But instead of shutting down, payday lenders in some of the same states that passed reforms continue making payday loans – and sometimes at higher rates than before the laws were enacted, according to public policy experts and consumer advocates who follow the payday industry. Most major payday lenders still are in business, using loopholes in existing small loan laws or circumventing new laws entirely to continue charging triple-digit annual interest rates, in some cases as high as nearly 700 percent, advocates contend. Lenders issue loans in the form of a check, then charge the borrower to cash it. They roll into the loan a $10 credit investigation fee — then never do a credit check. Or they simply change lending licenses and transform themselves into car title companies, or small installment loan firms, while still making payday loans.

“In Ohio, New Mexico, Illinois and Virginia, every major payday lender is violating the intent of the law,” said Uriah King, senior policy associate with the Center for Responsible Lending. “I’ve been involved in public policy issues for a long time, and I’ve never seen anything like this.”

“It is kind of astonishing. The more I look into it, the more brazen the practices are. Payday lenders, as a trade association, have consistently circumvented the intent of legislative efforts to address their practices.”

Payday lenders strongly refute that contention. Steven Schlein, a spokesman for the Community Financial Services Association of America, a payday lending trade group, said it’s simply untrue that payday lenders are circumventing the law in Ohio, or in any other state. “That argument is untenable,” he said. “It just shows you that our critics are really just anti-business.”

The dispute over Ohio’s payday lending practices began after voters upheld a 28 percent interest rate cap on payday loans in November of 2008, and many payday lenders began operating under several small loan laws already on the books. The legislature approved the cap in the spring of 2008, and payday lenders fought back with the voter referendum, but failed.

The small loan laws, which have been in existence for decades, are intended to govern installment loans, not single-payment, two-week payday loans. Payday lending opponents say the lenders are exploiting those laws to avoid the 28 percent rate cap. Lenders contend they are legitimately licensed by the state to make the small loans.

Some 800 of the Ohio’s 1,600 payday lending stores have shut down since rates were capped – and the rest are “trying to make a go of it” by adhering to the small loan laws, said Ted Saunders, CEO of CheckSmart Financial Co., a national payday lender with more than 200 stores in 10 states. “We’re lending money for far less than we did when all this started,” he said. “This is not business as usual. The activists just want to put us out of business entirely.”

Those activists are pushing the Ohio legislature to move once again, to close the loopholes in the loan laws by placing them all under the 28 percent cap. More than 1,000 payday lenders already have gotten licenses to make short-term loans under the old small loan laws, which allow for high origination fees and other charges, according to a report by the Housing Research & Advocacy Center in Cleveland.

Under those laws, for a 14-day loan of $100, lenders can charge an origination fee of $15, interest charges of $1.10, and a $10 credit investigation fee, for a total amount of $126.10, or a 680 percent annual interest rate.

David Rothstein, a researcher with Policy Matters Ohio, an advocacy group that pushed for payday lending limits, said testers for his group found that lenders sometimes told borrowers certain loan amounts, such as $400, were not allowed. But they could borrow $505. Loans over $500, according to the small loan laws, allow lenders to double origination fees to $30. Lenders also often issued the check for the loan from an out of state bank, but said borrowers could cash it immediately if they did so at their store – for another fee, often 3 to 6 percent of the loan total. Testers contended employees at some of the stores laughed as they explained the procedures, saying they were only trying to get around the new law.

In other cases, lenders directed borrowers to go get payday loans online, where rates can be higher.

“The General Assembly, in a bipartisan manner, passed a strong law on these loans and the governor signed it,” Rothstein said. “Then, the industry took it directly to the voters, who reaffirmed support for the law by some 60% despite the millions of dollars spent by the industry to overturn the law. This is a slap in the face. They are absolutely disregarding the spirit of the law that was passed.”

Saunders, however, said consumer advocacy groups promised that low-cost payday lending alternatives would pop up once the law was passed – but that hasn’t happened. Instead, there’s been an increasing demand for payday lending services by strapped consumers. “Should we be further eliminating access to credit in a bad economy?” Saunders asked. “We exist because we’re still the least expensive option for a lot of people.”

People hit by high overdraft fees from banks or faced with late charges on multiple bills sometimes decide that taking out a payday loan can be a cheaper alternative, he said.

Based on those kinds of arguments, the debate in Ohio now has shifted from how to best enforce the new law to arguing again over the merits of payday lending. Payday lenders are contending that curbing payday lending in a recession hurts low-income borrowers, and results in job losses. Lawmakers have yet to move on the latest bill to end the loopholes. King, of the Center for Responsible Lending, said that while payday reform advocates have fought in the past to make sure new laws were followed, Ohio marks the first time where the payday lending debate seems to have started over entirely.

“I haven’t seen that elsewhere,” he said. “Ohio is something new. I think there is some degree of frustration as to why we are redeliberating every aspect of this issue. It’s made a tough issue even tougher.”

Ohio isn’t alone in dealing with pushback from payday lenders, even after laws are passed.

In Virginia, payday lenders responded to laws passed last year to limit their fees by reinventing themselves as car title lenders, while still essentially making payday loans, said Jean Ann Fox, director of financial services for the Consumer Federation of America. Car title loans are high-rate loans usually secured by the borrower’s car.

State officials ordered payday lenders in December to stop making car title loans to borrowers who already had a car title loan outstanding, and to start filing liens on borrowers’ vehicles, as is the usual practice with car title loans.

In New Mexico, the state attorney general sued two small installment lenders, contending they used a legal loophole to continue charging extremely high rates on short term loans – in some cases, more than 1,000 percent. In both New Mexico and Illinois, the payday lending lobby supported reform laws, but then began using the small loan laws once the new limits took effect, CRL’s King said.

For other states, such as North Carolina, Pennsylvania, Georgia, and Oregon, state lawmakers or the attorney general had to go back and tighten laws or ramp up enforcement after initial payday reform legislation failed to rein in high fees. In Arkansas, an effort to end payday lending wound up involving the state Supreme Court and an aggressive campaign by the attorney general.

In Ohio, Saunders said payday lenders will be gone entirely if lawmakers move to limit their use of the small loan laws. The additional fees allowed by those laws, he said, are “the cost of doing business,” and companies like his can’t realistically operate without them. His solution is to launch a statewide financial literacy campaign, in which CheckSmart will provide an expert to train nonprofit groups and churches and provide them with a variety of resources to help consumers with budgeting and saving issues. The campaign won’t involve marketing payday loans or pushing any products. Saunders said he took on the idea after several lawmakers during the 2008 debate told him his firm needed to have a higher community profile. Providing financial literacy help, he said, will highlight CheckSmart’s good corporate citizenship.

“In 2010, financial literacy is a big part of what we’ll do going forward,” he said. “It’s not a conflict of interest. We’re going to be giving good, sound financial advice for free. I have nothing to hide. Look, no amount of financial literacy would solve every person’s financial shortfalls. If consumers were being served by other sectors, we wouldn’t be here. This is a way of saying, ‘We’re the good guys.’”

While consumer advocates may not see it that way, attempts in Ohio to limit charges on short-term loans also have been hampered by confusion over who should take the lead – the governor, lawmakers, the attorney general, or state agencies, Rothstein said. As that fight goes on, the question of how much people in financial peril should have to pay for a short-term loan remains as unresolved as ever, in Ohio and in many other states.

President Obama. Photo: WDCpix

Only a year ago, hopes were high that a big push by the government to stop foreclosures would be a great success, living up to its billing as “Help for America’s Homeowners.”

Last January started out with a foreclosure moratorium, giving time for the Obama Administration put the final touches on Making Home Affordable – its $75 billion signature program aimed at helping 3 to 4 million homeowners. After having bailed out banks and the financial system, the administration began turning its efforts to borrowers on the verge of losing their homes. The program rolled out with fanfare in the spring.

But as 2010 begins, it’s already clear that Making Home Affordable has fallen far short of its goals, with only 31,382 permanent loan modifications completed by November 30. Lenders last year were doing far more loan modifications on their own, before the Obama plan was launched. And although foreclosures show no signs of slowing down and are predicted to reach 13 million during the next five years, no one’s expecting a dramatic turnaround in helping people keep their homes. The only way the administration will get significant numbers of loan modifications done will be to bring back failed bankruptcy cramdown legislation, or to put billions of dollars into a mass effort to rework loans – neither of which seems politically feasible.

That means 2010 will be another year when only a small number of loan modifications get done each month, as the administration and mortgage servicers continue pointing fingers at each other for the impasse, some industry experts say. The only bright spot ahead for the government’s foreclosure prevention will be that down the road, foreclosures eventually will slow of their own accord. To use the Vietnam analogy, that will allow the Treasury Department to declare victory and get out of the loan modification business for good.

“I don’t hold out a great deal of hope that the administration will do more” to complete more loan modifications, said Patricia McCoy, a University of Connecticut law professor who studies financial services regulation. “There’s just no political will for that.”

As the program falters, a move to blame borrowers for problems with the effort has grown.

When difficulties with Making Home Affordable became apparent early on, servicers began contending that borrowers were refusing to provide income verification and other paperwork to quality for permanent modifications. Under Making Home Affordable, eligible borrowers first receive a three-month trial modification. In order to convert it to a permanent modification, they need to provide servicers with pay stubs and other documentation, as well as making all their trial payments.

