You know what happened in the financial crisis: home values crashed, and left millions of homeowners underwater on their mortgages, with devastating results. Then, thanks in large part to the Fed, interest rates fell, and home prices recovered.
But there’s an America where that didn’t happen at all – where home values never recovered, and families remain stuck deep underwater. That America is poor, and disproportionately black.
In Ferguson, Missouri, for instance, more than 43% of homes are classified by RealtyTrac as “seriously underwater”, which is to say that the principal amount of the mortgage is more than 125% of the value of the home.
That’s maybe not surprising, when you learn that at the end of the first quarter of 2016, a whopping 34% of homes worth $100,000 or less were seriously underwater. For homes worth less than $50,000, more than half – 53%, to be precise – are seriously underwater. What’s more, that number seems to be going up, rather than down.
How is it that the cheapest homes in America – the biggest bargains – have not participated in the price appreciation seen everywhere else? The answer, surprisingly, lies in the Dodd–Frank Wall Street Reform and Consumer Protection Act, the sweeping finance-industry reform that was passed in the immediate wake of the financial crisis.
One of the ways that Dodd-Frank protects consumers is by putting a cap on the fees lenders charge when they give you a mortgage. Or at least, it caps the fees they can charge if they want to be able to sell the loan on to Fannie Mae or Freddie Mac, rather than taking on your credit risk themselves. And they certainly want to do that: while banks are willing to take a certain amount of risk, they generally prefer safe-and-lucrative rich-people risk. When they lend to poor people, they just want to get that mortgage off their books as quickly as they can.
If a bank is selling a mortgage of anywhere between $20,000 and $60,000, the fee it can charge is capped at 5%. To put that into hard dollars: let’s say you want to buy a $50,000 home in Ferguson, and you have your $10,000 down payment. That means you need a $40,000 mortgage, and the fees that the mortgage lender can charge you are capped at 5% of $40,000, which is $2,000.
Jorge Newbery explains why that kind of fee makes no sense, for a bank:
Once fees for processing, document preparation, lock-in fee, and other lender services are charged against the $2,000, maybe $1,000 is left for points. Lenders and their agents share the points, so the potential to generate a few hundred dollars each is so unattractive that most lenders choose to not originate loans of under $50,000.
Newbery is the CEO of American Homeowner Preservation, a fascinating company which, over the course of various incarnations over the years, has held true to a single mission: to help underwater homeowners get out from under their unmanageable debts. It started as a nonprofit, and then it became a hedge fund – the only hedge fund I’ve ever wanted to invest in. (I didn’t, in the end, because I was working for Reuters at the time, and when I checked with the Reuters ethics chief, she told me I couldn’t.)
The main activity of AHP has always been pretty simple. First, it buys mortgages, normally in poor neighborhoods, from lenders who are convinced that they will never be fully repaid. Often the mortgages have been in default for some time, or are are much bigger than the value of the home. Once AHP finds itself in possession of a loan, it then works with the homeowner – writing down principal, giving them back equity, reducing monthly payments – so that they can stay in their home. (Or, for people who don’t want to stay in their home, it works out a way for them to sell.) Once the homeowner is back making regular payments, or the home has been sold, AHP can end up making a profit on its investment, since performing loans are nearly always worth more than non-performing loans, and AHP never pays more for a loan than the value of the home.
AHP shouldn’t need to exist. Banks should, in theory, be able to negotiate these kind of deals themselves. But in practice they almost never do, because the loans are too small for them to put a lot of effort into, and also because of problems with the way that loan servicers deal with homeowners, banks, and investors. Only once the loan has been written off and sold to AHP can anything helpful or constructive happen.
In its current incarnation, AHP is funding itself by borrowing money from members of the public at an attractive rate of 12%. Its cash flows go first to paying back interest, and then to paying back principal. Then, if there’s any money left over, that’s AHP’s profit. If you want to support AHP’s work you can invest as little as $100, and help to keep Americans in their homes. But, don’t invest money you can’t afford to lose. You know neither when nor whether you might ever see that money again.
AHP is far from being a solution to the bigger problem: all it can do is be helpful at the margins. All too often, poor urban neighborhoods are doomed by a brutal financial logic. The houses are too cheap for the banks to want to extend mortgages on them, which means their owners can’t sell them, because no one can get financing to buy them. The consequent lack of demand keeps prices falling, forces families to stay in homes they want to be able to sell, and keeps millions of Americans underwater on their mortgages.
This is not the America of housing-bubble cities like New York and San Francisco; it’s much more likely to be found in the rust-belt cities of Ohio. But it’s not going away. Because right now, neither party has a plan to help these homeowners. And certainly the banks won’t do it.