Enduring Today’s Financial Quicksand

Huddled inside a crowded room in the California Science Center in Los Angeles — the epicenter of today’s foreclosure wave — were community leaders, homeowners and lawmakers such as Los Angeles Mayor Antonio Villaraigosa and U.S. Rep. Maxine Waters (D-Los Angeles). All were there to discuss what’s needed to rescue homeowners caught in the subprime mortgage debacle.

“First, with respect to why we’re holding this hearing, it would arguably be derelict of this subcommittee not to hold a hearing regarding the subprime mortgage market on the home foreclosure crisis,” said Waters, who acts as chairwoman of the Financial Services Subcommittee on Housing and Community Opportunity. “This issue is not only the biggest story in the housing world that this subcommittee operates in daily; it is currently the biggest economic story in the nation and perhaps the world.”

The Nov. 30 Congressional field hearing on mortgage foreclosure prevention and intervention represents one of many discussions taking place throughout the country, with lawmakers looking to bailout distressed consumers through legislation. These proposals are what have finance companies, including those serving the auto industry, concerned.

“I think the mortgage bankruptcy bills would have a negative impact on the housing market, the economy, as well as lenders who made the loans,” said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable. “If enacted, they could impact the overall health and strength of lending companies, which could trickle down to the auto industry.”

Talbott’s organization joined 13 other groups, including the Consumer Bankers Association (CBA) and the Mortgage Bankers Association (MBA), in writing a letter to the House Judiciary Committee in opposition to one of the bills, titled H.R. 3609. They say the bill is an overly broad response to the problem in the subprime mortgage market that could have unintended and adverse consequences for consumers.

At Waters’ hearing was U.S. Rep. Linda Sanchez (D-Calif.), who is championing the bill Talbott and the 13 organizations oppose. Called the Emergency Home Ownership and Mortgage Equity Protection Act, it would give bankruptcy judges the authority to alter mortgage terms, possibly reducing the size of home loans for those people at risk of going into foreclosure. Sanchez claims the legislation could reduce the number of foreclosures in the next few years by about 500,000.

The House Judiciary Committee was expected to meet on Dec. 12 to discuss a possible compromise between Sanchez and proponents of her bill. Results did not make F&I’s January press deadline.

“Lenders are nervous, so they are looking at the worst-case scenario,” Sanchez explained. “But this legislation would give bankruptcy judges the power to do what lenders have said they will do. Less than 1 percent of loans have been modified, but now lenders recognize that there is a need to change this.”

GMAC joined 20 other companies, including Capital One and HSBC, in signing a second letter in opposition to Sanchez’s bill. They contend that Sanchez’s legislation would lead to increased interest rates to offset the reduced balance on unpaid loans. This, GMAC spokesman Michael Stoller said, would push more consumers into higher-risk categories.

“It’s important to help people,” he said, “but altering the bankruptcy codes is not the best way to do it.”

The American Bankruptcy Institute (ABI) agreed, and expressed doubt that the bill’s supporters realize the consequences that may result, specifically a spike in bankruptcy filings that courts may not be prepared to accommodate.

“Chapter 13s could spike to record levels if Congress enacts pending legislation to allow homeowners to rewrite their mortgages by filing for bankruptcy,” wrote ABI Executive Director Samuel J. Gerdano in a recent release.

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Problem Can’t Be Ignored

Foreclosures are hitting numbers not seen since the great depression. And with a number of adjustable-rate mortgages due to reset soon, about 2 million more homeowners could end up in foreclosure in the next few years. This was one of the reasons why the Bush administration jumped into action, putting a freeze on interest rates six days after the Los Angeles hearing. The plan, which he negotiated with the mortgage industry, could help 1.2 million eligible people.

“A positive impact would be if it does provide relief to borrowers, especially if it eliminates the mortgage crisis, or eliminates any spillover into other sectors, such as auto,” said Jack Tracey, executive director of the NAF Association, of Bush’s plan. “A negative impact could occur if these deferred interest charges result in reduced income for someone else. If the loss falls back on owners of securities of mortgages, it may cause Wall Street to be more reluctant to securitize auto loans, raising the prices of securities. Even worse, Wall Street could back away from auto loans altogether.”

As recent as September, Tracey told F&I magazine that auto lenders were not overly concerned about the fallout from the subprime mortgage industry, despite signs of increased delinquencies. His sentiment remained the same in December after Lehman Brothers released results from a survey that showed delinquencies jumped in September to their highest levels in at least eight years.

“I do think there appears to be a rise in delinquency, but I’m not hearing anything about a crisis,” Tracey said in December. “This is a reflection of the general economic climate we’re in. It’s slowing down a bit, and portfolios tend to reflect the overall economy. This has very little to do with the mortgage crisis.”

