Tag Archive for 'credit'

In a Turn of Events That’s Sure to End Well, Mortgage-Backed Securities Are Cool Again

You’ve probably heard the phrase “mortgage-backed security” plenty of times in recent years. And if you’re anything like me, and most of the rest of the country, you probably don’t have the clearest idea of what that is.

To most people, a “mortgage-backed security” is little more than a piece of paper that somehow brought the Western world to the brink of economic collapse.

Anyway, the New York Times is reporting that these legal and financial instruments are regaining in popularity, largely due to the fact that most analysts believe that the housing market has finally bottomed out, and real estate prices now have nowhere to go but up. And mortgage-backed securities are so cheap that many investors see them as no-lose propositions: even in the worst case scenario, they are betting that they can still make money off of them.

A mortgage-backed security is a type of bond that involve mortgage debts being pooled together into large bundles, and then sold to investors, who collect dividends which are ultimately derived from the payments that homeowners make on the original mortgages. These pools often contain hundreds of mortgages, and they can be chopped up and resold countless times – to the point that a homeowner who dabbles in investment can end up owning shares of their own mortgage and never know it.

These securities found their way into countless investment portfolios around the world. So, when the housing crisis hit, and record numbers of borrowers began defaulting on their mortgages, these bonds suddenly became worthless, causing huge amounts of wealth to simply evaporate.

So, could this resurgance in interest lead to a repeat of the 2008 financial crisis? Obviously, that question is impossible for even the most brilliant economists in the world to answer, so I’m not even going to try.

It is worth noting, however, that the legal landscape has changed since 2008. Most significanlty, the Dodd-Frank Wall Street Reform and Consumer Protection Act (usually just referred to as “Dodd-Frank”) has created many new rules regulating risky financial instruments such as mortgage-backed securities, which are meant to smooth out some of their rough edges, and give investors incentives to be more prudent.

One of the biggest factors that led to the rise and fall of the mortgage-backed security was the fact that banks were able to lend money to people without much regard to their ability to repay the loans. They could simply issue the loan, and sell it to a bigger bank, which would, in turn bundle it up in a package of securities to be sold to investors. The investors down the line bore the ultimate risk of the borrower defaulting. Because of this fact, banks were issuing mortgages to anybody with a pulse when the housing market was booming. And why shouldn’t they? They profit even if the borrower defaults.

Dodd-Frank requires the originators of assets (lenders) to retain at least 5% of the credit risk of the loans they issue. This should, in theory, give them an incentive to be more diligent in issuing mortgages than they were before the financial crash.

However, if you listen to any pundit talk about this law, you’ll probably hear one of two things: it doesn’t go far enough, and leaves plenty of loopholes for Wall Street to exploit, and they’ll be back to their old ways in no time. At the other end of the spectrum, you’ll hear people saying that the law goes way too far, and will cripple banks’ ability to issue credit, which is necessary for any modern economy to function.

Maybe it’s just a symptom of how divided the political discourse has become in the last few years, but you’d be hard-pressed to find anyone making the case that Dodd-Frank strikes a good balance between protecting consumers and ensuring that banks are able to continue to easily issue credit to deserving borrowers.

Even one of the cornerstones of Dodd-Frank couldn’t be implemented until very recently: one of the key provisions of the law was the creation of the Bureau of Consumer Financial Protection, which is intended to regulate financial products aimed at individuals, such as credit cards, payday loans, and others. However, President Obama wasn’t able to appoint a director for this bureau until just a few months ago, because Senate Republicans refused to allow a vote on the confirmation of the president’s appointee. They openly stated that they had no objections to the director’s qualifications – they were simply opposed to the bureau’s very existence, and would do everything they could to stop it form being implemented. This required the president to resort to a recess appointment.

