It's Not Your Parents’ Mortgage Market Anymore Page 2 of 3

to those with less-stellar credit records and carry higher rates, points, and fees. Most
prime mortgages feature down payments; many subprime mortgages don't.

Made by banks and thrifts, most prime mortgages are fixed-rate. Negotiated by
independent mortgage brokers, many subprime mortgages are adjustable. Most prime
mortgages carry no prepayment penalties; most subprime mortgages do,

The bottom line? The new subprime mortgage market is far riskier than the old prime
market. The foreclosure rate in the prime market has typically been less than 1
percent, compared with about 7 percent in the subprime market.

Now, the interest rates of the recent raft of subprime mortgages are about to rise
(since they track short-term interest rates). The Center for Responsible Lending
predicts foreclosure rates of about 20 percent, excluding distress sales. Millions of new
homeowners who stretched to make their payments when short-term interest rates
were very low are beginning to lose their homes.

Should we close down the subprime market and return to the world of the early 1990s?
No way. Regrettable foreclosures notwithstanding, three-quarters of new homeowners
are making their payments, building wealth and participating in the American dream.

Should we increase protections and safeguards for the new homeowners? Absolutely.

The key is stopping the shortcuts taken in the recent go-go subprime market. Lenders
should scrutinize borrowers’ ability to repay the loan, using the maximum rate on
adjustable-rate mortgages—not the initial low rate. Lenders should escrow property
taxes and insurance payments. Independent subprime lenders should be as carefully
supervised as banks and thrifts making prime loans are.

Congress can get going, too. The 1994 Homeowner Equity Protection Act imposed
controls on predatory lending by preventing balloon payments on high-priced
mortgages, outlawing long-term prepayment penalties, and forcing lenders to evaluate
borrowers’ creditworthiness.

HOPEA's rate thresholds could be tightened up, and strictures on balloon payments
could be applied to rate hikes on adjustable-rate mortgages and other payment shocks.
If both lenders and borrowers had to confront the long-term costs of a mortgage, fewer
households would lose their homes.

The clock cannot be turned back on the subprime mortgage industry. But financial
regulators and legislators could look forward by promoting less risky homeownership.

Edward Gramlich, a member of the Federal Reserve System's Board of Governors from
1997 to 2005, is the Urban Institute's Richard B. Fisher Senior Fellow and author of the
forthcoming "Subprime Mortgages: America's Latest Boom and Bust."

The views expressed are those of the authors and should not be attributed to the Urbar
Institute, its sponsors, staff, or trustees.

Related Research

e Race, Schools, and Neighborhoods: Reducing Barriers to Achievement

e Promoting Neighborhood Improvement while Protecting Low-Income Families >>

e Housing Partnerships: The Work of Large-Scale Regional Nonprofits in Affordable
Housing >>

http://www. urban. org/url.cfm?ID=90 1063 &renderforprint=1 6/8/2007


American Securitization Forum
Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007

B.

manipulating the application of delinquency triggers or cumulative loss
triggers which control whether excess cash flow may be released to the
residual.

The ASF will conduct a survey of typical document provisions and
interpretations, on the question of whether and under what conditions a
modified loan is to be considered current for purposes of investor
reporting, and for purposes of delinquency triggers and cumulative loss
triggers which control whether excess cash flow may be released to the
residual. Additional guidelines should be developed and recommendations
should be made and evaluated regarding amendments to securitization
transactional documents, based on the results of this survey.

Future securitizations:

The ASF will develop standard, uniform model contractual provisions
governing the servicer’s ability to provide loan modifications for use in
future securitizations. Such provisions should expressly authorize the
actions referenced in Loan Modification Interpretive Guidance point 1
above.

Use of an increased or supplemental servicing fee should be considered
for loans that have been modified to defray the additional costs of
administering modifications.

The ASF will develop standard, uniform model contractual provisions,
both as to timing and priority, to govern the servicer’s ability to obtain
reimbursement for P&I advances and servicing advances made in respect
of loans where there has been a loan modification, or where other types of
loss mitigation have been used.


American Securitization Forum
Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007

then explore modification possibilities. In particular, such outreach should be
permitted and encouraged prior to an upcoming first adjustment date on a
hybrid ARM loan.

Loan modifications should be considered and made on a loan-by-loan basis,
taking into account the unique combination of circumstances for each loan and
borrower, including the borrower’s current ability to pay. The ASF is opposed
to any across-the-board approach to loan modifications, and to any approach
that would have all modifications structured in a particular manner. The ASF is
also opposed to any proposals that would provide an across-the-board
moratorium or delay period on foreclosures.

Generally, the ASF believes that loan modifications should only be made:

a. Consistently with applicable securitization operative documents (including
amendments that can be made without investor or other consents);

b. Ina manner that is in the best interests of the securitization investors in the
aggregate;

c. Ina manner that is in the best interests of the borrower;

d. In a manner that, insofar as possible, avoids materially adverse tax or
accounting consequences to the servicer and, to the extent known, to the
securitization sponsor or investors;

e. Where the loan is either in default or default is reasonably foreseeable,
and if the latter, where there is a reasonable basis for the servicer
determining that the borrower is unlikely to be able to make scheduled
payments on the loan in the foreseeable future;

f. | Where there is a reasonable basis for the servicer concluding that the
borrower will be able to make the scheduled payments as modified; and

g. In a manner that is designed to provide sustainable and long-term
solutions, but does not reduce the required payments beyond the
magnitude required to return the joan to performing status, or beyond the
anticipated period of borrower need.

The ASF believes that loan modifications meeting the criteria in Loan
Modification Principles point 4 above are generally preferable to foreclosure
where the servicer concludes that the net present value of the payments on the
loan as modified is likely to be greater than the anticipated net recovery that
would result from foreclosure.


Inman News Page 2 of 2

is irrelevant. Neither does it matter whether a loan provider is a broker or a lender. You find the loan
provider who offers the best combination of rates and total fees, period.

But if you are not up to price shopping, which is extremely difficult to do effectively, and you prefer to
retain a broker to shop for you, then you should know what you are paying for this service. Upfront
Mortgage Brokers tell you, discount brokers don't.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left at www.mtgprofessor.com.

Copyright 2005 Jack Guttentag

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FIGURE 3. Mortgage Originations, 1994-2005

4000 +
3000 +
2000
1000
of
1995 2000 2005
Year
— Total Originations — — Prime Originations © —— Subprime Originations

Source: Mortgage Statistical Annual

(Schloemer et al. 2006). And foreclosures
have likely been held down by the recent
period of very low short-term interest rates
and the proliferation of financing instru-
ments that take advantage of these rates.
Now that short-term rates establish more
normal levels, interest payment burdens
for many subprime borrowers are rising
sharply, and further increases in delin-
quencies and foreclosures are almost sure
to follow.

Indeed, early reports show exactly that
happening in late 2006. Three subprime
lenders have recently declared bankruptcy,
and an intensive study of six million re-
cently made subprime mortgages fore-
casts sharply higher foreclosure rates
(Schloemer et al. 2006). The numbers are
not large enough to threaten the macro-
economy, but even a small rise in fore-
closures could damage the prospects of
millions of low- and moderate-income
households.

The Role of House Prices

House prices play an ambiguous role in
this story. When house prices rise at

healthy rates, as they have until just
recently, borrowers make capital gains on
their homes and build wealth. If they get in
trouble with their mortgages, they can just
sell their houses, pay their prepayment
penalties, and walk away from the whole
problem. Or they can refinance their mort-
gages on favorable terms.

Yet, the rise in house prices, combined
with slow growth in low-income wages, has
led to significant gaps in the stock of afford-
able housing. Nearly half of all households
in the bottom quarter of the income scale
now spend more than 50 percent of their
income on housing, and another quarter
spend between 30 and 50 percent of their
income (Joint Center 2006, table A.6, 36).
With housing expenditures at this rate,
households have little left to spend on other
things, and whether they buy or rent, they
are likely to experience financial difficulties.

Consequently, the latest slackening in
house price appreciation rates could have
ambiguous impacts. Foreclosure problems
might worsen or, perhaps, shortages of
affordable housing might become less
serious.


‘Thacher
Proffitt

Memorandum

TO: ASF Loan Modification Working Group
FROM: Mason L. Crocker and Stefano Taverna
DATE: May 16, 2007

RE: Cancellation of Indebtness Income in Conjunction with Typical
Subprime Loan Modification Provisions

This memorandum highlights some of the federal tax consequences that result from
certain loan modification provisions with respect to loans provided to individuals who
purchased homes for primary or secondary residence and not for their trade or business (each,
a “mortgagor”). Examples of loan modifications include: (1) capitalizing any amounts owed
on a mortgage loan by adding such amount to the outstanding principal balance of the
mortgage loan, (2) deferring amounts owed to a later date or to the final payment date of a
mortgage loan, (3) extending the maturity of any such mortgage loan, (4) amending the
related mortgage note to reduce the related mortgage rate with respect to any mortgage loan,
(5) converting the mortgage rate on any mortgage loan from a fixed rate to an adjustable rate
or vice versa, (6) with respect to a mortgage loan with an initial fixed rate period followed by
an adjustable rate period, extending the fixed period and reduce the adjustable rate period, (7)
forgiving the amount of any principal owed by the related mortgagor, and/or (8) forgiving the
amount of any interest owed by the related mortgagor.

Summary
Generally, a mortgagor will recognize income upon:
forgiveness of principal;
a short sale or short payoff; and

forgiveness of past accrued and unpaid interest, to the extent that interest
would not have been deductible by the mortgagor.

In addition, a mortgagor may recognize income if the rate on the mortgage loan is
reduced prospectively to a below-market rate, defined herein as the AFR.

Thacher Proffitt & Wood LLP
671646_5.DOC


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Real estate settlement services take bite out of borrowers
By Jack Guttentag

(This is Part 1 of a four-part series.)

"The impression I get from reading your articles is that our mortgage system doesn't work well for
borrowers...Isn't there any way to fix it?”

In some respects, the United States housing finance system is the best in the world. In other respects,
it is unworthy of a banana republic.

Our housing finance system has a primary market and a secondary market. The primary market is the
market the borrower sees, where loans are executed. The secondary market is where the loans
originated in the primary market are sold to investors, the ultimate source of funds.

Our secondary market is the envy of the world. Investors acquire mortgage-backed securities at the
smallest possible margins over U.S. government securities. However, much of the benefit stemming
from our efficient secondary market is eaten away by excessive costs in the primary market.

The first three articles in this series focus on excessive charges paid by borrowers to third-party
settlement service providers, lenders and brokers. The fourth article is directed toward making it easier
for borrowers to shop effectively.

Why third-party settlement service charges are too high:

Third parties involved in the lending process include title insurance companies, mortgage insurance
companies, appraisers, credit-reporting agencies, flood insurance companies and escrow companies.
Their costs are generally higher than they would be if they were purchased in a normally competitive
market.

The reason is that third-party service providers compete not for the favor of borrowers, who pay their
fees, but for the favor of the lenders who select them. This type of competition is perverse because it
drives up the costs of the service providers. This in turn raises prices to borrowers or prevents prices

from falling in response to improvements in technology.

