Tuesday, February 26, 2008

Case Study - Cleveland, Ohio

LOOK through squinted eyes and you can still see what once attracted people to Cleveland’s Slavic Village.

The area took its name from the Czech and Polish immigrants who settled there in the mid-19th century to work the city’s wool and steel mills. Its tree-lined streets and attractive, wood-framed homes were once home to a community filled with factory workers, young families and first-time homebuyers.

Small pockets still have that family feel, but decline set in during the 1980s as those jobs moved overseas and drug dealers and violence moved in. The city authorities cracked down, local people rallied round, and until a few years ago residents said life in the village seemed to be improving again. Then came the sub-prime debacle.

Now Slavic Village looks as if it has been hit by a hurricane. And this man-made disaster rivals hurricane Katrina when it comes to displacing families. The 2005 storm displaced some 35,000 people in the worst-hit districts of New Orleans. Since 2003 34,156 people have lost their homes to repossession in the Cleveland area, according to Case Western Reserve University, and the pace of those losses is accelerating. The new year is barely two months old and so far there have been 1,857 foreclosures in the Cleveland area.

Slavic Village has street after empty street of boarded-up houses, their roofs caving in, collapsed balconies hanging from the fronts of buildings. Some people seem to have just upped and left, leaving their belongings behind for the rats and vandals. Owners have put up signs offering their burnt-out homes for a $500 (£250) downpayment.

Bins and rubbish litter the street. Signs warn trespassers the structures are unsafe. People have spray-painted “No copper” or “No metal” on their doors to deter crooks who have stripped anything of value from these decaying shells. Even brick steps have been ripped off, leaving houses that look as if they are floating on a dark sea of garbage.

Slavic Village is Ground Zero for a tragedy being repeated across America. The dramatic rise and fall of the sub-prime mortgage market has left borrowers across the country facing repossession. In 2002 there were 101 foreclosures in Cleveland. In 2005 the number was 2,000, last year it was almost 8,000. Across America the number of foreclosures rose 79% last year, according to Realtytrac, an American property analyst, as people, many of whom would never have received loans in the past, have failed to keep up their mortgage payments.

Similar, and in some cases worse, situations can be found in cities from California and Nevada to Michigan. The reverberations from this crisis have been felt across the world, wiping billions off the value of banks’ investments and making them reluctant to lend money even to each other, a problem that drove Britain’s Northern Rock to the edge of collapse.

Cleveland’s mayor Frank Jackson knows who to blame: Wall Street. The mayor’s office is suing some of the world’s biggest banks. including Citigroup, Goldman Sachs, HSBC and Royal Bank of Scotland’s Greenwich Capital, claiming they acted like organised criminals financing the sale of products that they knew could do nothing but harm to Cleveland. Sub-prime mortgages have proved as bad as drugs in the destruction they have wrought on the community, he said.

“Follow the money,” said Jackson. “If you ask organised crime figures why they persist in doing what they are doing, knowing the damage they are doing and the risks they are taking if they are held accountable, do you know what they will say to you? The money was just too good. You ask these financiers on Wall Street why they persist in doing this when they know the risks they are running and the damage they are doing to their communities and shareholders, do you know what they will tell you? The money was just too good.”

Low interest rates and rising house prices convinced Wall Street that sub-prime loans were a safe bet. With Wall Street’s blessing a once niche and – frankly – dodgy product aimed at borrowers with bad credit histories went mainstream.

The mayor’s writ sets out in black and white just how much money was once available in this market. Brokers targeted people in areas like Slavic Village offering loans to people with poor credit records. Those loans were then pooled together (securitised) and sold on to investors. If a few failed, there were others to pick up the loss and, if house prices rose, repossession would cover the debt.

RBS’s Greenwich Capital underwrote more than $180 billion in securities backed by sub-prime mortgages, according to the suit. HSBC issued more than $200 billion in such securities and also made loans to people through Household Finance, its sub-prime lending arm. Between 2004 and 2007, the suit states, HSBC moved to foreclose on 1,300 loans in the Cleveland area.

