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 (Editor's Note:  This is the second in a series of articles summarizing material in the latest edition of "Evidence Matters" the new digest of housing research first published in February by the Department of Housing and Urban Development (HUD).  The current issue is devoted to rental housing as it was discussed at the Next Generation Housing Policy Conference held in October 2010.) 

The Next Generation conference featured three presentations on the topic of the future of the mortgage interest tax deduction (MID).  This feature of the tax code allows homeowners to deduct interest paid on one or more mortgages on up to two homes and its elimination is suggested in current attempts to reduce the budget deficit.  It is, in fact, the only tax increase to have come under wide discussion. The three economists who made presentations were:

• Edward Glaeser, Ph.D., Fred and Eleanor Glimp Professor of Economics at Harvard University.
• Todd Sinai, Ph.D., Associate Professor of Real Estate and Business and Public Policy at the University of Pennsylvania's Wharton School, Visiting Scholar at the Federal Reserve Bank of Philadelphia and Faculty Research Fellow at the National Bureau of Economic Research.
• David Crowe, Ph.D., Chief Economist and Senior Vice President at the National Association of Home Builders (NAHB).

Two of the three speakers argued forcibly for curtailing the deduction although their reasons differed.  Only Crowe, speaking for an industry group which benefits from home ownership, favored its continuation. 

Glaeser called the deduction a regressive one that artificially distorts behavior, including pushing people toward single-family detached houses, while at the same time being poorly designed to actually promote homeownership. He maintained that the government should not be encouraging people to use leverage to gamble on "the vicissitudes of the housing market," particularly in the wake of a housing crisis.  

The deduction, he said, also encourages people to buy bigger homes and he believes that Americans already live in homes that are too big for their budgets or for the environment.  Homeownership is generally equated with single-family structures so, by encouraging ownership rather than rentals the government is pushing people away from multifamily dwellings and thus from urban areas where they are more common.  "We should not be bribing people to leave our economically productive urban cores," he said.

Homeownership, Glaeser said, has often been pushed as a path to middle-class prosperity, but in the wake of the housing boom he calls this "dubious."  It is also credited with other desirable social outcomes but the deduction is actually poorly designed to encourage homeownership because it disproportionately benefits the wealthy who are likely to own anyway.  Glaeser quoted research from James Poterba and Sinai that the MID is ten times more beneficial to upper income individuals than the family earning $40,000 to $75,000 and stated that many poorer households "on the margin between owning and renting do not even itemize."

Reform is needed but with the market still in distress eliminating the deduction all at once would be too extreme.  He suggested reducing the upper limit from $1 million to $300,000 over the next seven years.  "Eventually, policymakers could replace the deduction with a straight owner's credit that provided some incentive for ownership (if absolutely necessary) but did not encourage extra borrowing or larger homes."

Sinai opted for referring to the MID as a subsidy rather than a deduction and says it is only one component of the total tax subsidy for owner-occupied housing. "In an undistorted tax code, taxpayers would be allowed to deduct their expenses (mortgage interest) when they pay tax on their income (rent). Because the United States does not tax estimated rental income for owner-occupiers, the interest deduction should not be allowed." This constitutes a subsidy. "However, the tax code also does not permit many actions that could offset the effects of untaxed rental income, such as taxing the estimated return to equity invested in owner-occupied houses."

The deduction costs an estimated $93.8 billion in each year which constitutes nearly 9 percent of the 2011 budget deficit as projected by the Congressional Budget Office.  However, Sinai said that his and Poterba's research concluded that in 2004 the total tax subsidy for owner-occupied housing was $330 billion. The MID is just a subsidy that uses mortgage debt to finance home purchases. Curtailing it leaves behind a host of subsidies, the most important being a subsidy for using equity to buy a house.  "Many positive aspects of homeownership exist, but the inappropriate use of mortgage debt negated nearly all of them in the latest downturn."

Eliminating MID would not eliminate the tax subsidy for owner-occupied housing. High-income households might substitute equity finance for debt, allowing them to retain their housing subsidy. Older homeowners with little mortgage debt and low-income households that do not itemize do not benefit from MID, so curtailing it would have the biggest impact on middle-class families and would discourage wealthy households from using leverage. "Is a partial reduction in the housing subsidy worth these distortions to household capital allocation and progressivity? Because the government can change other parts of the tax code to restore progressivity, the answer is likely yes."

The solution depends on implementation; reducing MID requires corresponding reductions in the income tax burden and any changes must be phased in to mitigate an adverse impact on home prices.

Crowe outlined what he called the fundamental role of homeownership in American society including improved educational outcomes, better health, reduced crime, and in the long run, homeownership a path to wealth accumulation.  The net worth of the average homeowner, he said, is more than 45 times that of the average renter.

Homeownership for most is impossible without debt financing and the MID provides parity with the tax treatment of interest expense associated with other forms of debt-financed investment, including financial assets and rental housing and lowers the effective interest rate making homeownership accessible to more households.  "The MID is well justified as housing policy given the documented positive externalities associated with homeownership."

