Fair Housing, Foreclosure Problems, and the Global Economic Crisis Monday, Nov 17 2008

This is the text of the keynote speech delivered by Dr. Nandinee K. Kutty at the 2nd Annual Fair Housing Conference organized by the Massachusetts Fair Housing Center on November 14, 2008. The conference was titled “Reclaiming Civil Rights: Commemorating the 40th Anniversary of the Fair Housing Act.”

This powerpoint presentation accompanied the keynote speech (slides are numbered below).

Dr. Kutty delivering the keynote speech at the fair housing conference held at the Western New England College School of Law, Springfield, MA.

It is an honor to be here before this distinguished audience. You have through your work touched the lives of millions of Americans and improved their housing experiences. And as we know, housing experiences relate directly to opportunities—opportunities for a good quality education, good health and access to healthcare, access to jobs, access to social networks, and quality of life. The book that I co-edited—Segregation: The Rising Costs for America —speaks about these complex inter-connections. Thank you, the fair housing community, for your good work which moves our nation forward towards that perfect Union we have been striving to achieve for more than 200 years.

This is a time of great optimism in America. We are on the verge of new Administration starting its work in Washington—and a new President who has promised us change. 

While this is a time for optimism, this is not a time for letting down our guard on housing discrimination and lending discrimination.  I submit that in the midst of a national foreclosure crisis and the subprime mortgage meltdown, a climate has been created in which minority households and minority neighborhoods are being looked upon with suspicion—as risky propositions. And an a priori formation of such an assessment and acting upon it in a manner that is unfavorable to minority individuals is the essence of racial discrimination, which is illegal. Not only is it illegal, we see the evidence all around us, that racial discrimination in housing markets imposes heavy costs on the entire nation.

I shall speak today about the subprime mortgage crisis and the central role that racial discrimination in housing and housing finance has played in the genesis of this crisis.

There is a clear link between residential segregation and predatory subprime lending—a link that is not often acknowledged. And then, there is a link between predatory subprime lending, that is, lending through subprime mortgage products with abusive features, and the current foreclosure crisis. Beyond that, the link between rising delinquencies and foreclosures on the one hand, and the failure of the U.S. and global financial system seems to be well-known; and there is a great deal written about that. But there does not seem to be clear understanding about the earlier part of this complex story—what led up to the rising delinquencies and foreclosures. In fact, there are a number of myths floating about this, that I shall also address.

It is said that old sins have long shadows. In my presentation today, I shall not go so far back as the original sin of slavery or the “birth defect” (as it has been called) in the founding of our nation —that when the founding fathers asserted that all men are created equal, they did not include in this group men of color or women with or without color. I shall not go that far back. Let me start by talking about residential segregation, and its creation around the early part of the 20^th century.  Residential segregation has been around in the United States for so long that people often view it as a permanent feature of the American landscape—and as something that is natural, or inevitable.

But in fact, residential segregation is largely a 20^th century phenomenon. At the end of the 19^th century, and indeed even in very early 20^th century, U.S. cities in both the North and the South were not residentially segregated. In the North, African Americans and whites of equal professional status lived as neighbors quite easily. In the South, although African Americans and whites were rarely of equal social status, they were not spatially isolated from one another—they lived adjacent to one another.

So the relatively new phenomenon of so many African Americans being spatially removed from whites and of whites living in homogenous white communities was created in the 20^th century. It was created through individual and collective actions, and by private and public agencies. It was created through statute, acts of hostility and intimidation that created “sundown towns” across America, where persons of color were not allowed after sundown. This phenomenon is documented in the book Sundown Towns by sociologist James Loewen. The significant progress made by African Americans during the period of Reconstruction, immediately after the Civil War, was reversed in the subsequent period known as the Nadir in race relations in America.  After 1890, town after town, rural area after rural area began to expel non-whites from their jurisdiction. They artificially created pure white communities. This, in fact, preceded and directly contributed to the Great Migration of blacks to large cities of the North and the Midwest.  The Jim Crow laws in the South were also an instrument for the tragic reversal of gains made during Reconstruction.

The U.S. federal government, in the 20^th century, played an important role in maintaining and strengthening residential segregation. It did so through its agencies like the Home Owners Loan Corporation, the Federal Housing Administration (FHA) and Veteran’s Administration (VA) that openly and legally discriminated against minority and integrated neighborhoods till the middle of the 20^th century. 

It was around the 1930s that the practice of redlining became widespread.

Slide 2kuttynov14

Here is the Home Owners Loan Corporation’s redlining map of Philadelphia. The blue areas were considered desirable—and the red areas were designated as Hazardous. These red areas were predominantly minority neighborhoods. The HOLC did not guarantee any home mortgage loans in these designated “hazardous” areas. This is the practice of redlining—or denial of home mortgage credit to minority neighborhoods.

The FHA promoted segregated neighborhoods. Here is a page from the FHA underwriting manual of 1939.

Slide 3kuttynov14 FHA Underwriting Criteria

 ”If a neighborhood is to retain stability, it is necessary that properties shall continue to be occupied by the same social and racial classes”

 The FHA recommended the use of racially restrictive housing covenants, and did not withdraw this recommendation till 1950, after the U.S. Supreme Court declared such covenants to be unenforceable.

 

Landmark fair housing legislation was passed in the 1960s—the Fair Housing Act of 1968 (FaHA). This made housing discrimination for nearly all types of housing illegal.

 

 

 

 

 

 

 

 

 

 

 

Slide 4kuttynov14 President Johnson signing the Fair Housing Act

 The Fair Housing Act was good in terms of coverage of housing, it had weak provisions for enforcement.  Also, enforcement was poorly funded. You see, this was legislation passed after a 20-year delay and was a result of a series of legislative compromises that left it quite eviscerated in terms of enforcement power.

 Slide 5kuttynov14—Implementation by President Nixon

 

 

 

 

 

 

 

 

 

 

 

 

 

Although the FaHA provided an affirmative mandate to HUD, there does not seem to have been a commitment on the part of the government to end segregation—to reversing this harmful phenomenon that had been artificially created and foisted on the U.S. landscape and the American people.

 

Not surprisingly, the practices of the real estate industry and the mortgage lending industry did not change significantly after the Fair Housing Act. Housing and mortgage lending discrimination continued in one form or another.  

Slide 6kuttynov14—George Romney

 George Romney, the HUD Secretary in the Nixon Administration, testifying before Congress in 1970 acknowledged that:

 The FHA “generally withheld insurance from existing housing in central city areas” because it was believed that neighborhoods “occupied largely by minority groups had an unfavorable economic future” ….. The policy of redlining stemmed from “an unwritten but well-understood agreement between financial institutions and the FHA.”