For example, borrowers pay for private mortgage insurance, but the insurance company (PMI) is
selected by the lender. Lenders use their referral power primarily to benefit themselves. The process is
much the same in the markets for other third-party services.

The direct payment of referral fees has long been illegal under the Real Estate Settlements and
Procedures Act (RESPA), However, RESPA is ineffective because it does not eliminate referral power,
which is the crux of the problem. Small players often ignore the rule because HUD, which is responsible
for enforcement, cannot possibly police all the ways in which one party can transfer something of value
to another.

Large lenders circumvent RESPA through circuitous but legal devices, such as reinsurance affiliates that
share the insurance premiums paid by borrowers. The process of legalizing referral fees increases the
costs that borrowers ultimately pay. So long as referral power is allowed to persist, the cost to
borrowers might be lower if referral fees were paid openly in cash.

Why do borrowers pay for services required by lenders?

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American Securitization Forum

‘Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007 :

common framework relating to the structure and interpretation of loan modification
provisions in securitization transactions, thereby promoting greater uniformity, clarity and
certainty of application of these provisions throughout the industry. As a consequence, ASF
hopes that this guidance will facilitate wider and more effective use of loan modifications in
appropriate circumstances.

While this Statement addresses certain legal, regulatory and accounting matters, it does not
constitute and should not be viewed as providing legal or accounting advice.

This Statement is focused on modifications of first lien subprime residential mortgage loans.
Many of the principles reflected in this Statement would also apply to modifications of other
types of residential mortgage loans. This Statement does not address modifications of second
lien residential mortgage loans.

Il. Overview of Typical Securitization Document Modification Provisions

Servicing of subprime residential mortgage loans included in a securitization is generally
governed by either a pooling and servicing agreement or servicing agreement. These
agreements typically employ a general servicing practice standard. Typical provisions
require the related servicer to follow accepted servicing practices and procedures as it would
employ “in its good faith business judgment” and which are “normal and usual in its general
mortgage servicing activities” and/or certain procedures that such servicer would employ for
loans held for its own account.

Most subprime transactions authorize the servicer to modify loans that are either in default,
or for which default is either imminent or reasonably foreseeable. Generally, permitted
modifications include changing the interest rate on a prospective basis, forgiving principal,
capitalizing arrearages, and extending the maturity date. The “reasonably foreseeable”
default standard derives from and is permitted by the restrictions imposed by the REMIC
sections of the Internal Revenue Code of 1986 (the “REMIC Code”) on modifying loans
included in a securitization for which a REMIC election is made. Most market participants
interpret the two standards of future default — imminent and reasonably foreseeable — to be
substantially the same.

The modification provisions that govern loans that are in default or reasonably foreseeable
default typically also require that the modifications be in the best interests of the
securityholders or not materially adverse to the interests of the securityholders, and that the
modifications not result in a violation of the REMIC status of the securitization trust.

In addition to the authority to modify the loan terms, most subprime pooling and servicing
agreements and servicing agreements permit other loss mitigation techniques, including
forbearance, repayment plans for arrearages and other deferments which do not reduce the
total amount owing but extend the time for payment. In addition, these agreements typically


It's Not Your Parents' Mortgage Market Anymore Page 3 of 3

Browse by Topics
e Housing >>

Other Publications by Authors
e Edward Gramlich >>

Disclaimer:

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics
worthy of public consideration. The views expressed are those of the authors and
should not be attributed to the Urban Institute, its trustees, or its funders.

Terms and Conditions for use of this website:

Copyright of the written materials contained within the Urban Institute website is
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appropriate acknowledgment, for research, academic, policy or other non-commercial
Purposes. Proper attribution is required. Posting UI research papers on other websites
is permitted provided the poster first gains approval from the Urban Institute. For
approval, please contact us.

Source: http://www.urban.org | © 2005 The Urban Institute

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share sells their houses after only a
few years.

On the cost side, delinquency and
foreclosure are the dramatic risks.
Studies of the foreclosure problem in
the city of Chicago suggest significant
costs all around (Home Ownership
Preservation Initiative 2006). Home-
owners can lose their property, their
equity, and their chance to build
wealth. Even the lenders do not often
fare well, with a series of servicing
costs. The city loses, particularly
when the property remains vacant
and entails continuing costs. And
neighborhood values go to pot when
surrounding homeowners lose signif-
icant value.

There are more subtle costs as
well. Even though refinancing a sub-
prime mortgage is costly, some home-
owners refinance often, up to several
times a year. A series of terms—loan
flipping, equity stripping—have
come into use to characterize condi-
tions in these markets. Some of these
problems can be attributed to preda-
tory lending and some to the fact that
borrowers may have lost jobs (and
their ability to make their mortgage
payments).

Policy Changes

The country has, in effect, performed
a huge experiment in opening up
housing and mortgage markets to
new groups of homeowners with
marginal credit records, presumably
lower incomes, and a higher repre-
sentation from racial or ethnic minor-
ity groups. The changes are so huge
they are likely to be irreversible—the
country will not likely go back to
homeownership rates of a decade ago
and the subprime mortgage market
will not likely shrink.

From an overall standpoint, this
change would appear to represent a
net social improvement. There seem
to be more gainers than losers, and
unless the losers lose a lot more per
household, the net gains would seem

to outpace the losses. Hence the over-

all net social benefit tally should be
positive. But this is not the best way
to view the change. Rather than eval-
uate the overall change, it makes
more sense to see if there are mea-
sures that could reduce the costs or
enhance the benefits.

An obvious potential policy mea-
sure is improved lending counseling,
now already used by various commu-
nity groups such as Neighborworks
America. Targeted programs such as
these can require that clients enter
lending counseling programs, mak-
ing these clients more selective in tak-
ing on credit and more disciplined in
making mortgage payments. The pro-
grams can give valuable advice when
consumers want to refinance, provide
legal help in disputes, and refinance
loans on terms preferable to those
privately available. But lending coun-
seling might inherently have limited
effectiveness. Mortgage contracts can
be unfathomable even to those with
advanced degrees in finance, and the
notion of universal housing counsel-
ing may be hard to shove down
prospective buyers’ throats. Also,
attempts to establish universal coun-
seling may create an industry of
phony consultants.

Product restrictions might play
some role. Very often subprime, and
even prime, borrowers exhibit what
economists call myopia, where they
are more aware of short-term than
long-term costs. If consumer myopia
is a general problem, it may make
sense to ban balloon payments in
this market, as the Home Owner-
ship Equity Protection Act of 1994
(HOEPA) already does for very high
cost mortgages. HOEPA also contains
strictures against long-term prepay-
ment penalties, another restriction
that may be appropriate to lessen the
costs of mistakes. Many states have
adopted their own policies, often pat-
terned after the 1994 law, and these
can be extended as well.

Measures could also be taken to
reduce market inefficiencies. The U.S.
Department of Housing and Urban
Development (HUD) has promoted

the idea of folding all closing costs
into one amount and of informing
the consumer of this total amount in
advance. Such a plan would provide
better market information to con-
sumers, and also give consumers

a chance to shop around, as they

do in other areas of the economy.
Secondary-market purchasers such
as Fannie Mae and Freddie Mac
could also use their considerable
leverage to lessen market distortions
and standardize and clarify loan
terms.

Financial lenders in this market
could also be more closely regulated.
Prime mortgage lenders are subject to
arduous bank examinations every
three years, examinations that moni-
tor lending practices, verify borrow-
ers’ incomes, and assess repayment
probabilities. Similar regulations
could be extended to the affiliates of
these prime lenders, and perhaps
even to independent lending com-
panies, the source of most allega-
tions about predatory lending.

There may also be ways to regulate
mortgage brokers, who are placing
ever-growing shares of subprime
mortgages.

There are also ways to encourage
homeownership on better terms.
HUD has been doing some experi-
mental programs under which ten-
ants’ rent payments are partially
devoted to escrow accounts, to per-
mit the tenants to become owners.
These tenants have to satisfy difficult
conditions to become owners, but the
early experience is that once they do
that, foreclosure rates are much lower
(Lubell 2006). The lesson again seems
to be that some coaching on home-
ownership may pay big dividends.

Conclusion

Wittingly or unwittingly, the United
States has passed through an era of
enormous social change in housing
markets. The mortgage market has
been opened up to millions of poten-
tial new homeowners, and the impli-
cations are huge, for both owners


FIGURE 1. Homeownership Rates, 1940-2005 (percent)

70

65 +

60

55 +

50

45

1940 1960 1980 2000
Year
Source: U.S, Census Bureau
But any social change this large is prime market (Joint Center 2006). Various

likely to have some mixed blessings. indicators suggest that another 10 percent
Overall delinquency rates for subprime of subprime borrowers could be flirting
mortgages are on the order of 7 percent, with credit problems, even if not in
10 times as high as the normal rate in the actual delinquency or foreclosure status

FIGURE 2. Homeownership Rates, 1970-2005 (percent)

80

70

60

50

ect t TT
Nexen
1970 1980
Year
— AllHouseholds  - — Black © — White ~ — Hispanic

Source: U.S, Census Bureau,



American Securitization Forum

Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007

permit loss mitigation through non-foreclosure alternatives to terminating a loan, such as
short sales and short payoffs.

Beyond the general provisions described above, numerous variations exist with respect to
loan modification provisions. Some agreement provisions are very broad and do not have any
limitations or specific types of modifications mentioned. Other provisions specify certain
types of permitted modifications and/or impose certain limitations or qualifications on the
ability to modify loans. For example, some agreement provisions limit the frequency with
which any given loan may be modified. In some cases, there is a minimum interest rate
below which a foan's rate cannot be modified. Other agreement provisions may limit the
total number of loans that may be modified to a specified percentage (typically, 5% where
this provision is used) of the initial pool aggregate balance. For agreements that have this
provision: i) in most cases the 5% cap can be waived if consent of the NIM insurer (or other
credit enhancer) is obtained, ii) in a few cases the 5% cap can be waived with the consent of
the rating agencies, and iii) in all other cases, in order to waive the 5% cap, consent of the
rating agencies and/or investors would be required. It appears that these types of restrictions
appear only in a minority of transactions. It does not appear that any securitization requires
investor consent to a loan modification that is otherwise authorized under the operative
documents.

Til. Loan Modification Principles

Based upon extensive consultation with its members and other securitization market
participants, ASF believes that the following principles articulate widely-accepted industry
views regarding the use of loan modifications in connection with securitized subprime
residential mortgage loans:

1. For subprime mortgage loans that are in default or where default is reasonably
foreseeable, loan modifications are an important loss mitigation tool that should
be used in the circumstances described in this Statement. Modifications may
include changing the interest rate on a prospective basis, forgiving principal,
capitalizing arrearages and extending the maturity date. Other loss mitigation
alternatives include forbearance, repayment plans for arrearages and other
deferments which do not reduce the total amount owing, and also non-
foreclosure alternatives to terminating a loan, such as short sales and short
payoffs. Unlike other loss mitigation alternatives, loan modifications have the
additional advantage that they can be used prior to default, where default is
reasonably foreseeable.

