The Mortgage Mess: It’s The Borrower’s Fault

With so much mortgage mayhem in the news it follows that we must blame someone for today’s growing real estate reverses, so why not fault he borrower?

The blame game was part of an interesting discussion that took place at the annual Five Star Default Servicing Conference, an event that attracted several thousand attendees to Dallas in mid-September. The Five Star is the place to be if you want to understand the world of loan servicing, a real estate specialty much in the news because servicers are the folks who have a lot to do with mortgage modifications, the buying and selling of large packages of properties, mortgage defaults, foreclosure auctions and REOs — foreclosed real estate owned by lenders.

I went to learn, and also to participate on a panel to discuss looming legislative trends. Given that the presidential election cycle is heating up — and given the urge to have the government “do something” about the growing foreclosure mess — the idea of forthcoming government action is hardly unreasonable. Less clear are what actions the government should actually take.

The panel itself included individuals with substantial experience in such fields as loan servicing, real estate auctions, foreclosure data, automated valuation systems, risk analysis and real estate law. Not only was the panel’s expertise diverse, so were the viewpoints.

“What’s remarkable about the Five Star legislative panel is not that views conflicted, but how much the debate has changed.” says Jim Saccacio, chairman and CEO at, the leading online marketplace for foreclosure properties. “Six months ago there was no widespread talk about requiring lenders to serve the best interests of borrowers or ending prepayment penalties. Now such topics are plainly on the table.””

In the Dallas setting — and with two hours available for debate — you might expect to hear the pros and cons of such subjects as an end to prepayment penalties, the creation of a “suitability” standard for loan officers, better up-front loan disclosures, an end to the tax on borrower losses when a loan is not fully repaid, the new FHASecure program and whether loan officers should be licensed. And while these subjects were debated, one underlying issue kept the panel animated: Borrower responsibility.

Almost instantly this issue divided the panel into what was dubbed a “libertarian” wing and what I would call a “not-so-quick” faction, a faction of which I was a part.

The libertarian camp presented an equation that went like this: Since borrowers ultimately make all loan decisions, any and all shortfalls, misunderstandings, unexpected costs or excess fees are simply a by-product of inadequate market research. It’s the borrower’s fault. If borrowers want better loans they should go out there, shop around, get educated and find the mortgages that best meet their circumstances.

As to increased government regulation or requiring lenders to act in the best interest of borrowers, forget it. Instead, said the libertarians, let reform be driven by market forces and voluntary lender changes.

Why such a harsh attitude? The libertarian view largely reflects an online petition which says “any proposed bailout will only reward lenders and borrowers who acted irresponsibly, and it will punish people who work hard and diligently manage their finances by not buying houses which they cannot afford.”
The not-so-quick group took a more nuanced stance, suggesting that some borrowers may well be responsible for their own loan problems while most could benefit from better regulatory oversight.

The borrowers who evoked little panel sympathy were those who simply lied on their loan applications and as a result defaulted on their loans within one to three payments.

Yet even these most-tainted borrowers raised sticky issues. If mortgage fraudsters are so hideously unqualified and dishonest, how come lenders accepted and processed such loan applications? What happened to lender due diligence and underwriting standards? Would the libertarian contingent argue that lenders taken in by fraudulent borrowers deserved to suffer losses?

At this point it became fairly obvious that inept lenders, in fact, did have a major responsibility for the mortgage mess. Not to borrowers, but to investors who buy mortgage-backed securities.

Why is it that lenders have an obligation to protect investors but not borrowers? Because loan originators can be forced to buy back loans that quickly default or were created with fraud. Alternatively, a borrower who gets a lousy loan has little recourse other than to refinance — with still-another lender and at great cost. The first lender, who has already collected an assortment of fees and charges, is neither punished nor pummeled in the process.

While borrowers who lied on their mortgage applications evoked little sympathy from the panel, the same was not true with borrowers who were misled, misdirected and misadvised by lenders. While the libertarian contingent favored voluntary lender restraint, the panel majority generally agreed that some form of modernized government regulation is necessary.

For instance:
Should not borrowers have some expectation of fair play when dealing with lenders?
What’s fair or conscionable about a lender who offers to refinance your home at a low, low rate — but the fine print shows that the new rate only lasts for one month, after which the loan becomes just another high-cost ARM?

How are borrowers supposed to understand incomplete ads or complex mortgage terms when their only source of specific information are the very lenders who originate such loans?

The panel readily acknowledged that it’s not only lenders who have some responsibility for the current mortgage situation. That said, the idea that lenders have no responsibility to create suitable loans and no fiduciary obligation to get the best possible financing for borrowers didn’t fly with most panel members.

The panel generally agreed that for better or worse the foreclosure problem is now being politicized. Figures from RealtyTrac show why: There were 885,000 foreclosure actions in 2005, 1.26 million in 2006 and we may top 2 million foreclosure notices this year. Many of these homes will not actually be lost, however, because some borrowers will bring loans current, refinance or sell before the property is put up for sale.

Whatever happens, the irrefutable point is that armies of homeowners are being impacted by the mortgage meltdown. As the Mortgage Bankers Association points out foreclosure starts in the second quarter were the “highest in the history” since they began to survey such data.

How many people are being impacted by the current mortgage meltdown? The Census Bureau says a typical household has 2.61 people. Multiply that number by approximately 4 million actual and anticipated foreclosure actions from 2005 through 2007 and now you’re looking at 10.4 million people. Yes, some of them lied on their loan applications. Yes, some deserve little sympathy or no sympathy. But many borrowers were duped by unscrupulous lenders who offered incomprehensible mortgages as well as misleading and self-serving information, advice and counsel.

Those 10.4 million people recently wrapped up in the foreclosure process have friends, family, neighbors and co-workers. Suddenly we’re talking about vast armies of people — voters — with an immediate and unpleasant involvement in the foreclosure process or who know someone with mortgage problems.

“At every step in the process, from loan origination through the use of exotic unsuitable mortgages to the sale of securities backed by those mortgages, the largely unregulated uninsured firms have created problems, while the regulated and FDIC-insured banks and savings institutions have not,” said Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, in an op-ed piece for the Boston Globe.

Looking toward the future, Frank added that “in the coming months, Congress needs to apply that lesson — to adopt for all of the mortgage industry, both origination and secondary market sales, the sort of rules that served us well in the regulated sector.”
Mortgage reform lies ahead and it won’t be voluntary. It may not be as much as some members of the Five Star panel would advocate, but it will be far more than the libertarian contingent would prefer.
Columnist Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.

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