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					The Great Mortgage Market Implosion of 2007
        The Evolution of Risk Based Lending

                         By
                 George W. Lawrence
   The Great Mortgage Market Implosion of 2007


                       Table of Contents


Chapter I     Introduction                               Page 5

Chapter II    Pre-depression Years                       Page 11

Chapter III   Lessons from the Great Depression          Page 15

Chapter IV    Recessions of 1973-75 and 1980-82          Page 21

Chapter V     Savings and Loan Crisis                    Page 24

Chapter VI    Recession of 1990-1991                     Page 31

Chapter VII   Post Recession Real Estate Market          Page 34

Chapter VIII Subprime Mortgage Market Explosion          Page 37

Chapter IX    Mortgage Market Implosion                  Page 45

Chapter X     Fraud in Lending                           Page 51

Chapter XI    New Laws for Predatory Lending Practices   Page 61

Chapter XII   Help for Home Owners in Default            Page 67

Chapter XIII Conclusion                                  Page 73


Author: George W. Lawrence
Revised November 20, 2008




                                     1
Notice
This course and materials distributed are intended to assist REALTORS® and other
industry professionals by providing current and accurate interpretation concerning the
subject matter covered. However, no assurance is given that such information is
comprehensive in its coverage of such subject matter or that it is suitable in dealing with
a client’s particular problem or related circumstance. Accordingly, information published
or provided should not be relied upon as a substitute for independent research to original
sources of authority. No accounting, legal or other professional advice is rendered nor is
any responsibility assumed for updating or revising any courses or course materials
presented, distributed or sponsored.

Course Description
This course explores the history of the evolution of real estate lending institutions,
practices and products which led to the credit market crisis of 2007. The author has not
offered an opinion as to the actual cause and effect, if any, of the facts provided as they
relate to the events which unfolded during the past two years or so. Rather it has been left
up to the student to make his or her own conclusion to what extent the historical events
discussed should have offered red flag warnings.

Course Goals

This course is designed to enable students to:
   Develop an understanding of how lending institutions evolved in the U.S.
   Understand the significance of political and economic policies during times of
    financial crisis and how they impacted the housing and lending communities.
   Gain an insight into how and why lenders and Wall Street investors felt comfortable
    in developing and offering risk based loan products.
   Understand the basic process of the secondary mortgage market and packaging and
    selling mortgage backed securities.
   Gain an understanding of how risky subprime mortgage products were able to be
    offered as mortgage backed securities and why the insurers accepted them.
   Understand how the slowing real estate market and rising interest rates in 2004 led to
    the collapse of the subprime market and the eventual credit market crisis.
   Learn the extent to which industry professionals as well as the borrower participated
    in mortgage fraud and the most common activities involving fraud.
   Understand new regulations which have been implemented or will soon be
    implemented to protect the consumer from predatory lending practices, confusion in
    settlement and closing statements, as well as those new provisions designed to better
    educate the mortgage originator.



                                             2
          The Great Mortgage Market Implosion of 2007


I.      Introduction
A.      The Housing Bubble Begins to Leak

        It was fall 2005. After enjoying nearly ten years of relatively low mortgage
        default rates, double digit price appreciation, low interest rates and brisk sales
        activity, the housing market started showing signs of weakness.

        1.       Home sales started a steady downward slide in late 2005 and housing
                 inventory began to rise.

        3.       Prices began to soften in early 2006.

        4.       Significant numbers of subprime mortgage defaults showed up in 2006.

B.      Sub-prime Loan Problems Appear

        A number of factors appear to have contributed to the market's change of
        direction. First both former U. S. Fed Chairman, Alan Greenspan 1, and Freddie
        Mac CEO, Richard Syron ,2 finally acknowledged we had a bubble in housing. So
        called housing bubbles occur when values increase rapidly until they reach
        unsustainable levels as they relate to incomes and other economic factors3.

        1.       In this case “other economic factors” include the Fed’s decision to attack
                 inflation. Beginning in June 2004, embarking on a campaign of systematic
                 rate increases, sixteen in all, the Fed took the fed funds rate from 1% to
                 5.25% before resting. As a result home mortgage rates started to rise late
                 in 2005, going from an average of about 5.75% to over 6.75% by mid-
                 20064. The market, not surprisingly, cooled.

        2.       Then short term fixed rate loans which converted to adjustable after two or
                 three years, referred to as “2/28” and “3/27”, originated starting near the
                 end of 2003 began showing increasing delinquencies.

                 a.       Offered to borrowers with substandard credit, these are loans with
                          moderately higher fixed rates than prime or Alt-A for the first two
                          or three years then become adjustable for the balance of a thirty
                          year term.


1
  "Greenspan alert on U.S. home prices", Financial Times, Sept. 17, 2007
2
  "Subprime Shock Waves", Bloomberg, Sept. 25, 2007
3
  "Housing Bubble Trouble", The Weekly Standard April 10, 2006
4
  "Mortgage Rates Historical Chart: Contract rates of fixed rate mortgages", FHLMC


                                                   3
                   b.      The margins on these ARMs are significantly higher than typical
                           prime ARMs, oftentimes 4 to 6 percent. An initial fixed rate of 7%
                           could jump to 13% or higher.

                   c.      Even before payment resets took place, many borrowers found
                           difficulty continuing to make the initial payments which had rates
                           considerably higher than prime rates and even higher than Alt-A
                           loan rates. Most found it difficult to refinance, having not cured
                           whatever situation it was which led them to these risky loans in the
                           first place. The lucky ones were at least able to sell. But as the
                           slowing market caused values to continue dropping, exacerbated
                           by sellers with sub-prime loans reducing prices in hopes of at least
                           getting out with something, eventually even selling wasn’t an
                           option.

          3.       Foreclosures and the downward trend in both home values and sales
                   gained speed.

C.        Wall Street Mortgage Portfolios Collapse

          It wasn't long before the effects were felt in Wall Street. Lenders originating these
          high risk loans had sold them in the secondary mortgage market to investment
          bankers who in turn used some creative financial engineering to market them.

          1.       They packaged them as residential mortgage backed securities (RMBS),
                   nothing unusual there, but then they sliced them up using a method called
                   Collateral Debt Obligation (CDO) in a way that made them more
                   attractive to investors than the risky subprime collateral should have
                   allowed, and sold them off.

          2.       As real estate values continued their downward adjustment and mortgage
                   defaults increased, pools of mortgage backed securities lost not only their
                   income stream but their value. The investment bank and the investors who
                   purchased them began to see their holdings vanish, and soon all left the
                   marketplace.5

          3.       Not only did the market suffer billions of dollars of losses, subprime
                   lenders no longer had a source to place their loans. They were essentially
                   out of business. Some closed their doors, some filed bankruptcy.6

D.        Home Values Slide

          As these events unfolded, the pace and amount of foreclosure activity increased.
          Home values steadily dropped, eroding the equities of most home owners. Even

5
    "Bear Stearns Hedge Fund Woes Stir Worry in CDO Market", Barrons June 21, 2007
6
    "New Century files for Ch.11 Bankruptcy", MarketWatch April 2, 2007


                                                   4
     credit worthy borrowers who had obtained standard “prime” loans began to fall
     victim to the market. We began to see a “foreclosure driven” real estate market.


E.   The Cost of Foreclosure

     The cost of foreclosure is not limited to the lender or the borrower. Neither is it
     limited simply to financial loss. The stress and emotional impact of a foreclosure
     on the borrowers can be insurmountable. Oftentimes it leads to divorce, illness
     and even suicide. It confuses and displaces children, leaving behind schoolmates
     and neighborhood friends. The financial cost is borne by neighbors and
     government as well. According to an April 2007 study by Senator Charles
     Schumer, (D. NY), and the Joint Economic Committee of Congress, “Sheltering
     Neighborhoods from the Subprime Foreclosure Storm”, the typical cost of a
     foreclosure is:

     1.     Borrower: $7,200 in administrative costs, principal paid and moving.

     2.     Lender: $50,000 in foreclosure expense, property repair, legal fees and
            costs to resell.

     3.     Local governments: $19,227 in lost property taxes, upkeep, sewage and
            maintenance, unpaid utility bills and reduced tax base.

     4.     Neighbors: $1,508 in lost value through neighborhood deterioration due to
            vacant and neglected properties, diminishing security.

F.   Searching for Blame.

     Many are quick to point their fingers at the lending industry, mortgage brokers
     and real estate agents as the exclusive culprits, ignoring the possibility that more
     than a few borrowers knew exactly what they were getting, and a good number of
     them certainly misstated their qualifications.

     While there certainly were a number of those in the industry who engaged in at
     least aggressive if not predatory practices, I would like to think that most of us
     were simply participating in helping the borrower achieve the American Dream
     by way of loan plans designed for those prospective home owners and borrowers
     who had been disenfranchised. In fact as you begin reading what I hope will be an
     interesting journey I think you’ll be surprised by the comments made by members
     of the Federal Reserve actually praising subprime lending!

     Unfortunately, however, there were a few in our ranks who did indeed trade ethics
     for enrichment and gave the media the fuel to paint us all with the same brush.




                                          5
G.   New Programs Increase Market Liquidity, Strengthen Regulation and Offer
     Aid to Homeowners

     Recent and innovative changes implemented by the financial community and
     government agencies offer hope in restoring the confidence to absent investors to
     return and help jump start the mortgage industry. These new programs include:

     1.     The Housing and Economic Recovery Act of 2008, effective October 1,
            2008, increased loan limits for high cost areas for both conforming and
            FHA loans.

            a.     The new permanent limits for Fannie Mae and Freddie Mac
                   include an increase of up to $625,500 maximum loan amount
                   based on 115% of the area’s average housing cost, but not to
                   exceed 150% of the base conforming loan amount, $417,000.

                      For all areas in which 115% of the average housing cost is
                       equal to or less than the base conforming loan amount the
                       maximum loan would be not less than the base conforming
                       loan amount.

     2.     FHA new limits follow the same guidelines and maximum limit based on
            115% of the average housing cost of each Metropolitan Statistical Area
            (MSA, typically an individual county) up to $625,500. If 115% of the
            average housing cost of an MSA is equal to or less than the base
            conforming loan amount the maximum loan would be 65% of the base
            conforming loan amount, or $271,050 (65% of $417,000).

            a.     All down payment assistance programs for FHA, such as
                   Nehemiah, are abolished under the Act.

     2.     The Act also established a new government agency for the oversight of
            Fannie Mae, Freddie Mac and the Federal Home Loan Bank, the Federal
            Housing Finance Agency (FHFA), a world class empowered regulator
            according to the Secretary of the U. S. Treasury, which hopefully will
            offer greater confidence in the investment community of the stability and
            security of the GSEs. However, on September 8, 2008, fearing the GSEs
            were greatly undercapitalized after reviewing what some believed to be
            misleading accounting practices, the U. S. government took direct control
            of Fannie Mae and Freddie Mac, placing them under the control of the
            FHFA as conservator. It remains unclear at this time what the future holds
            for them and therefore for a secondary mortgage market facilitator of
            affordable home loans. Some favor selling them off to become completely
            privatized with no government support, clearing impacting affordable
            housing. Yet others in Congress want to see them become government




                                         6
     agencies, much like FHA. Even others vision them as government
     regulated utilities.

3.   Under the Act, the U. S. Treasury is authorized to buy preferred stock in
     Fannie Mae and Freddie Mac, providing them essentially with an
     unlimited line of credit for a term of eighteen months beginning October
     1, 2008.

4.   The Act provides for rigid regulation of mortgage brokers and other loan
     originators, requiring them to register with the newly established
     Nationwide Mortgage Licensing System and to be licensed under a state
     system to be identified or established by the state’s Secretary of State.

     a.     Originators must submit to a background and credit check.

     b.     They must also complete certain educational courses approved by
            the Nationwide Mortgage Licensing System and Registry and
            successfully pass an approved examination.

     c.     Licenses must be renewed annually, requiring at least eight hours
            of specific continuing education.

     d.     Mortgage originators are defined by the Act as essentially anyone
            who assists a loan applicant or prospective borrower in obtaining
            financing, such as a mortgage broker, mortgage banker and real
            estate agent, except in an administrative capacity such as a loan
            processor unless that person is an Independent Contractor in which
            case registration and licensing is required.

5.   Established a new FHA refinance plan “HOPE for Homeowners”,
     apparently patterned after the 1933 “New Deal” relief and recovery
     program “Home Owners Loan Corporation”, (see Chapter III), to help
     homeowners presently in default or who soon no longer to be able to
     afford the current monthly mortgage payment. This new plan brings $300
     billion in funding to FHA lenders and opens the door to approximately
     400,000 additional homeowners who need help but who may not be
     eligible for FHA Secure.

6.   Independent of the Act, the U. S. Treasury and FDIC announced their
     support and approval of a guaranteed “covered bond” program to
     complement the traditional mortgage backed security industry, designed to
     attract global investors back into the U.S. mortgage marketplace. Treasury
     Secretary Henry Paulson, Jr., said as he announced the program, July 28,
     2008, “We are at the early stages of what should be a promising path,
     where the nascent U. S. covered bond market can grow and provide a new
     source of mortgage financing.”



                                  7
             a.      Major issuers of covered bonds, which actually have been issued
                     by Bank of America and Washington Mutual to a limited extent
                     since 2006, will include Bank of America, J.P. Morgan-Chase,
                     Citigroup and Wells Fargo.

             b.      Covered bonds have been used in Europe since 1769 and
                     historically have offered a greater degree of security to the investor
                     compared to the typical mortgage backed security. Unlike a
                     mortgage backed security which is sold by the issuer and removed
                     from its balance sheet, a covered bond, secured by a pool of loans,
                     remains on the books of the issuer as an asset while the investor
                     receives interest from the issuer’s cash flows.

             c.      A unique feature offering enhanced protection to the investor
                     requires the issuer to replace any loan in the pool which becomes
                     nonperforming with one which is performing.

             d.      Additionally in the event of the issuer’s failure to perform, the
                     investors have recourse to the loan pool, and in the event the pool’s
                     liquidation is insufficient they have a claim against the issuer’s
                     assets.

     7.      Freddie Mac, on August 1, 2008, announced it was doubling the amount
             of money it pays mortgage servicers for each workout that helps a
             delinquent borrower with a Freddie Mac-owned mortgage avoid
             foreclosure, and will reimburse servicers for the cost of door-to-door
             outreach programs, as well as make changes intended to streamline the
             workout process. The compensation for repayment plans will double to
             $500 from $250 while loan modification compensation will increase to
             $800 from $400, effective today. Compensation for short-pay off will
             increase from $1,100 to $2,200. In order to qualify for the reimbursement,
             the mortgage must be at least 90 days delinquent, the servicer has to have
             had no prior contact with the borrower, and the outreach must have been
             done by an independent third party vendor.

H.        Planning for the Future

          To better understand why the financial markets reacted as they did, why
          originating lenders and mortgage brokers felt comfortable in offering risky
          loan products such as sub-prime and Alt-A, to what extent actual fraud on the
          part of brokers and borrowers contributed to the problem, and what the future
          may hold, to the extent we can reasonably guess, taking a look at the evolution
          of real estate lending and how other troubled economic times impacted the
          housing market may offer some meaningful insights and allow the real estate
          professional to better plan his or her business strategies.



                                           8
II.   Pre-depression Years
A.    Early Banks

      It was not until after the turn of the 19th Century that commercial banks began to
      offer long term lending for any purpose, including real estate. Most loans were
      short term, payable in thirty to sixty days, and usually were provided to merchants
      to pay costs of manufacturing or purchasing goods until they could sell them to
      their customers.

      1.     One problem was the political climate in post-revolutionary war America.
             A national banking system as advocated by Alexander Hamilton to pay off
             the federal debt and to offer a uniform and stable currency was fiercely
             opposed by Thomas Jefferson, Secretary of State, who felt it was
             unconstitutional and should be left up to each state. Jefferson also believed
             a central bank would favor industrialism and the wealthy, abandoning the
             nation’s farms and working class. But with President George
             Washington’s support Hamilton succeeded in establishing a banking
             system with the first Bank Act of 1791 and the creation of the Bank of the
             United States. Short lived, its charter expired in 1811 and Jefferson was
             able to prevent it from continuing until the Second Bank of the U.S. was
             established in 1816. It too lost to national banking foes, including
             President Andrew Johnson, and its charter expired in 1832.

