by Calculated Risk on 4/07/2008 10:41:00 PM

The WSJ has some excerpts from FDIC Chairwoman Sheila Bair's speech tonight: FDIC Chairwoman Calls for Activism.

“We’ve got a real problem. And I do think we need to have more activist approaches. And I think it will be something we need to be honest with the American public about. We do need more intervention. It probably will cost some money.”

On CRE and bank failures:

Regulators are “increasingly concerned” about the risks posed by high concentrations of commercial real estate loans at banks, especially at financial institutions with between $1 billion and $10 billion in assets.

And on lending standards:

“These internet originators have been a problem too…it’s unbelievable to me they are back already. When I go on my AOL account over the weekend I’m seeing no-doc, low-doc, ‘bankruptcy okay,’ a $200,000 loan for $800 a month. They are back. It is just amazing to me.”

A transcript isn't available yet.

by Calculated Risk on 4/03/2008 01:26:00 PM

'Capital is not synonymous with liquidity.'
Christopher Cox, SEC

From MarketWatch: Bear Stearns crisis tests liquidity rules, Cox says

[Cox] said that Bear Stearns was adequately capitalized "at all times" during March 10 to 17, "up to and including the time of its agreement to be acquired by J.P. Morgan Chase.

But, facing skeptical lawmakers, Cox acknowledged that the firm had massive liquidity problems and that "capital is not synonymous with liquidity." He said the SEC is working with the five biggest Wall Street firms to make sure they increase their liquidity pools and redouble their focus on risk practices.
...
In one day -- March 13 -- Cox indicated, liquidity at Bear Stearns fell from $12.4 billion to $2 billion because of "the complete evaporation of confidence" in the company.

"I think the speed with which this happened is truly the distinguishing feature," the SEC chairman commented. "The Bear Stearns experience has challenged the measurement of liquidity in every regulatory approach, not only here in the United States but around the world."

From the WSJ: Regulators Defend Bear Rescue

"We judged that a sudden, disorderly failure of Bear would have brought with it unpredictable but severe consequences for the functioning of the broader financial system and the broader economy, with lower equity prices, further downward pressure on home values, and less access to credit for companies and households," Federal Reserve Bank of New York President Timothy Geithner said in testimony to the Senate Banking Committee.
...
"If you want to say we bailed out markets in general, I guess that's true," Mr. Bernanke told the Senate Banking Committee, adding the Fed's role in the rescue was necessary given the fragile state of financial markets. "Under more normal conditions we might have come to a different decision" with respect to Bear Stearns, Mr. Bernanke said.

And also from MarketWatch, here is Geithner's presentation: N.Y. Fed's Geithner explains Bear Stearns deal

Geithner was the key player in this deal.

by Calculated Risk on 4/03/2008 10:38:00 AM

From the NY Fed: Portfolio Overview

Following is an overview of the portfolio supporting the loan to be extended by the Federal Reserve in connection with the proposed acquisition of Bear Stearns by JPMorgan Chase.

The $29 billion credit extension is supported by assets that were valued at $30 billion by Bear Stearns, which valued the assets at market value on March 14. JPMorgan Chase will extend a subordinated loan for $1 billion that will absorb losses, if any, on the sale of these assets before the Federal Reserve.

The portfolio supporting the credit extensions consists largely of mortgage related assets. In particular, it includes cash assets as well as related hedges.

The cash assets consist of investment grade securities (i.e. securities rated BBB- or higher by at least one of the three principal credit rating agencies and no lower than that by the others) and residential or commercial mortgage loans classified as “performing”. All of the assets are current as to principal and interest (as of March 14, 2008). All securities are domiciled and issued in the U.S. and denominated in U.S. dollars.

The portfolio consists of collateralized mortgage obligations (CMOs), the majority of which are obligations of government-sponsored entities (GSEs), such as the Federal Home Loan Mortgage Corporation (“Freddie Mac”), as well as asset-backed securities, adjustable-rate mortgages, commercial mortgage-backed securities, non-GSE CMOs, collateralized bond obligations, and various other loan obligations.

The assets were reviewed by the Federal Reserve and its advisor, BlackRock Financial Management. The assets were not individually selected by JPMorgan Chase or Bear Stearns.

The Federal Reserve would be required by GAAP to report the valuation of the portfolio on an annual basis. We will report the valuation and recoveries from liquidation of the portfolio on a quarterly basis, subject to annual review by our outside auditors Deloitte Touche Tohmatsu.

The Federal Reserve will make arrangements with the appropriate Committee staffs to allow review of the list of assets on a confidential basis that permits appropriate Congressional oversight of the Federal Reserve's actions while also protecting the ability of the Federal Reserve to minimize risk of loss and danger to markets and preserve privacy and other confidentiality concerns.

by Calculated Risk on 4/01/2008 03:23:00 PM

From the Federal Reserve:

The Federal Reserve System on Tuesday announced the availability of a set of dynamic maps and data that illustrate subprime and alt-A mortgage loan conditions across the United States.

The maps, which are maintained by the Federal Reserve Bank of New York, will display regional variation in the condition of securitized, owner-occupied subprime, and alt-A mortgage loans. The maps and data can be used to assist in the identification of existing and potential foreclosure hotspots. This may assist community groups, which can mobilize resources to bring financial counseling and other resources to at-risk homeowners. Policymakers can also use the maps and data to develop plans to lessen the direct and spillover impacts that delinquencies and foreclosures may have on local economies. Local governments may use the data and maps to prioritize the expenditure of their resources for these efforts.

To access the data visit: www.newyorkfed.org/mortgagemaps/. Monthly updates are planned.

The maps show the following information for subprime and alt-A loans for each state and most of the counties and zip codes in the United States:

• Loans per 1,000 housing units
• Loans in foreclosure per 1,000 housing units
• Loans real estate owned (REO) per 1,000 housing units
• Share of loans that are adjustable rate mortgages (ARMs)
• Share of loans for which payments are current
• Share of loans that are 90-plus days delinquent
• Share of loans in foreclosure
• Median combined loan-to-value ratio (LTV) at origination
• Share of loans with low credit score (FICO) and high LTV at origination
• Share of loans with low- or no documentation
• Share of ARMs with initial reset in the next 12 months
• Share of loans with a late payment in the past 12 months

Accompanying data tables report further statistics for states. The maps and data are drawn from the FirstAmerican CoreLogic, LoanPerformance Loan Level Data Set. For more details, see the website's technical appendices to the map and the data tables.

Additional mortgage foreclosure resources, including helpful information and links to agencies and organizations that may provide assistance to consumers experiencing difficulty making their mortgage payments, are available on the Board's website at: http://www.federalreserve.gov/pubs/foreclosure/default.htm

by Calculated Risk on 4/01/2008 12:38:00 PM

Video from CNBC (hat tip idoc)

CNBC's Steve Liesman reports on a letter from Treasury Secretary Paulson to New York Fed President Tim Geithner. In the letter, Treasury agrees that the Fed can bill Treasury for any losses from the Bear Stearns deal.

by Calculated Risk on 3/31/2008 10:24:00 AM

Paul Krugman explains the Paulson plan in the NY Times: The Dilbert Strategy

Anyone who has worked in a large organization — or, for that matter, reads the comic strip “Dilbert” — is familiar with the “org chart” strategy. To hide their lack of any actual ideas about what to do, managers sometimes make a big show of rearranging the boxes ...

You now understand the principle behind the Bush administration’s new proposal for financial reform, which will be formally announced today: it’s all about creating the appearance of responding to the current crisis, without actually doing anything substantive.

One of the key points is this plan was mostly in place to further deregulate the financial industry:

... the new plan was originally conceived of as “promoting a competitive financial services sector leading the world and supporting continued economic innovation.” That’s banker-speak for getting rid of regulations that annoy big financial operators.

Now, using the credit crisis as cover, the plan is being sold as "a fix" for the current problems.

I’ve been disappointed to see some news outlets report as fact the administration’s cover story — the claim that lack of coordination among regulatory agencies was an important factor in our current problems.

The truth is that that’s not at all what happened. The various regulators actually did quite well at acting in a coordinated fashion. Unfortunately, they coordinated in the wrong direction.

