Before the

Housing and Urban Revitalization Committee

Ohio House of Representatives
February 25, 2009
The Need for Foreclosure Reform in Ohio: HB 3
Submitted by Paul Bellamy, JD, Ph.D.
Director, Cuyahoga County Foreclosure Prevention Program
Cuyahoga County Foreclosure Prevention Program
I amthe Director of the Cuyahoga County Foreclosure Prevention Programin
Cleveland. The Foreclosure Prevention Programwas created by the County
Commissioners and County Treasurer JimRokakis in the spring of 2006 to assist
the residents of Cuyahoga County who were having trouble with (or had
questions about) their home loans. The program, which has become a model for
other programs nationwide, connects borrowers in distress with local, non-profit,
housing counseling agencies through the United Way's First Call for Help line.
My testimony today will attempt to summarize the scope, severity and likely
future trends concerning home foreclosures in Ohio, and howand why it is that
we desperately need to change Ohio lawto assert more control over the home
foreclosure process. We must act to transformthe current foreclosure system
froma wealth destroying process into a wealth preserving process.
Scope of the Problem
Ohio Foreclosure Filings
1994 - 2008
17,026
15,975
18,818
21,914
25,862
31,229
35,377
43,419
55,274
57,083
59,007
63,994
79,072
83,230
85,773
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: Supreme Court of Ohio
2
By nowwe have all seen some variation of the graph above. Foreclosures have
increased in Ohio every year since 1996. The increases are not rural, and they
are not urban, they have afflicted all of Ohios communities for well over a
decade. The damage they have caused to our communities has been
cumulative and in too many neighborhoods, devastating.
The latest National Delinquency Survey fromthe Mortgage Bankers Association
breaks out Ohio foreclosure filings in the 3
rd
quarter of 2008 by type of loan.
In Ohio, the plurality of home foreclosures continues to consist of subprime loans.
This is important to remember, because it is the subprime loans that are causing
staggering losses to investors, and those ever-increasing losses (in both
subprime and prime) have emerged as the most important reason we need to
change the Ohio foreclosure process. Our communities aggregated wealth is
needlessly evaporating under the stress imposed by of the current, often
irrational, foreclosure process.
According to a November report fromFirst American CoreLogic, Ohio ranks 7
th
nationally in the percentage of owner-occupied homes that are underwater---
more is owed on the mortgage(s) than the home is worth. This translates into
419,000 Ohio homes saddled with mortgage debt that exceeds the selling price
of the house. Add in Ohioans who are debt leveraged to 95%of their current
home value (the-soon-to-be-underwater) and the total rises to 553,000
households or nearly 30%of all the mortgaged properties in Ohio. This debt
Foreclosure Filings
Ohio, 3Q08
By Loan Type
Cases in Quarter - 17,018
VA
2%
Prime
37%
Subprime
45%
FHA
16%
Source: National Delinquency Survey, 3Q08, MBA
3
burden in Ohio translates into a statewide average loan to value rate of 76%, ten
percentage points over the national rate of 66%.
These upside down homes are teetering on the edge. Owners have no
options to sell or refinance when their household income takes even a slight hit.
To that extent, these are foreclosures waiting to happen.
As if these ominous measures werent enough, statewide unemployment is now
contributing to the casual vortex of home foreclosures. Unlike the 1980s when
unemployment spiked and mortgage delinquencies rose incrementally, todays
typical Ohio household is over-leveraged and often facing a subprime ARMor
even Alt-A reset on their mortgage. Little wonder that the most recent statistics
Ohio Quarterly Mortgage 90+ Days Past Due & Unemployment Rates
1979 to 3Q 2008
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Q
3
_
2
0
0
8
Q
3
_
2
0
0
7
Q
3
_
2
0
0
6
Q
3
_
2
0
0
5
Q
3
_
2
0
0
4
Q
3
_
2
0
0
3
Q
3
_
2
0
0
2
Q
3
_
2
0
0
1
Q
3
_
2
0
0
0
Q
3
_
1
9
9
9
Q
3
_
1
9
9
8
Q
3
_
1
9
9
7
Q
3
_
1
9
9
6
Q
3
_
1
9
9
5
Q
3
_
1
9
9
4
Q
3
_
1
9
9
3
Q
3
_
1
9
9
2
Q
3
_
1
9
9
1
Q
3
_
1
9
9
0
Q
3
_
1
9
8
9
Q
3
_
1
9
8
8
Q
3
_
1
9
8
7
Q
3
_
1
9
8
6
Q
3
_
1
9
8
5
Q
3
_
1
9
8
4
Q
3
_
1
9
8
3
Q
3
_
1
9
8
2
Q
3
_
1
9
8
1
Q
3
_
1
9
8
0
Q
3
_
1
9
7
9
Sources: MBA Delinquency Surveys & US Bureau of Labor Statistics
0%
2%
4%
6%
8%
10%
12%
14%
16%
All Loans: 90 days Past Due, Ohio (NSA, %) Ohio Unemployment Rate
Ohio
4
on Ohio loan delinquencies are showing a sharp upward spike along with the
rising unemployment rate.
