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10 Questions – And Answers – To Help You Understand the Foreclosure Crisis

ProPublica reporter Paul Kiel (Lars Klove)

 Last week, our reporter Paul Kiel took time out from promoting his e-book to answer reader questions on Reddit about the foreclosure crisis, buying a home and how he got started as an investigative journalist. We rounded up some of the best, trying to represent a full view of the chat (and the crisis).

 What caused the foreclosure crisis and what can be done to fix this problem? — erkapathy

Big questions! Causes: well, two big causes. The crisis started with subprime loans, or loans made to risky borrowers, like the one I write about in my new e-book. Starting in 2007, housing prices turn downward. That meant people with loans they couldn't afford couldn't sell to get out of it any more.

And there were lots of really crappy loans out there, loans that really were never affordable for people to start with. Those loans got made because ...unscrupulous mortgage brokers were pushing them, and yes, because borrowers were willing to take them on. Fraud was really common — brokers just making up income numbers. Some of the loans didn't even require proof of income or assets.

So the first big cause was bad, mostly subprime lending. The second big cause was that the economy tanked, and there was a spike in unemployment. Mortgage servicers handling these loans made matters worse. They had a financial incentive to just push people toward foreclosure, to be understaffed, etc.

For years, the government mainly took a carrot approach. They tried to provide subsidies to convince banks to competently handle modifications and foreclosures. It didn't work. So now there's more of a stick approach. If there are real consequences, it might work, but it's sure taken a long time for the approach to change.

I should mention that I discuss one big policy alternative in the piece: allowing bankruptcy judges to modify loans. Obama had supported that when campaigning, but essentially ditched the issue once he was in office.

I've been surprised at the public's relative lack of anger...everything just seems to roll along like it always has. Do you see some sort of breaking point? —AndyRooney

Even at the height of the crisis, this was a problem affecting a relatively small minority of the population. Six or seven million delinquencies sounds like a lot, and it's historically high, but you have to keep in mind that's out of about 50-55 million total mortgages. So I think there's always been some wariness among policymakers about seeming to favor that minority. But the robo-signing scandal did at least prompt some change as far as that goes.

I keep hearing that "banks don't want to be in the housing business." But if not, why didn't they try harder to work with people on their mortgages? I know two different homeowners who couldn't get their lenders to even return their calls when they began to have trouble paying their mortgages. Is this a simple transfer of assets from the poorer to the richer? Why did the crisis play out this way, if the banks aren't truly better off because of it? — krrush5

Keep in mind that roughly 90 percent of the time, the bank handling your mortgage payments doesn't actually own your loan. They're just acting as the mortgage servicer — their job is to process your payments and then deal with you if you fall behind. A lot of what's happened over the past few years flows from that simple fact.

Basically, during the housing boom, the banks saw servicing as an easy way to make some good money. The model, essentially, was: let's take on as many loans as we can while dealing with those customers as little as possible. It worked great as long as the boom continued. But when housing prices started dropping and millions of people started calling their servicer, it proved a recipe for disaster.

The [foreclosure] problem seems so large, so intractable — do you see an end in sight? And How long do you estimate it will take for the market to recover? For all these underwater homes to be dealt with? — AndyRooney

I think it's too soon to say that the end is in sight, but the homeowner facing foreclosure now at least has a bit better of a shot than someone facing foreclosure two or three years ago.

Oddly enough, some of that is due to the robo-signing scandal. That finally prompted regulators and law enforcement to take some sort of meaningful action. Regulators swear up and down that this time if the banks break the rules, there will be consequences. We'll see about that, but at least it's movement in the right direction.

And it depends on what you think "recovering" means. A number of analysts think house prices will bottom this year. But it will likely take until 2014 or so before the number of homes facing foreclosure descends to something like normal levels.

Moving forward, are there any workable proposals out there to cure the dysfunction and prevent this from happening again? - teaperson

In the past few years, there really weren't real rules governing how banks had to deal with homeowners facing foreclosure. That's been changing, as I said above, in large part due to the robo-signing scandal.

The Justice Department and attorneys general say that these new rules will have teeth behind them. There's reason to be skeptical of that, but there's no doubt that someone facing foreclosure now has at least some actual rules to point to.

The Consumer Financial Protection Bureau announced earlier this week that they would also be formulating new rules in this area.

Because the crisis is dragging on so long and there's still a large number of people facing foreclosure, I don't think we will have to wait for the next housing crisis to see if these new rules actually work. If people are still facing the same problems in 2013 that they were in 2009, then it's clear the system is still broken.

Reducing mortgage principal, either through Fannie/Freddie or by forcing private banks to do so: good idea, terrible, or mixed? - MDA123

Yeah, that's the big question of the day.