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

So, the open and legal discrimination by the FHA during the 1930s, 40s, and 50s gave way to a widespread practice of covert and illegal discrimination. Nevertheless, this was a discrimination that was harmful to minority families, their neighborhoods and the entire nation. And this was also a discrimination which, though illegal, could not be prosecuted against under existing law—because it was carried out through unwritten agreements.  And investigations and other enforcement efforts for fair lending were weak.

 

 

 

 

 

 

 

 

 

 

 

 

 Slide 7kuttynov14  Jimmy Carter etc.

The use of such language in the mainstream and by a winning candidate tells us something about the climate in the nation, and the challenges in the implementation of the Fair Housing Act and other efforts to end segregation in America.

 

 Slide 8kuttynov14   FaHAA 1988  ; 40 years after FaHA, more than 4 million fair violations occur each year.

 Slide 9kuttynov14

 While redlining also contributed to further racial segregation (a white family would not want to move to neighborhood where it could not get federally guaranteed loans), it is important to see that it was residential segregation that made redlining possible and efficient.

 If the American landscape had not been so segregated, it would have been difficult to exclude entire neighborhoods from being serviced by mainstream providers of federally insured mortgages. In serving white families, at least the neighbors of minority families would have been served, allowing minority families also the benefit of appreciation in home values in the neighborhood when they sold their homes.  But in a segregated environment, not only were minority families themselves not served, but their entire neighborhood suffered from the lack of a healthy flow of mortgage finance. This also meant that homes in their neighborhoods fell into disrepair, as finance for maintaining and refurbishing the homes was also not available.  In contrast, white neighborhoods (and the white families that lived there) benefited from the flow of affordable housing finance made possible through programs like the HOLC, FHA and VA.

Thus, it was residential segregation that made redlining possible. Mortgage lenders, home insurance providers and other real estate professionals were able to mark off entire areas–neighborhoods that they did not serve—the segregated minority neighborhoods.

 In this lacuna, caused by redlining, bad actors rushed in to take advantage of the situation. And what resulted is reverse redlining. The same types of neighborhoods that had been denied mortgage credit, were now targeted for special service    —  for predatory subprime lending. Lots of it. Now credit denial was not the problem, there was plenty of credit available, but on abusive terms.  

And again, it is residential segregation that made reverse redlining possible—and efficient. It made these practices efficient from the point of view of the lenders who profited from this arrangement. They could target their marketing efforts, their sales staff, branch offices—all– to particular neighborhoods, to particular blocks, instead of having to fragment their efforts geographically. 

Predatory lending practices have existed for a very long time. But these practices grew at an exponential rate from the early part of the 1990s.

Slide 10kuttynov14—Predatory subprime lending was piloted in minority communities in the 1990s

In this phase of predatory lending or abusive subprime mortgage lending, racial and ethnic minorities were the chief market targets. In addition, the elderly and women-headed households were also targeted.  There was a second phase, 2000-2007, and I shall talk about that later.

There is strong evidence that high-cost lending is concentrated among minority borrowers:

Under the Home Mortgage Disclosure Act (HMDA), the Federal Reserve collects data on “high cost” mortgage lending, defined as mortgage loans which are 3 points above the Treasury rate. According to the most recent HMDA data released by the Federal Reserve last year (2007), 54 percent of African-Americans and 47 percent of Hispanics received high cost mortgages in 2006. Only 18 percent of non-Hispanic whites received high cost mortgages. The Federal Reserve study found that borrower-related factors accounted for only one sixth of this disparity.

Slide 11kuttynov14

 Here  is only a partial list of predatory practices in mortgage lending.  

The exponential growth in predatory subprime lending in minority communities is a direct result of the denial of prime or standard mortgage products to these communities.

 

Slide 12kuttynov14  Subprime lending in the 1990s

 

 

 

 

 

 

 

 

 

 

 

 Throughout the 1990s, minority communities and minority families—mainly African Americans and Latinos –found themselves targeted for abusive subprime lending.

It seems that the lenders were given free rein in these neighborhoods. These operators were generally unregulated. While numerous consumer advocate groups and civil rights groups represented the case of the victims of fraudulent practices before lawmakers, little was done—at least at the federal level to regulate these operators. On the contrary, federal agencies like the Office of the Comptroller of Currency (OCC) intervened to prevent states from implementing their consumer protection laws for mortgage loans.

 

Slide 13kuttynov14  Spread of abusive practices

 

 

 

 

 

 

 

 

 

 Lenders found abusive lending practices to be quite profitable. They learned a great deal about the market, marketing techniques, and the design of deceptive mortgage products during this period. This learning was then used to extend the market beyond minority households to also some white households on whom the same predatory marketing techniques were applied.

 Slide 14kuttynov14 Growth in subprime lending 2001-2005

 This new phase of predatory and imprudent lending –2000-2006– saw a massive expansion of  subprime products throughout the U.S. housing market. And new prime products began to appear on the market, with subprime features.  Prime products like Alt-A and Prime Option ARMs became popular.

This growth was driven by lenders and investors, not by demand from borrowers. These types of mortgages were highly profitable for investors on Wall Street—more profitable than the standard mortgage products. As Alan Greenspan said in a Newsweek interview last year (2007):

 

 “The big demand [for subprime mortgages] was not so much on the part of the borrowers as it was on the part of the suppliers who were giving loans which really most people couldn’t afford.” (Newsweek, Sep 24, 2007)

 

 

 

 

 

 

 

 

 

 

 

 The risky underwriting practices such as low- or no-documentation of income loans were driven by Wall Street’s interest in these high yielding investments. Significant losses to Fannie Mae and Freddie Mac came from its subprime-like prime products, like Alt-A and Option ARMs.

 The result of this is record high foreclosure rates:

 Slide 15kuttynov14

 The result of imprudent lending, and in many cases fraudulent and deceptive practices, is that we now have more than 2,700 foreclosures a day. This is the statistic for the period July through September this year—70% higher than last year.

 Slide 16kuttynov14

 

 There are more than 4 million homeowners who are at least one-month delinquent or in foreclosure.

 

 

 

 

 

 

 

 

 

 Spatially concentrated foreclosures

 

A feature of the current foreclosure crisis is that foreclosures are highly spatially concentrated—in a city within certain neighborhoods, and nationwide, 3 or 4 states account for a very large share of the foreclosures because abusive subprime lending was also spatially concentrated. Foreclosures are highly concentrated in the subprime market.

 

 Slide 17kuttynov14 Foreclosures impose high costs to communities

—shrink revenue base for state and local governments.

 Slide 18kuttynov14  Dr. King

When Dr. King wrote from the Birmingham Jail in 1963 that we are “caught in an inescapable network of mutuality, tied in a single garment of destiny” and that “whatever affects one directly, affects all indirectly,” he was not talking about the subprime mortgage crisis of the early-21^st century. 

But these words aptly describe the current situation.