      2.     After the Second Bank of the U.S. ceased to exist banking was the
             business of state governments, each issuing its own currency supposedly
             backed by adequate reserves of gold and silver to pay the bearer of the
             bank notes on demand. That wasn’t always the case and in fact was
             usually not the case. By 1860 there were thousands of worthless bank
             notes floating around the country, crippling commerce and short term
             lending. Counterfeiting was rampant and hundreds of banks failed

      3.     Finally with the passage of the National Currency Act of 1863 and the
             National Bank Act in 1864 signed into law by Abraham Lincoln a new
             national banking system was born under the supervision of a “Comptroller
             of the Currency”. Under this new system national banks would buy U.S.
             government securities and place them on deposit with the Comptroller of
             the Currency, receiving in return national bank notes, elaborately engraved
             and with the name of the national bank on it, for example “First National
             Bank of Waverly” or “Merchants National Bank of Providence.”

      4.     Although the Bank Act brought more stability to the nation’s banking
             system, especially in requiring each bank to maintain certain capital
             reserves, there was no actual central federal banking structure to
             adequately regulate the money supply in response to economic conditions.
             The nation was at the mercy of the aggregate total of each individual


                                           9
                   bank’s capitalization. The financial Panics of 1893 and 1907 underscored
                   the problem causing severe financial losses in all markets with no central
                   federal bank available to pour money into the system

           5.      The Federal Reserve Act of 1913 gave the banking system the central
                   control it required with a regulatory body which could monitor and govern
                   the nation’s money supply as necessary. The Act did away with the
                   national bank system with its individual notes and established a central
                   bank which would issue Federal Bank Notes. It provided a more stable
                   source of liquidity for the financial markets and the ability to inject capital
                   into the banking system if needed, including lending

           6.      In spite of the significant improvements resulting from the Federal
                   Reserve Act, it would take the Great Depression to make real estate
                   lending a major part of the business of commercial banks. It is easy to see,
                   therefore, why today’s major home lending institutions evolved from other
                   sources.

B.         Terminating Building Societies

           The real evolution of today’s real estate lending began around the early to mid
           19th century when life and times were simpler. The way we did business was
           simpler as well, and that included financing the family home or ranch. Borrowing
           the concept from the English who had been financing homes through Terminating
           Building Societies since 1775, Americans began forming village based lending
           associations comprised of a town’s citizens who would pool their money for the
           purpose of financing the purchase of homes and farms7

           1.      Most contributors were working class people who generally would not
                   have access to the banking system to finance a home. The terminating
                   society would be created and begin accepting members who would make
                   small periodic savings deposits into it. Once the agreed upon number of
                   members had been reached the society was closed or “terminated” to new
                   members, and the members continued to make savings deposits until a
                   desired amount had been raised, taking usually about ten years.

           2.      The order in which each member had the opportunity to obtain a home or
                   farm loan from the society was determined by ballot or lottery. The winner
                   would receive an interest free loan from the association for about 60% of
                   the home’s purchase price, with the 40% balance coming from the
                   member’s personal contribution account. Repayment was then made to
                   the society, usually in semi-annual installments.

           3.      The concept worked to the benefit of only a portion of the members as the
                   society would run out of money, naturally, before all could obtain
7
    U.S. Dept. of Housing and Urban Development, “Evolution of U.S. Housing Finance System”, April 2006


                                                   10
                  financing. Those remaining would only be entitled to the return of their
                  savings deposits, on which they received no interest. For awhile it worked.

B.        Building and Loan Associations

          Terminating Building Societies became more permanent after a few years,
          referred to then simply as “building societies”, and remained open to new
          members, many of whom had no intention of buying or building a home,
          increasing the chances for others to obtain financing, and leading to the
          development of permanent savings institutions.

          1.      Permanent building societies led to the birth of building and loan
                  associations, the forerunners of today’s savings and loan industry. The
                  first record of a savings institution in the U.S. was the Oxford Provident
                  Building Association in Frankfort, Pennsylvania, established in 1831.8

          2.      The building and loans were community rather than neighborhood based,
                  but still for the most part relied on depositors’ savings accounts to make
                  real estate loans. Unlike the early building societies interest was earned on
                  savings and financing was not interest-free. However, earning the highest
                  return on capital invested was not the most important principle of the
                  building and loan but rather operating in the best interest of all members
                  of the association. Its policy would be continued some years later with the
                  creation of the savings and loan industry and its original public policy by
                  which it was governed.

          3.      Loan terms of both the building societies and building and loans were
                  from 6 to 10 years, offered semi-annual, non-amortizing (interest only)
                  payments and had only adjustable rates. Later loan plans offered ten year
                  amortizing payments with the entire balance due in 3 to 5 years. All
                  programs required 50% down payment.

          4.      Liquidity issues would plague the building and loan industry. Since there
                  was no such thing as a secondary mortgage market place in which a bank
                  or building and loan could sell its mortgage paper, they relied on
                  depositors’ savings accounts and investors contributions to make real
                  estate loans. Once deposits were depleted, they were out of the lending
                  business.

C.        Early Mortgage Backed Securities

          While the securitization of mortgages is generally considered a product of the
          20thCentury, they were used briefly beginning around 1880. Western U.S.
          mortgage brokers would originate farm loans, package them into pools of about


8
    Funk & Wagnalls New Encyclopedia, 2006


                                               11
        $100,000 each and issue debentures (bonds) secured by the loans. They would
        then sell the bonds to Eastern investors and insurance companies.9

        1.       There was considerable risk to the broker who would remain liable to the
                 investor in the event of default, being required to repurchase loans if the
                 borrowers couldn’t bring them current. Default was a constant possibility
                 with inconsistent underwriting practices of the time.

        2.    Securitization lasted only about a decade. Beginning in 1890 several years
              of severe weather took their toll on farm income resulting in numerous
              losses and foreclosures. Then the financial “Panic of 1893” caused the
              entire market to collapse.
        Key Points to Remember:

        1.       Early commercial banks for the most part offered only short term
                 loans, usually to manufacturers and merchants who would repay in about
                 about 30 to 60 days, giving them time to sell to their customers.

        2.       Due to the political opposition to a federal banking system, it would not be
                 until the Bank Act of 1864 and the Federal Reserve Act of 1913 to bring
                 stability to the U.S. banking system and make long term lending a major
                 part of the banking industry.

        3.       Terminating Building Societies, first “community based” institution for
                 savings accounts established for real estate loans.

        4.       Building & Loan associations, first “permanent” savings and loans.
                 Primary emphasis placed on best interests of its members instead of
                 earning greatest return on its capital.

        5.       Typical loan plan of the time was 6 to 10 years, semi-annual interest only
                 payments, some 3 to 5 year terms with 10 year amortization.

        6.       Mortgage backed securities first issued by mortgage brokers in western
                 U.S. in 1880’s, sold to eastern investors, led to numerous defaults due to
                 lax underwriting standards. Disappeared after the financial Panic of 1893.




9
 “Mortgage Companies and Mortgage Securitization in the Late Nineteenth Century”, Kenneth Snowden,
Associate Professor, Bryan School of Business and Economics, University of North Carolina at Greensboro


                                                  12
III.    Lessons from the Great Depression

A.      Then and Now: Similarities and Differences

        History has a way of repeating itself. There are some interesting similarities
        between the Great Depression of 1929 and the current economy. But it’s
        important to understand there are some significant differences as well.

        1.      As pointed out by Marc LaBonte, a U. S. government economist, "the
                (Great Depression does not provide a meaningful comparison to current
                (21st Century) events, as the 1929 economy was characterized by the
                maintenance of a gold standard and little financial regulation”10

        2.      On the other hand we have seen bank failures due to risky investments,
                speculation and easy credit, both then and now.

B.      Easy Credit and Good Times

        One could likely say the root cause of today’s so called subprime implosion was
        easy credit, just as it was during the good times following World War I.11 The
        stock market had become to the average mom and pop investor what real estate
        has become today. Everyone wanted for themselves what the major investors and
        the wealthy were enjoying, a leveraged ride on a runaway stock market, with the
        end to attractive values and profits nowhere in sight. 12 It was the “Roaring
        Twenties” and Americans became hooked on easy credit, businesses and
        consumers alike, with a “dollar down and a dollar a week” allowing them to buy
        homes, automobiles, home furnishings and stocks. Especially stocks.

        1.      Thousands of home owners went to non-banking sources (the sub-prime
                lending community of the time) and pledged the family home in order to
                finance their purchase of stocks. The market was chasing “400” in the
                Dow Jones and everyone wanted to get in on it.

C.      Black Thursday and Black Tuesday

        As it became to be called, “Black Thursday”, October 24, 1929, the stock market
        experienced its first ever catastrophic sell off, followed by its largest losses on
        “Black Tuesday”, October 29, 1929, causing widespread panic. These events were
        preceded by a number of market losses beginning around September.




10
   “The Current Economic Recession: How Long, How Deep and How Different From the Past”?, Marc
LaBonte, Economist, Congressional Research Service, January 10, 2002
11
   "The Great Depression", Robert Samuelson, The Concise Encyclopedia of Economics
12
   Samuelson


                                               13
        1.      It would be ten years before the economy would see any meaningful
                recovery.13

        2.      One of America’s leading economists at the time, Irving Fisher,
                declared shortly before the crash in 1929, “stock prices have reached what
                looks liked a permanently high plateau”. And on October 21, 1929,
                following steady but gradual losses beginning on September 3, 1929 he
                explained, “the market was only shaking out the lunatic fringe”. Both were
                comments which were to cost him his reputation.14

                a.       It’s easy to see how he could have adopted such an attitude.
                         Compare that to our California real estate market, especially before
                         the bubble burst in the ‘90s. Few were worrying about devaluation,
                         and when it started to happen, even fewer thought it would be as
                         severe as it turned out. As it turned out it looks as if we forgot our
                         lessons from the ‘90s as well.

D.      Federal Reserve Bank’s Mistakes

        Just as many thought the initial wave of subprime foreclosures was a mild bump
        in the mortgage market, many economists believed the crash of 1929 would result
        in only a recession, and a short lived one at that. Of course they were proved
        wrong. The market’s slide and the depression which followed was caused, claims
        Federal Reserve Chairman Ben Bernanke, by the result of faulty Federal Reserve
        action, or lack of such action as the case actually was. 15

        1.      The Fed first allowed the expansion of the money supply in the 1920s to
                the extent that it led to a speculative and an unsustainable boom in the
                stock market and capital goods. A bubble to be exact. The Fed failed to
                put the brakes on in time.

        2.      We were enjoying high levels of employment through business growth
                and expansion financed by private debt outside the banking system with
                high interest rates collateralized by mortgages on homes and businesses.16
                And the bubble was primed to burst.

        3.      When the Fed finally decided to slow things down and began raising rates
                in the spring of 1928, for whatever reason they continued to do so through
                a recession that began in August 1929, certainly deepening the economic
                problems and, some believe, actually causing the depression.17


13
   "The Great Depression, America 1929-1941", Robert S. McElvaine, New York: Times Books, 1981
14
   "Irving Fisher of Yale", William Barber, The American Journal of Economics Sociology
15
   "Remarks by Ben Bernanke, H. Parket Willis Lecture in Economic Policy" FDR Library March 2, 2004
16
   "Beckoning Frontiers", (Memoirs of M.S. Eccles, Fed Chairman 1934-1948), Alfred A. Knopf, 1951
17
   "Bernanke", H. Parket Lecture in Economic Policy, FDR Library, March 2, 2004


                                                 14
        4.       On September 3, 1929, the Dow Jones Industrial Average peaked at
                 386.10, then, losing investor confidence and steam it started a downward
                 slide, closing the day at 381.17.

        5.       Over the next month the DJIA lost 17%, briefly recovering about half its
                 losses over the next week. Then on October 24, 1929, Black Thursday,
                 12.9 million shares were traded in a sell-off frenzy, with prices
                 plummeting.

        6.       The following Monday, October 28, 1929, the Dow suffered another 13%
                 loss as more investors sold off stocks.

        7.       Tuesday morning, Black Tuesday, October 29, 1929, the market opened
                 for business only to finish the day with a 12% loss, a record 16.4
                 million shares traded, closing at 230.07 and a 40% total loss since Sept. 3.
                 a.      At the end of the day the market wound up losing $14 billion in
                         value, a total loss for the week of $30 billion, ten times more than
                         the annual budget of the United States federal government, and
                         greatly exceeding what the U.S. had spent in all of World War I.18


E.      Bank Failures Cause Americans’ Savings to Evaporate
        Banks which had invested heavily in the stock market began to suffer losses. It is
        estimated up to 40% of the money supply normally available for purchases and
        bank payments were lost due to bank failures.
        1.       In all 9,000 banks failed during the 1930s.
        2.       It was no wonder that consumers lost confidence in the banking system,
                 withdrawing their savings and hoarding cash. Those who didn’t act fast
                 enough lost all.
        3.       By 1933 depositors saw $140 billion of their savings disappear due to
                 bank failures as there was no deposit insurance. That would happen as one
                 of Franklin Delano Roosevelt’s New Deal programs.19
        4.       As savings accounts became depleted, banks were required to become
                 extremely conservative in lending practices, holding on to reserves.20
                 Businesses, and consumers, encumbered by heavy debt began to suffer
                 with nowhere to go for refinancing.
        5.       Home owners who had financed the family home to buy stock lost
                 everything. With their savings gone and their stock worth nothing (the
                 Dow was down to 41.22 by July 8, 1932), defaults and foreclosures
                 became widespread.

18
   "pbs.org", New York, A Documentary Film
19
   "Farm Prices, Myth and Reality", Willard Cochrane, League of Nations, World Economic Survey '32-'33
20
   "DJIA, 1924-1935", Chart, Eleanor Roosevelt National Historic Site


                                                 15
        6.       The Fed had allowed nearly a one-third reduction in the U. S. money
                 supply. Because of the Fed’s actions what should have been only a
                 recession turned into the Great Depression.21
        7.       Construction work in the housing industry and factory orders in
                 manufacturing plunged.22
        8.       Unemployment jumped from 3% in 1929 to 25% by 1933, and excluding
                 farm payroll was actually over 33%.


F.      The New Deal: Relief and Recovery
        Within 100 days of Franklin Delano Roosevelt assuming office in 1933, his “New
        Deal” act was signed into law. With the aid of a Democratic controlled congress,
        it called for the establishing of 42 new agencies designed to turn the economy
        around by creating jobs and establishing new government programs and agencies
        to promote the general welfare of the American people. Among them were:
        1.       The Securities and Exchange Commission (SEC)
        2.       The Federal Deposit Insurance Corporation (FDIC).
        3.       The Home Owners' Loan Act
        4.       The National Industrial Recovery Act
        5.       The National Housing Act and the Federal Housing Administration


G.      The Home Owners' Loan Act
        In June 1933 the Home Owners' Loan Act was signed into law, establishing the
        Home Owners’ Loan Corporation (HOLC) whose sole purpose was to provide
        relief to homeowners in or nearing foreclosure, similar to today’s “Hope for
        Homeowners” FHA refinance program.
        1.       Under the program, the U. S. government would buy loans in default or
                 foreclosure from the originating bank, paying for them with government
                 bonds with a guaranteed 4% yield. The home owner would then make
                 payments on new refinance loans directly to the HOLC. The HOLC
                 was authorized to make loans for three years, ending in 1936.23
                 a.       Terms were 15 years fully amortized with a fixed rate of 5%
                          interest.
                 b.       Over one million loans were originated.
                 c.       Only 20% of the loans wound up in default and foreclosure.



21
    Bernanke
22
   "The Great Depression", Eleanor Roosevelt National Historic Site
23
   "It's not a Wonderful Life", Andrew Jakabovics, Center for American Progress


                                                   16
H.        The National Housing Act
          Passed in 1934, the National Housing Act established the Federal Housing
          Administration. Its goals were, first, to promote jobs in the housing construction
          trades and related industries, such as building products and suppliers, and
          transportation of materials, second, it was to provide affordable housing through
          government insured loans, with long term financing for both rehabilitation and
          purchases of owner occupied homes.
          1.      The National Housing Act consisted of four major features.24
                  a.      Provide insurance against loss on property improvements.
                  b.      Provide Mutual Mortgage Insurance
                  c.      Establish National Mortgage Associations to buy and sell FHA
                          loans, each with capital stock of at least $5,000,000.
                                 By 1938 no private National Mortgage Association had
                                  been chartered, due to the slow pace of the recovery and the
                                  recession of 1937, whereupon the Federal National
                                  Mortgage Association was created (Fannie Mae), a
                                  government agency, to do the work.
                  d.      Provide insurance for savings accounts with the establishment of
                          the Federal Savings and Loan Insurance Corporation (FSLIC).
          2.      Desperate times called for desperate action. Out of financial crisis, through
                  creative thinking financial wizards developed a unique and novel loan
                  program. With the goal of making home ownership available to all, not
                  just the wealthy or reasonably comfortable, they set about to create a loan
                  program which the average worker could realistically obtain.
                  a.      Before 1934, lenders required 50% down payment and offered loan
                          terms of three to five years maximum. Even before the depression
                          few had the cash resources or incomes to be able to buy a home
                          subject to such loan terms. The Depression eliminated almost
                          everyone else.
                  b.      The first FHA loan plan had a term of 20 years, fully amortized,
                          and a maximum loan to value of 80%.25 The idea was that the
                          typical home owner would work for about twenty years, making
                          small affordable monthly housing payments during the entire term.
                          When it was time to hang up the tools of trade and receive the
                          obligatory gold watch the family home would be paid off.
                                 In 1938, the loan term was extended to 25 years and
                                  allowed up to a 90% loan to value.



