Tuesday, April 8, 2008

Fair Housing For All

By Stephen Menendian, Research Associate at the Kirwan Institute

As we pay tribute to the life of MLK Jr. and celebrate the anniversary of the Fair Housing Act, it is fitting to reflect on a new housing crisis that is affecting our cities and urban neighborhoods. A wave of foreclosures threatens not just the lives of Americans who are black or poor, but entire regions. The short-term profit making of financial institutions, mortgage brokers, and securities dealers now threatens the health of the entire economy.

Deregulation in the 1980s and a rise in real estate values led investment bankers, hungry for mortgage backed securities to sell to investors, to promote asset-based lending rather than income-based lending, a practice that fueled the subprime market. This phenomenon took off in 1994 when $10 billion worth of subprime home equity loans were securitized. By the end of 2005, the volume of securitized loans leaped to $507 billion. This arrangement let mortgage companies specialize in home equity lending and make a lot more money. They could make loans and quickly resell the loan into the secondary market. Mortgage brokers were acting like direct salesmen rather than agents of the homeowner, marketing subprime loans to would-be homeowners who might not be able to afford a home under a prime mortgage arrangement and even those who qualified for prime mortgages.

This ponzi scheme may have made sense if property values kept on rising. You could purchase a home with very low, interest-only, monthly mortgage payments and refinance a few years later with tens of thousands of dollars of equity due to home value appreciation.

The mortgage broker earned an origination fee, typically $2500, and then made that money again when the homeowner refinanced. The investment bank had already made their money selling these securities to investors. The originating mortgage lender had already sold the mortgages to the investment banks. In short, the banks and mortgage brokers set people up in loans they knew they would not be able to afford and passed the risk off to investors and to the home-buyer.

About 46% of Hispanics and 55% of blacks who obtained mortgages in 2005 got higher-cost loans compared with about 17% of whites and Asians, according to Federal Reserve data. Other studies indicate they would have qualified for lower-rate loans. The most recent estimate is that African American and Latino homeowners will lose a quarter of a trillion dollars in home equity in the next two years as a result of the crisis—the largest loss of home equity ever experienced in US history among African American and Latino homeowners.

It’s not too late to do something about it, but it won’t be easy. The servicers, the companies hired by the mortgage holders to manage the mortgage payments, are not particularly interested in the well being of the homeowner or the investors either. They make more money when the homeowner is saddled with late payments and other ancillary fees. Forbearance agreements are onerous and tend to accelerate foreclosure rather than stave it off.

The final result is foreclosure. The homeowner loses their house. The investors lose their collateral asset. Foreclosures lead to abandoned and vacant homes. This causes neighborhoods, especially ones already struggling, to decline rapidly by reducing the value of property of nearby homes. (A Fannie Mae study using Chicago found that every foreclosure is responsible for an average decline of 1% in the value of each single-family home within a quarter mile). This in turn results in lost tax revenue from property taxes, which makes it more difficult for the city to borrow funds because the value of the property tax base is used to qualify for loans. Communities lose property tax values with cities and states suffering. Schools lose revenue. Services have to be cut back. In Baltimore, for example, the total estimated costs for the city are about $34,199 per foreclosure.

The subprime implosion is fueling a cycle of foreclosures and economic loss that is as vicious as it is pernicious. I only hope that it is not too late to intervene, but the solution will not come by saving Bear Sterns, by corporate tax breaks, or by rescuing investors from bad investments. It will come by empowering homeowners to renegotiate the basic terms of predatory mortgages to reflect the real value of the home and a realistic ability to repay.

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