For example, there was a 2003 photo-op in which officials from multiple agencies used pruning shears and chainsaws to chop up stacks of banking regulations. The occasion symbolized the shared determination of Bush appointees to suspend adult supervision just as the financial industry was starting to run wild.

by Calculated Risk on 3/29/2008 06:29:00 PM

Nelson Schwartz and Floyd Norris provide an analysis of the new regulatory plan from the Treasury: In Treasury Plan, a Reluctant Eye Over Wall Street

[T]he proposal would impose the first regulation of hedge funds and private equity funds, that oversight would have a light touch, enabling the government to do little beyond collecting information ...

The plan hands vast new authority to the Federal Reserve, essentially formalizing what has been an improvised process over the last three weeks.

There is much more in the analysis.

by Calculated Risk on 3/28/2008 09:39:00 PM

From Edmund Andrews at the NY Times: Treasury Dept. Seeks New U.S. Power to Keep Markets Stable (hat tip AllenM)

The Treasury Department will propose on Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system.

Here is the Treasury’s Summary of Regulatory Proposal. Just some light reading for a friday night.

by Tanta on 3/28/2008 10:19:00 AM

Which, as Dave Barry always says, would be a great name for a band.

CR posted this shocker yesterday, a memo with a Chase logo attached (which doesn't mean much in these copy & paste days), sent via e-mail to mortgage brokers in what appears to be a "package" of "training documents," that provides tips on how to "cheat" and "trick" Zippy, Chase's AUS (automated underwriting system), into approving loans it would not normally approve. (Or, possibly, allowing loans to be documented or priced in a way they would not have been had the loan been submitted properly. It's hard to say exactly.)

I am not especially interested in the debate over whether it was "official Chase policy" (undoubtedly it was not) or whether it was a "joke" started by some wag at Chase ("this is how we oughta be training the brokers, ha ha!"). My own hunch is that it did start out as a joke, but there was at least one Account Executive at Chase who either didn't "get" the joke--which is scary--or who didn't have the sense to realize that certain forms of satire shouldn't leave the building.

But that's the thing: it works for me as a "joke," of the black humor deadpan sort, because, well, it isn't that far off "official policy." "Official policy" is simply couched in ponderous language, hedged about with earnest exhortations not to "misuse" the system that everyone ignores, and mostly "functional" in the sense that it covers certain raw acres of corporate butt, not in the sense that it really communicates clearly to a worker-bee what you're actually supposed to do when certain things--cough, cough--cross your desk.

I say this with complete confidence even though I haven't read Chase policy documents for years, and I have never read internal use only Chase policy documents. I have read hundreds of documents produced by dozens of institutional lenders, wholesalers, and aggregators describing credit policy and acceptable origination practices. I have written quite a few of them, to tell the truth. For that reason I have been in plenty of arguments over the years about those documents, since I have this thing about using language people can actually understand, explaining things clearly, and making policy documents actually useful to everyday operations rather than merely having them around in a file cabinet in case the regulators show up, and entirely ignored by everyone in-house unless and until that day arrives. So I am not speaking with actual detailed knowledge of Chase policy or the likely tone or content of Chase policy documents in particular. I am generalizing based on years and years of having to wade through that crap because no one else will.

What I really got interested in was not where, exactly, this document came from, but why, precisely, it says what it says. I mean, you can see this as a Chase Account Executive (or whoever authored it) simply baldly encouraging fraudulent misrepresentation, and that of course is what it is. But you also have to see that it does appear to require some misrepresentation to get past Zippy in some respects. That much is to Chase's credit.

Also, the way these things tend to work is that the "cheats and tricks" that people come up with--and no, this isn't the only one out there by a long shot, it's just the only one I know of so far that got to a reporter--tend to focus on routine problems. Nobody writes "cheat sheets" to deal with obscure complex things that only arise on one out of 200 loan applications. People write "cheat sheets" to deal with the problems you are most likely to have. And yes, I am using this term "cheat sheet" in its commonplace sense of a "dumbed down" policy or procedure, a set of "short cuts." The term has always been ambiguous: is a "cheat sheet" directions for breaking the rules, or just directions for following them faster and more easily? "Efficiency" and "user friendliness" have always been in danger of converging on the unethical. This is not a new problem. Perhaps our apparently willful lack of attention to this problem over the last several years is what was, in fact, different this time.

Besides the "most common problems," I have often found "cheat sheets" appearing in contexts where it's not so much that the issue at hand is "common," it's that this particular lender has a "thing" about that particular issue. If you ask a bunch of industry participants who are willing to tell you the truth, I suspect you'll find a high degree of consensus on what the "preoccupations" or "hot buttons" for any given wholesaler are. "Everybody knows," the story will go, that X is touchy about gift funds and Y is the hardest to deal with on short-form appraisals and Z isn't the place to go if you want a high-rise condo loan approved. And so on.

That kind of "eccentricity" is less common than it used to be, given nearly universal securitization of loans (which tends to "homogenize" the industry and make lenders willing to write loans they wouldn't touch for their portfolio) and competitive pressures that spawn "races to the bottom" all over the place. In the early years of the boom (until 2005 or so) I used to actually keep spreadsheets in which I tracked policy of ten major correspondent/wholesalers on a couple of dozen selected issues. I did not necessarily select the "common ones"; I was precisely interested in the more offbeat. Like condos with less than four total units in the project, or the rarer forms of temporary buydowns, or non-arm's-length transactions, or foreign national borrowers. ("Foreign national" in this context does not mean undocumented immigrant. It means someone who is not only not a U.S. citizen, but also not even a U.S. resident.) In other words, "niche" stuff that was once simply not allowed at all in the "prime" world, but which increasingly crept into "expanded criteria" programs--the precursor of what you all know as "Alt-A"--and then even into so-called "prime jumbo" or "prime non-agency."

What my little spreadsheet showed was that, over time, we went from an environment in which "go to Lender X if you have a small condo project" was the way it worked, to "just about everyone does small condo projects these days, so why shouldn't we?" It also showed that certain things were "migrating" from "expanded criteria" programs into "mainstream" programs. The race was on. Back in 2005 I was arguing strenuously that it was a race to the bottom, but that was of course a minority view.

Way too many people were convinced that we had the technology that would allow us to "race to the top." The idea was that in the Days of the Dinosaurs, doing 2-flats turned into condos or non-arm's-length deals or what have you was really very risky, but not any more, because now we have all these computer models that can much more finely-tune our risk assessments. Plus there was always the supplementary argument that hey! if someone like Chase is willing to do it, that must mean it's "respectable." That last argument wasn't always stated in such an unvarnished fashion, but that was the drift.

So this brings us back to the Zippy tricks, and the specific content of the infamous memo. If you read it from a certain angle--just for the sake of analytical clarity, not in aid of "defending" what is obviously indefensible--you can see it as some evidence that Chase's system, Zippy, has been correctly programmed to weed out a couple of serious problems:

1. Unstable income. The "trick" of putting all income in "base," instead of breaking it out (as the application form is designed to get you to do) into base salary, bonus, commissions, etc., is partly about getting the AUS to "let you by" with only a paystub to verify current income, if that. This is because it has been recognized since about the end of the last Ice Age that base salaries tend to be fairly stable, but bonuses and commissions tend to be rather volatile. This "other" income is, traditionally, used to qualify borrowers only when they can verify a history of having received it regularly, typically for a minimum of two years, and prospects for continuing to receive it, typically for at least the next three years. It is difficult to verify prospects; in most cases lenders digged so deeply into the past history of the income because that was the best clue to its likely continuation. The theory, for instance, was that an employer who regularly paid bonuses for the last several years was more likely to continue to pay them in the future than an employer who only just paid its first bonus a few weeks ago. Of course, stability of income projecting into the future was important because, well, we expected loans to repay out of income, not refinance money or sale of the home.

You can, if you like, theorize that Zippy has some "rules" built into it that involve a different set of parameters or a higher degree of scrutiny or possibly even a different "rate sheet" when the loan has substantial qualifying income other than base salary. It should. So the instructions to defeat that purpose by lumping everything into "base" is not just saving some idiot some keystrokes. And it's not a trivial thing involving some fussbudget who wants the forms filled out properly for no real reason. There's a real reason here.