24
     "The FHA Story, 25 Years of FHA", Julian Zimmerman, FHA Commissioner, May 1, 1959
25
     Ibid


                                                 17
                           In 1948, the loan term was further extended to 30 years
                            with a maximum allowable loan to value of 95%.
                           In 1957 and 1958 higher loans to value were authorized.
                           In July 2008 FHA loan limits finally were raised to the
                            GSE limits which also had limits increased by fifty percent.
                           Just as the Great Depression led to sweeping changes in the
                            lending industry the mortgage market crisis of 2007 led to
                            significant changes in the FHA program.
      3.     With Fannie Mae in place to buy these new FHA loans, and Mutual
             Mortgage Insurance protecting the profits guaranteed to investors who
             would in turn buy loans from Fannie Mae, Americans in previously
             unheard numbers would finally become home owners.
Key Points to Remember:

1.    Root cause of the Great Depression was “easy credit”, similar to the mortgage
      market meltdown of 2007.

2.    Homeowners refinanced through “subprime” lenders to finance purchase of
      stocks. The 1929 crash saw both the value of stocks decline or evaporate and their
      homes as well.

3.    According to Federal Reserve chairman, Ben Bernanke, incorrect action on the
      part of the Federal Reserve at the time caused what should have been a recession
      to become the Great Depression

4.    Due to the great numbers of bank failures, 9000 in all, depositors saw $140 billion
      in savings disappear. Banks still in business all but ceased lending.

5.    Homeowners still encumbered by heavy debt had few sources for refinancing,
      declining home values made selling difficult. Widespread foreclosures resulted.

6.    Home Owners’ Loan Act of 1933 established the Home Owners’ Loan
      Corporation (HOLC), offered help to homeowners in default. For three years
      bought existing loans from originating lenders and refinanced with government
      loans.
.
7.    The National Housing Act of 1934 established new standards in lending including
      use of leverage, long fully amortized terms. Created a secondary mortgage market
      place for lenders, introduced once again mortgage backed securities to attract
      capital for lending.




                                          18
IV.     The Recessions of 1973-1975 and 1980-1982
A.      Arab–Israeli Conflict Hits Home

        In 1973 the war between Israel and a coalition of Arab states led by Egypt and
        Syria was in full swing. The United States had long been a supporter of Israel and
        had naturally favored Israel in the current conflict. Putting pressure on the West,
        the Arab states retaliated by placing an oil embargo on the countries which were
        supporting Israel, including the United States.26 The effects on the U.S. were
        swift:

        1.       Gasoline prices jumped over 45%, and led to rationing.

        2.       The New York Stock Exchange lost $97 billion in six weeks.

        3.       Factories cut production and laid off workers.

B.      Stagflation: The Fed Makes a Choice between Inflation and Jobs

        As inflation grew the Fed introduced a tightened monetary policy, in spite of an
        increase in unemployment.27 The Fed was more concerned with rising energy and
        food costs, and around the fourth quarter of 1973 the U.S. entered what would
        become its most severe recession since the Great Depression. Five years after its
        recovery in 1975 it would be followed by an even greater recession in 1980.28

        1.       Unemployment increased from 5% in 1973 to 9% by 1975.

        2.       Inflation went from 7% in 1973 to 9% in 1975.

        3.       With stagflation crippling the economy (the combination of high
                 unemployment accompanied by inflation), the Fed had a dilemma: control
                 inflation or address unemployment?29

                 a.       Today we see growing evidence of stagflation. As in 1973, the
                          Federal Reserve Board is faced with the challenge of controlling
                          inflation or growing the economy.

        4.       The Fed decided to attack inflation, and continued on a path of increases
                 to the Fed Funds rate which prolonged the recession and stagflation.

                 a.       The Fed Funds rate, 6% in 1973, jumped to 12% in July 1974.

26
   "The Prize: The Epic Quest for Oil, Money and Power", Yergin (New York: Simon & Shuster 1991)
27
   "Inflation, Recession and Fed Policy", William Poole, Pres., Federal Reserve Bank of St. Louis, Midwest
Economic Education Conference, St. Louis, April 11, 2002
28
   LaBonte
29
   "Shades of Stagflation", Mark Gongloff, CNN/Money, Feb. 21, 2003


                                                   19
                b.       Long term mortgage rates went from 7.5% in early 1973 to 9.25%
                         in mid 1974.

        5.      In late 1974 the Fed began a series of rate cuts which helped bring both
                inflation and unemployment down somewhat, but by mid 1977 inflation
                was creeping up again, and was back into double digits by 1979. 30

C.      The Fed Engineers a Recession to Fight Inflation

        Economic woes simply would not go away in the '70s. Another oil crisis caused
        fuel and energy prices to jump in 1979 and inflation skyrocketed. In the middle of
        all this, the nation's Savings & Loans’ problems were becoming worse.

        1.      By May 1980 inflation was up to 14.4%

        2.      The Fed was fixed on ridding the economy of inflation, and steadily
                increased the Fed Funds rate to over 19% by July 1981.

        3.      The recession that followed was intentionally engineered by then Fed
                chairman, Paul Volker. By tightening the money supply, he sought to
                defeat inflation.31 Home sellers and buyers lost in the process.

        4.      30 year fixed mortgage rates rose to 18.5% by October 1981.

        5.      The prime rate reached 21.5% in June 1982.

        6.      All sectors of the business community felt the effects, and unemployment
                reached 10.8% in December 1982, an all time high since recovering from
                the Great Depression and a rate of 12% in 1941.32

D.      The Fed Opens the Money Supply and the Recovery Begins

        Through a combination of deficit spending and a gradual reduction in the Fed
        Funds rate, the economy began its recovery as 1982 came to a close. Fed
        chairman Paul Volker opened up the money supply and led the nation’s economy
        to a rapid recovery.33 The Fed Funds dropped to a low 5.85% in October 1986.34

        1.      30 year fixed rate mortgages slowly fell to 12% by mid 1985.

        2.      Loan availability due to S&L problems continued to impact real estate
                lending. Home ownership fell from over 65.5% in 1981 to 63.5% in 1986.

30
   InflationData.Com; and U.S. Dept. of Labor: Bureau of Labor Statistics
31
   "Did the Federal Reserve Cause the Recession?", Paul Krugman, New York Times, April 1, 1991
32
   LaBonte
33
   Krugman
34
   "Fed Funds Historical Rate Chart from 1955", Federal Reserve Bank,


                                                 20
Key Points to Remember:

1.    Energy prices contributed to slowing economy, eventual recession.

2.    Stock market suffered significant losses.

3.    Federal Reserve challenged with stagflation, chooses to fight inflation and let the
      economy struggle with job losses.

4.    Fed continues to tighten money supply through 1982 recession, home buyers
      cannot qualify for financing.

5.    Inflation under control by end of 1982, however lending problems persist.

5.    Savings & Loan crisis hampers lending liquidity. Home ownership falls.




                                           21
V.      The Savings & Loans Crisis
A.      The Federal Home Loan Bank System

        Established by the Federal Home Loan Bank Act of 1932 to provide a source of
        liquidity for the Savings and Loan industry, the Federal Home Loan Bank System
        consists of twelve regional Home Loan Banks. Although the Regional Banks were
        federally sponsored, they were owned by stock holdings of the member
        associations of their respective regions, and were supervised by the Federal Home
        Loan Bank Board. In 1933 the Home Owners' Loan Act authorized the FHLBB to
        charter and to regulate the federal savings and loan associations.35

        1.       Legislation for the S&Ls was driven by a public policy goal of
                 encouraging home ownership, unlike that of commercial banks which
                 included commercial and business development.36 The S&L's business
                 was essentially restricted to accepting funds from depositors for savings
                 accounts and originating long term fixed rate residential mortgages using
                 the monies from the savings accounts funds (S&Ls were prohibited by
                 federal law from offering adjustable rate loans until 1981).37

        2.       The next step in the evolutionary process was the creation by the National
                 Housing Act of 1934 (which also created the FHA) of the Federal Savings
                 and Loan Insurance Corporation, providing federal deposit insurance
                 protection for the S&Ls depositors just as the Federal Deposit Insurance
                 Corporation provides for commercial bank depositors. With the birth of
                 the FSLIC, S&Ls could more effectively solicit savings accounts offering
                 federal protection against loss. One difference between the two, however,
                 was that the FDIC was established as a separate agency while the FSLIC
                 was part of the FHLBB.

B.      Weak Examination and Budgetary Restraints Plague the S&Ls

        From its inception, the FHLBB suffered from weaker examination, supervision
        and enforcement practices than those which regulated commercial banks.
        Additionally, it was subject to tight budgetary restraints on staffing and
        compensation, unlike its sister agencies.

        1.       These were all conditions which would lead to a compounding of the S&L
                 crisis as the industry entered the 1980s.38




35
   Watson
36
   Watson
37
   "Savings and Loan Crisis", Bert Ely, The Consise Encyclopedia of Economics
38
   Watson


                                                  22
C.      Regulation “Q” Restricts S&Ls’ Ability to Compete

        Part of the restrictions the government placed on the S&Ls included a ceiling on
        the interest they could offer depositors when Regulation Q (The Banking Act of
        1933) was extended to thrifts in 1966.39

        1.      As we approached the end of the decade in the 70s, the then high inflation
                rate with equally high rates offered by money market accounts caused
                depositors to begin moving their savings accounts away from the S&Ls
                and into high-yield money market accounts.40

                a.      The result was disintermediation caused by income from mortgage
                        loans being less than savings rates they had to pay to depositors.41
                        Although with some deregulation beginning in 1978 and again in
                        1980, the S&Ls could not effectively compete with non-regulated
                        industries offering the high rates of money market accounts. In
                        1981, for example, the difference between savings rates and
                        mortgages was 1%. The S&L would have to lend at a loss!42

        2.      Additionally, most of the S&Ls assets were in the form of low fixed rate
                mortgages in a market with rising rates. With due-on-sale clauses not
                uniformly enforceable at the time, borrowers selling their homes would
                transfer their lower-than-market rate mortgages to buyers, preventing the
                S&L from being paid off and releasing the funds allowing them to loan to
                the buyer, or someone else, at current market rates.43

        3.      As interest rates continued moving higher, the value of these portfolios of
                fixed rate loans being held by the S&Ls moved lower, eroding their capital
                and threatening insolvency.44

D.      Federal Deregulation Backfires

        Savings & Loans began closing their doors as losses mounted. In an attempt to
        forestall further insolvency, the government stepped in with relaxed regulation.45
        In 1980 through 1982, congressional and regulatory action sought to accomplish
        solvency for the S&Ls with four major policy objectives:46



39
   "Congress, Regulators, RAP and the Savings and Loan Debacle", Ahmad W. Salam, The CPA Journal,
January 1994
40
   Jameson
41
   "U.S. Savings and Loan Crisis", Rob Jameson, Sungard Bancware Erisk, August 2002
42
   Ely
43
   Ely
44
   "The 1980s", The Learning Bank, Federal Deposit Insurance Corporation, May 2, 2006
45
   Watson
46
   Salam


                                                23
          1.      Enhance economic survival of the thrifts by reducing its interest rate risk
                  by allowing it to diversify its assets and remove its restriction of lending
                  on only residential real estate.

                  a.      Depository Institutions Deregulation and Monetary Control Act of
                          1980 allowed for the following:
                              Invest up to 20% of assets in consumer loans.
                              Raised deposit insurance to $100,000 from $40,000
                              Offer checking accounts
                              Issue credit cards

          2.      Adopt a policy of forbearance to give the industry time for
                  deregulation to work, thereby avoiding insolvency. Regulators,
                  lobbyist and legislators used a variety of means, including reducing
                  capital requirements.

          3.      Encourage asset growth by allowing higher interest rates on savings
                  accounts through the elimination of Regulation Q.

          4.      Stop disintermediation by the following:

                  a.      Allowed S&Ls to offer 6 month money market certificates

                  b.      Allowed higher savings rates as described above.

                  c.      Passed the Garn-St.Germain Depository Institutions Act of 1982:47
                              Allowed S&Ls to hold up to 40% of its assets in higher
                                 yielding commercial real estate construction and
                                 development.
                              It allowed them to finance up to 100% of commercial
                                 development projects
                              Allowed them to have up to 30% in consumer loans.
                              Allowed them to use land and other non-cash assets as part
                                 of their capital requirements.
                              Authorized them to offer money market deposit accounts.
                              Established a time period of three years to resolve the
                                 enforcement issue of due on sale provisions.




47
     FDIC Learning Bank


                                                24
E.         The Garn-St. Germain Depository Institutions Act of 1982

           Although included in the federal assistance program to aid the failing thrifts, the
           Act would prove to be costly to them.

           1.      The Act provided a moratorium on lenders' ability to enforce due on sale
                   clauses in their notes for home mortgages. In doing so, fortunately for
                   home buyers and sellers, it propped up a sluggish real estate market for a
                   few years by allowing prospective home buyers to take over the low rate
                   in existing loans of sellers without fear of the effects from a due-on-sale
                   action.

                   a.       The downside to the S&Ls was the fact that it was trying to raise
                            much needed capital to keep their doors open by selling off low
                            fixed rate loans on their books at severe discounts.

                   b.       Instead of being paid off at face value on transfer of title when
                            buyers would “take title subject to” sellers existing loans, they
                            were left still holding a low rate note which they would likely have
                            to sell at a discount to continue raising capital. The provision
                            prohibiting enforcement of due on sale was effective from October
                            15, 1982 to October 15, 1985. One bright spot, however, was that
                            the S&Ls could enforce due on sale provisions of all loans
                            originated on or after October 15, 1982.

           2.      Deregulation promoted the rapid growth of new S&Ls. One factor was a
                   new and extremely liberal approval process for new S&Ls. Prior to the
                   1980s charters for new thrifts were approved and granted based on the
                   needs of the community. After deregulation, the "FHLBB and the Office
                   of the Comptroller of the Currency approved any application as long as the
                   owners hired competent management and provided a sound business
                   plan". Thrift assets jumped from $686 billion in 1982 to $1,068 billion in
                   1985, a 56% increase and more than twice that of commercial banks. The
                   industry attracted high rollers and risk takers, including more than a few
                   new owners engaging in fraudulent activities, and many more just plain
                   greedy.48

           3.      With the ability to invest up to 40% of their own assets in commercial and
                   development projects and to finance up to 100% of a project, thrift owners
                   began moving from traditional residential mortgage lending into
                   commercial and business financing which promised greater returns:
                   ethanol plants, wind farms, Las Vegas casinos and commuter airlines.
                   S&L managers had no experience in these types of ventures and weren't
                   capable of adequately evaluating the risk.49

48
     Watson
49
     "Special Report: The Savings and Loan Crisis", Barbara Rudolph, Time/CNN, February 20, 1989


                                                   25
                a.      Thrifts which had invested heavily in energy investments,
                        especially in Texas and California, lost as heavily when oil prices
                        fell 75% from $39 per barrel in 1983 to $10 in 1986. Real Estate
                        markets which collapsed in California took with them the thrifts
                        which had financed them. 50

                b.      S&Ls residential mortgage origination dwindled beginning even
                        before the Garn-St. Germain Act was passed, and from 1978’s high
                        of 78% of assets fell to 56% in 1986 as they concentrated on the
                        prospects of greater profits in commercial projects, which for the
                        most part failed to materialize. 51

F.      S&L Failures Increase from Inadequate Regulatory Examination

        When much of the S&L industry was facing insolvency even as it entered the
        1980s, the FHLBB's enforcement personnel were characterized as under
        compensated compared to those at sister agencies, as well as being understaffed
        and poorly trained.

        1.      A major problem was the enforcement structure itself. Examiners were
                hired by and worked for the Office of Examination of the Bank Board
                while the supervisory personnel, on the other hand, with authority for the
                System itself worked for the FHLBB. Therefore no one really was directly
                responsible for identifying a failing member thrift.52

        2.      1982 would see 73 S&L failures, followed by 51 more in 1983.

