Tag: mortgages

Regulators Repeat Exactly What They Did During the Last Housing Boom

By James Kwak

The Dodd-Frank Act was supposed to require securitizers to retain 5 percent of the credit risk of the mortgage-backed securities that they issued, in order to reduce the risk of a repeat of the last housing bubble. Today, the federal financial regulators said, “Whatever,” and ignored that requirement. In particular, they created an exemption that would have covered at least 98 percent of all mortgages issued last year.

Why? Because

“adding additional layers of regulation would have contracted credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market.”

That’s according to the head of the Mortgage Bankers Association.

This is the exact same argument that was made in favor of deregulation during the two decades prior to the last financial crisis, without the slightest hint of irony. It’s further proof that everyone has either forgotten that the financial crisis happened or is pretending that it didn’t happen because, well, maybe it won’t happen again?

Even leaving aside the specific merits of this decision, the worrying thing is that the intellectual, regulatory, and political climate seems to be basically the same as it was in 2004: no one wants to to anything that might be construed as hurting the economy, and no one wants to offend the housing industry.

The Bad Old Days

By James Kwak

There was a time when the main purpose of this blog was to explain just how some government policy or other official action was designed to benefit some large bank under the cover of the public interest. In a bit of nostalgia, I wrote this week’s Atlantic column on the Freddie Mac–Bank of America story reported on by Gretchen Morgenson. It’s clear that Bank of America got a sweetheart deal from Freddie. The question is why. Did Freddie Mac’s people, some of the most knowledgeable people in the country when it comes to mortgages, not realize they were giving away money? (Hint: Probably not.) Did FHFA examiners, some more of the most knowledgeable people in the country when it comes to mortgages, not realize that Freddie was giving money away? (Hint: See above.)

It’s amazing that after three full years of our government trying to give Bank of America money at every possible opportunity, it’s still a basket case. Now it’s charging people $5 per month to use their debit cards. Yes, this is a predictable response to new Federal Reserve regulations limiting debit card fees. But it’s easily avoidable: just find another bank. (Neither of mine charges me debit card fees.) Not every bank out there is still trying to pay for the Countrywide acquisition.

Made-Up Definitions

By James Kwak

Many commentators who want to blame Fannie and Freddie for the financial crisis base their arguments on analysis done by Edward Pinto. (Peter Wallison bases some of his dissent from the FCIC report on Pinto; even Raghuram Rajan cites Pinto on this point.) According to Pinto’s numbers, about half of all mortgages in the U.S. were “subprime” or “high risk,” and about two-thirds of those were owned by Fannie or Freddie. Last year I pointed out that Pinto’s definition of “subprime” was one he made up himself and that most of the “subprime” loans held by Fannie/Freddie were really prime loans to borrowers with low FICO scores. Unfortunately, I made that point in an update to a post on the somewhat obscure 13 Bankers blog that was mainly explaining what went wrong with a footnote in that book.

Fortunately, there’s a much more comprehensive treatment of the issue by David Min. One issue I was agnostic about was whether prime loans to people with low (<660) FICO scores should have been called “subprime,” following Pinto, or not, following the common definition. Min shows (p. 8) that prime loans to <660 borrowers had a delinquency rate of 10 percent, compared to 7 percent for conforming loans and 28 percent for subprime loans, implying that calling them the moral equivalent of subprime is a bit of a stretch. Min also shows that most of the Fannie/Freddie loans that Pinto classifies as subprime or high-risk didn’t meet the Fannie/Freddie affordable housing goals anyway — so to the extent that Fannie/Freddie were investing in riskier mortgages, it was because of the profit motive, not because of the affordable housing mandate imposed by the government.

Min also analyzes Pinto’s claim that the Community Reinvestment Act led to 2.2 million risky mortgages and points out that, as with “subprime” loans, this number includes loans made by institutions that were not subject to the CRA in the first place. Of course, the CRA claim is ridiculous on its face (compared to the Fannie/Freddie claim, which I would say is not ridiculous on its face) for a number of reasons, including the facts that only banks are subject to the CRA (not nonbank mortgages originators) and most risky loans were made in middle-income areas where the CRA is essentially irrelevant.

Mainly, though, I’m just glad that someone has dug into this in more detail than I did.