Crowe said that among the misleading or incorrect information used to attack the MID is that few homeowners actually benefit because they do not itemize on their tax returns.  In fact, Crowe said, 86 percent of all mortgage interest paid over the past decade was claimed as an itemized deduction.

He also argued that it is not regressive, citing a Congressional committee which estimated that about 70 percent of the benefits from MID go to households earning less than $200,000 and figures NAHB that show middle-class households earn the largest benefits as a share of income. That these benefits are greatest during the early years of a mortgage when most of a monthly payment is interest provides significant help to younger homebuyers when their household budgets are the tightest and wealth accumulation is beginning.

Another NAHB analysis indicates that families with children collect larger tax benefits so, rather than causing homebuyers to buy a larger home, the MID helps growing households finance the larger home they need.

Crow disputed that the MID played a role in the recent housing crisis as it has been part of the tax code since 1913 and widely used by the middle class since the 1940s, with no evidence of having created a housing bubble.  If the MID were responsible for recent problems, "you would expect a positive relationship between the use of the MID and foreclosures, but none exists."

"Given the macroeconomic damage that weakening the MID would cause," Crowe said, "the MID must retain its place as a cornerstone of U.S. housing policy."

Affordable rental housing is the focus of the second edition of Evidence Matters, the Department of Housing and Urban Development's (HUD's) new quarterly publication devoted to housing and community development issues. 

This edition focuses on several proposals that came out of the Next Generation Housing Policy Conference held last October.   The Conference, sponsored by the White House, HUD and the Departments of Treasury and Agriculture, brought together prominent housing experts and practitioners to discuss, among other topics, the role affordable rental housing plays in improving life outcomes, particularly for children, families and the homeless. The discussions that took place at the conference fell into four distinct topic areas:

• The mortgage interest deduction;
• Multibank Consortia and their role in affordable rental housing
• Informing the Next Generation of Rental Housing Policy

The fourth topic was defined by a conference participant, University of Southern California economist Richard Green who suggested that the concept of rental housing needs re-branding.  Rent, he said, carries a negative connotation and should be replaced with an alternative name such as "leased housing." The editors of Evidence Matters point out that this is just one of many misconceptions about rental housing that need to be addressed.  For example, the image of towering multi-family structures providing rental housing in general and affordable rentals in particular is belied by the reality that these large multi-family developments provide only about a tenth of the rental housing stock.

So, in order to discuss rental housing it is necessary to define the terms with a profile of the rental market and rental market research. For example, the article suggests that rental housing should be defined by tenure choice rather than structure type.  Although most multifamily properties are utilized as rentals, small single family properties (one to four units) make up nearly half of all rental housing and these plus developments of five to 49 units account for nearly 70 percent.  "Therefore," the report points out, "policies tailored to massive multifamily development will affect only a portion of the rental stock."

In the same way that rental housing is conflated with multi-family housing, affordable housing is assumed to be subsidized.  This applies to the most affordable rental units, but not to families earning 50 percent of the area median income (AMI). These units are not subsidized.  The American Housing Survey suggests that of the 17 million units affordable to households at 50 percent of AMI, only about 30 percent are subsidized.  In urban areas this unassisted housing tends to be older, smaller properties in low-income neighborhoods which are typically owned by "mom and pop" landlords. This type of housing has been ignored by federal housing policy for years so local financial institutions have stepped into provide affordable financing.   These small operations are critical sources of housing but their age, high maintenance demands, and low profit margins mean they have high loss rates.  "Preserving these structures is an important element of a broader strategy to ensure quality, affordable rental homes for low income Americans, but it is not a substitute for basic rental assistance."

More than 70 percent of HUD's budget is devoted to some form of rental housing assistance and, even though no consensus exists on how best to measure it, rental housing affordability is the biggest measurable housing problem that HUD programs must address.  The approach that most policy makers have adopted to assess affordability is rent-to-income ratios and the current standard is whether gross rents account for less than 30 percent of a tenant's monthly income.  Worse case need is defined as very low-income renters (earning less than 50 percent of AMI) who do not receive assistance and pay more than 50 percent of their income for housing or live in severely inadequate housing or both.  As a result of the recent recession nearly 7.1 million households are considered to have worst case needs - the highest level on record in both absolute and percentage terms.

Another measure is the difference between the numbers of low-income renters and the units affordable to them.  In 2009 there were 10 million extremely low-income renters (earning less than 30 percent of AMI) and just 6.2 million units that they could rent and pay no more than 30 percent of their income for housing.

Another definition that is necessary is one that takes local nuances into account. Constraints on new construction, employment growth, immigration, housing prices can all create frictions which differ across markets so Federal housing policy should promote market-sensitive investments that recognize how housing stresses play out in different localities.

Related MND comments....

READ MORE: Builder Report Offers Reminder. Affordable Rental Units Needed

READ MORE:  HUD Focused on Rebuilding America's Dilapidated Housing Inventory

READ MORE:  Affordable Housing Units Needed for Low Income Renters

READ MORE: The Dearth of Affordable Rental Housing

READ MORE:  Gimme Shelter: Homelessness Rate Climbing. Low Income Rental Units Needed

Affordable rental housing is the focus of the second edition of Evidence Matters, the Department of Housing and Urban Development's (HUD's) new quarterly publication devoted to housing and community development issues. 