So, will Dodd-Frank ensure that this new wave of mortgage-backed securities doesn’t collapse the economy? In theory, its provisions do give incentives for everyone involved to be much more diligent in assessing the risks of their actions, since it makes it more difficult for them to shift risks elsewhere. I honestly have no idea. What I can say, however, is that the predictable calls to repeal it are premature. The fact is, the old way of doing things on Wall Street simply do not work anymore. We should give this law at least a few years to see if it works. If there are parts of it that do more harm than good, they should be changed. And, if the entire law proves to be an unmitigated disaster, it should be scrapped. What we should not do with Dodd-Frank, however, is let the perfect be the enemy of the good.

States are Finally Getting the Right Idea by Limiting Credit Checks on Job Applicants

Job applicants bristle at the request for a credit check. There’s always the fear that if you have poor credit, you will be denied the job. Even if you do have good credit, a potential employer looking through your financial history feels like an annoying invasion of some privacy right you’re sure you’re guaranteed somewhere.

Up until recently, employment credit checks were allowed by most states. However, within the last three years, four states have passed laws limiting credit checks on job applicants, and at least 20 other states have bills pending to do the same. There have also been talks in Congress of implementing a federal law to limit employment credit checks.

So what’s the reason for this growing tend? I believe it’s actually been a long time coming, and the recent recession has been the tip of the iceberg pushing it over the edge. Below is my take on some of the major arguments for limiting employment credit checks:

Argument One: “First and foremost, credit checks don’t really reveal an applicant’s ability to do the job well, or reveal an applicant’s likelihood of committing fraud on the company.”

Companies cite impressive figures showing how employee fraud, theft, and lying are real concerns. But this doesn’t make up for the fact that there haven’t been any studies confirming the correlation between poor credit and job performance/company security. In fact, there have been lots of studies confirming just the opposite. If companies are concerned about weeding out these types of applicants, then I agree with many that looking at the criminal record would be a better way to gauge employee behavior.

Furthermore, credit reports are just an amalgamation of numbers, and they don’t give any of the back-story behind the data. What I mean is that often times, applicants will have a very good explanation for their poor credit, yet none of this would be reflected in the credit report. For example, poor credit may not always be due to irresponsible or ignorant behavior. Instead, people may have poor credit due to unfortunate events beyond their control, such as medical debt or a divorce. Yet employers would know none of this if they simply thumbed through the report.

Argument Two: “The recession and economy demands it.”

As I mentioned earlier, I believe the recession was the impetus for many states limiting credit checks. The reasons for this are probably multifold, but they all start out with the idea that now more than ever, many people have poor credit.

This results in credit checks being less helpful than before, as they don’t do as much to differentiate who the “bad guys” versus “good guys” are. Second of all, it’s kind of a Catch-22: if credit checks stop people from getting jobs, then unemployment will cause these people to further worsen their credit. There’s no way to break the cycle, and with the economy going the way it is, we can’t really afford to have so many people veering down this path.

Argument Three: “Laws limiting credit checks are not all-encompassing.”

Granted, this is not really an argument for limiting credit checks, but I thought it was worthwhile to point out how these state laws are actually being executed. These laws show that just because you limit employment credit checks, it doesn’t mean that you have to get rid of them altogether.

Most states limiting employment credit checks have carved out exceptions for job positions that are finance-oriented or demand a greater amount of security. For example, Oregon exempts many banks and credit unions from the limit on credit checks. Illinois, another state limiting employment credit checks, exempts debt collectors, insurance agents, and several government agencies. Thus, the laws are pretty reasonable, and recognize cases where employment credit checks really are necessary.

In conclusion, I understand that for many employers, credit checks are just one piece of the puzzle, and they don’t use it as the definitive factor in evaluating job applicants. (In fact, if they did, it would be illegal, unless the credit check revealed attributes that were critical to the job function). I guess employers are just saying, in a roundabout way, that they don’t have enough information about job applicants, so issuing credit checks helps. But if this is the case, then I think the negative aspects of using credit checks on job applicants outweigh the benefits. As I said earlier, I think that in most cases, credit checks reveal very little useful information about a potential employee.