Not with a Bang

By James Kwak

In the Times, Neil Barofsky, Special Inspector General for TARP, performed the admirable feat of fitting a clear, comprehensive, sober critique of how TARP was implemented and what its long-term impact will be in fewer than 1,000 words. It’s a perspective I mainly agree with,* and it highlights the different priorities that the administration put on aid to large banks and aid to homeowners, even though both were goals of the bill.

Back in late 2008 and early 2009, there was a lot of talk about how a true solution for the problems of the banking system would require a solution for the problems of homeowners, since the banks’ losses were largely the result of mortgage defaults. One of the major technical achievements of the administration was showing that it was possible to stabilize the financial system and restore the banks to short-term profitability without doing much for homeowners. As Barofsky says, and as the Times reports in yet another article today, the administration’s programs to help homeowners obtain loan modifications had little impact on the behavior of the banks that service mortgages and foreclosures continue unabated. Real housing prices have fallen below the previous lows of 2009 and now look likely to overcorrect on the downside.**

Housing modifications are admittedly more difficult than bailing out banks. It’s administratively easier to write a few $25 billion checks and create unlimited low-interest credit lines for a few of the Federal Reserve’s existing customers than to intervene in millions of mortgages. But the financial crisis was a time of bold action on other fronts. Treasury and the Federal Reserve were willing to push the limits of the law, for example in J.P. Morgan’s takeover of Bear Stearns. (See the chapter in Steven Davidoff’s book Gods at War for the details.) Henry Paulson threatened to declare the nation’s largest banks insolvent if they didn’t agree to sell preferred stock to the government. By contrast, as law professor Katherine Porter says in the Times article, “The banks were so despised, and TARP was so front and center, you could have actually done something. In the midst of real boldness in bailing out the banks, we get this timid, soft, voluntary conditional program.”

The lesson we learned learned is that homeowners were only a priority insofar as their health mattered to the banks’ health. When those two things became unmoored, the administration was willing to declare victory.

* The main thing I don’t agree with is Barofsky’s implied criticism of the Bush administration for using TARP money to buy preferred stock from banks rather than buying mortgage-backed securities directly. While I have often criticized various aspects of the preferred stock purchases, I think it was a more direct way to stop the panic of September-October 2008, and at that point a program to purchase MBS would probably have been an even more blatant transfer to the banks.

** I’m all for prices falling from bubble levels, but the policy goal should have been preventing them from falling through the long-term trend.

A Bit More on Fannie and Freddie

By James Kwak

My previous post on Fannie/Freddie had two major parts. In the first part, I questioned whether the thirty-year fixed-rate mortgage would really go away (or become much more expensive) without Fannie/Freddie, as some people have argued. In the second part, I said, who cares?

The first part has gotten a fair amount of good criticism, for example from Arnold Kling and John Hempton (by email), and also in comments. My position, simplified, was that a thirty-year fixed-rate mortgage includes three kinds of risk: credit risk, interest rate risk, and prepayment risk. Credit risk can be diversified, interest rate risk can be hedged, and Fannie/Freddie didn’t do anything about prepayment risk anyway. This is the kind of theoretical argument people make all the time, and the obvious question is whether the world actually works that way.

Continue reading “A Bit More on Fannie and Freddie” →

My Most Libertarian Post Ever

By James Kwak

(Yes, I know that isn’t saying much.)

Most people think that Fannie Mae and Freddie Mac had something to do with the financial crisis. Some people think that they were the major reason the crisis happened, which (to them) proves that activist government policy was the cause of the crisis. Other people, including me, think they were a modest contributing factor because they did buy a lot of securities that were backed by subprime loans, but they were well behind the curve when it came to mortgage “innovation” and the creation of toxic assets. But that’s not the question here.

The question now is what to do about them. Although they had been private, profit-seeking companies for forty years, they were taken over by government regulators in September 2008 when they had become clearly insolvent, and are still being operated in conservatorship. Because Fannie and Freddie were very, very long housing, they have suffered massive losses since the financial crisis began. But because the private mortgage securitization market has collapsed, they are the bulk of the secondary mortgage market at the moment, which means the housing market could collapse without them.

