Friday, February 22, 2008

MBA and Cram-Downs

by Tanta on 2/22/2008 11:15:00 AM

I see America's mortgage lenders have put aside their differences long enough to unite against cram-down legislation:

The nation's largest lending institutions are lobbying hard to block a proposal in Congress that would give bankruptcy judges greater latitude to rewrite mortgages held by financially strapped homeowners.

The proposal, which could come to a vote in the Senate as early as next week, is being pushed by Democratic congressional leaders and a large coalition of groups that includes labor unions, consumer advocates, civil rights organizations and AARP, the powerful senior citizens' lobby.

The legislation would allow bankruptcy judges for the first time to alter the terms of mortgages for primary residences. Under the proposal, borrowers could declare bankruptcy, and a judge would be able to reduce the amount they owe as part of resolving their debts.

Currently, bankruptcy judges cannot rewrite first mortgages for primary homes. This restriction was adopted in the 1970s to encourage banks to provide mortgages to new home buyers.

The Democrats and their allies see the plan as an antidote to the recent mortgage crisis, especially among low-income borrowers with subprime loans. The legislation would prevent as many as 600,000 homeowners from being thrown into foreclosure, its advocates say.

"We should be giving families every reasonable tool to ensure they can keep a roof over their heads," said Sen. Richard J. Durbin (Ill.), the Senate's second-ranking Democrat and author of a leading version of the legislation.

But the banks argue that any help the proposal might provide to troubled homeowners in the short run would be offset by the higher costs that borrowers would have to pay to get mortgages in the future. The reason, banks say, is that they would pass along the added risk to borrowers in the form of higher interest rates, larger down payments or increased closing costs.

If banks were unable to pass on the entire cost, they could be forced to trim their profits.

"This provision is incredibly counterproductive," said Edward L. Yingling, president of the America Bankers Association. "We will lobby very, very strongly against it."
You are, of course, really and truly living in Wonderland if you think that larger down payments and higher credit-risk premiums aren't already starting to get here in part and will only get more "severe" until we return to something like normal lending practices. Just yesterday Freddie Mac published a new Bulletin, adding another 30 bps in delivery fees to loans with LTV/CLTV at or over 80% and FICOs less than 740 (that's 0.125 or less in rate), plus basically getting rid of almost all conventional (non-FHA) loans with LTV greater than 97%. This is "serious" credit tightening only in the context of the egregiousness of the last few years, of course. But it's rather amusing that the MBA seems to think that we could avoid reversion to mean lending standards if only we didn't approve bankruptcy changes to allow cram-downs.

It's particularly amusing just after the OTS made a bit of a splash with its "Negative Equity Certificate" proposal, which is as close to a Chapter 13 cram-down as you can get without a judge involved. Regardless of what you might think about the NEC proposal--insofar as any of us really has enough detail to understand it at the moment--you must recognize that it represents a clear statement from the regulator of the largest thrifts and savings banks in the country--like, you know, Countrywide and WaMu--that principal is going to be charged off. Somehow. Some way. Sooner or later. The MBA can natter on all it wants to about how cram-downs would add 1.50% to mortgage interest rates (wherever that number comes from); if that's true, though, then it is entirely not clear why that 1.50% isn't already on its way even in the absence of cram-down legislation. As usual, the MBA lets the cat out of the bag in its breathless prose:
In December, the U.S. House of Representatives Committee on the Judiciary passed bankruptcy reform legislation that would allow bankruptcy judges to change unilaterally the terms of many mortgage loans, including the loan balance, as part of Chapter 13 bankruptcy proceedings. By granting judges this power, this bill throws into question the value of the collateral that backs every mortgage made in this country -- the home. Even a change Congress says will be temporary will be interpreted by the market as an additional risk, which lenders' prices must reflect.
That's right; there's no question about the value of the collateral now. It would only be in question if we let BK judges see those appraisals.

What this really means is that a successful cram-down would tell the investors in mortgage-backed securities that people can prove to a judge that 1) they cannot afford the mortgages they have and 2) the current value of the home is nowhere near the amount of the mortgage and 3) they do not, actually, want to just "walk away." (Nobody sane who really didn't care about keeping the home would subject themselves to a Chapter 13 just to get a cram-down; they'd mail in the keys.)

Apparently the MBA thinks that item 2) is not yet common knowledge among investors in mortgage-backed securities. This is ridiculous enough an idea that we have to assume it's willful smoke.

