Tag: mortgages

The Mystery of Rating Agencies

Calculated Risk has a routine post about S&P increasing its loss projections for subprime and Alt-A loans and for the mortgage-backed securities built out of those loans. These announcements have been so common over the last several months that I usually don’t even think about them. But today I had a thought about them: these are forecasts, which means that they should not get worse just because the economy is getting worse. Forecasts should only change when there is new news that affects expectations about the future. So if you take these rating agency reports at face value, they imply not only that the economy is getting worse (by traditional measures such as the unemployment rate), but that there is new bad news about the future of the economy, despite all this talk you hear about green shoots and a recovery. If there is only old news, then that should have been “priced in” to S&P’s forecasts already.

So what gives? Do the rating agencies see some new perils in the economy that are being overlooked? Or are they just stretching out a writedown in their forecasts over several quarters? Under the latter theory, they should have known what would happen to subprime and Alt-A loans the same time people like Calculated Risk did – that is, several months ago – but it would be too embarrassing to do a massive writedown all at once, so they are spreading it out over time for respectability.

By James Kwak

The Paradox of Strategic Defaults

Real Time Economics and Calculated Risk both discuss new research by Paola Sapienza, Luigi Zingales, and Luigi Guiso on homeowners defaulting on mortgages even though they have the money to pay them. According to their research, 17% of households would default when their negative equity reaches 50% of the house’s value. The argument is that public policy has not sufficiently addressed this problem, focusing instead on homeowners who cannot afford their mortgages.

Let’s make this a little more concrete. Let’s say you bought a house with zero money down for $300,000 in early 2006. A few years later, the house is now worth $200,000, so your negative equity is 50% of the market value. Yet only 17% of people in your situation would walk away from the house. The other 83% would continue to pay the mortgage,  essentially throwing money away. Apparently people value the transaction costs of moving and the damage to their credit ratings at $100,000 (I think my numbers are approximately on the right scale – if anything they are probably low) – even after the fact that you can live in a house for free for several months before being evicted.

Or people are not as rational as economists would assume.

By James Kwak

Foreclosures and Modifications for Beginners

On last week’s This American Life, Chris Arnold of NPR did a good segment on loan servicers and why they do or do not modify loans for delinquent borrowers (starting around the 10-minute mark). There isn’t a lot that avid readers won’t know already; the central message is that it would be better for everyone involved – including lenders and investors – if more loans were modified. It also doesn’t address the legal issues created by collateralized debt obligations where the tranches have different priorities. But if you’re confused about the basics, it’s worth listening to.

Still, there were a couple things that were new or interesting to me:

  •  Scott Simon, a managing director at PIMCO (the world’s biggest bond fund manager), said that he thinks loan servicers should be modifying more mortgages; that seems like a pretty clear vote from the investor side.
  • The segment brings up the issue of computer systems, which is something I hadn’t thought of but should have. Apparently, most if not all of the big, bank-owned servicers don’t have computer systems (software) that can estimate the net present value of a foreclosure as opposed to a modification, taking into account zip code-specific repair costs, broker’s fees on the sale, closing costs, foreclosure-specific legal costs, and expected sale proceeds. Big-company information technology is something I know well, and I can say with a high degree of confidence that if they started designing these things in 2007, they won’t be done until sometime next year at the earliest, and there’s a good chance they won’t work, and even if they do they will have difficulty handling the load. On the other hand, one good product manager and ten good developers in Silicon Valley could probably build something better in about 12-18 months. I sure hope the fate of the economy doesn’t depend on custom homegrown software.

By James Kwak

New Cars, Mortgages, and Race

Like most forms of hardship in our society, the foreclosure crisis is disproportionately affecting minorities. The New York Times conducted a study of foreclosures in the New York area and found, among other things:

Defaults occur three times as often in mostly minority census tracts as in mostly white ones. Eighty-five percent of the worst-hit neighborhoods — where the default rate is at least double the regional average — have a majority of black and Latino homeowners.

