by Calculated Risk on 7/04/2009 08:32:00 PM

This piece "Mortgages Made Simpler" by Richard Thaler, is a discussion of the proposed Obama Administration regulatory requirement that lenders offer consumers "plain vanilla" mortgages. From the Treasury regulatory reform proposals (page 66):

We propose that the regulator be authorized to define standards for “plain vanilla” products that are simpler and have straightforward pricing. The CFPA should be authorized to require all providers and intermediaries to offer these products prominently, alongside whatever other lawful products they choose to offer.

I found the following description amusing:

Traditional economics is based on imaginary creatures sometimes referred to as “Homo economicus.” I call them Econs for short. Econs are amazingly smart and are free of emotion, distraction or self-control problems. Think Mr. Spock from “Star Trek.”

Real people are not Econs. Real people have trouble balancing their checkbooks, much less calculating how much they need to save for retirement; they sometimes binge on food, drink or high-definition televisions. They are more like Homer Simpson than Mr. Spock. Call them Homer economicus if you like, or just Humans. Behavioral economics is the study of Humans in markets.

Designing policies for Econs is pretty straightforward. Because they are smart consumers and make good choices, the best policies give them as many choices as possible and simply assure that they have access to all the relevant information.

Humans, however, can use a bit more help, especially when the options are hard to understand.

I like the idea that all consumers be offered a "plain vanilla" mortgage option, and also that many of the non-traditional mortgage products come with warning labels.

Of course most CR readers are probably "Homo economicus" and are free to opt out.

by Calculated Risk on 4/03/2009 12:37:00 PM

From the Office of the Comptroller of the Currency and the Office of Thrift Supervision: OCC and OTS Release Mortgage Metrics Report for Fourth Quarter 2008

The Office of the Comptroller of the Currency and the Office of Thrift Supervision today jointly released their quarterly report on first lien mortgage performance for the fourth quarter of 2008. The report covers mortgages serviced by nine large banks and four thrifts, constituting approximately two-thirds of all outstanding mortgages in the United States.

The report showed that credit quality continued to decline in the fourth quarter of 2008. At the end of the year, just under 90 percent of mortgages were performing, compared with 93 percent at the end of September 2008. This decline in credit quality was evident in all loan risk categories, with subprime mortgages showing the highest level of serious delinquencies. However, the biggest percentage jump was in prime mortgages, the lowest loan risk category and one that accounts for nearly two-thirds of all mortgages serviced by the reporting institutions. At the end of the fourth quarter, 2.4 percent of prime mortgages were seriously delinquent, more than double the 1.1 percent recorded at the end of March 2008.
emphasis added

Much of the report focuses on modifications and recidivism (see Housing Wire). But this report also shows - for the first time - more seriously delinquent prime loans than subprime loans (by number, not percentage).

Click on graph for larger image.

Note: "Approximately 14 percent of loans in the data were not accompanied by credit scores and are classified as “other.” This group includes a mix of prime, Alt-A, and subprime. In large part, the loans were result of acquisitions of loan portfolios from third parties where borrower credit scores at the origination of the loans were not available."

This report covers about two-thirds of all mortgages. There are far more prime loans than subprime loans - and the percentage of delinquent prime loans is much lower than for subprime loans. However, there are now more prime loans than subprime loans seriously delinquent. And prime loans tend to be larger than subprime loans, so the losses from each prime loan will probably be higher.

We're all subprime now!

by Calculated Risk on 3/04/2009 09:24:00 AM

From MarketWatch: Treasury says mortgage plan to help up to 9 mln homeowners

The Treasury Department released guidelines to its mortgage modification plan on Wednesday and said that the program will help up to 9 million homeowners avoid foreclosure. The guidelines will enable servicers to begin modifying mortgages right away ... The Treasury program also includes incentives for removing second liens on loans.

From financialstability.gov (Treasury site):

Summary of Guidelines

Modification Program Guidelines

Counselor Q&A

Fact Sheet

by Calculated Risk on 2/06/2009 04:49:00 PM

From Bloomberg: Wells Fargo May Cut Loans for Some Wachovia Customers

Wells Fargo ... offered to cut mortgage balances for some Wachovia Corp. customers by 20 percent ... Wells Fargo mailed letters to those borrowers, asking for proof of current income and a 2007 income-tax statement, bank spokeswoman Debora Blume said today in an e-mail. ...

“We are encouraged by the response we are getting to our outreach efforts, as it means we will be able to help more people with a solution that works,” Blume wrote.

... San Francisco-based Wells Fargo inherited billions of dollars in future losses when it bought Wachovia for $12.7 billion. Wells Fargo said last week that Wachovia’s option adjustable-rate mortgage portfolio has close to $60 billion of impaired loans.

The real cost of the Wachovia purchase was the pending losses on the Wachovia loan portfolio - and most of those losses will come from the $118.7 billion portfolio of “Pick-a-Pay” option ARMs Wachovia acquired in the Golden West Financial acquisition in 2006.

The Wells offer is probably mostly to ex-Golden West borrowers. We can be pretty sure that Wells thinks this will minimize their losses on these loans. Remember Wells is also receiving favorable tax treatment that makes this more palatable (a somewhat hidden bailout from the taxpayers).

by Calculated Risk on 1/27/2009 07:08:00 PM

From the WSJ: U.S. House Panel Approves Mortgage Measure (hat tip Ken)

A measure to allow judges to reduce the principal amounts of mortgages for troubled borrowers in bankruptcy cleared a key hurdle Tuesday when it was approved by a U.S. House panel.
...
Under the legislation, borrowers would be eligible to have a bankruptcy judge reduce the principal balance on their home loan -- a move known as a "cram down."
...
In key concessions to the banking industry, Mr. Conyers agreed to alter the legislation to allow court-ordered modifications only for existing mortgages and to require that borrowers contact their lender at least 15 days before filing bankruptcy.
...
In another change, the legislation will now require recipients of cram downs who resell their home within five years to share the proceeds with their lender.