2. Establishing early contact with borrowers is a critically important factor in the
success of any loss mitigation initiative. Servicers should be permitted and
encouraged to reach out affirmatively and proactively to borrowers for whom
default is more likely, determine whether default is reasonably foreseeable, and


Inman News Page 2 of 2

compensation from the transaction, and passes through the best price from the broker's Jenders.

The agency approach recognizes that shopping mortgages is difficult for borrowers, but brokers are
experts at it. The optimal arrangement for many borrowers, therefore, is to purchase the shopping
expertise of brokers for a fixed fee.

The advantage of the UMB approach is that it breeds confidence, which lowers costs and increases
productivity. I know UMBs who charge half the industry average per transaction but close three to four

times as many loans. Their secret is a continuous stream of referrals from previous clients -- and from
me.

Implementation of the Agency Approach: The way to break the circle of distrust is to change the
operating model, from independent contractor to agency. Government should mandate the agency
approach, but probably won't because it would be opposed not only by the broker associations, but
also by the wholesale lenders, who are as shortsighted as the brokers. They support the independent
contractor model in order to limit their own liability for broker misdeeds.

The agency approach will have to win the battle in the marketplace, which will take time. When this
was written, there were 135 UMBs. Growth will accelerate, however, with the activation of Upfront
Mortgage Brokers Association, a non-profit organization dedicated to promotion of the agency
approach to brokering.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left at http://www,mtgprofessor.com.

Copyright 2006 Jack Guttentag

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Inman News Page 2 of 2

agent of the borrower, to whom they owe a fiduciary responsibility. A UMB agrees with the borrower on
total broker compensation from the transaction, and passes through the best price from the broker's
tenders.

The advantage of the UMB approach is that it breeds confidence, which lowers costs and increases
productivity. I know UMBs who charge half the industry average per transaction but close 3-4 times as
many loans. Their secret is a continuous stream of referrals from previous clients - and from me. They
are listed on my Web site.

Implementation of the Agency Approach: The way to break the circle of distrust is to change the
operating model, from independent contractor to agency. The broker trade associations will never do
this, because they cater to the lowest common denominator of member opinion.

Government should but probably won't mandate the agency approach because it would be opposed not
only by the broker associations, but also by the wholesale lenders, who are as short-sighted as the
brokers. They support the independent contractor model in order to limit their own liability for broker
misdeeds. The agency approach will have to win the battle in the marketplace, which it will, slowly but
surely, When this was written, there were 113 UMBs, many with multiple loan officers.

_ The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left at www.mtgprofessor.com.

Copyright 2005 Jack Guttentag

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Five Questions With Edward Gramlich Page 4 of 4

don't have—inflation. We've actually gotten that under control.

Related Research

e A Perfect Opportunity for Health Reform >>

e Access Gaps among Uninsured Children in Los Angeles County >>

e Assessing Community-Based Outreach and Enrollment Activities and Outcomes
Relative to Need in Los Angeles County >>

Browse by Topics

e Health/Healthcare >>
e Housing >>

Other Publications by Authors
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Disclaimer:

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics
worthy of public consideration. The views expressed are those of the authors and
should not be attributed to the Urban Institute, its trustees, or its funders.

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Copyright of the written materials contained within the Urban Institute website is
owned or controlled by the Urban Institute. This information may be used, with
appropriate acknowledgment, for research, academic, policy or other non-commercial
purposes. Proper attribution is required. Posting UI research papers on other websites
is permitted provided the poster first gains approval from the Urban Institute. For
approval, please contact us.

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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics
worthy of public consideration. The views expressed are those of the authors and
should not be attributed to the Urban Institute, its trustees, or its funders.

Edward Gramlich, a former member of the Federal Reserve System’s Board of
Governors (1997-2005), recently became the Urban Institute's first Richard B. Fisher
Senior Fellow. An expert in macroeconomics and public finance, he got involved in
affordable housing issues at the Federal Reserve. He has written America's Second
Housing Boom, a new brief on the benefits and risks of the subprime mortgages
offered to lower-income buyers.

1. What are your priorities after a decade in government?

Asset building and ownership, for one. In the past, people zeroed in on how much
incomes figure into welfare. That's great. But asset building matters too because that's
the way that people develop wealth.

My first project on housing fits right in because low- and moderate-income people
generally build wealth through owning a house. Housing is a predominate form of
wealth for all families, even into the top echelon.

The housing situation is complicated greatly by a serious debt-burden problem.
Families with high debt levels are in a risky position already, and many of them took
out even more debt to buy their house. There's evidence that the foreclosure rate may
jump, causing big social problems as families lose homes and plunge more into debt.

With some assets, like IRAs [Individual Retirement Accounts], you just put money in
and that's it. If you miss a few payments, it just means that there's less money in the
account. With housing, it doesn't work that way—if you miss too many payments and
get foreclosed on your house, you lose virtually all of the equity you had accumulated
in the house.

The stakes are much higher for housing. The foreclosure problem, and where that may
lead, is what got me interested in this issue at the Federal Reserve.

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Eliminating mortgage lender fee surprises

By Jack Guttentag
(This is Part 2 of a four-part series. See Part 1: Real estate settlement services take bite out of
borrowers.)

The first article in this series indicated that third-party settlement services are overpriced because
borrowers paid for them but lenders selected the service provider. Lenders generally use their referral
power to benefit themselves rather than to drive down prices to borrowers. The remedy is to eliminate
referral power through the adoption of a simple rule: Any third-party service required by lenders must
be paid for by lenders.

This article is directed toward lender fees, sometimes referred to as junk fees. These are fees charged
by lenders to cover specific lender costs. They are defined in dollars, as opposed to points, which are
defined as a percent of the loan. Where points are one number, junk fees can be a whole bunch of
numbers, each covering a specific charge.

The problem is that some retail lenders increase these fees after it is too late for the borrower to back
out. Often, the borrower finds out about it at the closing table. It happens because of borrower
inattention, industry locking practices, and terrible disclosure rules.

Borrower inattention: Borrowers are usually only dimly aware of lender fees. When they shop, their
focus is mainly on interest rate and points, which are all that appear in media ads. The borrower's first
exposure to lender fees is likely to be when they receive a Good Faith Estimate of Settlement (GFE),
but this typically doesn't happen until after an application has been submitted. At that point, the
borrower will be at least partially committed.

Industry locking practice: The mortgage market is highly volatile, with prices changing from day to
day and sometimes within the day. Hence, rate/point quotes are not binding until the lender locks
them. Lender fees, in contrast, are not volatile, and therefore the practice is not to include them in
locks. The presumption is that at closing, they will be exactly what they were when the borrower
received the GFE, and with honest lenders, they will be. But with dishonest lenders, the practice of
excluding fees from the lock provides an opportunity to cheat.

The Good Faith Estimate: The GFE makes it all too easy for the cheaters. Lenders are not bound by
any of the numbers on the GFE, which are "estimates." This is ridiculous, since lenders know their own
charges. In addition, the GFE confuses borrowers by showing each individual lender fee but no total,
when the total is all that really matters. If the GFE were deliberately designed to take the borrower's
eye off the ball, it couldn't have been done better.

Mortgage brokers provide protection: Excessive junk fees generally are not a problem on loans
that go through mortgage brokers. Brokers know the fees charged by all the lenders with whom they
do business, and they would not accept fee surprises at the closing table that put no money in the
broker's pocket. Broker fees are another matter, to be discussed in article 3 of this series.

Home purchases are most vulnerable: Excessive junk fees are more likely to arise on a home
purchase transaction than on a refinance. On a home purchase, a buyer cannot walk away from the
mortgage without walking away from the house. On a refinance, in contrast, a borrower can usually
begin anew at any point without much loss.

Eliminating junk-fee escalation: In article 4 of this series, I propose a mandatory fixed-dollar fee on
all mortgage transactions. The fee would cover all lender and third-party charges. Among other

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We have lived with this practice for so long that it seems the natural state of affairs, but in fact, there
is nothing natural about it. If automobiles had to be shopped in the same way as mortgages, the
shopper might only receive the chassis from the dealer, purchasing tires, electrical system and painting
from third parties. Can there be any doubt what would happen to the price of these components if,
instead of purchasing them as a package, they had to be purchased separately from vendors selected
by the dealer?

The unbundled package of mortgage services is a historical relic of usury laws limiting the interest
rates lenders could charge. When lenders could not raise interest rates to cover their costs, it seemed
reasonable to lawmakers to allow them to pass costs through to borrowers. They didn't realize that this
was a sure-fire recipe for referral abuse. When the abuses became too obvious to ignore, they
responded with RESPA, which made referral fees illegal but left referral power unchanged. RESPA is
essentially a make-work project for lawyers.

The remedy is to eliminate referral power:

This could be done by the enactment of one legal rule that is as simple as it is obvious: any third-party
service required by lenders must be paid for by lenders.

If lenders paid the charges, they would be included in the rate, of course, but would cost borrowers far
less than now. Competition by third-party providers to sell lenders would force the prices down, and
rate competition by lenders would force them to pass the savings on to borrowers. Indeed, if lenders
had to pay for ail these services, they would discover that some that they had found essential when
borrowers had to pay were not really necessary after all.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left at www.mtgprofessor.com.

Copyright 2005 Jack Guttentag

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It's Not Your Parents' Mortgage Market Anymore Page 1 of 3

It's Not Your Parents' Mortgage Market Anymore

Urban Institute > It’s Not Your Parents’ Mortgage Market Anymore

Author(s): Edward Gramlich

Other Availability: Printer-Friendly Page

Posted to Web: April 06, 2007

Permanent Link: http://www.urban.org/url.cfm?ID=901063

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics
worthy of public consideration. The views expressed are those of the authors and
should not be attributed to the Urban Institute, its trustees, or its funders.

WASHINGTON - Is the American housing dream going sour? The Dow Jones industrial
average tumbled 243 points in early March when missed payments by holders of
subprime mortgages hit a four-year high and foreclosures on all homes a four-decade
peak.

The homeownership dream first solidified in the 1950s. Then, the mortgage of choice
was the 30-year, fixed-rate mortgage with 20 percent down. Millions of middle-class
households bought suburban houses, erected backyard swing sets, and sent their kids
to new public schools. The overall homeownership rate shot up from 45 percent to 65
percent in just more than a decade.

But most lower-income families either could not make the down payment or the
monthly payments. Racial and ethnic minorities faced discrimination to boot. Most of
these households continued to rent, and the American homeownership rate stabilized
near 65 percent for 35 years.

Following that postwar boom, other seismic shifts reverberated in mortgage markets—
usury laws ended, credit scoring developed, and Fannie Mae and Freddie Mac made
advances in packaging mortgages into securities. The Community Reinvestment Act
obligated banks and thrifts to make low- and moderate-income mortgage loans. Many
new independent mortgage companies sprang into action.

As these factors converged, the subprime mortgage market blossomed. Lending
swelled from almost zip in the mid-1990s to more than $600 billion today, one-fifth of
all new mortgages. About 12 million new homeowners emerged—including many
moderate-income households and minorities previously excluded—raising the overall
U.S. homeownership rate to about 69 percent, among the world's highest.

While an arbitrary threshold (defined by the rate of interest charged) delineates the
Jower edge of the prime mortgage market from the subprime market, the two are
different animals.