Before the program began, servicers voluntarily were completing 120,000 permanent loan modifications per month during the first quarter of last year, according to Alan White, a Valparaiso University law professor who studies loan modifications. Once the Obama administration’s program rolled out, those totals dropped to about 70,000 per month, as servicers worked to switch borrowers into Making Home Affordable. According to Treasury Department figures, nearly 700,000 trial modifications under Making Home Affordable were underway by the end of November. But with fewer than 32,000 converted to permanent modifications, it means a net loss of permanent loan modifications since the Obama plan began.

The voluntary plans by servicers, however, were called “extend and pretend”plans by critics, who said servicers simply were setting up repayment plans with late fees and other charges rolled into them, without ever actually reducing a borrower’s debt. Re-default rates on those loan modifications have been high, as a result. Making Home Affordable has been more aggressive about lowering a borrower’s monthly payment, and the government is pressing servicers to switch to using its program – one reason why Making Home Affordable permanent loan modifications are lagging behind. In addition, some borrowers simply can’t qualify for the government’s program, because they are too far underwater on their mortgages.

But unless a surge of permanent loan modifications suddenly occurred in December, the New Year will begin with fewer loans permanently reworked than during the same period a year ago. Treasury officials said in November that 375,000 trial loan modifications were scheduled to expire by the end of December, but it was unclear how many would be converted into permanent plans. Then, on Dec. 23, the government announced it would order servicers to give borrowers more time to complete trial loan modifications before kicking them out of the program.

Servicers have responded to the lack of progress so far by suggesting that borrowers are refusing to turn in income and other documentation because they probably lied about their incomes to qualify for their current mortgages. Liar Loans, or loans that required no documentation of income or assets, have been cited as a major culprit in the financial collapse, as some borrowers began defaulting on them just a few payments into their mortgages beginning in 2006.

Guy Cecala, publisher of Inside Mortgage Finance, which covers the lending industry, said the mortgage firms and servicers were skeptical from the start that any loan modification plan would work. “No one ever thought seriously that this would put a dent in the problem,” he said.

Now the industry is likely to fight back at any criticism not by doing more loan modifications, but by blaming borrowers, as well as the Obama administration, for a faulty program. All this may add to a backlash and moral hazard charges of helping out homeowners who may have lied to buy bigger homes than they could afford, while other homeowners who may have lost their jobs struggle to meet their mortgage payments, he said.

“I hear people saying all the time, that all the administration is doing is offering help to the people who deserve it the least,” Cecala said.

Housing counselors and attorneys find that argument infuriating. Already struggling to get servicers on board with Making Home Affordable, they now also face dealing with a shift in a public perception toward blaming the borrower.

Diane Thompson, an attorney with the National Consumer Law Center, said the situation has gotten so ridiculous that servicers are simply looking for excuses to deny reworking loans.

“I met with a woman who oversees a counseling program in St. Louis, and she told me that the most common reason for denials now is that the borrower’s hardship isn’t permanent– surely at some point in time the borrower will get a new job,” she said. “And of course servicers continue to lose documents at an astounding rate.  Any counselor I talk to is almost seething with frustration.  I’ve had counselor after counselor in recent weeks tell me, “They’re just stalling.”

“I think there’s a bit of a face-off developing between the administration and servicers.  My impression is that servicers find the program burdensome and so would like to see it fail, but would prefer not to be held accountable for that failure.  And the administration, of course, would prefer to see the program succeed.  Whether this results in a scrapping of the program or a major reworking of it, I have no idea.”

White, of Valparaiso, thinks the situation is even more dire.

“I would give it another month or two to see if they can do any better, but if not, it is definitely time to try something else,” he said of Making Home Afforable loan modifications. “As far as blaming the homeowners, that is really sad.  From all reports I hear from housing counselors and legal aid lawyers, the servicers are losing the documentation.  It is hard to believe that 75 percent of borrowers on temporary mods are making their payments but that they can’t come up with two pay stubs and a hardship statement.  I think we are dealing with a massive failure and breach of contracts by the servicers.”

The administration will handle this by continuing its current tactic of singling out for public condemnation servicers who aren’t doing enough loan modifications. But that approach hasn’t worked so far, and it’s not likely to be any more successful this year, said Kathleen Engel, a Suffolk University law professor and expert on mortgage securitization.

“A shame list may work when country club members don’t pay their dues, but I don’t think it works with servicers and lenders,” Engel said. “If it did, they wouldn’t have been making and financing abusive loans all these years.”

What might work would be a massive, multi-billion dollar effort to get loan modifications done on a large scale, said Cecala, of Inside Mortgage Finance. But there would be little political support for spending that kind of money on troubled homeowners. Since the Obama administration sat back last year and let mortgage cramdown legislation fail, it’s also not expected the White House would suddenly turn around and once again push for legislation to let bankruptcy judges modify mortgages to keep borrowers in their homes.

And not everyone agrees on the right approach to jumpstart the program. McCoy, for example, said she considers loan modifications a “one size fits one” option, that can’t be done a mass scale.

As a result, Cecala sees an entirely new direction in 2010 – lenders will aggressively go after homeowners who walk away from their underwater mortgages, using debt collection agencies that will focus on that as a new business. Or lenders will move to ensure a borrower’s credit remains impaired for a decade or more, should they walk away. In the meantime, the Obama administration will talk a good game, and keep criticizing servicers, while only small numbers of homeowners end up with lower payments.

In the end, Cecala said, the only thing that will become clear is that “there’s plenty of blame to go around” for a program that began this time last year with lofty expectations, and then fell painfully short.

Illustration: Matthew Hertel

With home prices continuing to fall and more foreclosures yet to come, it’s clear that tough times remain for a housing market recovery. And to add to the troubles, another threat to any rebound is emerging: mortgage fraud.

The risk of mortgage fraud in the third quarter of this year on U.S. home loans shot up 11 percent from the previous quarter, according to Interthinx, a firm that provides fraud prevention services to lenders. But unlike the inflated home values and incomes that marked the mortgage fraud common during the housing boom, things are different this time around. Interthinx, which analyzes mortgage fraud nationally, and uses its risk measure to show where it may be increasing the most, found a continuing shift to schemes involving bank-owned foreclosed homes, and short sales, in which an owner sells the house for less than what’s owed on the mortgage and the lender forgives the remaining debt. The firm also reported that real estate agents and other professionals increasingly are involved in the schemes, which are growing in popularity due to the abundant supply of  foreclosures, and the fact that appraisals frequently aren’t required in order to sell distressed properties.
The fraud goes beyond just just ripping off banks. Mortgage fraud leads to more property value declines in hard-hit neighborhoods, leaves homeowners already in distress in even worse shape, and ultimately will end up costing taxpayers, who will be stuck with the costs when loans go bad.

As fraud picks up, a typical scheme increasingly works like this: A homeowner underwater on a mortgage, owing more than the home is worth, arranges a short sale – with a friend or relative as the buyer. The relationship is never disclosed to the lender. The home then gets deeded back or gifted to the troubled borrower shortly after the sale. Or, the bank unwittingly accepts a lowball short sale offer, allowing the new owner to quickly flip the property to a buyer already on standby, willing to pay a higher price. Such schemes amount to fraud because buyers and sellers lie to the bank about the true nature of the transactions. Banks lose more money than they would have, had the short sales occurred at their true market value – the profits go into the pockets of the flippers. Some investors only flip the properties again, saddling the buyer’s lender with a property that’s not worth the mortgage amount.
Flipping foreclosures and short sales is taking off as the latest real estate craze, with numerous web sites popping up to market advice on turning quick profits on distressed properties. And short sales also are expected to only increase as loan modification efforts continue to falter, and borrowers facing foreclosure have few other options. Interthinx expects fraud involving a “straw” borrower – a deceptive stand-in used as cover for a questionable transaction – to also become more frequent as a result.

“Since many large for-profit schemes during the boom were fueled by a steady stream of straw borrowers recruited through ‘investment’ clubs and networks,  the coincidental proliferation of “get rich quick” websites targeting short sale and REO investors and the continuing popularity of “flip this house” programs on TV suggests that there is a significant pool of potentially willing participants, and that left unchecked, the damage could be significant,” Interthinx said.

The problem for neighborhoods with distressed homes is that investors buying them up and flipping them can destabilize a community even further, since some investors may not maintain properties or may walk away from losses. Using relatives for short sale fraud means the bank ends up approving a mortgage that the owner still may not be able to afford, creating more losses, both for the bank and for the neighborhood.

And, increasingly, people involved in fraud schemes are finding ways to finance them through taxpayer-backed Federal Housing Administration loans, an agency already dealing with delinquency problems and and mortgage fraud, said Robert Simpson, president of Investors Mortgage Asset Recovery Co. in Irvine, Calf., a firm that analyzes mortgage fraud. The FHA’s loan volume has quadrupled since 2006, and FHA-backed loans have been beset by rising defaults that some contend put the agency at risk for a taxpayer bailout. Between the FHA, and government-controlled mortgage giants Fannie Mae and Freddie Mac, nearly 90 percent of all mortgages are backed by the U.S. taxpayer. Banks and lenders took the losses, at least initially, the last time around. This time, taxpayers may end up on the hook, he said.

“Anytime there’s money out there, someone will begin trying to figure out a way to get to it,” Simpson said. “Right now, the fraud gets shipped over to the FHA. We’ve got to hope they are being very diligent, because if they are not, the damage will be irreversible.”