Tanta argued that cram downs would help discipline lenders in the future. So I think she'd consider the concession to make the legislation applicable to only existing mortgages significant. Excerpting from Tanta's Just Say Yes To Cram Downs

I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.

by Calculated Risk on 1/06/2009 09:16:00 AM

From Reuters: Lawmakers set new mortgage bankruptcy bill

Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.
...
The legislation would change allow bankruptcy judges to modify home loans in the same way that they currently may modify other unsettled obligations, such as credit card debt.

For a discussion of the cram-down issues, see Tanta's:

Just Say Yes To Cram Downs Oct, 2007

Here are a couple more posts from Tanta on cram-downs:

House Considers Cram Downs Sept, 2007

MBA and Cram-Downs Feb, 2008

by Calculated Risk on 11/11/2008 12:19:00 PM

From the WSJ: Fannie, Freddie Work on Mass Loan Modification Plan

Fannie Mae, Freddie Mac and U.S. officials are expected to announce plans Tuesday to speed up the modification of hundreds of thousands of loans ... The streamlined effort will target certain loans that are 90 days or more past due ... The program will aim to bring the ratio of mortgage payments for these homeowners to 38% of their income by modifying interest rates and in some cases forgiving portions of principal debt ...

The announcement is expected to come at a press conference at 2 p.m. at the Federal Housing Finance Agency ...

by Calculated Risk on 8/26/2008 05:31:00 PM

From Bloomberg: Carteret Mortgage Will Close, Chief Executive Says (hat tip Dave)

Carteret Mortgage Corp., a closely held mortgage broker that originated more than $4 billion in loans in 2006, plans to close in several weeks, said Chief Executive Officer Eric Weinstein.

``We ran out of money,'' Weinstein, 49, said in an interview today. ``We're not technically out of business yet, but we're winding it down and trying to do the best we can for everybody.''

Weinstein said the ... company has about 800 employees ...

Just a reminder that Mortgage brokers are still going out of business. Carteret had more than 4,500 employees at one time, and operated in 45 states.

by Calculated Risk on 7/01/2008 01:23:00 AM

From the Telegraph: UK house prices in grip of slump that experts expect to deepen

Britain is in the grip of a housing slump as bad as at any stage since the 1970s, property experts warned, as data suggested that first time buyers had all but disappeared from the market.
...
Just 42,000 loans were handed out in May – down from 58,000 in April and a massive slump of 64pc compared to this time a year ago, when 116,000 mortgages were given to home buyers. This is the lowest level recorded in any month since the Bank of England started collecting data in 1993.

We've sure seen a lot of records recently. Record foreclosures. Record inventory. Record house price declines. Record low mortgage approvals in the UK.

Another day, another record ...

by Calculated Risk on 4/22/2008 11:04:00 AM

From Reuters: Bank of America-Countrywide to curb risky mortgages

Bank of America said on Tuesday it plans to stop offering some riskier mortgage loans after it finishes buying Countrywide... the combined businesses will not offer "option" adjustable-rate mortgages ...

It also plans to "significantly curtail" other non-traditional mortgages, including some loans that don't require borrowers to fully document income or assets.

I'm a little surprised they are still offering Option ARM and stated income loans now.

by Calculated Risk on 2/28/2008 04:25:00 PM

Blown Mortgage has the details: Wells Fargo Names Most of California Severely Distressed

Wells Fargo has named nearly every California county a “Severely Distressed Market” which requires LTV reductions of 5% for any conforming loan over 75% LTV and also eliminates financing over 75% LTV for any non-conforming loan. The Wells Fargo Mortgage Express product (which is Wells Fargo’s stated income/stated asset program) is also not permitted in “Severely Distressed Market” areas.

Look for the rest of the market leaders to quickly follow suit. This immediately puts a huge swath of the state with increasingly limited refinance options. A huge portion of California loans are of the non-conforming variety and well over the 75% LTV mark ...

And from the BizJournals.com: Wells Fargo tightens mortgage guidelines (hat tip Michael)

The tougher lending standards take effect Feb. 29 ...

Twenty counties in California, including Los Angeles County and Orange County, are on the severely distressed markets list. At-risk markets around the country include 33 in Florida, 15 each in Michigan and Virginia, and 13 each in Maryland and Ohio. Many other states, including Arizona, Colorado, Connecticut, Louisiana, Massachusetts, Minnesota, New York, Nevada, New Jersey, Washington and Wisconsin had markets on the list.

by Tanta on 1/03/2008 08:06:00 AM

We all knew that technology would solve our productivity problems, and National Mortgage News has the proof:

One question some of you might be asking is this: if subprime volumes have screeched to a halt, what are all those traders on Wall Street doing? Good question. We're told that come January there will be a wholesale shakeup at several firms. Sources tell us that Deutsche Bank, Lehman Brothers and Merrill Lynch all are conducting reviews (or soon will) of their entire mortgage operations. As for where the most drastic changes might occur, Merrill Lynch might be a good bet. An account executive there told us recently about conditions at Merrill's First Franklin Financial Corp. He said many offices are not funding loans while awaiting training for Fannie Mae products. "So far, there's been no training," he told us. The AE, requesting his name not be used, painted a bleak picture, saying business is so slow that employees pass the day playing Scrabble and PlayStation on the conference room projector screen. He said FFFC AEs and executives keep asking Merrill why they can't just originate loans and put them on the balance sheet of Merrill's FDIC-insured bank. "We're not getting any answers," he said.