Well, that might simply be a function of poverty: statistically speaking, minorities are more likely to be poor, and therefore more likely to become delinquent on their mortgages. But I don’t think it’s that simple.

Continue reading “New Cars, Mortgages, and Race” →

Bankruptcy Cramdowns Defeated in Senate

President Obama, he of the 68% approval rating, asked Congress to allow bankruptcy judges to reduce the principal amounts of mortgages on primary residences (they can already modify almost all other loans in bankruptcy). The goal was to pressure mortgage lenders, or the investors who now own those mortgages, to modify the mortgages themselves to give homeowners a better option than foreclosure. Because, you know, we have a housing foreclosure crisis going on. But after passing the House, the measure got only 45 votes in the Senate, with zero Republican support and twelve Democrats defecting.

Banks campaigned against the measure by – get this – threatening that it would destabilize financial markets. The New York Times reported:

A letter signed by 12 industry organizations this week to senators warned that the legislation would “have the unintended consequence of further destabilizing the markets.” 

Translation: banks are weak; weak banks are dangerous; therefore Congress should not do things that might be bad for banks.

According to the Washington Post:

[Senator Richard] Durbin negotiated with Bank of America, J.P. Morgan Chase and Wells Fargo for weeks, hoping their support would bridge the gap. Even after the proposal was weakened significantly, the financial services industry refused to sign on.

I know the main legitimate argument against bankruptcy cramdowns: it increases the riskiness of mortgages, and therefore mortgage rates would have to go up a little for everyone. (Which sounds fine with me.) But the way this issue played out had nothing to do with what would be best for the country as a whole; it had everything to do with what the banks wanted. 

Instead of bankruptcy cramdowns, the Times reports that the banks got a reduction in the insurance premiums they will pay the FDIC for deposit insurance – which is like a group of car owners voting themselves lower premiums on their auto insurance. But because there is zero chance the government will let insured depositors lose money, any shortfall in the premiums paid by banks to the FDIC will be made up by the taxpayer.  

Not that this should surprise anyone.

By James Kwak

The Missed Opportunity

For a snapshot of what’s wrong with our banking policy, look at the front page of the business section of today’s New York Times. On the left side: “U.S. in Standoff with Banks over Chrysler.” On the right side: “Banks Show Clout on Legislation to Help Consumers.”

On the left side, a consortium of banks holding Chrysler debt is refusing to agree to the current restructuring plan, which involves bondholders holding $6.9 billion in secured debt getting about 15 cents on the dollar – roughly where the bonds are currently trading, according to the Times.* The banks are playing the ongoing game of chicken with the government, betting that the government will cave and give them a better deal rather than take a risk on a bankruptcy.

On the right side, the banks are using their lobbying clout to block the administration’s proposals to help consumers and households, including the mortgage cram-down provision (which would allow bankruptcy courts to modify mortgages on first homes) and added consumer protections for credit card customers. They currently have all 41 Republican votes in the Senate tied up, which means nothing can pass.

The banks leading the charge over Chrysler: JPMorgan Chase and Citigroup. The banks opposed to cram-downs: Bank of America, JPMorgan Chase and Wells Fargo. The banks blocking credit card protections: American Express, Bank of America, Capital One Financial, Citigroup, Discover Financial Services, and JPMorgan Chase. All or almost all are bailout beneficiaries. But don’t blame them: they’re just doing what they can to maximize their profits at the expense of the taxpayer, which is perfectly legal (and even ethical, depending on your conception of shareholder rights). Instead, you should be wondering why they are in a position to be maximizing profits at the taxpayer’s expense.

Continue reading “The Missed Opportunity” →

Modifying Securitized Mortgages

Amidst the gallons of ink spilt, here and elsewhere, over the nationalization debate, the AIG collateral payments, and the AIG bonuses, I neglected to comment on the details of the new housing plan, which were released on March 4. When the initial plan was announced in February, I was concerned about the seeming lack of any provision that would enable servicers of securitized mortgages to modify those mortgages without being sued by the investors who bought the securities. (In brief, the problem is that the pooling and servicing agreements (PSAs) that govern those securitizations may not allow loan modifications, or may require the servicer to gain the consent of all of the investors, which is practically impossible.) People who know housing better than I said there was something in there.