 He also wrote that the quality of justice is indivisible. “Injustice anywhere is a threat to justice everywhere.” Market discipline, market soundness is also indivisible in our age of globalization. We have seen that market misbehavior in one sector – earlier only in home mortgage lending to minorities, and then to a significant proportion of the U.S. home mortgage market—is a threat to markets everywhere—to financial markets, and the world markets.

 

 

 

 

 

 

 

 

 

 

 

The problems of segregated minority communities, that we have paid insufficient attention to for so long,–the problems of credit denial—denial of prime credit in these neighborhoods—even in middle class minority neighborhoods—have now inescapably affected all Americans—and indeed the global financial system.  There is an important historical lesson here.

The network of mutuality holds greater gravity in the 21^st century as a result of the integration of financial markets and globalization.

Slide 19kuttynov14  Myths

There is a lot of misinformation floating around–claims are being made about how wonderful subprime lending really was. Scapegoats are being found. We need to examine these claims carefully. It is claimed that the CRA resulted in banks making unwise loans to minorities and in minority neighborhoods; and this is what has led to the current foreclosure crisis. (I am embarrassed even repeating this claim—even saying that “such a claim has been made,” because it is so patently false—it is almost laughable). Jack Kemp, a prominent Republican and a person who has been very active in the housing field, described this argument as “Nonsense.”

What are the facts about the Community Reinvestment Act?

This Act has been around for more than 30 years; it was most aggressively implemented in the 1990s, and yet there were no widespread foreclosure problems in that period. In fact, a majority of loans made under CRA were sound—they were serviced and repaid by borrowers properly. The CRA has resulted in affordable and sustainable loans in minority and lower income communities—the historically underserved communities.

Let us briefly examine why the CRA was legislated. As I mentioned earlier, federal government institutions systematically discriminated against integrated and minority neighborhoods in the decades prior to this legislation—in the 1930s, 40s, 50s, and even in the 60s—even after the blatant discrimination in the written rules of some federal  agencies had been outlawed through a series of court challenges and the FaHA. As a result, minority families and minority neighborhoods had been virtually excluded from the homeownership opportunities—federally subsidized homeownership—that so many white families had successfully availed of.  Till 1965, 98 % of the 10 million homes that had received federal underwriting guarantees had been sold to white households. Redlining of minority neighborhoods went on for years, even after fair housing and fair lending laws were passed.

The CRA was aimed at correcting the existing inequities in access to credit. This is a very reasonable law, based on a simple principle: anywhere a federally insured bank or thrift receives deposits, it must make loans. Completely reasonable.  Several studies conclude that most of the loans made under CRA were sound. CRA-loans were made in a more responsible way than other subprime loans. CRA-loans carried lower rates than other subprime loans, and they were less likely to end up securitized into the mortgage-backed securities that have now led to the financial crisis.

 

While the CRA has been around for more than 30 years, the predatory and abusive lending practices that are at the root of the current crisis started becoming widespread only about 12 years ago, reaching their peak in the early- to mid-2000s.

In fact, a great majority of subprime loans were made outside the purview of CRA. The CRA covers only certain types of financial institutions – banks.

Mortgage brokers and a majority of home mortgage lenders are not within its scope of purview.

Who are the main players in the subprime market? They are the mortgage brokers, mortgage companies and the Wall Street investment banks that provided the financing. These are not within the purview of CRA.  Finance company affiliates of major banks were also active in the subprime market. But many banks shifted their most risky lending to their affiliates precisely to escape CRA-scrutiny and compliance with  CRA-requirements.

 As Michael Barr testified this year before the House Committee on Financial Services,  50% of subprime loans were made by mortgage service companies not subject to comprehensive federal supervision; and another 30% were made by affiliates of banks or thrifts which are not subject to routine supervision or examinations. It is the non-CRA-covered lenders that drove the growth in subprime lending. The subprime lending sector was virtually unregulated. And that is precisely the problem.

If the government had taken steps to ensure that communities of color had adequate access to prime-rate mortgage finance, then the abusive lenders would not have been able to engage in risky practices in these markets.  After 2000, the enforcement of the CRA became very weak. And that is precisely the period when the most risky lending took place.  Indeed, if the CRA had been better enforced, much of the abusive lending could have been prevented, and the foreclosure crisis would not have occurred.

It is clear that the CRA is not responsible for the current foreclosure crisis.

In my opinion, there are some problems with CRA — and those problems are that CRA does not cover enough financial institutions, and the regulators have been all too willing to hand out satisfactory ratings to lenders—even when they have not done enough to expand lending to historically underserved communities. Those are the problems with CRA—not that the CRA caused the current foreclosure crisis. In fact, if these deficiencies of the CRA are overcome—the ones I just mentioned, we would have affordable, sustainable loans being made in historically underserved communities, so that people in these communities would not have any need to even talk to a subprime predatory operator. 

 Let us examine a second claim that is being made:

that subprime mortgages were a great homeownership opportunity for Americans, and that minorities in particular were able to raise their homeownership rates because of subprime lending.

 A Center for Responsible Lending study (report titled “Subprime Lending is a Drain on Home Ownership”(March 2007) demonstrates through analysis of data from 1998 to 2006 that subprime mortgages have not increased homeownership in America, instead they will have led to a net loss in homeownership. Since 1998, only about 10% of these loans were made to first-time homebuyers, the remaining were to people who already owned a home. These people were lured into subprime refinances.  A majority of the subprime loans are for refinancing existing mortgages. Prior to the refinance, these households held mortgages that they were able to pay, and could have gone on paying till the remaining term of the mortgage. But they were targeted through aggressive marketing tactics to get subprime refinances that were often on abusive terms—this is the classic predatory subprime lending. Refinancing of an existing mortgage does not add to the homeownership rate—they were already homeowners.

This study found that between 1998 and 2006, only about 1.4 million first-time home buyers purchased their homes using subprime loans. The Center for Responsible Lending estimates that for loans made till the end of 2006, there will be 2.4 million subprime foreclosures (projected). The net result is that subprime loans made during 1998-2006 have led or will lead to a net loss of homeownership for almost one million families.

 And what about minority homeownership?

 A claim has been made that subprime mortgages were the best thing that happened to prospective homebuyers in the minority community—that these mortgages added to minority homeownership.  Again, it is seen that these mortgages resulted in a net drain on minority homeownership. The Center for Responsible Lending estimates that in 2005, about 51,000 subprime mortgages were sold to African American first-time homebuyers. This is out of about 500,000 total subprime mortgages to African Americans that year. Of these subprime mortgages, 98,000 are expected to go into foreclosure – now you have a gain of 51,000 and a loss of 98,000 — giving a net loss of 47,000 African American homeowners. It is a similar picture for Latino homeownership—for Latinos there is a net loss of about 38,000 for subprime mortgages originated in 2005.

