Randall S Kroszner: Mitigating the impact of foreclosures on
neighborhoods
Speech by Mr Randall S Kroszner, Member of the Board of Governors of the US Federal
Reserve System, at the NeighborWorks America Symposium on Stabilizing Communities in
the Wake of Foreclosure, Cincinnati, Ohio, 7 May 2008.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
Good morning. I would like to thank NeighborWorks America for inviting me to be with you
today to continue the very important discussion of community stabilization in the wake of
rising foreclosures in neighborhoods across the country. As a member of the board of
directors of NeighborWorks America for the last two years, I am impressed that attendance
at these training institutes continues to grow - a strong testament to the importance of the
subject matter being discussed as well as the quality of the curriculum and instruction.
Today's discussion of the impact of foreclosures on neighborhoods and what can be done to
mitigate those impacts is not only timely, it is essential to promoting local and regional
economic recovery and growth.
This morning, I will provide an overview of current conditions in the mortgage market and
discuss how the disruption in this market is affecting neighborhoods. I will also outline the
steps that the Federal Reserve System is taking to address these challenges and assist
communities struggling with the impact of foreclosures.
Foreclosures continue to affect the housing market
The mortgage market continues to face challenges, especially in the subprime segment,
which serves consumers who have imperfect or limited credit histories. The delinquency rate
on subprime mortgages has continued to climb and has about doubled in the past year and,
as of February, one in four subprime adjustable-rate mortgages was seriously delinquent,
meaning the borrower was either in foreclosure or ninety days or more past due on a
payment. Delinquency rates have risen on most other types of mortgages as well, but these
increases have been more recent and less dramatic than those in the subprime segment.
Foreclosures have also risen appreciably. Lenders initiated roughly one-and-a-half million
foreclosures last year, up 53 percent from the previous year. On the basis of preliminary
estimates published by the Hope Now Alliance, foreclosures are likely to have risen further in
the first quarter of 2008.
Homeowners may become delinquent on their mortgage for a variety of reasons. Historically,
an adverse life event, such as a job loss, was often the reason a homeowner fell behind on
his or her mortgage payments. And in the current economic environment, job losses have
continued to contribute to the rise in mortgage delinquencies and foreclosures, particularly in
areas of the Midwest, such as here in Ohio. Yet, other factors also explain the recent rise in
mortgage delinquencies and foreclosures. Mortgage underwriting standards slipped in the
middle of this decade, resulting in greater numbers of mortgages that had high combined
loan-to-value ratios or for which incomplete documentation was provided. More than 40
percent of the subprime loans originated in 2006 had combined loan-to-value ratios in excess
of 90 percent, a considerably higher share than earlier in the decade. In some cases, lenders
originated mortgages that had multiple risk factors - a practice often referred to as
risklayering. Taken individually, these risk factors may not have significantly raised the likelihood
that a homeowner would fall behind on payments; taken together, however, these risks
materially increased this likelihood.
High loan-to-value ratios at origination, combined with stagnant and eventually declining
home prices, are a key aspect of the recent rise in delinquencies and foreclosures. After
rising rapidly during the early part of this decade, home prices began to decelerate in 2006
and are now declining appreciably in some areas. As home prices declined, homeowners
who had little or no equity at the time of their mortgage origination saw their home equity
disappear - and with it their ability to refinance into a more-sustainable mortgage. Declining
home equity may also reduce a stressed borrower's incentive to stay current on his or her
mortgage or remain in a home. Recent research conducted by the Federal Reserve Bank of
Boston suggests that homeowners who have experienced a 20 percent or greater fall in
house prices are about 14 times more likely to default on a mortgage compared with
homeowners who have experienced a 20 percent increase in the price of their home.1 Some
types of mortgage borrowers appear to be particularly sensitive to home-price declines; at
least 18 percent of foreclosures started in the third quarter of 2007 involved
non-owneroccupied properties.
