Tuesday, July 26, 2011

You and Your Student Loan--Suze Orman is Wrong About This Too

If poor financial advice were currency, we could get rid of the dollar and just trade copies of The Money Class in exchange for all goods and services.  A couple of months ago, I took exception to Suze Orman's statements that homeowners who are underwater on their mortgages need to simply "walk away" in a strategic default. 

Yesterday, Orman was featured on Marlo Thomas's blog on AOL and once again, I am encouraging readers not to follow at least one of her money tips.  Yesterday's AOL page featured six tips from Orman about money management.  Some of these are innocuous--for instance, Orman's advice to live below your means so that you are consistently spending quite a bit less than you earn.  But her tip about which debt to pay first is another piece of extremely bad financial advice from a woman whose financial views appear to line up closely with the Progressives in this country who don't care whether we as a society pay any of our bills as long as we make sure that the government always gets its share first.

Orman's advice was that the first debt we should always pay off is student loans.  In the letter from a viewer that Marlo Thomas read on the video program, the writer said that his credit card has a 2.99% interest rate and his student loan has a 6% interest rate, and he wondered which one he should pay first.  Orman replied that he should pay the student loan first, and not just because in this example the student loan carried the higher interest rate.  Even if the student loan carried a lower interest rate than the credit card, viewers should still pay the student loan first.  Why?  Student loans are government-backed loans which cannot be discharged through bankruptcy, while the credit card is unsecured debt which can be discharged in bankruptcy.  If you don't pay the credit card, says Orman, it's really not that big a deal.  "What can they really do?"

Really?  It is appalling to me that we have sunk to a level in our society where one of our leading financial experts constantly preaches the joys of defaulting on credit obligations.  Following Orman's logic, we should never pay for anything.  The fact that we knowingly took out a loan and that by refusing to pay it, we are actually stealing from the creditor is unimportant.  Morality is not an issue.  Nor, it appears, is just good old-fashioned common sense.

The reality is that typically student loans carry lower interest rates than credit cards.  With the Card Act of 2009 and now the Durbin Amendment which is part of Dodd Frank, we can all look for the interest rates on our credit cards to continue to rise regardless of our payment history.  My brother, who has spotless credit, was complaining last week when he was visiting that after the Card Act passed, all of his credit cards saw huge interest rate hikes. When he called to complain since he has a perfect pay history, the representatives told him that the interest rates are going up because of new legislation.  In other words, if credit card companies can no longer price higher-risk borrowers according to their pay history, they will make up their lost revenues by charging more to everybody.  So this whole concept of the cheaper interest rate on the credit card than on the student loan is disingenuous to start.

Second, student loans offer extremely favorable terms.  Not only are the rates low, but they offer fixed payments for a set period of time.  So if you pay their student loans on schedule, at the end of the fixed term the loans will be paid in full.  Since loan payment is often deferred until six months after you finish school, you have a chance to find a job and start working before repayment begins.  And since many student loans offer an interest-only feature for up to two years after payments commence, you ease into the payment.

Credit card balances, on the other hand, are revolving balances. Without making a concerted effort to pay them off, a credit card holder will be carrying that balance forever.  For that reason, the traditional logic has always been to put extra cash toward paying off the revolving debt--the credit cards--first and then concentrating on fixed, lower interest rate installment debt.

But Orman does not encourage us to spend years struggling to pay off our credit cards slowly. Instead, she quips that the cards can be discharged in a bankruptcy.  The implication is that since the creditor does not have collateral to back up the debt, we can walk away from this obligation unscathed.

That may sound nice, but it flies in the face of some basic facts.  Fact # 1:  A bankruptcy stays on a credit report for up to 10 years.  Ten years is a long time to have to explain why you were unable or unwilling to pay your debts.  Fact #2:  Bankruptcy ruins your credit, and in today's world, your credit determines much of your life.

I realize that in Orman's world, nobody needs credit because we are not going to be using credit--we all live below our means so we don't buy anything except what we have the cash to pay for. But a good credit rating is useful for more than just getting a flat screen with a surround sound system.  Many employers do routine credit checks as part of the hiring process. This is particularly true in federal government jobs and many corporate jobs where an applicant's ability to successfully manage his own financial affairs is considered an indicator of his overall integrity and competence.  In a society where high unemployment is a serious issue, filing bankruptcy so that you don't have to pay Visa can lock you out of a job that you would have otherwise gotten. 

Lousy credit costs money on so many different levels. Low credit scores cause insurance premiums to be higher than they would have otherwise been. And it can cause a financial institution to deny someone wanting to open a bank account.  Credit is tied to character in our society--poor credit makes a person a bad financial risk for all types of financial products--not just loans.