 

So the evidence shows that subprime lending was a net drain on homeownership—on general homeownership and on minority homeownership.  More people have lost homes than gained homes as a result of subprime lending.

 

 

Another claim is that it was the affordable housing goals of Fannie Mae and Freddie Mac that led to this crisis.

 

This is not true. For one thing, the affordable housing goals set by HUD for these GSEs were not very demanding. Second, the Clinton administration discouraged Fannie and Freddie from buying predatory subprime loans. It was investment banks and brokerage companies that led the growth of subprime mortgage-backed securities, not Fannie and Freddie.

 

However, from around 2005, Fannie and Freddie felt the pressure from their shareholders and Board of Directors to recover the securitization market share they had lost to unregulated investment banks.  From 2005 to 2008, Fannie Mae purchased or guaranteed $270 billion in loans to risky borrowers — three times the amount in all its earlier years combined. Again, this behavior of the GSEs was driven by the profit motive of shareholders and not by the affordable housing goals set in the 1990s or by the Community Reinvestment Act of 1977.

In my opinion, Fannie and Freddie did feed the housing price bubble—this was the result of their success in increasing the flow of capital for mortgage finance through securitization. Questions have been raised about whether these GSEs practiced due diligence on the matter of appraisals of property. They have now entered into an agreement with the New York State Attorney General to work only with lenders who use independent appraisers. According to U.S. Senator Schumer, “This settlement represents one of the first major blows against the types of predatory lending that were so prevalent in the mortgage business of the last few years. Appraisal fraud has left millions of Americans unable to afford their homes and has created a drag on the American economy.”

I believe we need to ensure that the same due diligence is also exercised by Fannie and Freddie with respect to fair lending. I shall talk more about this later.

If we are looking for culprits in the current economic crisis—the culprits are the decades of housing and lending discrimination that led to the exponential growth in abusive subprime loans, the lack of adequate regulations in this sector, the failure to enforce existing consumer protection laws, the 2000-law which ensured that credit default swaps would remain unregulated, the SEC’s  2004-decision to allow the largest brokerage firms to borrow more than 30 times their capital, the unchecked close relations between rating agencies and companies packaging mortgages and selling securities, and the SEC’s failure to oversee the brokerage firms as they got further invested into subprime debt. These are the culprits, not the ones that are being made scapegoats of in this crisis.

 

One salient lesson from the foreclosure crisis is that the type of mortgage matters. Risky mortgage products contributed to current problems of delinquencies and foreclosures.

Homeowners were steered to subprime loans even when they qualified for prime loans. It is the abusive features of the subprime mortgages that have led to delinquencies and foreclosures. Many of these same families would be able to sustain homeownership—make regular mortgage payments—if they had a fair mortgage product.

According to a study done by the Wall Street Journal last year, more than half the subprime borrowers in its study had good enough credit to qualify for prime loans. This study found that in 2005 (for example), 55% of the subprime mortgages were obtained by homeowners who had high enough credit scores to qualify for prime credit. Previous studies by Freddie Mac and Fannie Mae also showed that significant proportions of their subprime mortgage holders would have qualified for prime credit.

A new study by the Center for Community Capital of the University of North Carolina has shown that when families are provided with a sound mortgage product (and by that I mean a product without abusive subprime features), they can make their mortgage payments regularly and face little risk of foreclosure.

This national study tracked two large groups of home mortgage borrowers – both groups had similar risk profiles, most of them would not have qualified for prime credit. The first group, on their own, got subprime loans; and the second group (the experimental group) was given prime fixed-rate loans through a program funded by the Ford Foundation to help banks serve low-income families. Although both groups had similar financial background and the same ability to pay, the first group that had loans with features like prepayment penalties, variable interest rates and other subprime features was four times more likely to fail than the second group that got prime loans. This clearly suggests that it is the abusive features which is the chief problem, and not so much the families who find themselves in these situations. This  study concluded that for similar borrowers (that is, borrowers with roughly the same risk profile), subprime loans, ARMs, loans with prepayment penalties, and loans originated by brokers–all have significantly higher risks of failure than prime-type fixed rate loans made under community lending programs.

 

 Fair housing and fair lending enforcement has never more important than at the present time.

As I mentioned earlier, a climate has now been created—in the midst of the foreclosure crisis and financial crisis—that somehow it is lending to historically underserved groups that is the cause of this crisis. That these are inherently risky borrowers. This misconception is near the germ of truth, and that is what makes it so dangerous. The truth is that it is the predatory lending targeted at minorities which is at the root of the problem. It is not risky borrowers, it is risky mortgages, deceptive practices,  and risky leveraging by financial institutions that is the cause of this crisis. We can understand this problem well only by examining the period of redlining which preceded this reverse redlining. In the present climate, all minority borrowers and all minority neighborhoods are going to be erroneously seen as risky propositions. This is also a time of credit scarcity. Combine these two together, and you get a high likelihood of discrimination against minorities. Again, the discrimination  will take new and varied forms. It may take forms that makes it difficult to pin down as discrimination, to prosecute in a court of law. These are the challenges of the future. We must rely on tried and tested methods like fair housing and lending audits and also be on the lookout for new methods of detecting discrimination where it exists, and ending it. 

Fair housing and fair lending are areas of policy that have strong bipartisan support.  In this post-ideological era (as it is being called), it should be possible to find strong political support for fair housing and fair lending.

A number of misconceptions need to be cleared. And the public, legislators and the government bureaucracy needs to be educated about the continuing salience of fair housing/fair lending enforcement; and the high cost of neglecting fair housing —of allowing discrimination to persist.

 It is important to create an understanding about how widespread discriminatory practices really are. And testing is one important way of doing this. Testing should also examine the behavior of any steering of borrowers who qualify for prime credit to subprime loans.

 Tomorrow, the first global financial summit is being held in Washington DC.  Will anyone attending it talk about segregation in America, about redlining, reverse redlining? Will anyone talk about the needlessly perilous journey to homeownership for minority families in America? Although it is reverse redlining which is responsible for the proliferation of subprime mortgages—and recently, even prime mortgages with subprime-like features. And it is precisely these risky mortgage products that are responsible for a majority of the foreclosures—the high-cost mortgages, the teaser rates that reset to exorbitant rates, the Option ARMs, the Alt-A mortgages. These products were piloted in minority communities in America, in neighborhoods that had suffered from decades of redlining—discrimination in mortgage markets. Will this remain a hidden story?

 Slide 20kuttynov14 Dr. King –Jericho Road

 If I may read from a speech that Dr. Martin Luther King made in April 1967 at the Riverside Church:

“A true revolution of values will soon cause us to question the fairness and justice of many of our past and present policies. On the one hand we are called to play the Good Samaritan on life’s roadside, but that will be only an initial act. One day we must come to see that the whole Jericho Road must be transformed so that men and women will not be constantly beaten and robbed as they make their journey on life’s highway. True compassion is more than flinging a coin to a beggar. It comes to see that an edifice which produces beggars needs restructuring.”