This edition focuses on several proposals that came out of the Next Generation Housing Policy Conference held last October.   The Conference, sponsored by the White House, HUD and the Departments of Treasury and Agriculture, brought together prominent housing experts and practitioners to discuss, among other topics, the role affordable rental housing plays in improving life outcomes, particularly for children, families and the homeless. The discussions that took place at the conference fell into four distinct topic areas:

• The mortgage interest deduction;
• Multibank Consortia and their role in affordable rental housing
• Informing the Next Generation of Rental Housing Policy

The fourth topic was defined by a conference participant, University of Southern California economist Richard Green who suggested that the concept of rental housing needs re-branding.  Rent, he said, carries a negative connotation and should be replaced with an alternative name such as "leased housing." The editors of Evidence Matters point out that this is just one of many misconceptions about rental housing that need to be addressed.  For example, the image of towering multi-family structures providing rental housing in general and affordable rentals in particular is belied by the reality that these large multi-family developments provide only about a tenth of the rental housing stock.

So, in order to discuss rental housing it is necessary to define the terms with a profile of the rental market and rental market research. For example, the article suggests that rental housing should be defined by tenure choice rather than structure type.  Although most multifamily properties are utilized as rentals, small single family properties (one to four units) make up nearly half of all rental housing and these plus developments of five to 49 units account for nearly 70 percent.  "Therefore," the report points out, "policies tailored to massive multifamily development will affect only a portion of the rental stock."

In the same way that rental housing is conflated with multi-family housing, affordable housing is assumed to be subsidized.  This applies to the most affordable rental units, but not to families earning 50 percent of the area median income (AMI). These units are not subsidized.  The American Housing Survey suggests that of the 17 million units affordable to households at 50 percent of AMI, only about 30 percent are subsidized.  In urban areas this unassisted housing tends to be older, smaller properties in low-income neighborhoods which are typically owned by "mom and pop" landlords. This type of housing has been ignored by federal housing policy for years so local financial institutions have stepped into provide affordable financing.   These small operations are critical sources of housing but their age, high maintenance demands, and low profit margins mean they have high loss rates.  "Preserving these structures is an important element of a broader strategy to ensure quality, affordable rental homes for low income Americans, but it is not a substitute for basic rental assistance."

More than 70 percent of HUD's budget is devoted to some form of rental housing assistance and, even though no consensus exists on how best to measure it, rental housing affordability is the biggest measurable housing problem that HUD programs must address.  The approach that most policy makers have adopted to assess affordability is rent-to-income ratios and the current standard is whether gross rents account for less than 30 percent of a tenant's monthly income.  Worse case need is defined as very low-income renters (earning less than 50 percent of AMI) who do not receive assistance and pay more than 50 percent of their income for housing or live in severely inadequate housing or both.  As a result of the recent recession nearly 7.1 million households are considered to have worst case needs - the highest level on record in both absolute and percentage terms.

Another measure is the difference between the numbers of low-income renters and the units affordable to them.  In 2009 there were 10 million extremely low-income renters (earning less than 30 percent of AMI) and just 6.2 million units that they could rent and pay no more than 30 percent of their income for housing.

Another definition that is necessary is one that takes local nuances into account. Constraints on new construction, employment growth, immigration, housing prices can all create frictions which differ across markets so Federal housing policy should promote market-sensitive investments that recognize how housing stresses play out in different localities.

Related MND comments....

READ MORE: Builder Report Offers Reminder. Affordable Rental Units Needed

READ MORE:  HUD Focused on Rebuilding America's Dilapidated Housing Inventory

READ MORE:  Affordable Housing Units Needed for Low Income Renters

READ MORE: The Dearth of Affordable Rental Housing

READ MORE:  Gimme Shelter: Homelessness Rate Climbing. Low Income Rental Units Needed

At the second anniversary of the current economic expansion, housing remains stuck in a rut according to Fannie Mae's Economic Outlook for June which notes that most housing indicators started the second quarter with little momentum.  Housing starts and builder's confidence are still at depressed levels and the sluggish construction activity reflected in both measures is one of the reasons that the current economic recovery is less robust than previous ones have been. 

Total construction spending improved in April but it was driven by home improvements rather than single or multifamily construction, both of which declined below the first quarter's average.  Single-family construction spending fell for the third consecutive month to reach the lowest level since June 2009. 

The report says that market conditions continue to favor multifamily and rental housing with demand outpacing supply in some markets.  Consequently, rents are beginning to rise.  The strong multifamily figures in the first quarter had already moved Fannie Mae to revise higher its multi-family starts projections for the year.  Total housing starts are now expected to increase 3.5 percent solely because of the multi-family sector.  Single-family starts will fall "modestly" in 2011 compared to 2010. 