Mortgage fraud played a huge role in the mortgage market collapse. Borrowers qualified for loans they couldn’t afford when brokers inflated their incomes, sometimes without their knowledge.These days, fraud revolves less around the origination of the mortgage loan and more with all the different transactions that take place over distressed properties, from sales of Real Estate Owned homes to short sales, said Guy Cecala, publisher of Inside Mortgage Finance, a trade publication that follows the subprime industry. The well-documented proliferation of foreclosure rescue and loan modification scams is a prime example, Cecala said.

Mortgage fraud also is on the rise because former subprime loan officers are out there looking for new jobs, and new ways to make money, he noted.

“Whenever there’s a new transaction, there’s a new way to game they system, and this is exactly what people are trying to do,” he said.

Short sales at first seem an unlikely target for fraud, because they can be a lengthy and difficult process, with banks often taking months to approve sales, if they do at all. For that reason, Cecala said, he believes short sales – at least for now – comprise only a small piece of the mortgage fraud picture. But the Treasury Department is expected to issue guidelines soon on streamlining short sales and offering financial incentives to borrowers and lenders. The push for more short sales, combined with a backlog of foreclosed homes, distressed homeowners, and banks anxious to get foreclosures off their books, will likely make short sale and REO flipping fraud more prevalent.

A recent investigation by the Sarasota Herald-Tribune of sales in two Florida counties, for example, found that banks had lost “untold millions” because of  short sale flippers using questionable appraisals and failing to disclose that a quick sale at a higher price had already been arranged. The report found a small industry of flippers buying distressed properties and reselling them within days. Real estate professionals were a key part of the schemes, participating in both buying and selling properties. All the losses added up, with just the most suspicious sales, where properties were flipped within a day, already costing banks $1.7 million in Sarasota and Manatee counties alone.

Flipping properties isn’t illegal, but it can involved fraud in several ways, explained Ann Fulmer, vice president of business relations for Interthinx. It’s when a seller never mentions higher offers on the table from bona fide purchasers, or fails to disclose that the seller already has a contract with a buyer for a higher price. Red flags sometimes should be raised when borrowers use transactional funding, which means essentially renting someone else’s money for one day, in order to appear in a stronger financial position. Then there’s the the use of land trusts – they’re not illegal, in and of themselves. Land trusts are organizations created to purchase and hold real estate. But short sale gurus are advising investors to set them up to evade FHA anti-flipping rules, and to hide the true borrower’s identity, which can amount to fraud.

“Short sale flips are today’s equivalent of the California gold rush,” Fulmer wrote recently.

She and other mortgage experts noted that banks already are on to some of the schemes. In some cases, banks are requiring everyone involved in a transaction, from the real estate agent to the mortgage broker, to sign affidavits swearing they have aren’t in the flipping business with anyone else involved in the sale. Cecala, of Inside Mortgage Finance, said federal law enforcement agents also are moving more aggressively even on smaller cases of mortgage fraud, unlike during the housing boom, when only major cases drew attention.

But a fraud specialist for a major wholesale lender, who declined to be named, said there’s still plenty of misdeeds going on. Some borrowers are filing amended tax returns showing a much higher income than the borrower’s true income. The borrower pays a penalty to the IRS for unpaid taxes, but uses the higher income figure to qualify for a bigger loan, or for a loan he wouldn’t otherwise have qualified for. In addition, some builders still are offering “silent seconds” to borrowers who can’t afford a home on their own. A silent second refers to a second mortgage, sometimes used for a downpayment, that is not disclosed to the lender of the first mortgage.

Stated income and no documentation loans known as liar loans, may be gone, the fraud specialist said, but some lenders still are seeing borrowers and loan officers still trying to fudge or doctor financial information, a common practice during the pre-liar loan days of the 1980s, he said. “We’re seeing white out again,” he said.

lllustration: George Peters

WASHINGTON — Mortgage giant Fannie Mae’s recent announcement that it will give homeowners facing foreclosure the chance to stay in their properties as renters for as long as a year is the latest aggressive move by the government to help troubled borrowers and tenants avoid being evicted. But as past efforts to stem the foreclosure crisis have already shown, even well-intentioned programs haven’t managed to reach significant numbers of people in peril – meaning any new approach faces a tough road ahead.

Consider, for example, a new federal law approved in May that protects renters from foreclosure evictions by giving them the right to stay in their residences after foreclosure for 90 days or for the duration of of their leases. Despite the new law, some tenants aren’t getting notice of their rights and are simply moving out, housing advocates said.

The problem has been particularly widespread surrounding a provision in the law, called the Helping Families Save their Homes Act, that allows for borrowers with Section 8 affordable housing vouchers the option to also stay in their residences when their landlord is in foreclosure. Some tenants who call their state or local housing authorities in Massachusetts and Connecticut after a foreclosure eviction notice are mistakenly told they have to move, noted Judith Liben, a senior housing attorney with the Massachusetts Law Reform Institute, a nonprofit legal services advocacy group. Better training of housing authority staff would help fix the situation, she said.

“Even with well-intentioned policies, there’s a disconnect between a good idea put into law, and what really happens on the street,” Liben said. “We see that disconnect on the ground, all the time.”

Despite anti-foreclosure initiatives by the government and lenders, the housing crisis has continued to worsen. Foreclosure notices totaled a record high of nearly 938,000 in just the third quarter of this year, according to RealtyTrac, an online foreclosure database. The Center for Responsible Lending predicts a total of 9 million foreclosures by 2012. Vacant and abandoned foreclosed properties are adding to neighborhood blight problems. Renters increasingly have become caught as innocent bystanders, evicted often without notice when their landlord faces foreclosure.

The new federal protections are supposed to address that. But in some cases, tenants in foreclosed homes either can’t reach real estate agents in charge of selling the properties to let them know they want to continue renting, or they get incorrect information from agents and think their only option is to move out immediately, said Shelley White, litigation director at New Haven Legal Assistance in Connecticut. In some instances, law firms send misleading letters that imply a financial incentive to move, known as cash for keys, is a renters’ only option, she said.

“We’re definitely seeing a lot of problems with tenants that just get notes from Realtors that say the bank has foreclosed on your property, and it’s time to get out,” Wright said.

The difficulties in outreach to tenants comes as the government continues expanding options and assistance to borrowers and renters dealing with foreclosure. In addition to the new federal law, the Treasury Department plans soon to rollout its plan encouraging more short sales by offering financial incentives to lenders and borrowers. In a short sale, a homeowner sells his home for less than the amount owed on the mortgage, and lenders forgive the remaining loan balance.

Both Fannie and Freddie Mac earlier this year began allowing qualified tenants in foreclosed homes under their control to sign month-to-month leases. Freddie Mac also started offering former owners of foreclosed homes the month-to-month lease option. Last week, Fannie announced its new policy, which significantly expands on the idea, allowing some owners who didn’t qualify for a loan modification and can’t afford their mortgage  the option of staying on in their homes. The owner would voluntarily turn over the property to Fannie in a “deed for lease” transaction, instead of going through a lengthy foreclosure process. The former owners in exchange would be given the option to rent back their homes for at least a year. Unlike in a short sale, their credit is unlikely to take a hit because of the transaction. And even investors may be eligible, meaning they would turn over their properties to Fannie, but their tenants would have the option to remain.

“This is huge,” said Dean Baker, co-director of the Center for Economic and Policy Research, who proposed a similar own to rent idea when the financial crisis first hit two years ago.

Baker would prefer that Fannie’s new policy extend the the rent-back period even further, to five or 10 years. But, overall, Baker said Fannie’s program addresses the problem of growing numbers of vacant properties, and represents a shift to promoting rental policies as a foreclosure solution. “You’re guaranteed a year, and that gives you some stability and a chance to plan ahead,” he said.

He and others also described Fannie’s new program as a big step forward over some efforts currently in place to help renters in foreclosed homes.

Fannie Mae, for example, already gives renters in foreclosed homes the option to continue renting on a month-to-month basis, or to accept a cash for keys offer. According to Fannie’s data, the financial help has been a far more popular option. Since January, it has tallied 3,500 cash for keys agreements, and 300 signed leases. Fannie Mae spokesperson Amy Bonitatibus said the program was set up to offer both choices to renters. It is open to all tenants of Fannie Mae-owned properties, but she had no information on specifically how many tenants had been approached with offers.

The small number of leases signed isn’t really surprising, said Danilo Pelletiere, research director for the National Low Income Housing Coalition. The options to renters were offered post-foreclosure, by which time some tenants may have decided to make other living arrangements. Cash for keys can be a more attractive option than a month to month lease. The new federal tenant protection law also overlapped with Fannie’s program, so some tenants may not have felt a need to sign leases, he said.

Pelletiere and other advocates said they have much higher expectations for Fannie’s new approach for former owners. A deed for lease transaction can happen far more quickly than a foreclosure, and having a longer-term lease will be more attractive to many people. Fannie also has hired a national property management company to handle the new program, while its existing rental initiative for tenants uses local real estate agents and property managers.

“Because of the way it’s designed, it should do a much better job,” Pelletiere said. “That makes it much more likely that we’ll see a national response. It provides a way for Fannie to be proactive and to get to the property earlier. And it costs less than getting someone out of a home and foreclosing on them.”

Alan Mallach, a senior fellow at the National Housing Institute and the Brookings Institution, agreed. “What’s interesting will be to look at how many people this new policy affects,” Mallach said. “I think it will be significant.”