2. Gift funds. We have been banging on for years now about borrowers having no "skin in the game." Lenders need to know--have always required to know--what the source of the down payment money is. It isn't just that loans with gifted down payments default more often, although they do. It's also that a lot of fraudulent "straw borrower" deals require "gift funds" to work out. Zippy was programmed to require this information for very good reasons.

3. "Inching up" income. Well, that one's pretty obvious. It is, however, the point at which I for one conclude that Zippy was probably not programmed correctly.

The fact of the matter is that an AUS should simply ignore DTI or cash reserve calculations when income or assets are or can be unverified. In fact, using DTI or months of reserves in your underwriting decision will inevitably produce worse results on a "stated/stated" loan than ignoring them will. They mislead you. I have known good, experienced, savvy human underwriters to fall into this trap, in spite of themselves: they see those "nice-looking" numbers and can't stop themselves from using them as a "compensating factor" on the loan.

There are people in the industry who think that "NINAs" are "worse than" stated income/stated asset loans, but I have never been one of them. What distinguishes them is that in a NINA, you don't even state numbers. You literally leave those boxes on the application blank. The loan is qualified with a credit report and an appraisal.

Now, I'll agree that NINAs are stupid--no problem there. But they're less stupid than "stated" deals. They don't "distract" you with made-up numbers. Actually, they often result in much better analysis of the appraisal and the credit report than you get in a "stated" deal. After all, the appraisal and the credit report are all you got in a NINA: you work 'em over. In the "stated" world people--and apparently some computers--keep getting sidetracked by those unverified numbers.

So I got the impression, for what it's worth, that Zippy is a mixed bag: it seems to have some responsible programming and some stupid programming. As I remarked in the comments to yesterday's post, the fact that it doesn't flash red lights and immediately refer the loan to the fraud-detection squad when it notices that a file keeps getting "resubmitted" with "refreshed" income and asset numbers is a huge problem. If this AUS really does allow multiple resubmissions with increasing stated income each time without setting off the red fraud flags, this is a very big deal for Chase. I'm here to suggest that Chase's regulators need to look into that. As I said, given the chance that the memo is a "joke," it's possible that the thing handles re-runs better than it sounds like it does. But Chase should have to answer this question now that the memo is on the table.

The final question for me, then, is what if anything is likely to be "unique" to Chase here. My answer is "not much." This just isn't in the same class as small condo projects or foreign nationals. We're talking Underwriting 101 stuff that brokers can, apparently, defeat by just putting a number in the wrong data-field or putting a "no" in the gift funds field or getting the system to keep "recalculating" DTI or cash reserves until you have forced it to reveal to you where its cutoffs are.

We all know why people do those things. What somebody needs to explain to me is how, after all this time, it's still so easy to do it. Where are the internal plausibility checks? Where is the "behavioral" logic that notices not just the content of the datafile but the manner in which it was submitted? Where's the basic randomly-selected pre-closing QC that snatches files out of the AUS queue and matches up the data submitted to the AUS with a quick phone call to the borrower?

Where, in other words, is the "high" tech? We've had AUS since the green-screen mainframer days of the 80s, kids. Thirty years down the road and these things are as easy to fool as Barbie's My First Laptop? After all the money these lenders have spent over the years on IT? There's something else that doesn't add up here besides a borrower's paystubs.

Technology aside, where, we also have to ask, are the "real" writers of policy and procedural and training documents? My own sense is that you find "cheat sheets" in companies that don't provide "real sheets" that are usable or comprehensible or updated or easily available on the website. We are, you know, in the "cut & paste" days. It's just no longer difficult to provide your people--or your broker clients--with the "real thing." Anyone who used to prepare policy with a Selectric and an old slow photocopier has a right, I think, to ask just what we're getting out of the "information" part of the "IT revolution." We just shouldn't have to have "cheat sheets" any longer; the "search" button takes care of the difficulties of looking things up. It matters, and it matters because asking people to look at the "real" policy instead of some dumbed-down "cheat sheet" written up by an Account Executive is not too much to ask. You think you will ever control for unethical behavior when you don't even demand moderate amounts of effort?

The whole industry has some explaining to do.

by Calculated Risk on 3/28/2008 09:15:00 AM

From Bloomberg: Fannie, Freddie May Raise $20 Billion, Regulator Says

Fannie Mae and Freddie Mac, the U.S. government-chartered mortgage companies, may raise as much as $20 billion in capital as part of an agreement that allows them to buy more debt securities, their regulator said.
...
``There's no specific number,'' [James Lockhart, director of the Office of Federal Housing Enterprise Oversight] said. ``There was a range of numbers. The best way is to say it's significant.'' The amount raised will be ``much more'' than the $5.9 billion of capital released by reducing the cushion, Lockhart said.
...
``The two enterprises have effectively become the mortgage market at this point,'' Lockhart said. ``Effectively they have become the lender of first, last and every resort.''

by Calculated Risk on 3/26/2008 12:45:00 PM

How many people think the new "temporary jumbo conforming loan limits" are really temporary?

Apparently the Office of Federal Housing Enterprise Oversight (OFHEO) does.

From OFHEO: OFHEO Issues Final Guidance on Conforming Loan Limit Calculations

The final Guidance addresses the handling of decreases in the house price data used to set the conforming loan limit as well as procedural matters relating to calculation of the limit that determines the size of mortgages eligible for purchase by Fannie Mae and Freddie Mac.

Based on comments received in two public comment periods, OFHEO is issuing a final Guidance that provides that the conforming loan limit would not decrease from its current level of $417,000 in 2009 and subsequent years. However, the conforming loan limit will not increase until cumulative increases in house prices exceed cumulative decreases since the $417,000 limit was first reached.

This means the conforming loan limit can never decrease, but it will not increase until prices have returned to earlier levels. Under the old guidance, the conforming loan limit was supposed to move with house prices, both up and down.

Of course, "temporary" probably means "permanent", and the limit will vary by MSA (Metropolitan Statistical Area).

by Tanta on 3/19/2008 04:48:00 PM

HUD has just released yet another proposal for changing the disclosures required under the Real Estate Settlement Procedures Act (RESPA), a federal law that is implemented by regulations promulgated by HUD. I’m not terribly impressed by the proposal, but it’s hard to say why without a lot of background rambling. So I’m going to ramble. Those who aren’t up for it should skip this. In a future post, I’ll get into the specifics of what I don’t like about the proposed new GFE.

A quick recap: RESPA requires a lot of things, two of the most important of which being the Good Faith Estimate of settlement costs, known as the GFE, and the HUD-1 or HUD-1A Settlement Statement, the exact accounting of closing costs and settlement charges given to borrowers when the loan closes. The GFE is given at application. The idea when RESPA was first enacted was to prohibit lenders from giving low-ball estimates of costs up front, only to shock the borrower with a lot more costs at closing, when it was often “too late” for a purchase-money borrower (or a refi borrower with a rate lock expiring) to back out. The estimates of costs on the GFE have to match what’s on the HUD-1 within a certain tolerance, or else you have a regulatory problem. The GFE/HUD-1 rules have been around for decades. In the last few years HUD (the agency, not the document) has made a few attempts to revise them, all of which have failed for one reason or another. The current proposal is just the most recent in a long line of unsuccessful attempts to get control of the disclosure of financing costs to borrowers, most specifically in the case of brokered loans (although the new rules would apply to retail lenders as well).

In some ways, what HUD is doing is formalizing the brokered application model into the RESPA disclosure scheme, a decade or two after certain problems and concerns first arose. One of the troubles that wholesale lenders have had for a long time is making sure they’re meeting RESPA rules for when the GFE has to be given to the applicant; the rule has for a very long time been that the disclosures must be provided within three business days of “application.” But what is the date of “application”? The date the broker takes an application from a borrower, or the date the wholesaler receives an application from the broker? From the borrower’s perspective, of course, this is easy: it’s the day you gave the broker sufficient information to complete the application. This implies that it is the broker’s job to provide you with the GFE. (And for what brokers charge borrowers, you might well think providing a written estimate of closing costs isn’t so much to ask.)

