States move to minimize damage from subprime loans

Washington and Idaho regulators are increasing their vigilance of subprime lending despite the minimal damage done in this region, so far, by the bankruptcies and other problems troubling the industry.

The Washington Department of Financial Institutions last week took the first step toward adopting new standards that will apply to independent mortgage brokers and lenders. Federal oversight agencies have already implemented tighter controls at insured banks and thrifts.

Deb Bortner, director of consumer services for DFI, says the “guidance” kicks off a rule-making process that will codify the standards by the end of the year. Meanwhile, she says, examiners will begin educating brokers about the new requirements.

The subprime meltdown began earlier this year with bankruptcy filings by dozens of industry players, including the largest, New Century Financial. That lender had about 500 mortgages in the pipeline when it ceased business in Washington, but Bortner says the state was able to place those loans with other lenders, sometimes on better terms for the borrower.

Idaho is also working toward putting the new guidelines in place, says Mike Larsen, head of that state’s Consumer Finance Bureau.

Larsen says state regulators are following the lead of federal agencies trying to catch up with the subprime implosion and its ramifications for credit markets. Even a sophisticated investment firm like Bear Stearns, where two hedge funds are under water on almost $2 billion in subprime loans, has been harmed.

Early on, subprime lending had been encouraged as a way to get consumers who could not meet traditional lending criteria into homes. But as prices surged and more marginal buyers got into the market, mortgages brokers and their lenders offered interest-only mortgages or those with low introductory rates that were designed to keep monthly payments to a minimum.

Many borrowers who did not produce any proof of income were nevertheless signed up for “liar loans.” The worst, says Larsen, were “Ninja loans;” no income, no job, no assets.

But as rates are reset at higher levels, one million borrowers face bigger mortgage payments. With housing markets in California, Florida and elsewhere cooling off, many will find themselves unable to unload their homes at prices that will cover their mortgages. The result was a national foreclosure rate in June almost 87 percent higher than for June 2006.

According to RealtyTrac, which monitors foreclosures around the country, Washington and Idaho remain healthy compared with other states, but foreclosure rates are climbing. In Washington, there was one foreclosure in June for every 1,507 households, the rate a modest 13 percent higher than that for June 2006. The problem is becoming more serious in Idaho, with one foreclosure per 949 households. That’s an increase of 284 percent. Figures from another service showed foreclosures trending down in Idaho during the second quarter, while activity in Washington increased slightly.

Both states have advised homeowners with adjustable-rate mortgages to anticipate higher monthly payments as their rates reset, and to adjust household budgets to allow for an increase. Larsen says regulators want borrowers communicating with their lenders to see what arrangements can be made before “payment shock” triggers more foreclosures. In states like New York and Massachusetts, where subprime problems are especially severe, state governments are stepping in with money to help with refinancings.

Larsen says the industry and consumers should benefit greatly from a national licensing system expected to be in place by early 2008. A national license will prevent bad apples from skipping from state to state, victimizing consumers as they go.

The region’s prosperity has spared the Northwest the worst of the subprime woes. The remedial action regulators are taking now may prevent us from ever catching up.