        3.      S&Ls continued to fail to the end of the decade, from 65 failing in 1986 to
                190 in 1988. In 1987, FSLIC became insolvent with a $6 billion loss.

                a.      S&Ls lost $30 million each business day.

                b.      A total of 747 FSLIC insured S&Ls had failed by the time it was
                        over, plus an additional 333 “technical” mergers, forced upon them
                        by the regulators. 200 FDIC insured banks failed and the FDIC
                        showed a loss.

G.      The Financial Institutions Reform Recovery and Enforcement Act of 1989

        The S&L industry recovered as George H. W. Bush takes office and announced a
        plan to resolve its insolvency, the Financial Institutions Reform Recovery and
        Enforcement Act of 1989 (FIRREA). Major provisions of the Act include:53

50
   Ibid
51
   Watson
52
   Ibid
53
   FDIC Learning Bank


                                             26
          1.     Abolished FSLIC and established two new insurance funds administered
                 by the FDIC:

                 a.      The Savings Association Insurance Fund

                 b.      The Bank Insurance Fund

          2.     Established the Resolution Trust Corporation (RTC), a temporary agency
                 which administered S&L failures.

                 a.      Funded the RTC with $30 billion from bond sales, $18 billion from
                         the U. S. Treasury and $2 billion from the FHLBB.

          3.     Replaced the FHLBB oversight responsibility of S&Ls with the Office of
                 Thrift Supervision (OTS).

H.        The Cost of the Savings and Loan Crisis

          The final cost of the Savings and Loan crisis is estimated to be $160 billion.54

          1.     Of that the U.S. taxpayers paid $132 billion

          2.     The thrift industry paid $28 billion.

          3.     And then we entered another recession!


Key Points to Remember

1.        Savings and Loans regulatory provisions establish public policy of providing for
          accepting savers’ deposits and for home loan financing, not commercial and
          development projects as with commercial banks.

2.        Savings and Loans suffered from weak examination and regulatory oversight.

3.        In late ‘70s and into the ‘80s high savings rates offered by non-banking
          institutions saw S&Ls depositors withdraw savings for these high-yielding money
          market accounts.

4.        Federal deregulation to aid S&Ls provide little help, and in fact back fire with the
          Garn-St. Germain Act prohibiting due-on-sale enforcement for 3 years for all
          home loans except those originated after the date the Act was signed into law,
          Oct. 15, 1982.



54
     Watson


                                               27
Key Points to Remember, continued:

5.    Deregulation also changed its public policy mission of providing solely home
      financing, with the S&Ls now able to finance risky high leveraged real estate
      commercial projects and developments, wind farms, airlines and oil exploration
      projects, activities in which the S&Ls managers had no experience.

6.    The result was 747 S&Ls closing their doors, another 333 forced into solvency
      through mergers with stable institutions.

7.    The U.S. bails out the S&Ls with the Financial Institutions Reform Recovery and
      Enforcement Act of 1989 (FIRREA).

8.    Cost to the taxpayers is $132 billion.




                                           28
VI.     The Recession of 1990-1991
A.      Primary Victims: Real Estate, Finance, Construction and Aerospace

        In mid-1990 the nation's longest peacetime expansion came to a close. Although
        not as severe as previous recessions, the 1990-1991 downturn would have been
        even milder had it not been for the set of circumstances which propelled the
        economy downward to begin with,55 the Persian Gulf crisis, the Savings & Loan
        failures and subsequent credit crunch in mortgages.

        1.      Cutbacks in defense spending, especially aerospace losing 190,000 jobs

        2.      Unemployment reached 1.5 million jobs by March 1991, the official end
                of the recession. Most job losses occurred in manufacturing, construction,
                the real estate industry, finance, insurance and other related industries.

        3.      New real estate construction and home sales were negatively impacted by
                the Savings & Loan crisis, with tighter access to credit and financing.

        4.      For the first time in our economic history, many of those who lost jobs
                during a recession did not return to the same job or even the same
                industry.56

        5.      Never before did so many white collar employees incur job losses,
                especially in finance, insurance and real estate.

        6.      In addition to white collar job losses, rust-belt industries and aerospace
                manufacturing suffered significant job losses, the effects eventually
                spilling over into just about every occupation.

        7.      New home sales peaked in 1989 then fell 25% through July 1990.

        8.      Existing home sales dropped 16% by January 1991 before recovering.

        9.      Home prices began a gradual decline.

B.      The Fed Takes Action

        Fortunately the recession was relatively short lived, officially lasting from July
        1990 to March 1991. Then as the Fed intervened, triggering lower mortgage rates,
        sales of both new and existing homes began to rise in early 1991.


55
   "Industry Employment and the 1990-91 Recession - Job Losses Compared to Previous Recessions",
Christopher J. Singleton, Monthly Labor Review July 1993
56
   "The 1990-91 Recession: How Bad was the Labor Market", Jennifer Gardner, Monthly Labor Review,
June 1994


                                                29
        1.      The Fed Funds rate dropped from 8.15% in July 1990 to 6.12% in March
                1991. However, long term mortgage rates fell only slightly as the nation
                recovered, from a high of 10.5% in mid-1990 to 9.5% in March 199157

                                        30 Year Fixed Rates          Fed Funds

     25.00%

     20.00%

     15.00%

     10.00%

      5.00%

      0.00%
          73

          75

          77

          79

          81

          83

          85

          87

          89

          91

          93

          95

          97

          99

          01

          03

          05

          07
        19

        19

        19

        19

        19

        19

        19

        19

        19

        19

        19

        19

        19

        19

        20

        20

        20

        20
                     (Chart 1: Freddie Mac Annual Average Mortgage Rates Historical Chart)

                a.       Rates continued to hover between 8.5% and 7.5% until April 1997.

                b.       It was not until late 2001 when we began witnessing the low rates
                         we enjoy today. The rate as of June 2008 stood at 6.32%.

                c.       Chart 1 below shows annual average mortgage rates since 1973.
                         Although the chart reflects annual averages only, the highest
                         monthly average rate during any month in the period was 18.5% in
                         Oct. 1981 and the lowest was 5.25% in June 200358


C.      Businesses Become More Efficient, Result: Unemployment Remains

        Even as the recession came to an end, unemployment in many sectors continued
        to rise as business' streamlined operations shedding unnecessary jobs, resulting in
        a much smaller share of the unemployed returning when the economy improved
        than previous recessions. It would be October 1993 before unemployment would
        return to pre-recession rates.59

        1.      Larger businesses restructured operations emphasizing efficiency with
                fewer employees, tempering the recovery of loss jobs. Many smaller


57
   FHLMC Mortgage Rates Historical Chart
58
   Ibid
59
   Singleton


                                                 30
             businesses simply went away, their owners standing in the unemployment
             lines alongside their former employees.

      2.     Efficiency led to greater labor productivity, reducing the need to increase
             employment.

      3.     Unemployment was at 5.2% at the start of the recession rising to 7.8% in
             June 1992 15 months after it officially end and continued up to nearly 8%
             in mid-1996 before it began its downward trend.

D.    Foreclosures Become Commonplace

      The loss of household income as the recession progressed, combined with a
      decline in home values, eventually resulted in numerous foreclosures.
      Foreclosures are usually one of the last things that appear in a recession, and will
      usually continue after the recession officially comes to an end, and we saw that
      following the recession of 1990-1991.

      1. By 1993, two years after the end of the recession, foreclosures had finally
         became commonplace in California, and did not disappear until 1997.

Key Points to Remember:

1.    1990’s recession, which saw over 1.5 million job losses, was made even more
      severe by the credit crunch in mortgages resulting from the S&L crisis.

2.    Cut backs in defense spending saw 190,000 jobs lost, mostly in aerospace.

3.    Housing construction suffered, causing job losses in housing trades, finance and
      real estate professions.

4.    First time in history the U.S. witnessed significant numbers of unemployed not
      returning to the same industry as business’ streamlined operations to become
      more profitable with fewer employees.

5.    New home sales fell 25% by 1990, existing home sales dropped 16% before
      recovering.

6.    Foreclosures became a growing problem as unemployment lingered.

7.    The U.S. would not work through its REO inventory until 1997, six years after the
      end of the recession.




                                           31
VII. The Post Recession Real Estate Market

A.         Foreclosures and “REO” Become Household Words.

           The relationship between foreclosures and home prices is two directional. Heavy
           foreclosures can both cause and be caused by declining home prices. This was the
           case at the time, with each feeding on the other. California home prices started to
           fall in late 1991, with foreclosure activity increasing steadily beginning in 1992,
           reaching its peak in 1997.60

           1.       In 1996, over four years after the recession ended, mortgage delinquencies
                    hit an all time high and then started a downward trend. As foreclosure
                    activity accelerated, banks and savings & loans became more aggressive
                    in efforts to eliminate "real-estate-owned or REO", the term used to
                    describe real estate acquired by lenders through foreclosure, from their
                    books as well as non-performing loans secured by real estate which had
                    not yet completed, or even entered the foreclosure process.

           2.       Foreclosures and "REO" became household words in the real estate and
                    financial industries. Just about every lending institution and secondary
                    market investor was involved in the process, Commercial banks, savings
                    & loans, the GSE's (Fannie Mae and Freddie Mac), The Department of
                    Veterans' Affairs, The Department of Housing and Urban Development
                    and mortgage insurance companies. They each used a variety of marketing
                    methods to try to satisfactorily dispose of their inventories, which differed
                    among them depending on their own goals and regulatory agency
                    requirements. Marketing strategies included:

                    a.      Listing properties with local real estate agents.

                    b.      Outsourcing management and marketing responsibilities to third
                            party companies.

                    c.      Holding Public Auctions

                    d.      Offering "pools" of properties to investors by bid.

B.         The Broker Price Opinion

           In assessing the marketability of foreclosed properties, lending institutions
           typically will reply upon value representations provided by the real estate
           community. The REALTOR's® research is documented on a form referred to as a
           Broker Price Opinion (BPO), used by banks, the GSEs and asset management
           companies. It was an extremely important and effective tool used by
60
     Office of Federal Housing Enterprise Oversight


                                                      32
      institutional investors who were bidding on large pools of REOs offered by some
      of the larger financial institutions (and especially those in California who were in
      the process of being acquired by Washington Mutual). More limited in scope than
      an actual appraisal, but more detailed than the typical REALTOR's® property
      market analysis, the BPO gave the bank or investor the essential information it
      needed to accomplish its task. The results of the BPO include the following:

      1.     The estimated market value of the property in its "as is" condition.

      2.     The estimated repair and rehabilitation costs, if any, to improve the
             property to a condition compatible with those properties in the
             surrounding area.

      3.     The estimated market value of the property "as repaired".

C.    Lenders’ Marketing of REO Impacts Area Values

      Area home prices became hostage to some banks' sales philosophy. Those
      institutions which adopted a general policy of listing its properties for sale in their
      "as is" condition, and having significant repairs that were not to be performed,
      certainly caused a negative impact on neighborhood home values. Conversely,
      REO properties which were repaired, rehabilitated and priced accordingly helped
      restore and maintain attractive home values in those neighborhoods.

      1.     As lenders worked through their inventories of REOs, more than not
             fortunately began improving their REOs as needed before placing them on
             the market. They wisely realized not only could they demand a higher
             sales price, recovering most or all of their foreclosure loss and repair costs,
             but by doing so they protected the value of the collateral which secured
             other loans they had originated for other homeowners in the
             neighborhood.

D.    Dot-Com Bust Aids Real Estate Recovery.

      By 1998 lenders had worked through most of their REO inventories with sales
      and prices reflecting signs of recovery. Activity steadily increased aided by
      the "dot.com" bust in 2001-2002 which saw investors fleeing the stock market for
      real estate. By 2001, the market had not only recovered completely but was on its
      way to an amazing five year boom in sales and rates of appreciation.


Key Points to Remember:

1.    Foreclosures can both cause and be caused by declining home values.




                                            33
Key Points to Remember, continued:

2.    Foreclosures are typically one of the last things to occur in a recession, and
      continue for some time afterward.

3.    REO became a household word, with lending institutions using a variety of
      marketing strategies to rid them from their books, including using REALTOR®
      services in traditional listing arrangements, as well as using services of the
      emerging third party asset management industry.

4.    Broker Price Opinions appeared in a variety of forms. Fannie Mae BPO becomes
      standard for many.

5.    REO valuation policies held neighborhood home prices hostage.

6.    Following the elimination of most REOs by 1998, the real estate market began a
      rapid recovery, aided in part by the “dot-com” bust during the recession of 2000
      to 2001 which witnessed small investors switching to real estate.




                                           34
VIII. The Subprime Mortgage Market Explosion
A.         Risk Assessment Models, Automated Underwriting Accelerate Lending

           As we emerged from the 1990-1991 recession real estate sales activity accelerated
           with the clean up of foreclosure sales in 1997 and 1998 and home prices started to
           climb steadily. Home buyers adopted an attitude of "buy now before its too late",
           and multiple offers on properties for sale became more common than not. During
           all this a number of changes had occurred in lending practices. Over the past
           decade lenders had introduced new programs in hopes of capturing a greater share
           of the mortgage market place. Using new risk assessment guidelines to implement
           so-called risk-based lending, aided by automated software and underwriting
           models, they placed the loans they offer in the following categories, in order of
           ascending risk:

           1.      Prime conforming: The safest of all, these are loans which are sold to the
                   Government Sponsored Enterprises, Fannie Mae and Freddie Mac, and are
                   for the most part risk free to the lender.

           2.      Prime, non-conforming: Offered to borrowers with good credit who
                   can fully document income, assets and employment information.

           3.      Near prime, usually referred to as Alt-A: Offered to borrowers who have
                   superior credit and who are not usually required to document income and
                   asset information.

           4.      Subprime: Extended to borrowers who are deemed the least creditworthy
                   and carry the highest risk to the lender. Potential borrowers of subprime
                   loans offered a relatively untapped profit source to the lending industry,
                   providing they could find a way to market volumes of them in the
                   secondary market place. To accomplish that would require packaging in a
                   manner which would reduce the impact of their high risk of default.

B.         Wall Street Turns Junk into Jewels

           In 1994 the lending community experienced a sharp rise in prime mortgage rates
           with a resultant slowdown in origination. Mortgage companies and brokers went
           looking for additional sources of business and focused on the subprime market.
           The subprime industry happily responded, armed with new "financial
           engineering" of products which accelerated the sale of subprime loans on Wall
           Street facilitating the brisk pace of sales and the corresponding run up in prices.61

           1.      1994 is generally credited as the year the subprime business took off with
                   origination volume growing from about $50 billion in 1994 to over $665

61
     "What Caused the Housing Bust", Porter Stansberry, Daily Wealth, August 18, 2007


                                                    35
                       billion in 2005 representing over 20% of total loans originated, as shown
                       in Chart 2 below.62
                                                    Subprime Loan Volume

                              $700

                              $600

                              $500

                              $400
                   Billions
                              $300

                              $200

                              $100

                               $0
                                     1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007


                                 (Chart 2: Inside Mortgage Finance Statistic Annual, 2007 Edition,)

             2.        The expansion of Subprime lending allowed millions of Americans who
                       previously would have been denied credit to become home owners, and
                       more than half of the new households were minorities.63 Chart 3 below
                       reflects home ownership’s rise from 64% in 1994 to a record 69% in
                       2005.64

                                               Home Ownership


             70
             69
             68
             67
             66
Percentage
             65
             64
             63
             62
             61
                  1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

                                              (Chart 3: U. S. Census Bureau)

             4.        As the market gained speed and home values rose, growing competitive
                       pressure in the lending industry and the desire for increased profits led

    62
       Inside Mortgage Finance Statistic Annual, 2007 Edition; Freddie Mac historical loan origination
    63
       "Subprime Mortgage Lending: Benefits, Costs and Challenges", Edward Gramlich, Governor, Federal
    Reserve Board (Financial Services Roundtable Annual Housing Policy Meeting; Chicago IL) May 21, 2004
    64
       U. S. Census Bureau


                                                           36
                 many mortgage lenders to deviate from standard underwriting principles,
                 offering a variety of new loan products. 65 Lenders and consumers were
                 aided by a number of new developments and regulations.66

                 a.      Technological innovations, such as automated underwriting.

                 b.      Changes and improvements in some government support
                         programs, such as the Community Reinvestment Act, amended in
                         1995, especially to make smaller institutions more competitive
                         with their larger counterparts.

                                 The amendments aided lenders in increasing loan
                                  origination activity to low and moderate income borrowers.

                                 The CRA also allowed the securitization of subprime loans,
                                  which in itself promoted the relaxation of underwriting
                                  standards.