But the wholesaler has always had a problem here, because the wholesaler is going to close that loan and the wholesaler is going to have the “RESPA risk,” or the risk that the disclosure was inaccurate or not provided in a timely fashion. As with other things, it has never especially mattered that it might be the broker’s “fault”; brokers haven’t got the money to make you whole on fines, penalties, recissions and re-closings of loans, or sales of loans as “scratch and dent” because the higher-paying investors won’t buy a loan with iffy RESPA docs in the file. So wholesalers developed this habit of simply “redisclosing” or providing a GFE for the borrower within three days of getting the application from the broker, even if the broker had already supplied one. This was supposed to assure that whatever the broker did, the wholesaler complied with RESPA and made sure that the fees disclosed on the GFE were fees the wholesaler was comfortable with charging on the final settlement statement.

That meant several things, one of which is that borrowers were usually waiting the three full business days to get a GFE, and were paying application fees before getting one. At minimum, borrowers were paying for credit reports, since in these days of risk-based pricing, you don’t get a GFE until we know what your rate/points are, and we don’t know that (even approximately) until we know what your FICO is. RESPA, which predated such practices, was based on the assumptions of an older way of doing business, in which an application could be submitted and an estimate of costs given well before any “processing” on a loan, like ordering a credit report, commenced. Of course, once a borrower has paid a fee to get a GFE, it’s much less likely that borrower will “shop around” and pay several other lenders the same fee to get alternative GFEs.

It also pretty much erased—and then some—the wondrous efficiencies we had achieved at least since the mid 90s with cool technology. I am hardly the only person to have spent centuries of her life she’ll never get back in meetings and task forces and committees and piles of documentation and user testing working on rolling out “point of sale” (POS) technology that would allow loan officers armed with laptops and a portable printer to take a complete application right there, on the granite countertops, at the open house, and print out a pretty, complete GFE, right there on the granite countertops. With a dial-up connection, the LO could run the loan through an AUS and even hand out a commitment letter (subject to getting the appraisal and so on). Ah, the glorious days of progress, when we congratulated ourselves on providing a GFE to applicants in three business minutes.

It’s not exactly an accident that the acronym “POS” means both point-of-sale and piece of . . . stuff. There were any number of problems with the POS technology, not the least of which was those portable printers, which were “portable” as long as you didn’t expect them to be “printers” and vice versa. Many lenders got gung-ho about giving their loan officers the authority to issue commitment letters at POS, and found themselves committed to making loans that the underwriting department wouldn’t have approved on PCP. There was also, it transpired, a little problem with those pesky consumers. It turned out that what they really wanted out of life wasn’t always to stand around at an open house giving personal information to an LO and getting not just “estimates” but a commitment letter they were feeling pressured to sign without any cooling-off period or shopping around. As is often the case, the industry told itself customers were really interested in speed, when in fact the industry was really interested in speed and the customers had to be made to see reason about it. I can remember at one point a local competitor of mine proudly announcing it didn’t offer that “high-pressure tactic” of POS technology, and that competitor took a lot of our business.

The issue for retail originators was having an LO out there like a loose cannon with a laptop, making quickie commitments often based on quickie evaluation of the borrower’s seriousness or capacity. Those commitments were always supposed to be “subject to” finally getting all the real documentation and verifications and so on, but some loan officers figured out that such a heavily-conditioned commitment is hardly much of a commitment—it just encouraged people to “shop around”—and so “competitive pressures” led to leaving out a lot of those conditions. In fact, at least one of us believes that the “stated income/stated asset” phenomenon really began here. The Official Story in the industry is that it grew out of perfectly reasonable ways to underwrite self-employed borrowers with complicated financial lives, and somehow spread to W-2 borrowers with a single checking account when we weren’t looking. I don’t personally remember it happening that way.

The issue for wholesale lenders was even worse, since the brokers often weren’t quite sure which wholesaler they’d be closing this loan with—it would depend on who paid the richest premium, often, and that couldn’t be established until they got back to the office and checked rate sheets. So the brokers would hand out GFEs based on wild-arsed guesses of the fees required by the wholesalers, leading to endless situations in which the fees charged on the final settlement statement were pretty far off the original estimate, leading to endless situations in which regulators and consumer attorneys had to remind everyone what the “good faith” part of GFE meant. That was when the broker actually bothered to hand out a GFE, or do it within the holy three days. The wholesalers concluded it would be better for them to “re-disclose” on receipt of the application package (later, the electronic submission) from the broker. Aside from the monumental customer confusion that creates—which GFE is the “real one”?—it began to dawn on at least a few wholesalers that duplicating too much of the work the broker was supposed to be doing was approaching the same operating cost structure of a retail lender. It wasn’t just the disclosure issue, after all. You had to re-verify the broker’s verbal verification of employment and order (and review) a field review appraisal to reality-check the appraisal you let the broker order and so on until there wasn’t much the broker did that you didn’t also do.

The obvious answer to that was to make the borrower pay for it all. You began to find GFEs showing “underwriting fees” and “document preparation fees” all over the place, for instance. Now, underwriting your loans and drawing up your closing documents used to be considered basic overhead, you know, and lenders covered that in an origination fee charged to borrowers (or in the margin on the interest rate). The only time you ever charged a “doc prep fee” to a borrower was a situation in which you actually had to draw up unusual, complex documents—like a convoluted trust agreement or one of the gnarlier “hold harmless” agreements—that you needed to actually pay outside counsel for. You never charged anyone a separate fee for standard mortgage docs; that was like charging them for the air conditioning in the closing room. But in the wholesale model, you had to find some way for the broker to draw up GFEs and the wholesaler to then do it again and the whole thing to remain profitable for everyone. All kinds of other things, like flood hazard determinations and tax service contracts, that we always had to obtain for loans but that we always just covered out of the origination fee, started to appear as separate items on the GFE and HUD-1.

It was and still is argued all over the place that these practices are really pro-consumer, since it’s a clearer “itemization” of the real cost of credit than some all-in “origination fee” or “broker fee.” Had the origination fees shrunk proportionally to the newly added itemized fees, that might have been plausible. But in way too many cases, you were paying the same origination point you had always paid, plus $40 for a flood cert and $75 for a tax service contract and $100 for doc prep and on and on and on. In fact, you were paying so much in fees at closing that you were in real danger of not being able to scrape up that much cash—or increase your loan amount enough—to cover them and get a loan closed. This was (pre-RE bubble) a huge problem with refis. Refis are brokers’ bread and butter in low-rate environments, and it’s hard to convince people to refi for a 25 bps drop in rate—which people did—with that nasty cash requirement.

The solution was obvious: find a wholesaler who is willing to price a higher interest rate at a “premium,” and use that premium to “credit” the borrower, or to do the now-ubiquitous “no cost closing.” Of course it’s plenty of “cost”; it’s really just a “no-cash” closing. Obviously there are only certain actual historical rate environments in which this kind of thing will work in the prime lending world: if you’ve got borrowers wanting to “take advantage” of new, lower interest rates to refinance, you can’t always charge them the highest rate out there in order to produce enough premium to pay inflated closing costs with. It’s the kind of thing that might work in the beginning of a steep rate drop, like the 2002-2003 period, when existing loans on the books had a high enough interest rate that they could refinance into a current “premium” rate and still show a rate reduction. The trouble is, if you do too much of that on a wide scale—and the turnover in the entire nationwide mortgage book in 2002-2003 was enormous--it gets harder to do it again. Once the prime mortgage book had “reset” itself to very low current rates via a refi boom, it was hard to tempt them with a premium to current market, unless fixed rate mortgages hit 4.00%. They didn’t, so someone had to invent a mortgage product that seemed like a lower rate to borrowers but that also paid enough hefty premiums that closing cost inflation could be masked. The Option ARM, among others, stepped into the breach and here we are.

The comments to this thread will be choked with outraged mortgage brokers who will once again give you the same old story that “premium” closing cost credits are a god-send to us average schmucks who don’t have several grand sitting around to pay closing costs with, but who oughta get the benefit of lower rates just like the Big People, etc. They will tell you that there are too many “competitive pressures” preventing brokers and wholesalers from larding up settlement statements with both origination fees and a boat-load of “itemized” fees. They will tell you that there are all kinds of perfectly “legitimate” reasons why the final settlement statement you get has all these fees and charges on it that weren’t on the GFE, most of which are your fault for delaying the process or not following what you were told. They will tell that they shop around to get the best rate for you, and deserve to be compensated for that, but that it is the consumer’s responsibility to shop around for several shop-arounds so that they can assure themselves of getting the cheapest deal on the fees. They will tell you that while they don’t do it, retail lenders do it too, so we should stop picking on brokers.

