Fixing the subprime lending crisis

When we learned that the foreclosure rate jumped 47 percent in March 2007 from just one year ago, it sent shock waves through the halls of Congress. The rumors of the impending crisis in the subprime lending market were trumpeted several weeks ago, when Freddie Mac, which buys loans from lenders and sets underwriting standards, stopped purchasing loans on which interest rates are fixed for only the first two years or three years of a 30-year loan.

Within the last month, the nation’s second largest subprime lender, New Century Financial Corp., ceased making any new subprime loans because of the huge number of defaults on subprime mortgage loans. New Century has since filed for bankruptcy protection.

Just as Congress begins serious deliberations on this issue, defaults on subprime mortgage loans have prompted investors to sour on mortgage backed securities, making it more difficult for subprime lenders to sell their loans or to raise cash for new loans. This liquidity trap for many borrowers, who want to refinance out of the non-traditional mortgage products, is a far cry from the huge amounts of cash that once sought high yields tied to mortgage backed securities. The symbiotic relationship in the subprime market, while creating easy money for borrowers, would never have been necessary for many borrowers if the mortgage market operated fairly.

Unfortunately, no one knows for sure what the extent of the exposure is and exactly who is exposed because of how mortgages are packaged into pools and sold to investors, making it difficult to determine who owns the loans and how much money is lost. A recent estimate by Lehman Brothers cited $19 billion in losses parked in loan pools assembled in the last three years, representing 5.5 percent of all mortgages.

In 2006, the Center for Responsible Lending’s “Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners” report documented the relationship between subprime lending and foreclosures — 2.2 million households could be at risk. Foreclosures are costly, and homeowners stand to lose as much as $164 billion in equity. Who realized that 25 percent of subprimes originated since 2005 would end in foreclosure? The wealth creation expected from homeownership has translated into wealth evaporation — tied to foreclosures.

Regulators issued guidance that acknowledged that subprime loans were a problem. Even so, the Federal Reserve was lambasted in Senate hearings for not acting quickly enough on this issue. That guidance suggests that lenders be required to take into account the borrower’s ability to make monthly payments at higher rates and also pay property taxes and homeowners insurance, which are often not escrowed in the subprime loans.

Forbearance on the part of lenders is critical to borrowers while Congress sorts through the subprime landmines, and before this crisis leads to something catastrophic in the financial markets. Earlier this year, global financial markets became jittery as the subprime debacle unfolded. Having already spilled over into the homebuilding industry, we know that the fallout is far from over.

Congress must balance the interests of homebuyers who are low- and moderate-income first-time buyers, ensuring that they avoid the pitfalls of the subprime market in the future with safer mortgage options. Investors and others who made rational decisions that led to using a subprime product are not victims. Many Americans were steered to the subprime market; some could have had their mortgage needs met in the conventional market. There is documentation substantiating that African Americans and Latinos hold a disproportionate number of subprime mortgages such as Adjustable Rate Mortgages (ARMs), which can lead to foreclosures.

I have introduced H.R. 1852, the Expanding American Homeownership Act of 2007, to modernize the Federal Housing Administration (FHA). We will be able to alter the mortgage landscape to allow FHA to become a more viable mortgage insurer to low- and moderate-income families and first-time homebuyers. Counseling and reasonable workout plans represent other mechanisms that can assist homeowners from falling into foreclosure. Lenders know that they are better off not losing borrowers to foreclosure, since it very costly to the lenders as well as to communities, creating a ripple effect in the communities where the properties are located — vacancies, blight and arson.

Congress can stem the tide of foreclosures by considering anti-predatory lending legislation that protects consumers and is fair to lenders. If lenders are not willing to use forbearance and other measures to correct subprime lending, Congress can not sit by and watch Americans lose their homes. Every time there is a victim to foreclosure, the rate of homeownership in America falls.

Waters is a member of the Financial Services Committee.

SPECIAL SECTION: FINANCE

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