By nowit is well documented that rampant foreclosures cause losses to spill
beyond the households caught up in the painful legal process of losing their
home. Foreclosures diminish the value of adjacent and near-by properties and
are a major contributing factor in the loss in value that is dragging our real
estate market down. This correlation is illustrated by the four graphs attached
to this testimony that portray foreclosure volumes and tanking values across
housing markets in Ohio.
Moreover, the implications for Ohios real estate tax base are frightening.
Communities across that state are already suffering fromdeclining sales and
income tax revenues and cutbacks to local government services are well
underway. And this body is well aware of howthe struggling Ohio economy has
affected the states own budget.
This is no longer an issue of borrowers vs. lenders, or even lenders vs.
communities. It is no longer an us and them issue. The problemfacing
Ohio is the accelerating loss of wealth, everybodys wealth, and the reason the
states foreclosure process must be reformed is because, as presently constituted,
foreclosures are costing everyone money: not just borrowers, not just investors,
and not just local communities. Everybody.
Underlying Structural Problems with the Foreclosure Remedy
A recent Credit Suisse study (Deep Dive into Subprime Mortgage Severity, Fixed
Income Research Report, June 19, 2008) found that in Ohio, Michigan and
Indiana the loss severity rate for foreclosures on subprime loans was averaging
over 80%in the six months leading up to May of 2008. So in Ohio, on a
foreclosure of a $100,000 subprime loan, the average recovery for the investors
was less than $20,000.
Howdid it come to pass that the foreclosure process, a legal remedy designed to
preserve the value of the asset securing a lenders capital, has evolved to be a
major cause of investor losses? The answer lies in recent developments in the
structure of the mortgage industry coupled with sustained, declining real estate
values.
Mortgage Servicers: Third Party Managers of Investors Risk
The table belowlists the top ten prime and subprime mortgage servicers in the
United States as of the 3
rd
quarter of 2008. Together they manage about 75%
of the countrys outstanding mortgage debt, approximately 7.4 trillion dollars.
While the firms listed belowseemto overlap with the banks and companies that
5
originated mortgages, to the extent they are servicing loans they comprise a
wholly different industry.
Clockwork mortgage
Mortgage servicers are paid a set fee to act as go-betweens for the investors
who bought into a mortgage-backed security. The fee is measured in basis
points (ordinarily 25 to 50) and is tied to the outstanding loan balance for the
mortgages they administer. The relationship between the investors and
servicers is governed by a complicated document called a Pooling &Servicing
Agreement (PSA) which outlines a multitude of relationships and responsibilities
between the investors, their representative trustee, the servicer and, as a
practical matter, the homeowners whose mortgages are included in the pool.
Among the duties that fall to servicers is supervising collection efforts on
delinquent loans and triggering and overseeing the foreclosure process.
Servicer Advances and Other Complications
Key to understanding howand why servicers pursue economically irrational
foreclosures is knowing that pooling and servicing agreements require that the
Rank Company City State Prime Subprime Total Mortgage
Balance
1 Bank of America Charlotte NC $2,012,100,000,000 $92,125,000,000 $2,104,225,000,000
2 Wells Fargo & Co. San Francisco CA $1,509,179,000,000 $48,000,000,000 $1,557,179,000,000
3 Chase Iselin NJ $845,438,000,000 $63,806,000,000 $909,244,000,000
4 CitiMortgage, Inc. O'Fallon MO $815,273,000,000 $60,000,000,000 $875,273,000,000
5 Washington Mutual* Seattle WA $585,100,000,000 $585,100,000,000
6 ResCap (GMAC) Minneapolis MN $391,945,000,000 $391,945,000,000
7 Wachovia Mortgage* Charlotte NC $200,380,000,000 $200,380,000,000
8 National City Mortgage Miamisburg OH $189,244,000,000 $189,244,000,000
9 IndyMac Bancorp* Pasadena CA $172,000,000,000 $172,000,000,000
10 Sun Trust Mortgage Richmond VA $156,809,000,000 $156,809,000,000
4 Litton Loan Servicing Houston TX $53,000,000,000 $53,000,000,000
5 Saxon Mortgage Services Fort Worth TX $48,122,000,000 $48,122,000,000
7 Home Loan Services, Inc. Pittsburgh PA $47,443,000,000 $47,443,000,000
8 Ocwen Loan Servicing W. Palm Beach FL $44,832,000,000 $44,832,000,000
9 American Home Mortgage Irving TX $40,771,000,000 $40,771,000,000
10 Homeq Servicing Corp. North Highlands CA $38,110,000,000 $38,110,000,000
TOTALS $6,877,468,000,000 $536,209,000,000 $7,413,677,000,000
Top Ten Prime and Subprime Servicers
3
rd
Quarter 2008
Source: www.nationalmortgagenews.com/freedata/?what=serv
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servicer carry a defaulting homeowner by advancing missing monthly payments
(usually principal and interest) to the investors. PSAs also require that servicers
advance the considerable costs of foreclosure, REO and final liquidation.
