When Uncle Sam forecloses

June 20, 2011
who's on which side:

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You probably won’t be surprised to hear that Wells Fargo is sparring with the government on the subject of foreclosures. But you might be surprised to see who’s on which side:

Wells Fargo & Co. decided to exit reverse mortgages after federal officials insisted it foreclose on elderly customers who were behind on property tax and insurance payments, a Wells executive wrote in an email to business contacts Friday…

Reverse mortgage market participants generally agreed that the industry is enduring hard times…

One problem is that lenders are not allowed to set aside payments for property taxes and other such recurring costs, leading to trouble if the borrower cannot pay them. Contributing to the issue is a prohibition on underwriting loans based on borrowers’ credit rather than the equity they have in their home.

A third problem arises in the course of disposing of the property. If the borrower dies and the equity in the home does not cover the mortgage, the FHA is responsible for making up the difference. But it is often the lender’s duty to dispose of the house, a process that sometimes forces it to eat some of the costs. An FHA requirement that the lender not sell the house for less than 95% of its appraised value can make that process difficult, Lewis says. “Imagine 5% as your margin on this kind of housing market — it’s insane. If someone has a 375 bid for a 400 house, we can’t sell it.”

All of this is, of course, a direct consequence of the fact that the government is now more lender than regulator when it comes to mortgage finance. Rather than standing up for beleaguered borrowers, it now has a huge financial interest in extracting as much money from them as it can, as quickly as possible.

It’s also completely insane that lenders can’t underwrite reverse mortgages: if we learned anything during the housing crisis, it’s that writing mortgages based on nothing but home value is a recipe for disaster. Tanta, of course, explained this better than anyone:

Three things have been the core of mortgage underwriting since roughly the dawn of time: the three Cs, or Credit, Capacity, and Collateral. Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid? …

“Traditional” subprime lending was about loans to people who had capacity but not creditworthiness or who had creditworthiness and capacity but not great collateral…

Given assumptions about the collateral—like, its value always goes up and its value always goes up—you could more or less forget about problems with the other two Cs. When the RE markets were hot enough, in fact, there weren’t “problems” with the other two Cs.

This was spectacularly boneheaded even during the height of the real-estate boom. But it’s even more boneheaded in an environment where homes are falling in value. You can’t underwrite a mortgage, reverse or otherwise, based only on collateral and not at all on creditworthiness. You just can’t. We’ve learned this a million times. And yet HUD is forcing lenders to do just that — and then forcing them to foreclose when the loans go sour, even if the only delinquency is on property tax and insurance payments.

The big problem here, of course, is that no regulator is going to tell HUD to shape up and get its act together. The private sector turned out to be very bad at writing mortgages, during the boom. But it looks increasingly as though the public sector will turn out to be just as bad, during the bust.


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