Aside from the idea of loan officers having sufficient spelling skills to play Scrabble, which is new to me, here we have the two same old dumb ideas that emerge in any mortgage downturn, with a delicious twist that it's Wall Street getting it instead of Main Street.

First, there's the old "let's retrain a bunch of subprime loan officers to be prime GSE loan officers." You civilians might think this should be fairly easy, but the fact is that training a lot of these people to be prime loan officers basically means training them to be loan officers. If they had any basic depth of understanding of the business they're in, they could move to prime origination by just reading that other rate sheet. The reality is that they've been doing no-doc no-down no-sweat stuff for so long--some of them have never done anything but--that they're sitting around with the PlayStation waiting for someone to tell them how a 30-year fixed rate loan with a down payment and verified income actually works. Which is to say, their bosses are sitting around in the busier conference rooms trying to figure out if it's possibly worth the time and money to turn these people into mortgage experts instead of corner-cutting order-takers.

Item the second causes a deep belly laugh in anyone who ever worked for a depository in a mortgage downcycle: "Why can't we just put the loans on the balance sheet?" I know it makes me a bad person, but the thought of Merrill getting this one from its mortgage people is floating me heavenward on a warm tide of schadenfreude. I suspect that it may well be tickling the folks at National City, insofar as they have anything to laugh about these days. In case you don't remember, Merrill bought First Franklin from National City just over a year ago--but apparently nobody explained to the First Franklin folks that they no longer had a parent with a big fat hold-to-maturity portfolio with which loan originators can be subsidized in a low-volume period.

That is--or once was--an old strategy for depositories: when you can't sell your loans, hunker down, stuff 'em on the books and wait for the tide to turn. We are seeing depository after depository shutting down its wholesale and correspondent lending divisions, meaning it will, as always, only allocate those portfolio dollars to keeping an expensive but much safer retail operation alive. If you're a mortgage broker right now, you are staring in the face of hunger.

But Merrill really really wanted to be a retail originator in its own right. Welcome to the other side of the mortgage world, Mother Merrill, and try turning in some tiles. Maybe you'll get a vowel.

by Tanta on 1/02/2008 09:32:00 AM

Go here, and then go here.

(Sorry, I'm in the middle of installing software. That requires attention to my dishwasher.)

. . . Install is going quite well, thanks.

by Tanta on 12/18/2007 10:04:00 AM

Only a mere fifteen months after the eagerly-awaited Nontraditional Mortgage Guidance began closing the barn door slowly enough that the entire wretched 2006 subprime and Alt-A loan vintage still managed to get out, the Fed has deemed the time right to take decisive action on mortgage regulation:

Dec. 17 (Bloomberg) -- The Federal Reserve will make it harder for lenders to charge fees for early repayment of subprime mortgages, according to consumer advocates and a regulator.

The change will probably be one of several recommendations from the Fed's Board of Governors when it gathers in Washington tomorrow to respond to the collapse in the market for subprime home loans. . . .

Fed staff, with input from policy makers, will propose as many as four new requirements for lenders tomorrow before a Board of Governors meeting scheduled for 10 a.m. They may also set two new standards for disclosure.

The proposal will suggest limiting prepayment penalties for most high-cost loans, while giving lenders some flexibility through several exceptions.

``The consensus seems to be that they are going to do something on no-documentation loans, and they are going to ban prepayment penalties,'' said Brenda Muniz, legislative director in Washington at Acorn, a community advocacy group. ``The devil is in the details,'' she said. There may be several loopholes for lenders, Muniz added.

The staff memorandum will also probably recommend lenders be forced to include property taxes and insurance in monthly payments. They are already included in payments on most prime home loans, which banks make to their best customers. The proposal will also address standards for measuring whether borrowers can afford a loan for the duration of the mortgage, instead of just for an initial period of lower interest rates. . . .

"It is a common practice for these payments to be escrowed in the prime markets, and I see no reason that escrows should not be standard practice in the subprime markets too," Kroszner said in a Nov. 5 address in Washington.

In the real world, it is common practice for tax and insurance escrows to be required on prime loans only when the LTV is greater than 80%; if there's still a lender around who won't waive escrows for lower-LTV loans (usually for an additional 0.25% in points), I haven't heard about it. I can tell you that nobody complains more bitterly than a prime borrower with a low LTV forced to escrow; these are responsible folks who quite rightly consider escrows on a par with excess tax withholding. It is particularly galling when servicer escrow processes, in this day and age of frequent loan servicing transfers and stripped-down operations, are such a mess in so many respects. Escrowing your tax and insurance payments should at least guarantee that you'll never have a policy cancelled or get a late notice from the county assessor, but too many people are finding that not to be the case.

Practically speaking, what changed in the world of the last several years was the explosion of the piggyback loan. Purchase mortgages, especially for first-time homebuyers, that would a few years ago have had high LTVs and mortgage insurance (which is always escrowed), became 80% first mortgages and therefore fell under the escrow waiver rules. So at some level this problem is going to solve itself, as second-lien lenders exit the game and low-down loans have to secure mortgage insurance, which then require escrow accounts. I will be quite interested to see what gets proposed here by the Fed, however, as a rule.