Most prime mortgages go to credit-worthy households; most subprime mortgages go

http://www.urban.org/url.cfm?ID=90 1063 &renderforprint=1 6/8/2007


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Mortgage brokers struggle with consumer distrust
By Jack Guttentag

(This is Part 3 of a four-part series.)

The first two articles in this series dealt with overcharges by third-party settlement service providers,
and lender fee escalation at the closing table. This one is about high mortgage broker fees.

Role of Mortgage Brokers: Because brokers deal with multiple lenders, they play a critica! role in
helping a borrower find a |jender who offers a particular type of loan program. When the needed loan is
one offered by many lenders, brokers are able to shop among them to find the lowest price. That's the
good news.

Excessive Fees: The bad news is that broker charges per transaction are generally excessive. In part,
this is due to low productivity. Brokers spend a lot of time looking for clients, and they also spend a lot
of time with potential clients who don't close and waste their time. Low productivity generates pressure
to earn more on the deals that do close.

Brokers are able to charge a lot per transaction because borrowers usually don't know at the outset
how much the broker will make. If they find out, usually the deal is too far advanced to do anything
about it.

Only the loosest relationship exists, furthermore, between broker charges and the amount of work the
broker does for the borrower. The general rule is that brokers charge what the market will bear.
Unsophisticated borrowers who visit a single broker will generally pay more than knowledgeable
borrowers who shop alternative sources.

The Independent Contractor Mode! of the Industry: The dominant ideology of mortgage
brokerage, as promulgated by the National Association of Mortgage Brokers and the various state
associations, is that brokers are independent contractors. They view themselves as merchants who buy
at one price and sell at another price, and how much they make on a transaction is no one's business
but their own. The independent contractor model supports the view that brokers are entitled to make
as much per transaction as they can.

The Independent Contractor Model Generates Distrust, Which Increases Costs: Distrust runs
like a red line through the hundreds of letters I receive every month from borrowers relating
experiences with brokers. And distrust translates into higher costs.

Brokers detest borrowers who flit from one broker to another, submit applications through multiple
brokers, or pump them for information and then deal elsewhere. Yet these practices arise from
attempts by borrowers to protect themselves against brokers they don't trust. Borrower reactions to
distrust raise broker costs, which pressures brokers to make more per transaction, which generates
more distrust in a vicious circle.

Other Fallacies of the Independent Contractor Model: The fact is that brokers are service
providers, not merchants; they do not buy and resell anything. Furthermore, shopping mortgages is so
difficult that few borrowers can do it effectively. Brokers are the experts at shopping mortgages, not
borrowers. The optimal arrangement for most borrowers, therefore, is to purchase the shopping
expertise of brokers for a fixed fee. Fortunately, it is now possible to do this.

The Agency Approach of Upfront Mortgage Brokers: Upfront Mortgage Brokers (UMBs) operate
according to a different set of rules than the remainder of the industry. UMBs view themselves as the

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What Caused the Changes?

Several factors opened up housing mar-
kets. One clear factor is the disappearance
of usury laws against unreasonable or
excessively high interest rates. The
Depository Institutions Deregulatory and
Monetary Control Act of 1980 abolished
usury laws on first mortgages, and states
followed the federal lead and eliminated
many of their own usury laws throughout
the 1980s. Borrowers with inferior credit
histories previously denied credit have
become much more likely to qualify

for subprime mortgage loans, perhaps
even for prime mortgage loans. Reflect-
ing this fact, mortgage denial rates,
reported under the Home Mortgage
Disclosure Act, have dropped noticeably
(figure 4).

The reduction in usury laws has joined
larger changes in credit markets. Lenders
now rely much more on credit scoring and
other such technologies to assess the risk of
particular borrowers, and they have set up
entities to compete for the new subprime
business. Parallel developments have
taken place in markets for auto finance and
credit cards. Many new mortgage brokers
and subprime lenders have emerged, as

ct Exploring Upward Mobilit

have many old-line lenders with subprime
mortgage subsidiaries. Financial regulation
of these new entities is a good deal less
stringent than for the traditional banking
sector.

Another regulatory change that facili-
tated these developments was the 1977
Community Reinvestment Act (CRA).
Through the 1980s and 1990s, the CRA
encouraged banks to make low- and
moderate-income mortgage loans in
redeveloping areas. To their surprise,
banks often found these loans to be prof-
itable. In effect, the CRA opened up new
areas of business to lenders unaware of the
profit possibilities in these low-income
markets. Thus, lending has expanded sig-
nificantly to low- and moderate-income
households. A large share of the new
loans has financed the new set of low-
and moderate-income homeowners.

There are other changes as well. The
scope and breadth of community-based
organizations have expanded significantly,
whether they operate on their own or are
tied to national networks such as Neigh-
borworks America or the Opportunity
Finance Network. The Federal Housing
Administration, which guarantees the

FIGURE 4. Denial Rates for Conventional Mortgages, 1997-2005 (percent)

60

50

1996 1998 2000

— All Households ~ + Black

2002 2004 2006

Year

— White — — Low Income

Source: Home Mortgage Disclosure Act.


FDIC: Speeches & Testimony Page 1 of 4

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Speeches & Testimony

American Securitization Forum (ASF) Annual Meeting
Remarks of FDIC Chairman Sheila C. Bair
June 6, 2007

1 would like to acknowledge up front the leadership of the American Securitization Forum in working with
us to address some of the problems in the subprime market. | thank you for stepping up to the plate —
especially your Chairman, Greg Medcraft, and your Executive Director, George Miller. It hasn't been
easy for any of us. This is a very complicated market. There’s a lot of money at stake, and millions of
people whose homes are on the line.

But | think we’re making good progress in developing solutions that promote a stable secondary market,
and that benefit most market participants and borrowers. The immediate task is to sustain
homeownership by ensuring that servicers have the flexibility they need to make prudent loan
modifications, if it is reasonably foreseeable that a loan may default. The next thing we need to do is to
come up with national standards for all subprime lenders.

Strong underwriting standards will bring stability to this market going forward. It will help keep families in
their homes and help others buy homes in the years ahead. The market also needs to know when and
how troubled loans are modified. Transparency promotes market stability.

Subprime mortgages have benefited Wall Street, and boosted homeownership across the country. The
trick now is getting all the actors working together -- from Main Street to Wall Street to Washington -- to
get this market on track as an engine for sustainable homeownership.

Positive Benefits

With little doubt, mortgage securitization has been a net positive for many middle- and lower-income
communities, as well as the broader economy. Homeownership is at record levels. And lenders have an
effective tool for managing and diversifying risk. The liquidity provided by private label mortgage-backed
securities (MBS) has been a significant factor in the growth of nontraditional and subprime mortgage
lending.

Let me give you a couple of numbers:

e The share of U.S. mortgage debt held in private label securities doubled between 2003 and 2006,
from 9 percent to 18 percent.

This increased liquidity allowed lenders to make these mortgages more widely available.

e Asashare of all mortgage loan originations, subprime loans more than doubled from 8 percent
in 2003 to 20 percent in 2005.

Problems
While this market-driven process has evolved in remarkable ways over the years, the process is now

clearly under stress. Significant changes in the subprime mortgage market in recent years have

http://www. fdic.gov/news/news/speeches/chairman/spjun0607.html 6/8/2007


Inman News Page 2 of 2

every borrower would be a potential enforcement agent. Borrowers would know what the allowable
charge was, and the closing documents would reveal whether the lender was in compliance.

How Much Should the Fixed Fee Be? The fee should not be so high that lenders can make money
on the origination process, regardless of what happens later. That encourages abusive practices. Nor
should it be so tow that early prepayment will cause the lender serious loss because then there won't
be any loans made without prepayment penalties. $3,000 is about right for now. This is the fee set by
Innovation Mortgage, a sub-prime lender out of California, which has adopted a one-price rule
voluntarily as a marketing tool.

Eliminating Low-Ball Price Quotes: If price quotes can't be depended on, price shopping goes for
naught. Some lenders and brokers routinely offer fow-bail price quotes designed to capture the
customer, which they retract at the time the price is locked. Because the market is so volatile,
borrowers are rarely positioned to contest a loan provider's statement that market rates increased
more, or decreased less, than they did in fact.

Full protection against this common tactic requires a "twin sibling rule." Lenders must tock at the same
rate that they would quote to the borrower's twin who is shopping the same loan on the lock date. This
rule would also be easy to enforce, since loan providers do quote prices to shoppers on the same days
that they lock prices to borrowers in process.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left at www.mtgprofessor.com.

Copyright 2005 Jack Guttentag

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sy
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Cost consolidation improves real estate loan shopping
By Jack Guttentag

(This is Part 4 of a four-part series.)

The three previous articles in this series advanced proposals for reducing the cost of settlement
services provided by third parties, eliminating the escalation of lender junk fees at the closing table,
and making mortgage broker compensation transparent to borrowers. This one is about making it
possible for borrowers to shop effectively. Shopping is extremely difficult now because mortgages have
so many price dimensions.

Even if lenders paid for all the services provided by third parties, which I proposed in the first article, a
borrower would have three prices to juggle: interest rate, points, and fixed-dollar fee. (On ARMs, there
are more, but I'll ignore that for now). This is confusing and makes shopping difficult. The solution is to
mandate one fixed-dollar fee covering lender and third-party costs.

Mandating a Fixed Fee: If government mandated the same fixed-dollar charge for alt lenders and all
programs, borrowers would have to shop only rate and points, which is easily manageable. For
example, a borrower can shop for the lowest rate at zero points, or the fewest points on a 6 percent
loan.

Within reasonable limits, the exact amount of the fixed charge is not important, provided the charge is
the same for every lender and every loan. It is the variability in these costs that makes it difficult to
shop.

This is price-fixing by government, but in a good cause. When a service carries one price, price-fixing
invariably reduces the supply of the service. When a service carries three prices, however, fixing one
price merely channels market adjustments into the remaining prices, making it easier for consumers to
shop.

A Fixed Fee Would Discourage Predatory Lending: Perhaps the greatest benefit of the one-price
rule would be in the sub-prime market, where predatory practices are widespread. Under a fixed-
charge rule, these practices become much more difficult to execute.

A common feature of price gouging, for example, is the inclusion of large fees in the loan balance,
which borrowers often know nothing about until they get to the closing table. With a fixed-price rule,
along with a rule that limits the financing of points, any gouging would have to be in the interest rate,
where the potential for snookering the borrower is limited. Even unsophisticated borrowers understand
the difference between 7 percent and 12 percent.

In a similar vein, making loans that borrowers can't repay, or churning loans in successive cash-out
refinances, are profitable only if the lender can load heavy fees into the balance. The fixed-charge rule
should eliminate both practices.

Enforcement of a Fixed-Fee Rule Would Be Easy: Lawmakers sometimes give little consideration
to whether, and at what cost, the rules they promulgate can be enforced. This is certainly true of the
existing law against the payment of referral fees, which couldn't be effectively enforced with an army
of examiners. State laws directed at predatory fending that bar loans that "fail to benefit the
borrower," or that "borrowers do not have the capacity to repay," present similar enforcement
problems.

