Lenders should bail out consumers

By Bruce Marks | September 20, 2007

THE HUMAN SIDE of the subprime crisis is that more than 2 million homeowners are at risk of losing their homes. If immediate action is not taken, the repercussions of allowing this meltdown is likely to affect virtually every community, drive the economy into recession, and affect economies overseas. The most effective and just remedy is for the lenders and investors who created these "exotic" products to restructure the loans. This does not require taxpayer dollars to bail out an industry that has profited hugely from this scheme.

Some have portrayed this crisis as one created by "risky borrowers" taking advantage of generous lenders. These hardworking Americans did not design these "exotic" products and package them for worldwide investments. Blaming borrowers would be like a car maker designing and selling cars that suddenly go into overdrive and cause accidents, and rather than having a recall to fix the cars, the owners are penalized for being negligent drivers.

This subprime crisis is about risky and greedy lending. These "exotic" products are unique in their type and magnitude. The majority are adjustable rate mortgages, but these ARMs are unique for they do not decrease if the prime rate or other indexes go down. These are Strangulation ARMs that are structured to always increase, resulting in foreclosure or financial ruin for the majority of borrowers. Payments are initially affordable but dramatically increase over three to four years to more than 10 percent, even if the lending indexes decrease. There was no perceived subprime crisis prior to 2007 when the initial payments were affordable. But double-digit interest rates over the long term would transform anyone into an at-risk borrower.

These loans - hundreds of billions of dollars worth - have generated huge profits for the brokers who originated them, the lenders who purchased them, the rating agencies that evaluated them, and the investment bankers who packaged and sold them to investors. A New York Times investigation of Countrywide, the country's largest mortgage company, detailed how the company structured employee incentives that exploited borrowers by imposing large costs on the borrowers, and pushed many into unaffordable mortgages. Additionally, the billions of dollars in bonuses paid out last year by the investment bankers reflect the profitability of the subprime lending market.

These defective products require the restructuring of loans. Developing a borrower-focused solution, based on what the borrower can afford, is the most viable remedy. This requires lenders who service the loans to reduce the interest rate and/or reduce the outstanding mortgage balance to what the homeowner can afford. This can be determined by documenting the homeowner's net income, required debt payments, necessary expenses, with the remaining amount available for the mortgage payment.

However, lenders refuse to restructure loans, and instead demand more money while maintaining the unaffordable mortgage. Regulators must exercise their power to require lenders to restructure these loans. This remedy addresses the interests of all parties involved: the investor can obtain a reasonable return, homeowners can keep their homes, and the local tax base can be maintained.

The Neighborhood Assistance Corp., a nonprofit mortgage broker and community advocacy group, has begun this process by bringing Countrywide borrowers who need their loans restructured to the mortgage company's regulator, the Office of Thrift Supervision. For uncooperative lenders, the regulators must impose "cease and desist" orders. The Neighborhood Assistance Corp. has also stepped forth with a $1 billion commitment to refinance borrowers out of their loans on the best terms available.

It is unfortunate that the solutions put forth by politicians focus on a taxpayer bailout of lenders and investors. Congress is also proposing to expand Fannie Mae and Freddie Mac's lending authority. This should not occur until they commit to restructure the subprime loans in their portfolios, and require lenders who place loans with them to also restructure loans and eliminate their predatory practices. The legislation needed immediately is to allow bankruptcy judges to restructure unaffordable loans.

Everyone needs to be concerned even if they do not have a subprime loan. Neighborhoods are being devastated, and it will only get worse. Politicians and regulators have ignored the plight of over 2 million homeowners who are at risk of foreclosure. The restructuring of loans is straightforward, attainable, and can be done at no cost to the taxpayer. This puts the responsibility where it rightly belongs - with the lenders and investors who created the crisis.

Bruce Marks is founder and CEO of the Neighborhood Assistance Corporation of America.