The interesting thing is that the industry never knows what to think about escrow rules. Servicers like them, since in addition to the obvious risk reduction, escrow balances are a profitable source of float. Originators, however, have two important reasons to resist giving up escrow waivers: you lose low-LTV refi business (it's hard to talk a low-LTV borrower into refinancing an existing loan that doesn't require escrows into a new loan that does, if the low-LTV borrower wants to manage her own T&I), and you just can't play qualifying games with stretched borrowers. A high-DTI loan without T&I included in the payment is more than usually likely to fail eventually, but often not until the first or second tax bill comes due. A high-DTI loan with T&I included in the payment is more than usually likely to fail early, while it's in that nasty early default warranty period. So I expect the usual schizoid response from the lobbyists.

One thing that has been a particular problem lately is estimated tax payments--escrowed or just calculated for qualifying purposes--on new construction. A perfectly common slimy origination practice is simply to use the last actual tax bill on the parcel to calculate next year's tax bill, even though a moderately alert cub scout could tell you that as the property was unimproved acreage last year and will be assessed next year with a 3,000 square foot home on it, last year's tax bill is going to be a tiny fraction of what the borrower will actually have to pay. Every underwriter knows this practice is creating loan failure; every loan officer knows this practice is shoe-horning in marginal borrowers who wouldn't meet DTI requirements using sane numbers and hence is a way of keeping the party going.

I certainly wouldn't expect Fed regulations on mortgage escrows to include drilled-down rules on how to calculate taxes on recently improved property. But that's kind of the point: the industry has behaved in such perverse, self-defeating ways lately that you probably do have to actually write legislation including the kind of blindingly obvious rules on tax calculation that underwriter trainees used to master by the end of their first week. If you don't, then these self-defeating practices will continue as long as the industry is structured so that someone profits from it.

There's also the chronic problem of "de minimus" HOA assessments and ground rents. Servicers hate having to manage escrow accounts for HOA assessments of $50 a year, not to mention those $1.00 ground rents. Those things never get escrowed. But that means that the increasing number of loans with quite significant assessments are also going un-escrowed, as servicers just decide not to handle HOA dues across the board. That wasn't a huge problem back when we didn't put first-time homebuyers with no savings into gated communities with an absurd DTI. Now that we do, we're seeing the first foreclosure notice coming from the HOA, not the lender or the tax assessor.

The safe prediction is that as soon as the draft rules are announced, we'll get a press release from the MBA decrying the additional cost of mortgage financing that will result. What with the add-ons from cram-down legislation and prepayment penalty restrictions and eliminating no-docs and ending appraiser-shopping and everything else they've warned us about in dire tones, we can (should we choose to believe them) prepare for 12.00% mortgage rates by about March. Of course, by then your tax bills might actually start dropping a bit, once the assessor gets the new comps . . .

by Tanta on 12/05/2007 07:30:00 PM

I am, in fact, working on detailed post about The Plan. Since it appears there will be details released tomorrow, I expect to have more worthwhile to say after that.

But, to speak to what just got released (as presented in Bloomberg): this thing with the FICO score buckets seems to have taken a lot of people aback. Certainly we hadn't heard explicit mentions of FICO bucketing in the earlier hints about The Plan.

I think what this is about is a way to keep this focused on subprime loans. As regular readers of this blog (at least) know, there really aren't hard-and-fast definitions of subprime. Saying that efforts will be "prioritized" by FICOs under 660 is a way to try to target this effort to what we would consider "subprime," regardless of how the loans might be described by a servicer or in a prospectus.

And that, really, is a way to target the "freeze" to start rates that are already pretty high. I think some people are getting a bit misled by the idea of "teaser" rates here. As Bloomberg reports quite correctly, the loans being targeted have a start rate in the 7.00% to 8.00% range. (My back-of-the-envelope calculation is a weighted average of about 7.70%, with a weighted average first adjustment rate of just over 10.00%.) Nobody wants to come out and say that "Hope Now" is all about freezing just the highest initial ARM rates that there are, but that's in fact what it's about.

So asking, in essence, why we are "rewarding" people with the worst credit profiles is, really, missing the point. The point is that the cost of this goes directly to investors in asset-backed securities, and those investors are being asked to forgo 10% (the reset rate) and take 7.70% (the current or start rate). They are not being asked, say, to forgo 7.70% and take 5.70%, which is roughly what it would be if this "freeze" were extended to the significantly-over-660 crowd (Alt-A and prime ARMs).

So far, I'm prepared to believe assurances that this will not involve taxpayer subsidies: the cost of this is, actually, going to be absorbed by investors in mortgage-backed securities. This is why "good credit" borrowers are not going to be "rewarded"--because investors cannot be brought to forgo that much interest. Somebody did the math, and somebody concluded that freezing a rate that is still about 200-250 bps over the 6-month LIBOR isn't going to be a disaster (at least not compared to having to foreclose these things).

More tomorrow.

by Calculated Risk on 12/05/2007 05:08:00 PM

I believe Tanta is working on an analysis for tomorrow or later this week. Meanwhile here are some details via Bloomberg: Subprime Rate Five-Year Fix Agreed by U.S. Regulators

The freeze may apply to mortgages issued between January 2005 and July 2007 that are currently scheduled to reset between January 2008 and July 2010, said a person who has seen a draft proposal. Borrowers whose credit scores are below 660 out of a possible 850 and haven't risen by 10 percent since the loan was issued will be given priority.

by Tanta on 11/17/2007 11:47:00 AM

This is going to be a long post. It is going to attempt to answer the question stated in the post title. It is also going to function as further proof of the old axiom that you can create quite a ruckus in 150 badly-chosen words, but it takes ten times that many words (at least) to return some sanity to the discussion. “Gotcha” reporters of course know this, which is why they do what they do. Most people don’t have the time or desire to wade through the high-attention span Nerd part to evaluate the reporter’s claim. That it’s a deadly serious business for anyone who owns shares in a publicly-traded company being compared to a criminal conspiracy on the basis of a misunderstanding of accounting rules doesn’t seem to bother writers who just want a “scoop.”