If it is, I still can’t find it in the March 4 documents (fact sheet, guidelines, modification guidelines). In any case, an important question is whether the plan will do enough to encourage servicers to modify securitized mortgages, as opposed to mortgages they own. “A New Proposal for Loan Modifications,” a short (13-page) paper by Christopher Mayer, Edward Morrison, and Tomasz Piskorski that will appear in the next issue of the Yale Journal on Regulation, describes the problem clearly and makes three proposals to solve it. (A longer version with appendices is available here.)

Continue reading “Modifying Securitized Mortgages” →

YLS Conference on the Financial Crisis

If you are a true crisis junkie (or you are having trouble falling asleep tonight and need more to read), my own Yale Law School held a conference on the financial crisis, its causes, and potential solutions (including better regulation) on Friday. There were a number of famous names present, including Lucian Bebchuk, Christopher Mayer (of the Hubbard-Mayer proposal), Anil Kashyap, and others. You can look at the agenda or check out the readings for sessions one, two, three, and four (each includes links to PDFs of the papers).

And where was I during all of this? I was home with my daughter.

(Let me know if you find something particularly important that I should read – I’m finding it impossible to keep up.)

We Have a Winner?

After seeing dozens of mortgage proposals emerge over the past several months, there are news stories that Larry Summers and the Obama economic team are converging on an unlikely candidate: the proposal by Glenn Hubbard and Christopher Mayer first launched on the op-ed page of the Wall Street Journal on October 2. Hubbard and Mayer published a summary of the plan in the WSJ last week; a longer version of the op-ed is available from their web site; and you can also download the full paper, with all the models.

Continue reading “We Have a Winner?” →

Community Reinvestment Act Makes Bankers Stupid, According to AEI Research

One might have hoped that one collateral benefit of the end of the election season would be the end of the attempt to pin the financial crisis on the Community Reinvestment Act, a 1970s law designed to prohibit redlining (the widespread practice of not lending money to people in poor neighborhoods). Unfortunately, Peter Wallison at the American Enterprise Institute (thanks to one of our commenters for pointing this out) has proven that some people will never give up in their fight to prove that the real source of society’s ills is government attempts to help poor people. Regular readers hopefully realize that we almost never raise political topics here, but sometimes I just get too frustrated.

Many people who are more expert than I in the housing market have already debunked the CRA myth. Here are just a few: Janet Yellen, Menzie Chinn, Randall Kroszner, Barry Ritholtz, David Goldstein and Kevin Hall, and Elizabeth Laderman and Carolina Reid. Mark Thoma does a good job keeping track of the debate.

One of the main arguments against the CRA-caused-the-crisis thesis is that the large majority of subprime loans, and delinquent subprime loans, and the housing bubble in general, had nothing to do with the CRA; it was done by lenders who are not governed bythe CRA, and was done in places like the exurbs of Las Vegas or the beachfront condos in Florida, not poor neighborhoods (which generally saw less price appreciation than average). So Wallison comes up with a new argument: relaxed lending standards, encouraged by the CRA, caused lending standards to be relaxed in the rest of the housing market. Really, I’m not making this up.

Continue reading “Community Reinvestment Act Makes Bankers Stupid, According to AEI Research” →

The Lawsuits Begin, Part 2

Yesterday I mentioned a lawsuit against Goldman Sachs (article by HouseingWire) alleging that Goldman misled investors in its mortgage securitizations. Here’s the complaint. It’s a fun read.

The allegations are pretty simple. As part of each securitization, Goldman had to produce a registration statement and prospectus. In theory, as any investor knows, you are supposed to read the prospectus before buying a security. The claim is that these statements and prospectuses (someone help me with that plural) contained false statements regarding the underwriting standards used when making the underlying mortgages. The bulk of the complaint (pages 12-28) goes originator by originator and compares the statements made about that originator’s lending practices in the prospectus to information that has since emerged about how these lenders actually made loans.