My problem here is with the basic mechanism of, in essence, financing your closing costs in this way (by taking the higher rate to get the “credit” that reduces the amount of cash you bring to closing). It is simply ripe for abuse because there is (now) such a large segment of the borrower world who do not already have prime-quality fixed rate loans, who are desperately focused on monthly payment, not total cost over the term of a loan, and who simply do not have the basic financial skills necessary to do the cost/benefit analysis of fees versus interest rate, even if they could afford to pay three separate credit report fees at $40 a pop to several different brokers in order to amass several different GFEs so that they could find a way to save back the $80 in “wasted” fees and then some. Not to mention the fact that they are, as a group, generally the most susceptible to high-pressure sales tactics (this is true generally of a lot of people with heavy consumer debt and thus low FICOs; they are just incapable of saying “no” when the clerk at Macy’s offers “10% off today’s purchase with Instant Credit!”).

To be honest with you, too many people in this business do not fully understand its cost structure. There’s just a massive confusion all over the place about the difference between “financing costs that are paid up front at the closing of a loan” (as distinguished from interest charges that are paid in the future) and “settlement costs.” There are quite a few things you have to cough up money for at the settlement of a mortgage that are really “prepaid items,” not finance charges. For instance, the money you bring in to fund your tax and insurance escrow accounts. You have to pay real estate taxes and homeowner’s insurance anyway; you either pay it yourself once or twice a year or you pay it on the “installment plan” by paying your lender one-twelfth of it a month. In order to get an escrow account established up front, you’ll probably have to put two months or so worth of escrow payments in the account to start it out (because the annual bills will be due the first time before you’ve managed to make twelve payments, basically, given the lag between closing a loan and the first payment due date). Escrow funding is a relatively large-dollar item on most loans compared to things like a $75 tax service fee, but it’s not the kind of thing shopping around will do you any good with, since it is what it is (assuming lenders get their hands on a realistic estimate of RE taxes) and there’s no “markup” in it—it’s your money, the lender is just taking it up front as a deposit into your escrow account.

It is easy enough, unfortunately, to low-ball the estimated escrow funding amounts on a GFE while larding up on actual finance charges. If borrowers are only comparing this lender’s total to another lender’s total, they can be highly misled about who has the cheapest “closing costs.” And almost all lenders charge a higher rate (or more points) to borrowers who are allowed to get a “waiver” of escrow accounts. If you aren’t paying attention, you might be comparing a GFE from one lender that includes two months’ worth of tax and insurance payments in “closing costs” to a GFE from another lender that includes no escrow dollars but increases your interest rate by 12.5 bps.

The same thing goes, on a less expensive plane, with things like surveys and pest inspections. It might be a lender requirement that you get one of these things, and you might be willing to play dice with your hard-earned money by ignoring survey lines or signs of termite damage if you weren’t required not to by some lender. But the fact remains that (unless the lender is conspiring with the surveyor or exterminator/inspector to get a “kickback”) you’re paying for a real good or service there that doesn’t benefit the lender only. A tax service fee, on the other hand, benefits the lender and investor, not you. You will get your tax bills directly from the county; you don’t need to pay someone to track them. A tax service fee is a classic case of a “finance charge” in the regulatory sense: it is a cost you incur because you are financing the property, that you wouldn’t incur in a cash purchase of the same home. This is why mortgage insurance, unlike your homeowner’s insurance, is considered a “finance charge.”

There are other things you might pay at a mortgage settlement that are a little murkier, conceptually. You wouldn’t pay for a lender’s title insurance policy in a cash sale, but you would (if you were sane) pay for a title search and an owner’s policy. You wouldn’t pay for an attorney to prepare a deed of trust (a “mortgage”) in a cash sale, but you’d pay for a grant deed (otherwise you wouldn’t have legal ownership of the home you’re buying). Appraisal charges aren’t considered “finance charges” for regulatory purposes, on the assumption that a reasonably competent cash buyer would also get an appraisal, although I’m willing to bet that most people think of them as “finance charges” or things you wouldn’t have to pay if the lender didn’t make you and that benefit only the lender.

All this matters for regulatory purposes—the rules about how lenders disclose “finance charges” as distinct from “settlement costs”—but it also matters because there has for some time been something very important getting lost in discussions of “closing costs” or the cost of mortgage credit. A lot of those costs are real estate transaction costs. We have been hearing for years on end, during the boom, that people “who are only going to stay in the house for two years” shouldn’t be “having to pay for a 30-year fixed rate.” We don’t hear many people wondering why you’d buy a home in that situation in the first place.

The reality in most markets across nearly any time period you care to name is that it’s almost never worth buying a house to live in for two years. It pretty much requires a bubble for the RE agent commission and the title search and the survey and the pest inspection and the deed recording fee and so on, let alone the true “finance charges,” to pay for themselves in two years. But there has been a shift in rhetoric and terminology that seems to lump “transaction costs” into “financing costs,” allowing people to “make sense of” buying a house you plan to live in for only two years because you can find some lender who will let you finance the transaction costs through this premium-rate “closing cost credit” deal.

The reality of things is that no lender makes any money charging premium interest rates to recover costs it didn’t charge the borrower at settlement if the borrower pays the loan off in a short period of time (unless it was a really really big premium). This is where your “prepayment penalties” came from; it’s also where all these expensive post-settlement fees (like the notorious fee for getting a payoff quote or a release of the old lien in a refi) come from. The economics of making “bridge loans” (short-term loans) at “permanent loan” terms just doesn’t work if you don’t collect fees up front. You can get by with a small enough percentage of your loans behaving like that—credit card lenders can get by with a small enough percentage of people who pay in full every month, and Best Buy can get by with a small enough percentage of people who do the “one year same as cash” thing and pay it off before a finance charge is imposed. But nobody can handle everybody behaving like that. Not for long.

And it’s not just home buyers, it’s refinances. It simply isn’t rational for an investor to “pay up” for a high interest rate if said loan is going to refinance at the next little market bump. But people will refinance, these days, for amazingly small rate increments, for two reasons. First, loans are a lot bigger than they used to be, while incomes haven’t been growing. That means that the dollars at stake in monthly payment savings become more significant even with small decreases in the interest rate.

The second reason is where this gets into a vicious cycle: people refinance at the drop of a hat because they don’t pay the closing costs in cash. They either roll the costs into the loan—driving balances up over time and creating even further incentive to refinance again—or they get that “premium credit” thing, which means that the borrower has a built-in incentive to refinance the new loan as quickly as possible. This dynamic creates regular income for brokers who get paid for each refi, but it doesn’t always do much for investors.

A great deal of this business over the last several years of refinancing people out of perfectly affordable fixed rate loans into these toxic ARMs came about because there was no longer any way to price a premium-rate fixed rate loan at a lower rate than what the borrowers already had. However, the market was full of “dumb money” that would pay 105 for a “high quality” Option ARM—not to mention the “low quality” ones. Many people focus on “YSP” as broker compensation, and that’s a big issue. Some of the sleazier brokers took those five points from the wholesaler and the borrower didn’t see a five point credit on the HUD-1. My point, though, is to question whether the ones who did get a closing credit really got such a great deal.

Would borrowers have balked at doing the refi to start with if they had had to pay at least some of the closing costs in cash? Would they have paid a touch more attention to those prepayment penalties they were signing up for if it had occurred to them that the only way a “no cost closing” can be profitable to a lender is by extending the life of the loan long enough for the costs to come out of the interest paid each month? Would borrowers have been more likely to catch on to an ARM masquerading as a fixed rate or nasty ARM terms “hidden” in a big pile of legalese if they had a realistic sense of how low 30-year fixed rates are likely to go on any given day? There is something terribly wrong with lenders who give out misleading disclosures, and I don’t blame borrowers for lender sleaziness. But there is also something terribly troubling about the apparent fact that a lot of people thought they were getting a 30-year fixed rate loan at 1.95%. That is much too good to be true. Why didn’t it occur to anyone that that’s much too good to be true?