In contrast, the fixed-charge rule would be virtually self-enforcing, because it is unambiguous, and

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The applicable federal rate (“AFR”) is the federal short-, mid-, long-term or blended
rate that is determined and published by the IRS monthly. The AFR is based on the yield of
marketable U.S. Treasury obligations of similar maturities outstanding during the one-month
period ending on the 14** day of each month prior to the month for which the rates are
applicable. For purposes of ascertaining whether a loan is a below-market loan, a mortgagor
must use the appropriate AFR depending on the terms of the loan, including length,
compounding periods, and type of rates charged. The chart below provides an example of the
AFRs for May 2007, as published in Rev. Rul. 2007-29.

AER (term of loan: Compounding Period
Annual Semiannual = Quarterly Monthly
Short-term AFR (3 years or less) 4.85% 4.79% 4.76% 4.74%

Mid-term AFR (over 3 years but 4.62% 4.57% 4.54% 4.53%
not over 9 years)

Long-term AFR (over 9 years) 4.90% 4.84% 4.81% 4.79%

Lastly, in conjunction with the securitization of the mortgage loans, in addition to the
authority to modify the loan terms, most subprime pooling and servicing agreements and
servicing agreements permit loss mitigation techniques, including short sales and short
payoffs. Since these loss mitigation techniques effectively allow for a reduction of principal
amount on the underlying loans, they would result in COD Income to the mortgagors.

The information in this memorandum is provided as background information for
discussion purposes only, and does not constitute and should not be construed as substantive
legal advice. To ensure compliance with requirements imposed by the U.S. Internal Revenue
Service, any U.S. federal tax advice contained herein, as to which each taxpayer should seek
advice based on the taxpayer's particular circumstances from an independent tax advisor, (i)
is not intended or written to be used, and cannot be used, for the purpose of avoiding
penalties under the Internal Revenue Code and (ii) is written in connection with the
promotion or marketing of the transaction or matters addressed herein.

eee

If you have any questions or comments on any of the issues discussed in this
memorandum, please contact Mason L. Crocker at (212) 912-7867 or mcrocker@tpw.com or
Stefano Taverna at (212) 912-8244 or staverna@tpw.com.

Thacher Proffitt & Wood LLP 3


Five Questions With Edward Gramlich Page 3 of 4

What's happening is that states like Massachusetts and California are starting to
establish universal health care. The last thing we need is to have 50 different state
programs. We aren't that far away from the time that we really have to confront this
as a nation.

It will be costly. Whether the aggregate costs go up is not that clear. It will bring costs
out into the open, and will certainly seem costly.

But the country can’t go on much longer without confronting health care. Every year
we sweep it under the rug. At some point, we can no longer do that.

With Medicare and the prescription drug program, it's certainly possible to do some
fine-tuning. But I'm pessimistic about doing anything in Social Security. I do think that
President Bush poisoned that debate a couple years ago with his push for private
accounts.

A lot of people would accept individual accounts if they came on top of regular Social
Security benefits. But if you carve them out of Social Security, no Democrat will
support the plan.

Solving Social Security needs presidential leadership and the Democrats and
Republicans in a room—and you have to get them to agree to hold their noses and
come out with something. That was done in 1983, and it can be done again.

The preconditions don't strike me as being there right now for a compromise. Social
Security is a wonderful issue to demagogue your opponent with. Somehow you have to
change the dynamics. Frankly, I think the next president will have a better chance.

5. What's your advice for the new Congress?

I would love to see them do something about the budget. I would love to see them
work toward honest budgeting—on the AMT and military. I would love to see them go
to some pay-go rules so if there is some measure that busts the budget, attention gets
paid to financing. And I would really love to see them make some reforms in
entitlement spending.

The most we can hope for is that we get back some fiscal responsibility. I'm a little
skeptical, but I would love to see it.

I also think Congress is going to have to confront health insurance—some sort of
universal benefits plan. We can't keep letting all the states do it without at some point
thinking that the national government should do this. It will happen, not because
anyone wants it to happen, but because the issue is forced by rising health care costs
and state action.

Health care may not necessarily get done in the next couple years, however, because
Congress is facing such highly divisive issues as Iraq. It may not be the time to get
together and compromise on things like health insurance or Social Security.

Congress might be able to help with housing. I could see measures against predatory
lending and perhaps payment shocks in subprime mortgages passing without huge
budget implications. But these issues definitely are not center stage.

Monetary policy is one thing in pretty good hands. After a century of working at it, I
think the Fed is operating well. Of all the problems that we have, there is one that we

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Five Questions With Edward Gramlich Page 2 of 4

I also may do a project for the World Bank on urbanization for emerging market -
countries. Workers earn more in the cities than in the country. That sets up a very
difficult social problem because, without careful planning, the population will flood to
the cities and have trouble getting housing and jobs. It puts a strain on the social
services. Not that you want to keep people down on the farm, where they don’t make
any money.

2. How wil! affordable housing play out in this year’s budget?

Rent subsidy programs will probably be level funded, so that won't help much or hurt
much. The fundamental problem is that these programs aren't structured very well.

The other problem with housing is the subprime mortgages. Many of them have been
taken out under very risky circumstances. The subprime mortgage of choice is an
adjustable rate mortgage. Short-term rates have been very low. So adjustable rate
mortgages on very good terms have been available. But that period is over.

The short rates have gone up and a lot of these mortgages are in for a big payment
shock. Many people have borrowed to the end of their resources. Groups studying this
issue are projecting pretty significant increases in foreclosures. There's not too much
the federal budget has historically done about that. It really is a question of
restructuring personal debt.

Now I do have some ideas on changing the rules of the game of subprime credit
markets. It's very important and I hope Congress will get interested. [House Financial
Services Chairman] Barney Frank already plans to hold hearings.

3. What should people watch as the budget process unfolds?

There are several critical issues to watch. One is the deficit. The deficit problem is not
one of imminent financial collapse. It is one of long-term appropriate macroeconomic
management. Everyone here would love to see Congress get the deficit under control,
particularly over the long run. But I'm a bit dubious that it will happen.

There is always the entitlement problem. Short-term, there is going to be a war of
numbers. If you want a guide on this war of numbers, you have to keep your eye on
two things. One is whether the military costs are fully priced in. The administration
funds Iraq on a series of supplemental spending bills, so it's hard to see the real costs.

The other thing is the alternative minimum tax [AMT]. If you leave it alone, it brings in
a huge amount of revenue. But the AMT affects millions of people. This is a very large
tax bill. Congress has typically indexed it so it brings in about the same amount of
revenue as it did the previous year. It's often not counted in the budget, so you have
to be careful about how it's treated.

In terms of whether anyone is serious about budget change, you have to just wait and
see. But in terms of honest budgeting, I'd keep my eye on the AMT.

4. What big-ticket items might be tackled in the next two years?

We may not be far from thinking about national health insurance. We've got 47 million
people without insurance. Of course, they really are covered. If they go into hospitals,
they get treated. Then it gets loaded onto everyone else in a very inefficient way. Our
health system is breaking down in some fundamental sense.

http://www.urban.org/url.cfm?ID=901039&renderforprint=1 6/8/2007


Inman News Page 2 of 2

benefits, this would eliminate fee escalation at the closing table. Fee escalation could also be
eliminated by a rule stipulating that when lenders lock the rate and points, they also lock their fees.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left at www.mtgprofessor.com.

Copyright 2005 Jack Guttentag

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pportunity and Ownership Project

RE THE URBAN INSTITUTE

Millions of new low=-
anid Moderate-liconte
homeoweners now have
a chance to build
wovalthy, have their
children attend better
schools, and reap other
advantiges of home-
ownership. But any
soci change this large
ts Likely to dutoe some

nuxed blessings.

An Urban Institute
Project Lxploring
Upward Mobility

No. 7, February 2007

America’s Second Housing Boom

Edward M. Gramlich

The American landscape changed dra-
matically after World War II, as home-
ownership rates rose from 45 percent to

65 percent in little more than a decade.
This burst was fueled by the opening of
mortgage credit and ownership to the mid-
dle class, symbolized by the now-classic
30-year fixed-rate mortgage. Millions of
American households were able to pur-
chase their split-level homes in the suburbs
and send their children to the public
schools there.

Low- and moderate-income house-
holds were generally excluded from this
earlier movement. Either they could not get
mortgage credit at all, or could not afford
the down payment or monthly payments.
Minority families often faced discrimina-
tion on top of these other factors. As a con-
sequence, the national homeownership rate
stabilized at about 65 percent for 35 years
(figure 1).

But recently, homeownership again
expanded. The share of Americans who
owned homes rose from 64 percent in 1994
to 69 percent by 2005 (figure 2). This time
the new homeowners were largely low-
and moderate-income groups, and minori-
ties. Over the decade, the homeownership
tate in the lowest tenth of the income
scale rose 4 percentage points to 43 per-
cent, the second lowest rose 4 percentage
points to 49 percent, and the rates for
blacks and Hispanics rose 7 and 8 percent-
age points, respectively, to 49 percent.
About 12 million new homeowners have
emerged, roughly half of them blacks,
Hispanics, and others of mixed race. The
overall rate of 69 percent moves the United
States into the top rung in world home-
ownership rates.

The Subprime Mortgage Market

While the first surge in ownership involved
the prime mortgage market, the second
surge has been largely fueled by the devel-
opment of the subprime mortgage market.
This subprime market can render down
payments as low as zero. Subprime bor-
rowers have lower incomes and inconsis-
tent credit histories, forcing them to pay
high interest rates, sometimes double-digit
interest rates, to get their loans. Points and
fees are higher for subprime mortgages and
prepayment penalties are almost universal,
making it much more costly for borrowers
to get out of subprime mortgage loans.

This subprime mortgage market is a
reasonably new financing option. Subprime
mortgage originations were a mere $35 bil-
lion in 1994, less than 5 percent of total
mortgage originations. By 2005, subprime
originations had risen to $625 billion
(figure 3), now up to 20 percent of total
originations and 7 percent of the total out-
standing mortgage stock. Over the decade,
subprime originations increased 17-fold,

a whopping 26 percent annual rate of
increase.

Just as the middle classes did at the
close of World War II, these new low- and
moderate-income homeowners now have a
chance to build wealth, invest in their
neighborhoods, have their children attend
better schools, and reap other advantages
of homeownership. Both presidents Bill
Clinton and George W. Bush have engaged
in significant cheerleading for the growth
in homeownership. At this point most of
the cheerleading has been from the bully
pulpit, since there has been very little
new federal money behind the growth in
homeownership.


American Securitization Forum
Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007

With respect to existing pooling and servicing or other operative agreements
that expressly prohibit or restrict the servicer from taking the actions referenced
above, the ASF believes that amendments to those agreements authorizing such
actions should be approved by all parties required to consent to such
amendments, as and when requested to do so.

The ASF believes that securitization operative documents should not impose
numerical limitations on loan modifications, such as limits based on the
percentage of the pool that may be modified.

The modification standards “default is imminent” and “default is reasonably
foreseeable” should be interpreted to have the same meaning.

