that as | 23 | 69 |
| something that causes delinquencies and | 24 | 69 |
| foreclosures as well. | 1 | 70 |
| GOVERNOR OLSON: Two questions. One, | 2 | 70 |
| let me come back to you, Doug, and this is for | 3 | 70 |
| clarification, and then I want to come back to Ira | 4 | 70 |
| on the sheriff. We think, in most of the rest of | 5 | 70 |
| the country, we think of some of these products as | 6 | 70 |
| being very new. The option Alt A payments, if you | 7 | 70 |
| will, and the negative AM payments, and they are | 8 | 70 |
| relatively new in the east, but they're old | 9 | 70 |
| products, 25 years, in some cases, in the West | 10 | 70 |
| Coast. So we have a long history of those kinds | 11 | 70 |
| of products in the West Coast. Do the statistics | 12 | 70 |
| that you cite -- and we have seen those products | 13 | 70 |
| -- we have history of those products going through | 14 | 70 |
| rate cycles, and Peter, you would, perhaps, help | 15 | 70 |
| with this. What has the market's experience been | 16 | 70 |
| with those products through rate cycles? | 17 | 70 |
| MR. ZORN: You go, and then I'll go. | 18 | 70 |
| MR. DUNCAN: Well, the -- I think the | 19 | 70 |
| difference is the volume of them that's been done | 20 | 70 |
| relative to the size of the market, and we don't | 21 | 70 |
| know whether that's going to reveal a performance | 22 | 70 |
| difference today from what would have historically | 23 | 70 |
| been the case. Historically, lots of those loans | 24 | 70 |
| were held in portfolios with regulated lenders. | 1 | 71 |
| GOVERNOR OLSON: It's a huge | 2 | 71 |
| difference. | 3 | 71 |
| MR. DUNCAN: That's right. And they | 4 | 71 |
| performed well in those institutions but the | 5 | 71 |
| expansion outside of that, leaves open an | 6 | 71 |
| empirical question which we won't know until it | 7 | 71 |
| plays out. | 8 | 71 |
| MR. ZORN: Our experience is historical | 9 | 71 |
| experiences. They, in our portfolio, overperform. | 10 | 71 |
| That is, they are our best credit risk that | 11 | 71 |
| reflects, I believe, the changes -- | 12 | 71 |
| GOVERNOR OLSON: Sorting out your | 13 | 71 |
| insider jargon. The interest lending loans | 14 | 71 |
| perform better than the other product in terms of | 15 | 71 |
| their delinquency. | 16 | 71 |
| MR. ZORN: Correct. Historically. | 17 | 71 |
| Which I think has almost nothing to do with how | 18 | 71 |
| the current -- | 19 | 71 |
| GOVERNOR OLSON: Okay. Ira, the | 20 | 71 |
| sheriff. In my lending days, we would do anything | 21 | 71 |
| to avoid a foreclosure. In a foreclosure, from | 22 | 71 |
| the time we initiated the foreclosure -- from the | 23 | 71 |
| time the sheriff got involved in Minnesota, it was | 24 | 71 |
| a one-year period before we could do anything with | 1 | 72 |
| that property. The value of the property | 2 | 72 |
| disappeared, or at least declined. It was | 3 | 72 |
| enormously expensive. | 4 | 72 |
| Foreclosure -- I don't know what the | 5 | 72 |
| laws are in Pennsylvania, but the laws | 6 | 72 |
| significantly protected the interest of consumers | 7 | 72 |
| in that respect and provided the lenders with a | 8 | 72 |
| significant incentive to avoid the foreclosure | 9 | 72 |
| process. And now I'm hearing that -- in fact, we | 10 | 72 |
| heard this on Wednesday, that the initial notice | 11 | 72 |
| of foreclosure -- by the grace of God I'm not | 12 | 72 |
| burdened with a law degree, so I don't know the | 13 | 72 |
| legal terms, but the initial notice of | 14 | 72 |
| foreclosure, in fact, triggered other lenders to | 15 | 72 |
| come in, or pass the buck artists, more likely, to | 16 | 72 |
| come in and provide what they perceived to be | 17 | 72 |
| solutions, but, in fact, put them in deeper | 18 | 72 |
| trouble. The Neighbor Works tell us, who have a | 19 | 72 |
| great service of assisting people who are, | 20 | 72 |
| perhaps, facing foreclosure, the greatest | 21 | 72 |
| difficulty that they have is finding the people | 22 | 72 |
| who may be in need of the counseling. So bring me | 23 | 72 |
| current, if you will, on how that process works | 24 | 72 |