When the sub-prime mortgage market imploded, HSBC and its rivals lost billions but their debt to Cleveland has yet to be paid, said Jackson. The city’s property taxes are falling, people are leaving the city. As the city’s income falls, its expenses are rising. Vacant properties attract crime. Arson rates are soaring. Cleveland used to spend $1.7m a year tearing down abandoned properties. Last year that figure had reached $6m – as far as the budget would stretch. “We tore down 1,000 structures and we didn’t make a dent,” said Jackson.

“They created the demand and in a market like ours that was completely unable to withstand the failures that arose. We did not have the increase in the real-estate markets that other areas of the country experienced. We have had a difficult economy over the past decade as we have moved from a manufacturing economy to a services economy. We have struggled here. They created an environment where there was no other outcome than the foreclosures. We saw it coming. How could Wall Street not see it coming?”

Many others take the same view. “They knew,” said Robert Triozzi,” Cleveland’s director of law. “They knew.”

TWO YEARS AGO Aquila Eberhardt saw an advertisement in the local paper offering loans to people with poor credit histories. The 29-year-old single mother had not worked for three years and had trouble keeping up with credit-card payments.

“The advertisement said that if I looked at this house they would put me up in a hotel,” she said.

At the time her social-security benefits were worth about $1,400 a month and she had $1,300 in savings. A week after she visited the offices of a local estate agent she had a loan for $103,589 and had become a first-time homebuyer. “I thought this is crazy. I told them I didn’t even have any pay slips to show them. They told me I would be okay and that I could afford it because I would be paying about $400 a month.”

Almost as soon as she moved into the three-bedroom house in Slavic Village she was horrified to receive her first mortgage bill for $681, a figure she says she cannot afford and one she has struggled to keep up with ever since. The house is in disrepair. She lives in dread that something will happen to the roof, which she cannot afford to fix. Neighbours have moved out; their houses have been boarded up. But Eberhardt says she has nowhere else to go. On March 17 she must go to court and face eviction.

Credit checks, ignored when she took out her loans, are in vogue again at financial institutions. Eberhardt’s credit score has been further destroyed by her home-loan disaster, making it all but impossible for her to pass the financial checks set by most landlords. In pursuing the dream of homeownership she has lost her life savings, what was left of her creditworthiness and is now set to lose her home.

“I don’t think I should ever have been given this loan, but they tricked me. If I knew I was going to get into this big a mess, I would never have done it,” said Eberhardt.

Barbara Anderson, 60, has lived in Slavic Village for 25 years and says predatory lending is nothing new. Anderson, a community activist who is now a city liaison officer, nearly lost her own home in the 1990s when a new loan company took it over and her interest rate shot up from 7% to 20%. The unscrupulous have always targeted the poor. What’s different now is the scale of the problem, she said.

“Why would a bank want to harass me? Why are they so concerned about me paying an extra $40?” she said. “Because I was isolated I thought it was just me. It wasn’t about just me it’s about the terrorisation of a whole city,” said Anderson.

She feels the banks should take the biggest share of the blame, but homebuyers have some responsibility too she said: “The papers you sign affect an entire city. When something happens to your loan it affects me. If something happens to your loan, it affects my taxes, it brings down my house’s value, it adds a criminal element. It’s a terror to the neighbourhood.

“Somebody once said we have found the smoking gun and everyone’s fingerprints are on it,” she said. “That’s how I feel about it. We all can take some blame for some of this.”

THE CRISIS is likely to get worse before it gets better. As home prices fall and lending standards tighten, more people are defaulting on their mortgages, potentially causing billions of dollars in additional losses. Some 1.6m mortgage holders defaulted on home loans last year, and at least that many are expected to default this year, according to Moody’s, a financial website.

A December 2006 study by the Center for Responsible Lending (CRL), a Washington-based lobby group, predicted that sub-prime foreclosures would cost American households as much as $164 billion. The nationwide study predicted that 19.4% of such loans taken out between 2005 and 2006 would fail.

Even during the period of strongly rising house prices, sub-prime foreclosures were high. Some 13% of these home loans ended in foreclosure within five years of being taken out, according to CRL.

And those rising house prices masked another problem that is only now starting to emerge. Many homeowners who were struggling with their loans were using equity from their rising house price to refinance their mortgages. With the housing boom over, and lenders tightening their standards, troubled borrowers could end up without the equity they need to refinance their loan or to sell their home and pay off their loans. According to the CRL, when these distressed borrowers are added to the foreclosure rates, the total “failure rate” for sub-prime loans approaches 25%.

