State must aid homeowners

New homes sales in metro Atlanta fall 52 percent in 12 months. Area foreclosures set a record in February, and the state’s jobless rate hits a record high in January.

One in eight Georgia mortgage holders are now either behind on their payments or in foreclosure.

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Kimberly Smith/staff / ksmith@ajc.com

Georgia ranks eighth nationwide in foreclosures, while North Carolina ranks 33rd, in large part because of its effective lending law. Georgia repealed its similar law in 2003.

Given ongoing bad news about the state’s economy, the General Assembly can’t sit back and trust the free market will set things right. State government helped set the stage for this economic bloodbath by failing to stop lending abuses when it had the opportunity, and now it must help to mitigate it.

“By acting in the ways it can act and in ways consistent with other states, the General Assembly can reduce the depth of the harm and the length of the harm to our housing market,” says Emory law professor Frank Alexander, author of “Georgia Real Estate Finance and Foreclosure Law.”

And if lawmakers — six dozen of whom have financial ties to the banking industry — continue to dither and take little consequential action, as was the case last year?

“Our foreclosures will continue higher for longer, and the consequences to our market will be far worse,” says Alexander.

Historically, the Georgia General Assembly has dismissed foreclosures as personal tragedies, blaming irresponsible homeowners for buying more house than they could afford or failing to read the fine print. But in 2003, it went beyond that. The new Republican majority in the Statehouse repealed the 2002 Fair Lending Act, which prohibited many of the lending practices now blamed for the collapse of the market and the deepening recession. Georgia’s law was patterned after one still in effect in North Carolina. Today, Georgia ranks eighth nationwide in foreclosures, while neighboring North Carolina ranks 33rd, in large part because of its effective lending law.

Those foreclosures are now corroding housing prices, consumer spending, construction jobs and tax collections. Yet even with neighborhoods in decline, the construction industry in tatters and state revenue in the tank, the Legislature still prescribes minor remedies to stem the bleeding.

An example is Senate Bill 57, which provides a few new protections for “subprime” borrowers — people with interest rates higher than prime. While the bill offers some help, it stops short of curbing such practices as negative amortization and balloon payments. It also is too narrow. The scope of the legislation ought to be broadened to all residential mortgages.

“Twenty-four or 36 months ago, I would have been pleased if this bill could be enacted,” says Alexander. “Today, however, we know that the housing and foreclosure crisis is far deeper and broader than subprime loans as defined in this bill. I suspect that the majority of residential loans being foreclosed in 2009 will not be subprime loans.”

A more complete bill is House Bill 264, which ends yield spread premiums, one of the more egregious lending abuses. Yield spread premiums are payments to mortgage brokers in return for steering consumers to higher-interest, riskier loans. Brokers and bankers oppose the elimination of yield spread premiums, arguing that the rebates represent one of the few ways left to make money.

“The banks will always argue that any and all such legislation either hurts borrowers or reduces bank profits,” says Alexander. “It seems to me that the current economic crisis is pretty powerful evidence that the recent mortgage lending practices themselves are what hurt borrowers, and that banks have no profits unless they get federal bailouts.”

The General Assembly also must slow down Georgia’s foreclosure process, which is the fastest in the country because it doesn’t require judicial review. Here, once a homeowner falls behind and a lender begins foreclosure, a house can be sold on the courthouse steps in as few as 37 days.

“If I want to repossess a refrigerator from your house, I have to get a writ of possession from the court, but if I want to take the whole house, a judge is never involved,” says former Gov. Roy Barnes, an attorney who now practices consumer law.

Also needed is legislation that protects borrowers in high-interest loans by requiring mandatory counseling, a seven-day waiting period during which borrowers can change their minds, clear notification that their rate is above market rate and limits on prepaid interest and junk fees.

More complex, but very beneficial, would be a federal law that encourages banks to reduce the debt on a house to fair market value. A new study found that one in five U.S. homeowners now owes more to lenders than the home is worth. That situation — where the mortgage is $300,000 and the house is now only $225,000 — encourages the owner to walk away from the home, adding to the foreclosure problem. It makes sense for the bank to lower the mortgage amount to $225,000 — and enable the homeowner to stay in the house — rather than sell the property at foreclosure for $200,000.

For now, lenders are reluctant to reduce the principal. Most loan modifications involve only adjusting the interest rate temporarily or extending the loan terms. They don’t strike at what Sheila Bair, chairman of the Federal Deposit Insurance Corp., calls the core problem — too many unaffordable home loans.

Families would have better chances to keep their homes if the principal reflected the home’s fair market value today. Congress should approve proposed legislation allowing bankruptcy judges to reduce the principal amount of mortgage loans for struggling borrowers, a process known as “cram-down,” as part of the borrower’s debt restructuring plan. The bankruptcy code already permits restructuring of almost all personal debt, including yachts, cars, vacation homes and farms, but exempts mortgages on primary residences.

Introduced by Sen. Dick Durbin (D-Ill.), the Helping Families Save Their Homes in Bankruptcy Act would benefit many of the 10 million homeowners at risk of default on their mortgage loans in the next 24 months.

“The question that faces us now is this: after committing over $1 trillion in taxpayer money to address the financial crisis, why don’t we take a step that would indisputably reduce foreclosures and that would cost taxpayers nothing?” says Durbin.

State legislatures also have a role to play, according to Alexander. Under current Georgia law, the holder of a $250,000 mortgage who forecloses on a home and sells it for $200,000 could still sue the debtor for payment of the additional $50,000. He advocates a law limiting the debt to the value of the home.

“If enacted, such a statute would functionally mean that a mortgage is always limited to the value of the property,” says Alexander.

The General Assembly pushed Georgia deeper into recession by refusing to rein in the renegade subprime industry. It will prolong the state’s economic doldrums if it fails to act again this time.

• Maureen Downey, for the editorial board (mdowney@ajc.com)