The supply of new homes hit a record low in April while sales of new homes have increased twice since they hit an all time low in February.  At present the inventory of new homes stands at 6.5 months, nearing the long-term average of about six months.  However, the good news does not carry over to existing homes where few of the indicators are positive.  The National Association of Realtors® (NAR) is blaming the sluggish market on what is calls unnecessarily tight credit and to low appraisals.  NAR reported that one-quarter of its members claimed in a survey that they had to cancel contracts or renegotiate them at a lower price because of the appraised values.

That same NAR survey showed that distressed and cash sales continue to account for a big but declining part of the market.  Distressed sales made up 37 percent of all sales in April, down from 40 percent in March while 31 percent of sales were all-cash compared to a record 35 percent in March.   The report states that a continued decline of distressed home sales as a percentage of the market would reduce the discount component and might give a lift to home prices in the second quarter.

The discounts serve to depress appraised values, leading to the canceled or renegotiated contracts referenced above.  Homebuyers have also become accustomed to watching prices fall and continue to delay action on purchasing non-distressed homes. 

There is some good news about mortgage performance.  The Mortgage Bankers Association reported that short-term mortgage delinquencies were near pre-recession levels.  Serious delinquencies (90+ days) have dropped for five consecutive quarters and are at their lowest levels since the beginning of 2009 and foreclosure starts are at the lowest point since the end of 2008.  The report states that these figures along with the drop in the percentage of loans in the foreclosure process from the record high of the previous quarter indicate that the shadow supply of housing may have peaked, although remaining at very elevated levels.   "It will likely take years for the excess supply and the shadow supply of housing to be absorbed, even with a meaningful improvement in the labor market and household formation, which has been elusive so far."

The elevated inventories continue to hold home prices down.  "However, most third-party price indices adjusted for distressed sales seem to indicate that troubled loans being put through foreclosure are getting seasonally adjusted (foreclosure is not a seasonal activity), and also are likely causing an over statement of price declines for "arms length" transactions."

On the broader economy Fannie Mae believes the likelihood that "the economy will slip into another downturn within a year is still quite low, but has risen slightly." Still Fannie Mae did downgrade their economic growth outlook for 2011 from +2.9 percent to +2.5 percent in the previous forecast, which is more than a full percentage point lower than their forecast at the start of this year.  Several reasons for the downgrade were cited including continued European sovereign debt problems, a marked slowdown in growth in China as it fights rising inflation, the trade-related effects of reduction in Chinese economic activity , and dampening effects surrounding U.S. monetary and fiscal policy.

Fannie Mae's economists conclude that the near-term outlook for home sales appears gloomy with both mortgage applications down in May and again in June and pending home sales dropping 12 percent in April. 

"Ultimately, employment remains the key to the outlook for the economy and the housing market. If the tentative labor market recovery falters amid signs of a slowdown in consumer demand, it could jeopardize the projected moderate rebound in home sales later this year. Continued deterioration in home prices, tight lending standards, and households' desire to reduce their debt loads much further are among the main risks to the housing market and the overall economy."

The National Association of Homebuilders (NAHB) today reported  that its Housing Market Index (HMI) fell to 13 after standing at 16 for six out of the last 7 months seven months.  The HMI is a measure of builder confidence gleaned from homebuilders' responses to a monthly survey that has been conducted by NAHB for over 20 years.

 "Builders are being squeezed by the continuing weakness in existing-home prices - against which they must compete -- as well as rising material costs," said NAHB Chairman Bob Nielsen, a home builder from Reno, Nevada. "In addition to the ongoing impacts of distressed property sales on home prices, appraisal values and consumer confidence, rising costs for materials such as roofing, copper, wallboard, vinyl siding and other components have made it extremely difficult to construct a new home and sell it at a price that covers the costs."

The NAHB/Wells Fargo survey asks homebuilders to gauge both current single-family home sales and their expectations for those sales over the next six months as "good," "fair," or "poor."  They are also asked to rate current traffic of perspective buyers as "high to very high," "average" or "low to very low." In addition to the composit HMI, a component index is constructed for each of the three sets of responses.  A score over 50 on any index indicates that more builders view sales conditions as good rather than as poor.  The index has not had a score over 50 since late in 2006.

Every component of the HMI fell in June.  The component measuring buyer traffic decreased 2 points to 12 after last month's reading of 14 was the highest since May 2010.  Current Sales Conditions also fell 2 points, bringing that component of the index to 13.  Sales Expectations fell from 19 to 15, matching record lows from February and March of 2009. 

"Builder confidence has waned even further as economic growth has stalled, foreclosures have continued to hit the market and the cost of building a home has risen," agreed NAHB Chief Economist David Crowe. "Meanwhile, potential new-home buyers are being constrained by difficulty selling their existing homes, stringent lending requirements, and general uncertainty about the economy. Economic growth must pick up in order for housing to gain the momentum it needs to get back on track."

Regionally, the HMI results were mixed, with the Northeast actually rising 2 points while the West represented the other end of the spectrum, falling 4 points.  The midwest and south dropped 3 and 2 points respectively.   