Continue reading “My Most Libertarian Post Ever” →

Finance and the Housing Bubble

By James Kwak

Adam Levitin and Susan Wachter have written an excellent paper on the housing bubble with the somewhat immodest title, “Explaining the Housing Bubble” (which has been sitting in my inbox for a month). My main complaint with it is that it’s eighty-one pages long (single-spaced), which is most likely a function of law review traditions; had it been written for economics journals, it could have been one-third the length. I also have some quibbles with the seemingly obligatory paean to the importance of homeownership, which I think is an assumption that deserves to be contested. But overall it presents both a readable overview of the history and the issues, and a core argument I have a lot of sympathy for.

The argument is that the motive force behind the credit bubble was an oversupply of housing finance—in other words, the big, bad, banking industry. Levitin and Wachter’s key evidence is that the price of residential mortgage debt was falling in 2004-06 even as the volume of such debt was rising. As Brad DeLong’s parrot would say, that can only happen if the supply curve is shifting outward, not if the demand curve is shifting outward (which is what would happen if it were all the fault of greedy borrowers who wanted to flip houses).

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Once More into the Breach . . .

By James Kwak

I’ve been largely sitting out the foreclosure scandal/crisis. Partly I’ve just been too busy, and partly the coverage on other blogs has been great. Mike Konczal in particular has been providing the “beginners” posts–here’s part one of five–that were my niche during the earlier part of the financial crisis, basically putting me out of a job, and Yves Smith has also been all over the issue.

I want to ask one question, but for those who are not economics blogs junkies, let me get you up to speed. It first turned out that in their haste to foreclose on houses, the law firms filing for the foreclosures (in many states, you have to get a judgment from a court in order to foreclose) were cutting corners and sometimes filing fake documents. Then it turned out that sometimes they were filing fake documents because the real ones didn’t exist. In particular, it is possible that many of the trusts that issue mortgage-backed securities never had properly-endorsed copies of the notes that underlay those mortgages. (See this Yves Smith post. Highlight quote, from the CEO of a mortgage originator: “We never transferred the paper. No one in the industry transferred the paper.”)

The question is this: Why, just weeks from an election in which Democrats are probably going to get clobbered, is the Obama administration sitting on its hands, writing this off as a bunch of technicalities, and opposing a foreclosure moratorium?

Continue reading “Once More into the Breach . . .” →

Foreclosure Wave Hits Cash Buyers, Too

By James Kwak

Since most of you probably read Calculated Risk, you’ve probably seen the Sun Sentinel story of the man in Florida who paid cash for a house–and still lost it in a foreclosure. Not only that, but he bought the house in a short sale in December 2009, the foreclosure sale happened in July 2010, and only then did he learn about the foreclosure proceeding.

Even after that,

“Grodensky said he spent months trying to figure out what happened, but said his questions to Bank of America and to the law firm Florida Default Law Group that handled the foreclosure have not been answered. Florida Default Law Group could not be reached for comment, despite several attempts by phone and e-mail. . . .

“It wasn’t until last week, when Grodensky brought his problem to the attention of the Sun Sentinel, that it began to be resolved.”

Bank of America now says it will correct the error “at its own expense.” How gracious of them.

If the legal system simply allows Bank of America to correct errors, at cost and with ordinary damages, after they happen, this type of abuse will only get worse. There’s obviously no incentive for banks not to make mistakes, and as a result they will behave as aggressively as possible at every opportunity possible. Yes, this was probably incompetence, not malice, on the part of the bank. But if you don’t force companies to pay for the consequences of their incompetence, they will remain willfully incompetent, and the end result will be the same.

Underwater Second Liens

By James Kwak

Mike Konczal did some more great work earlier this week in two posts on the not-so-exciting topic of second liens. I don’t have much in the way of new insight or analysis to provide, so let me just summarize.

A second lien is a second mortgage on a house. The second lien is junior to the first mortgage, meaning that if the borrower defaults and the first lender forecloses, the proceeds from the sale go to pay off the first mortgage; the second lien only gets paid back if the sale proceeds exceed the amount due on the first mortgage. You can see where this is heading.

Konczal’s first point was that in the stress tests almost a year ago, the big four banks held $477 billion of second liens and estimated that these assets were worth 81-87 cents on the dollar, so they would take $68 billion in losses (under the “more adverse” scenario). Konczal estimated that they were instead worth 40-60 cents on the dollar, implying $191-286 billion in losses.

