Testimony of James H. Carr

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Written Testimony of James H. Carr
Chief Operating Officer
National Community Reinvestment Coalition

Submitted to the United States House of Representatives
Subcommittee on Commercial and Administrative Law
2141 Rayburn House Office Building
Washington, DC

Tuesday, January 29, 2008

Introduction

Regional economic downturns, speculation on skyrocketing home prices and rampant unfair and deceptive mortgage lending practices have combined to create the perfect foreclosure storm
in America. According to the FDIC, there is roughly $1.3 trillion of outstanding subprime mortgage debt (Poirer, 2007). In 2006 alone, more than $600 billion of subprime mortgages were originated (Inside Mortgage Finance, 2006). RealtyTrac data shows roughly 450,000 homes experienced foreclosure in the third quarter of 2007, up a full 100 percent from the same period one year ago (Yoon, 2007). And, although foreclosures are most heavily concentrated in 12 to 20 states, foreclosures are up in 45 of 50 states. Federal Reserve Board Chairman Ben Bernanke reported that 21 percent of subprime adjustable-rate mortgages were ninety-days delinquent or more as of January 2008 and according to the Center for Responsible Lending (Center for Responsible Lending) fully one in five subprime loans are expected to fail
(Bernanke, 2008; Center for Responsible Lending, 2007). That rate of foreclosure is estimated to translate into more than two million families losing their homes to foreclosure over the next year to 18 months (Center for Responsible Lending, 2007). Estimates of the full economic costs of the foreclosure crisis vary greatly. The projections share, however, a common theme: the prospect of significant financial costs that extent beyond the housing market.

Collapse of the Subprime Market

In November 2007, the U.S. House of Representatives voted overwhelmingly to approve a comprehensive anti-predatory lending bill. One of the key provisions of that legislation bars financial institutions from making mortgage loans to consumers who cannot repay those loans (HR 3915). This provision serves as a metaphor for the dysfunctional practices that have come to define the subprime market over the past decade. Studies and reports on subprime loans reveal problems in almost every aspect of the subprime lending process (Carr et al., 2001; Carr, 2006; National Community Reinvestment Coalition, 2002, 2005, 2007; Center for Responsible Lending, 2007; Schloemer et al., 2006; Engel & McCoy, 2002). In fact, nearly a decade ago, the North Carolina legislature passed a law to prohibit predatory lending (North Carolina, 1999). Inappropriate loan products, inadequate underwriting, bloated appraisals, abusive prepayment penalties, excessive broker fees, steering borrowers to high cost products, and servicing abuses, have been widely reported (Calem et al., 2004; Eggert, 2004; Engel & McCoy, 2004; Farris & Richardson, 2004; Lax et al., 2004; Quercia et al., 2004; Renuart, 2004; Seifert, 2004; White, 2004; Wyly et al., 2004). Funding of subprime loans has also played a major role in the crisis. The rating of securities as investment grade products that were backed by loans that might aptly be described as subprime mortgage junk bonds fueled the funding pipeline that enabled the exponential growth of the subprime market. Without the extraordinary access to financing provided by securitization, the growth of the subprime market would have been greatly limited and the financial damage to homeowners and the economy significantly reduced.

Prior to securitization, banks were meticulous about making sure that borrowers could repay their loans. That was because banks held loans in their portfolio. In short, their own money, and
that of their customers, was at risk. But with securitization, this self-regulatory incentive mechanism was lost.1 And, despite this transformation of the markets, federal regulation of the mortgage lending industry grew increasingly inadequate. The result was increasingly risky behavior of mortgage lenders, particularly in the subprime market. In recent years, a majority of subprime mortgages peddled to consumers have not been structured or underwritten to sustain homeownership; rather they were intended to lock borrowers into a financial relationship with mortgage brokers and mortgage finance companies whereby loans had to be refinanced, usually within two to three years, in order for mortgage payments to remain affordable. With each refinancing came another set of upfront broker and mortgage finance fees and servicing and securitization revenue. Securitization of the underlying assets allowed the risks of these products to be spread widely, literally to investors around the world (Landler, 2007; National Public Radio, 2007; Paletta & Hagerty, 2007; Werdigier, 2007). The result was that billions in profit were made while millions of families were put at high risk for foreclosure.

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Date published: Jan 29, 2008

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