The Tax Club Report

The mortgage crisis caused the country and partially the world to go into a recession.  Why did it happen and how does it affect you and who do we blame?  During the 90’s administration, banking laws were deregulated thus allowing banks to act as investment banks.   Instead of banks just lending money and making interest, they could now invest in all sorts of different investment activities.  The situation did not seem bad at the time but increasingly became a critical ingredient to a perfect storm for a financial meltdown.

Next the banks started to Securitize the loans.   Securitizing a loan is when a bank provides mortgages to lots of people.  The bank then groups the loans together, any amount, and sells them to investors in parts or shares.  Now all the banks had to do was find a person who needed a mortgage to buy a house or wanted to refinance.  They would issue them a mortgage and then be able to sell it.  They also could hold it so it would look great on their financial statements.   On their balance sheets, it would look like a strong asset and on the income statement the bank would show large amounts of mortgage interest income.

The bank structure and the securitizing of loans made it great to be a mortgage broker.  A broker is an intermediary between the lender and the borrower and would try to find the borrower a loan and get a commission.  While brokers searched for loans, the banks in competition with each other to originate loans increased causing banks to loosen their terms and conditions.  First, putting down 15% instead of the normal 20% was okay.  Next, 10% was plenty, and then a person could borrow 105% of what the property was worth.  Even though you would pay a higher interest rate, 7-8% became cheap enough. People were able to take out lots of money from a refinance, or buy that Mansion they always wanted. Builders kept on building because people kept buying.  Then, banks started lending with no income verification.  If you had a decent credit score, you could get a loan. All a person had to do was sign a paper saying they were making whatever the bank wanted to hear.

Let’s assume I am buying a house for $500,000 and I cannot afford the $3,000 a month payment on the $500,000 house I just purchased (assuming a fixed rate of 6% over 30 years).  No problem! The banks will only require me to make interest payments.  As a bonus the bank will give a rate of about 2% for the first two or three years.  Now I can pay $840 a month for the mortgage on the house.   The house sounds great until two or three years later when principal needs to be paid and the interest rate jumps up 5 percent or more at one time.

Many Americans could not afford these large jumps and as a result people faced foreclosure.  In a lot of cases the loans were not interest only. In some cases there were adjustable rate mortgages where the rate automatically jumped up after an introductory period of anywhere between two and seven years.

Somebody needs to take the blame. How could banks be so liberal with their loans? Easy! Bank executives were the ones cashing in on the bonuses because the incomes of the banks were so high.  They were making a quick profit at the expense of building long term wealth.   An employee with Washington Mutual bank had threatened to go to the Federal Government and Securities and Exchange Commission to expose the situation, but employees with this knowledge eventually decided against being a whistle blower because of fears of retribution or losing their jobs.

Now let us look at the mortgage brokers. The broker’s job is to sell the loan.  That resulted in some brokers not telling people everything they should know about the loan.  An example of this is when people would get an adjustable rate mortgage where it had a low promotional rate for the first 3 years but then automatically when up by 5% or more.  The broker would say it became adjustable but would leave out the part about the jump.  Unless the borrower read the fine print, they were in for a surprise.  Brokers are paid by “points,” (a point is 1% of the loan value).  They would then encourage people to borrow more than they could afford in order to raise their commissions.  Another very illegal tactic that the brokers would do is falsifying documents.  It was not uncommon for brokers to create pay-stubs or tax returns for clients to show more money than they actually made.   Most lenders now require people to sign forms allowing them to verify the income with the IRS.   If you found crooked enough brokers, there was no limit to the forgery and or fraud that existed.

Home owners can share in the blame as well.  People wanted to borrow as much money as they could to get the best house possible figuring their income would only go up.  Everybody wants to do the best for themselves and their family, but people were not realalistic.  Soon principle and interest payments were due and the rates had adjusted to an amount that could not be controlled.  The only area of concern was getting into the house as soon as possible.

When a loan goes into default and a house or other real estate property goes into foreclosure a bank has to send several legal notices to the home owners in an attempt to get the mortgage up to date. If payment is not made, the bank will become the owner of the house.  In general, if the loan cannot be repaid, the borrower will eventually lose the house.  In Long Island, New York a judge in foreclosure case actually ruled that a couple was no longer responsible for their mortgage of around $500,000.  The reason he cited was the lenders complete disregard for the couple who took out the mortgage.  While this will probably be overturned on appeal, this does send out a very harsh message to banks.  In an appeal the court will only look at the application of law by the judge in the initial case and will not make rulings on the circumstances of the case.   In this situation the bank will not help the couple who took out the mortgage.   The likely result of will be banks becoming more flexible and compassionate toward lenders.  The federal government has also been encouraging banks to refinance people’s loans in order to make it easier on people.  Unfortunately only around 85,000 people have taken advantage of this out of the 50 million plus mortgages in this country.  One of the reasons why so few people took advantage is because people who really struggled but paid their bills on time were either not eligible or not offered help.

In an effort to fix the mortgage mess Congress had to get involved.  While they were not directly bailing out people in trouble I do believe it was necessary to bail out the banks.  If one of the large banks failed it would have had catastrophic results.  Many more people would have lost their jobs and all the investors in those institutions would have lost all of their investments.  The situation would have had a ripple effect on the market that would have made the recession much more serious than it already was and is currently.

The problem has a solution as do most problems.  On the loan side more needs to be required from potential borrowers.  Interest only loans should be only issued in rare cases to people with outstanding track records. Those types of loans should also only be given to people with proven track records.  The adjustable rate mortgages should not be given out to anybody including “subprime borrowers,” who are borrowers with credit scores below 620.  This way there is no chance of the payment jumping up to the point where the loan is no longer affordable.  Thirdly, people should be required to put down a substantial amount of money; at least 10% plus closing costs.  The more money put down would give people more of a financial interest and the banks a little cushion in case the market does take a dip.  If these procedures are done along with legitimate verification of loan documents, the system would be more efficient.  The house prices also would not go up as high or as quick because less people would be able to bid as high as they were able to during the buying frenzy.  Right now as the markets begin to recover housing prices are getting more stable.  Even with all these procedures foreclosures are still inevitable but the percentage of loans in foreclosure will drop.

If you have been foreclosed upon, there are things you can do to fight back from a financial perspective.  If you are in dire straits, start to prioritize.  Cut expenses such as: cable, going out to eat, and entertainment. Do not spend any more money on paying off your credit cards since the debt is unsecured debt which means the credit card companies cannot take your house, car, boat or other possessions in order to satisfy the debt.   Your credit score will suffer tremendously but when you are in this position your credit score matters less.  Next, if income is very limited, stop making car payments.  One can always find a cheap-older model car that will get you from point A to point B.  All money should be going toward your house, food and medical expenses.  You can even stop paying property taxes before you stop paying the mortgage.  A city or state foreclosing for unpaid property taxes takes years and that can give you a reprieve if you are looking for new employment.   Before you stop paying the taxes contact an attorney and understand the laws for your local jurisdiction.  You will still be responsible for the taxes but if you can defer the payments it may be the way to go for now.

This country has had a tough time with the financial mess but it does present lots of opportunities for people.  If you are looking to buy a house right now, you can get it for a lot less then what people were paying for it two years ago.  Investors can also take advantage because there are a lot of houses on the market at reasonable prices and plenty of room to negotiate.  Rents have also gone down so if you have had the unfortunate circumstance of being foreclosed upon, you may be able to live easier paying less in a rented space.  Don’t forget the $8,000 first time home buyer credit the government is offering.

Tags: finance, loans, mortgages

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