The ruckus started last week. On November 9, Fannie Mae released its 10-Q for the third quarter. This is the first time in years that Fannie has gotten a timely Q out; its 10-K for 2006 was released just in August, it never filed Qs for 2006, and the Qs for the first two quarters of 2007 were also just released in November. That little detail is important to this story. I assume everyone knows the long wretched saga of why Fannie Mae has been so far behind with its SEC filings. The point is that, in catching up, they have released a flurry of reports in a short period of time, which don’t have the same numbers on them (they shouldn’t; they are for different periods), and since they never reported quarterly numbers for 2006, we don’t have the by-quarter breakout that would provide details for some of the whole-year numbers reported in the 2006 K.

On November 15, Peter Eavis of Fortune Magazine published a breathless essay accusing Fannie Mae of having changed the method it uses to calculate its credit loss ratio in the Q3 filing. It is quite obvious that the presentation of this information has changed; the Q says so (page 54-55). Eavis, moving from a change in presentation to a change in calculation with intent to mislead at the speed of light, says “Uh oh. It’s Enron all over again.” Throughout the original article, he keeps referring to “bad loans” in such a way as to give the misleading impression that the metric in question, the credit loss ratio, is about reporting on delinquent loans, not on realized losses on defaulted loans in the current period. This allows him to accuse Fannie Mae of being “misleading” by not including fair-value write-downs on delinquent but not yet defaulted (not yet realized-loss producing) loans in the credit loss ratio.

Fannie Mae stock started to tank badly, and Fannie scheduled an analyst conference call for Friday morning to address this one very specific issue in one table in the Q. Fannie Mae explained, among other things, that the item excluded from the credit loss ratio calculation is, actually, included in net charge-offs on the consolidated financial statements. However, for the purpose of this specific metric, the credit loss ratio, fair value write-downs that have not yet produced an actual loss are excluded.

You can listen to the webcast here. Several analysts pointed out, quite nonconfrontationally, that they though Fannie could have provided more information to put this matter in context. Fannie agreed, and indicated that future disclosures would include more information. What’s amusing is that in two instances, analysts ended up asking whether in fact Fannie Mae wasn’t over-reserving for certain delinquent loans! Fannie Mae’s response was that they don’t think they’re under-reserving or over-reserving; they are simply applying GAAP rules for how fair-value write downs are taken. At no time in the conference call did anyone challenge this as a misapplication of GAAP rules.

So what did Eavis do, after the conference call and some delving into the credit loss ratio suggested that perhaps he merely misunderstood the math? He wrote a follow-up article on Friday, in which he continues to insist, even after Fannie Mae’s explanation of the issue, that the amount of exclusions from the credit loss ratio (that is, the amount of the fair-value write-downs on repurchased loans that are delinquent but not yet defaulted) is inexplicably large, and that these are forced repurchases, and that this is somehow sinister. This is after a conference call in which Fannie Mae explained, for those who have been living under a rock since last summer, why it is that write-downs on repurchased loans in Q3 can be many, many times the write-downs on loans repurchased earlier in the year, even if the total number of repurchased loans hasn’t grown all that much. There was this mere matter of a giant freeze in the mortgage secondary market, and spooked investors offering mere pennies on the dollar for delinquent mortgage paper, whether it was prime or subprime or something else. Eavis has to pretend to not remember that, I suspect, because his claim of “Enron all over again” is crumbling around his ears and he needs to keep kicking sand.

It is amazing to me that in light of all the real problems we have right now, we still want to go down expensive rabbit holes over “accounting tricks.” Nobody, least of all Fannie Mae, is trying to deny that there are severe problems in the housing and mortgage market, that large losses are being taken, and that this will hurt all over the place. I am not suggesting that Fannie’s Q is as clear as it could be, and I’m glad they indicated a willingness to report more color in future disclosures to make these numbers easier to evaluate. But writing a not completely helpful Q based on GAAP isn’t a crime in this country. I know a lot of people will argue that GAAP isn’t very helpful to the non-specialist. You get no argument from me about that, either. That still doesn’t make Fannie Mae Enron, and I for one would be livid if I were a Fannie Mae shareholder, and watched my money get flushed down the toilet for two days because, frankly, some reporter can neither read nor report. (I may well be a Fannie shareholder via indexed stock funds in one of my retirement accounts. But for disclosure purposes, I own no shares of FNM that I know about.)

Eavis could have gotten the same explanation from Fannie Mae that the analysts got in the call if he had asked for it, I am sure. No one forced him to write an article that makes accusations of willful dishonesty and implications of criminal behavior based on his inability to understand Table 26. He gave himself that assignment. And instead of apologizing for it, he continues to insist that the numbers don’t make sense.