Employment credit checks have always been one of the more controversial issues in employment background checks, which is already a controversial issue in itself. What is interesting is to see what will happen once the recession is over (which it will end, at some point). Will this trend to limit employment checks keep growing, and will the laws already in place stay once the recession is over?

Perhaps if we lived in a world where almost everyone had perfect credit, and it was only the exceptional person who truly had bad credit, then employment credit checks might actually reveal something useful and make more sense. But as much as I would like to see that day come, I’m pretty sure it won’t be happening anytime soon.

Bankruptcy, the Forgotten Right of the Consumer

Economic recessions are things that, by nature, few ever expect.  But it would be hard for any responsible statesman to believe that economic downturns would never happen at all.  Didn’t the drafters of the constitution expect financial difficulty?  If “we the People” made this country, wouldn’t the founding fathers have thought to help the people first as they anticipated these economic downturns?

Well, regardless of whether they had our troubles in mind or not, the constitution includes a remedy just right for the situation: Bankruptcy.  Power over bankruptcy was given to the federal government in the very first article of the constitution.  That means it was included before things like freedom of speech, protection against illegal searches and seizures, and other basic rights.  The idea of bankruptcy soon thereafter evolved into the ability to file bankruptcy as a voluntary choice, and even that concept predates the right of equal protection, and the right for all citizens to vote.  People are often surprised to discover that Bankruptcy was considered so important historically.

And it has certainly been important in recent history.  Last week at the Health Care Summit, Senate Majority Leader Harry Reid brought light to the fact that 70% of all consumer bankruptcies every year are caused by health care costs.  Lately as well, many have pointed out the financial benefits of defaulting on home loans and giving the title back to the bank.

The truth is that the health care controversy, the mortgage crisis, the stock market downturns… they’re not just a Garfield Monday, where everything bad happens at once.  The housing bubble was a major root cause of the recession, and then when the federal government had to pay for Wall Street’s losses, the fact that the majority of federal expenditures are for Medicare, Medicaid and Social Security causes a breakdown in health care as well.  In short, what we pay for is directly linked to how we’re paying for it.  And the traditional criticism that bankruptcy usually only follows a frivolous lifestyle starts to look like a pernicious lie when in so many cases Americans are forced to take on debt just to stay alive.

For that matter, there seems to be an overabundance of opposition to bankruptcy considering it is such a long-standing right.  Some have suggested that you may not be able to get a job if you file bankruptcy, even though there are provisions in the Bankruptcy code that prohibit discrimination by both government and private agencies based on prior filings.

Others cite the correlation between bankruptcy, job loss and divorce to suggest that the morally deficient are the only ones filing.  But illness is positively correlated to bankruptcy as well.  No one since the Dark Ages would argue that sickness is caused by moral corruption.  The fact is that job loss, divorce, and illness commonly cause bankruptcy, not the other way around.

Some also give advice that if you feel bad about filing bankruptcy (as they say you should), then you might consider going back afterward and pay those creditors whose accounts were discharged.  Reaffirmation, as it is called, is something that attorneys are required by the professional code of conduct to counsel against.  After all, it’s strictly against the interests of those the lawyers represent.  Still, many people who would benefit from filing bankruptcy are convinced that it is their moral obligation to pay their debts.

Is the assumption of debt a moral responsibility?  Well, maybe so.  But even if it is, that obligation is not at all unlike the fiduciary duty that home mortgage lenders owed their constituencies to whom they sold risky securities.  It’s also not unlike the duty the government had to manage social security payments in a way that those who paid into the program would have the retirement promised.  Even Donald Trump and many other celebrities filed bankruptcy.  They may not be moral paragons, but they are certainly financial ones.

So, if it seems to you that the honoring of obligations isn’t the two-way street it’s supposed to be, you’re not the only one.  And ever since the idea of fascism, all you need to do is follow the trail of misinformation to find those who would benefit from the lie.  In this case, it’s the same banks that were bailed out by taxpayers.  Law professors have even thought that the negative stigma of default is actively cultivated by those who are trying to pass the buck.  It’s like a game of hot potato where the other players promise a prize in the afterlife if you stick with it and hold on.  But if there’s one group in the economy who has to step up and pay out, why should it be consumers?