Federal Deposit Insurance Corporation Chair Sheila Bair recently took issue with the "Qualified Residential Mortgage" rule in a wide ranging interview conducted by New York Times editor Andrew Ross Sorkin at the Council on Foreign Relations seminar last Thursday. This was surprising feedback from Bair, a Bush appointee whose term of office ends on July 8, as she has been one of the stronger voices pushing back against anti-regulation forces. 

The Dodd-Frank financial reform act requires the originator of a residential mortgage to retain at least a 5 percent interest in that mortgage when selling it into the secondary market, a provision commonly referred to as "skin in the game."  Loans backed by FHA, VA, USDA, Fannie Mae and Freddie Mac will however be exempt from risk retention regs. For non-agency loans to meet the QRM definition and avoid being subject to risk retention regs, they must have down payments of 20% or more and a DTI of 28%/36% or less.  MORE DETAILS

Bair said that requiring securitizers to keep a 5 percent slice of loan packages "can do a lot to tame underwriting standards in a way that we regulators don't have to get into micromanaging what the standards are." However, the industry pushed the QRM exception into the bill so regulators now must define the new gold standard in mortgages "and these are just such great standards...we're just so sure against default that nobody would really need to retain any risk."  Now there is a huge push back, she said, because people think that this is going to become the new normal, "and I think people are right to the extent that it is going to create two-tiered pricing for securitized loans."

"So the risk retention loans will probably be some incrementally higher.  It's more like 10 or 15 basis points, not some of the other numbers that people are throwing around.  If we could just get rid of it it'd be fine with me, just making sure everybody keeps 5 percent, I would love that; that statute has this direction."

It is unclear whether Bair's comments reflect a growing opinion among regulators to forego QRM definitions and simply apply the 5 percent rule to all securitized loans including those backed by government agencies,  but we do know there has been a push-back from consumer advocates and politicians on the issue: FULL STORY

Bair commented on a number of other FDIC-related issues concerning  the economic downturn as well as the recovery.  Besides risk retention regulations, here are a few of the areas she touched upon in the discussion with Sorkin and the audience Q&A that followed.

Housing

"I think it's up to Congress to decide how much they want government involved in mortgage finance. I do think there's a difference between subsidizing mortgage finance and supporting home ownership.  And so I think they need to look at policies that actually promote home ownership; not a lot of leverage with people who own houses."

She suggested an FDIC model for supporting secondary mortgage finance; a government-run agency that charges premiums for this and prefunds a reserve to take losses if the loans go bad rather than a hybrid model of a private-sector entity with a government backstop.  "If I was going to continue a U.S. government presence, I would continue it (in housing for low and moderate income people) before I would continue it anyplace."

The foreclosure process, she said, is becoming dysfunctional.  There is an overhang of delinquencies and inventory and increasing litigation that will also be slowing things down.  Early on, she said, she had suggested a two part process; for retroactive problems there would be a bank-funded pool to provide a nominal settlement to waive claims and a process for those who were wrongfully foreclosed and going forward a streamlined modification that would write down loans below appraised value, give homeowners a year to perform before refinancing them with a bit of equity or they would agree to turn in their keys.  Something dramatic must be done rather than the current incremental fixes. Instead, she said, she sees modifications becoming more and more complicated.

She is quite angry with the servicers. "We saw this coming for years. We talked about ramping up their staff, putting assistance in place for workout, but it wasn't done. Now we have poor quality servicing plus litigation and issues around poor documentation.

Elizabeth Warren

While Bair didn't exactly throw Elizabeth Warren, the person designated to establish the new Consumer Financial Protection Bureau, under the bus, she didn't provide much support for her appointment as permanent CFPB Director.  It is critical there be a presidentially appointed and Senate-confirmed head, Bair said she hopes that the administration and the Senate "come together and for this and other jobs "find quality people to serve."

Sorkin quoted William Cohen's suggestion that it was Warren's duty as a citizen of this country to get out of the way; that there was no way to move the agency forward with her in the mix.   Bair responded, "Elizabeth is a very talented person who had a wonderful career prior to this and there's a lot of wonderful things she can do, and there are -- you know, there's a good reservoir of candidates out there, but I think it's important for the president to make a decision on this and to move forward and engage the Senate and hopefully in a way that can move these nominees to confirmation, because at this point it's looking like they're all going to get bogged down and I think that's a very difficult situation for the country right now."

Accountability

Asked about the need for accountability for what happened in the financial industry prior to the collapse, Bair said, "We obviously can't put people in jail. We are certainly being very vigorous in suing directors and officers who we feel did not exercise the appropriate duty of care in running their banks; try to recoup some of the losses we suffered as part of the failed banks."  "Instead of just going after the (D&O) insurance proceeds; I think you need to have some pain be felt by people.  So I think you can -- you know, can have financial pain without sending somebody to jail, and maybe it's appropriate that some people should go to jail too."

I think at the origination level I think there was a lot of fraud going on, and I think the question is how much of it begs -- are there larger financial institutions funding this stuff, did they know about it and it was just a matter of looking the other way, not having appropriate controls or did they actually know about that."