Your credit rating also determines the cost of all of your future credit.  And, yes, Orman's advice aside, someday you will probably want to have future credit.  For example, under the new qualified residential mortgages which have been proposed and are about to be implemented, a 60 day delinquency can prevent you from qualifying for a low interest rate mortgage.  Without pristine credit, you will be forced to go into a mortgage that will be approximately 3 times more expensive than the prime mortgages.  Again, I realize that in Orman's world everybody is supposed to be happy renting a home forever, but in America most people eventually want to own their own place.

Working in financial services for 13 years, I saw so many people who were victims of the same cavalier mindset toward credit that Orman teaches.  A few of them had a huge debt or collection that they could not pay due to a catastrophic circumstance--an illness, loss of a business, etc.  But many more had pages and pages of bad credit reflecting dozens of small decisions not to pay their bills.  I saw a lot of people whose credit was terrible because they owed a lot of money that they had not repaid, but normally they did not owe a great deal to any one creditor. What was more common was the borrower who owed lots of small amounts of money to many creditors and had let all of it go into collections.  They had the $35.00 collection from the video store because they never bothered to return the DVD and the $50.00 bounced check to the local chain restaurant. They usually had a number of small bills (under $200.00) for the portion of the doctor's visit that the insurance didn't cover. And they had the collection account to the satellite TV company and the mobile phone company for using their services and never paying the first bill.  Somewhere, years ago, these people embraced the idea that it was all unsecured debt and the creditors "couldn't do anything about it anyway."

Because they chose not to pay any of these bills, which in most cases they could have paid by doing a little budgeting, they paid more for everything else.  They paid higher interest rates on their mortgages, their cars and their insurance.  Because they had learned early in life that "nobody could make them pay" they went through life paying substantially more than they would have otherwise had to for almost every product and service they used.  And they dragged their bad financial decisions around behind them like Jacob Marley's chain--every year their credit defaults became a little heavier and more ponderous.

That is the reason that Orman's advice bothers me so much.  Even if today you do not file bankruptcy--if you just simply allow your credit cards to go into collection--you will be living with that decision for many years.  Collection agencies sell collection accounts as the accounts get old and every time they sell your account, your credit report updates as if it were a new collection.  Collections follow you around for up to seven years--even without a bankruptcy to formalize your refusal to pay.  And if later you decide to settle the balance with the collection agency so that you can get a loan, or a better rate on your car insurance, the difference between what you owe the creditor and what you agreed to pay becomes subject to federal income tax as taxable income.  So while you may get by with paying $1000 on a bill that was originally $2500.00, as far as Uncle Sam is concerned the remaining $1500 that you failed to pay is income and subject to taxation. When you decide to "stick it to the man" you look up in a few years to find out that you were the one who got stuck.

One thing Orman is right about--student loans must be paid.  The government has powerful collection tools including the ability to garnish wages.  But they are not the only debt that needs to be paid. And to say that they need to paid first before everything else is ridiculous. Pay them as scheduled and pay them off.  That should leave funds to deal with your other debt. When you purchase on credit, implied in the contract with the creditor is your promise to pay.  And unless you are willing to keep that promise whenever possible by paying your bills, you can never have any genuine financial success.

For books by Alexandra Swann visit her website at http://www.frontier2000.net/

Tuesday, July 19, 2011

They're Heeeeeere!

Remember the terrified little girl in "Poltergeist"? Little  Carol Ann Freeling warned her family whenever she sensed the spirits that haunted their otherwise average, normal middle-class home with her calm, almost whispered, "They're heeeeere!" At first the poltergeists did not seem threatening--they were just playful! But as they became more active, the malevolent spirits terrorized, abused and dominated the entire family, until little Carol's warning became an unnerving exercise in sheer spine-tingling horror!

The White House blog today reminds us that this is a big week for all Americans as the Consumer Financial Protection Bureau assumes its new role as official financial cop of the U.S. But although supporters and proponents of the CFPB are touting its arrival as a wonderful step forward for civic minded citizens everywhere, as I prepared to write this week's post, all I could think of was Carol Ann Freeling and Poltergeist.

