Minnesota Monitor: Minnesota and the mortgage crisis: We’ve only just begun


by Molly Priesmeyer

Mortgage fraud. Negative equity. Exotic loans. As the former assistant attorney general for the state of Minnesota and current attorney for the Housing Preservation Project, Mark Ireland has seen his fair share of cases leave homeowners defrauded or left holding mortgages they can’t pay. Subrpime loans might have peaked in the Twin Cities last summer, but Ireland’s calls aren’t slowing down. Now, he says, Minnesota homeowners are facing new issues that will keep the economy shackled for years to come.

Ireland is also staff attorney for the Foreclosure Relief Law Project, which seeks to inform and develop policy strategies that ameliorate the effect of foreclosures on homeowners. And while a number of new federal and state laws protect homebuyers from predatory lenders, Ireland says Minnesota’s mortgage crisis is just now starting to unfold, and we have tens of billions of dollars’ worth of specious mortgages that will continue to adjust until 2011.

Ireland talks to Minnesota Monitor about how we got where we are, what we can expect to see in the housing market over the next few years, what can be done to slow down the descent, and that ugly, negative equity that is expected to get a whole lot deeper.

Minnesota Monitor: We’re just now feeling the ripple effect of the subprime crisis. What are some of the new issues and claims your office is seeing as a result of the meltdown?

Mark Ireland: I think that the newest trend is more and more people have negative equity in their house. They owe more than the house is worth. People have mortgages on their homes that are for an appraised value at the market’s peak. And sometimes those appraisals were also very optimistic that the market was going to continue to grow at 10 percent every year.

I am also getting more calls from people in the suburbs. Many are dealing with negative equity, and their rates are about to adjust and they can’t make the payments or refinance. Here, we are a legal-services office, so we don’t have a natural conduit for folks to call us. We are self-selected, really. But the fact that we are getting calls from people in Lakeville and Chaska and Rogers — those aren’t areas you think of as hotbeds of foreclosure.

So why are new foreclosures hitting the suburbs now? What makes those loans different than what we were seeing in the cities last year?

The subprime mortgages are starting to work their way out of the system, and the adjustable-rate mortgages peaked in June of last year. So there still are a lot of people that need to have their economic situation resolved.

But now we are seeing an uptick in calls from the alt-a market. Those are people who have good credit, or they have just slightly damaged credit, and they got what Alan Greenspan called “exotic mortgages,” like interest-only pick-a-payment adjustable-rate mortgages. Those mortgages were more prevalent outside the core inner cities of St. Paul and Minneapolis.

And when will those mortgages peak? Are we just waiting out a secondary crisis?

Those will peak in 2009, and then they won’t work themselves out of the system until 2011. Over the next two to three years, there’s going to be between $20 billion and $44 billion worth of these mortgages adjusting to really high rates every month.

And that’s why economists are freaked out. Because you can only pump $30 billion into the market every so often. But if every month you have $20 billion to $50 billion worth of mortgages that are adjusting, you can’t keep the liquidity in the market at that rate.

With negative equity becoming a serious issue, it’s literally as if hundreds of thousands of people in the Twin Cities and surrounding suburbs can’t access their bank accounts and life savings. Equity is what we relied on for more than half a century. What advice are you giving all the homeowners facing this problem?

It depends on each situation. For many of those facing negative equity, Congress passed a new law [the Mortgage Forgiveness Debt Relief Act] at the end of 2007 that is really helpful for consumers facing foreclosure. It allows you to sell your house, and if you have an agreement with your lender to accept whatever you can get for your house on the market as a full payment for the amount that you owe, you don’t have to pay taxes for the difference between what you gave the lender and the amount you owed on the home.

In the past, prior to this law, someone’s house might be worth $150,000 but they have a mortgage for $200,000. They would do what’s called the short sale. They’d sell it for the $150,000, and the mortgage company would issue them a 1099 saying they’d essentially received a $50,000 gift from the mortgage company.

Under this new law, there’s no longer any tax consequences. And the second option is to wait it out until things calm down.

And what about those who aren’t facing foreclosure? What are the chances a market like this will correct itself anytime soon?

The consensus among most of the experts who are smarter than I am is that the number of foreclosures will likely peak in the fall of 2009 or spring of 2010.

A lot of the excess homes that were built out in the suburbs and exurbs are being liquidated by the homebuilders. So we won’t have that housing stock on the market. And you will also start to see a reduction of the number of people who are selling their home while they are in a financial crisis, and a reduction of homes owned by banks that just want to sell to reduce the properties on their books.

So while in the fall of 2009 and spring of 2010, we will start to see the number of foreclosures going down, but there are long-term financial issues to come out of this that go far beyond the housing market.

What are we looking at beyond 2010?

One of the most pessimistic economists, and my favorite economists, Nouriel Roubini, believes that unless there is some dramatic action, this could be a decade-long not necessarily recession, but malaise, where it will take 10 years for everything to settle and start to grow at the rate of a healthy economy. I hope that’s not true. But he has been pretty right about everything else for the past four or five years.