The Federal Reserve's response to the challenges resulting from foreclosures
The Federal Reserve views the current high rate of mortgage foreclosures as an urgent
problem, and we are addressing the issue on many fronts: we are contributing to initiatives
already underway at the local and national level, as well as collaborating with other
regulators, community groups, policy organizations, financial institutions, and public officials
in an effort to identify ways to prevent unnecessary foreclosures and the associated negative
effects on local communities. We are also leveraging the decentralized structure of the
Federal Reserve System, which consists of the Board of Governors in Washington, D.C., and
the twelve Federal Reserve Banks that each represent a distinct region of the country. This
structure enables us to gather information and tailor responses to foreclosure issues at the
local level, while using our collective experience to address regional and national policy
issues. In addition, the Federal Reserve uses its considerable analytic resources to conduct
research at the national level, which the Reserve Banks can disseminate to local community
groups, counseling agencies, financial institutions, and others who are working to help
troubled borrowers and communities.
Timely analysis of data and other available information is critical to crafting appropriate
remedies to any problem. To that end, the Federal Reserve recently helped NeighborWorks
America identify those regions and neighborhoods throughout the country that are most at
risk for higher rates of foreclosure and would therefore benefit from an increased capacity to
provide mortgage counseling. Using this analysis, NeighborWorks America in February
awarded $130 million in newly granted funds from Congress to thirty-two state housing
finance agencies, eighty-two community-based NeighborWorks organizations, and sixteen
counseling intermediaries approved by the Department of Housing and Urban Development
(HUD).
The Federal Reserve has recently made available on its public website detailed reports
identifying neighborhoods that have especially high concentrations of foreclosures. These
data - in the form of dynamic maps and other data - illustrate the regional variation in the
condition of securitized, owner-occupied subprime and alt-A mortgage loans across the
United States.2 Local leaders can access these reports and work with community affairs staff
at the local Reserve Banks to more effectively address foreclosure problems.
For example, a user can choose to view key foreclosure measures such as "Foreclosures
per 1000 housing units," "Share ARMs," and other factors. The maps drill down from
national-level data to zip code level. They also depict factors such as "Share of low FICO and
high LTV" and "Share late payment in last 12 months" that may help to predict which areas
are most likely to experience higher rates of foreclosures. Finally, the Federal Reserve is
providing, via downloadable files, the data supporting the maps, as well as data for scores of
other loan-performance variables at the state, metropolitan area, and county levels. By
making more data and information on emerging trends available to key local leaders,
financial institutions, and community organizations, our aim is to improve the efficiency of
their efforts to rebuild neighborhoods.
The Federal Reserve System has also established a working group of economists and
community development experts in order to coordinate System research efforts. This working
group will monitor developments in the mortgage markets and study how these
developments may affect individual borrowers and neighborhoods. Currently, the group is
assessing existing research on house prices, mortgages, and foreclosures, with the goal of
identifying important analytical gaps.
The Federal Reserve System conducts outreach and education efforts through its regular
contact with financial institutions and market intermediaries, as well as through its network of
Community Affairs staff members who work with communities to identify trends and issues
affecting low- and moderate-income neighborhoods. This communication with both financial
markets and communities allows the Federal Reserve to act as a bridge between the two
groups and between local communities and the organizations that provide community
resources, such as credit counselors.
For many borrowers who are behind on their mortgage payments, refinancing their loan is
not an option. Therefore, the Federal Reserve is engaged in a number of efforts to
encourage the use of loss-mitigation tools by lenders, servicers, and not-for-profit
organizations that help individual borrowers resolve delinquency issues. The cost of
foreclosure is high for everyone involved; estimates of the direct losses resulting from a
foreclosure range from one-fifth to one-half the principal balance of a mortgage loan.3 With
these costs in mind, the Federal Reserve, together with the other federal banking agencies,
has issued guidance urging lenders and servicers to pursue workout arrangements, when
feasible and prudent, as an alternative to foreclosure. In some cases, temporary adjustments
to payments may not be sufficient, and more-permanent reductions in interest rates or an
extension of the loan term may be required to help a borrower. In some situations, lenders
and servicers may want to consider using principal writedowns as a way to reduce re-default
risk or to facilitate a refinancing.
