Does recent Fed Reserve
study indicate a second housing crisis?
By Robert Brannum
A recently released study by the Federal Reserve Bank of New York called attention to an analysis that indicates that, despite a strong state-ranking of New York, nearly two dozen towns on Long Island rank among the nation’s most distressed zip codes. Its report in Facts & Trends, titled “Long Island Mortgage Distress: Analysis at the Neighborhood Level” and released in early May, presented an analysis that Suffolk and Nassau counties have an estimated 50 percent of its combined nonprime loans in jeopardy – loans either already in default or foreclosure, bank-owned or with underwater mortgages.
The study has raised concerns among the states’ legislators, regulators, bankers and community advocates – should we expect a second loan crisis? And more importantly – what can be done to prevent it?
Is Long Island Vulnerable to “Strategic Defaults?”
The Federal Reserve’s study examined a sample of 61,000 nonprime loans (defined as either Alt-A or subprime mortgages) on Long Island, and found that 40 percent were already in default, in foreclosure or already owned by a bank, and that an additional 10 percent had underwater mortgages, in which homes have outstanding mortgage balances in excess of the home’s current value.
It’s this group of 10 percent that have local officials concerned – although these loans are current, they are highly vulnerable due to their negative equity status. A growing trend across the U.S. has been the emergence of “strategic defaulters” who willingly walk away from their “no equity homes” if cheaper or more desirable housing becomes available. A recent report by Morgan Stanley now estimates that 12 percent of all mortgage defaults are “strategic,” a significant increase from 2007, when only 4 percent were thought to be strategic.
Current laws, meant to help people work through challenging situations in order to try to avoid foreclosures, can have the opposite effect in situations where borrowers strategically choose to default. Often, a borrower can be in default for three months before a lender begins to initiate its foreclosure process. In New York a lender must provide a 90-day notice of its intent to begin a foreclosure. When the lender-borrower workout period is included, homeowners with intentions to walk away can often remain in their homes for a year or longer without making payments. And those who are considering bankruptcy proceedings, either Chapter 7 or 13, can potentially walk away owing very little at the end of the process.
Indeed, a Newsday article in early February that noted that there was a 23 percent increase in foreclosure proceedings in January on Long Island over the previous January – including 1,130 homes in Suffolk and Nassau counties.
Deeper Examinations Reveals Important Town-Level Issues
Among the most alarming findings from the Federal Reserve’s study was that New York’s relatively healthy state ranking masks serious loan distress at the town level. The Federal Reserve developed a “distressed mortgage ratio analysis,” which is a ratio of distressed loans per 1,000 homes. In that analysis, New York State ranked 14th among all 50 states with a DMR ratio of 9.2 (New York ranked well below the worst performing states of Florida, California and Nevada – all with DMRs over 20), and also ranked below the national average. On a state-level basis, New York appears relatively healthy.
However, New York’s ranking has masked a very different county-level story: when the Federal Reserve extended its analysis to 544 counties across the United States, Suffolk County ranked number 21, with a DMR of 27, and Nassau county ranked number 44 with a DMR of 21. (Not surprisingly, all of the top ten most-distressed counties were from either Florida or California.)
But the next level of examination has really raised the alarm: focusing their probe on the Suffolk and Nassau zip codes only, the study revealed a more startling result regarding bad loan concentration: that over half of the Island’s distressed mortgages were concentrated within 22 zip codes, a designation the bank calls “hotspots.” In other words, 50 percent of the counties’ at-risk loans are concentrated within 10 percent of its towns. The study has revealed a startling question: are these 22 towns vulnerable to another major downturn due to their large concentrations of negative equity homes?
Step 1: Identification,
Step 2: Prevention
The Federal Reserve’s study has provided a very important approach to identifying neighborhood-level analysis for regulators, lenders and housing advocates to identify other at-risk communities.
The study raises two critical questions: what is it about these 22 locations that led to a high concentration in high-risk loans, and what can be done – by bankers, regulators and community advocates – to prevent a significant default situation should the economy fail to improve in the short term?
In a recent interview in Newsday, the Community Development Corporation of Long Island, a nonprofit involved in housing and economic development, concurred that organizations need to come together to address the issue before it worsens. “The question is what can we do proactively to try to correct this and bring the Island back to a healthier, more sustainable place,” said Marianne Garvin, its executive director.
At a minimum, it is likely that loan counselors will staff up and prepare for what could be a rising level of activity in those neighborhoods. The study provide early notification for counselors to proactively provide both town-wide information sessions and one-on-one proactive counseling.
at the State Level
In addition to local housing authorities state regulators and legislators are also paying attention. The state’s Banking Department issued a press release in mid-June stating that it had sent more than 57,256 ninety-day pre-foreclosure notices to New York homeowners who had fallen behind on their mortgage payments since mid-February. Not surprisingly, among the five counties with the highest total number of pre-foreclosure filings were Suffolk with 8,293 and Nassau with 5,755 filings, almost 25 percent of the state’s total. In a departmental announcement, Richard H. Neiman, superintendent of banks for New York state, said that “with the new information gained from these pre-foreclosure notices, we are now able to identify geographic areas of the most at-risk homeowners before they fall into the foreclosure process.” More than half of the pre-foreclosure notices sent were on mortgages less than 60 days delinquent, illustrating New York’s progressive efforts to try to stem potential issues before they grow.
The bank superintendent isn’t the only state-level leader taking a hands-on approach to the potential second wave of defaults. New York State Senator Brian X. Foley, a Democrat from Suffolk County, hosted a foreclosure prevention event in May in Brookhaven attended by hundreds of homeowners facing home foreclosure. The event, the second event sponsored by Senator Foley, featured major lenders such as Citi, American Home Mortgage Servicing, Bank of America, Chase, GMAC and Wells Fargo, who conducted individual conferences with homeowners and worked towards loan modifications as an alternative to foreclosures.
For just about every attendee, this event was the first opportunity to meet one-on-one with their lender and attempt to secure a loan modification. Homeowners were also offered free counseling from non-profit housing and support groups including the CDC of Long Island, Community Action Partnership, Long Island Housing Partnership and Long Island Housing Services.
In a statement to Banking New York, the Senator noted, “Like many homeowners throughout New York State, those on Long Island were persuaded into believing that their homes had ever-increasing values and that they could draw limitless equity therefrom. Although there were a few predictions regarding the market consequences of default swaps, collateralized debt obligations, or other synthetic investment devices, no real preventive regulatory measures were taken until last year.”
Robert Brannum is a freelance writer based in Boston with special expertise in the finance industry.