Rather than a stepping stone to standard loans, as their champions once promoted them, sub-prime loans have left borrowers mired in spiralling debts. The CRL report said: “In reality, many borrowers refinance from one sub-prime loan to another, losing equity each time to cover the cost of getting a new loan. When we analyse the likelihood of foreclosure for borrowers who repeatedly refinance, we find that the risk of losing the home climbs to 36%.”

Last month the CRL put out a new report “Sub-prime Spillover” that attempted to quantify the impact of the crisis on the larger community. According to the report, foreclosures on sub-prime home loans originated in 2005 and 2006 will devalue the properties of 40.6m neighbouring homes. Homeowners living near foreclosed properties will see their property values decrease $5,000 on average. The report estimates that the total decline in house values and tax base from nearby foreclosures will be $202 billion.

“For all the headlines we are seeing, this situation is going to get worse,” said Kathleen Day, a CRL spokeswoman. “There has been irresponsibility all along the line. Many of these loans were made to people who never had the ability to repay. It’s ridiculous, like selling someone a car without a steering wheel and then being surprised when they crash. Sub-prime loans need not be bad but once you stop assessing the borrowers’ ability to pay and the interest payments don’t reflect the borrowers’ ability to pay, that’s crazy.”

NEXT WEEK Ohio gets its chance to vote for the Republican and Democrat candidates who will fight it out to be the next president. Anderson set out her views to the Democrat front-runner Barack Obama during a recent visit: “Families that used to sit in their homes around the kitchen table are now sitting around a steering wheel. Some children who should be in their beds at night are laying in the backseats of cars. Their closets are the trunks of those cars and what should be a personal bathroom is now a bathroom in any public area. It ain’t right,” she told the senator.

“It ain’t right,” repeated the senator. He didn’t offer much else by way of solution.

As the crisis gets worse, so will the clamour for action. So far there has been a cool reception to President George Bush’s latest action plan. Project Lifeline is backed by six big mortgage lenders and aims to slow the rising tide of foreclosures. Borrowers who are at least three months behind on mortgage payments can apply to the lender for a 30-day “pause” on foreclosure proceedings. If the delay is granted, then borrower and lender can work out a more affordable repayment scheme. Bankrupt homeowners or those who face foreclosure within the next month do not qualify.

The new plan follows a programme announced in December that would freeze interest rates on certain sub-prime loans. Unlike that effort, this plan will apply to all home mortgages.

Reaction was tepid at best. An analysis by found that 425,000 households would be eligible to benefit, but in practice only a fraction of that number would be helped. Day said the government was both underestimating the problem and overestimating the ability of the industry to deal with it.

And as home prices fall and lending standards tighten, borrowers further up the economic ladder are starting to feel the pinch. In middle-class Maple Heights, a Cleveland suburb just 15 minutes drive from Slavic Village, foreclosures are starting to take their toll.

“This is a white-collar, upper-middle-class neighbourhood,” said Lindsey Sacher of East Side Organizing Project, a Cleveland nonprofit group. “But people got sick and then they couldn’t afford their payments.”

Now with debts mounting and home values falling “people are just leaving this city. If you look at the areas of the country that are losing the most population, this region is number six. Numbers one to five are areas hit by hurricane Katrina,” said Sacher.

“We are hoping the next president will have some comprehensive plan to work this out.”

The rest of the world will be hoping so, too.


Number of families with a sub-prime mortgage: 7.2m

Proportion of sub-prime mortgages in default: 14.4%

Sub-prime loans outstanding: $1,300 billion

Sub-prime loans outstanding in 2003: $332 billion

Percentage increase from 2003: 292%

Proportion of loans approved without fully documented income: 43%-50%

Number of sub-prime mortgages that will have their interest rate reset this year: 1.8m

Typical rise in monthly payment (third year): 30%-50%

Sub-prime share of all new mortgages in 2006: 28%

Sub-prime share of all new mortgages in 2003: 8%

Number of homes not in foreclosure whose value will decline in 2008-9 as sub-prime foreclosures lower the prices of surrounding homes: 45m

Value of that decline: $233 billion


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