Let me cut through the accounting archana (we can discuss that in the comments if we need to) to what I think is the real issue here. Fannie Mae has always had the option to repurchase seriously delinquent loans out of its MBS at par (100% of the unpaid principal balance) plus accrued interest to the payoff date. This returns principal to the investors, so they are made whole. If Fannie Mae can work with the servicer to cure these loans, they become performing loans in Fannie Mae’s portfolio. If they cannot be cured, they are foreclosed, and Fannie Mae shows the charge-off and foreclosure expense on its portfolio’s books (these are no longer on the MBS’s books, since the loan was bought out of the MBS pool).

Now, Fannie also sometimes has the obligation to buy loans out of an MBS pool. But we are—Fannie Mae made this clear both in the footnote to Table 26 of the Q and in the conference call—talking about optional repurchases. Why would Fannie Mae buy nonperforming loans it doesn’t have to buy? Because it has agreed to workout efforts on these loans, including but not necessarily limited to pursuing a modification. Under Fannie Mae MBS rules, worked out loans have to be removed from the pools (and the MBS has to receive par for them, even if their market value is much less than that).

There is, however, a little matter of accounting rules for booking these loans. Under GAAP, known internally to Fannie Mae as its SOP 03-3, the loan is taken onto the books at the lower of cost (par, in this case) or the fair market value of the loan at the time of repurchase. When the FV is lower than par, Fannie Mae has to charge-off the difference, at the time. This is not a true realized loss: it is a reflection of a mark to a real market value of a delinquent loan. You take the FV write-down at the time, even if you think that no loss, or a very much smaller loss, will actually end up occurring. That’s the rule. Anything else would be “mark to model” or “mark to myth.”

Now, anyone who hasn’t been living under a rock knows that bids for delinquent loans were either nonexistent or atrocious in July-September of this year. Certainly Fannie Mae knew that if it exercised its option to buy loans out of MBS in order to modify them, it, not the MBS, would have to take a nasty FV write-down. I don’t know about you, but I happen to think that a lot of private investors/servicers are refusing to do modifications of securitized loans precisely because they don’t want to have to buy them out of the pools and show that nasty write-down on their own books. They claim that it’s because securitization rules won’t let them modify loans, but I’ve never really bought that argument, nor have many regulators or the SEC.

The problem is that the market right now does not distinguish between a scratch & dent loan—one with a problem that could be cured with a modification—and defaulted nuclear waste that is facing 50% or more loss severity on imminent foreclosure. Whether it should be making that distinction or not—whether this is partly irrational panic or not—is not the point here. The point is that it just isn’t doing so, and so anyone who takes a loan to portfolio right now and uses a true market value instead of a fantasy is going to show the same huge write-down for the scratch & dent as for the nuclear waste. This will continue to be true until the market decides that everything isn’t nuclear waste any more.

So nobody wants outfits like Fannie Mae to mark to model; we want them to mark to market. We also want them to work out loans that can and should be worked out. Remember, we aren’t talking about horror subprime exploding ARMs here, we’re talking about troubled loans in typical Fannie Mae MBS. We’re talking about the kind of loans that would have taken a $60 million write-down in a past quarter, but that are taking a $600 million write-down in this quarter, solely because the market price of those loans has deteriorated so badly.

We also need to remember that Fannie has no intention of ever reselling these loans. If they can be cured, they will stay in Fannie’s portfolio. So establishing a market price is not about determining a loss Fannie would take if it cured the loan and then resold it. Establishing a market price is just a requirement of the accounting rules for a situation in which the price you must pay for a loan (par) is more than the market value of the loan. After all, what Fannie is doing here is making the MBS investor whole and taking the deteriorated asset onto its own books. The FV write-down means exactly that it is not hiding a loss this way.

Fannie Mae could avoid these write-downs by failing to exercise its option to buy the loans from the MBS. That would mean Fannie Mae refusing to work out loans with borrowers. Or, to put it another way, the price of Fannie agreeing to work with troubled borrowers is an out-sized hole in the current quarter’s charge-offs, not just because of the loan quality, but because of the total melt-down in the secondary market for nonperforming loans.

Fannie says that it does not expect most of these loans to default and produce large realized losses. You may or may not find that convincing. But Fannie does, because that’s why they bought them out of the pools. If they thought the stuff would go straight to the FC department, they’d have let the servicer take the loan out of the pool and foreclose, and let the losses hit the MBS guarantee fee income.

Fannie’s story is that in normal times, these FV write-downs of repurchased loans are included in total charge-offs, and therefore are reported in the credit loss ratio. In Q3 07, because of the enormous size of the FV write down, Fannie Mae backed out of the charge-offs the ones due to an up-front write down of delinquent but not defaulted loans. It added back any part of that write down that did, actually, become a realized loss, so that readers of the Q could get a true picture of how much the total charge-offs in Q3 were affected by repurchased loans.

Eavis is saying that this is inexplicable. Of course it’s explicable. You can and some analysts did on Friday ask Fannie Mae why it didn’t supply more information about what it was doing with those loans, and what its expected cure rate would be for these workouts. Fannie Mae acknowledged that such information would have helped and promised to provide more in future disclosures. But nobody on that conference call, as far as I remember, questioned the size of the Q3 07 FV adjustments. People who have been following the credit markets all year are not surprised here. Eavis is.

For the love of all that is holy, what does anyone think Fannie Mae (and Freddie Mac) are up to these days? The enormous pressure they are under by Congress and the public to modify as many loans as can possibly be saved has been so well-documented in the press that I’m sure they heard about it on Mars. It’s possible that Fannie is too optimistic about the cure rate of these loans. It’s possible that deep inside, they realize they are going to eat huge losses on all this stuff. But they were told in no uncertain terms to buy it out of the pools, take the FV write-down like a big kid, and start working out loans. Does anyone actually expect them to write a quarterly report that says “We think all this stuff will result in 100% losses in the next 90 days, but our regulators made us buy it anyway, so we’re reporting the worst possible credit loss ratio we can calculate, just to spite them”? On no planet, at no point in time, will that ever happen. You have to be willfully ignorant to think it would.