        5.       Near prime (Alt-A) and subprime loan products were introduced which
                 made it easier for millions of Americans who had been locked out of home
                 ownership to finally get their "piece of the rock".

                 a.      Loan plans, such as piggybacks, reduced documentation, interest
                         only, 100% financing and loans which even exceeded the home's
                         value were rolled out.

        6.       Qualifying standards were revised, offering a variety of loan products to
                 borrowers with substandard credit and less qualifying income and cash
                 savings than typically required. Lenders evidently believed the then
                 current rapid appreciation in the market justified loosening their lending
                 standards.

C.      Credit Scoring and Securitization: Keys to Subprime Success

        In order to originate any significant numbers of these new and unique loan
        programs, the lending community would have to secure new secondary mortgage
        market resources. Two developments gave them the tools they needed and caused
        the rapid growth of subprime lending.67




65
   Gramlich
66
   "Revisiting Traditional Paths to Ownership", Mark Olson, Governor, Federal Reserve Bank of Cleveland
(Community Development Policy Summit, Cleveland OH), June 23, 2005
67
   "The Rise and Fall of Subprime Mortgages", Danielle DiMartino, economics writer, and John Duce, V.P.
and senior policy advisor, Federal Reserve Bank of Dallas, November



                                                  37
        1.      Mortgage lenders adopted credit-scoring to determine borrower eligibility
                for non-conforming loans, including the riskier Alt-A and the even riskier
                subprime loan products. Lenders, using established credit profile models,
                could better determine which borrowers were suitable for appropriate risk-
                based loans, and more importantly satisfy the secondary market
                purchaser's risk assessment. But credit scoring by itself could not
                accomplish the rapid growth of less than prime lending. Additional
                sources of funding were necessary to accomplish the task.68

        2.      Before 1994, most lenders offering subprime loans were those which held
                them in their own investment portfolio. They lacked the capital resources
                to originate and hold large amounts of risky loans so they had to develop a
                way to package them to be acceptable to secondary market investors and
                insurance companies who they would submit for rating to make them
                attractive as “safe” investments to their global investors.

                a.       The secondary market investor may either hold a loan it purchases
                         in its own portfolio, or package it as a residential mortgage backed
                         security (RMBS) and sell it off in shares. But with the additional
                         risk of subprime loans, it would be difficult for a secondary market
                         investor to attract buyers without some extra protection against
                         default.

                b.       One innovative technique is a Collateralized Debt Obligation
                         (CDO), a unique form of RMBS derivative which divides it into
                         multiple risk grades, referred to as tranches, each grade
                         representing the level of risk to the investor purchasing that
                         particular part. A variety of techniques were employed, ranging
                         from CDOs consisting of only subprime loans to those blended
                         with prime loans, even auto and student loans of good quality. The
                         less risky tranches offers lower yields to the investor purchasing
                         them but greater security and protection from loss. Conversely,
                         greater yields are paid to buyers of the higher risk tranches. These
                         levels would incur the first of any losses.69

                                The lender originating the loan would be liable for early
                                 defaults, and typically only those involving fraud.

                                The next defaults would be taken out of what is referred to
                                 as the "equity slice". This equity slice is usually sold at a
                                 significant discount to the investment banker's hedge fund
                                 as a cushion against expected defaults since it remains
                                 uninsured. Therefore, even if the borrowers default the fund

68
 DiMartino and Duce
69
 "Investment Landfill: How Professional Investors Dump Their Toxic Waste on You", Paul Tustain,
Bullion Vault, July 2007


                                                 38
                                 still wins as the discount is typically large enough to cover
                                 anticipated losses in the CDO's value.70

                                After the equity tranche came the next highest risk rated
                                 tranches, typically BB or BBB and offering somewhat
                                 lower yields. Following these came the A to AAA rated
                                 senior levels with the lowest yields. With the safety net of
                                 first liabilities going to the originating lender and then to
                                 the holder of the unrated equity slice, the insurance
                                 companies declared the senior tranches secure and
                                 relatively risk-free allowing them to be rated. Investors
                                 world-wide snatched them up.


                                                                                       AAA+ Tranche receives
                                                                                       lowest yield but absorbs no
                                                                                       loss until all other tranches
                                                                         AAA+          below are liquidated.
                                                                         Tranche


                                                                                               AAA Tranche
                                                                                               receives next lowest
                                                                          AAA                  yield, and absorbs no
                                                                        Tranche                loss until tranches
                                                                 (Absorbs next losses)         below are liquidated.


                                                                                                     Jr. Mezzanine
                                                                 Junior Mezzanine BBB                 Tranche earns next
                                                                        Tranche                       lowest yield,
                                                 (Absorbs next losses. AAA Rated Tranches continue to absorbs loss after
                                                                   receive earnings)                  equity is liquidated


                                                                      Equity Tranche                    Equity tranche
                                                                         Unrated                        receives highest
                                     (Absorbs first losses in income stream. Rated                      yield, all losses
                                     Tranches above continue to receive earnings)                       until liquidated


                                  Losses Absorbed Ascending from Bottom to Top


                              (Chart 4: Example of Collateralized Debt Obligation)

           3.     Wall Street banks made a fortune packaging them. Hedge funds generated
                  what appeared to be risk free profits in the equity tranche for several years.
                  Fund managers kept putting pressure on loan originators to keep them
                  coming.

                  a.     Before 1994, only 32% of subprime mortgages had been packaged
                         as mortgage backed securities. After 1994, with the help of this
                         new financial structuring from Wall Street, securitization of
                         Subprimes reached over 81% by 2005.

70
     Stansberry


                                                           39
                  b.        As a result subprime origination grew from an insignificant share
                            of the total mortgage market to about 9% of the market in 2001,
                            then to over 20% by 2006.71

D.        Home Sales and Prices Skyrocket.

          The real estate buying frenzy was aided by the "dot.com" bust and the short lived
          2001 - 2002 recession, which saw investors leaving the stock market for real
          estate.72

          1.      The new and relaxed underwriting standards added to the accelerating
                  pace of the market. Mortgage denial rates, reported under the Home
                  Mortgage Disclosure Act, dropped significantly from 29% in 1997 to only
                  14% in 2003.73

          2.      The short lived recession of 2000-2001 only slightly slowed the market’s
                  growth, with aggressive increases from 2002 through 2005. See Chart 5
                  below.

          3.      Interest rates at an all time low, well below 6% for most of
                  2003 through 2005, helped fuel the rush to buy and prompted further
                  speculation in housing.74
                                        Number of Homes Sold


                 8000

                 7000

                 6000

                 5000

     Units (000s) 4000

                 3000

                 2000

                 1000

                    0
                         1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

       (Chart 5: U. S. Department of Housing and Urban Development; National Association of REALTORS®)

71
   Inside Mortgage Finance Publications, Inc., The 2007 Mortgage Market Statistical Annual vol. I (IMF
2007 Mortgage Market)
72
   Schiller
73
   "Federal Financial Institutions Examination Council Press Release", July 26, 2004
74
   "Official Says Bad Data Fueled Rate Cuts, Housing Speculation", Wall Street Journal, March 6, 2006


                                                   40
   4.        California homes enjoyed seemingly unending appreciation through 2006
             before declining in 2007. Not since the end of the 1973-1975 recession
             had we seen such rapid rates of appreciation. See Chart 6 below.

                                          California Median Home Prices


600000


500000


400000


300000

200000


100000

        0
        3

             5

                       7

                             9

                                   1

                                          3

                                                5

                                                       7

                                                                9

                                                                      1

                                                                            3

                                                                                   5

                                                                                          7

                                                                                                 9

                                                                                                      1

                                                                                                             3

                                                                                                                    5

                                                                                                                          7
    197

            197

                   197

                            197

                                  198

                                         198

                                               198

                                                     198

                                                            198

                                                                     199

                                                                           199

                                                                                  199

                                                                                         199

                                                                                               199

                                                                                                     200

                                                                                                            200

                                                                                                                  200

                                                                                                                         200
                              (Chart 6: Source, California Association of REALTORS)

   5.        Chart 7 below, based on the Case-Shiller U.S. Home Price Index study
             which shows appreciation, inflation adjusted, from 1890 to present to be
             about 66% (only .4% annually) and most of compressed into the last ten
             years.
                                   U. S. Home Prices Inflation Adjusted 1890-2008

              250


              200


              150


              100


                  50


                   0
                    90

                             00

                                    10

                                           20

                                                  30

                                                         40

                                                                      50

                                                                             60

                                                                                    70

                                                                                            80

                                                                                                   90

                                                                                                             00

                                                                                                                    08
                  18

                           19

                                  19

                                         19

                                                19

                                                       19

                                                                    19

                                                                           19

                                                                                  19

                                                                                          19

                                                                                                 19

                                                                                                           20

                                                                                                                  20




                                         (Chart 7: Home Price Index, 1890 to 2008)




                                                           41
Key Points to Remember:

1.    In 1994 rising home mortgage rates resulted in a significant slowing of loan
      origination and real estate sales.

2.    Searching for new sources of business, mortgage companies and their Wall Street
      partners, using new “financial engineering” discovered an untapped inventory of
      new borrowers in the subprime market.

3.    Innovative, but risky, new loan products caused an explosion in subprime lending.

4.    1994 is generally credited, therefore, as the year subprime year exploded and was
      the primary cause of the brisk pace of sales and rapid run-up in home
      appreciation.

5.    Many, including the Federal Reserve, at first praised subprime lending as making
      home ownership available to millions of Americans who had previously been shut
      out of the housing market.

6.    Subprime lending accelerated due to a number of innovations, including
      automated underwriting, credit scoring and new risk based underwriting in both
      loan origination and the packaging and rating of their corresponding mortgage
      backed securities as CDOs.

7.    Subprime securitization jumped from 32% in 1994 to over 81% by the peak of the
      market, 2005, and home ownership followed pace going from 64% in 1994 to
      over 69% in 2005. Low prime rates also aided the market’s pace, especially
      between 2003 and 2005.

8.    Mortgage denial rates dropped during the period from 29% in 1997 to about 14%
      in 2003, mostly attributed to subprime origination.

9.    Home sales and prices continued to rise sharply, especially from 2001 through
      most of 2006 before declining in 2007.




                                          42
IX.     The Mortgage Market Meltdown

A.      Subprime + Stated Income = Default

        In late 2005 the real estate market started its journey downward. A number of
        factors contributed. Economists, the Fed, Fannie Mae and others pointed out that
        there was indeed a housing bubble and it could no longer be sustained. One cause
        was the Fed’s war on inflation, with sixteen rate hikes taking the fed funds rate
        from 1% in June 2003 to 5.25% by June 2006. Mortgage rates followed the
        upward climb. Then short term fixed rate loans which converted to adjustable
        after two or three years, referred to as “2/28” and “3/27”, originated starting near
        the end of 2003 began showing increasing delinquencies. Even before payment
        resets took place, many borrowers found difficulty continuing to make the initial
        payments which had rates considerably higher than prime rates and even higher
        than Alt-A loan rates. (Although the media commonly reported payment resets
        were the major cause of default a government study and report would contradict
        them).

        1.       Government research found the primary cause of default was the result of
                 the lender’s extension of credit on the basis of stated income without
                 verification. Low-doc loans, the study showed, accounted for over 40% of
                 all Subprime loans by 2006. The majority of subprime borrowers who
                 defaulted became delinquent even before payment resets occurred.75

                 a.      The numbers may not be completely accurate since there is no one
                         system which tracks originations from all sources. For example,
                         economists for the Federal Reserve Bank of Dallas reported
                         originations of "low-doc" or "no-doc" loans accounted for 81
                         percent of Alt-A, 55 percent of jumbo, 50 percent of subprime and
                         36% of prime securitized loans.76

        2.       The rapid growth of these loans, with some 5 million originated between
                 2003 and mid-2007, can be singled out as one of the likely cause of the
                 crisis in the mortgage market and some say the primary cause.77

        3.       Adjustable rate subprime loans originated in late 2005 and in 2006
                 have performed the worst due to "the slippage in underwriting standards,
                 high loan-to-value ratios, and incomplete documentation", according to
                 Fed Chairman Ben Bernanke.78

75
   U.S. Gov’t Accountability Office, GAO-08-78R, “Information on Recent Default and Foreclosure Trends
for Home Mortgages and Associated Economic and Market Developments” , 2007;Fannie Mae, “Weekly
Economic Commentary”, Mar. 26, 2007
76
   DiMartino and Duce
77
   "The Importance of Loss Mitigation Strategies for Keeping Families in Their Homes", Michael
Krimminger, Special Advisor for Policy, Office of the Chairman, FDIC, Los Angeles, CA Nov. 30, 2007
78
   Bernanke, "Housing"


                                                 43
                a.      It is clear the relaxed underwriting standards which allowed for
                        reduced documentation loans certainly played a major role in the
                        increasing foreclosure activity.

        4.      The vast majority of borrowers faced with high reset payments of loans
                originated as late as 2004 had sufficient equity as rising home prices
                allowed them to at least sell if not refinance and avoid foreclosure.79

        5.      The effect of home prices finally reaching an unsustainable level took its
                toll on homeowners' equity. As more homeowners' payments reset at
                levels beyond their ability to pay, the softening of values combined with
                increasing interest rates impeded refinancing as a way out.80

        6.      An additional factor which contributed to the heavy default problem was
                most did not require impound accounts for tax and insurance. A recent
                study by the Home Ownership Preservation Initiative in Chicago found
                that for as many as one in seven low-income borrowers facing difficulty in
                managing their mortgage payments, the lack of escrow of tax and
                insurance payments was a contributing factor.

        7.      Rising mortgage rates beginning in the summer of 2005 added to the
                market's weakness. Loan quality problems started showing up in growing
                numbers, and lenders began tightening underwriting standards.

                a.      As lenders continued cutting back, returning to traditional risk
                        assessment guidelines, eliminating subprime loan products and
                        tightening standards for both Alt-A and prime loans, housing
                        activity fell, followed by prices in mid-2006.

                b.      By spring 2007 the market witnessed increased delinquencies and
                        foreclosures,81 with most of the defaulting loans having been
                        originated between July 2005 and September 2006.82

                c.      Delinquency rates for subprime and Alt-A loans underwritten in
                        2006 greatly exceeded those originated in 2004.

                d.      By the end of the first quarter 2007, the rate at which subprime
                        loans entered foreclosure rose at its fastest pace since tracking of
                        the data began in 1970.83



79
   Krimminger
80
   "Housing, Housing Finance, and Monetary Policy", Ben Bernanke, Chairman Federal Reserve Bank,
Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole Wyoming, August 31, 2007
81
   DiMartino and Duce
82
   Krimminger
83
   Ibid


                                               44
        8.       With home prices continuing a slow downward adjustment and inventories
                 of both new and resale homes rising, increasing numbers of homeowners
                 were not able to sell their way out of trouble, and "the outlook suggests
                 foreclosures will increase for some time"84

B.      Weakness in Financial Markets Cripples Mortgage Funds

        The growing economic crisis was not to be confined to the housing market and
        lending industry. Their weaknesses carried over into the financial markets on
        Wall Street, causing a thinning in trading of subprime mortgage backed securities.
        Downgraded by the rating agencies, market investors raised the yields they
        required on risk premiums for nonprime mortgages. One result was a spike in
        jumbo interest rates for even prime mortgages.85

        1.       Jumbo rates jumped an entire one percentage point between June and
                 August 2007, further impacting the already slowing real estate market.

        2.       Investors concerns about mortgage credit markets intensified, primarily
                 over the impending resets of 2/28 and 3/27 adjustable rate loans.

        3.       Losses began to cripple the financial markets, leading to the virtual
                 cessation of subprime lending. In June, 2007 two mega hedge funds
                 collapsed. On July 10, $12 billion of subprime backed securities were
                 downgraded, followed by another $1 billion on August 7.86

        4.       With billions of dollars in hedge funds liquidated or wiped out as a result
                 of the collapse of their equity slices, and the subsequent downgrading of
                 the rated tranches, fund managers had to sell the underlying residential
                 mortgage backed securities and CDOs.

        5.       As market conditions worsened, and more hedge funds suffered, they too
                 having to liquidate, fund values dropped. CDO buyers were few, and then
                 disappeared.

        6.       Since then, essentially no CDO or other subprime mortgage backed
                 securities have been issued. Investors abandoned not only subprime loans
                 but even jumbo and "Alt-A" issues have fallen sharply as well since July
                 2007.87 Subprime loan origination fell to 7.8% of total loans originated in
                 2007.

        7.       Subprime originators lost their secondary market place and their Wall
                 Street connection with its global investors’ CDO shares now valueless.