Banking Regulation

Early in the discussion, Sorkin asked Bair about CitiBank CEO Jamie Dimon's recent remark that most of the bad actors and the exotic derivatives are gone; standards are higher, banks have more liquidity and capital, boards and regulators are tougher and more regulations are coming. The cumulative effects of regulation are the reason banks aren't lending and unemployment hasn't gotten better.

Bair responded that we need to be careful to ensure that regulations are efficient, understandable, and present the desired outcomes "But on basic things, obvious things like higher capital standards, I say full speed ahead and the higher the better."

A lot of research, she said, challenges that notion that higher capital requirements have much impact on lending.  "Lending is really just another way of funding your balance sheet, and it's more expensive than debt. But it can influence losses in a crisis. And then you have financial institutions, especially large ones, that are too highly leveraged. If you get into a crisis, they don't have that loss absorption capability, so they have to quickly reduce their balance sheet to maintain solvency, and that's what we saw during the crisis."

Now there is better regulation, higher capital standards, rules that prevent regulatory arbitrage.  There will always be cycles, she said, but we can help ensure these are normal cycles not economic cataclysm.

Too Big to Fail

Sorkin asked if regulations to prevent too big to fail will work or will create risk, and lead to political favor trading.

Bair said she did worry about the government's will to use the new tools, but not about favoritism.  FDIC has always had resolution authority for member banks and has tools to resolve banks and get the assets back into the private sector quickly; rules that don't allow favoritism.  Under Title II of Dodd-Frank that resolution authority now applies outside of insured banks

She said that large complex entities, especially those with multinational operations, will be difficult but not impossible to resolve. Banks are fundamentally too big if they cannot demonstrate that they can be resolved, than they are too big and need to be downsized now.  Unless those large banks think that FDIC and the Fed is serious about using that authority, we won't get credible resolution plans; we'll get "nice paper exercises to sit on the coffee table somewhere".

Bair said the FDIC could have easily resolved Lehman Brothers under the new rules.  There were ready buyers who had done due diligence, there was a lot of time for planning.  It might not, she said, have even gotten to resolution - the FDIC's authority provides strong incentives for bank management and bank boards to right their own ship. 

The Departments of Housing and Urban Development and Treasury issued their joint Housing Scorecard for May on Thursday. The big news is that the Administration is finally moving to penalize servicers who have consistently failed to meet the goals of the Making Home Affordable Program, which is designed to help homeowners who have fallen behind on their loan payments.

The Scorecard contains results of new Servicers' Assessments, which summarize performance for the 10 largest loan servicers.  The assessments rely on information from reviews conducted during the first quarter of 2010 on three categories of program implementation:  identifying and contacting homeowners, homeowner evaluation and assistance, and program reporting, management, and governance. 

While all ten servicers are in need of improvements, four were identified as needing "substantial improvements"; Bank of America,  J.P. Morgan Chase Bank,  Ocwen Loan Servicing, LLC; and Wells Fargo Bank.  Program administrators found that there were extenuating circumstances leading to the negative results in the assessment of Ocwen Loan Servicing (they acquired another servicing portfolio during the testing period), however Bank of America,  J.P. Morgan Chase and Wells Fargo will have financial incentives withheld for this quarter and payments will continue to be withheld until specified improvements are made.   

To be clear, new fines are not being imposed. Incentive payments are simply being withheld. Servicers receive payments from Treasury  for every successful permanent modification they complete under the Home Affordable Modification Program as well for each short sale/deed-in-lieu they complete (pursuant to the Home Affordable Foreclosure Alternative Program). The three companies were reported to have received $24 million in incentive payments last month. New incentive payments will be withheld.  In certain cases though, particularly where there is a failure to correct identified problems within a reasonable time, Treasury may also permanently reduce the financial incentives paid out to servicers.

Six servicers were identified as needing moderate improvement and no financial penalties were assessed.  Those servicers are:  American Home Mortgage Servicing, Inc.; CitiMortgage, Inc; GMAC Mortgage, LLC; Litton Loan Servicing LP; OneWest Bank, and Select Portfolio Servicing.  Treasury said those servicers that fail to improve in the areas identified will be subject to servicer incentive withholding in the future.

 "While we continue to get tens of thousands of new homeowners into mortgage modifications each month, we need servicers to step up their performance to meet the needs of those still struggling," said acting Treasury Assistant Secretary for Financial Stability Tim Massad. "These assessments set a new benchmark by providing an unprecedented level of disclosure around servicer performance and will serve to keep the pressure on servicers to more effectively assist struggling families."

The HAMP report for May indicated that 20,000 more homeowners entered into a trial modification during the month and 29,000 converted from trial to permanent status.  Since the program began 1,588,000 borrowers have entered the program and 699,000 have converted to permanent status. Below is a chart illustrating the conversion rate of individual loan servicers.

It is clear that many of the problems that existed with HAMP early on have eased.  Seventy percent of trial modifications started since June 2010 have been made permanent and the average length of a trial modification beginning after that that date is 3.5 months.  Trial modifications started before that date required an average of 5.2 months before converting to permanent status.  In May 2010 the number of borrowers who had been in the "three month" trial modification period for six months or more stood at over 190,000.  Today that number has fallen to under 25,000. Below is a chart illustrating the time it takes individual servicers to convert a trial modification to a permanent modification.