One thing that struck me was how open these prospectuses were about what was going on. For example, here’s a passage on Countrywide’s “no income/no asset” loans:

Continue reading “The Lawsuits Begin, Part 2” →

Causes: Subprime Lending

Other posts in this occasional series.

Six months ago, this post would have been unnecessary. Back then, for most people, the crisis was the “subprime crisis:” subprime lending had become too aggressive, many subprime mortgages were going to go into default, and as a result securities backed by subprime mortgages were falling in value. Hedge funds, investment banks, and commercial banks were in danger insofar as they had unhedged exposure to subprime mortgages or subprime mortgage-backed securities (MBS). Still, if you were to stop the average reader of the New York Times or the Wall Street Journal on the street and ask what caused the current financial and economic crisis, there is a good chance he or she would start with subprime lending.

Asking whether subprime lending caused the crisis raises all the questions about agency and causality that I’ve raised before. On the agency question, insofar as there was a problem in the subprime lending sector – and few would deny that there was – does the fault lie with borrowers who took on loans they had no chance of repaying, perhaps sometimes without understanding the terms; with the mortgage lenders who lent them the money without doing any due diligence to determine if they could pay them back; with the investment bankers who told the mortgage lenders what kinds of loans they needed to package into securities; with the bond rating agencies who blessed those securities while taking fees from the investment banks; with the investors who bought those securities without analyzing the risk involved; or with the regulators who sat on their hands through the entire process? Note in passing that it may have been perfectly rational, as well as legal, for an investor to by an MBS even knowing that the loans backing it were going to default, but making a bet that he could resell the MBS before the price fell, under the “greater fool” theory of investing. (It may have been rational for an investment bank to do the same, but not necessarily legal, given the disclosure requirements relating to securities. Goldman Sachs is being sued over precisely this question.) Readers of this blog know that my opinion is that, although there is blame to be shared along the chain, the greatest fault lies with the regulators, for a few reasons. First, although the desire to make money may cause problems, it can be no more be said to be a cause of anything than gravity can be said to be the cause of  a landslide; second, bubbles are inevitable, at least in an unregulated market;  and third, there is a difference in kind between the mistake made by an investor, who is foolish and loses some money, and the mistake made by a regulator (or a legislator who votes to reduce funding for regulators), whose job is to serve the public interest.

But that was all the preamble, because today I want to talk about the question of causality.

Continue reading “Causes: Subprime Lending” →

How the SEC Could Have Regulated Subprime Mortgages

From a new paper (link below):

Kafka would have loved this story: According to our current understanding of U.S. law there is far better consumer protection for people who play the stock market than for people who are duped into buying a house with an exotically structured subprime mortgage, even when the mortgage instrument is immediately packaged and sold as part of a security.

The crux of the matter is that securities transactions – notably, the sale of a security to a customer by a broker – are governed by SEC regulations, which impose a fiduciary relationship on the broker, meaning, among other things, that the broker can only sell financial products that are suitable for that customer. However, no such rule governs the relationship of a homebuyer to a mortgage broker or company, meaning that behavior by the latter must be actually fraudulent before it can be sanctioned.

Jonathan Macey, Maureen O’Hara, and Gabe Rosenberg (two of whom are at my very own Yale Law School) have a new paper (abstract and download available) arguing not only that mortgage brokers should have a fiduciary responsibility to their customers, but that they already do under two reasonable interpretations of existing SEC regulations. (It has to do with whether a complex subprime mortgage is already a security or, failing that, whether it is related to a security transaction.) This means that the SEC could have been regulating these things all along.

The Lawsuits Begin …

OK, there are probably other lawsuits already. But now a hedge fund is suing Countrywide (Bank of America), claiming that its loan modification program violates contract law and that if Countrywide wants to modify any mortgages it must buy out the existing investors at face value.

This is one aspect of the “securitization problem” that got a lot of air time on this blog a few weeks ago.