 

 

 

 

 

 

 

 

 

 

 

 These are profound words of great relevance to all areas of policy—particularly our economic policies. If we apply them to the present context of policies in response to the housing market problems we are facing—we can see that in addition to playing the Good Samaritan through the loan modification programs, the FHA refinances,  and other programs to provide relief to homeowners at risk, it is necessary to transform the entire housing market—the process of homebuying, housing search, obtaining a mortgage, home insurance, the broker fees, appraisals, etc. to make sure that homebuyers are not beaten and robbed as they make their way to homeownership, which after all, remains a cherished part of the American dream.  And eliminating discrimination is an important part of the transformation that is needed.  

 We need better enforcement—more testing. I recommend mandatory testing for lenders and market areas served by Fannie Mae, Freddie Mac, FHA and VA.  These institutions must be themselves assured and assure the American public that the mortgages they purchase in the secondary market or insure are fair mortgages—that is, they were obtained by homebuyers from non-discriminating lenders. And what is the best way this assurance can be provided? I think fair lending audits is the best way. This should be a part of the due diligence that these institutions are expected to undertake. In addition, underwriting criteria and other practices of lenders can be examined to ensure that they are not discriminatory. The HMDA data is also an important tool for detecting lending discrimination. These data need to be strengthened and made more useful for fair lending enforcement. Let former and current judges weigh in on what data are required to prove discrimination where it exists—let them clearly outline the standard of proof; and then, let the government collect precisely those types of information on loans and lending practices. The infrastructure for fair lending enforcement needs to be strengthened. We have to play hardball here. The alternative is playing patty-cake, which is what seems to be going on.

Fair lending audits are important because they catch discrimination “in the act.” It is definitely not sufficient for lenders to identify themselves as fair lenders. Or for them to not have race explicitly mentioned in their loan approval criteria. As alluded to earlier, much of discrimination is carried out through unwritten agreements and practices.

 We need to ask our policy makers: are we serious about fair housing and fair lending? Are these to be merely platitudes and an espousal of good intentions? Do we say that lenders should practice fair lending “whenever possible” or “if not too inconvenient,” or “most of the time,” or “when liquidity is readily available?” No; the law is clear—it requires fair lending always—in each and every transaction, and at all stages of the transaction.  And the same goes for fair housing too.

Enforcing fair housing is an important tool in transforming the whole Jericho Road to decent and affordable housing.  

In 1787, one of the declared objectives for establishing the U.S. Constitution was “to form a more perfect Union.” The journey towards perfection has been a long one. Enforcing fair housing and fair lending, ensuring equal access to housing and credit markets for all Americans is an important component of the perfection we seek. We cannot have America default on its promissory note to the nation—the note promises equal protection of the law for all Americans, and this includes consumer protection laws, and the housing and lending laws. I am confident that America will deliver on that promise—the efforts of people in this room, in the government, in courts, in community organizations and  ordinary citizens will ensure that discrimination will end. Our prosperity depends on it. The healthy functioning of housing markets depends on it. The healthy functioning of financial markets and the global economy depends on it. We need fair housing for a prosperous America. Let that be our slogan: Fair Housing for a Prosperous America.

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Sadr City, Chicago, and Segregation Tuesday, May 6 2008

May 5, 2008 Sadr City, Chicago, and Segregation By Sherwood Ross    Preoccupied with the fighting in Sadr City, it may have escaped President Bush’s notice that most African-Americans live in blighted neighborhoods, some of which, like Sadr City, also appear to have been ravaged by bloodshed and violence. “The physical landscape of such neighborhoods often consists of abandoned buildings, poor-quality housing stock, unclean streets, and a low quality of municipal services—particularly schools and recreational facilities,” urban affairs experts James Carr and Nandinee Kutty write in their new book, “Segregation: The Rising Costs For America”(Routledge). “High levels of crime, violence, and drug trafficking created extreme social disorder in America’s jobless ghettos,” write Kutty, an urban housing consultant and Carr, Chief Operating Officer for the National Community Reinvestment Coalition. Chicago’s police superintendent Jody Weis doesn’t have to read about violence in books. The Associated Press reported April 21st Weis “blamed an excess of guns and gangs for a rash of 26 shootings over the weekend that killed (eight) and wounded victims from 13 to 65 years old.” Similar reports of slaughter have been seeping like swamp gas out of Philadelphia, Richmond, Calif., Cincinnati, Oakland, New Haven, and others.  “Violent Crime In Cities Shows Sharp Surge, Reversing Trend,” The New York Times reported March 9th. Since September 11, 2001, nearly 100,000 people have been murdered in the U.S., The Times’ Bob Herbert wrote last September 29th, surveying a period of just six years. As Chuck Wexler, executive director of the Police Executive Research Forum, put it: “There are pockets of crime in this country that are astounding.” Let’s see now, four thousand goes into 100,000 25 times, so for every GI killed in Iraq, 25 American civilians are murdered in USA and you can’t blame it on “Islamofascists.” Maybe President Bush’s would pay attention to our home-grown terrorism if newspapers publish photographs of all the local children and adults that have been murdered in their communities just as they print the pictures of GI’s killed in the Middle East.  Bush won’t change his policy, of course, but the graphics might make Americans realize Iraq is a trillion-dollar sideshow we can’t afford because we have an urgent crisis at home. Back in 1962, the National Urban League’s Whitney Young called for a “Marshall Plan” to combat urban poverty and President Kennedy didn’t respond, either.  Generation after generation, America consigns its minorities to largely segregated cities, some even more segregated today (80 and 90 percent) than they were in 1860. Congress is shelling out $700 billion to fight wars around the world this year but can’t find pennies to open the doors of opportunity to our segregated millions. A single fighter plane today can cost $15 million. You can hire a lot of good teachers with that kind of money.  You can finance a lot of housing. You can create a lot of domestic jobs.  Sure, there are whites who insist blacks should lift themselves up by the proverbial bootstraps—without recognizing that in some ghettos the most lucrative business open to the poor is drug-running.  As Gary Orfield, co-director of the Civil Rights Project at UCLA told AP, “The criminal economy is one of the only alternatives in some of these places. You basically have the criminalization of a whole community, particularly in some inner cities.”  Result: of 2.3 million Americans behind bars, 500,000 of them were caged for drug crimes. And who is surprised that about 40% of them are African-Americans? Steve Mariotti of the non-profit National Foundation For Teaching Entrepreneurship(NFTE) says drug gang members display much the same ingenuity as entrepreneurs—but lack constructive opportunities for their talents. NFTE has helped 150,000 inner city youth “turn street smarts into business smarts,” so it can be done. Kids who once served as lookouts for drug lords are running legit start-ups of their own, taking a bite out of crime. It’s fortunate some inner city kids can create their own businesses because racism in employment is alive and well. Just as real estate operators steer minority renters and home-seekers away from functional, white suburbs, employers in those suburbs don’t have openings when minority job-seekers knock. “There is strong evidence that prejudiced attitudes on the part of employers result in discrimination against qualified minority job applicants,” writes Margery Turner, director of the Urban Institute’s Metropolitan Housing and Communities policy center, in “Segregation.” “Blacks are particularly unlikely to be hired for jobs that require higher cognitive skills, especially daily computer use, arithmetic, or customer interaction. Many analysts have suggested that customer prejudice may also be a factor, since the racial composition of a firm’s workforce has been found to be related both to the race of the manager and to the racial composition of the firm’s customers.” Turner adds, “In general, minority job seekers are less successful in using their networks of family and friends than whites. Again, although residential segregation is not the only reason why minorities have less effective networks, it certainly is a factor, particularly for minorities living in high-poverty center city neighborhoods and also for those in the segregated suburbs.” And as long as public education is funded from property taxes, white school children continue to enjoy a competitive advantage. Deborah McKoy and Jeffrey Vincent, both with the University of California at Berkeley Center for Cities and Schools, point out a single-family home in predominantly Prince George’s county, Md., outside Washington, D.C., was priced at $195,400 in 2003 compared to $365,900 for a house in predominantly white Fairfax county, Va. “Residential segregation clearly contributes to minorities’ unequal educational attainment and hence to their disadvantaged position in the evolving labor market,” they write in “Segregation.” “Black high school graduation rates, employment rates, and wages are all negatively affected by the level of black-white segregation in a city. Other things being equal, high levels of segregation have shown to increase high school dropout rates among blacks, reduce employment among blacks,  (while increasing the white employment rate), and widen the gap between black and white wages.” The struggle to create a color-blind republic with a level playing field has been underway in earnest ever since returning black World War Two veterans decided “we aren’t going to take it anymore.” Significant gains have been made over stubborn opposition, gains that Rev. Martin Luther King and others paid for with their blood, yet equal opportunity remains America’s unfinished business. If injustice continues to breed poverty and crime, we may soon be sending our kids to school in bullet-proof vests, just like the flak jackets Commander-in-Chief Bush’s embassy workers must wear in Baghdad’s Green Zone.  # (Sherwood Ross is a Miami-based public relations consultant and reporter. During the 1960s he worked in an executive capacity in the civil rights movement. Disclosure: Steve Mariotti cited in this article is a former business associate of this writer. Reach Ross at sherwoodr1@yahoo.com)