On Sunday the White House announced that Elizabeth Warren definitely will not be the head of the new agency.  The Administration had to finally bow to pressure from Republicans who had promised not to confirm Warren.  But the White House did allow Warren to write the blog introducing the CFPB and the president's new nominee to head the agency, former Ohio attorney general Richard Corday. Although Republicans have promised to block the nomination of anyone until structural changes are made to the CFPB, Cordray's confirmation is likely.  In the meantime, the agency is charging forward without a leader--which has led some observers to nickname it "the headless horseman."  Without a director, the CFPB cannot write any new regulations, but they can enforce the regulations that are already on the books and they can take up the task of consolidating and merging much oversight of the financial services industry.  They have already released to the press their intentions of immediately beginning their audits of all major banks.

The bureau is charged with preventing "unfair, deceptive and abusive" business practices, but these terms are very vague. Particularly the term "abusive" is pretty much left open to the discretion of the regulators, who may decide arbitrarily whether they deem a particular practice to be "abusive." 

In her blog yesterday, Warren gushed about the great task ahead of the CFPB--making sure that another financial meltdown never again happens by identifying problem financial instruments before they have a chance to crash the markets.  She says that we got into this mess "one lousy mortgage" at a time, and CFPB will be there in the future to identify and quash harmful and debilitating loan policies before they spread into the market place.

To do that, CFPB has a huge web of investigators who will audit the major banks, all independent non-bank mortgage lenders, mortgage brokers and credit unions, payday lenders, and practically all financial service providers except insurance agents.  Some smaller community banks will escape the prying eyes of the CFPB because smaller institutions are not regulated by the agency.  But in the end, we are all the eyes and ears of the CFPB.  In a USA today interview given in December of 2010, Warren tells us that CFPB will encourage consumers to use their digital cameras and phones to scan "dubious or suspected financial offerings or products" and email them to the CFPB so that they can open investigations.  By using consumers as the first line of information, the CFPB can supposedly catch problems more quickly, keep track of recurring issues and determine whether certain groups are being "targeted." Remember that the CFPB has the power to call in the IRS on any business they examine whom they determine may not be complying with tax law, so a CFPB audit is a serious issue indeed.

We are also all the watched and spied upon.  One of the five objectives of the CFPB is to "make sure that markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation, " according to Cordray in a speech that he gave to a conference of state attorney generals in March of 2011.   To meet this mission, the CFPB houses a "Research, Markets, and Regulations Division."  This division's purpose is to "track market practices, developments, successes and failures."  The agency will track the various types of financial markets and instruments and how consumers interact with them.  Plain English translation:  The CFPB will be able to track where Americans keep their money, how they spend it, where they spend it, how much debt they carry, etc. They will know more about us than most of us know about ourselves.  At present, one concern of the CFPB is to have more regulation over prepaid debit and credit cards.  They want to know where every dollar is going and how it is spent.

The CFPB has unprecedented powers not only to watch us but also to interrogate us.  As part of the CFPB's objective to prevent "unfair and abusive practices," the agency has the authority to open a civil investigation. "Whenever the Bureau has reason to believe that any person may be in possession, custody, or control of any documentary material or tangible things, or may have any information, relevant to a violation, the Bureau may, before the institution of any proceedings under the Federal consumer financial law, issue in writing, and cause to be served upon such a person, a civil investigation demand requiring such person to produce such documentary material for inspection..., submit such tangible things, file written reports or answers to questions, give oral testimony...or furnish any combination of such material answers or testimony. (H.R 4173 Dodd Frank Act, Subtitle E section 1052)  Plain English translation:  Any person can be subpeoened to produce records and/or testify under oath to a CFPB investigator as part of a civil investigation where no criminal charges have been filed.  A person testifying under oath is allowed to have an attorney present, but they may not invoke the Fifth Amendment or refuse to answer any question.  At the conclusion of the testimony, they will be asked to sign a written transcript of the testimony, but if the witness refuses to sign, the investigator will sign the report notating that the witness did not choose to sign it.  The investigator may or may not furnish the witness with a written copy of his testimony, at the investigator's discretion. (Bear in mind, folks, this is a civil investigation with no criminal charges.)

Notice that the language of the bill does not say "any person working for a financial institution" or "any person who is being compensated through a financial transaction;" it says "any person".  That could be any of us--it could be you.  CFPB powers give agency investigators the right to pursue people under investigation to foreign countries if necessary.  In other words, you can run, but you can't hide.

In her USA Today interview, Warren says that "the new agency did not come into being because special interests demanded it or lobbyists spent hundreds of millions of dollars to make it happen...But ordinary Americans pushed hard for this agency. They said loud and clear that they wanted an agency in Washington to level the playing field with big banks."  Who were these ordinary Americans?  Well, unions for one--the SEIU was lobbying heavily to have Warren confirmed even after any genuine hope of that happening had long since died.  And, of course, consumer advocates wanted the CFPB armed with maximum fire power to hunt down anyone who might be trying to profit from capitalism. But I don't think most Americans wanted an agency that can sift through their finances with a fine tooth comb and force them to give sworn testimony about their personal financial transactions.