To see this as strictly a “disclosure” issue is to simply cop out, as far as I’m concerned, on the question of a very old-fashioned view of what loan officers and brokers were supposed to be doing, which is explaining things like the fee/rate tradeoff, the point of prepayment penalties, and the likely range of prevailing market rates on fixed-rate loan quotes. “Educating” your borrowers is just off the table. All we’re left with is “disclosing” loan terms that truly educated borrowers probably wouldn’t have anything to do with, and relying on borrowers to “shop around” in a market in which they still have no idea what the “going rate” is.

We’ve gone, just in my career in this industry, from taking three whole business days to get a GFE into a consumer’s hands, because we did them with adding machines and typewriters and snail mail, to taking three whole minutes to do that with only reasonably fancy technology, and back to taking three whole days again because there are too many intermediaries in the process (all of whom have to get paid). And HUD is, after years and years of this practice going on, finally working up a way to disclose premium-rate closing cost credits right when the terrible market distortions partially due to that practice are melting down the credit markets. Behind the whole thing lurks the ideology that regulators are not there to tell anyone what is an allowable business practice; they’re there to just make sure you “disclose” what you’re up to. It is aided and abetted by a “consumer advocate” lobby who frequently seems to believe that “complexity of disclosures” is the problem, rather than unrealistic expectations consumers develop based on the onslaught of marketing they get from the industry, which tries to tell you there is a free lunch if you act now.

Once you and I have recovered from this post, we’ll look at some of the details of the new proposed GFE. I do hope it will make more sense after this ramble.

by Calculated Risk on 3/19/2008 09:34:00 AM

Press Release: OFHEO, FANNIE MAE AND FREDDIE MAC Announce initiative to increase mortgage market liquidity

OFHEO, Fannie Mae and Freddie Mac today announced a major initiative to increase liquidity in support of the U.S. mortgage market. The initiative is expected to provide up to $200 billion of immediate liquidity to the mortgage-backed securities market.

OFHEO estimates that Fannie Mae’s and Freddie Mac’s existing capabilities, combined with this new initiative and the release of the portfolio caps announced in February, should allow the GSEs to purchase or guarantee about $2 trillion in mortgages this year. This capacity will permit them to do more in the jumbo temporary conforming market, subprime refinancing and loan modifications areas.

To support growth and further restore market liquidity, OFHEO announced that it would begin to permit a significant portion of the GSEs’ 30 percent OFHEO-directed capital surplus to be invested in mortgages and MBS. As a key part of this initiative, both companies announced that they will begin the process to raise significant capital. Both companies also said they would maintain overall capital levels well in excess of requirements while the mortgage market recovers in order to ensure market confidence and fulfill their public mission.

OFHEO announced that Fannie Mae is in full compliance with its Consent Order and that Freddie Mac has one remaining requirement relating to the separation of the Chairman and CEO positions. OFHEO expects to lift these Consent Orders in the near term. In view of this progress, the public purpose of the two companies, and ongoing market conditions, OFHEO concludes that it is appropriate to reduce immediately the existing 30 percent OFHEO-directed capital requirement to a 20 percent level, and will consider further reductions in the future.

by Calculated Risk on 3/18/2008 10:12:00 PM

From the WSJ: Fannie, Freddie Regulator Plans Capital Announcement

Ofheo for the past several years has required Fannie and Freddie to hold 30% more capital than their usual minimum while they have worked to resolve lapses in their accounting and internal risk controls, a process now viewed as largely complete. Ofheo is expected to reduce that capital "surcharge" initially to 20%.

The move should reduce Freddie's capital requirement by about $2.6 billion and Fannie's by $3.2 billion.

It wasn't that long ago when Fannie and Freddie were the problem, now they are the solution. The press conference is Wednesday at 9 AM.

by Tanta on 3/14/2008 10:37:00 AM

Barney Frank has released draft details of a new plan for FHA to insure "short refis," or refinances that involve the old lender accepting less than full payoff. I know you mortgage junkies are on the edge of your seats, so here's the dirt.

A draft proposal of the plan is available here. According to Rep. Frank's website, comments and suggestions are being solicited, so consider yourself encouraged to look it over and let Rep. Frank know what you think.

The proposal is to allow FHA to insure up to $300 billion in refinance "Retention Mortgages" in the next two years that involve lender write-downs of principal ("short refis"). In the context of FHA, $150 billion a year is a very large number: it is nearly double FHA's volume for 2006. In the context of loans that are now or will be underwater in the next two years, it's as little as 10% of distressed mortgage loans. (That depends on whose estimates of price declines you use, and also whose estimates of the eligible borrower universe you choose.) So it's either a deluge or a sizable drop in the bucket; take your pick.

How it works:

1. The new mortgage may have an LTV of no more than 90%, and no subordinate financing (all existing subordinate liens must be extinguished). If I am reading the draft correctly (page 4), the new mortgage LTV includes financed allowable closing costs, as well as the special one-time up-front mortgage insurance premium (UFMIP).

2. All loans require a UFMIP of 5.00% of the new loan amount, in addition to an annual mortgage insurance premium (MIP) of 1.50% (which is added to the interest rate) and the "exit premium" (see below). The 5.00% UFMIP is essentially paid by the old lender in the form of principal write-down.

3. The old mortgage lender must therefore accept payoff proceeds (as "payment in full") that allow the new mortgage amount to be 90%. For example: assume an existing $110 loan on a property with a current valuation of $100. The maximum new loan amount is $90. Out of that $90, $4.50 (5.00% of $90) must be paid to HUD for the up-front insurance premium. Assuming 5.00% in allowable closing costs and prepaid items (escrow funding and per-diem interest), another $4.50 is paid at closing of the new loan. There is therefore $81 left to satisfy the old lender, and so the payoff amount is written down to $81. The old lender's loss is $29 ($110 minus $81, or 26%). Any and all prepayment penalties or fees related to prior delinquency or default must be waived (written off) by the old lender.

4. Some kind of principal reduction of an existing first mortgage is required under this loan program in the draft bill; any refinance that could achieve a 90% LTV without principal reduction of the first mortgage would presumably be processed under a standard FHA program, without the additional premia. It appears, then, that if a current loan had both a first and a second mortgage, with the current LTV of the first being 85-90%, the first mortgage could be refinanced into a standard FHA or FHASecure, with the existing second lien extinguished or subordinated. This would be a better deal for borrowers than the Retention Mortgages, since the MIP would be less expensive (5.00% is a giant UFMIP in FHA terms; the current maximum UFMIP is 1.50-2.25%). Loans fall into the Retention Mortgage bucket when necessary write-offs get to the first lien.

5. When the new loan is originated, HUD gets a second lien that involves no payments or interest. It is designed to recapture an "exit premium" of at least 3.00% of the original mortgage amount, up to as much as 100% of the property appreciation. Upon sale or refinance of the loan, the borrower must pay HUD the greater of 3.00% of the original loan loan amount or a share of appreciation. The appreciation is adjusted for capital improvements (as defined in section 1016 of the IRS code). The shared-appreciation provisions (although not the 3.00% exit premium) phase out after five years, so the amount due is the greater of 3.00% of net proceeds or

100% during the first year
80% during the second year
60% during the third year
40% during the fourth year
20% during the fifth year
0% thereafter

What this appears to mean is that the borrower cannot "cancel" this provision by doing a rate/term refinance of the loan into a conventional mortgage, although it isn't exactly clear to me how the actual calculation works in a refinance. Presumably, a refinance would be treated for calculation purposes like a sale, meaning that the borrower would have to refinance for a high enough loan amount to pay HUD the forgiven principal according to the schedule above.

6. All new mortgages must be fixed rate, and are subject to whatever loan limits are currently in place at the time of refinance. (This draft does not commit to the new higher limits within the two-year period of the program.)

Eligibility for the program is as follows:

7. Owner-occupied principal residences only

8. The borrower must establish lack of capacity to pay existing mortgage or mortgages: the borrower must "certify" that default on existing mortgage has not been "intentional," and must demonstrate that as of March 1, 2008 the borrower's mortgage debt to income ratio on all existing mortgages is greater than 40%.