Apart from the HAMP report, the Housing Scorecard is primarily a recap of information compiled from other sources and generally covered previously by Mortgage News Daily.  This includes Census Bureau reports on construction permitting and housing starts, National Association of Realtors® data on sales of existing houses, RealtyTrac foreclosure statistics and the S&P/Case-Shiller Housing Price Index.

New to this month's report is a Housing Scorecard Regional Spotlight which, in this edition highlights recovery conditions in Phoenix, Arizona, one of the cities hardest hit by the housing downturn.  According to Assistant HUD Secretary Raphael Bostic, the administration's programs have assisted over 100,000 families avoid foreclosure in Phoenix.  Foreclosures still dominate the market in the city where sales of distressed homes currently represent 56 percent of all existing sales compared to a national figure of 35 percent.

Approximately 22.7 percent of all U.S. homeowners were in a negative equity position with their mortgages at the end of the first quarter of 2011, down slightly from 23.1 percent in the fourth quarter of 2010.

In a report released Tuesday, CoreLogic states that some 10.9 million borrowers are "underwater", i.e. owe more on their mortgages than their property is worth and another 2.5 million borrowers (5 percent) were in a near-negative equity position,  which the real estate data and analytics company defines as having less than 5 percent positive equity.

While the drop in housing prices caused much of the negative equity, equity extraction was also a key driver.  Borrowers with second mortgages on their home were twice as likely to suffer negative equity as those with only one lien.  18 percent of borrowers without home equity loans were underwater while 38 percent of borrowers with home equity loans were in a negative position.  A total of 4.5 million negative equity borrowers (40 percent) have home equity or other junior liens.

The current CoreLogic report does not attach a total dollar value to negative equity statistics but an analysis of the distribution of negative equity based on fourth-quarter 2010 numbers was published by the company last month which put the aggregate national net equity at $750 billion.  The percentage of underwater borrowers has declined only 4 basis points since that time.

The negative position of individual borrowers is significant.  The average underwater borrower owes $65,000 more than his property is worth.  This number varies widely by state from a low of $31,000 in Ohio to $129,000 in New York.  Not surprisingly, states that were among those with the biggest housing booms now report the largest negative equity averages; Massachusetts, $120,000; Connecticut ($111,000), Hawaii ($98,000), and California ($93,000).  States which saw the smallest run-up of prices also have the lowest negative averages.  In addition to Ohio those states are Indiana ($34,000) and Minnesota ($38,000.)*

Going back again to the May report on negative equity distribution, CoreLogic found that the $750 billion in negative equity that existed in the fourth quarter was distributed fairly evenly between properties with only one lien ($355 billion) and those with one or more junior liens ($395 billion).  However, over 38 percent of first-lien only negative equity ($135 billion) was in properties valued between $100,000 and $200,000 as opposed to properties with more than one lien ($95 billion or 26 percent).  At the higher end, 39 percent ($154 billion) of negative equity properties in the $300,000 to $700,000 range had multiple liens while 26 percent ($91 billion) had only one.  In Q1 2011, the average negative equity for an individual with only one mortgage was $52,000 while a negative equity borrower with a 2nd lien was underwater by an average of $83,000.

The states with the largest percentage of underwater borrowers were Nevada (63 percent), Arizona (50 percent), Florida (46 percent), Michigan (36 percent) and California (31 percent).   These states account for a 40 percent share of the net negative equity and then they are excluded from the national figures, the percentage of underwater properties drops from 22.7 percent to 16 percent.  The three hardest hit states did show slight improvement from the fourth quarter of 2010; Nevada was down 2.7 percentage points, Arizona fell 1.3 percentage points and Florida 1.3 percentage points.

Default rates rise with the level of negative equity but not necessarily with the number of outstanding loans.  At a low level - a CLTV under 5 percent - the default rate is slightly above 2 percent with multi-lien properties defaulting at a slightly higher rate than single lien properties.  Above the 115 percent CLTV level where the default rate is 4 percent, single lien properties begin to default at a fractionally higher rate than multiple lien properties.  Once the CLTV reaches 125 percent the default rate soars, reaching 12 percent at 150+ percent CLTV with single lien properties marginally higher than those with multiple liens. 

"Many borrowers in negative equity are still able and willing to make their mortgage payments, Mark Fleming, CoreLogic's chief economist said.  "Those in negative equity and impacted by an income shock of some kind, such as a job loss, divorce, or death, are much more likely to be at risk of foreclosure or a short sale.  The current economic indicators point to slow yet positive economic growth, which will slowly reduce the risk of borrowers experiencing income shocks.  Yet the existence of negative equity for the foreseeable future will weigh on the housing market recovery by holding back sale and refinance activity."

"This data is certainly cause for concern", says MND's Managing Editor Adam Quinones. "If home prices continue to fall, we'll be looking at another wave of strategic defaults".

READ MORE: Strategic Default: Inconceivable Assumptions Suddenly Conceivable

*Individual data was not given for seven states; Louisiana, Maine, Mississippi, South Dakota, Vermont, West Virginia, and Wyoming.  We assume those states are also not included in aggregate national numbers.  

