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The Foreclosure Crisis

Coming on the heels of a decade of rapid growth in real estate prices, the foreclosure crisis has had wide-ranging consequences for homeowners, communities, financial institutions, and the country at-large.  As real estate prices spiraled ever higher between 1996 and 2006, lending standards deteriorated as the ability of borrowers to repay their loans became of, at best, academic importance.  Financial institutions presumed that borrowers would be able to quickly refinance their mortgages if they began to have difficulties in making their payments (due to the false belief that home values would always go up.)  With the borrower's ability to repay relegated to a status of secondary importance, financial institutions sought to heighten the profits garnered through the lending process by adding features, including adjustable interest rates and prepayment penalties, which increased costs for borrowers.  In this context, lenders steered many borrowers seeking to purchase homes or refinance their mortgages into higher cost loans even when the borrowers would have qualified for loans for the needed amount under more conventional terms.  African American and Latino borrowers were particularly likely to be victimized in this manner, and advocates have brought many fair lending lawsuits against financial institutions on their behalf.

In 2007, however, a long and at first slow reckoning began for both borrowers and lenders as real estate prices began a decline that has not yet reversed to this date.  The stock of available single-family homes, which had been expanding rapidly in a real estate construction boom that coincided with price increases, had grown to the point where downward pressure was exerted on prices.  Borrowers unable to afford their loan amount, the loan terms, or both, no longer had the easy out of selling their home at a profit.  Instead, often faced with mortgage balances greater than the market values of their homes, foreclosure became imminent for many.  According to data from RealtyTrac, a real estate market research firm, foreclosure filings nationwide increased from 1.3 million in 2006 to 2.2 million in 2007, 3.2 million in 2008, and 4 million in 2009. 

For a household, the impact of a foreclosure can be devastating.  Aside from losing one's home and being forced to migrate to a rental market, borrowers who default on their mortgages suffer severe damage to their credit rating, the loss of often their most significant financial asset, and, at times, strains on their mental and emotional health.  In addition, a poor credit rating can serve as a barrier to employment, thus extending the negative impact of a foreclosure on a person's financial prospects well out into the future.

The devastating impact of the foreclosure crisis on the broader economy is, by this point, well known.  High cost lenders did not bear the risk of the mortgages they originated, as they sold the notes to investment banks, which then proceeded to divide the mortgages into securitized pools.  Investment banks then sold the securities to other investment banks and institutional investors around the world.  The securities worked so long as borrowers made their payments, properties were sold, or loans were refinanced when the low "teaser" rates readjusted to higher rates. All this was possible as long housing prices continued to spiral upwards.  Soaring profits in the financial sector helped to drive Wall Street in era of unmerited optimism, pushing the Dow Jones Industrial Average over a staggering 14,000 points in July 2007.  However, by 2009 the Dow Jones index sat at a level under half of its peak value.  Events of the intervening months included a heightened major spike in delinquencies and foreclosures, the collapse of Countrywide, IndyMac, Bear Sterns, Lehman Brothers, and Washington Mutual, continued dramatic declined in housing prices, last minute mergers to save Wachovia and Merrill Lynch, and the bailout of the financial services industry by the federal Troubled Asset Relief Program.

Various responses to the foreclosure crisis have helped only a small fraction of distressed borrowers remain in their homes through loan modifications.  The resources devoted to this fight by federal, state, and local governments, the financial services sector, and the nonprofit community have failed to stop the bleeding in a systemic way.  The federal government's plan to assist homeowners modify their loans, through the "Making Home Affordable" program, has fallen far short of its goal of modifying the mortgages and saving the homes of 7 to 9 million homeowners.  Congress has failed to amend the bankruptcy code to allow for the judicial modification of mortgages on primary residences.  When they do happen, loan modification terms often have increased rather than decreased costs to borrowers.  Foreclosure moratoria have merely delayed the days of reckoning for vulnerable homeowners as good faith negotiations often did not occur during such periods of delay.  Nonprofit legal services and housing counseling organizations have strained under the incredible demand for their limited resources.  In short, the foreclosure crisis continues to grow with no end in sight at this time.