Over lunch a friend of mine who is an attorney told me recently that if most people knew what the Dodd Frank bill says, "there would be rioting in the streets." He was actually referring to the government's ability to take over and dissolve private companies at its own discretion.  I think if most people knew that the CFPB is about to make the CIA and Homeland Security look like the entertainment segment at a child's birthday party, they might be rioting in the streets.  The problem is that they don't know.  A great many have never even heard of the CFPB.  But they will.

And so it begins.  The day after tomorrow the CFPB is open for business.  And as soon as their new director is confirmed, they can be armed with their "full powers."  To me, that is scarier than any plot line Hollywood ever dreamed up.

For books by Alexandra Swann, visit her website at http://www.frontier2000.net

Monday, July 11, 2011


I have written several times about the new defense to foreclosure provisions of the Dodd Frank bill.  These provisions go into effect this month and they make the manner in which the loan originator was compensated on the transaction grounds for permanently staying foreclosure on a property.  Since these rules are the new reality for lenders, I am republishing my blog post on the new defense to foreclosure.

In 1953 my grandmother went through a divorce at a time when very few people living in middle America got divorces. Abandoned by her husband at about thirty years of age, she and her three young children (all under the age of 10) moved back to the tiny town of Parsons, Kansas, where her parents and siblings lived. My grandmother moved in with her mother and father and got a job in town which barely covered the expenses for herself and her children. After a short time, she realized that she needed a loan from the local bank in order to make ends meet.

My grandmother did not have credit or any collateral, but she hoped that her family's long-time presence in the community would help her in securing the small loan she needed. When she talked to the banker, she told him that her father would be willing to co-sign for her for the loan. The banker's only question was, "Who is your father?"

"Harlan Stringer," replied my grandmother.

"In that case, I don't need a co-signer," replied the banker. "I know your father. If you don't pay this money back, he will, whether he co-signed for it or not." She left the bank with the money, which she did pay back in full from her meager wages.

My great-grandparents were fairly typical of Depression-era families. They never had any extra money, but they raised a garden and a cow which allowed them to feed their own six children plus six extra children from town every night. (Each of their children had instructions to bring home one classmate from school each night for dinner, but to rotate the children so that all of the classmates could come out to the farm and eat. Children who lived in town often went hungry, so it was important that the invitations be extended to everyone since the Stringers raised their own food so they always had plenty to eat.) My great-grandfather eventually went to work for the railroad, and after he retired he stayed home and kept the garden, raised and sold chickens and fished. At that point, my great-grandmother got a job in town where she worked until well into her seventies.

They had no expectation of wealth--no concept of winning the lottery or some other contest that would bring a windfall into their lives. They expected to work for whatever they received and to pay for whatever they owned. They did not borrow money carelessly, because their sense of honor required that debts had to be paid--even if the debt were for an adult child who had borrowed the money because of a personal crisis but could not afford to repay the loan.

We hear a lot of comparisons today between our present day crisis, "The Great Recession," and the "The Great Depression" but I really don't think that it is fair to compare our society with the generation from 70 years ago who weathered that storm. The Depression-era generation was not as sophisticated as we are today and not nearly as well educated or well traveled, but they had a sense of values that our generation cannot begin to understand.

Today, we hear a lot about responsible lending but virtually nothing about responsible borrowing. By portraying the borrower as the perpetual victim who is not responsible for the choices he makes, we are creating a society in which lending is almost impossible. The most immediate example of this is the defense to foreclosure provisions of  the Dodd Frank bill which become law this month. Section 1413 of the Dodd Frank bill, "Permits borrower to assert a defense to foreclosure against creditor or assignee or other holder of mortgage loan in judicial or non judicial foreclosure or any other action to collect debt in connection with mortgage loan when there is a violation of anti-steering and ability to repay provisions. Claim can lead to actual damages, statutory damages and enhanced damages including return of finance charges." (Quote taken from a 16 page summary of the mortgage provisions of Dodd-Frank).
Notice, that the claim can be against "creditor or assignee," which means that a current servicer of a closed, sold loan can be forced to pay "enhanced damages" if either the ability to repay or loan officer compensation statutes are violated. Of course, the "qualified residential mortgages" which are now being developed create a "safe harbor" for lenders, but that safe harbor can be rebutted in a legal argument.

