Friday, December 26, 2008

The Mortgages of the Future

In this time of economic crisis, help for troubled homeowners often arrives late, when it arrives at all. All too frequently, families are going into default on their mortgages, facing foreclosures and evictions that may have traumatic consequences.

It doesn't need to be this way. Mortgages could be structured differently, so that adjustments in payments would be made as a matter of routine -- systematically, automatically and continuously -- starting even before any distress is perceived by borrower or lender. By avoiding thousands and even millions of individual family crises, we might also make institutional crises, like the collapse of Lehman Brothers and Bear Stearns, less likely.

We need to innovate, with the creation of "continuous-workout mortgages." Such mortgage contracts, when originally signed, would specify a program for steady adjustment of the balance and payment schedule over the life of the mortgage, enabling most homeowners to continue to afford to make payments and maintain some home equity, even in harsh economic circumstances. These contracts might become the standard, with automatic adjustments based on shifts in national housing-cost indexes and futures markets (I've been involved in creating both), as well as economic indexes like the unemployment rate.

Continuous-workout mortgages would be privately offered. They would not be bailouts; the cost of workouts would be priced into the original mortgage rate. This transparency has a great advantage: when the actual risk to the investor is explicit from the beginning, mortgages are less likely to be initially overvalued in the market, and so the kind of financial crisis we are experiencing now would be less likely. It is, after all, the rapid decline in value of subprime mortgages, and of derivative financial instruments based on them, that has wreaked such havoc in the global financial system.

The cost to mortgage lenders of providing continuous-workout mortgages may actually be negative. That's because the workout provisions would help prevent the costs of forced sales of homes, associated litigation, inadequate home maintenance and damage to the properties, and associated neighborhood collapse, which can create serious losses for mortgage lenders. Anticipating lower costs on these fronts, originators of continuous-workout mortgages may be willing to offer more attractive terms to borrowers from the beginning.

A major innovation like this would need government help. Earlier this year, Congress passed the Housing and Economic Recovery Act, which promised to bail out as many as 400,000 homeowners who could not pay on their mortgages. But the act made no fundamental reform of the mortgage market and included no plan to prevent more of the same problems from appearing.

In the past, Congress has been more inventive. During the housing crisis of 1933, for example, Congress created the Home Owners' Loan Corporation to force some fundamental shifts in mortgage institutions. The HOLC swapped its own debt, which was guaranteed by the government, for mortgages of defaulting homeowners, and it reissued mortgages with some important new features. The new loans had a 15-year term and were self-amortizing -- that is, the homeowner made the same fixed payment each month until there was nothing more to pay.

This was a huge change. Until 1933, home mortgages in the United States generally had terms of three to five years, and homeowners had to go back regularly to refinance them. If a mortgage could not be refinanced -- because the homeowner was unemployed or because the price of the home had fallen too much relative to the loan amount -- a homeowner had to pay back all principal, typically a huge payment, or lose the house.

The HOLC changed this, effectively establishing a new conventional mortgage that the private mortgage lending industry then embraced. To this day, long-term mortgages are the norm, and, in fact, 20- and 30-year mortgages have become commonplace (although the popularity of adjustable-rate mortgages with artificially low initial "teaser" rates have exacerbated our housing problems).

The government did not finish the job of improving mortgages in the 1930s, even though some had begun to see what should be done then. In a 1931 article, for example, Professor Irving Fisher of Yale argued that more flexible instruments should be substituted for conventional debt. "The principle of sharing risks must be extended," he said, adding: "Bonds and debts are rigid. We need more elasticity. Then there will be less of 'breaks' and 'crashes' and 'crises.'"

But neither Congress nor the private sector took his advice then. We might not have today's financial crisis if they had grasped back then how to provide such elasticity and had established even better mortgage conventions. We have the intellectual tools to do so now.

Neither presidential candidate has announced a plan to transform our mortgage institutions so they work better for our people. Such plans may not be fodder for election campaigns. They might be implemented after further discussion at the beginning of a new Congress and a new administration. It is time to set the stage for a better mortgage contract.

Robert J. Shiller, Arthur M. Okun professor of economics at Yale and co-founder of MacroMarkets LLC, is the author of "Subprime Solution: How Today's Global Financial Crisis Happened and What to Do About It."

All Revved Up With No Place to Borrow

he era of easy auto loans has come skidding to a halt.

Mortgages were among the first consumer products to be hit by the credit-market freeze. Now car loans and leases are drying up as dealers, auto-finance companies and other lenders are having trouble finding money to lend to car buyers. The upshot: Those with less-than-stellar credit are getting shut out of loans, and even some so-called prime borrowers are having trouble getting financing.

"You have to just about be walking on water to get financed," says Mike Jackson, chief executive of AutoNation Inc., the largest U.S. chain of dealerships. He added that the subprime market is "basically almost closed" but "even with our prime customers, banks are looking for a reason to say no."

AutoNation dealerships sold 532,862 light-duty cars and trucks last year, and this year, amid the credit crunch, that number could fall by as much as 20%, Mr. Jackson says.

For shoppers with good credit, financing is still usually available, especially among healthier foreign auto makers like Toyota Motor Corp. and luxury companies like BMW AG. But overall, financial institutions have become less likely to lend.

Credit unions and so-called captive-finance companies -- the lending arms of major auto makers -- are likely to offer the best chance of getting a loan. Paying down outstanding debt to boost your credit score could also help. And car shoppers should consider turning to the used-vehicle market if they can't get financed, or at least settle for a less-expensive car.