The modification standard “default is reasonably foreseeable” should be
deemed to be met where there has been direct contact between the servicer and
the borrower, where the servicer has evaluated the current ability to pay of the
borrower, and has a reasonable basis for determining that the borrower is
unlikely to be able to make scheduled payments on the loan in the foreseeable
future. (This interpretation is intended to provide guidance only as to a set of
circumstances where the standard would generally be viewed to be met, and not
to reflect any view that the standard would not be met in other circumstances.)

In evaluating whether a proposed loan modification will maximize recoveries to
the investors, the servicer should compare the anticipated recovery under the
loan modification to the anticipated recovery through foreclosure on a net
present value basis. Whichever action is determined by the servicer to
maximize recovery should be deemed to be in the best interests of the investors.

The standards “in the best interests of’ or “not materially adverse to the
interests of” investors or securityholders in any securitization should be
interpreted by reference to the investors in that securitization in the aggregate,
without regard to the specific impact on any particular class of investors, and in
a manner that is neutral as to the effect on the cash flow waterfall or any
particular class of securities.

Vv. Loan Modification Recommendations

The ASF recommends the following further actions in respect of loan modifications:

A.

Existing and future securitizations:

1. The ASF endorses and encourages the adoption of the position articulated
in the Mortgage Bankers Association position paper titled “FAS 140


American Securitization Forum
‘Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007

Implications of Restructurings of Certain Securitized Mortgage Loans”,
dated May [24], 2007 (the “MBA Position Paper”).

Servicers should maintain policies, procedures and guidelines that are
reasonably designed to identify and manage any actual or perceived
conflicts of interest that may arise in connection with their loan
modification activities and decision making. Such policies, procedures
and guidelines should address, among other topics, situations in which a
servicer (a) has an ownership interest in one or more classes of bonds
supported by principal and/or interest collections on subprime mortgage
loans that it services; (b) receives servicing fees or other compensation
that is tied to various attributes of subprime mortgage loans that it services
(e.g., outstanding principal balance, delinquency/default status); and (c) is
not reimbursed for the costs of loan modifications from collections on
subprime mortgage loans that it services.

Securitization operative documents should clearly state, for purposes of
“delinquency triggers” or “cumulative loss triggers” which control
whether excess cash flow may be released to the residual, the following:
(a) whether and under what conditions a modified loan is to be considered
“current”, and (b) whether and how any interest rate reduction or
forgiveness of principal resulting from a loan modification should be
treated as a realized loss.

As an urgent, high priority matter, the ASF should develop guidelines
under which delinquency triggers and cumulative loss triggers in
securitization operative documents, which control whether excess cash
flow may be released to the residual, should be interpreted in a manner
consistent with the parties’ intent and in a manner that appropriately
reflects any loan modifications that have occurred. It is the sense of
investors that (a) any partial forgiveness of principal should be treated as a
loss for purposes of cumulative loss triggers, and (b) a modified loan
performing in accordance with its modified terms should be treated as
delinquent for purposes of delinquency triggers for some appropriate
period of time.

Greater clarity, transparency and consistency should be established
regarding how any interest rate reduction or forgiveness of principal
resulting from a loan modification should be reflected for purposes of
investor reporting, and for purposes of allocating payments for the cash
flow waterfall.

Consistent with the foregoing recommendations, servicers should not
make decisions to use or not use loan modifications for the purpose of


An Urban Ir

and renters. There has been much

research on particular aspects of these
changes but very little in the way of
overall assessment. There has also
been little evaluation of potential pol-
icy changes. It is now time to begin
that process.

References

Dietz, Robert D., and Donald R. Haurin. 2003.
“The Social and Private Micro-Level Con-
sequences of Homeownership.” Journal of
Urban Economics 54: 401-50.

Herbert, Christopher E., and Eric S. Belsky.
2006. The Homeowner Experience of Low-
Income and Minority Families: A Review and
Synthesis of the Literature. Report to the US.
Department of Housing and Urban Devel-
opment, February. Washington, DC: U.S.
Department of Housing and Urban
Development.

Home Ownership Preservation Initiative. 2006.
Partnership Lessons and Results. Three Year
Final Report, July 17. Chicago: Neighbor-
hood Housing Services.

Joint Center for Housing Studies of Harvard
University. 2006. The State of the Nation's
Housing: 2006. Cambridge, MA: President
and Fellows of Harvard College.

Lubell, Jeffery. 2006, “Strengthening Resident
Opportunities for Self Sufficiency and
Homeownership through Rent Reform
Linked to Asset Building.” Washington,
DC: Center for Housing Policy.

Schloemer, Ellen, Wei Li, Keith Ernst, and
Kathleen Keest. 2006. Losing Ground: Fore-
closures in the Subprime Market and Their Cost
to Homeowners, Research Report, December.
Durham, NC: Center for Responsible
Lending.

About the Author

" Edward M. Gramlich
is a senior fellow at the
Urban Institute. He
developed expertise in
housing while serving
as a member of the
Board of Governors of

the Federal Reserve System, from

1997 to 2005. Dr. Gramlich spent his
academic career at the University of
Michigan, serving as provost and
dean of the Public Policy school. From
1994 to 1996, Dr. Gramlich was chair
of the Quadrennial Advisory Council
on Social Security. In 1986-1987, he
was first deputy and then acting
director of the Congressional Budget
Office. He also served as director of
the Policy Research Division at the
Office of Economic Opportunity
(1971-1973), as senior fellow at the
Brookings Institution (1973-1976),
and in the Research Division at the
Federal Reserve Board (1965-1970).
Dr. Gramlich also was the staff direc-
tor for the Economic Study Commis-
sion of Major League Baseball. He is
author of a popular text on benefit-
cost analysis, and has authored sev-
eral other books and many articles
on topics such as macroeconomics,
social security, budget policy, income
redistribution, and fiscal federalism.



FDIC: Speeches & Testimony : re - Page 4 of 4

I'd like to end by pointing to the obvious. We're all in this together. All of us bear some responsibility for
the turmoil in the subprime market. And all of us need to be a part of the solution. And let's be honest
about it. Hybrid ARMs were never made based on the assumption that the borrowers would be able to
make the payment once the loan reset. They were designed as two- or three-year “bullets,” with the
assumption that home appreciation would allow the borrower to refinance at or before reset. Given
current conditions in the housing market, this business model is no longer viable. But market
participants should not now claim to be shocked that borrowers are in distress.

Let me be clear, regulators support subprime mortgage lending. Securitization has injected tremendous
liquidity and strengthened the American marketplace. But products such as the 2/28 and 3/27 hybrid
ARMs create such a huge payment shock at reset that they cannot be sustained through normal
economic cycles. | am hopeful that more secondary market funding can be directed at traditional 30-
year fixed-rate loans. These loans are steady and predictable, yet still provide a healthy return. They do
not put subprime borrowers in the position of having to gamble on home price appreciation or the
direction of interest rates. | think the more subprime borrowers we can put into fixed-rate loans the
better off everyone will be. As | told Congress, there is no silver bullet. This problem will take time to
work out. But our talks with the industry, the ASF Principles, and reviews of the accounting and REMIC
rules are all steps in the right direction.

| would ask that you work with us to support national standards for responsibly underwritten subprime
mortgages. | would ask that in making your own investing decisions; you seek out securities backed by
responsibly underwritten mortgages. | believe this is in everybody’s best interest -- lenders, investors
and homebuyers. And it is in the national interest because it will go a long way to preserving the
American dream of owning a home.

Thank you very much.
Last Updated 06/06/2007 commynications@tdic.gov

Home ContactUs Search Help SiteMap Forms
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Should I do business with a broker or a lender?
By: Jack Guttentag

"I have read all your articles about mortgage brokers and lenders, and I still don't know which to go to.
Can you convert your generalizations into specific suggestions about who should see a lender, and who
should see a broker?”

If borrowers could shop for home loans as easily as they can shop for the houses that secure the loans,
it wouldn't matter whether you dealt with a broker or a lender. You would shop the market for the best
price, and whether the loan provider offering it was a broker or a lender wouldn't matter. Because the
home loan market is so difficult to shop, however, the type of loan provider can matter to some
borrowers.

The key difference between brokers and lenders is that brokers offer loan programs from many
different lenders. This means that brokers are more likely to find a loan that will meet the specialized
needs of borrowers than a single lender.

For example, many lenders won't offer loans to borrowers with poor credit, borrowers who can't
document their income or assets, borrowers who want a mortgage on which the payment starts low
and rises over time, borrowers who can't make any down payment, borrowers who want to purchase a
condominium as an investment, borrowers with very high existing debts, borrowers who need to close
within 72 hours, or borrowers who reside abroad. The list goes on and on.

But there are lenders in every one of these niches, and brokers can usually find them when needed.
The implication is that borrowers with special needs such as these can save much time and effort by
patronizing a broker.

Borrowers who fall into generic market niches that are serviced by all lenders can go either way. Their
decision should be based on whether they want to shop the market on their own, or whether they
prefer to retain a broker to shop for them.

If you elect to shop on your own, you are exposed to all the booby traps that await the unwary in this
market. Here are just a few:

= Loan prices are reset every day, so you can't compare A's price on Monday with B's on Tuesday.

= Loan prices depend on the type of loan, loan features, type of property, purpose of loan, and more.
Unless you specify them all, A may give you the price of a sedan and B the price of an SUV.

= Loan prices have at least three price dimensions (interest rate, fees expressed as a percent of the
loan, and fees expressed in dollars). If you don’t take them all into account, you may not select the
lowest overall price.

= Lenders and brokers do not guarantee prices until they are locked, and some give "low-bail" quotes
to snare the business. If you don't know how to avoid phony price quotes, you may be snared.

Those who elect to shop for themselves should read "Steps in Shopping For a Mortgage," which is
available on my Web site. It will guide you on how to deal with these and other impediments to
effective shopping.

If you don't feel up to the challenge and would prefer to delegate responsibility to someone else, go

Page 1 of 2

6/8/2007


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e
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Upfront mortgage brokers veer from traditional business model
By Jack Guttentag

Q: “I want to be an Upfront Mortgage Broker because I already do business the UMB way. Iam
concerned, however, with the part of the UMB 'Commitment' that states that ‘the broker will be the
customer's representative or agent.’ The model broker disclosure form of the National Association of
Mortgage Brokers states that ‘in connection with this mortgage loan we are acting as an independent
contractor and not as your agent.' What does this mean?”

A: The mortgage broker trade associations have always promoted the independent contractor model
and warned against the agency model, because the agency opens the broker to claims of violation of
fiduciary duty. If you want to be a UMB, however, you must accept the agency model and the
obligations that come with it.

Independent Contractor Versus Agency: The issue is a legal! one but it has major financial
ramifications. The independent contractor model views brokers as similar to merchants who buy at one
price and sell at another. They can earn as much on transactions as they can induce borrowers to pay,
need not disclose what they make except where required by law, and have no obligation to deliver the
mortgages best suited to borrowers’ needs.

The agency model, in contrast, accepts that brokers are service providers, not merchants, and they
negotiate fees with clients upfront. Their services include finding mortgages that best meet borrowers’
needs.

The agency model is in its infancy. The independent contractor model dominates the industry, and
prevailing industry practices reflect that dominance.