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Uncontrolled Lending to Consumers Spawned the Financial Crisis

This guest post was contributed by Norman I. Silber, a Professor of Law at Hofstra Law School, and Jeff Sovern , a Professor of Law at St. John’s University. They were principal drafters of a statement signed by more than eighty-five professors who teach in fields related to banking and consumer law, supporting H. 3126, which would create an independent Consumer Financial Protection Agency. Some of the research on which this essay is based is drawn from an article by Professor Sovern.

Did under-regulated lending to consumers play a big part in destabilizing the financial system? Many knowledgeable people say yes, but Professor Todd Zywicki disagrees. (“Complex Loans Didn’t Cause the Financial Crisis,” Wall Street Journal, February 19, 2010). He claims that the present troubles resulted from the “rational behavior of borrowers and lenders responding to misaligned incentives, not fraud or borrower stupidity.”

Professor Zywicki’s argument enjoys, at least, the modest virtue of technical accuracy, because many objectionable misleading sales practices and agreements that lenders used were, and continue to be, unfortunately, quite legal. Lending practices may have been regularly misleading and confusing and reckless-but fraudulent? Well, no, usually not unlawful by the remarkably low standards of the day. But that in itself is an argument for saying consumer protection laws failed.

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Brad Miller’s Challenge

Since the peak of the financial crisis, both the Bush and Obama administrations have been trying to rescue both large banks and homeowners, often announcing programs for both in the same press conference. The programs for large banks have gone well, from the beneficiaries’ perspective (but not for small banks); programs for homeowners, not so much. As more people walk away from underwater mortgages, Assistant Treasury Secretary Herb Allison recently said, “We haven’t yet found a way of dealing with this that would, we think, be practical on a large scale.”

The failure of the Obama administration so far to come up with a working solution to the problem of mass defaults and foreclosures may be due to practical barriers, such as lack of capacity among mortgage servicers or legal uncertainties regarding securitization trusts. Alternatively, however, it may simply be that the administration doesn’t care that much. Perhaps the primary goal of homeowner assistance all along was to detoxify the toxic assets on large banks’ balance sheets; now that those banks are off of life support, maybe the mortgages themselves don’t matter that much.

Congressman Brad Miller’s proposal in The New Republic should put that question to the test.*

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The Problem That Won’t Go Away

With everyone hoping for positive GDP growth in Q3 and Goldman Sachs analyst Jan Hatzius now predicting growth at an annual rate of three percent in the second half of the year, the banks, investors, and politicians are all hoping that that nasty problem of foreclosures would just go away already. Unfortunately for everyone – especially the people losing their houses – there’s no reason for it to go away.

Unemployment is always a lagging indicator, and given the record low number of average hours worked, it will turn around especially slowly this time. Until then, people will continue to lose their jobs and wages will remain flat, and any small rebound in housing prices is unlikely to help more than a few people refinance their way out of unaffordable mortgages. So unless the other part of the equation – monthly payments – changes, the number of foreclosures should just continue to rise.

Calculated Risk provides this great chart from Matt Padilla (see the CR post for definitions of the categories):

Continue reading “The Problem That Won’t Go Away” →

Soaking Customers as a Form of Prudential Regulation

Good for Deputy Treasury Secretary (and YLS alumnus) Neal Wolin for wading into the American Bankers Association to defend the Consumer Financial Protection Agency. According to FinReg21’s article:

Wolin firmly rejected the argument made by American Bankers Association chief executive Ed Yingling in recent congressional testimony that responsibility for consumer protection should not be separated from the responsibility for safety and soundness. . . .

The industry has argued that prudential regulators are careful to preserve a profit margin on financial products, to keep financial institutions sound.

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The Finest of the Flavors

Richard Thaler has a simple argument for plain-vanilla financial products. Mike at Rortybomb deals with some of the predictable objections. This is also similar to Adam Levitin’s position on credit cards, which I wrote about a while back.

I’m in favor, although I don’t think it will be enough to simply make the vanilla offering available; in that case nothing would stop lenders from paying higher commissions to brokers in order to steer customers toward exploding mortgages.

By James Kwak