84
   Ibid
85
   Ibid
86
   Stansberry
87
   Bernanke, (Housing)


                                              45
           8.      Most major lenders cancelled their subprime lending business. According
                   to a recent speech by Ben Bernanke, Chairman of the Federal Reserve
                   Bank, "a number of (lenders) that specialized in nontraditional mortgages
                   have been forced by funding pressures to scale back or close down".88
                   By October 2007, many nonbank lenders have imposed more rigid
                   standards or have left the business entirely.

           10.     41% of banks tightened prime loan standards and 56% for subprime loans.


C.         Pay-Option ARM Resets Possibly Next Wave of Foreclosures

           Foreclosure fallout and its economic consequences from impending ARM resets
           coming due between years end 2007 and December 2008, an anticipated $330
           billion, if borrowers cannot meet the reset payments will be significant.89. The
           next wave of potential defaults appearing on the horizon consists of the "pay-
           option" ARMs which feature the possibility ("probability", more likely) of
           negative amortization. These usually are not subprime loans but rather are prime
           and Alt-A, originated for borrowers with good credit at the time. As seen in the
           chart below, resets should begin in volume by late 2008 and peak by mid 2010,
           following subprime ARM resets diminishing by mid to late 2008. (See Chart 8)

                                                            ARMS Forecast to Reset


                  50
                  45
                  40
                  35
                  30
      $ Billion   25
                  20
                  15
                  10
                   5
                   0
                       Jun-08




                                                   Mar-09

                                                            Jun-09




                                                                                        Mar-10

                                                                                                 Jun-10




                                                                                                                            Mar-11

                                                                                                                                     Jun-11
                                          Dec-08




                                                                              Dec-09




                                                                                                                   Dec-10




                                                                                                                                                       Dec-11
                                 Sep-08




                                                                     Sep-09




                                                                                                          Sep-10




                                                                                                                                              Sep-11




                                                            Subprime                   Pay Option


                                (Chart 8: First American Loan Performance, ARM Resets Forecast)



           1.      The inherent risk of the pay-option ARMs is the negative amortization
                   which occurs when the borrower makes only the minimum monthly

88
     Ibid
89
     Krimminger


                                                                                       46
                payment based on the extremely low "teaser" or start rate, which can be as
                little as one-third the amount of the actual full monthly payment.

        2.      Most of these loan plans allow the borrower to make this minimum
                payment for up to five years or until the negative amortization reaches
                115% of the original loan amount at which time the payment will reset.

                a.       The new payment is based on the actual note rate, likely to be at a
                         rate 5% to 6% over the start rate, with the accrued negative
                         principal added to the original principal, and then amortized over
                         the remaining term of the loan, 25 years in the case of an original
                         30 year term.

                b.       Over 75% of pay-option borrowers make only the minimum
                         payment.90

        3.      Compounding the risk is the fact that most of these plans also allow for
                reduced or stated-income documentation in which the borrower's income
                is not verified. A recent survey revealed the following:91

                a.       Over 80% of pay-option ARMs are stated-income

                b.       Over 90% of borrowers exaggerated their income on stated-
                         income applications by at least 5%.

                c.       Over 60% of these borrowers exaggerated their income by
                         50% or more.

        4.      Borrowers who obtained pay-option ARMs under stated-income
                plans, and who chose to exaggerate their income to qualify, will
                likely become foreclosure casualties. Certainly if they couldn't
                afford the payment based on the note rate to begin with they will
                not be able to afford the much higher reset payment unless their
                employment income has increased significantly.

        5.      As home values have declined, in some areas substantially over the past
                two or three years, many home owners will find they have insufficient
                equity to refinance and may even find selling impossible.

D.      Market Forecast

        The market's impact on new home sales and the building industry offers bleak
        news. Sales cancellations have skyrocketed, new buyer traffic has slowed, and

90
   "Straight Talk on the Mortgage Mess from an Insider", Herb Greenberg, DowJones Market Watch, News
and Commentary, Dec. 6, 2007
91
   "IRS Tax Return Survey", Mortgage Asset Research Institute, Inc.


                                                47
        with the lending community's tightening of credit standards many builders have
        offered large discounts and special incentives, resulting in prices plunging 8.6%
        in October 2007. Analysts are looking for growing declines in both sales and new
        construction, with the recovery extending a few months longer.92

        1.      California's housing slump and mortgage difficulties have spread to
                related industries, primarily construction with employment down over
                16% from the previous year.93

        2.      Job losses have also extended beyond housing, showing up in retail
                businesses, especially building material and garden equipment stores.94
                Continuing job losses will no doubt further increase delinquency and
                foreclosure activity but by an amount which cannot be easily or accurately
                predicted.



Key Points to Remember:

1.      The housing bubble, which many thought did not exist, finally burst in late 2005,
        due in part to sixteen rate hikes by the Federal Reserve as it tried to fight inflation.
        Mortgage rates began to climb, slowing the real estate and lending markets.

3.      Defaults in 2 and 3 year fixed subprime loan plans began to appear in 2006 and
        2007, especially those whose payments had reset at high adjustable rates. With
        home values steadily declining many borrowers could not refinance or sell,
        foreclosures mount.

4.      Foreclosures triggered severe losses among Wall Street investors who had
        purchased MBS bonds. Hedge funds collapsed, losing billions of dollars.

5.      Global investors, damaged and with CDO shares worthless, left the mortgage
        market resulting in the virtual evaporation of loan liquidity.

6.      Pay-option ARMs feared to be the next wave of foreclosures as payment resets
        begin in great numbers by mid 2008, expected to peak by mid 2010.

7.      Most of these borrowers made only the minimum payment causing negative
        amortization, and with declining home values added to the negative amortization
        most pay-option borrowers have difficulty refinancing or selling.




92
   "Housing Chartbook: December 2007", Mark Vitner, Senior Economist, Adam York, Economic Analyst,
Wachovia, Economics Group Special Commentary, Dec. 11 2007
93
   Krimminger
94
   Ibid


                                               48
X.         Fraud in Lending
A.         Extent of Fraud Not Completely Known

           The extent to which fraud played a role in the collapse of the mortgage market is
           not actually known since there is no single tracking source according to the
           Federal Bureau of Investigation. The Mortgage Bankers’ Association estimates it
           exceeds 10% to 15% of all loans, including prime and Alt-A. The relative fraud-
           loss rate of Alt-A loans was more than three times higher than nonprime loans.

B.         Fraud for Property vs. Fraud for Profit

           The Federal Bureau of Investigation distinguishes between “fraud for property”
           and “fraud for profit”. The former usually involves only the borrower whose sole
           purpose is to buy and hold the property. Fraud for profit, however, typically
           involves a real estate agent, mortgage broker, appraiser or some other industry
           professional whose primary goal is income driven. A recent study by the FBI and
           the U. S. Treasury revealed the following statistics regarding fraud.95 It was
           refreshing to see the low percentage of REALTOR® participants!

           1.       Fraud for Property.

                    a.       Represented up to 20% of all loan fraud

                    b.       Involved a borrower obtaining a single loan.

                    c.       The loan application had few misrepresentations.

                    c.       The borrower intended to make the loan payments.

                    e.       The borrower participated in 87.06% of cases with the mortgage
                             broker participating in 58.55% of cases.

           2.       Fraud for Profit.

                    a.       Represented up to 80% of all loan fraud with at least one industry
                             professional being involved.

                    c.       The FBI reported during a sting operation conducted between
                             March and June 2008 the Agency arrested 406 mortgage brokers
                             for fraud.

                    d.       The borrower participated in 60.66% of cases and the mortgage
                             broker participated in 62.07% of cases

95
     Federal Bureau of Investigation, Statistics on lending fraud, 2005


                                                       49
       C.        Fraud by Participant

                 The Department of U. S. Treasury Financial Crimes Enforcement Network
                 report of April 2008 identified the following level of participation in fraud as
                 shown in chart 9 below:96

                                                     Fraud Percent by Participant


                 120

                 100

                 80

                 60

                 40

                 20

                  0
                            Income Fraud      Documents         Occupancy         Appraisal    Straw Buyers         Flipping

 Appraiser                      6.18               3.23              16.47          92.67             25              100
 Borrow er                     87.12               83.06             70.2           39.22             69             58.33
 Mortgage Broker               64.13               68.15             61.96          48.71             66             68.75
 Real Estate Agent              1.18                 1               1.57           2.59              4               6.25
 Seller                         1.58               1.61              7.84           11.21             21             29.17
 Investor                       6.18                 1                20            9.48              11             14.58

                                       Appraiser    Borrow er   Mortgage Broker   Real Estate Agent   Seller   Investor

                        (Chart 9: U. S. Dept. of Treasury, Financial Crimes Enforcement Network, April 2008)

D.          Fraud by Activity

            The Federal Bureau of Investigation has identified the following as the primary
            types of loan falsifications in the fraud cases investigated by the agency.

            1.         Altered bank statements.

            2.         Altered or fraudulent income documents, such as pay-stubs, W2s and tax
                       returns.
                       a.         Applications with misrepresentations were also five times as likely
                                  to go into default. Many of the frauds were simple rather than
                                  ingenious.


96
     U. S. Dept. of Treasury Financial Crimes Enforcement Network, Mortgage Fraud Report April, 2008.


                                                                50
                   b.      In some cases, borrowers who were asked to state their incomes
                           just lied, sometimes reporting five times actual income; other
                           borrowers falsified income documents by using computers.

           3.      Fraudulent letters of credit or gift.

           4.      Misrepresentation of employment.

           5.      Altered credit scores.

           6.      Invalid social security numbers.

           7.      Silent seconds.

           8.      Failure to disclose all debts or assets.

           9.      Mortgage brokers using identities of past clients to obtain loans for other
                   borrowers who could not qualify.

           10.     Fraudulent appraisals, especially in property flipping.

                   a.      Appraisers failed to use comparable properties to establish
                           property values;

                   b.      Appraisers failed to physically visit the property and based the
                           appraisal solely on comparable properties, i.e., the actual condition of
                           the property was not factored into the appraisal;

                   c.      Appraisers participated in a fraud scheme such as flipping

                   d.      A licensed appraiser’s name and seal were used by unauthorized
                           persons.

                   e.      Ninety-percent of licensed appraisers, according to the 2007
                           National Appraisal Survey, indicated they had felt the pressure to
                           restate appraisals in order to “hit a certain property value”, up from
                           55% in 2003.97

           11.     Forged documents.

                   a.      Borrowers forged co-owners’ signatures to loan documents (most
                           often one spouse forging the other spouse’s signature without prior
                           knowledge or permission);



97
     October Research Corporation, 2007


                                                  51
                b.       Loan closing services forged applicants’ signatures on loan
                         documents (possibly to expedite the loan process); or

                c.       Builders forged borrowers’ names on loan draw documents.

        12.     Occupancy was the most common type of fraud activity regarding
                intended use, with borrowers wanting to obtain the more attractive owner-
                occupied interest rates.98
        13.     Other fraudulent activity reported by the FBI in its investigations:
                a.       Loan closing services failed to properly disburse loan proceeds or pay
                         off underlying property liens, including prior mortgage trusts.

                b.       Loan settlement officers were also reported for failure to pay
                         insurance premiums from funds collected at settlement.

                c.       Borrowers signed multiple mortgages on the same property from
                         multiple lenders. The mortgage settlements were held within a short
                         period of time to prevent the lenders from discovering the fraud.

                d.       Loan closing services failed to record the mortgage.

                e.       Prior lenders failed to release home equity loans in land record offices
                         after receiving mortgage pay-off, causing the new lender’s loans to
                         have a subordinate position. Homeowners continued to use the prior
                         lines of credit in addition to the new loan to obtain an extension of
                         credit that exceeded the property value

                f.       Violations of the Mortgage Broker Practices Act by mortgage brokers
                         who abused the terms of a power of attorney.

                g.       Mortgage brokers or correspondent lenders failed to ensure all loan
                         documentation was properly signed.

                h.       Real Estate Settlement Procedures Act (RESPA) violations by lenders
                         accepting kickbacks from mortgage brokers.

                i.       Non-arm’s-length sales occurred when parties to the real estate
                         transaction failed to disclose relationships between the buyers and
                         sellers. Knowledge of a non-arm’s-length sale would alert lenders to
                         scrutinize loan packages more carefully.

                j.       Elder exploitation where older individuals were persuaded to sign
                         loan documents without understanding borrower rights and
                         responsibilities under applicable federal and state law.

98
  U. S. Department of Treasury, Financial Crimes Enforcement Network, Fraud Report, November 2006,
and April 2008.


                                                52
               k.          Unofficial loan assumption occurred when property ownership was
                           transferred without the knowledge of lenders. This could indicate that
                           a straw buyer was used to obtain the loan, with the property title being
                           transferred to the actual owner after the loan disbursement.

               l.          Theft of debit card or convenience checks associated with home
                           equity lines of credit.

               m.          Fraudulent bankruptcy filings to stall or prevent foreclosure.

               n.          Suspected use of real estate purchases to launder criminal proceeds.

E.      Number of Fraud Cases Reported.

        The U. S. Treasury report indicated an increasing number of lenders are filing a
        “suspicious activity report” (SAR) to the Department before funding loans. Chart
        10 below reflects SAR filings since 1996.

        1.     SAR filings increased 454% since 2003, with 52,868 filed in 2007.

        2.     In California, SAR filings increased 71.3% between 2006 and 2008,
               second only to Illinois which had a 75.8% increase.
                                 Mortgage Fraud Reports Filed

              60000

              50000

              40000

              30000
     Cases

              20000

              10000

                      0
                          1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007


                    (Chart 10: U. S. Treasury Department, Financial Crimes Enforcement Network)



        3.     The Treasury presently has 1,409 cases pending investigation.

        4.     The IRS independently has 223 cases pending, having prosecuted 881
               since 2005.


                                                   53
        5.       The IRS average incarceration rate is 87.7%, with an average incarceration
                 time to serve of 43 months.

        6.       Mortgage brokers initiated the loans on 58% of the fraud filings.

F.      The Role of Mortgage Brokers and Real Estate Professionals in Fraud

        Not only does fraud for profit include at least one industry professional as
        explained earlier, but according to the FBI’s research, mortgage fraud in a
        depressed housing market often involves perpetrators who take advantage of
        lending industry personnel attempting to generate loans to maintain current
        standards of living. Those who succumb to the schemes sacrifice not only their
        integrity, ethics and honesty, but if caught suffer the obvious consequences, loss
        of licenses, possible imprisonment and fines, and the devastating effects on their
        families.

        1.       Paul Leonard, California Office Director for the Center for Responsible
                 Lending, in testifying before the California Senate Banking Committee,
                 March 26, 2007, stated “Brokers often determine whether subprime
                 borrowers receive a fair and helpful loan, or whether they end up with a
                 product that is unsuitable and unaffordable. Unfortunately, given the way
                 the current market operates, widespread abuses by mortgage brokers are
                 inevitable.”

                 a.       Leonard also said, “While brokers in California have a common-
                          law fiduciary duty to borrowers, the subprime mortgage market, as
                          it is structured today, gives brokers strong financial incentives to
                          sell excessively expensive loans to borrowers.”

        2.       Federal Reserve Board Chairman Bernanke recently noted that placing
                 significant pricing discretion of mortgage loans in the hands of financially-
                 motivated mortgage brokers can be a prescription for trouble, as it can
                 lead to behavior that violates fair lending laws.99

        3.       Broker-originated loans, according to Harvard University’s Joint Center
                 for Housing, are also more likely to default than loans originated through a
                 direct lender’s retail store. Mortgage brokers, they said, “who are
                 responsible for originating over 70 percent of loans in the subprime
                 market, have strong incentives to make abusive loans that harm
                 consumers, and no one is stopping them.”100



99
   Remarks by Federal Reserve Chairman, Ben Bernanke, Opportunity Finance Network Conference,
Washington D.C., November 1, 2006
100
    Joint Center for Housing Studies, “Credit, Capital and Communities: The Implications of the Changing
Mortgage Industry for Community Based Organizations”, Harvard University.


                                                   54
     a.     The report concluded, “In recent years, brokers have flooded the
            subprime market with unaffordable mortgages, and they have
            priced these mortgages at their own discretion. Given the way
            brokers operate today, the odds of successful homeownership are
            stacked against families who get loans in the subprime market.”

4.   With reports and articles expressing the foregoing, possibly without
     supporting evidence, honest, reputable and ethical lenders, mortgage
     brokers and REALTORs® are faced with growing mistrust by the public
     and even regulatory agencies.

     a.     In his testimony before the California Senate Banking Committee,
            Leonard cited that “California’s mortgage laws do not establish
            even the most basic protections for underwriting and the
            Department of Corporations has never examined the underwriting
            criteria used by state-regulated mortgage originators.” Moreover,
            he said, “the Department’s 25 mortgage licensee examiners could
            not possibly be adequate to monitor the activities of some 4,800
            licensees originating $150 billion in mortgages each year. Nor is
            an examination schedule of once every four years likely to be
            sufficient to evaluate the activities of an industry with a remarkable
            capacity for product innovation.”

            b.      While it appears Leonard was referring to Department of
                    Corporation licensed mortgage brokers and not DRE
                    licensed, it is unfortunate he did not make that clear in his
                    report. He failed to report on the rigid and thorough
                    regulatory control by the California Department of Real
                    Estate and the Commissioner over licensed real estate
                    professionals, including examination, licensing and
                    continuing education standards to which real estate
                    licensees are subject.