Pelletiere said he also found some encouragement in early results from Freddie Mac’s program earlier this year to rent back properties to former owners of foreclosed homes on a month by month basis. According to Freddie Mac’s figures, almost 12,000 units entered its portfolio of foreclosed homes between April and October. In 70 percent of cases, a borrower is working on a mortgage loan modification, leasing the home back, or accepting cash for keys. In another 27 percent of cases, the property was vacant by the time Freddie Mac took it over. In three to four percent of cases, an owner or renter faced eviction. Of those occupants who signed leases, two-thirds were owner occupants and one-third were tenants. Spokesman Brad German said he had no further breakdown of the numbers.

The long-held belief has been that owners would decline to become renters again, so having more owners than renters sign rental leases is an encouraging sign for Fannie’s new program, Pelletiere said.

Still, he and others noted the government wouldn’t be prompted to move toward a more aggressive rental policy if a greater number of loan modifications were successful. A recent report by the Congressional Oversight Panel for the government’s taxpayer-funded bailout program criticized the progress being made under the administration’s Making Home Affordable program, saying that in a best case scenario it would prevent fewer than half of expected foreclosures.

As foreclosure notices pile up, troubled tenants and borrowers don’t always understand they might be eligible for help, or they don’t know who to contact to apply for programs, or they just give up and leave upon a foreclosure – even in cases where they have new federal laws and programs intended to avoid evictions. To Liben, the Massachusetts housing attorney, one constant of the housing crisis has been that some people “get lost in the shuffle.” She’s waiting to see if that will finally change.

Photo: The Truth About..., Flickr

Just a year ago, the theory that poor and minority borrowers were to blame for the housing crisis took hold with a vengeance, and so did the belief that the government forced lenders to make subprime mortgages to meet affordable housing goals. The view took on greater prominence in the heat of a presidential campaign, and an obscure anti-redlining law known as the Community Reinvestment Act became a scapegoat for subprime lending and the collapse of the mortgage market.

Things have changed quite a bit since then, as the spotlight has shifted to lenders and their behavior during the boom. States and cities continue to aggressively pursue subprime lending discrimination suits, and judges across the country are signaling a willingness to move forward with some cases. As the lawsuits wind their way through the court system, more details and allegations about the inner workings of the subprime world are emerging. And as startling as some of the charges already have been — a former loan officer for Wells Fargo testified in one affidavit that employees regularly referred to minority borrowers as “mud people” and called subprime mortgages “ghetto loans,” — there’s even more ahead, said David Berenbaum, executive vice president of the National Community Reinvestment Coalition.

“The ’smoking guns’ are coming out,” Berenbaum said, referring to possible evidence that lenders targeted minority communities and borrowers for higher priced loans. “And I expect more and more of these smoking guns to become apparent.”

In the latest development, a Superior Court Judge in Los Angeles recently certified a 2005 lending discrimination lawsuit against Wells Fargo as a class action case. The suit contends that area managers at the bank refused access in some minority neighborhoods to a software program that allowed for discounted prices on mortgage loans. Barry Cappello, a partner with Cappello & Noel in Santa Barbara, which represents some 10,000 to 20,000 borrowers in the suit, said he believes it is the first subprime lending discrimination suit in California to be classified as a class action.

According to Cappello, Wells Fargo introduced a program in 2002 called “Loan Economics,” which gave loan officers the authority to offer discounts to loan applicants. The savings on lower fees and interest rates could be significant, ranging from $500 to as much as $10,000 per loan. The suit claims that the Los Angeles area Wells Fargo manager refused to allow loan officers operating in certain minority neighborhoods to offer the program. Borrowers in predominantly white neighborhoods were given access to the software.

Cappello said the suit stemmed from complaints by black and Hispanic loan officers for Wells Fargo, who said they asked to use the software in their branches but upper management refused.

Wells Fargo is fighting the suit and has denied all the charges. In a statement, the bank said, “We are disappointed in this ruling and intend to vigorously defend this matter as the case proceeds. The decision does not indicate the court believes the underlying allegations have any merit. We feel the allegations represent a complete mischaracterization of our long-standing commitment to responsible lending and the pricing practices and tools we use. The policies, systems and controls we have in place ensure race is not a factor in the pricing or products we offer.”

The case could go to trial in about a year, Cappello said.

More lawsuits are expected in the near future over the treatment of Hispanic borrowers in Arizona and Texas, who were offered high-cost loans they didn’t understand at misleadingly low teaser rates, then refinanced into even more expensive loans than their initial mortgages, Cappello said.

Wells Fargo, the nation’s largest home lender and Minnesota’s second-largest employer, also has been a target of lawsuits elsewhere. Last month, Illinois Attorney General Lisa Madigan sued the lender, alleging that blacks and Hispanics were sold high-cost subprime loans more frequently than white borrowers with similar incomes. The suit contended loan officers were offered incentives by the bank to steer borrowers into the more expensive loans, and that white borrowers generally received the lower-cost prime mortgages.

Some borrowers thought they were getting prime loans from Wells Fargo Home Mortgage, the suit also charged. But their loans actually came from Wells Fargo Financial, the bank’s subprime unit.

In Iowa, two watchdog groups charged this week that minority homeowners in Des Moines were three times more likely to receive high cost subprime loans from Wells Fargo than white homeowners.

In June, the New York Times reported on affidavits from a 2008 lawsuit by the city of Baltimore against Wells Fargo over subprime lending, which charged that the bank targeted blacks in Baltimore and suburban Maryland for high-interest subprime loans. Former loan officers testified in affidavits about using terms like “mud people” and “ghetto loans.” The bank also had an emerging markets unit that pinpointed black churches as fertile ground for selling subprime loans, according to the former officers. And in March, the NAACP filed suits in federal court in California against Wells Fargo and HSBC, alleging minority borrowers were more likely to be issued higher rate subprime loans than white borrowers with similar credit scores and qualifications. Both banks have strongly denied the charges. The NAACP also has pending litigation against nearly a dozen other banks and lenders over subprime lending discrimination.

Should all the charges in all the lawsuits be proven, it would amount to massive and violations of the Fair Housing Act, the Equal Credit Opportunity Act, and other fair housing and lending laws, Berenbaum noted. Enforcing fair lending laws has been “an issue the government has failed to address over the past decade,” he said. Lenders could face criminal penalties from the government for violating fair housing laws, and they could be subject to punitive damages and fines from government lawsuits.

Big lenders like Wells Fargo and HSBC are obvious targets for suits because of their size and the amount of lending they did. In addition, many other lenders and originators of subprime loans have gone out of business, complicating efforts to address allegations of lending discrimination through lawsuits.

That leaves a major question regarding all the lending still unanswered, Berenbaum said: Where has the U.S. government been? The Federal Reserve reported in 2005 that an analysis of federal mortgage data found that blacks and Hispanics were more likely to receive higher interest rates on mortgage loans – and that it intended to examine the practices of 200 lenders as a result.

But nothing’s happened since that announcement, Berenbaum noted. Instead, as the years go on, and the government takes no action, allegations about price differences in mortgage loans based on the race of borrowers and their neighborhoods continue to grow.

Mary Kane is an economy reporter for the Washington Independent.

Related: Wells Fargo: Minnesota’s No. 2 employer is No. 1 for targeting minorities with high-cost loans

Image: Matt Hertel, iStockphoto

WASHINGTON — As bank-owned foreclosed properties pile up across the country, from abandoned houses in hard-hit neighborhoods to empty big box retail stores in failed strip malls, the fight over holding someone responsible for the brick and mortar mess left behind by the mortgage crisis continues to heat up.

More than two years into the crisis, local authorities still are slapping banks, servicers and speculators with fines ranging from $30,000 to even $90,000 for ignoring orders to take care of foreclosed and vacant properties under their control. The continuing punitive measures come as servicers already find themselves under fire for failing to complete more loan modifications under the Obama administration’s Making Home Affordable program – an effort that includes $75 billion in taxpayer money as incentives for the lending industry to rework loans. And it also comes as some realtors and lenders are mounting challenges to local anti-blight ordinances, and promoting the use of a mortgage database to track down servicers. Some housing advocates fear the industry will go beyond lobbying for the use of its mortgage system to push for getting rid of local vacant property laws altogether.

The end result: Some of the same servicers the Obama administration is urging to complete more loan modifications still are walking away entirely from vandalized homes, or failing to fix broken windows, get rid of junked cars, clear trash, repair damaged roofs and gutters, or even demolish a condemned house, all of which can be violations of local housing codes. And housing courts keep hearing persistent arguments from servicers that they’re merely temporary custodians who can’t alienate investors by spending money to bring properties up to code.

“They may think it’s unfair, but the law provides that if you have ownership of a property, you take care of it,” said Cleveland Housing Court Judge Raymond Pianka, who regularly fines lenders $5,000 a day for properties that don’t comply with city codes. “There’s no provision to exempt corporations. I’m not going to treat them any differently than the individual property owners who come into my courtroom in wheelchairs and walkers.”

And while the lending industry contends its working more cooperatively than ever with local authorities, not everyone sees it that way.

“For every one vacant property owner who wants to work with the local government, there are five other property owners who are gaming the system,” said Joseph Schilling, a Virginia Tech urban affairs professor and co-founder of the National Vacant Properties Campaign. “My sense is the industry is also overwhelmed, almost as much as the code departments, and properties still fall through the cracks.”