The Independent Contractor Model and Industry Practices: Most brokers charge what the
market will bear. This means that unsophisticated borrowers who accept what they are told and visit a
single broker will pay more than knowledgeable borrowers who challenge the broker and shop
alternative sources. There is very little relationship, therefore, between broker charges and the amount
of work the broker does for the borrower.

Broker charges average more than 2 percent of loan amounts, which is about twice as high as they
should be. A major reason for high fees is low productivity. Brokers spend an inordinate amount of
time looking for clients, pay heavily for leads from an industry of lead generators, and also waste time
with potential clients who don't close. Low productivity generates pressure to earn more on the deals
that close.

A major reason for low productivity is distrust, which pervades the letters I receive from borrowers
concerning brokers. A broker who is an independent contractor has the right to make as much money
as possible from a complex transaction that the broker understands and the borrower doesn't. How can
that not breed distrust?

Brokers detest borrowers who flit from broker to broker, submit multiple applications, or pump brokers
for information and then deal elsewhere. Yet these practices are how borrowers try to protect
themselves against brokers they don't trust. Borrower reactions to distrust raise broker costs, which
pressures brokers to make more per transaction, which generates more distrust in a vicious circle.

The Agency Approach of Upfront Mortgage Brokers: UMBs operate according to a different set of
rules than the remainder of the industry. UMBs view themselves as the agent of the borrower, to
whom they owe a fiduciary responsibility. A UMB agrees with the borrower on total broker

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FDIC: Speeches & Testimony Page 3 of 4

recognize and support many of the key conclusions reached in our discussions with the industry. These
include:

The importance of loan modifications as a loss mitigation tool;

e The importance of establishing early contact with borrowers and taking action prior to default
where it is reasonably foreseeable;

e The need for modifications that provide sustainable and long-term solutions;

The need for amendments to existing securitization agreements that prohibit or restrict servicer
flexibility; and

e The need to establish greater clarity and consistency in investor reporting and the treatment of

modified loans for purposes of “triggers” that control the release of excess cash flow.

| also want to highlight the principle that specifically encourages servicers to conduct modifications that
are in the best interest of the borrower. This principle alone should ensure that the borrower’s needs are
not subordinate to the interests of everyone else. Finally, | fully support the ASF’s commitment to
develop standard, uniform model contractual provisions governing a loan servicer’s ability to make loan
modifications in future securitizations.

| appreciate that ASF has a number of interests to balance. However, | do wish to emphasize my strong
belief that modifications should be for the long term. This is an absolute necessity if we are to stabilize
neighborhoods and preserve the homeownership gains of recent years.

So, where do we go from here? The next big step is finalizing our reguiatory guidance. As | said, we
hope to get these rules out in June. Our new rules focus on two fundamental consumer protection
principles. First, a loan should be approved based on a borrower's ability to repay according to its terms,
not just at the initial rate.

We say subprime loans should be qualified and underwritten based on the borrower's ability to meet
fully-indexed and amortizing terms. In my view, this is simple common sense. | don't think any of us
would advise our kids to take out a loan they can’t repay. But to make good choices, borrowers need
clear, easy-to-understand information.

The proposed guidance provides that mortgage product descriptions and ads should provide clear,
detailed information about all costs and features, including payment shock. All the regulators, both
federal and state, feel very strongly that clear, common sense underwriting and marketing standards for
subprime mortgages are extremely important. So, | believe our current draft will remain largely intact.
Without strong rules we can’t protect consumers. Nor can we reinforce the market discipline that
preserves a steady flow of capital for responsible lending.

Looking to the future, | believe that the ultimate solution is a national standard for subprime mortgages
regardless of who does the underwriting. There are two core elements for developing a national
standard: One, underwriting standards that truly measure the ability to repay. And two, marketing
standards that require upfront, complete, and clear cost disclosures for adjustable rate and non-
traditional loans and prohibit deceptive advertising based on teaser rates or misuse of the word “fixed.”

Anational standard should deal with abusive prepayment penalties and the use of “stated income”
loans, issues that are also addressed in our proposed guidance. One way is for the Federal Reserve to
use its powers under the Home Ownership and Equity Protection Act (HOEPA). New HOEPA rules
could strengthen protections for subprime borrowers. And they would apply to bank and non-bank
lenders alike. An additional advantage would be a clearer standard for secondary market liability by
allowing it only if the loan was abusive on the face of the loan documents. This feature could provide
necessary comfort to the market, while protecting against truly egregious lending. Members of the
Senate Banking Committee have urged the Fed to use this authority. The Fed will hold a public hearing
next week on HOEPA. The FDIC supports the Fed’s efforts and would welcome new rules against
abusive subprime or predatory lending practices.

Investors and Good Citizenship

http://www. fdic.gov/news/news/speeches/chairman/spjun0607.htm] 6/8/2007


American Securitization Forum
Statement of Principles, Recommendations and Guidelines for the Modification of
Securitized Subprime Residential Mortgage Loans

June 2007

In considering loss mitigation alternatives that reduce the interest rate
prospectively, servicers should consider whether to make the rate reduction
temporary (such as a relatively short term extension of the initial fixed period
on a hybrid ARM), or permanent, based on the anticipated period of borrower
need. For temporary rate reductions, servicers should re-evaluate the
borrower’s ability to pay, and the continued need for a rate reduction, at the end
of the temporary period.

Any loan modification that reduces otherwise lawful, contractually required
payments of principal or interest must be understood to be a financial
concession by the securitization investors. There is no basis for requiring such
concessions from investors unless the modification is determined to be in the
best interests of the investors collectively. Loan modifications should seek to
preserve the originally required contractual payments as far as possible.

Reasonable determinations made by servicers with respect to loan
modifications, where made in good faith and in accordance with generally
applicable servicing standards and the applicable securitization operative
documents, should not expose the servicer to liability to investors and should
not be subject to regulatory or enforcement actions.

IV. Loan Modification Interpretive Guidance

The ASF endorses the following interpretive positions on specific issues arising in
connection with loan modifications:

The ASF believes, based on prevailing existing practice, that standard and
customary servicing procedures for servicing subprime mortgage loans included
in a securitization, as typically used as an overarching servicing standard in
securitization operative documents, should be interpreted to allow the servicer
to: a) permit loan modifications (including prospective interest rate reductions
which may be either temporary or permanent, forgiveness of principal,
capitalizing arrearages, or maturity extension not beyond the securitization
maturity date) for loans that are in default or for which default is reasonably
foreseeable, so long as the modification is in the best interests of investors in the
aggregate, and b) engage in other loss mitigation alternatives including
forbearance, repayment plans for arrearages and other deferments which do not
reduce the total amount owing, and also non-foreclosure alternatives to
terminating a loan, such as short sales and short payoffs. The ASF believes that
existing securitization pooling and servicing agreements should be interpreted,
to the maximum extent possible, to authorize the servicer to take the actions
referenced above.


mortgages of many first-time homebuyers,
has liberalized its rules. Giant secondary-
market purchasers like Fannie Mae and
Freddie Mac have expanded into lower-
income mortgage markets to meet their
new and more stringent housing goals.

Benefits and Costs
for the New Homeowners

The parallel growth of homeownership
rates and the subprime market suggests
that the new homeowners are drawn
largely from groups formerly excluded
from credit markets. A voluminous litera-
ture has tried to measure the basic benefits
of homeownership. Essentially, these
homeowners save more, build wealth, and
act to improve their neighborhoods. The
biggest problem with this literature is cor-
recting for selection bias—are the new
homeowners benefiting from owning a
home, or would they have benefited any-
way because of innate differences between
them and renters? Did homeownership or
the innate differences cause the gains?
Earlier studies did not correct for this bias
and generally found significant impacts of
homeownership. Some of the newer stud-
ies in this area, beginning about 1990, have
used panel data and other sources to cor-
rect for these biases (Dietz and Haurin
2003). While these new studies still find
positive effects from homeownership, the
impacts are not as large and are sometimes
quite tenuous.

These post-1990 studies can be sum-
marized briefly (Dietz and Haurin 2003).
Homeowners might be expected to save
more—and they seem to—since they have

the self-control mechanism of having to
make their monthly mortgage payments.
Homeowners might also be expected to
build more wealth, both because of any
added saving and the relative rise in house
prices. Here the empirical confirmation is
stronger, especially in areas where house
prices are rising rapidly. Homeowners
might be expected to be less mobile, due to
the higher transaction costs of owning a
home. Here there is strong empirical con-
firmation. They might be expected to work
harder, particularly if they have to stretch
to make their mortgage payments. Here
there seems to be strong evidence that at
least women increase their labor supply.
Homeowners might be expected to invest
more in their home, neighborhood, com-
munity, and children, and to guard more
against crime. There is confirmation of
some of these relationships, though not all.
There is also some empirical evidence of
greater self-reported satisfaction (table 1).
The American Housing Survey per-
mits a more careful look at those buying
a home for the first time in the 1990s
(Herbert and Belsky 2006). These new
homebuyers seem to be satisfied with their
homes and to have made reasonable pur-
chases from a physical standpoint. Again,
it is hard to verify significant neighbor-
hood improvements. The new homebuyers
have generally put very little money down
on their mortgages, though their interest
rates are only slightly higher than on con-
ventional mortgages. The most troubling
aspect is that many new buyers now face
significant cost burdens, and while they are
not actually going into foreclosure, a high

TABLE 1. Theoretical and Empirical Impact of Homeownership (Post-1990 articles)

Impact on

Theoretical Impact

Empirical Confirmation

Household saving
Wealth aécumulation

Weak positive Weak
Strong positive

Mobility Strong negative Strong

Labor supply Weak positive Reasonable, for women
Property improvements Strong positive Weak

Urban environment Strong positive Weak

Political activity Strong positive Reasonable, on voting
Crime Strong negative Weak

Child outcomes Strong positive Reasonable
Satisfaction Weak positive Reasonable

Depends on house prices



FDIC: Speeches & Testimony .

http://www. fdic.gov/news/news/speeches/chairman/spjun0607.html

substantially complicated the relationship between borrowers and lenders. Mortgages have become
commodities, involving multiple players. As a result, it may be easier to get credit but it’s much harder to
resolve troubled loans. When the market turns as we’ve seen in recent months, workout strategies for
troubled loans in securitized structures are much tougher to put together.

Further complicating the situation is the fact that the investors may see their interests differently, with
each other, or with the borrower. As all of you know, the problems in this market are a major concern for
the FDIC. In March, the FDIC and other federal bank regulators jointly proposed new guidelines for
underwriting and marketing subprime mortgages. We've received over 100 public comments on the
guidelines. And we hope to finalize them later this month.

Protecting Current Borrowers

These proposed rules are designed to assure strong underwriting and consumer protection for subprime
mortgage lending by banks. | am hopeful that Congress or the Fed will act to impose comparable
requirements on nonbank lenders to prevent future abusive lending practices. There remains the urgent
issue of how to address an estimated 2 million loans that will reset over the next 18 months. Almost
three-quarters of securitized subprime mortgages originated in 2004 and 2005 were “2/28 and 3/27”
hybrid loan structures. These loans have lower payments during the first two to three years but then
reset to higher interest rates that impose payment “shocks” of 30 percent or higher. Those are huge
increases. Most subprime borrowers will be unable to make the payments on these loans after they
“reset.”