9. The existing first mortgage must have been originated on or after January 1, 2005 and before July 1, 2007.

10. The mortgage debt ratio must be "meaningfully reduced" from the existing first mortgage. This devil will undoubtedly get worked out in the details of HUD guidelines promulgated to implement this program. It isn't clear to me, for instance, what one would do with an existing interest-only mortgage, which, even with principal reduction, could result in a higher payment, since the new loan must be an amortizing fixed rate loan. The bill clearly requires that the base interest rate on the new loan be a "market rate," but with the 1.50% annual MIP added, the rate on the new loans may be not that far under what a subprime borrower is currently paying. (The draft clearly states that there must be a reduction in debt load in terms of the first mortgage, so elimination of a second lien payment would not "count" here.) The draft mentions that the reduction in payment can come from extending the mortgage term, although I see nothing here specifically authorizing terms on the new mortgage of greater than 35 years (what I believe to be the current limit, although 40 years is in the currently proposed "modernization" bill).

11. Full verification of income is required.

12. The borrower's current FICO, or any prior delinquency of the old loan, is not counted against the borrower in qualifying for the new loan.

13. The new loan may not have a total debt to income (DTI, which includes debt other than the mortgage payment) of more than 40%, if the lender expects immediate endorsement (FHA insurance certification) of the loan. New loans may be made with a DTI of up to 50% or 55%, but in those cases the loan remains uninsured until the first six mortgage payments are made on time. This means that the originating lender holds the default risk on those loans until they have performed for six months.

My thoughts on this so far:

I give points for attempting to balance incentives and protect against abuse. The draft bill does not come right out and limit this explicitly to subprime loans, but in practice it would probably do so, since it limits the program to high-rate existing loans. If the new loan payment has to be an improvement over the old loan payment, and the new loan requires a 1.50% MIP, it would be difficult for a borrower with a prime loan that does not carry private mortgage insurance to be "in the money." Even an existing prime loan with mortgage insurance would probably have a current rate less than the rate offered on these Retention Mortgages. I would still like to see clarification of the maximum loan term allowed here. If the maximum term on the new loan is 40 years, then borrowers with an existing 30-year loan at a relatively lower interest rate may still qualify under the "reduced debt load" guideline.

I hope I am correct about financed closing costs being included in the maximum LTV, since this would have an important impact on preventing "fee loading" on the new originations. That is, the new lender may want to lard the loan up with origination fees, but if those are essentially being paid by the old lender in the form of reduced payoff, then the old lender exerts some counter-pressure on closing costs and fees. (I am simply assuming that eligible borrowers are unlikely to be able to pay their closing costs in cash.) I would like, however, to see an explicit provision in this bill for no premium rate/YSP deals (where the borrower is charged a higher interest rate on the loan, with the "yield spread premium" paid by the wholesaler for the higher-rate loan used to pay closing costs instead of financing them into the loan). It isn't necessarily likely that a premium-rate/YSP deal could work out anyway, given the requirement that the payments on the new loan be lower than the payments on the existing first lien, but it's possible if the rate on the old loan was high enough and market rates in the next two years are low enough. If you remove the possibility of paying closing costs with premium, then you're making the old lender pay them, and that will exert downward pressure on what the new lender will charge. If you don't do that, this can turn into just another fee-extraction opportunity for the slimier mortgage brokers. If HUD allows premium pricing here, it needs to hold the line very firmly on what fees can be charged and put into place strict quality-control measures for making sure that the YSP does not exceed allowable fees.

The shared-appreciation provision seems reasonable enough to me, given that it exempts appreciation due to improvements made by the borrower, which removes a major disincentive of shared-appreciation provisions (the borrower's failure to maintain or improve the property).

I certainly like the idea that lenders wishing to write high-DTI loans have to carry the risk for the first six payments. I suspect we would see, after passage of this, just how much lenders really do believe that high DTIs are sustainable.

As far as HUD's risk, there is certainly always the risk that values will continue to decline, although having 5.00% of the loan amount up front as a loss reserve, in addition to the MIP and the "exit premium," will certainly help. This certainly doesn't seem any riskier to me than HUD's current willingness to insure 97-100% LTV purchase-money loans.

Whether lenders will go for it--or be allowed to go for it--is the real question. The draft bill says that "The Secretary (of HUD) may take such actions as may be necessary and appropriate to facilitate coordination between the holders of the existing senior mortgage and any existing subordinate mortgage to comply with the requirements." It doesn't say what necessary actions might be to force second lien holders to roll over and die--threats? bullying? shunning at cocktail parties?--but that's likely to be a sticking point given current second lien holder behavior. The problem for first lien lenders comes back to the issue of what securitizations do or do not allow. A separate bill is on the table in Congress (Castle-Kanjorski) that gives a legal "safe harbor" to servicers who write down principal on a loan, as long as the net present value of the write-down is greater than the NPV of foreclosing. If that is enacted and clearly applies to short refi payoffs as well as modifications, then it would certainly encourage more servicers of securitized loans to participate.

The final question of how much of that $300 billion could get used in two years is, then, hard to gauge at this point. There are undoubtedly going to be trillions of dollars worth of underwater loans in the next two years, but I'm certainly not convinced that all of them would meet the 40% DTI requirement or, if so, involve borrowers willing to sign that shared-appreciation agreement.

As far as mortgage relief proposals go, this isn't anywhere near as dumb as most. It puts the up-front loss on the existing lender, it is fairly careful to exclude outright speculators, flippers, and abusers, and it limits the outsized-profit potential of the originators of the new loans. It is hardly the dumbest kind of loan FHA insures (see the 97% purchases with "down payment assistance" for the ultimate in dumb). I therefore expect that lenders won't like it much, but perhaps I am just cynical.

by Calculated Risk on 3/03/2008 11:38:00 AM

From OFHEO: OFHEO, NY Attorney General, Fannie Mae and Freddie Mac Sign Agreements to Combat Appraisal Fraud

There are many significant provisions in the agreements that are designed to strengthen the independence of appraisers, including eliminating broker-ordered appraisals, prohibiting appraiser coercion, and reducing the use of appraisals prepared in-house or through captive appraisal management companies in underwriting mortgages. The agreements also enhance quality control in the appraisal process and establish a complaint hotline for consumers. The agreements include a Home Valuation Code of Conduct that the Enterprises will apply to lenders selling mortgages to Fannie Mae or Freddie Mac. The Code becomes effective on January 1, 2009.

The parties also agreed to establish and the Enterprises fund an Independent Valuation Protection Institute designed to supplement current efforts to provide an appraisal complaint process, mediation of appraisal disputes, and mortgage fraud reporting.

Tanta had some commentary last week: Fannie Mae New Rules for Appraisals

by Tanta on 2/28/2008 08:17:00 AM

To refresh memories: Last fall, New York AG Andrew Cuomo sued an outfit called eAppraiseIt and its parent company, First American, for conspiring with WaMu to pressure appraisers to produce inflated appraised values. WaMu was not part of the suit, since for legal reasons state AGs can't sue federally-chartered thrifts in state court. Fannie Mae and Freddie Mac were not being sued either, but they were quickly served with subpoenas for documentation involving inflated appraisals on loans they may have purchased. The GSEs quickly agreed to appoint independent examiners to review appraisal practices, with the direct threat that lenders would be forced to buy back loans that failed to meet existing GSE rules.

It appears that Fannie Mae has finished or nearly finished its review, and is about to ruin several very large aggregators' and thousands of pissant brokers' day with a new set of rules regarding how appraisals can be obtained and what affiliations between lender and appraiser are acceptable:

Feb. 27 (Bloomberg) -- Fannie Mae, the biggest source of financing for U.S. home loans, told lenders it will probably ban their use of appraisals by in-house employees or those arranged by brokers.

Fannie Mae distributed the proposal, a response to New York Attorney General Andrew Cuomo's yearlong mortgage probe, to lenders in a ``talking points'' memo this week, according to a person familiar with the document. The memo was published on American Banker's Web site yesterday.

``It would be a monumental change because it would require a shift in the way that the lending industry does business,'' said Jonathan Miller, chief executive officer of Manhattan-based appraisal company Miller Samuel Inc. and a longtime proponent of creating a firewall between residential appraisers and mortgage originators. ``I think it would be tremendous.'' . . .

``Fannie Mae wishes to cooperate with the New York AG's investigation and, as part of a cooperation agreement, will likely agree to a number of items,'' according to the memo.