Controversies over vacant properties are one sign of how the aftermath of the mortgage crisis may be as complicated to address as the initial waves of foreclosures themselves.

As the Washington Independent reported recently, the volume of REOs, or bank-owned foreclosures, is growing at an alarming rate, exacerbating the foreclosure crisis by sticking hard-hit neighborhoods with vacant and sometimes vandalized homes that drive down property values. REOs are foreclosed properties that lenders take back after they don’t sell at foreclosure auctions or sheriff’s sales. They keep the homes in inventory until they can be sold again.

RealtyTrac, an online foreclosure database, predicts that REOs will total 1.5 million this year, up from 160,000 just a few years ago. And a significant percentage of those REOs still haven’t been listed for sale. That means a glut of bank-owned foreclosed homes remains in limbo in many communities. Some banks hire property managers, but others let houses fall into disrepair. Neighborhoods in Cleveland, Detroit, and other cities with weaker housing markets have been stung by growing blight from REOs. In once-hot areas, like Atlanta, “zombie” subdivisions that were half-built and then abandoned mar the suburbs.

Speculators who buy REOs in bulk over the Internet, then fail to fix them up or abandoned them, have added to the crisis. And more loan defaults are expected, with 9 million foreclosures predicted by 2012, according to the Center for Responsible Lending. On top of all this, the bust in commercial real estate means communities also are increasingly stuck with empty big box retail stores, closed-down car dealerships, and vacant strip malls – more blight, and more problems.

For its part, however, the lending industry contends that it’s doing more than ever to solve the problem, stepping up to work more closely with state and local governments, and promoting a mortgage database that local officials can use to track down servicers and notify them of violations.

“There was a disconnect a few years ago, but we’re moving forward,” said Robert Klein, CEO of Safeguard Properties, a company that maintains vacant homes nationwide for mortgage servicers and banks. “There’s been tremendous progress made between code enforcement officers and lenders and servicers around the country. I think we’re all on the same page now.”

Empty houses with code violations resulting in stiff fines usually are the result of years of previous neglect, or cases in which servicers can’t be found to be notified of problems, he said. That situation is happening with far less frequency than in the past.  “The $90,000 fines are an exception to the rule,” Klein said.

But in remarks to a recent Mortgage Bankers Association mortgage servicing conference that continue to be passed around on housing and community development listerves, Cary Sternberg of American Home Mortgage in Irving, Tex., went further. Sternberg, the firm’s senior vice president of Real Estate Owned (RE0) properties, contended that servicers increasingly are caught “in the cross hairs of disgruntled and cash-strapped local governments” looking to drum up revenue. The local governments often don’t understand the legal and other constraints under with servicers operate when it comes to REOs, he said.

“They need to look for ways to keep their cities going,” Sternberg said. “It’s a difficult problem to deal with and servicers like us are dealing with cities and municipalities all over.”

In Chula Vista, Calif., Realtors and lenders complained this summer that the city’s landmark anti-blight ordinance, which includes fined of up to $1,000 for lenders that ignore code violations, was driving away new business. Chula Vista’s 2007 ordinance became a national model, with more than 200 other communities adopting similar rules. The city has issued a total of $1.3 million in fines. Realtors asked the city to lessen fines and give firms more time to repair properties. The city is reviewing possible changes to the ordinance.

While servicers and code enforcers have made real progress sharing information through the mortgage database, the huge volume of REOs and continuing foreclosures continues to swamp the resources of everyone involved, Schilling said.

And in some places, problems run even deeper..

“From my experience, servicing of properties in the inner city, particularly in African-American neighborhoods is either non-existent or erratic,” said Kermit Lind, a Cleveland State University law professor who specializes in housing and foreclosure issues. And, he added, “servicers have testified under oath that they receive instructions to stop maintaining properties and walk away. Servicers have complained that they cannot afford to bring their properties up to code and still make money selling them, and that their investors will not allow them to comply with local laws.”

Lind had little sympathy for the plight of servicers, noting archly that “any reasonable person should see that compliance with local building and housing codes protecting the health, safety and welfare of taxpaying neighbors should be subordinated to the duties and responsibilities of servicing and pooling agreements concocted on Wall Street.”

But Christopher Oswald, a lobbyist with the Mortgage Bankers Association, which launched the mortgage database project, said lenders hit with huge fines only face additional obstacles getting foreclosed properties on the market and into the hands of new owners. Communities may once have needed to levy punitive fines to get the attention of servicers, but that problem has been addressed by the mortgage database, known as MERS, he said.

The industry database was expanded to allow its use by local governments. Enter an address, and up pops the name and contact information for a servicer or property management firm.

“We’re both after the same thing – to make sure the properties are maintained,” Oswald said.

The MBA introduced database in a handful of pilot cities more than a year ago, and the effort has been so successful the group plans to expand it nationally, he said.

Schilling said the industry outreach has been particularly successful in the West, in fast growth markets, and in some individual cities such Dayton, Ohio. But there are still problems elsewhere. At a recent housing conference in Kansas City, Schilling said he “got an earful” from housing and code officials throughout the state about how hard it was to find and work with mortgage servicers.

The mortgage database itself has drawbacks. It covers many, but not all, mortgage loans. It has no data at all on commercial real estate owners. And in some cases, a property contact shifts once a house moves from foreclosure to an REO. “There are gaps,” Schilling said.

An even bigger concern is that the lending industry will lobby state and local governments not just to use the database, but to also get rid of their local vacant property ordinances. Communities still need those regulations on the books as a powerful tool to make sure servicers and lenders take care of their properties, Schilling said.

The MBA isn’t actively lobbying against any anti-blight measures, Oswald said. But it makes sense for some towns to realize they may not need anti-blight ordinances if they can track down owners through the database instead. Communities can then avoid having to issue large fines that may delay transferring properties to new owners, he said.

“Anything standing in the way of getting servicers to put properties back on the market would be of concern to us, and should be of concern to local code officials too,” Oswald said.

Some local officials already have plenty of concerns about getting foreclosed homes back on track.

In Cleveland, Judge Pianka said some banks and servicers finally are catching on, showing up in his courtroom to answer to violations and repair properties. He’ll often forgive the big fines if a firm cleans up its property. (Court records show Pianka reduced a $30,000 fine for U.S. Bank to $3,000, after the bank brought a house into compliance.) But a recent court docket also gave a glimpse of continuing disputes, from the speculator from Dubai, who bought six properties, sight unseen, off Craigslist, and hasn’t fixed them up, to a real estate company that purchased REO worth only $1,000, and already has racked up $50,000 in fines.

Pianka recently spoke to a conference of property management contractors sponsored by Safeguard, showing photographs of graffiti-scarred, abandoned homes, and letting the lending industry know he’ll hold them accountable for their foreclosures. Klein, of Safeguard, said the judge’s talk was well-received – another small step in a continuing battle over cleaning up after the foreclosure mess.

Mary Kane is an economy reporter for the Washington Independent.

Image: Matt Hertel, iStockphoto

WASHINGTON, D.C. — Even as the Obama administration presses the lending industry to get more mortgage loans modified, the practice of forcing borrowers to sign away their legal rights in order to get their loans reworked is a tactic that some servicers just won’t give up on.

Waivers requiring borrowers to give up any legal claims related to their mortgages, even in cases where borrowers may be victims of predatory lending, are showing up sporadically in loan modification agreements under the Obama administration’s Making Home Affordable plan, consumer attorneys say. They were stunned to find the legal waivers still being used, despite more than a year of efforts – including calls from lawmakers – to get rid of them.

“It was shocking to see that people are still being asked to waive their legal rights,” said Bruce Dorpalen, national director of housing counseling for ACORN Housing Corp. “I mean, this should be abolished. It’s incredible that it’s still in there.”

The Obama modification plan, launched five months ago as the centerpiece of the administration’s anti-foreclosure efforts, includes financial incentives for servicers to participate, with the government paying $1,000 for each loan they modify, and $1,000 per year for up to three years. The goal is to rework loans with more favorable terms and lower interest rates, and to keep delinquent borrowers or those at risk of default in their homes.

The Treasury Department’s published guidelines for the $75 billion taxpayer-funded program specifically prohibit the waivers. Mortgage giants Fannie Mae and Freddie Mac removed the waivers from their standard loan modification agreements earlier this year. But Diane Thompson, an attorney with the National Consumer Law Center, said she has seen legal waivers resurface in loan modification agreements by Aurora Loan Services, Ocwen Financial Corp., and other firms. She also is getting complaints about waivers in Bank of America agreements.

“The waivers continue to be an issue,” Thompson said.

Complaints about the waivers come just as the Obama administration tries to ramp up loan modifications under its plan, which has gotten off to a slow start. More than 200,000 trial loan modifications have begun under the program’s Home Affordable Modification Program initiative, the Treasury Department said, well short of the initial goal of 3 to 4 million agreements. On Tuesday, top officials from the Treasury Department and the U.S. Department of Housing and Urban Development met with 25 servicers to put pressure on them to complete more loan modifications – something Thompson described as a “come to Jesus” meeting. The administration will begin publicly reporting loan modification progress by individual servicers next month, HUD said in a news release. The government also will develop a “second look” program with Freddie Mac to make sure borrowers aren’t wrongly turned away.