| and to who's advantage it works, if anyone. | 1 | 73 |
| MR. GOLDSTEIN: I, too, am not burdened | 2 | 73 |
| by a law degree. I'm burdened by a degree in | 3 | 73 |
| sociology; it's a different kind of burden. | 4 | 73 |
| In Pennsylvania, one gets, first, a | 5 | 73 |
| notice, by law, by state law, that you are in | 6 | 73 |
| trouble and that your lender is going to | 7 | 73 |
| foreclose. | 8 | 73 |
| GOVERNOR OLSON: And that's typically | 9 | 73 |
| with what, a 180-day delinquency? | 10 | 73 |
| MR. GOLDSTEIN: It varies dramatically | 11 | 73 |
| from 90 to -- | 12 | 73 |
| GOVERNOR OLSON: But the lender | 13 | 73 |
| definition of going into foreclosure. | 14 | 73 |
| MR. GOLDSTEIN: Exactly. They get that | 15 | 73 |
| notice, and in Pennsylvania, they have an | 16 | 73 |
| opportunity to apply to a state program, which, | 17 | 73 |
| under certain circumstances, it will bring them | 18 | 73 |
| current if they apply and are approved. It's | 19 | 73 |
| called the HEMAP, Homeowners Emergency Mortgage | 20 | 73 |
| Assistance Program, and it's been in the state of | 21 | 73 |
| Pennsylvania for 25 or 30 years. It's designed to | 22 | 73 |
| get people past the point in time when they are in | 23 | 73 |
| trouble, essentially, through no fault of their | 24 | 73 |
| own, and manifest some likelihood of being able to | 1 | 74 |
| get back on their feet again at some point in the | 2 | 74 |
| future. | 3 | 74 |
| So people make application to this | 4 | 74 |
| program through an approved state housing | 5 | 74 |
| counseling agency. If they are approved, the | 6 | 74 |
| state gives them a loan, which brings them | 7 | 74 |
| current. It sits out there as a second loan. | 8 | 74 |
| They make a minimal monthly payment until such | 9 | 74 |
| time as they can pay, both, their existing | 10 | 74 |
| mortgage and this other mortgage. That is not | 11 | 74 |
| available, by the way, to people with FHA loans. | 12 | 74 |
| It was designed at a time when FHA had a different | 13 | 74 |
| set of loss mitigation things than they have | 14 | 74 |
| today. | 15 | 74 |
| Assuming that they're not successful | 16 | 74 |
| there, a piece of paper, a lawsuit, is essentially | 17 | 74 |
| filed with the prothonotary or the clerk of courts | 18 | 74 |
| in the various counties of Pennsylvania, and at | 19 | 74 |
| that point, having worked with the prothonotary | 20 | 74 |
| somewhat, we find that those lists are oftentimes | 21 | 74 |
| sold to two parties, one party being attorneys | 22 | 74 |
| looking to represent people, and secondly to | 23 | 74 |
| lenders or brokers who are looking to make those | 24 | 74 |
| loans that you were describing. | 1 | 75 |
| That process can stretch out over a | 2 | 75 |
| year to, maybe, even five years, depending on the | 3 | 75 |
| kinds of things that people do to defend against | 4 | 75 |
| the foreclosure, if anything, including an | 5 | 75 |
| affirmative defense that something went wrong in | 6 | 75 |
| the transaction or a bankruptcy or something else | 7 | 75 |
| of that nature. Ultimately -- and during that | 8 | 75 |
| period of time, obviously, they could make some | 9 | 75 |
| other kinds of arrangement to become current. | 10 | 75 |
| At the end of that process, if the | 11 | 75 |
| lender succeeds in the foreclosure action, the | 12 | 75 |
| house is listed for sheriff's sale and then is | 13 | 75 |
| sent to the auction block, and that could take a | 14 | 75 |
| year as well. It's not a speedy process. In | 15 | 75 |
| fact, I would say that Philadelphia and | 16 | 75 |
| Pennsylvania, generally, is relatively slow in the | 17 | 75 |
| process, and we've observed, for example, in | 18 | 75 |
| Delaware or Maryland, our experience in Baltimore | 19 | 75 |
| is, a year from start to finish; you're out. It's | 20 | 75 |
| quick and certain. | 21 | 75 |
| But that is the way it works in | 22 | 75 |
| Pennsylvania. And I would say that in terms of | 23 | 75 |
| the lenders appetite for not wanting to foreclose, | 24 | 75 |
Class Act Reporting Agency, Philadelphia, Pennsylvania, 215-928-9760
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