Generally, the servicer will be reimbursed for their advances---but ordinarily only
when the foreclosed property is finally liquidated, that is, sold to a third party.
In addition to the financial pressure for servicers to get out fromunder their
advancing obligations as soon as practiable, there are other structural problems
that create disincentives for serviers to seek alternatives to foreclosure. In a
recent speech, Federal Reserve Chairman Ben Bernanke summarized the
dynamics:
However, despite the substantial costs imposed by foreclosure . . . some
foreclosures are continuing to occur even in cases in which the narroweconomic
interests of the lender would appear to be better served through modification of the
mortgage. This apparent market failure owes in part to the widespread practice of
securitizing mortgages, which typically results in their being put into the hands of
third-party servicers rather than those of a single owner or lender. The rules
under which servicers operate do not always provide themwith clear guidance or
the appropriate incentives to undertake economically sensible modifications. The
problemis exacerbated because some modifications may benefit some tranches of
the securities more than others, raising the risk of investor lawsuits. More
generally, the sheer volume of delinquent loans has overwhelmed the capacity of
many servicers, including portfolio lenders, to undertake effective modifications.
To reviewan exhaustive list of all the forces that groove the industry to
foreclose on a home in preference over other, less drastic measures, would
range well beyond the scope of my testimony today.
However, to summarize Chairman Bernacke, servicers are third parties who act
on behalf of mortgage backed security investors who are, in turn, represented by
trustees. There is little or no direct oversight of the servicing process by the
investors themselves. The PSAs, contracts that define what servicers can and
cannot do when faced with a defaulting homeowner, often fail to provide explicit
guidance. And too, investors in the same mortgage backed security will usually
have conflicts amongst themselves because they hold different risk and return
levels or tranches that define howlosses to the trust will be allocated among
the investors. Finally, the explosion in mortgage delinquencies has simply
overwhelmed the servicers, who set their compensation levels according to
historic, as opposed to the current, inflated, rates of default.
As a result of these complicating issues, often the safest and most cost effective
option for the servicers is to foreclose on a property. The alternative is to make
the substantial commitment of time and resources required for a loan workout or
modification---efforts (and advances) that, even when successful, will not be fully
reimbursed to the servicer.
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And so, economically irrational foreclosures proceed apace, ever increasing
losses to investors notwithstanding.
In a stable or appreciating real estate market with historically normative
delinquency rates, these complicated PSA arrangements served the best interest
of investors by encouraging servicers to foreclose on soured loans as quickly as
possible. In a stable or appreciating market, the investors could rely upon
getting most of the principal balance back fromthe sale the property. But in an
unprecedented, swooning market---such as prevails today---these underlying
dynamics and safeguards become impediments that cause, rather than avoid,
losses.
Reforming the Foreclosure Process
Defining the scope and controlling the legal process of foreclosure is well within
the constitutional purviewof the state. Under the exceptional economic
conditions facing Ohio today, this power must be judiciously exercised so as to
return a rational, economically efficient dynamic to the foreclosure process. In
ordinary times this would not be necessary, but these are not ordinary times.
Ohio is faced with a wealth-destroying crisis of unprecedented proportions that is
undermining the economic viability of the states entire economy.
This is not a matter of interceding to protect borrowers, or investors, or even
local communities. The goal must be to return the original purpose of the
foreclosure proceeding to the system---preserving asset values which will
ultimately serve to benefit everyone---no matter who actually owns the home.
As mortgage investors have come to know, indiscriminately foreclosing on homes
in Ohio is causing themtremendous losses, because all too often it is not
economically rational to evict yet another family, to create yet another vacant
house, to burden yet another neighborhood.
Ohio needs to reformthis lose-lose-lose process and return economically
rationality and order to the foreclosure systemand thereby preserve wealth,
whenever and wherever possible.