But the re-emergence of the waivers shows how dramatic gestures or public shaming might not be enough. They’re an example of how problems exist deep in the the fine print of loan agreements — something media attention to a high-level meeting of servicers in Washington doesn’t address. The waivers prompt concerns about how carefully the program was put together, and how well Treasury is supervising it. And they raise questions about how effective it can really be, if there are no real consequences or penalties for doing loan modifications improperly, or for not doing enough of them.

Frustration over the program has been growing. Sen. Christopher Dodd (D-Conn) chairman of the Senate Banking Committee, sent a letter to Treasury Secretary Timothy Geithner last week, asking for an investigation into violations in loan modifications, including the waivers. Thompson testified before Dodd’s committee on July 16, providing copies of the waivers found in loan agreements.

Adam Levitin, a Georgetown University law professor and credit expert, said the inclusion of waivers by servicers being paid by the government to complete proper loan modifications is especially galling. It’s not clear how widespread the use of the waivers is. It’s also unknown many servicers are charging the government for loan modifications that include waivers, and how many are simply doing them independently of the government’s program. But it’s also obvious that the waivers aren’t rare exceptions, he said, and that the administration should be looking into them.

“Is Treasury paying money for this?” Levitin said. “If so, it’s like paying a government contractor for performing substandard work. Why are servicers getting millions of dollars for doing loan modifications if they’re not going to do them the right way? We’re relying on the servicers to do the right thing and time after time, they don’t do it. These companies just say one thing in front of Congress and then go and do something else. Treasury should be demanding its money back and handing out some penalties for this.”

The fact that the administrations’ main foreclosure program allows for a slip-up like the waivers also is troubling, he said. Getting loan modifications done “does not seem to be the top priority of this administration,” Levitin said.

Legal waivers in loan modifications have a long history. Until last summer, they were regularly included in loan modification contracts, often buried in a long list of requirements. Borrowers often had no idea they were signing their rights away. The waivers could mean that borrowers would have to give up all legal claims related to their mortgage, not just to the loan modification, even in cases where borrowers signed up for predatory loans they didn’t understand.

In a dramatic confrontation last July, Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, told representatives of Bank of America to get rid of waivers in their agreements. His pronouncement came after Bank of America representatives denied they were using the waivers – and Julia Gordon, senior policy counsel at the Center for Responsible Lending, produced one from her briefcase.

Then, in January, Fannie Mae and Freddie Mac also removed the waivers from their standard streamlined loan modification agreements, following a Washington Independent story about the practice.

Advocates hailed the end of the waivers as a win for borrowers, who would no longer be forced to give up their rights to pursue legal action regarding their mortgages, in order to get a loan modification. As a result, they find the resurfacing of the waivers particularly troubling.

“At this point, it’s this constant whack-a-mole exercise,” Gordon said. “By this time, I would think the issue would have been aired sufficiently that servicers would be aware of this.”

Gordon added that the waivers illustrate that “there’s a lot of sloppiness out there” with regard to the administration’s loan program, which she finds disappointing.

For the program to work, there must be consequences for servicers that include the legal waivers or any other irregularities in their loan modifications, she said. “There shouldn’t be any gray areas here,” she said.

Thompson, of the National Consumer Law Center, said it’s possible that some servicers simply are using outdated forms that still require the waivers. Nonetheless, she said, it’s not in the servicers’ interests to get rid of the waivers in a timely manner – and some clearly aren’t doing so, she said.

Some advocates were particularly surprised to find that Ocwen had used the waivers, considering the servicer has been leading the industry in doing loan modifications. But Paul Koches, general counsel for Ocwen, said his company was just as surprised, and called their inclusion a mistake.

The waivers had been “fairly standard practice” in loan agreements for years, he said. But in late 2008, after meeting with representatives of the National Community Reinvestment Coalition and hearing concerns about the waivers, Ocwen agreed to remove them from all loan modification agreements.

The company assumed all the waivers were gone, until Thompson’s testimony showed otherwise. Ocwen then realized one of its old forms still included the waiver. Ocwen is working to fix the form. Only a handful of borrowers were affected, and they’ll be assured the waivers won’t be enforced, Koches said.

Including legal waivers “is no longer our policy and we will be so notifying the homeowners to whom we mistakenly sent the old version,” he said.

Bank of America stopped using the waivers in September of last year, said spokesperson Jumana Bauwens. She did not know why or how waivers might be showing up in Bank of America loan modifications, and said the bank had not been aware of complaints about them. Bank officials will look into the matter, she said.

Aurora Loan Services could not provide a representative to comment.

Dorpalen, of Acorn, said his staff saw waivers showing up in loan modification agreements in May. Counselors told servicers to take them out before allowing their clients to sign contracts, he said. Since then, the waivers haven’t appeared in loan modifications that his group sees, he said.

Some kinks in launching a new program are to be expected, and the Treasury Department doesn’t have past experience with loan modifications, Levitin noted. But it’s hard to remain patient with the slow pace of the administration’s efforts to slow down foreclosures, he said. At this rate, by the time Treasury gets all the program’s difficulties ironed out, it will be slated to expire.

“I lost patience a year ago,” Levitin said. “At this point, it’s just sad.”

Gordon, of the Center for Responsible Lending, said the waiver mess shows once again how Congress’ failure to approve mortgage cramdown legislation is adversely affecting foreclosure prevention. Allowing bankruptcy judges to modify mortgage loans was the “backstop,” if voluntary loan modification wasn’t enough.

Lenders that opposed cramdown argued that the loan modification program was a better choice, Gordon noted. But so far, loan modifications aren’t keeping pace with foreclosures, and some borrowers already in trouble are unknowingly signing their legal rights away.

Mary Kane is an economy reporter for the Washington Independent.

(iStockPhoto)

There’s more proof out today that the foreclosure crisis is only getting worse, despite everything that’s been thrown at it so far: Foreclosure notices reached a new record high during the first half of this year.

Citing data from RealtyTrac, an online foreclosure database, Bloomberg said the rising number of notices shows how job losses and falling property values are making the housing crisis even more severe.

More than 1.5 million properties received a default or auction notice or were seized by banks in the six months through June, the Irvine, California-based seller of default data said today in a statement. That’s a 15 percent increase from the year earlier. One in 84 U.S. households received a filing.

“People are losing their jobs, seeing their income go down and are underwater on their mortgage,” Richard Green, director of the Lusk Center for Real Estate at the University of Southern California in Los Angeles, said in an interview. “It’s a toxic combination.”

The foreclosure jump even prompted RealtyTrac CEO Joseph Saccacio to echo TWI’s story on Monday, and call for a new strategy to tackle the crisis.

Stemming the tide of foreclosures is a critical component to stabilizing the housing market, so it is imperative that the lending industry and the government work in tandem to find new approaches to address this issue.

The Wall Street Journal, in the meantime, takes a look at servicers trying to do loan modifications, and offers a glimpse into why so few loans are getting reworked. The story profiles the troubles of Morgan Stanley’s mortgage loan servicing firm, Saxon Mortgage Services Inc., which has been slower than most servicers to get loan modifications off the ground.

Part of the problem at Saxon is that it didn’t ramp up its ability to modify loans as early as other servicing companies. A spokeswoman for Saxon says that when Morgan Stanley purchased the company in 2006, it lacked enough employees and systems to undertake massive numbers of modifications. It wasn’t until the spring of 2007 — after its portfolio of subprime loans had already started to sour — that Saxon began to focus on modifying loans. Not until the fourth quarter of 2008 did Saxon boost its capacity to handle a large flood of requests.

All this takes its toll, not just by increasing foreclosures but by adding to the woes of already troubled borrowers. The story profiles Steve Applegate, owner of a Lake Mary, Fla., building-supplies business. Hurt by the construction downturn, Mr. Applegate last fall asked Saxon to modify his $750,000 home loan.

Mr. Applegate, a 60-year-old father of two, says he was told in January that he’d been approved for a rate cut to 2.08% from 6.5%, which would cut his $4,063 monthly payment by more than half. But the confirming paperwork from Saxon never arrived, he says, and in March, he was notified he was in default. When he phoned Saxon, a different loan negotiator recommended foreclosure.

He tried to resuscitate the earlier modification. At one point in April, he spent nearly two hours on the phone with Saxon, got disconnected twice, and was routed to four individuals, according to a recording of the call.

In May, Mr. Applegate was informed by Saxon that he had approval under HAMP for a modification starting June 1.

The good news didn’t last. When he tried to make a second payment on the modified loan, he was told he hadn’t qualified after all. When the Journal asked what happened, a Saxon spokeswoman said that the company had erred in sending him paperwork for a HAMP modification because his outstanding loan balance exceeded the program’s limit of $729,750.

Earlier this month, Saxon said it would modify his loan outside the federal program. Mr. Applegate is still waiting.

If you want to know why foreclosures seem unstoppable, there’s one reason. And the more foreclosures there are, the more dramatic the domino effect. Foreclosures drive down home values for everyone else, forcing more people into negative equity situations, which can lead them to quit paying on their loans, which means more foreclosures. And the cycle repeats itself.

Foreclosures that are delayed don’t just go away; they resurface eventually. Borrowers like Steve Applegate sit in limbo, hoping to avoid a foreclosure that may be inevitable. How many more loans are in the pipeline, just like his? How much longer will the lending industry and Washington wait before heading this off? Time is not on their side, and each month that brings fresh evidence of record high foreclosures only proves that point.

Mary Kane is an economy reporter for the Washington Independent.

