Preserving the American Dream: California Lags Other States in Responding to the Foreclosure Crisis

Second, there are a number of concrete steps that California can take today to minimize foreclosures and stabilize housing markets, including providing emergency funding for foreclosure prevention counseling and legal assistance, establishing a strong monitoring system for loan modifications, and a targeted refinance product to help borrowers refinance loans contingent on lender preconditions.

Third, California should enact comprehensive changes to return subprime lending to more responsible standards, including requiring lenders to evaluate the borrower’s ability to repay their loans, eliminating risky product features for subprime borrowers and making structural changes in the roles of lenders, brokers and investors in the origination of mortgages.

California Lags Other States in Responding to the Foreclosure Crisis

There is an urgent need to address the epidemic of foreclosures in the subprime market today—the highest rate of home losses in the modern mortgage era. While other states have taken steps to raise standards on subprime lending and bold steps to prevent foreclosures, California’s efforts to address rising foreclosures have lagged considerably. California’s existing anti-predatory lending law is weaker than most states that have enacted these types of laws. The negative effects of subprime foreclosures are particularly serious for California:

• About one quarter of all subprime lending in the nation occurs in California.
• Foreclosures in California in the second quarter reached their highest level since 1988.
• The worst is yet to come: According to Moody’s Economy.com, more than two million subprime adjustable rate mortgages will be resetting later this year, with an estimated $50 billion worth of mortgages due for reset in October 2007 alone.
• CRL estimates that more than one in five (21.4%) subprime loans originated in California in 2005 and 2006 will end in a foreclosure. We estimate that nearly 500,000 Californians will lose their homes because of subprime loans originated since 1998.

In November 2006, the federal bank regulatory agencies finalized new guidance governing underwriting practices and disclosure requirements for banks and other federally-insured depository institutions that make “non-traditional” mortgages. Thirty-six states have already implemented similar guidance for their state-regulated lenders and brokers. By contrast, California regulators needed the threat of legislation to spur the drafting of regulations, which were not released for public comment until late April 2007, and have not yet been finalized.

This is the Committee’s third informational hearing on issues related to the collapse of the subprime mortgage market. ( Prior hearings were held January 31, 2007 and March 26, 2007.) While states like Maine, Minnesota and North Carolina have enacted strong and bold legislation to supplement federal guidance, California has not enacted any regulatory or statutory change to help or protect California borrowers in this period. We hope that today’s hearing will spur the Legislature act swiftly to assist current subprime borrowers in trouble and provide adequate protections for borrowers in the future.

We propose the state take immediate in the following areas, summarized in more detail below:

Assist Current Subprime Borrowers
● Emergency Funding for Foreclosure Prevention Counseling and Legal Services
● Monitoring Private Loan Modification Efforts—Including State Data Collection and Tracking

Protect All New Subprime Borrowers
● Ban Prepayment Penalties on All Subprime Loans
● Establish Statutory Standards for Ability to Repay: All mortgage originators should assess the ability of borrowers to repay their loan, based on the fully-indexed interest rate and fully amortized payments and with a limit on the debt-to-income ratio that is assumed.
● Require Appropriate Documentation of Income
● Require Mandatory Impoundment (or Escrow) of Property Taxes and Hazard Insurance
● Establish Lender Liability for Broker Acts and Omissions When Yield Spread Premiums are Charged