These days, though, even the used-car market can be hard to negotiate. Laura Ryan-Day of Austin, Texas, says she was rejected four times by Wells Fargo & Co. for a loan on a 2006 Honda Element, even though she has no credit-card debt and rents her home, and her credit score is above the national average. Her income as a psychotherapist has been consistently high, she says, and she earned an additional $30,000 last year after she started her own practice.

After she found the car, Ms. Ryan-Day, 32 years old, thought getting a $13,500 loan through Wells Fargo, where she has her checking, savings and two credit-card accounts, would be a snap. "I've had friends take out loans before for a bigger amount with much less hassle," she says.

Ms. Ryan-Day says that Wells Fargo's initial denial stemmed from confusion over her tax returns, which the bank said hadn't been filed. After she found the forms and resubmitted, the bank offered a series of objections to her income and expenses related to her new practice, she says.

Then, nearly two weeks after first applying for the loan, she received a call from Wells Fargo Financial, a subprime unit of the institution. She was quickly approved for a 12.24% APR loan for $14,500, after taxes and fees.

"I really needed the car," says Ms. Ryan-Day. "What else was I going to do?" She hopes to pay the loan off in six months.

"We work hard to ensure the best pricing for our customers while managing risk for the company," a Wells Fargo spokesman says. "Beyond that, we do not comment on customer relationships because they are confidential."

As of Sept. 20, about 64% of auto-loan applications were getting approved, down from 83% during the same period last year, according to CNW Marketing Research Inc., a research firm based in Bandon, Ore. Subprime-application approvals suffered a dramatic drop, falling to about 23% from 67% a year ago, but even near-prime and prime approvals fell somewhat.

When they do get a loan, car shoppers are likely to get less cash from lenders, requiring them to put more money down to borrow -- sometimes 10% to 20% of a car's value. The average down payment on a roughly five-year auto loan in August was $3,067, up from $2,435 a year earlier, according to, an auto-research firm. It's only the second time the figure has exceeded $3,000 in nearly four years.

J.P. Morgan Chase & Co.'s Chase Auto Finance unit is asking buyers for higher down payments and more documentation for loans, a spokeswoman says. Other standards implemented in the past year or so: no subprime loans longer than 72 months and capping all new-vehicle loans at 84 months.

Americredit Corp., a big subprime auto lender, expected to originate about $10 billion in loans between July 2007 and June 2008, but fell short. It now expects to originate about $3 billion for the year ending in June 2009, a spokeswoman says. The firm recently reached a financing deal with Wachovia Corp. for auto-asset-backed security notes it expects to issue in the future. Customers can expect interest rates on Americredit car loans to be two percentage points higher than a year ago, a spokeswoman says.

Customers used to leasing their vehicles will also have to grapple with a tougher financing environment. Detroit's auto makers have scaled back leasing amid big losses on SUVs, which they relied on more than their foreign competitors. Chrysler has stopped leasing altogether.

One piece of good news: With car sales plunging across the industry, you should be able to at least nab a good price. Overall, U.S. sales of light-duty cars and trucks were down 26.6% in September from a year earlier, according to Autodata Corp., a research firm in Woodcliff Lake, N.J. The best deals are being offered by General Motors Corp., Ford Motor Co. and Chrysler LLC, whose sales have suffered the most.

GM's employee-discount program ended last month, but the auto maker plans to offer discounts of up to $7,000 on some models, the company said Wednesday.

A 2008 Ford Edge with all-wheel drive, meanwhile, can be had for a little bit more than $23,500 in many areas after $3,000 cash back, or customers can get 0% financing for 60 months. Even a 2009 Toyota Camry, among the best-selling cars in the U.S., has modest cash-back offers or 0% financing deals in some regions.

Here are a few tips that could increase your chances of getting a new car -- and the financing needed to pay for it:

Negotiate a better price. To get the best price on a new car, you can email dealers for quotes through Web sites such as and Kelley Blue Book's Dealership sales managers know they're competing with other dealer quotes this way and are more likely to give you the lowest price possible.

Do your homework on lenders. Before visiting a dealership, try to get pre-approved for loans at a nearby bank or through Internet lenders such as E-Loan Inc. You'll know whether you can get a loan, and what the terms should look like. Then try to get the dealer to match or beat those terms.

Auto makers' captive-finance arms and credit unions are likely to offer you the best terms. Captive lenders are under pressure to sell vehicles for their parent companies, though Detroit's finance arms have become more discriminating in recent months amid the credit crunch. Credit unions, meanwhile, are in a better financial position these days than larger banks, and will often consider many factors with a customer beyond the litmus-test FICO score.

Improve your credit. Walking into a dealership with a FICO score in the upper 600s to 700 will make your car shopping a lot easier. Check your credit report -- available free from the three credit bureaus at -- for mistakes that could inadvertently lower your score. Pay down debt, especially credit cards. The more maxed-out your credit line is, the more potential for a negative impact on your credit. And, of course, try to come up with a bigger down payment -- the more you put down, the easier it is to get a loan.

Shop the used-car market. Average used-vehicle prices at auction were $9,430 in August, compared with $9,775 a year earlier, according to Manheim Consulting, an Atlanta firm that runs dealer auctions nationwide. Dealers often don't mark these vehicles up significantly. Fuel-thirsty full-size SUVs are auctioning for about $10,500, according to Manheim, 23% lower than a year ago. More efficient entry-level midsize and compact cars are auctioning for about $7,700 and $8,500, respectively.

As bad as the car-loan market is right now, it could get worse -- meaning that waiting too long to buy could be perilous. The federal bailout isn't likely to make car-loan conditions better in the short-term, as financial institutions are apt to be careful with any new infusion of capital, says Rich Kwas, a Wachovia auto analyst.

"Right now I think it's certainly tough, and I think it just gets tougher before it gets better," he says.