Image: Matt Hertel, iStockphoto

WASHINGTON, D.C.— The time may be ripe for a shift in strategy as the foreclosure machine grinds on, and new foreclosure notices reach the troubling milestone of 10,000 per day.

A weak economy has added job losses and falling home values to the mix of toxic loans that prompted the crisis two years ago, making an already difficult situation even more severe. Government measures from foreclosure freezes to loan modifications have only served, so far, to stall the inevitable – and to create an ominous backlog of millions of pending foreclosures. Plus, more than one in five homeowners now owe more on their mortgages than their homes are worth, according to the real estate website Zillow.com. No one can predict with assurance whether those underwater homeowners will keep paying on their loans, or take a walk.

And as bad as things may seem now, there’s still a long period of pain to come: A steady drumbeat of foreclosures, and a stagnant housing market, for the next several years ahead, at a minimum. Some experts see an even more dire picture: Five to 10 years, in California alone, of record high foreclosures. No significant home prices increases nationwide on the horizon in the next year. Or the year after. Or for as long as the next five years. Some 9 million foreclosures are expected by 2012.

While economists search for signs of green shoots, “no one’s really saying anything about this,” noted Guy Cecala, publisher of Inside Mortgage Finance, a Bethesda, Md. publication that covers the lending industry. “There’s really no good news out there, other than we can’t possibly get in much worse shape than we already are.”

Given this bleak scenario, some say it’s finally time for more forceful action. Congress and the Obama administration need to move boldly to stop foreclosures, requiring lenders to go beyond what Calculated Risk dubs “extend and pretend” repayment plans, and actually write down loan balances. And the Obama administration should move quickly to bring more players to the table to pick up the pace of those loan modifications – including the Internal Revenue Service. Servicers might be more aggressive about writing down loans if they’re sure it won’t create tax liabilities for trusts they represent, an impediment that currently stands in the way of getting more mortgages modified, said Kathleen Engel, a Cleveland State University law professor who studies mortgage securitizations.

There’s more to be done, Engel said: Expand the benefits of the homebuyer tax credit up the income ladder, offering it to move up buyers with existing homes as well as first time purchasers. Even direct government loans to borrowers, to keep them in their homes, shouldn’t be dismissed.

“Now is the time to do something,” Engel said. “There are a lot of things to be very concerned about right now. There are people underwater who aren’t making good on their home equity loans. With job losses increasing, more people aren’t able to make their mortgage payments at all. And REOs (Real Estate Owned properties) are driving down home prices. We really need to be trying some new things.”

Engel’s view was echoed by the Obama administration, which recently chastised lenders for their lack in progress in modifying loans. “We believe there is a general need for servicers to devote substantially more resources to this program for it to fully succeed and achieve the objectives we all share,” Treasury Secretary Timothy Geithner and Housing and Urban Development Secretary Shaun Donovan said in the letter, which was sent to to 25 mortgage-servicing firms.
Only about 270,000 borrowers have been offered loan modifications under Obama’s Making Home Affordable program, the Treasury Department says — a far cry from its much more ambitious goal of helping 4 to 5 million homeowners rework their loans.

Geither and Donovan weren’t the only ones speaking out. As the Washington Independent has reported, a small band of House Democrats last week urged for more action beyond voluntary loan foreclosures. Senate Finance Committee Chairman Chris Dodd (D-Conn.) and 19 other Senators also petitioned Geithner to adopt a more aggressive strategy for loan modifications specifically for homeowners with option adjustable rate mortgages scheduled to reset to higher payments over the next four years. In addition, the Washington Post reported the Treasury Department also is putting together a “Plan C” – a new strategy – to head off defaults in commercial real estate and to tackle delinquencies tied to job losses.

It seems like a full frontal assault. But it may not be enough.

Slowing down the inevitable

In reality, there’s little political will to force lenders to write down loan balances. Congress defeated mortgage “cramdown” legislation, which would have allowed bankruptcy judges to cramdown, or reduce, the terms of a mortgage to keep a borrower in his home. The Obama administration stood by as the measure failed. Only that small group of House Democrats still wants to revive it. Bailing out homeowners still runs smack into the wall of moral hazard, in the public’s mind, and even the worsening crisis hasn’t changed that. “I don’t know why this is still true, but people are willing to roll over and give billions of dollars to banks, and they get pissed off about the idea of their next door neighbor getting a break,” said Sean O’Toole, president and founder of ForeclosureRadar.com,which compiles foreclosure data for the California market.

Instead of pressing for more loan modifications, it may be time to conclude that all the programs thrown at the mortgage problem haven’t done much to fix it. The most infamous, Hope for Homeowners, intended to help 400,000 borrowers, resulted in just 25 loan closings. Various state and voluntary foreclosure freezes only gave a pause to foreclosures. And most foreclosure prevention programs were created two years ago, when subprime loans were the major cause of foreclosures, not unemployment and a faltering economy.

These days, if you can’t afford your mortgage payment because you just lost your job, it really doesn’t matter whether you have a toxic Option ARM or a standard 30-year fixed loan. You’re still in default.

“The bad economy is what’s driving foreclosures right now,” Cecala said. “Even if there were no Pay Option ARMs out there, many homeowners would still be in deep trouble.”

Foreclosure prevention efforts, at this point, are “just slowing down the inevitable,” he added. “You can take a look at any one of these programs and you won’t find a lot of value in it.”

The Obama Administration, for example, recently expanded the refinancing options available under Making Home Affordable, to include borrowers who are more deeply underwater on their loans. It sounds good -  but it’s unlikely to pan out, Cecala said. Borrowers may not qualify for refinancings, under new underwriting guidelines from Fannie Mae or Freddie Mac that are far stricter than when they originally applied for their loans. Or borrowers may have to pay such high fees or rates that it won’t make the refinancing worthwhile. In places like California and Florida, some homeowners are so far underwater they still won’t qualify.

The nuclear option

The big question, as Cecala notes, is whether foreclosures can be stopped at all. Which brings up the nuclear option: Unleash the pent up foreclosures and get the pain over with. Consider the backlog in California alone. More than 3 million households are expected to end up underwater eventually, according to O’Toole. As of now, some 851,000 households are delinquent on their mortgages. Of those, 264,977 already have received a foreclosure notice – but their properties have yet to be sold at auction. Only 22,245 foreclosures were completed in June, Foreclosure.com said.

Given that possibility that half of the the 3 million underwater homeowners or more also will eventually lose their homes, that means that working through the entire backlog could involve between five to 10 years of record high foreclosure levels, O’Toole said.
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Nationwide, the picture isn’t much better. After hitting a high point of about 900,000 in November 2008, REO inventory, or bank-owned foreclosures, slowly decreased over the last six months, down to about 770,000 in May, according to RealtyTrac, an online foreclosure database.

But don’t get your hopes up just yet.

“We believe the reason for that decline is largely due to the various foreclosure moratoria and state laws extending the foreclosure process that have been in effect in recent months,” said Daren Blomquist, a RealtyTrac spokesman. “As some of those moratoria were lifted in March and April we saw a substantial spike in initial foreclosure notices and we believe that will translate into a spike in REOs as well over the next several months.”

The bad news continues:  “In addition, we believe there is still a pent-up supply of delinquent loans that have not even hit the foreclosure process yet because banks are taking longer to start the foreclosure process after a loan goes delinquent – probably partly because they are overwhelmed with the volume of delinquent loans and partly because they are more aggressively trying to modify or refinance loans rather than foreclose.”

Blomquist added that the “twin threats” of risky loans and high unemployment will ensure a steady drumbeat of high foreclosure activity, for at least the remainder of this year.

The radical approach would be to stop staving all this off, take the pain, push the foreclosures through the system without delay, and get to the bottom. In California, at least, that could clear out the foreclosure backlog in about two years, O’Toole estimated.

“I’m not necessarily advocating that we should simply dump all the foreclosures at once – I actually think that could be disastrous,” he said. “But I think dragging them out over the next 5 to 10 years is an equally bad choice.”

But if there’s little political will to bail out homeowners, there’s even less stomach for announcing a strategy to bail on them entirely. It’s not the sort of thing that can be said in pubic. Even if there’s some logic to it.

An entirely new direction

And that opens the door for a third way.

Alan Mallach, a senior fellow at the National Housing Institute and the Brookings Institution, took a close look at the housing market in Phoenix, where prices have declined by as much as 60 percent in the past few years.  Houses that sold for a quarter-million dollars now go for $90,000 or so in the booming REO market. Buyers – both investors and individuals – are realizing that at those prices, they have options, if they are willing to be patient. They can hold on to those homes for six or eight years, rent them out until they earn their money back, and wait until they can possibly sell them at a profit.

Most importantly, the new owners often are more than willing to rent back the homes to their former owners, a situation that benefits both sides. Borrowers can stay in their homes, with rent payments they can afford. The homes don’t sit vacant, abandoned, or vulnerable to vandalism, which can drive down surrounding property values. “You don’t kick the person out,” Mallach said. “And many of the investors say it’s an advantage not to have to look for a new tenant.” The situation, he said, provides evidence of “the beginning of some sort of leveling off that’s going on” in neighborhoods hit with foreclosures, at least in Phoenix.

Based in that experience, Mallach these days reminds local governments and neighborhood development groups not all investors are enemies, despite their reputations. Communities can both encourage investors as partners in buying and fixing up bank-owned houses – and warn them they’ll come down hard if they sink too far into speculation. And there are more encouraging signs at the local level. As Philadelphia, and some other cities have found, mandatory face-to-face foreclosure mediation between borrowers and servicers has proven to help avoid foreclosures, without dragging out the process.