Keep this in mind: Of the mortgages that big banks service, they only actually hold roughly 10% on their balance sheets. And they've been doing modifications that reduce the borrower's principal for years on those loans. Last quarter, about 25% of the mods the banks did on their own loans involved principal reduction. That's not a new development.

One big focus of the $25 billion mortgage/robo-signing settlement was forcing the big banks to do principal reductions. But it seems to me that they're just going to be getting credit for something they were already doing.

Now, the current fight is over Fannie and Freddie, who forbid principal reduction. Because the Treasury Department has offered to boost the subsidies to support principal reduction, that's taken away the argument that it would be a money-loser for Fannie and Freddie. The only remaining objection is supposed "moral hazard:" that homeowners would start defaulting in droves because they see that their neighbor fell behind on his payments and then got a break on his mortgage.

I don't think there's any good evidence that this would happen. Would people risk foreclosure in order to get a break on their debt? Certainly nobody who's been paying any attention to the disaster over the past several years can think it's going to be easy to get that principal reduction. (It's also worth noting that some people were making the "moral hazard" argument against any kind of broad mortgage modification program back in 2008, and there was no huge movement in strategic defaults.)

On the other hand, Fannie and Freddie are unique institutions. It would be a major shirt and would probably get some publicity. I guess anything's possible, but I'm skeptical. Hope that answers your question?

It answers it, yes. My big concern regarding Fannie/Freddie is worsening their already-horrific balance sheets. Any Treasury efforts to defray that will just involve cost-shifting, if I understand things correctly. The bottom line is that Fannie/Freddie still pose enormous risks to taxpayers at this point and principal reduction is unlikely to improve that. — MDA123

Fair enough. Yes, it would involve using subsidies from TARP to defray the immediate cost. The idea would be that it would involve a short-term hit to Fan & Fred's balance sheets with a long-term benefit. It's certainly a reasonable concern.

As a Realtor - what advice would you suggest I give to first-time home buyers to help them be better prepared for the financial responsibility of owning a home? More specifically, are there good/better/best loan programs less likely to lead first-time homeowners to foreclosure? -MonkeyHouse

This is a little out of my area of expertise, but it's probably instructive to start with a simple debt-to-income (DTI) calculation. The government's mortgage modification program considers a 31% DTI ratio as affordable. In other words, no more than 31 percent of the borrowers' pre-tax income should go toward the monthly mortgage payment (mortgage insurance and escrow included).

It's a really rough calculation, because it excludes whatever other debt the homeowner may have. But it's a good starting point. Many people think 31% is too high and prefer something more like 28% or even 25%.

There's also the option of housing counseling. Anyway, hope that's helpful.

If you had to place the blame on one individual or group of individuals for the "foreclosure" crisis, and subsequently, the economic crisis? —rsherm25

I don't mean to be slippery on this, but I want to avoid oversimplifying. You can blame the government for lack of regulation and enforcement; you can blame lenders and banks for exploiting those weaknesses; you can blame (some) borrowers. One thing I tried to do with the e-book was paint a complete picture so people could see all these pieces worked together.

From my standpoint as a 16 year old, I feel that oversimplification on this subject would be helpful in my understanding on the 'crisis' as a whole. I think I understand for the most part of what is going on, but at the same time, you say (some) of the borrowers. I don't see how any of the borrowers could be blamed for this. Even if they didn't have the means to pay back their loans, the banks giving them their loans was a sure sign that it was the banks fault, and through that the governments fault for lack of oversight and regulation.

I agree that most of the blame should be put on the financial institutions (and by extension the government regulators who let them run wild). I just meant that there were certainly cases of borrowers who made the problem worse: mainly investors who bought up two, three, or more houses and exploited the broken system. I've talked to people who admitted to me that they lied about their income on their loan applications. But I don't think that describes most borrowers during the boom.

How about this: read the story and if you come away still confused about anything, write me an email at paul.kiel (at) propublica.org.

Some journalism questions for you: How'd you get into journalism, and what's its appeal to you?... benkeith

My first journalism job was as an intern at Harper's Magazine. We were paid with pizza (on Fridays). Eventually I made my way to Talking Points Memo, where I reported and blogged about corrupt congressmen. I've always wanted to write for a living, and I like to think it's useful, important work.

What advice do you have for aspiring journalists? - benkeith

It's really hard to give career advice in journalism, because as I say, everything is still in flux. It used to be that you'd get an internship at a newspaper and work your way up. It doesn't really work like that any more. The only advice I can give is based on my own experience. I took what work I could get, did the best I could at it, and bugged the hell out of Josh Marshall at TPM until he hired me. And I was lucky.

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