The Lehman Brother’s survey of companies servicing loans reported that about 4.5 percent of auto loans made in 2006 to top-rated borrowers were at least 30 days delinquent as of the end of September, up from 2.9 percent the previous month. During the same period, 12 percent of subprime borrowers were delinquent on their 2006 loans, the highest level since 2002 and up from 11.1 percent the previous month.

GMAC also reported in December that delinquencies in the third quarter reached their highest levels in at least three years, but company officials said credit losses were still well within historical levels.

During an investor Webcast on Nov. 15, AmeriCredit blamed poor-performing 2006 auto loans for its lowered fiscal-2008 profit projections. It makes about 500,000 new- and used-vehicle loans a year. The company, which tightened its credit criteria earlier this year, added that it will reevaluate its lending standards this month. If standards are tightened, officials said lending volume could drop by 10 percent.

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“Delinquencies are rising, but this is a cyclical business,” Tracey added. “Finance companies have tolerances in place for higher delinquencies and losses. To the extent that they stop buying auto paper, we don’t have a crisis, just a squeeze on profits from that portfolio.”

Autos Still Important to Consumers

While new-car sales have slowed, the automotive finance industry continues to grow. According to the NAF Association, about $575 billion in loans for new and used cars are made annually.

Many believe problems in auto loans won’t be as severe as the home mortgage industry because the two operate differently. Market experts also said spillover from the home mortgage industry would be tempered because consumers need their vehicles, with many putting more value on retaining their vehicle than retaining their home.

“The payment hierarchy is shifting,” said Experian’s Melinda Zabritski. “People will be late paying their mortgage, but will make sure they pay their cell phone bill on time.”

Zabritski added that consumers are being more strategic in their payments, realizing that vehicle repossession due to a delinquent auto loan will occur much faster than a foreclosure because of delinquent mortgage payments.

The real concern for the auto industry is what all the recession talk is doing for consumer confidence. In November, results from a survey conducted by Synovate of Chicago for GDEXAuto ¬— a new Web-based marketplace for auto dealers to sell asset-backed debt — showed that one-third of Americans were extremely or somewhat concerned.

The survey questioned 1,000 consumers in late October. A majority of those concerned were young borrowers, families and minorities. About 12 percent of those surveyed said their credit was already affected.

Lower consumer confidence and borrower problems could deal a double blow to the already struggling auto industry. During the 2001 recession following the Sept. 11 terrorist attacks, auto sales held up partly because lenders were able to offer easy borrowing terms. If lenders tighten terms in response to increases in delinquencies, consumers would have a tougher time buying vehicles. Bailout legislation could also fuel this scenario.

“Government regulation due to the mortgage crisis is going to be burdensome,” said Michael Sheridan, founder and president of GDEXAuto. “If this legislation goes through, the initial reaction of lenders will be to tighten credit as much as possible. This could last for six months or for all of 2008.”

Three Other Bills on the Table

Three other bills are also making their way through Congress, all of which were introduced in October. A hearing on one of them, called the Helping Families Save Their Homes in Bankruptcy Act of 2007 (S. 2136), was held on Dec. 5. Currently sitting in the Judiciary Committee, it would permit a bankruptcy judge to fix interest rates on a mortgage for 30 years. It would also exempt homeowners from having to get credit counseling — a requirement set by changes made to the bankruptcy laws in 2005 — if their home is scheduled for foreclosure. It also exempts up to $75,000 of interest if the debtor is over 55, and would waive any prepayment penalties.

There’s also the Home Owners Mortgage and Equity Savings Act (S. 2133), which would lower principal balances to fair market value, and waive early repayment and prepayment penalties. It would also delay interest rate adjustments. The bill was recently referred to the Senate Judiciary Committee.

In the House, there are two bills being considered. One is Sanchez’s bill. The other is also called the Home Owners Mortgage and Equity Savings Act (H.R. 3778). It aims to lower principal balances to fair market value while also waiving penalties and freezing interest rates. It currently sits in the House Judiciary Committee.

Opponents said the bills are nothing more than knee-jerk reactions.

“To date, the crisis has been relatively minor — a small decline in homeownership combined with a small uptick in foreclosures, with well-off investors absorbing the bulk of the damage,” wrote Eli Lehrer and John Berlau, analysts for the Competitive Enterprise Institute, referring to the Mortgage Reform and Anti-Predatory Lending Act of 2007 (passed in early December). “Doing too much could turn a minor crisis into a major one affecting ordinary Americans.”

The CBA’s Joe Crouse added: “If people are able to cram down their mortgages, bankruptcy will become more attractive and more people will cram down their debt on their homes. This will cause credit scores to suffer and people will get worse terms on financing overall, which may spillover into the auto industry.”