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Fair, Green, Smart–Housing Policy for the 21st Century Monday, May 5 2008

 

Fair, Green, Smart^TM—Housing in the 21^st Century

Op-ed by Nandinee K. Kutty

(first published April 22, 2008)

 

 

 On Earth Day 2008, I propose a housing policy for the 21^st century based on the triple principles of Fair, Green, and Smart. Fair refers to fair housing, and a pro-active enforcement of the principle of non-discrimination in housing markets, home mortgage lending markets, and home insurance markets. Green refers to deliberate efforts to protect the environment, to conserve resources, and use renewable resources. Smart refers to adopting principles of smart growth such as using space efficiently, creating affordable rental and ownership housing, and building livable communities that are conducive to healthy community interactions.

 

Fair

Several towns (large and small) and rural areas in the U.S. were deliberately made into all-white or predominantly white settlements from around 1890 to 1940 through the expulsion of non-whites. While American Jews, Mexican Americans, Chinese Americans, and Native Americans were also in the expelled and excluded categories in many places, by far, it was African Americans that were expelled in the largest numbers and in the most number of places. Sociologist James Loewen documents this in his book Sundown Towns. He has compiled a list of U.S. municipal jurisdictions that were or are possibly maintained as exclusive white settlements.

 

As we move to an era of greater tolerance and a general abhorrence of racial/ethnic discrimination in America, it is not enough for these towns to quietly decide to not discriminate and to abide by federal fair housing legislation. It is necessary for former Sundown Towns, and indeed all municipalities, to pro-actively eschew the artificial racial homogeneity of their communities and to invite households of all ethnicities to reside in these communities.

 

Even today, in the 21^st century, there are places in the U.S. that some even well-educated and middle class American Jews do not wish to settle in because they expect they will face hate and hostility there. Similarly, certain ethnic minorities too have learned to stay away from places where they expect to face a severe degree of hate and hostility. The relatively recent history of the expulsions and exclusions makes such fears understandable. Therefore, it will take more than merely stating that a town now has a policy of non-discrimination. There will have to be a more concrete expression of inclusivity and respect. Discrimination in housing markets (both sales and rentals) and in home mortgage lending persists till today, as is well-documented in several studies. It is important for cities, towns, and rural areas to be committed to fair housing and create diverse, integrated communities that look like America. Overcoming segregation will help fulfill our ideal of one nation under God, indivisible.

 

Green

Global warming and climate change are facts of life that even avid non-interventionists in the world have now reluctantly accepted. All new housing developments, and remodeling of existing housing should implement green principles and technologies. These include the, by now, well-known energy-efficient home appliances, lighting, insulation materials, building materials, and improved building shells. The ENERGY STAR label today helps identify many of these green products.

 

A host of green building technologies are now available that homebuyers can demand and planning authorities should require. The U.S. Green Building Council has issued green technology guidelines and provides information to the public on which homes and buildings meet these guidelines.  The LEED for Homes Pilot Program is being used to encourage the adoption of green technologies in housing. A LEED-rated home has 25% to 50% lower energy and water bills, reduced greenhouse gas emissions and fewer indoor toxins. What’s not to like! Green housing uses water resources wisely, emphasizing conservation, reuse and recycling. Alternative fuels such as renewable energy sources are also emphasized in green housing.

 

Traditional landscaping that helps keep the air clean, regulates temperatures, and helps prevent soil erosion and flooding may also be used. All housing development plans should include a designated space that will serve as the “lungs” of the community. This might be a park, a forest, or significant plantings throughout the development. Green roofs are now being used on buildings of all heights. This involves growing vegetation on the roofs of buildings, and is a way of managing storm water, reducing urban heat island effect, and improving air quality.

 

Innovative housing designs can adapt to global warming and can also mitigate the severity of climate-change. Energy conservation and alternative energy use are not only ways of protecting the environment, but also of working towards energy independence and strengthening national security. 

 

Smart

Smart growth subsumes the notions of housing affordability, inclusivity, mixed-use of space, mixed-income residents, livability and sustainability. Smart housing development uses land efficiently and emphasizes the connectivity of places and people. This is directly counter to the synthetic, disconnected spaces seen in urban sprawl models of development.