So there is, actually, a compelling story to be teased out of a couple of footnotes to a little table on page 55 of a 107-page quarterly report. It’s a story about political and market pressures and reactions; about the bottom-line impacts of workouts to investors like Fannie Mae; about the real-world effects on profitability numbers of things we see in fairly abstract forms, like those cliff-dives on the ABX and CDS charts or the dramatic ratings downgrades we post on regularly. There is a story that ties all of this together and shows how realized losses can be small compared to market losses, and how this ties into the debates over “mark to model” and other bad industry practices. There’s even possibly a story about how in certain unusual times, the old-fashioned GAAP rules fail to really tell investors what they need to know. These are fascinating and important subjects.

Eavis blew through all of those real issues to make a big deal about how Fannie projected losses in the 4-6 bps range for the year and might, actually, be at 7.5 bps as of Q3 if you calculate the number the way Eavis thinks you should. Think about this: he’s saying that it’s possible that credit losses on mortgage paper as of Q3 07 are worse than what was predicted at the end of 2006. OMG!!! No!! Really??? NEWS FLASH!! CALL THE POLICE!!!!! THE OBVIOUS!! IT IS BLINDING ME!!!

Sorry I let myself get out of control there, but come on. Anyone who has been reading USA Today on alternate weekends since February knows that losses are getting worse, and Fannie Mae did in fact explicitly report that losses were getting worse, even with the FV write-downs that were not realized losses backed out. What we are seeing is the whole problem with the “Another Enron” mentality: confusing the meaning of numbers with “accounting tricks,” and substituting some kind of gotcha for an honest attempt to understand the market mechanisms and economic reality that is creating those numbers. This mentality claims to be keeping companies honest, but it actually has the opposite effect, in my view, of inhibiting companies from presenting more detailed numbers, since the more you give people like Eavis the more they have to play gotcha with. And Eavis himself takes credit for his original article having lead to a 17% drop in Fannie Mae’s share price. I guess he’s proud of that. The other side of the Enron myth is the Famous Reporter Who Brought Down the Corporate Giant. It is worth not allowing oneself to get sucked into that sort of grandiose mythologizing.

I have to say I hate “blog triumphalism,” too. That’s the mindset too many internet writers have that us citizen journalists in our jammies are going to single-handedly bring down the Big Corrupt Media. I firmly believe in beating the press up a little when they do egregiously bad reporting, but that’s largely because I care about understanding what the real story is. And I hate being distracted by red herrings in my personal quest for understanding. Yesterday I spent over two hours rooting through SEC disclosures and listening to a 57-minute conference call trying to independently verify Eavis’s point; today I’ve spent a couple of hours writing this post. I am willing to believe that very few people have the time and the expertise to do what I just did. I therefore feel compelled to share my point of view with the rest of the world, in the interest of a worthwhile public discussion of financial and economic matters, which is the purpose of this blog. So I didn’t start out with the goal of catching Eavis being a lousy reporter; I started out with the goal of reading about Fannie Mae in a CNN Money article. But I believe that I did discover hyped, misleading, and ignorant reporting, and I believe it is fair to say so in public.

by Calculated Risk on 11/13/2007 08:29:00 PM

NOTE: See next post for context for this data.

Some useful data from the 2006 American Community Survey

B25097. MORTGAGE STATUS BY MEDIAN VALUE (DOLLARS) - Universe: OWNER-OCCUPIED HOUSING UNITS

	United States
	Estimate	Margin of Error
Median value --
Total:	185,200	+/-489
Median value for units with a mortgage	208,000	+/-379
Median value for units without a mortgage	140,400	+/-549

B25096. MORTGAGE STATUS BY VALUE - Universe: OWNER-OCCUPIED HOUSING UNITS

	United States
	Estimate	Margin of Error
Total:	75,086,485	+/-218,471
With a mortgage:	51,234,170	+/-153,174
Less than $50,000	2,242,784	+/-23,231
$50,000 to $99,999	7,002,253	+/-48,064
$100,000 to $149,999	8,245,296	+/-49,068
$150,000 to $199,999	7,219,252	+/-44,875
$200,000 to $299,999	8,898,887	+/-41,910
$300,000 to $499,999	9,785,782	+/-43,282
$500,000 or more	7,839,916	+/-38,531
Not mortgaged:	23,852,315	+/-87,013
Less than $50,000	3,840,853	+/-30,480
$50,000 to $99,999	4,972,827	+/-33,618
$100,000 to $149,999	3,773,919	+/-28,801
$150,000 to $199,999	2,857,034	+/-23,712
$200,000 to $299,999	3,025,977	+/-23,331
$300,000 to $499,999	2,942,344	+/-22,828
$500,000 or more	2,439,361	+/-17,432

by Calculated Risk on 11/08/2007 05:59:00 PM

Tanta wrote another incredible and timely post this morning: WaMu and The Rep War

IMO Tanta's posts on the mortgage industry are the most informative anywhere, and I suggest checking them out at Tanta's The Compleat UberNerd (a directory of her posts). These posts cover Mortgage Servicing, Private Mortgage Insurance, Reverse Mortgages, Mortgage Backed Securities (MBS) and much more.

You can also click on the The Compleat UberNerd in the menu at the top of the blog to access this directory.