5.   Real estate professionals, REALTORs®, appraisers and mortgage brokers,
     however, have indeed participated in instances of misrepresentation and
     fraud, both with and independent of the borrower. It is true, unfortunately,
     that not all real estate agents are concerned about fulfilling their fiduciary
     responsibilities to their principals nor have they all adhered to what should
     be their “principles”.

6.   According to a June 2008 IRS Criminal Investigation Report, Federal
     investigators have identified an increase in frauds and schemes in the real
     estate business. These schemes victimize individuals and businesses,
     including low-income families lured into home loans they cannot afford,
     legitimate lenders saddled with over-inflated mortgages and honest real
     estate investors fleeced out of their investment dollars.



                                  55
     7.     As an example of the current fraud cases being prosecuted by the Dept. of
            Justice, a joint investigation conducted by the Los Angeles FBI Office and
            HUD-OIG illustrated an extensive scheme in which fraudulent
            identification and employment documents were used to perpetrate
            mortgage frauds. The scheme was largely assisted by an individual who
            regularly manufactured false identity and income documents for a profit.

            a.      This document forger created W-2s, pay stubs, credit letters and
                    social security printouts over an eight-year period.

            b.      These documents were used by real estate professionals who
                    knowingly submitted the falsified information to lending
                    institutions. The loans were then insured by HUD and caused a
                    loss to that agency of more than $18 million.

            c.      A search warrant executed during the investigation revealed more
                    than 100 real estate professionals had ordered false documents in
                    the past.

            d.      To date, the document forger and six associates have been
                    convicted in the scheme, as well as 14 real estate professionals

G.   Victims of Mortgage Fraud

     According to the FBI, victims of mortgage fraud may include borrowers,
     mortgage industry entities, and those living in the neighborhoods affected by
     mortgage fraud. Lenders are plagued with high foreclosure costs, broker
     commissions, reappraisals, attorney fees, rehabilitation costs, and other related
     expenses when a mortgage fraud is committed. As properties affected by
     mortgage fraud are sold at artificially inflated prices, properties in surrounding
     neighborhoods also become artificially inflated. When property values increase,
     property taxes increase as well. Legitimate homeowners also find it difficult to
     sell their homes as surrounding properties affected by fraud deteriorate.


H.   Emerging Schemes: Foreclosure Assistance Fraud

     Foreclosure rescue scams continued to be problematic. Escalating foreclosures
     provide criminals with the opportunity to exploit and defraud vulnerable
     homeowners seeking financial guidance. The perpetrators convince homeowners
     that they can save their homes from foreclosure through deed transfers and the
     payment of up-front fees. This “foreclosure rescue” often involves a manipulated
     deed process that results in the preparation of forged deeds. In extreme instances,
     perpetrators may sell the home or secure a second loan without the homeowners’
     knowledge, stripping the property’s equity for personal enrichment.




                                          56
1.   The “Foreclosure Consultant Law”, California Civil Code Section 2945-
     2945.11, governs the practices of foreclosure consultants who work with
     home owners in or nearing default. Licensees should familiarize
     themselves with its provisions and gain a thorough understanding of what
     they may and may not do in assisting the homeowner.

2.   The “foreclosure consultant” may assist the homeowner by performing the
     following services, for compensation:

     a.     Stop or postpone the foreclosure sale.

     b.     Obtain any forbearance from the beneficiary.

     c.     Assist the homeowner in reinstating the loan.

     d.     Obtain an extension for reinstatement.

     e.     Obtain a waiver of the acceleration clause.

     f.     Assist the homeowner in obtaining financing.

     g.     Assist the homeowner to avoid impairment of their credit resulting
            from the notice of default.

     h.     Save the homeowner from foreclosure.

3.   Among laws proposed to help homeowners is legislation introduced in the
     California Senate, SB1054, passed and sent on to the Assembly where it
     failed first committee vote but was approved for reconsideration. No
     action has been taken since June. It is intended to protect homeowners in
     default from foreclosure assistance fraud.

     a.     The law, if passed, would remove the incentive of any real estate
            agent to derail a proposed or requested short sale in hopes of
            getting the listing by prohibiting any licensee who gives an opinion
            of value (broker price opinion) to the homeowner’s existing lender
            from acting as a listing agent on that property for twelve months.




                                 57
Key Points to Remember:

1.    Although the extent of mortgage fraud is unknown, the Mortgage Bankers’
      Association places it at 10% to 15% of all loans.

2.    FBI identifies fraud in two categories: Fraud for Property and Fraud for Profit.

3.    Fraud for Property accounts for 20% of all fraud, with the borrower actively
      participating in 87% of cases investigated while a mortgage broker participated in
      58.55% of cases.

5.    Fraud for Profit, with 80% of all fraud, involved the borrower in 60% of all cases
      and the mortgage broker in 69% of cases.

6.    Real estate agents (not identified as being REALTORs® or not) participated in as
      few as 1% of cases (involving assisting with fraudulent documents) up to 6.25%
      of cases (involving flipping transactions).

7.    Most common fraudulent activities included altered bank statements, income
      documents or falsifications, gifts, employment and forgeries.

8.    99% of licensed appraisers in a 2007 survey indicated they were pressured by
      industry professionals to “hit a certain” value, up from 55% in 2003.

9.    Greatest percentage of fraud cases involved “occupancy” in which the borrowers
      declared they would occupy the property.

10.   Lenders, during the underwriting and approval process, report to the U.S.
      Treasury what is referred to as “suspicious activity” of a loan applicant who is
      suspected of fraud. These “SAR” report filings have increased in California by
      71.3% between 2006 and 2008.

11.   Foreclosure assistance fraud is one of several emerging scams REALTORs® need
      to aware of, and to warn any home owner who is in default and who has been
      discussing options with the REALTOR® to beware of anyone who proposes any
      rescue plan that sounds “too good to be true”, and usually involve transfer of title.




                                           58
XI.     Tough New Laws for Predatory Lending Practices
A.      Praise by the Fed for Subprime Lending: Hindsight is Always 20-20.

        A few years ago the Federal Reserve Bank of Dallas claimed, “(subprime)
        practices opened the housing market to millions of Americans” and “the
        expansion of nonprime mortgages clearly played a role in the surge of home
        ownership.” In 2004, Federal Reserve Bank Governor Edward Gramlich
        commented, “the increased availability of subprime mortgage credit has created
        new opportunities of homeownership and has allowed previously credit-
        constrained homeowners to borrow against the equity in their homes to meet a
        variety of needs”. He did, however, caution increased subprime lending has been
        associated with higher levels of delinquency, foreclosure and “in some cases,
        abusive lending practices”.101

        1.      Despite the caveats of default and the predatory practices of some lenders,
                Gramlich indicated that because of subprime lending, “credit and
                ownership markets are democratizing. Millions of lower-income and
                minority households have a chance to own homes”. While rates of serious
                delinquencies raise red flags and call for efforts on the part of industry and
                government to prevent foreclosures, he pointed out that the vast majority
                of these new homeowners do not seem to be having problems.

                a.      As of May, 2008 Subprime loans which were delinquent 90 days
                        or more represented only 18% of all Subprime loans, and 27% of
                        Subprime ARMS. While the number is significant, Gramlich was
                        correct in stating the “majority” had no problems.

B.      Subprime Defaults Reveal Extent of Predatory Lending

        Such practices, however, “may have been at the expense of later sales, further
        dampening the market going forward” due to high foreclosures and the
        devaluation of the real estate market,102 according to Dallas Federal Reserve
        economists DiMartino and Duca. Foreclosures do not affect just the homeowner
        who loses the family home, as Fed. Governor Mark Olson warned, commenting
        “multiple foreclosures in one neighborhood will bring down the property value
        for all homeowners in the neighborhood”.103 Furthermore, Governor Gramlich
        said that pushing home ownership to the extent that the benefit is offset by
        foreclosures does no good. He called for the development of systems capable of
        identifying lenders and brokers whose practices facilitate foreclosures.



101
    Graml.ich
102
    DiMartino and Duca
103
    “Remarks by Governor Mark W. Olson”, Community Development Policy Summit, Federal Reserve
Bank of Cleveland, Cleveland OH, June 23, 2005


                                               59
        1.       In a speech in April 2005, former Fed Chairman Alan Greenspan praised
                 the rise of the subprime mortgage industry and encouraged the use of
                 adjustable rate loans,104 which turned out to account for most subprime
                 foreclosures, but later indicated he had missed the mark, saying “I really
                 didn’t get it until very late in 2005 and 2006”.105

        2.       Borrowers who were sold a loan plan which carried an inherently
                 unaffordable payment at time of reset probably are the victims of
                 predatory lending. Karl Case, an economics professor at Wellesley
                 College and co-author of the Case-Shiller Home Price Index, says “we had
                 an aggressive home-mortgage industry trying to get people into homes
                 they couldn’t afford at a time when home prices were very high. It turned
                 out to be a house of cards”,106

        3.       Subprime loans were originally intended for borrowers with lower income
                 and spotty credit. Fed. Governor Olson commented “(although) data show
                 record high homeownership rates among low-income and minority
                 borrowers, reports of lending abuses and increased foreclosure rates
                 loom as dark clouds”.107

        4.       Research shows the subprime market wasn’t restricted to just lower
                 income borrowers. As home prices accelerated, more affluent home
                 buyers sought high-rate loans to buy homes costing more than they could
                 afford under conventional lending guidelines.

                 a.       High rate loans are defined as those carrying interest rates 1.5 and
                          3.5 percentage points higher than market rates for 1st and 2nd loans
                          respectively under new Fed TILA amendments.

C.      Responsible Subprime Lending Recommended by Fed Governor Olson

        Predatory lending is a serious problem according to Fed. Governor Olson. But it
        must be dealt with in a way, according to him, that allows “responsible” subprime
        lenders to offer loan programs to worthy borrowers having imperfect credit,
        giving them the opportunity to become homeowners.108 He cautioned that
        returning to the days when some borrowers have very limited credit is not an ideal
        solution to the problem.

        1.       The goal is to encourage, not limit, mortgage lending by responsible
                 (non-predatory) lenders in low and moderate income markets.

104
    “Remarks by Chairman Alan Greenspan, Fed Reserve 4th Annual Community Affairs Research
Conference”, Washington D.C., April 4, 2005
105
    “Greenspan says didn’t see subprime storm brewing”, Reuters, September 13, 2007
106
    “The Unites States of Subprime Loans”, Rick Brooks, The Wall Street Journal, October 12, 2007
107
    Olson
108
    Olson


                                                  60
        2.      Instead of eliminating subprime lending from the marketplace, Olson is
                among those whose position is to offer objective, reasonable guidelines for
                the lender to follow which allows borrowers meeting risk-based qualifying
                standards to become homeowners in a way which protects them from
                abusive practices.

D.      Federal Agencies Implement Tough New Standards

        In mid 2007, the federal government took its first steps to regulate subprime
        lending practices, especially involving adjustable rate mortgages, and on June 29,
        2007, the federal banking agencies issued supervisory guidance to address the
        underwriting and marketing of subprime adjustable mortgages. They focused on
        two primary consumer protection principles:109

        1.      A loan should be approved on the borrower’s ability to repay based on the
                complete terms of the loan, which includes qualifying at the reset note rate
                and not simply the fictitious low initial or teaser rate.

        2.      A borrower must be provided with the information necessary to
                understand all the terms of the transaction, including the risks inherent in
                it, and in a manner which gives them time to decide if the loan is actually
                appropriate for them.

        3.      The FDIC and federal and state banking agencies believe clear and
                common sense standards of underwriting and marketing of subprime
                adjustable rate mortgages are necessary to protect the consumer, reinforce
                mortgage market discipline and preserve a flow of capital to fund
                responsible lending.110

        4.      Non-traditional loan products can be appropriate for the borrower who is
                both a low credit risk and financially savvy, according to the FDIC. What
                is not appropriate is to target those borrowers who do not fully understand
                the “embedded” risks of the subprime product being offered and who are
                not presented with potential risks associated with them in clearly written
                language. The challenges to today’s complex mortgage market, says the
                FDIC, call for an approach that encourages sound underwriting without
                inhibiting innovation, which regulators recognize has created
                opportunities for millions of homeowners”.111




109
    Kimminger
110
    Ibid
111
    “FDIC Outlook: Breaking Ground in U.S. Mortgage Lending”, Cynthia Angell and Clare Rowley, FDIC
Economists, Summer 2006


                                                61
E.      Federal Reserve Board Amends and Tightens Reg. Z

        In December 2007, the Federal Reserve Board proposed amendments to
        Regulation Z, Truth in Lending, under the Home Ownership and Equity
        Protection Act (HOEPA), which were finalized and approved July 2008. Not
        restricted to only adjustable rate mortgages) these amendments address and
        strengthen consumer protection in certain mortgages, identifying prohibited
        abusive practices and become effective October 1, 2009:112 The Board’s
        amendments include the formal inclusion of a new category of “higher-priced
        mortgages”, those mortgages whose annual percentage rate (APR) exceeds the
        “average prime offer rate” (average market rate) by at least 1.5% for 1st loans and
        3.5% for subordinate loans.

F.      “Higher Priced Mortgage” Amendments for Reg. Z

        The amendments for these higher-priced, which include not only Subprime loans
        but some of the Alt-A mortgages as well, include:

        1.      Prohibit a lender from engaging in a pattern or practice of lending without
                considering borrowers’ ability to repay the loan from sources other than
                the home’s value.

        2.      Prohibit a lender from making a loan by relying on income or assets that it
                does not verify.

        3.      Prohibits prepayment penalties on loans having payments which adjust
                within the first four years. On all other loans a prepay penalty may not last
                longer than two years.

        4.      Require the lender to establish an escrow account for the payment of
                property taxes and homeowners insurance for the first year of the loan, at
                which time the borrower could opt out of the escrow account. (This
                provision becomes phased in April 1, 2010).

G.      Amendments for All Mortgages Under Reg. Z

        Amendments for all mortgages, including higher-priced, include:

        1.      Prohibit certain lending practices, such as failing to credit a payment to a
                consumer’s account when the servicer receives it, failing to provide a
                payoff statement within a reasonable period of time, and “pyramiding”
                late fees (the practice of charging late fees to a borrower who has not paid
                a prior late fee).


112
  “Proposed Amendments to Reg. Z (Truth in Lending)”, Board of Governors of the Federal Reserve
System, Division of Consumer and Community Affairs, December 12, 2007


                                                62
2.   Prohibit a creditor or broker from coercing or encouraging an appraiser to
     misrepresent the value of a home.

3.   Prohibit specifically seven misleading or deceptive advertising practices
     for closed end loans, including:

     a.     Advertising “fixed” rates or payments without adequately
            disclosing that the rate or payment amounts are fixed only for a
            limited period of time rather than for the full term of the loan.

     b.     Comparing an actual or hypothetical consumer’s current rate or
            payment obligations and the rates or payments that would apply if
            the consumer obtains the advertised product, unless the
            advertisement states the (actual) rates or payments that will apply
            over the full term of the loan.

     c.     Advertisements that characterize the products offered as
            “government loan programs”, “government supported loans”, or
            otherwise endorsed or sponsored by a federal or state government
            entity, unless the loans are government supported or sponsored
            loans such as FHA or VA loans.

     d.     Advertisements that prominently display the name of the
            consumer’s current mortgage lender, unless the advertisement also
            discloses the fact that the advertisement is from a mortgage lender
            that is not affiliated with the consumer’s current lender.

     e.     Advertising claims of debt elimination if the product advertised
            would merely replace one debt obligation with another.

     f.     Advertisements that falsely create the impression that the mortgage
            broker or lender has a fiduciary relationship with the consumer.

     g.     Foreign-language advertisements in which certain information,
            such as a low introductory “teaser” rate is provided in a foreign
            language, while required disclosures are provided only in English.

5.   Require truth-in-lending disclosures to borrowers early enough for them to
     use while shopping for a mortgage. Lenders could not change fees until
     after the consumer receives the disclosure, except for a fee to obtain a
     credit report.

6.   These changes apply only to advertisements for closed-end loans and not
     for home equity lines of credit (the Board indicated they didn’t observe
     predatory practices in the origination of open-end home equity lines of
     credit).