 

Unaffordable housing is a quiet crisis that has been plaguing our communities for more than a decade. It is a quiet crisis because the people bearing the heaviest burden of it are low-income families, and in alarming numbers, working families with low incomes. Among the lowest-income 20 percent of renters in the U.S., more than one in two renters pays greater than half of income for housing. 

 

These severe problems of working families and renters have not merited newspaper headlines to the extent that the home foreclosure and subprime mortgage problems have. Nevertheless, the problem of unaffordable housing is widespread in the nation, and imposes costs on working families in the form of their greatly diminished ability to invest in the education and health of family members, consume adequate food, and save for their own retirement.

 

Affordable housing is an essential outcome of smart housing development. Lower average production costs are achieved by smart housing because more units are built on a given plot of land, units are smaller and sensibly-sized (rather than McMansions), units are designed to consume less energy, and housing is a part of mixed-use development. Mixed-use of land, such as when residences are built above retail stores, can help lower the cost of producing housing, and thereby create affordable housing.

 

Innovative land-use planning under smart growth decreases land costs for the development, such as when cheap parcels of inner city land are combined to create a sizeable development. Transit-oriented development reduces transportation costs for residents, thereby, easing the strain on the budgets of working families. Pedestrian-oriented development also reduces transportation costs and is environmentally friendly.

 

Walkability features in a housing development are known to be beneficial for health as well as for social relations and safety in the community. Similarly, the presence of grocery stores and farmers’ markets that residents can walk to are known to improve nutritional intake and health.

 

Conclusion

Municipal authorities should adopt Fair, Green, Smart^TM as criteria for approving development plans within their jurisdiction. The socially responsible investment (SRI) community should also adopt these criteria in rating companies and allocating funds to investment portfolios. Green is so rapidly becoming the standard for new buildings that if housing developers don’t build green today, they are essentially building housing that is already obsolete. Planning authorities should not permit obsolete construction within their jurisdictions as this will prove costly not only for residents of obsolete housing but also for the local jurisdiction. Communities that fail to create safe and welcoming places for ethnic minorities, immigrants, and sexual-orientation minorities lose the vitality, innovation, entrepreneurial energy, and financial investment that these groups can bring in. Local jurisdictions already know that a reputation for bigotry or intolerance is not an attractive feature for the community; promotional material for cities and towns in recent times never highlight this feature, and, in fact, take pains to conceal past bigotry and racial discrimination. Openly embracing Fair as a principle in all aspects of local governance will go a long way in American families viewing the locality as a livable community.

 

Providing affordable housing for a diverse workforce within communities where people provide their services combines Smart, Fair and Green; reducing commuting distance is going to be important to lower harmful gas emissions and conserve energy. When teachers, security personnel, etc. can afford to live within the communities where they work, there is greater stability in the community.

 

Today Green is popular. Cities that can show-case cutting-edge green technologies will attract tourists and new residents. They will generate confidence among investors in city projects and municipal bonds. Cities can signal their modernity, idealism and sophistication by adopting and highlighting green projects. Fair, Green, Smart^TM is the soundest way for a less-known jurisdiction to get on the map—for tourism, best practices, fiscal stability, and sustainability.

 

There is an inevitable connection between social justice, economic justice, and environmental justice. The common thread between these ideas is aesthetics. Racial discrimination offends one’s sense of aesthetics, as does gross, unjustified economic inequity, and polluted air and water.  There is another sense in which housing in America should consider aesthetics and that is in the physical appearance of housing and neighborhoods. Homes and streetscapes can be pleasing to the eye without being economically costly. With a proper consideration of aesthetics  in all aspects of housing policy, the new motto for housing should be “Fair, Green, Pretty, Smart^TM.” Yes, comma after “Pretty.”     

 Dr. Nandinee K. Kutty is an economist and a policy consultant. She is an editor and contributor for a new book Segregation: The Rising Costs for America (Routledge 2008). She is the author of numerous research papers published in peer-reviewed journals of economics and public policy. Dr. Kutty was formerly a professor at Cornell University. Her published research papers and op-eds are currently on the reading lists for courses taught at various universities in the U.S. Her e-mail address is nndkutty@aol.com. 

 

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New Move to Enable Fannie and Freddie to Ease the Mortgage Crisis Thursday, Mar 20 2008

March 19, 2008: The government today reduced the capital reserve requirements for Fannie Mae and Freddie Mac, giants in the secondary mortgage market. These companies were required to maintain a 30 percent capital reserve; and this was today reduced to 20 percent. The government regulator of Fannie and Freddie will consider further reductions in the future if needed.

This reduced cash reserve requirement will allow Fannie and Freddie to raise about $200 billion. The companies expect to raise billions of dollars through special sales of stock. Stocks of both companies rose significantly after today’s announcement.

This move is aimed at making greater housing finance available for new homebuyers and for existing homeowners who may want to refinance into more affordable mortgages. There is a significant shift in the government’s stance on the role of these government sponsored enterprises, Fannie Mae and Freddie Mac. The government seems to be viewing them more and more as a buyer of the last resort for primary mortgages and mortgage-based securities at a time when these markets are troubled.

Currently, Fannie Mae and Freddie Mac together hold nearly $20 billion in cash reserves. (Although in recent times, they had held reserves worth $53 billion). According to the regulator of these companies, the Office of Federal Housing Enterprise Oversight (OFHEO), cash reserves of these companies will come down by a third as a result of the new rules.

The government has recently made other changes with respect to Fannie and Freddie in order to ease the home mortgage finance crisis. As a part of the stimulus package enacted last month, the government raised the upper limit of the mortgages that these companies can buy or guarantee from $417,000 to $729,750 in high-cost markets. The mortgage limits were raised in several market areas across the nation. Then, on March 1, 2008, the government removed the combined cap of $1.5 trillion on the mortgage-investment holdings of these two companies. Thus, this plan today (Wednesday, March 19, 2008) is the third action that the government has taken in recent times with respect to Fannie and Freddie, aimed at injecting greater liquidity into the housing finance system and creating confidence in home mortgage markets.

OFHEO estimates that these actions will allow Fannie and Freddie to purchase or guarantee roughly $2 trillion in mortgages this year. Currently, the two companies taken together hold or guarantee around $4.9 trillion in home-loan debt.

Reactions to today’s move have been mixed. Republican lawmakers have for long been opposed to allowing Fannie and Freddie to take on more debt unless the regulator for these companies is strengthened significantly. They believe that more debt and allowing these giants to grow further will harm the global financial system. Prominent Republicans like Senator Richard Shelby have opposed this move and believe that a stronger regulator is needed for Fannie and Freddie. According to him, this move exposes the taxpayer to enormous potential risks.