The Mortgage Bankers Association has asked the Department of Housing and Urban Development to permit the use of electronic signatures (e-signatures) on all mortgage origination forms required by the Federal Housing Administration (FHA.)  The request was made by Stephen A. O'Connor, MBA's Senior Vice President for Public Policy and Industry Relations in a letter sent on Tuesday to Robert C. Ray, HUD's Assistant Secretary for Housing and Acting Commissioner of FHA.

O'Connor pointed out that e-signatures are now acceptable under federal law and that FHA already accepts them for certain purposes.  Permitting more universal use of the device would reduce the volume of lost paperwork, reduce signature fraud and the time required to close a loan, and might ultimately lead to lower borrower costs.

According to the letter, much of the work of originating mortgages is already carried out by electronic means.   Borrowers submit loan applications on-line and supply information to their lender electronically.  Underwriting and processing is done by lenders using available on-line tools and necessary documents such as appraisals, deposit verifications, and credit reports have long been requested and received electronically.

Cost savings will come from reduced printing and use of mail couriers by borrowers and lenders.  It would also provide consistency and increased flexibility for borrowers who would not have to redo documents if they switched from a conventional to a FHA loan.  Freddie Mac and Fannie Mae have been accepting electronic signatures for several years, O'Connor said, and this would align FHA with those agencies.  "Conforming to accepted industry standards on all documents would expedite the mortgage process, reduce lender costs because processes could be replicated, and fulfill consumers' growing preference for conducting electronic transactions."  Also, he said, both the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending Act (TILA) accept electronic records to meet their disclosures requirements.

MBA acknowledged concerns that FHA might have regarding mortgage fraud but said that there is much about the use of electronics which could mitigate many of the fraud issues that exist in the paper process.  He cited the example of additional borrower authentication capabilities such as challenge questions which are more foolproof than a "notary asking to see a driver's license."  Other safeguards such as tape recording and audit trails can safeguard the process and are not only beneficial for the lender and FHA but provide convenience and protection to the homebuyer.

In conclusion, O'Connor said the MBA realizes the intense processes that would be required to facilitate the change and offered the MBA's assistance in implementing a new program if requested. As a side note, by submitting this request to the FHA using O'Connor's voice, the MBA appears to be keeping to its promise to build a "revolving door" firewall between its new president David Stevens and the agency he headed until this past May.  

Over one-third of the current members of the U.S. Senate have written a letter to federal regulators urging they adopt a less restrictive definition of a qualified residential mortgage than has been formally proposed.  The bi-partisan group is led by Mary Landrieu (D-LA), Johnny Isakson (R-GA), and Kay R. Hagan (D-NC). The letter, addressed to the heads of the Federal Deposit Insurance Corporation, Office of Comptroller of the Currency, Federal Reserve Bank, Federal Housing Finance Agency, Department of Housing and Urban Development, and the Securities and Exchange Commission, is signed by 23 Democrats, 13 Republicans, and both independent senators. It urges the regulators to avoid restricting credit to middle class families who are saving to buy a home.

The Dodd-Frank financial reform act requires the originator of a residential mortgage to retain at least a 5 percent interest in that mortgage when selling it into the secondary market, a provision commonly referred to as "skin in the game."  Loans backed by FHA, VA, USDA, Fannie Mae and Freddie Mac will however be exempt from risk retention regs. For non-agency loans to meet the QRM definition and avoid being subject to risk retention regs, they must have down payments of 20% or more and a DTI of 28%/36% or less.

When Dodd-Frank was enacted, Landrieu, Isakson, and Hagan inserted an amendment which exempts suitably qualified mortgages (QRM), the definition of which was left up to regulators, from that 5 percent requirement.  The senators state that when they included the QRM exemption amendment in the Dodd-Frank Wall Street Reform and Consumer Protection Act that they were aiming to create a broad exemption from risk retention for historically safe mortgage products. The senators contend that they intended the exemption statute to require that the QRM definition be based on "underwriting and product features that historical loan performance data indicate result in a lower risk of default" and that they provided clear guidance on the types of factors that can be used including the documentation of income and assets, debt to income ratios and residual income standards, restrictions on negative amortization, balloon payments, prepayment penalties and the inclusion of mortgage insurance and features that mitigate payment shock.  The three senators who proposed the amendment said they intentionally did not include a rigid down payment requirement in the provision to ensure that creditworthy, qualified buyers could access mortgages with reasonable down payments.

The letter states that the proposed regulations go beyond what was intended in the statute by imposing down payment standards which it termed unnecessarily tight.  "These restrictions unduly narrow the QRM definition and would necessarily increase consumer costs and reduce access to affordable credit."  The senators said that well underwritten loans did not cause the mortgage crises and that the additional requirements proposed for QRM swing the pendulum too far and reduce the availability of affordable mortgage capital for otherwise qualified buyers.  Many will have to pay higher rates and fees and others may not be able to obtain a mortgage at all, the letter says.  The senators also criticized "overly narrow debt to income guidelines."