                                  63
        7.      The new regulations also extend early disclosure of good faith estimate
                disclosures to both purchase money and non-purchase money (refinance)
                closed-end transactions (current regulations provide only for the disclosure
                on purchase money loans).

        8.      Effective January 1, 2010 a new “consumer friendly” Good Faith Estimate
                of Settlement Costs” and revised HUD-1 will be required of all lenders. It
                uses plain language including simple “yes” or “no” answers to questions
                such as “Does your loan have a prepayment penalty?”, “Can your interest
                rate rise?”, as well as simple statements as “Your interest rate is”.

        9.      The Federal Reserve Bank has said, “the goal of these changes and of the
                Federal Reserve Bank is to ensure they are likely to protect consumers
                from unfair practices “without shutting off access to responsible
                credit”.113Fed Chairman Ben Bernanke said the Board responded to
                deceptive lending problems with rules that were carefully crafted with an
                eye toward deterring improper lending and advertising practices without
                unduly restricting mortgage credit availability.114

H.      Income Verification Guidelines Left to the Industry to Define

        The Fed, in response to its request for input, comments and recommendations
        from industry participants, especially regarding stated income issues, published
        the following in its announcement of the new Reg. Z. amendments.

        1. Salaried Employees: The Fed specified that for most consumers who are
           salaried employees, incomes can easily be documented by W2s and pay stubs
           since most consumers can, or should be able to, produce one of these kinds of
           documents with little difficulty. For other consumers, the Fed’s rule is quite
           flexible. It permits a creditor to rely on any third-party document that provides
           reasonably reliable evidence of the income or assets relied on to determine
           repayment ability. Examples include check-cashing or remittance receipts or a
           written statement from the consumer’s employer.

             a. The rule is also flexible as to consumers who depend heavily on bonuses and
                commissions. If an employed applicant stated that he was likely to receive an
                annual bonus of a certain amount from the employer, the creditor could verify
                the statement with third-party documents showing a consumer’s past annual
                bonuses. The same would be true with commissions.

        2. Self-employed borrowers: The Board’s rule about self-employed borrowers
           income verification allows considerable flexibility. The rule allows creditors to
           adapt their underwriting processes to the needs of self-employed borrowers. For
113
  Press Release, Federal Reserve System, December 18, 2007
114
  “Statement by Chairman Ben S. Bernanke”, Federal Reserve Bank, Federal Reserve System Press
Release, December 18, 2007


                                                64
          example the rule does not dictate how many years of tax returns a creditor must
          review to determine a self-employed applicant’s repayment ability. Nor does the
          rule dictate which income figure on the tax returns the creditor must use. The tax
          code may permit deductions from gross income, such as depreciation, that a
          creditor reasonably would regard as not relevant to repayment ability.

I.   Secure and Fair Enforcement (S.A.F.E.) for Mortgage Licensing Act of 2008

     The Housing and Economic Recovery Act of 2008 establishes rigid education,
     examination and licensing requirements for loan originators. It is designed to
     provide consumers with a higher degree of protection from a loan originator’s
     negligence, misrepresentation or fraud. It implements the following:

     1.      Loan originators, which include mortgage brokers and real estate agents,
             and anyone who assists a loan applicant or prospective borrower in
             obtaining financing, must register with the Nationwide Mortgage
             Licensing System and Registry and be licensed by the state in which they
             live and work. Persons who perform only administrative tasks are exempt
             from the licensing and registry requirements unless they are independent
             contractors.

     2.      Loan originators must submit to background and credit checks and be
             fingerprinted.

     3.      Prior to successfully passing a federally prepared examination with a score
             of 75% or higher originators must complete a total of 20 hours course
             instruction including the following;

             a.      3 hours of federal law and regulations.

             b.      3 hours of ethics, including instruction on fraud, consumer
                     protection and fair lending.

             c.      2 hours of instruction related to lending standards for non-
                     traditional mortgage products.

     4.      Each year the loan originator’s license must be renewed, requiring
             completion of 8 hours of continuing education as follows:

             a.      3 hours of federal law and regulations.

             b.      2 hours of ethics, including instruction on fraud, consumer
                     protection and fair lending.

             c.      2 hours of instruction related to lending standards for non-
                     traditional mortgage products.



                                            65
Key Points to Remember:

1.    Effective Oct. 1 2009 new regulations become effective under Reg. Z, Truth in
      Lending, which establish a new category of loan: higher priced, which for 1st
      loans would be any rate which exceeds market rate by 1.5% or more, and for 2nd
      loans a rate which exceeds market by 3.5% or more.

2.    Under the new higher-priced loan guidelines, a borrower must have income
      documented and verified, and it must be considered in the approval process.
      Relying on the home’s equity to offer repayment ability is not allowed.

3.    Prepay penalties are prohibited on loans having payments which adjust within the
      first four years. For all other loans prepay penalties may not last longer than two
      years.

3.    Additionally the borrower must agree to have property taxes and hazard insurance
      impounded with monthly payments for the first twelve months (effective April 1,
      2010).

4.    Other new laws apply to all loans, not just subprime, and include the prohibition
      of not clearly advertising loan terms, such as rate advertised as “fixed” is actually
      fixed for a few years after which it becomes adjustable.

5.    Also, the new regulations prohibit solicitation to a borrower which implies it is
      from the existing lender when in fact it is not, and advertising “debt elimination”
      if the debt is merely to be replaced by another obligation.

6.    The Housing and Economic Recovery Act of 2008 established a rigid
      examination, licensing and continuing education program for loan originators,
      including mortgage brokers and real estate agents.




                                           66
XII. Help for Home Owners in Default
A.         FHA Secure

           Borrowers who currently find themselves in default may have help available
           through one of two programs. The first, administered by HUD, is FHA Secure.

           1.      FHA Secure, designed for borrowers with satisfactory credit histories who
                   have not been delinquent on mortgage payments before an adjustable rate
                   loan interest rate hike at reset caused them to default, offers a possible
                   solution to avoid foreclosure. Eligibility requirements include:115

                   a.      The loan being refinanced must be a non-FHA ARM and the
                           interest rate has reset or will by the end of 2009.

                                  Reset must have occurred between 2005 and 2009.

                   b.      The home owner must now be delinquent in making payments
                           after reset, with the following exception.

                                  If the homeowner's payment has not yet reset, they must
                                   demonstrate they will not be able to make the new payment
                                   after it does.

                   c.      Prior to reset, the homeowner's payment history must reflect on-
                           time payments during the six months before reset.

                   d.      The homeowner must have 3.5% equity in the home.

                   e.      The homeowner must be able to document adequate income to
                           make the new monthly payment.

           2.      If the homeowner has adequate equity in the home, FHA will allow the
                   delinquent payments to be added to the new loan.

           3.      If the loan being refinanced exceeds the FHA maximum loan amount for
                   the region, the borrower is allowed to obtain a second loan from the
                   refinancing lender providing the lender's guidelines allow, of course
                   providing the borrower can afford both payments.

B.         HOPE for Homeowners

           In 1933, as discussed in Chapter III, to help homeowners in foreclosure the
           administration of Franklin Delano Roosevelt established a government program to

115
      Department of Housing and Urban Development


                                                    67
refinance loans of homeowners in default. It was in operation for three years,
from 1933 to 1936. The plan is reborn with “HOPE for Homeowners”, an FHA
refinance program established by the Housing and Economic Recovery Act of
2008, signed into law by President George W. Bush July 30, 2008. It offers the
hope of assistance for homeowners who are presently in default or may default in
the near future (they must document that their current financial situation is such
that they soon will no longer be able to afford the current monthly mortgage
payment). It is anticipated that up to four hundred thousand homeowners not
eligible for FHA Secure will benefit from HOPE for Homeowners. However, the
program is voluntary on the part of homeowners’ existing lenders who will be
asked to write down a portion of the unpaid loan balance and pay some costs
involved. Its success will depend entirely on their cooperation. FHA has $300
billion available for the program. HOPE for Homeowners will operate from
October 1, 2008 until September 30, 2011, three years just like its predecessor,
the HOLC. The guidelines are as follows.

1.     Eligible loans are those originated on or before to January 1, 2008.

2.     The homeowner’s current home payment debt ratio must be 31% or higher
       to qualify for the maximum loan-to-value of 96.5% for the new loan.

3.     The homeowner may not deliberately default on their current loan merely
       to obtain lower housing payments or better financing.

4.     With the assistance of the existing 1st lender, the homeowner must
       eliminate any existing second loan, such as a home equity line of credit.
       The 2nd lender, however, will receive a portion of the government’s shared
       appreciation as described below.

5.     The homeowner may not obtain another second loan or home equity line
       of credit for five years following the origination of the new FHA loan,
       unless it is for the upkeep of the home. The maximum combined loans to
       value may not exceed 96.5% providing the borrower’s housing debt ration
       does not exceed 31%, otherwise the combined loans may not exceed 90%
       and allowing for a housing ratio up to 38% and 50% for total debts.

6.     The new maximum FHA loan under the program is 96.5% LTV.

7.     The maximum loan for the program is $550,440.

8.     The homeowner’s existing lender must write down their loan to 90% of
       the value of the home as determined by the new FHA loan appraisal.

9.     They must also write off all penalties, fees and legal costs. Furthermore,
       they must accept the proceeds at closing as being “paid in full”.




                                    68
           10.     The Act doesn’t clearly specify if that means they are restricted from
                   reporting to a credit repository that it was “settled for less”.

           11.     The borrower must pay a 3 percent upfront mortgage insurance fee.

           12.     The homeowner must pay a 1.5 percent annual mortgage insurance fee.

           13.     The refinancing lender may pay all borrower’s costs through premium
                   pricing.

           14.     After obtaining the new FHA loan if the home is sold or refinanced the
                   homeowner must pay an “exit fee” of 3% of the remaining mortgage
                   principal to the FHA.

           15.     FHA will also receive a portion of the homeowner’s profit at time of resell
                   or refinancing as follows, and will share a portion of the proceeds with a
                   former 2nd lien holder to the extent of the borrower’s unpaid balance
                   which was extinguished upon refinancing.

                   a.      100% of profits if homeowner sells or refinances in one year or
                           less.

                   b.      The amount payable to FHA will be reduced by 10% for each
                           additional year which passes before selling or refinancing.

                                  For example, 90% of profit will be paid to FHA if sold or
                                   refinanced during year two, 80% if sold or refinanced
                                   during year three, etc, until the fifth year at which time
                                   FHA will receive 50% of the profits if sold or refinanced at
                                   any time thereafter.

C.         Hope Now

           An alliance of home lenders plus The U. S. Department of the Treasury and HUD,
           Hope Now offers the hope of assistance to an approximate 80,000 home owners
           to save them from foreclosure.116

           1.      This voluntary program, targets home owners with subprime loans with
                   rates which will reset between January 2008 and July 2010. Qualified
                   borrowers will have their interest rates frozen at the original rate for five
                   years. Basic eligibility requirements include:

                   a.      The borrower must be current on their present mortgage payment.

                   b.      They must not have been more than 60 days late in the past year.
116
      Hope Now, Press Release, Washington D.C., December 6, 2007


                                                  69
             c.     They must demonstrate they will not be able to afford the new
                    mortgage payment after it resets.
             d.     The borrower's FICO score cannot be higher than 660, and cannot
                    have improved more than 10% since applying for the original loan.
             e.     The borrower must have less than 3% equity in the home.
             f.     The borrower must be occupying the home.

             g.     The reset monthly payment must increase by more than 10%.

             h.     The original loan must have been originated between January 1,
                    2005 and July 31, 2007.

D.    Help for Others

      Borrowers who fail to meet the requirements for either FHA Secure, HOPE for
      Homeowners or Hope Now plans may still have relief available. Most alliance
      members have indicated they are prepared to work with home owners in or
      nearing default.

      1.     Homeowners in need of assistance may call 1-800-995-HOPE.

      2.     Options which may be offered to the homeowner include:

             a.     Modifying the loan payment or amount.

             b.     Refinancing

             c.     Accepting a "short pay".

Key Points to Remember:

1.    FHA Secure: FHA refinancing help for borrowers having subprime adjustable rate
      loans in default. Default must be due to payment reset and borrower must have
      been current for six months before reset. Maximum loan-to-value is 96.5%.

2.    Hope for Homeowners: FHA refinancing help for borrowers in default on any
      loan. Allows up to 96.5% loan-to-value new loan providing the existing lender
      accepts proceeds as payment-in-full. Second lien holder must release their debt.
      a.     Borrower’s housing debt ratio may not exceed 31%.
      b.     Borrower must pay upfront MI of 3% and annual MI of 1.5%.
      c.     Refinancing lender may pay all borrowers’ costs through premium pricing.
      d.     Hope for Homeowners will operate program for three years.

3.    Hope Now: Voluntary organization of conventional lenders offering help for
      borrowers in default through modification or refinancing.


                                         70
XIII. Conclusion

A.   It Was a Market Destined to Collapse
     The run-up in value of Americans’ homes beginning in the late ‘90s was possible
     due to the explosion of sub-prime lending, easy credit allowing millions of
     Americans who did not meet the more rigid standards of conventional loan
     programs to become home owners. Home owners tapped into increasingly high
     equities available due to the runaway rates of appreciation to finance more real
     estate, autos, SUVs, recreational vehicles, vacations and all sorts of big ticket
     consumer goods. In 2006 alone, over 58% of all loans originated, including prime
     and Alt A, were refinances.
     1.     Lenders and Wall Street investors relaxed lending and risk assessment
            guidelines. Using creative financing engineered to make subprime loans
            and securities which they backed less risky then they appeared, they
            generated income streams and profits which both drove and were driven
            by the rapidly rising home sales and prices. They all appeared to have no
            ceiling in sight, just like the 1929 stock market.
     2.     And like the 1929 stock market it was a house of cards, with home sales
            and values destined to reach an unsustainable level, practically
            guaranteeing widespread foreclosures.
     3.     The collapse of home values has affected not only subprime borrowers but
            creditworthy borrowers who had refinanced into mostly Alt-A loan
            products and even standard prime loans.
     4.     Escalating food and fuel prices, until recently, along with increasing
            joblessness have taken their toll on the American consumer. Growing
            numbers of borrowers who refinanced into high mortgages with high
            payments and now with evaporating home equities have become victims
            of default and foreclosure.
B.   Innovative Change
     Changes to lending industry regulations by the federal agencies as well as those
     voluntarily implemented by the industry along with new programs offer hope.
     1.     With guidelines which require borrowers to document adequate income
            and reasonable liquid reserves, home owners acquiring loans under the
            new standards should have less risk of default than in the past.
     2.     The emerging “covered bond” market and the additional regulatory
            oversight of and liquidity protection for Fannie Mae and Freddie Mac as a
            result of the government taking interim direct control as conservator could
            help return absent secondary market investors necessary to steadily
            advance home sales and prices.




                                         71
C.   Strengthened Regulation of Mortgage and Real Estate Industry
     Mortgage brokers, real estate agents, appraisers, escrow companies and other
     industry professionals are more closely regulated and controlled by new laws
     which have been implemented recently. Those in the business who have always
     conducted themselves in accordance with the National Association of
     REALTORS® Code of Ethics surely welcome any regulation which helps cleanse
     its ranks of those who would conduct their business practices contrary to NAR’s
     and CAR’s policies and the law.

D.   The Recovery

     The continuing liquidity problems in the markets, the collapse and bankruptcy of
     yet more financial institutions, the uncertainty of the future for Fannie Mae and
     Freddie Mac, the threat of inflation and growing unemployment offer little
     optimism for a robust housing market anytime soon. As lenders continue to
     reduce the loan products available to prospective borrowers, tighten lending
     standards and themselves become victims of the market, the tools available to
     those who make their living in the housing and finance industries to serve
     America’s home buyers and sellers in achieving their goals and dreams become
     fewer.

     But tough times and challenging markets don’t last forever. Things always get
     better, eventually. This market is no exception. I was recently trying to return
     home from San Francisco but the weather just wouldn't cooperate, with my flight
     continuing to be delayed later and later. After finally being able to take off, a few
     minutes into the flight we hit heavy turbulence. This was real heavy turbulence.
     I'm used to flying, having accumulated many hours over the years, including a lot
     of bumpy ones, so I usually don’t get real nervous about bumps in the air. But this
     was real heavy, don't try to take a drink, and try to act nonchalant, turbulence. We
     got through it, just as I knew we would (well, hoped we would I guess).

     The same is true of real estate down cycles. It may seem as if a recovery will
     never take off, and things may get bumpy along the way with some real heavy
     turbulence, but we get through them. This one is no exception.

     George W. Lawrence




                                          72
73

				
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