This game of accounts payable is a financial game.  And as such, the rule is that if you can save money doing something, you should do it.  I could bore you with the many scholarly theories that seem to indicate a certain morality all its own behind financial savvy, but it’s enough to say that many experts consider default a cheaper, easier alternative to the mortgage crisis for all parties.  And in the recent economic downturn, more and more professionals have counseled those they represent to just say no.  Consumer bankruptcy is a fundamental way to do that.

And you might be surprised what happens when you demonstrate that you know the rules of the game.  The simple act of considering bankruptcy in itself can be the last bargaining chip needed to tip the scales.  Creditors will often be more willing to negotiate debt if they know their client is aware of the option to file.  And if they don’t offer acceptable terms pre-bankruptcy, there are lenders on the other side who are more than willing to extend you credit afterwards.

That’s right.  Most people are in a better position to get credit after filing bankruptcy.  You’re not as great of a credit risk once all the debts you had before filing are discharged because you’re more able to pay new ones.  Who would have thought that bankruptcy happens because people can’t pay their debts, not because they won’t?  Lenders have certainly caught on to that fact.  And if that’s contrary to what you’ve been told of bankruptcy, then maybe you’ve been informed by the wrong people.  I would suggest the Bankruptcy Code, and even the Constitution.  But that’s just me.

Keeping Credit Card Companies in Check

credit-card-reformNearly 80% of Americans carry credit cards and about 44% of those individuals with credit cards carry credit balances.  On an annual basis, credit card companies have earned $15 billion in penalties for late fees alone!  (A New Era for Credit Cards)

President Obama attributes the practices of credit card companies to contributing to the down market economy.  While Obama expects American consumers to be responsible in paying their debt, he also expects credit card companies not to saddle already debt laden consumers with retroactive interest rate increases and other unfair credit practices.  Some of Obama’s sweeping legislation requires credit card companies: 1) to post their credit agreements online, 2) to provide 45-days advance notice if the credit card company plans to change its terms and conditions, 3) to standardize payment due dates rather than to shift payment dates to different dates each month, and 4) to apply excess payments to the highest interest rate balance first.  (White House Fact Sheet)

But, to keep the credit card companies in check, U.S. consumers will still need to proactively review their credit card records for accuracy and to (politely) challenge the credit card companies if there is a reporting error or a violation of the new White House reforms.

Americans are entitled, by law, to one free credit report per year from each of the three major credit reporting agencies: Equifax, TransUnion and Experion.  (Credit Reporting Rights)  After reviewing these reports, if there are inaccuracies, consumers have the legal right under the Fair Credit Reporting Act to dispute this information and to have it corrected, usually within 30-days. (A Summary of Your Credit Reporting Rights) Keeping your credit record accurate is important not just to obtain a mortgage or a short-term loan, but employers are also increasingly checking consumer records as part of their background screening process.  (Employers and Consumer Reports)

Even though U.S. consumers have these rights, some credit reporting agencies may be less than compliant. Always put your request for correcting reporting inaccuracies in writing, specifically identify the inaccuracy and provide verification of the reporting inaccuracy in your request for a reporting correction.  As a first step, write a demand letter.  Examples of demand letters can be found through Nolo press or through other on-line resources. (Credit Repair) When mailing a demand letter, send the letter by certified mail and keep a record of the delivery receipt so that there can be no denying that you’ve made an attempt to notify the credit reporting agency.  (7 Steps to Fixing Your Credit Report)

If these measures are ineffective, LegalMatch can help. Sometimes it is only with an attorney as your advocate that credit reporting inaccuracies can be more quickly resolved.  During the past five years, we’ve assisted nearly 2,000 consumers who have required the assistance of an attorney to correct inaccuracies in the credit reports and another 2,100 who have requested an attorney to assist them with other credit reporting issues.  It is obvious not just to our President, but to LegalMatch, that credit card companies and their reporting agencies need to be kept in check.