My own view is that a lot of mortgage lenders are still in serious denial on items 1) and 3). That'd be the whole "people who can afford their mortgages are just walkin' away" meme we've been dealing with. To admit to the fact that these mortgages are unaffordable for a lot of folks would be to admit that the whole stated-income/bogus DTI/teaser-rate qualifying games that lenders participated in for years was, in fact, what it appeared to be: a way to put people into mortgages who couldn't afford them. This is not a crisis of uncertainly about the collateral valuation. It is the recognition that the loans were made in the first place only because of the assumption that the borrower could always sell or cash-out when the true costs of the thing made themselves manifest, either through rate resets or just a couple of months of the reality of spending 50% or more of your gross income on house payments setting in. This recognition, which, frankly, the credit markets are actually getting to, contra MBA, is less about uncertain value of the collateral than exceptionally dubious reliance on such an uncertain thing to make loans work.

You have to keep remembering that the MBA is the same bunch who was all excited about increasing the conforming loan limits until mortgage bond traders--representatives to a man of that "market" the MBA is so solicitous of--announced, basically, that they had no intention of buying a pig in a poke (again). You do not make larger loan amounts less risky, especially in a declining value market, by simply declaring that "average" now means "125% of median." Mainstream media reports are getting fired up on the TBA issue, and as is generally the case with something this technical, they're not really getting it right. The issue isn't so much "segregation" of the new larger loans, it's specification.

In fact, there isn't any reason why the lower-balance currently-conforming loans couldn't go with the new higher-balance formerly-jumbo loans in a specified pool. (You just can't do it that way in a TBA pool.) It wouldn't necessarily be wise to do that, given that the lower-balance loans might get a better "execution" in TBA pools, but the point is that this isn't about "segregating" loans by balance. It's about, in essence, how much mortgage bond traders are willing to take on faith in "fungibility." TBA pools are sight-unseen: you are putting a price on loans not yet pooled, probably not yet even originated. You do this because you have the assumption that a conforming loan is a conforming loan, once it's got that GSE guarantee on it, so it doesn't matter which exact ones you get. The SIFMA announcement that the higher-balance loans would have to go in specified pools just means that you are putting a bid price on this exact pool of loans, and no other. If the loans are no longer truly "fungible"--if some of them are going to have characteristics that differ substantially from historical GSE pooling practices--then they're just not fungible. That doesn't mean they're bad loans or that nobody's going to bid on the things; it means traders need to know exactly what they're bidding on to price the prepayment risk adequately.

No, really. We've got specified pools. We have increased due diligence levels. We have the rating agencies adding additional data fields to pool-level tapes in order to rate them. We have the GSEs adding new loan-level reporting requirements so that correspondent and brokered loans can be identified in pools. This has all been going on for months and months now. "The market" wants to see, in rather more detail, just what it is we're putting in these pools. "The market" is already pretty sure there's some "uncertainty" here.

Strangely enough, at the same time the MBA is basically saying that all borrowers will get "priced" to the risk of underwater borrowers if cram-downs are allowed, as if we've never heard of the practice of risk-based loan-level pricing before. Either that, or everyone will have to make a down payment and verify income and meet reasonable ratio requirements. Which would, if it happened, pretty much make those loans "fungible" again, besides making them much less likely ever to end up in Chapter 13.

The mortgage industry's major lobbying group is coming out and telling you, explicitly, that cram-downs would ruin the party because we'd either have to disclose these bankruptcy-in-the-making loans to "the market" and watch it slap a punitive bid on the things, resulting in a rate the borrowers could never afford, or we'd have to stop making bankruptcy-in-the-making loans. Or perhaps we are being told that the MBA knows of no possible way to screen loan applications to cull out the ones most likely to end up in BK. That's rather a startling point of view from the folks who are supposed to be experts in mortgage lending.

To be perfectly honest, I'm not especially impressed with the rationale given for the cram-down proposal. I'm not convinced that 600,000 families are going to flock to Chapter 13 if the bill passes and end up financially better off and still in possession of their homes as a result. Most likely, they'll either be financially better off or still in possession of their homes, but not both. I support the bill, nonetheless, because giving residential mortgage lenders preferential treatment in BK proceedings has not worked out well for us, and if it takes the threat of cram-downs to sober everyone up on credit standards and pricing, then let's get on with it. At the very least we ought to be able to force the MBA to come clean on its rhetoric.