The Federal Reserve's outreach efforts inform its policymaking. We recently hosted focus
groups to evaluate regulatory proposals on credit disclosures and held a series of informative
hearings on the Home Ownership and Equity Protection Act (HOEPA) regulations. The
Board then issued a regulatory proposal under HOEPA that called for stricter regulations to
prohibit unfair and deceptive practices in the mortgage market. By targeting protections to
borrowers who face the most risk of experiencing unfair or deceptive practices, the proposal
seeks to protect consumers and preserve consumer choice in mortgage products. We have
also sought to provide lenders with clear standards that, without being overly prescriptive,
preserve access to responsible credit for qualified borrowers. The proposal covers the entire
subprime market, not just lenders supervised by the federal banking agencies, and focuses
attention on the areas of greatest risk - while preserving consumers' access to responsible
credit. The proposal addresses the extension of credit without consideration of a borrower's
ability to repay, verification of income and assets relied upon to make a loan, prepayment
penalties, and escrow accounts for taxes and insurance. The comment period ended on April
8, and we are currently reviewing the more than 4,000 comment letters received.
Legislative initiatives that would allow the Federal Housing Administration to increase its
scale to reach a wider range of borrowers and develop appropriate underwriting and pricing
methodologies to deal with any increased risk and another that would strengthen the
oversight of Fannie Mae and Freddie Mac are important compliments to our regulatory efforts
to strengthen the housing markets.
Another major outreach effort involves gathering information on the best practices for
addressing community development issues and then disseminating that information through
publications, meetings, and forums. Since January 2007, Community Affairs offices across
the Federal Reserve System have sponsored or cosponsored more than 75 events related to
foreclosures, reaching more than 5,800 lenders, counselors, community development
specialists, policymakers, and others. Beginning next month, the Community Affairs function
will host a series of System-wide forums in order to further examine the impact foreclosures
have on neighborhoods in both weak and strong housing markets, as well as the tools
available to address the impacts of foreclosures.
The Federal Reserve continues to provide educational resources to help consumers make
informed personal financial decisions, such as choosing the right mortgage. We provide a
variety of materials and other resources, including websites, to help consumers understand
mortgage- and foreclosure-related issues, and to help lenders educate borrowers. The
Federal Reserve Banks, through their Community Affairs offices, are working to establish
foreclosure-mitigation resources on their websites for use by municipalities, housing
counselors, and community groups.
The Federal Reserve System's partnership with NeighborWorks America
The Federal Reserve's most recent undertaking to address foreclosure issues is the
partnership we are announcing today with NeighborWorks America. Specifically, this
partnership will focus on efforts to stabilize neighborhoods that have experienced high rates
of foreclosures. This new partnership not only leverages our ability to conduct data analysis,
research, and outreach, it builds on our existing working relationship as one of the federal
agencies represented on the NeighborWorks America board of directors. Together, the
Federal Reserve and NeighborWorks America will develop and deploy resources, tools,
strategies, and best practices for mitigating the impact of foreclosures across the country.
The cost of foreclosures is not limited to individual homeowners. Communities in which a
high number of foreclosures have occurred are increasingly faced with large numbers of
properties held by lenders or servicers as "real estate owned," or "REO." REO is costly to
hold, and many lenders are not well equipped to handle large REO inventories. As a result,
the number of vacant homes in some neighborhoods has increased markedly. After
averaging about 1.7 percent starting in 1990 through 2006, the home-vacancy rate rose
sharply in 2006 and hit 2.9 percent in the first quarter of 2008, according to the U.S. Census
Bureau.