Further compounding this problem is that fewer and fewer of these borrowers are able to refinance
because of the slowing rate of housing appreciation, and the financial difficulties facing subprime
lenders. Many borrowers could avoid foreclosure if they were offered alternatives that allow for
affordable mortgage payments. Restructuring their loans would bring them back to good standing, allow
them to repair their credit histories and dampen the impact that foreclosures have on the broader
housing market. Most important, people would be able to stay in their homes.

In April, | testified before Congress on the subprime market and the difficulties that exist in developing
practical solutions for troubled borrowers whose loans are in securitization structures. The FDIC, along
with the other federal regulators and industry, including your own George Miller, have been talking
regularly about how to deal with this problem, most recently last week in Washington. We have focused
mainly on how market participants could help resolve the difficulties in modifying the mortgages that are
locked into securitized pools. Our goal is to facilitate an exchange of ideas and industry-led consensus
on ways to help struggling borrowers avoid foreclosure, while maintaining the integrity of the secondary
market.

One of the clear messages we heard is that loan modifications that provide sustainable mortgages for
borrowers are generally the best option for investors and borrowers. Foreclosure rarely is. Sustainable
mortgages help give the markets stability both for current borrowers and investors, and for those in the
future as well. This is an issue | hope we address squarely and not just end up kicking the can down the
road.

Another important message from the industry, not surprisingly, is that more and better information is
needed. As loans are modified, investors need to know. They need to see the details. This ties in very
closely to our goal of sustainable mortgages. If a loan modification puts a borrower into a loan that he or
she can afford, and the details about that modification are disclosed, we believe this will create
additional market pressure for sustainable loan restructuring. Sustainable loan modifications avoid
ongoing financial distress for borrowers, help keep them in their homes, ease demands on servicer
resources and help assure stable income flows for investors. This, too, will give greater stability to the
market.

ASF Principles

The ASF has taken a real leadership role in trying to resolve these issues. | commend the ASF and the
membership for developing principles and guidelines for modifying subprime loans. Those principles

: Page 2 of 4

6/8/2007


Ernenican
====FO0RUM.

American Securitization Forum

Statement of Principles, Recommendations and Guidelines
for the Modification of Securitized Subprime Residential Mortgage Loans

June 2007
I. Introduction

The American Securitization Forum (ASF)! is publishing this Statement as part of its overall
efforts to inform its members and promulgate relevant securitization industry guidance in
light of the widespread challenges currently confronting the subprime residential mortgage
markets.

Current subprime residential mortgage market conditions include a number of attributes of
concern that impact securitization transactions and the broader environment for subprime
mortgage finance: an increase in delinquency, default and foreclosure rates; a decline in
home price appreciation rates; a prevalence of loans with a reduced introductory rate that will
soon adjust to a higher rate; and a reduced availability of subprime mortgage lending for
refinancing purposes. In light of these concerns, the ASF is of the view that loan
modifications, for subprime mortgage loans that are in default or for which default is
reasonably foreseeable, are an important servicing tool that can both help borrowers avoid
foreclosure and minimize losses to securitization investors.

Moreover, the ASF recognizes that it is an important goal to minimize foreclosure and
preserve homeownership wherever possible. Higher than normal rates of foreclosure may
harm borrowers and their communities, and may adversely affect housing values and
therefore collateral values on both performing and non-performing loans. Accordingly, the
ASF recommends the use of loan modifications under appropriate circumstances as described
in this Statement.

The overall purpose of this Statement is to provide guidance for servicers modifying
subprime residential mortgage loans that are included in a securitization. It is our hope that
publication of these principles, recommendations and guidelines will help to establish a

' The American Securitization Forum is a broad-based professional forum of over 350 organizations that are
active participants in the U.S. securitization market. Among other roles, ASF members act as insurers,
investors, financial intermediaries and professional advisers working on securitization transactions. ASF’s
mission includes building consensus, pursuing advocacy and delivering education on behalf of the securitization
markets and its participants. This statement was developed principally in consultation with ASF’s Subprime
Mortgage Finance Task Force and Loan Modifications Working Group, with input from other ASF members
and committees. Additional information about the ASF, its members and activities may be found at ASF’s
internet website, located at www.americansecuritization.com. ASF is an independent, adjunct forum of the
Securities Industry and Financial Markets Association.

360 Madison Avenue, 17th Fi. * New York, NY 10017-7111 » P: 646.637.9211 « F: 646.637.9124
1399 New York Avenue, NW * Washington, DC 20005-4711 » P: 202.434.8400 » F: 202.434.8456
www.americansecuritization.com


Analysis

If any principal amount of a mortgage loan is forgiven, as in Example 7 above, subject
to certain exceptions for bankruptcy or insolvency, a mortgagor is treated as recognizing
income to the extent of the amount of principal forgiven (“COD Income”). In addition, if a
cash basis mortgagor is forgiven accrued but unpaid interest, as in Example 8 above, the
mortgagor would not have to recognize COD Income in the amount of such interest, to the
extent that its payment would have given rise to a deduction by the mortgagor. Thus, in
Example 8 above, a loan-by-loan determination would be appropriate.

In the event a mortgagor recognizes COD Income, banks and other financial entities
that discharge a debt of $600 or more must furnish a statement to the mortgagor by January
31 of the year following the year of discharge and file a Form 1099-C, Cancellation of Debt,
by February 28 of the year following the year of discharge. A copy of Form 1099-C can be
found on the website of the Internal Revenue Service (the “IRS”) at
http://www. irs.gov/pub/irs-pdf/f1099c. pdf.

When the mortgage loan’s principal is not forgiven and the rate on a modified
mortgage loan is above the AFR (as defined below), the terms of a mortgage loan may be
modified by changing the amortization of principal or the type and amount of interest rate
charged on the loan, as in Examples 1 through 6 above, without causing recognition of
income to the mortgagors at the time of modification. For federal income tax purposes, if the
terms of a mortgage loan, whether recourse or non-recourse in nature, are significantly
modified that loan is treated as being exchanged for a “new” mortgage loan. Treas. Reg.
§1.1001-3. The economic result of a significant modification is equivalent to the refinancing
of the underlying indebtedness, and to the extent that the principal amount of the “new” loan
is the same as the principal amount of the refinanced loan, a mortgagor does not recognize
any income and the loan retains the same characteristics and limitations as the original
mortgage loan (e.g., a mortgagor remains entitled to deduct the interest on the mortgage loan
as qualified residence interest, to the extent the loan was so treated prior to the
modifications),

Independently of whether a loan’s modifications are significant, in Examples 1 through
6, a mortgagor may be treated as having to recognize income if the modified loan bears a rate
that is less than the AFR (a “below-market loan”). IRC §7872. Generally, when a loan is
treated as a below-market loan, the lender is presumed to forego interest in an amount equal
to the difference between the rate on the loan and the AFR. Assuming the lender and the
mortgagor are unrelated third-parties, the mortgagor is deemed to {i) receive a payment (and
thus recognize income) in an amount equal to the amount of foregone interest and (ii) make
an interest payment in the same amount, the deductibility of which is subject to the same
restrictions as the interest actually due on the loan. Although Treasury Regulations
contemplate an exception from the below-market loan regime for loans that are available to
the general public on the same terms and conditions and which are consistent with the
lender’s customary business practice, it is not clear the extent of the availability of this
exception to subprime lenders in the event of distress situations as those presented at this
time.

Thacher Proffitt & Wood LLP 2


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Discount brokers not upfront about real estate loan fees
By Jack Guttentag

“In my market search I have come across discount brokers who seem to uphold many of the same
ethical standards as Upfront Mortgage Brokers (UMBs) but do not charge any fees for their service.
They claim they are compensated by the lenders. Isn't that even better?”

The term "discount broker" implies that the broker is providing services at a bargain price. Nothing
could be further from the truth. If they were practicing full and candid disclosure, here is what they
would say to you:

"You are paying me in the interest rate, which is higher than it would be otherwise. I prefer to charge
you this way because I fear you will resist paying out of pocket and will haggle about the amount. By
charging you in the rate, payment is spread out over time in the form of a higher monthly mortgage
payment. This will upset you less than a cash payment, especially since you are unlikely even to be
aware of how much higher the mortgage payment is. This is really win-win, since I get to charge you
more and my fee upsets you less."

Borrowers ~ and only borrowers - pay mortgage broker fees. However, payment can be made in two
ways. One way is to pay the broker in cash at closing, in which case the broker fee becomes a closing
cost to the borrower.

The second way is to pay a premium interest rate to the lender, who pays the broker's fee at closing as
a quid pro quo for the higher rate. In this case, the broker's fee is not a closing cost to the borrower.
Rather, the borrower pays for it every month as an increment to the mortgage payment.

Here is an illustration. On a 30-year fixed-rate mortgage, the lender quotes a rate of 6 percent at zero
points, 5.75 percent at 2.5 points, and 6.25 percent at -2 points. The lender will pay 2 points for a
6.25 percent rate, a payment referred to in the trade as a "rebate" or "yield spread premium."

If the borrower agrees to the 6.25 percent rate and the broker receives the rebate as his
compensation, the broker typically tells the borrower that "my fee is being paid by the lender." But this
is true only in the most superficial sense. The lender pays the rebate in order to get the higher interest
rate, and the borrower pays the higher rate. The 2 points paid by the lender to the broker is the
present value of the higher payments the borrowers will be making in the future.

Bottom line, the borrower pays the broker fee one way or the other. But many borrowers do not
understand how the process works, and are much more focused on the cash required to close than on
future payments. Further, the amount of any rebate paid to the broker is not readily apparent on
required disclosure forms. The borrower knows what the broker fee is when he pays it out of his
pocket, but may have little idea of what it is when he pays for it in the rate.

The result is that borrower resistance to broker fees is much weaker when the fees appear to be paid
by the lender. And increasingly, brokers seek their compensation entirely in this way. The so-called
"discount brokers” have merely formalized the process.

There is nothing wrong with a borrower electing to pay the broker with a higher rate rather than cash,
provided that this is a deliberate selection. For a borrower with a short time horizon who won't be

paying the high rate very long, paying with a higher rate makes sense. On the other hand, a borrower
who expects to have the mortgage a long time and has the cash does better using it to pay the broker.

If you are a shopper who intends to select a loan provider based on price comparisons, the broker's fee

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with a mortgage broker. Brokers are experts at shopping the market. They are far better positioned
than consumers to select the best deal available from competing lenders on the day the terms of the
loan are locked.

The problem in dealing with a broker is that most brokers view themselves as independent contractors,
and as such their interests are not fully aligned with those of borrowers. The broker's income on a
transaction is the mark-up of the wholesale price quoted by the lender. The higher the price the broker
can induce the borrower to pay, the larger the markup.

To minimize this conflict, borrowers should retain brokers as their agents for a fixed fee negotiated in
advance. The fee must include any compensation received from the lender, since you are paying that
fee indirectly in the interest rate. Upfront Mortgage Brokers, listed on my Web site, operate this way as
a matter of course, but others will as well if customers request it. Make sure the fee is in writing.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.
Comments and questions can be left www.mtgprofessor.com.

Copyright 2004 Jack Guttentag

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