Prominent Democrats such as Senator Chuck Shumer and Senator Christopher Dodd have welcomed this move. Chuck Shumer called it “a real shot in the arm to the idea that maybe we can get a good handle on the foreclosure crisis.”

The call for a stronger regulator for Fannie and Freddie makes sense in light of the recent accounting scandals in both companies. In the immediate term, this lowering of capital reserve requirements could be beneficial. However, regulators should raise the capital reserve requirements back to the old level after housing markets have stabilized.

However, the lack of transparency in the operations of these mortgage giants in terms of what the American public knows about them is quite troubling. It seems that deals are being struck behind closed doors between regulators and huge companies of which the American people have little prior knowledge. These deals don’t seem to be in response to public opinion. OFHEO ought to be required to seek public comment and opinion before it changes the rules.

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Stemming the Foreclosure Crisis with Principal Reduction Combined with Shared Equity—And Let State or Local Governments Step In Wednesday, Mar 19 2008

Tuesday, March 5^th 2008, marked a quantum jump in the response of U.S. federal authorities to the foreclosure crisis facing America. This was when Fed Chair Ben Bernanke urged bankers in Orlando, Florida to reduce the principal amounts of their mortgage loans to distressed homeowners. This, in simple terms, is debt forgiveness, or partial debt forgiveness. Such an action is normally anathema to lenders anywhere in the world. And U.S. mortgage lenders have not been too pleased to hear this, though some of their organizations have made polite noises showing some accommodation towards this suggestion, as long as it is voluntary for lenders to act upon it, and such action is consistent with the joint interests of lenders, borrowers and investors. But one bond investor minced no words and described the proposal as pouring napalm on the fire. 

As of today, the Administration’s response to the foreclosure crisis has taken the form of the “Hope Now” program and other similar programs, endorsed by Treasury Secretary Paulson and President Bush, that seek mortgage servicers to voluntarily reset mortgage rates to lower levels than previously decided, or to freeze the reset for a period of time. But now federal regulators, members of Congress, and advocacy groups are ratcheting up the pressure and talking about a “vigorous response.” According to Sheila Barr, Chair of the Federal Deposit Insurance Corporation (FDIC), current efforts are analogous to “kicking the can down the road.” Bernanke seemed to acknowledge the limitations of current programs when he exhorted:  “more can, and should, be done.”Although Tuesday was the first time that the Fed Chair used his bully pulpit to urge lenders to mark down principals of their home loans, federal officials have in the recent past made similar proposals. FDIC Chair Sheila Bair said last month that lenders should be more aggressive about writing down principal; and the Office of Thrift Supervision Director John Reich proposed a plan for principal reductions accompanied with loan servicers getting certificates that can be redeemed if home values rise by the time the property is sold.

What has prompted the quantum jump in proposed policy responses is the fact that a startling number of U.S. homeowners—8.8 million—now have negative equity in their homes—that is, the value of their mortgage loan exceeds the market value of their home. And this number is projected to grow to still more alarming levels, peaking to nearly 14 million in the second quarter of 2009, according to Moody’s Economy.com.Goldman Sachs has estimated that if home prices fall another 15 per cent, about 15 million homeowners (30 per cent of all U.S. households with mortgages) will face negative equity in their homes.  The received wisdom about the foreclosure crisis, that is now gaining wide acceptance, is that inflated home appraisals are even more to blame than high mortgage interest rates. A study at the Federal Reserve Bank of Boston (by Kristopher Gerardi, Adam Shapiro and Paul Willen) suggests that falling housing prices that have created negative equity situations are greater contributors to foreclosures than interest rate resets. This could be the basis for Bernanke’s statement on Tuesday that principal reductions “may be a relatively more effective means of avoiding delinquency and foreclosure” than renegotiating interest rates.   It is likely that inflated home appraisals were deliberately carried out with the support of mortgage lenders. In many cases, appraisers were related to the lender. It is clear that lenders have an incentive to cater to higher-valued homes because profit margins are higher for higher-valued loans. New York Attorney General Andrew Cuomo, who investigated the home loan industry after several loans ran into problems, said: “We believe the appraisals were often fraudulent because there were conflicts of interest and pressure on the appraisers.” Recently, Fannie Mae and Freddie Mac have entered into an accord with the New York Attorney General to purchase mortgages only from lenders who use independent appraisers that follow proper appraisal standards. Of course, where fraudulent appraisals can be established, the homeowner would have a case for redress in the form of lowered principal amounts through the legal system. But where this cannot be established, the inflated appraisals will just have to be accepted as reflecting the then “market value” of the home, albeit in a bubble market. In such cases, it is hard to make a case that lenders should reduce the principal amounts; indeed, such a course is contrary to elementary business principles.  

Costly foreclosures claim about 25 percent to 50 percent of the value of a home loan. Foreclosures also impose high costs on local and state governments. States and local jurisdictions feel the severest impacts of high foreclosure rates. According to a recent report by the U.S. Conference of Mayors, rising foreclosures and falling property values are expected to reduce tax revenue by more than $6.6 billion for ten states, including New York, California and Florida.  

There might be an incentive for local and state governments, lenders, and homeowners together to work out an acceptable principal readjustment with shared equity for all the parties involved. For example, if a home was bought with a mortgage loan worth $700,000, with practically no down payment, and now the market value of the home is $550,000, then the homeowner faces negative equity worth $150,000. He may have an incentive to walk out and allow the property to foreclose. In such a situation, local or state governments could step in and work out a plan with the lender to reduce the principal amount to $550,000, with the lender covering for $75,000 and the government covering for $75,000. In return for lowering the principal, the government and the lender each should get a 75/700 or 10.7 percent stake in the sales proceeds from the home whenever the home is sold. In housing markets that are expected to revive to previous peaks and beyond, this would be an attractive proposition for all.  

It is better that local and state governments, rather than the federal government, be involved in the deals because they have a better sense of the urgency and costs of the foreclosure crisis within their own jurisdictions. There may be places where it makes more sense to foreclose the property than to avoid or prolong a foreclosure. These might be places where there are buyers ready to buy the foreclosed property and keep the homes occupied and well-maintained. These might be places where a homeowner who has foreclosed can easily find suitable rental or owner-occupied housing at affordable rates; there, homeowners would simply move into more suitable housing that they can sustain in the long-term. Local and state governments are in a better position to make this assessment. There could well be a federal program to provide funding to states to enable them to take part in such programs.                             

Thus, a shared equity mortgage as proposed above will divide up the risks between the homeowner, lender and local government, and allow homeowners to sustain their homeownership with positive and growing equity as housing markets revive. And see the genius of this:  neighborhoods with homes in which the local government has an equity stake will receive good quality municipal services, and this will revitalize communities and boost the local housing market.   

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