Properties left vacant for long periods have many negative effects on a community. Research
indicates that foreclosures tend to reduce the value of nearby properties; the magnitude of
these price declines appears to differ, depending on the presence of variables such as the
strength of the local housing market or the distance between a foreclosed home and other
surrounding homes.4 Moreover, neighborhoods that have significant concentrations of vacant
properties are not attractive to potential buyers, further challenging community-stabilization
efforts.
Vacant homes also drain the coffers of municipalities, who must secure the homes from
crime, keep them clear of trash, or in extreme cases, demolish them in order to maintain
stability in the broader community.5 For example, the chief of regional development for the
City of Cleveland estimates that the city will spend $65 million each year for five years to
address costs related to abandoned properties.6 Not only are these costs high, they come at
a time when tax revenues are generally decreasing because of declining home values.
As state and local governments face diminished resources for dealing with vacant properties,
many nonprofit organizations are likewise struggling with capacity issues. We have heard
from many nonprofit community development organizations that foreclosures, and the impact
on the neighborhoods affected by them, limit the organizations' ability to proactively engage
in their previous development activities. As a member of the board of NeighborWorks
America, I am keenly aware of the resources needed to deal with community stabilization in
the wake of foreclosures.
I am also aware of some promising examples of programs that NeighborWorks affiliates have
developed to address problems associated with vacant and abandoned homes. In Chicago,
the Neighborhood Housing Services Redevelopment Corporation, in cooperation with the
city, has acquired hundreds of abandoned properties from several sources, such as HUD,
REO from financial institutions, and private owners. The properties are then rehabilitated and
sold to owner-occupants, frequently with appraisal-gap subsidies provided by the city and
federal resources. In other highly depressed housing markets across the country,
municipalities often demolish the worst-quality units in order to mitigate safety hazards,
reduce the total number of vacant homes, and restore the quality of life in the community.
The purpose of our partnership with NeighborWorks America is to support local communities
as they assess local housing conditions and evaluate responses to the challenges before
them. The partnership will develop and deliver training designed to help local communities
acquire, rehabilitate, and manage foreclosed REO. Working with NeighborWorks America,
the Federal Reserve will develop training resources for nonprofits and local governments to
foster their understanding of the foreclosure and REO process and to help them develop
specific strategies for the sale and effective use of REO in individual markets. The ultimate
goal is to return REO to productive use, for example, to provide affordable rental housing or
to supply new, sustainable homeownership opportunities in low- and moderate-income
communities.
Research and analysis will play a key role in the success of local efforts. The Federal
Reserve System is committed to providing NeighborWorks and others with timely reports and
information so that foreclosure-mitigation resources can be effectively targeted to local areas.
For example, the Federal Reserve may map mortgage-delinquency rates in specific
metropolitan areas, to help local governments and nonprofits develop and prioritize their
strategies for stabilizing communities.
As demonstrated by our partnership with NeighborWorks America, the Federal Reserve
System is committed to supporting sustainable, healthy communities. Bringing nonprofits,
local government representatives, and financial market participants together to share
information and develop best practices for addressing the negative impacts of foreclosures
on neighborhoods is the next phase of this commitment. Leveraging the System's unique
structure of Banks and Branches and NeighborWorks America's broad local presence will
allow us to make our research and outreach broadly available to nonprofits and community
leaders.
Conclusion
As the Federal Reserve builds on its consumer protection efforts in order to mitigate
foreclosures for current homeowners, we are also concerned about the impact current
mortgage market problems are having on individual communities. The challenges of rising
foreclosures are significant at the state and local level and the nature of the problem varies
by location. Through its structure, the Federal Reserve System is attuned to local issues,
which both informs its national policymaking and allows for responses tailored to local
conditions. We are committed to continuing to strengthen our relationships with local
stakeholders. Our partnership with NeighborWorks America is an important part of that
commitment. A unified effort is essential to mitigating and offsetting the negative impact of
foreclosures.