A combination of these kinds of ideas – smaller scale, targeted to the needs of particular markets – may a quicker and more effective blueprint for tackling the crisis, especially in the absence of an aggressive government approach.

“Maybe we’re coming to the realization that we can’t loan mod our way out of this,” Mallach said. “There’s no magic solution. There’s no government riding in on a white horse to buy up all the bad assets.”

The wild card

Congress and the administration, in fact, haven’t exactly come up with anything “radical and bold” yet to tackle the crisis – and it’s unlikely they will turn around and do so now. Instead, Mallach noted, Realtors, the real estate industry, and some economists are spending unnecessary time and energy trying to declare a bottom to the crisis and look for any evidence of good news. It’s a great time to buy a house, they insist.

But there are still 9 million foreclosures expected by 2012, according to the Center for Responsible Lending. Goldman Sachs estimates 13 million foreclosures on all types of loans by 2014. And a continuing decline in home prices for the majority of housing markets is predicted for at least the next two years, says a report by mortgage insurer PMI.

As Malllach noted, policies to encourage renting are one option to counter all this. Even with all their limitations, loan modifications could be another. It’s “a really crucial time” to jumpstart them right now, said Cleveland State’s Kathleen Engel. Servicers finally have gotten fully staffed and up to speed, after a slow start. Clearing away potential tax liabilities for trusts due to aggressive loan modifications could help, she said. So could ratcheting up the pressure on lenders and servicers alike to complete more of them.

But challenges remain. REOs are driving away other sales, keeping downward pressure on home prices, Mallach noted. Stronger markets that have been immune so far to plunging home prices, such as New York City, New Jersey, and the Philadelphia suburbs, still remain at high risk for a downward spiral. Frustration keeps growing over a lack of progress in anything being done to stem foreclosures, creating anger in neighborhoods, and even a movement to put squatters in vacant homes.

Beyond that, underwater homeowners remain a huge wild card, with the chance that a significant number of them will stop paying their mortgages in the near future clouding any hope for a quick recovery.

When it comes to the foreclosure machine, things are probably even worse than they seem. That’s a starting point for any strategy to challenge a housing crisis isn’t ending anytime soon.

Mary Kane is an economy reporter for the Washington Independent.

Sen. Chris Dodd (D-Conn.) (WDCpix)

Not long after foreclosures started to take off in 2007 and the mortgage market’s collapse began to cripple the economy, one lesson seemed obvious: The predatory lending practices that led to the crisis had to be reined in.

But despite massive government bailouts of banks and lenders due to losses from toxic mortgages, that reform still hasn’t happened. As the Obama administration urges lawmakers to quickly enact sweeping health care legislation this summer, the momentum to halt abusive lending practices and overhaul mortgage lending, by contrast, has stalled. A mortgage reform bill that passed the House in May was so complicated and contradictory it wound up angering some of the same consumer advocates who have been battling predatory lending. And – flaws and all – the measure isn’t likely to be taken up in the Senate anytime soon. Senate Banking Committee Chairman Christopher Dodd (D-Conn.) told reporters recently that mortgage reform will have to wait: “We’ve got a lot on our plate. We’ve got other things to do.” Dodd added that “There isn’t a lot of predatory lending going on right now… I’m not minimizing what happened before, and I don’t want to see a repetition of it, but there’s not subprime lending going on today.”

To many housing activists, the lack of action on the predatory lending bill is the final insult of a failed campaign to rapidly reform mortgage lending – something that once seemed like a slam dunk. First, a mortgage cramdown measure that would have forced lenders to write down loan amounts for borrowers in bankruptcy failed, after 12 Senate Democrats joined Republicans in refusing to support it. Then came dashed hopes for a more comprehensive predatory lending bill, and for quick action on it. To some, the window to tackle mortgage reform is open right now, and the time to act is before the housing market recovers and lending picks up again. The failure so far to do so, they worry, means little is being learned in Congress from the most severe financial crisis since the Great Depression – and even less progress is being made to ensure it doesn’t happen again.

“If there was anything that seemed like a sure bet, it was reforming mortgage lending,” said Alan White, a Valparaiso University law professor who studies subprime lending and foreclosures. “But the momentum seems to be fizzling. It’s certainly possible the subprime market could come back in some form someday, and I am surprised there hasn’t been more movement for real mortgage reform. The Blue Dog Democrats are being strong advocates for for the banking industry, and that makes it difficult for the more consumer-minded Democrats to get some kind of regulation passed.”

It gets even more complicated. Housing advocates aren’t eager to launch a high-profile campaign against Dodd over his relegation of the predatory lending bill to the back burner, given that Dodd is in the midst of a tough re-election battle. Should he lose, the next in line to head the Senate Banking committee would be Sen. Tim Johnson (S.D.), the only Senate Democrat to vote against Dodd’s credit card reform bill.

Beyond that, the House bill seems to have split the housing advocacy community, with some supporting it despite its drawbacks, and others strongly opposing it. The controversy is surprising, considering the measure was co-sponsored by Rep. Barney Frank (D-Mass.) chairman of the House Financial Services Committee, who has a history of consumer advocacy. As has been pointed out, Frank is trying to promote lending reforms without totally alienating the financial industry.

But it’s the housing advocates who are angry this time. Nine consumer, housing and civil rights groups, including the National Consumer Law Center and the National Association of Consumer Advocates, criticized Frank’s bill, saying it undermines existing state consumer protection laws. The NCLC said the bill would “do more harm than good” by pre-empting the state anti-predatory measures and by limiting the ability to sue Wall Street investment firms that buy up risky mortgages.

“The bill is complex, convoluted, and simply will not accomplish its main goal – to fundamentally change the way mortgages are made in this country,” the NCLC said in a statement.

The bill still won praise from some other consumer groups for prohibiting lenders from steering borrowers into higher cost loans and for requiring lenders to verify that borrowers have the ability to repay their mortgages, a long-sought goal of many housing advocates. And it bans pre-payment penalties, another fixture of subprime lending. But the bill doesn’t apply strong penalties for violating the law, and it includes the limits on legal challenges. The measure seems to have something in it for both mortgage lenders and consumer advocates, which only served to make everyone unhappy, Valparaiso’s White said.

Explained one advocate, who declined to go on the record in order to speak freely: “It’s the most complicated, arcane, ridiculous, confusing piece of crap any of us has ever seen.”

Other mortgage reforms also are running into complications. The National Association of Mortgage Brokers, for example, plans to restart a legal challenge to a new government approved code of conduct for appraisals, which is aimed at keeping lenders and brokers from pressuring appraisers to inflate home values. The new regulation stems from a mortgage fraud lawsuit by New York Attorney General Andrew Cuomo. It went into effect May 1 and requires mortgage giants Fannie Mae and Freddie Mac to only buy loans appraised under the new standard.

The NAMB and other industry groups, however, contend the regulation isn’t needed and only adds to the cost of buying a home. The NAMB plans to file another legal challenge soon to overturn the rule, after withdrawing an earlier attempt, said NAMB President Marc Savitt.

His group also continues opposing any changes in the way brokers get paid for making loans – something once considered an obvious target for reform.

An industry practice known as the yield spread premium, a form of sales commissions for mortgage brokers, has long been controversial, with consumer advocates contending some brokers misuse it to con borrowers into higher-rate mortgages. Frank’s bill appears to outlaw the yield spread premium – but no one’s entirely sure. “There are four different interpretations of the language right now,” Savitt said. Regardless, he said, “the yield spread premium and mortgage brokers are being used as scapegoats right now. Mortgage brokers don’t develop loan programs and don’t underwrite and approve loans, so how could this all be our fault?”

The problem for mortgage reform, said Margot Saunders, an attorney with the National Consumer Law Center, is that with mortgage brokers and mortgage originators in every congressional District, Congress has plenty of financial incentive to listen to arguments like that from the lending industry – and already does so. As the New York Times noted in an editorial on passage of the House anti-predatory lending measure: “The Senate needs to improve on the legislation and ensure that stronger reforms quickly become law. To do that, Senators will finally have to stand up to the mortgage industry and its all-too-well-paid lobbyists.”

Saunders and others say they’re trying to remain hopeful the Senate will take up mortgage reform again in the fall – but they’re not counting on it. “Congress,” said Saunders, “just acts like homeowners don’t matter.”

None of the current proposals, for example, even addresses the possibility of linking compensation to a loan’s performance, which would cut out incentives for brokers and lenders to make high-rate mortgages that borrowers can’t repay, Saunders said.

But some see some positive signs on reform. Both the Federal Reserve and the Federal Trade Commission are working on new rules for mortgages and other types of lending, which are expected to require greater disclosures of terms and rates. The Obama administration is backing a proposal to create a Financial Products Safety Commission, which would regulate mortgages, credit cards, and other kinds of lending by requiring more consumer protections.

And Congress may be slow to act on mortgage reform not because of lending industry opposition, but because “it’s incredibly complicated” to do so, and “Congress is running out of time” with so many other issues on its plate, said Bert Ely, a banking industry analyst.

Whatever the reason, Congress’ plate is full – and mortgage reform isn’t on it, at least in the near future. In the meantime, 5.4 million mortgages are delinquent or in some stage of foreclosure, and home prices continue to fall.

Mary Kane is an economy reporter for the Washington Independent.