The proposed changes include banning Fannie Mae's partners from using appraisers employed by their wholly owned subsidiaries. Mortgage lenders that own appraisal companies include Countrywide Financial Corp., the nation's largest home- loan originator.

The restrictions would apply to loans acquired after Sept. 1, according to the memo. Fannie also told lenders that an independent appraisal clearinghouse likely would be established.

`Laughable' Practice

About three quarters of residential mortgage appraisals are arranged through brokers who only get paid if a loan closes, Miller said today in a phone interview. He called the practice ``laughable'' because it creates a financial incentive for mortgage brokers to push appraisers toward higher valuations. Higher appraisals also mean more homeowners qualify to refinance their homes and take cash out, he said. . . .

Cuomo spokesman Jeffrey Lerner said today in an e-mail that that Cuomo, Fannie Mae and Freddie Mac hadn't reached an agreement.

``We have had ongoing discussions for several months,'' Lerner said. ``At the end of the process, we will either have agreements or we will take other appropriate action.''

Cuomo prefers to pursue cooperative resolutions before litigating, Lerner said.

``We are continuing our discussions and we are making progress,'' said Corinne Russell, spokeswoman for the Office of Federal Housing Enterprise Oversight, which oversees Fannie Mae and Freddie Mac. . . .

Freddie Mac hasn't sent any memo similar to Fannie Mae's, said company spokeswoman Sharon McHale.

``We are cooperating fully with the attorney general's investigation, but at this point it would be premature to speculate as to what the outcome will be,'' McHale said.

Countrywide spokeswoman Ginny Zoraster declined to comment on Fannie Mae's proposals.

``The company does not believe this case has merit and expects to present a vigorous defense,'' Zoraster said in an e- mailed statement.

My observations:

1. So much for "synergy." I only hope that if this puts a stop to large lenders buying appraisal firms (and destroying appraiser independence), we can next move on to large lenders buying title companies (and destroying escrow officer independence).

2. Insofar as brokering of mortgages is going to survive this bust--and the indications are that any bank with a shred of sense right now is shutting down its wholesale division--they will go back to being application-takers, for which they will earn a modest fee. They will have a hard time maintaining their current pose of a "full-service lender" by also processing loans--including ordering appraisals, selecting a closing agent, etc.--which are a huge source of fees collected from consumers and which tend to give consumers the (false) impression that brokers are actually lenders.

What has been going on for some time now is that the massive failures in the wholesale model have forced the wholesale lenders to, in essence, redundantly process these loans, as everything the broker does has to be checked and rechecked and in some cases simply repeated. (You let brokers order appraisals, and once you get it, you order a second appraisal or field review appraisal or run an AVM in order to reality-check the appraisal you got. The process pretty much ceases to be efficient here.) If the GSEs just come out and force wholesalers to take control of the appraisal process from the very beginning, then the kabuki ends and we stop pretending that brokers are doing anything except bringing in a consumer willing to sign an application. The rest of the loan processing is turned over to the wholesaler.

3. An "independent appraisal clearinghouse" would, presumably, be intended to remove some of the problems I discussed in this post with individual lenders managing approved or excluded appraisal lists. Without details I can't really say what they're doing here, but it sounds like Fannie and Freddie are seriously considering getting into approving or excluding individual appraisers or appraisal firms. FHA has always done that in some fashion or another; the GSEs never have. That's a very substantial change to the way the GSEs do business with lenders.

by Tanta on 2/27/2008 11:10:00 AM

OFHEO Press Release:

Fannie Mae published its timely, audited financial statement for 2007 today and Freddie Mac anticipates publishing its statement tomorrow. These steps constitute an important milestone in remediation of their respective operational and control weaknesses that led to multi-year periods when neither company released timely, audited financial statements.

Both companies have been operating under regulatory restrictions stemming from these past problems. These restrictions include growth limits on their retained mortgage portfolios, Consent Orders prescribing necessary remediation actions, and required 30 percent capital cushions above the statutory minimum capital requirements.

Mortgage Portfolio Growth Caps

In recognition of the progress being made by both companies, as indicated by the timely release of their 2007 audited financial statements, and consistent with the terms of the relevant agreements, OFHEO will remove the portfolio growth caps for both companies on March 1, 2008.

Consent Orders

Both companies have also made substantial progress with respect to completing the requirements of their respective Consent Orders. As each Enterprise nears completion, OFHEO is working with them to undertake a thorough review and validation of the completed work and will test the new systems and controls, as needed. To the extent that OFHEO finds the Enterprise has fulfilled the requirements of its Consent Order and the Enterprise has continued to file timely, audited financial statements, OFHEO will lift the Consent Order.

Fannie Mae has reported to us that its remediation activities under the Consent Order are nearing completion. Freddie Mac has completed most of the requirements under its Consent Order, but still faces the requirement of separating the CEO and Chairman position. Although not in the Consent Order, completion of the SEC registration process is a critical step.

OFHEO-Directed Capital Requirements

Since agreements reached in early 2004, OFHEO has had an ongoing requirement on each Enterprise to maintain a capital level at least 30 percent above the statutory minimum capital requirement because of the financial and operational uncertainties associated with their past problems. In retrospect, this OFHEO-directed capital requirement, coupled with their large preferred stock offerings means that they are in a much better capital position to deal with today’s difficult and volatile market conditions and their significant losses.

As each Enterprise nears the lifting of its Consent Order, OFHEO will discuss with its management the gradual decreasing of the current 30 percent OFHEO-directed capital requirement. The approach and timing of this decrease will also include consideration of the financial condition of the company, its overall risk profile, and current market conditions. It will also include consideration of the importance of the Enterprises remaining soundly capitalized to fulfill their important public purpose and the recent temporary expansion of their mission.

"And the recent temporary expansion of their mission." It does sound like Lockhart is still pissed about the jumbo thingy.

(Hat tip, bacon dreamz!)

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.

by Tanta on 2/21/2008 02:21:00 PM

This is certainly innovative:

The Office of Thrift Supervision is preparing a plan to help mortgage borrowers who owe more than their homes are worth and to discourage them from abandoning those properties, agency officials said yesterday.

Under the regulatory agency's proposal, still in its early stages, these borrowers would refinance into government-insured loans that cover the current value of their homes. The refinancing would pay part of what's owed to the original lender. For the remainder, the lender would get what the plan's backers call a "negative equity certificate." The lender could redeem the certificate if the home is eventually sold at a higher price. . . .

The proposal was briefly mentioned at a regular quarterly news briefing. More details should emerge over coming weeks, Petrasic said. The plan has been extensively analyzed internally and is now being discussed with policymakers and industry officials, he said.

The plan would separate a troubled mortgage into two parts. The first would cover the current fair-market value of the home and would be refinanced by the Federal Housing Administration. The remainder would be issued to the original lender as a certificate.

If the borrower eventually sells the home, the FHA mortgage would be paid off first. Remaining cash would be applied to paying off the value of that certificate. Anything left over would go to the borrower.

If there's not enough profit to pay off the certificate, the original lender would take a loss, which makes this proposal a gamble. However, the plan anticipates that there would be a market where these certificates are traded. That means the lenders could sell them immediately to offset some of the loss or hold them with the hope that they will appreciate, said Jaret Seiberg, an analyst at Stanford Policy Research.

The certificates would likely trade for small amounts, maybe $2 for every $100 in home value, and the amounts would increase as the housing market strengthens, Seiberg said.

But there are still many political and logistical hurdles.

This plan has not been vetted by the White House, Congress or other policymakers. The FHA declined to comment on the specifics except to say it is "regularly looking at new ideas and actively exploring ways to expand the eligible pool of creditworthy borrowers FHA can serve."

Whether investors will embrace the idea depends on many details that aren't resolved, Seiberg said. But it could be a way for lenders to cut their losses. "It beats foreclosure," Seiberg said. "These certificates enable [investors] to share in the upside if the housing market recovers."

For borrowers, avoiding foreclosure means they get to keep their homes and reduce damage to their credit.

"What we tried to do is figure out the best way to create market incentives for all the parties involved," Petrasic said.

That's a real twist on the idea of taking back a lien on a property to recapture any future equity. Apparently, only the FHA mortgage would be a lien against the property, with the certificate being an obligation of FHA? It certainly surprises me that the OTS feels confident it can work out the legal kinks with that quickly enough to make a difference.