So we could see 10 years of malaise due to an unregulated housing market?

It has to do with a couple of different things. One, our economy is now 70 percent service-sector. We don’t build stuff, we buy and sell each other’s stuff. It’s not a diverse economy, as it used to be.

So if the primary thing we do is buy and sell from one another, and we’re reliant on people buying plasma TVs and new cars, we’re going to need cash to do that. And for the past five or six years, people have gotten that cash from the value of their houses, either by selling their houses or tapping in to their home equity lines of credit. Now there is no equity in their houses. So that opportunity to tap into equity to get the cash to buy is no longer there.

You have health care costs that are continuing to go up, you have stagnant wages, and you also have oil prices that are at record levels. So unless you foresee some circumstance in which individual consumers are suddenly going to be $5,000 to $10,000 richer, the cycle we’re seeing now cannot be broken.

So if we’ve become over-reliant on equity, and for the first time ever it’s not there, what changes are we talking about?

Well, it gets at the core at how we live and how we spend money. And it gets into policy issues. There are lifestyle changes that will be forced on folks, and it’s going to cause a lot of pain, especially if our economy is reliant upon people buying $50,000 Suburbans. It’s very cyclical.

The idea that it’s cyclical, that this is what happens in a free-market economy and lenders were just giving consumers what they want — what do you say to critics who say this is what happens in a free-market economy, and that more government regulation will hurt it?

I think the lack of regulation is the reason why we’re in this mess. There was a conscious decision in the 1990s that culminated with the Gramm-Leach-Bliley Financial Services Modernization Act, which broke down a lot of those Depression-era walls. Banks and insurance companies and money-market managers and venture capitalists could now merge, and they did.

There was a decision there to deregulate the economy and financial institutions and allow the free market and the “invisible hand” to basically manage our economy. And the theory was fundamentally flawed in a couple of different ways.

One, the invisible hand of the economy is often too slow. There were signs of fraud and abuse years ago, and an aggressive regulator could have gone in and regulated and shut down these exotic mortgages, the stated-income no-document loans or, my favorite, the NINJA loans, No Income, No Job, No Asset, which are fundamentally unsound financial products. They could have gone in and stopped those financial instruments from going out into the marketplace, and they didn’t.

And because of that, there are billions and billions of dollars of these loans that will take years to get rid of. And the free market just shut that down pretty much in January of this year. You could have avoided billions of dollars of these being originated with proper regulation. But instead, people were allowed to continue to originate those mortgages.

Basically, it veiled what everyone was getting, from homeowners on up.

Just to put it in a different context: If you had a toy and 20 percent of that toy you’re selling to kids resulted in a choking hazard, it would be recalled. You have a car that explodes 20 percent of the time, you’d recall it. In a second. And here we have financial instruments that people knew years ago had about a 20 percent chance of blowing up. And no regulator stood up and pulled them from the market.

In order for a free market to operate, you need transparency and information. And the reason why there’s this credit crunch now, is that investors and Wall Street can’t differentiate between a good bond and bad bond because there’s not this transparency. They don’t know what’s underlying it.

And the CEO of CitiBank and CitiGroup resigned. One of the reasons he was asked to resign, was because he didn’t know their exposure to the subprime mess. And that totally freaks out Wall Street when you have a CEO of a major company saying, “I really have no clue.”

It’s like going into Best Buy and just having all the laptop computers out there with price tags on them, but you don’t know how much memory if has or if it can access the Internet, or any of the details. All you have is the price. Nobody would buy the computers without that information. And it’s the same with the deregulated bonds and financial instruments that are out there right now.

So now we’re seeing lawmakers scramble to come up with fixes. Can you talk about what some of these mean for homeowners right now? Are we just staving off the inevitable?

One of the most important bills out there is Sen. Harry Reid’s Foreclosure Relief Bill in the United States Senate [which Bush vows to veto]. It allows bankruptcy courts to cram down mortgages and readjust the terms of a mortgage for someone who has entered Chapter 13 bankruptcy. You can do that with every other debt pretty much, but you can’t do that with homes. That’s a major tool that would help homeowners over the next three or four years. That means that they could have a fresh start.

In terms of state bills, Rep. [Joe] Mullery’s package of foreclosure relief bills has some really good stuff in it. I think the highlight of those gives renters more control and notice over what is happening to their home or apartment building or duplex where they live.

A lot of times renters are paying rent to a landlord over the course of the [foreclosure] redemption period. But that landlord is just pocketing the money and not keeping the utilities paid. So this allows [tenants] to pay utilities directly and keep those on.

And the Mortgage Deferment Act is still the most powerful tool for homeowners. It is targeted at those who have toxic mortgages. It doesn’t allow them to live in their house for free. They still have to make payments. But it gives them time for the market and regulators to find what the solution is.

And given the current economy, what’s the rush in getting them out of their homes? There’s no advantage in that. There’s no advantage of creating even more housing stock in an already flooded market place. It just makes sense to do it, and do it now. 

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