Felix Salmon, at Market Movers on Portfolio.com had this to say yesterday about Tanta:

"Tanta is one of the best financial writers in the world, and explains complex ideas with wit and great clarity."

I couldn't agree more. Enjoy her posts!

by Tanta on 11/08/2007 09:46:00 AM

Via PJ at Housing Wire, I see that WaMu put a PR out yesterday on the matter of Mr. Cuomo's investigation into its appraisal practices. As PJ notes, this is the part that matters:

The contract with the vendor named by the NY AG requires that the vendor represent and warrant that appraisals are prepared in compliance with Uniform Standards of Professional Appraisal Practice and all guidelines issued by Fannie Mae and Freddie Mac. The contract also requires that the appraisals have been prepared without fraud or negligence on the part of the vendor, its employees or agents, including any appraiser.

Fewer than 5 percent of the appraisals performed under this contract were related to subprime loans.

WaMu has a very rigorous process regarding all repurchase requests and believes it is adequately reserved for such liabilities.

That last sentence is clearly a direct response to the last sentence of this part of Fannie Mae's PR from earlier yesterday:

It is against our interest to purchase or guarantee mortgages with inflated appraisals, and so it is in Fannie Mae's interest that these appraisal practices be investigated. The Attorney General has indicated that he also plans to subpoena Fannie Mae for documents and testimony related to the appraisal process. We intend to cooperate fully with the Attorney General. We also will appoint, with the Attorney General's approval, an independent examiner to review the appraisal practices cited in the complaint. If the examiner determines we own or guarantee mortgages with inflated appraisals, our guide states that the lender must buy back the loans that do not meet our standards and requirements.

In other words, Fannie Mae is saying that WaMu will take back any loans with dubious appraisals this "independent examiner" digs up. WaMu is saying that it will "rigorously" avoid doing so.

WaMu is also saying, in effect, that it signed a contract with eAppraiseIT that puts all liability for inflated appraisals on eAppraiseIT. Fannie Mae is saying, in effect, that it signed a contract with WaMu that puts all liability for inflated appraisals on WaMu. Cuomo, you note, is pursuing a civil complaint against eAppraiseIT and its parent First American, not against WaMu or Fannie Mae.

This is very interesting precisely because it isn't going to be about inflated appraisals. It's going to be about how far anyone can get away with two practices that are the lynch-pins of the mortgage industry: outsourcing regulatory liability to a third party bag-holder and doing business on a representation and warranty basis without pre-sale due diligence.

Neither Fannie Mae nor Freddie Mac nor most any other secondary market participant actually examines appraisals on individual loans prior to purchasing them. Some percentage of loans are chosen after purchase for a "Quality Control" review; if problems are found at that point, the investor demands that the seller repurchase (or indemnify) the loan.

This process works only to the extent that the representations made in the loan sale contract are clear, specific, and wide enough to capture all the serious problems an investor might have with a loan. In Fannie and Freddie's case, the loan seller represents that the loan meets every guideline currently published by the GSE or specified in the individual contract. The Fannie and Freddie guides themselves run to hundreds and hundreds of pages; in the case of something like appraisals, the GSE guidelines incorporate by reference things like USPAP (the standards promulgated by the Appraisal Foundation), which themselves run to a lot of pages.

Trust me; all of that stuff is detailed and specific enough that it isn't that hard to find contractual grounds to declare breach and demand repurchase of a loan. WaMu knows that perfectly well, as do all mortgage lenders: those loan sale contracts with all those warranties against all those representations add up to major potential repurchase liability. And the ugly thing is that it's repurchase liability. If your loans were all subject to 100% pre-purchase detailed QC review, your risk would be that the squirrelly ones get kicked out of the sale (you don't get to sell them). Post-purchase QC based on rep & warrant means you risk having to take them back in the future, at par, when they might be worth 90 cents on the dollar (or less), at exactly the wrong time to be owning nuclear waste. It's just like foreclosures: lenders don't make money on REO because they don't own much REO except in time periods when RE is worth a lot less, since they wouldn't be foreclosing so much if the RE market were hummin' along.

WaMu's statement is that it took all the "warranty" part of all of this off its own back and put it onto eAppraiseIT's. The plan all along was that if Fannie Mae (or anyone else) tried to force these loans back because of appraisal problems, WaMu would make eAppraiseIT take the losses. In essence, eAppraiseIT was writing an "appraisal default swap." Pity there's no public index for ADS like there is for CDS: I'm sure that would be some interesting cliff diving.

Anyway, this is why the whole flap is scaring the panties off everyone in the mortgage industry, far, far beyond any worry over stiffer appraisal regulation. The core issue here is a cornerstone of the whole "originate and sell" model that has created such a crisis. If Cuomo's suit makes any headway at all, it will put eAppraiseIT out of business one way or the other. That's because if appraisal management companies are no longer willing or able to write these liability swaps into their contracts, they won't be able to offer what the lenders really want from them. The advantage of doing business this way isn't really about saving a few dollars on outsourcing administrative work for the lenders, it's about getting out from under a huge expensive compliance and legal risk.

No wonder Cramer's head is exploding again. This thing really isn't about appraisals, it's about stopping the game of risk-layoff. The weakest (financially and politically) party in the chain, eAppraiseIT, appears to have taken on all the residual risks from WaMu and Fannie Mae, and now Cuomo is going to force those losses to materialize. You can bet that every General Counsel at every mortgage lender still operating is busy reviewing many, many contracts right now. The results will be very, very ugly.