Dodd Frank establishes prohibitions on "steering" by prohibiting payments to loan originators based on the terms of the loan and it prohibits the loan originator from receiving compensation from both the consumer and the lender. The "safe harbor" provisions also put a 3% cap on the total of broker and lender fees.

The bill further puts the penalty for violations of the compensation rules and "duty of care" on the shoulders of the loan originators as well as the servicers. Not only can violations be used as "defense to foreclosure" for the life of the loan, but the individual loan originator can be held liable for penalties of the greater of actual damages or an amount equal to 3 times the total amount of compensation or "gain" received by the loan originator plus costs and reasonable attorney fees.

In other words, if a consumer stops paying his mortgage, for whatever reason, and the lender starts the foreclosure process, if the attorney can argue successfully that the loan originator compensation rules were violated in any way or that loan originator did not meet the "duty of care" requirements, the loan originator is required to pay back the greater of whatever damages the court awards to the consumer or 3 times his compensation plus attorney fees and closing costs.

So let's see how this might look: John originates a loan for Sally for a $300,000 home. He knows that the new compensation rules do not allow him to collect money from both Sally and the lender, so he chooses consumer paid compensation of 1% or $3000.00. Sally receives a base salary from the office machines company where she works plus bonus. Since she has been receiving the bonus for the last two years, John uses the bonus as part of her income. Sally gets the loan. One year later, the office equipment company files bankruptcy and Sally loses her job. Since she is not able to find a job right away, she cannot make her payments on the house, and soon her current servicer begins foreclosure proceedings.

Sally gets an attorney who argues that she was not qualified properly with regard to her income because her bonus was used to qualify her and everyone knows that bonuses are discretionary. Without the bonus, she would not have qualified. Under the "defense to foreclosure" rules, Sally's home is now safe and she does not have to worry about making the payments. In the course of the attorney's investigation, he finds out that John's company is structured as a corporation rather than a sole proprietorship. Although he was self-employed, the judge rules that he does not meet the "salaried" requirements of the Federal Reserve interpretation of the loan originator compensation rule. So the judge rules that two violations have occurred.

Because of these violations, Sally's lender cannot foreclose on her even though she is not making the payments and in fact cannot afford to. And since the "defense of foreclosre" applies to the life of the loan, even when she gets a job and is able to make the payment, she can still live in her home without making the payment and without fear of foreclosure. John, on the other hand, is now liable for $9000.00 plus attorney fees and court costs for originating a loan that he worked hard on and believed was perfectly fine. If he is like most loan originators today, John won't have the money, so the judgment will actually cost him his business.

Sound far fetched? It isn't. We are rapidly creating a world where consumers have no responsibility for their choices or actions. Even though no one coerced Sally to purchase a $300,000 home and in fact when she bought the house she would have been insulted at the implication that she could not afford to live there, as soon as she starts having financial difficulties, the purchase of the home and the loan that made it possible is everyone's fault but her own. Meanwhile, John who has worked hard and survived three years of real estate drought, is out of business because of regulations he did not even understand he was disregarding.

Because of the defense to foreclosure rules in Dodd Frank,  my local bank where I have my personal accounts has closed its residential mortgage department.  Major lenders such as Wells Fargo will no longer purchase mortgage loans where loan originators are compensated differently for different products.  But this is just the beginning.  In 2006, independent mortgage originators (brokers) originated about 65% of residential mortgages in the US.  Today they originate 6.9%.  The defense to foreclosure provisions of Dodd Frank are about to reduce that percentage to 0% and to kill mortgage lending as it has existed in the US for the past 80 years for the simple reason that no lender is going to take on the liability of buying a residential mortgage loan when an attorney can challenge the lender's right to foreclose on such frivolous grounds.

We all know that if you want to stop any particular behavior, negative reinforcement is the way to do so.  By allowing judges to arbitrarily rule away a lender's right to foreclose, we are destroying the system of collateral-based lending.  That leads to fewer choices for consumers and higher prices and actually moves us closer to The New American Poverty where 60% of Americans are life long renters rather than homeowners. If we want to create a climate where originators will be able to do their jobs, we have to return to standards of personal responsibility and free enterprise. A basic fact of lending is that the only incentive that lenders have to make large personal loans in the form of residential mortgages is the collateral of the home and the lender's right to foreclose on it. As we make foreclosure impossible, we also make mortgage lending impossible. By punishing the delivery system for mortgages, which is the loan originator, we create a system where no housing loans exist at all.  And that is indefensible.

For related posts as well as books by Alexandra Swann, visit http://www.frontier2000.net.