by Anonymous on 4/02/2007 10:43:00 AM

CFC's Angelo Mozilo reminds us why letting lenders regulate themselves has worked out so well.

He said adjustable-rate mortgages and loans made without a downpayment have been used for more than a generation with proven results.

“It’s very important that we put liquidity back in the system,” Mozilo said while co-hosting "Squawk Box." “It’s important that that the Fed backs off on these guidelines and that people realize hybrids are very good loans.”

We're from the mortgage industry and we're here to help.

by Calculated Risk on 4/02/2007 12:17:00 AM

From the WSJ: New Century May Announce Bankruptcy Filing

New Century Financial Corp. is expected to make an announcement early Monday ... people familiar with the situation said.

The company is widely expected to seek relief from creditors through a bankruptcy filing.

by Anonymous on 4/01/2007 09:01:00 AM

CR may have posted on this study by researchers at the OCC and Federal Reserve Bank of St. Louis early last year just after it was published; at the time I was distracted by my post-surgical morphine pump (and you think I’m a Luddite?) and quite honestly was paying no attention to such matters. It’s not just that I’m too lazy to check the archives. Some questions have arisen in the comments recently about the history of subprime lending, as well as the extent to which depository institutions are implicated in it. So this may be worth a read even if we’ve been there before.

It’s a good paper; it’s also worth thinking about how off the mark some of its predictions about the direction of the subprime market turned out to be, just a year or two later. The authors were using data sets up to about mid-2004 and were writing in 2005, at what now appears the top of the real estate market in a lot of places. Even the list of subprime originators is sorely out of date: note the statement that “Household Financial Services, one of the original finance companies, has remained independent and survived the period of rapid consolidation. In fact, in 2003 it was the fourth largest originator and number two servicer of loans in the subprime industry.” Of course HSBC, a depository, was busy negotiating the purchase of HFS at the moment that sentence was written.

So the discussion here of the recent history of subprime originating is a bit dated in spots. What disappoints me is that the authors do not address one of the key facts about the situation in the 90s that I happen to remember: how the prime-lender depositories got their feet wet in subprime to start with.

Remember that back in the early-to-mid 90s, FICOs and AUS were still in development or not widely used, and nearly every loan was originated as “full doc” or what was called “alt doc,” which simply meant that it used borrower-provided documents (pay stubs, bank statements) instead of the probably more accurate but more expensive and time-consuming employer-provided or bank-provided documents (the Verification of Employment and Verification of Deposit forms a lender mailed to the relevant third party and received back, in the mail, with original signatures and in-depth information). Credit history was analyzed by looking at a full credit report (the old “RMCR” or “long-form” credit report ordered specially for residential mortgage applicants). Appraisals were all submitted on paper, with ink signatures and original photographs. Processing and then underwriting loans was time-consuming, and the application fee charged to a borrower was generally only enough to cover the actual cost to the lender of obtaining the credit report and appraisal. So the effort made by the lender to order verifications and evaluate the loan was sunk cost if the loan request was denied.

Several contexts converged here: after the S&L fiasco, prime depository lenders were finding themselves under some more attentive than usual regulatory supervision on safety and soundness issues, which, combined with RE busts, tended to make the declination rate for loan applications go up. At the same time, Fair Lending laws were getting enforced, which tended to make lenders less casual about having a high declination rate that they couldn’t justify on strictly credit-related grounds. For a lot of banks, specifically, the mortgage lending department (as opposed to other sources of loan assets like commercial, consumer, etc.) was a cyclical overhead-sink when rates went up (as they did in 1994-1995) and the refi boom of the early 90s came to an end.

Therefore, the issue of how one might recover some of those costs expended on loan applications one had ended up denying converged with the by-now commonplace idea that the prime-denied borrower class is an “underserved borrower segment” to create a willingness to dabble in subprime. If you, like me, had ever been handed a coffee mug with “There is no problem; there is only opportunity” emblazoned on it in some corporate pep rally in those days, you are familiar with the approach.

But the prime depositories of those days weren’t necessarily interested in placing these loans in their own investment portfolios, and they weren’t eligible for sale to the GSEs, which were the major buyers of loans the depositories didn’t hold. So banks and thrifts started developing whole-loan servicing-released loan sale programs, where the “fallout” from the prime pipeline could be recaptured by making a subprime loan and then selling it outright to a subprime conduit. Everybody gets a loan; all costs are eventually recouped; opportunity thrives. The subprime conduits could securitize the stuff and lay off the risk. It was great.

Except. There’s always an except. One unforeseen difficulty was that it became possible for certain participants who had always lived in the prime world to compare the profit margins on good old Fannie Mae fixed rates (maybe 50 bps if you were good at it) to those subprime deals (easily 150-200 bps if you were fair-to-middlin’ fastidious). Increased subprime lending could even improve those prime margins: as more and more of your weakest loans fell out of the bottom tier of your GSE loans and into the top tier of your subprime loans, you got paid better by the GSEs in the form of improved guarantee fees (since your average credit quality was so much better) and by your subprime investors (since your average credit quality was so much better). There was, in short, a moral hazard in play: in the shift from non-price to price rationing, more borrowers got mortgages, but it wasn’t always clear that they got the cheapest mortgage they should have gotten.

Those of us who were there at the time that the story about how “subprime is a way of serving the poor” got written do, then, tend to be somewhat more skeptical of this claim than others. The fact that many participants did not start out with the intention of preying on borrowers doesn’t change the fact that predation became widespread, or that a form of lending that had once been reserved for people with a lot of equity became associated just a few years later almost exclusively with people who had no money at all.

We can certainly debate the extent to which price-rationed lending provides true benefit to the historically credit-constrained. I’m game. I just think that market participants with short institutional memories are a menace. To all of us.

by Anonymous on 3/31/2007 04:07:00 PM

Because you all need something else to talk about.

Yes, I remember what I was doing when this song came out.

Yes, I used to have a bat-winged blouse that tied at the hip just like that.

You wanna make something of it?

by Anonymous on 3/31/2007 10:53:00 AM

From "Housing Crisis Knocks Loudly in Michigan":

For most of the past year, Michigan has ranked among the three states with the highest percentage of late mortgage payments and foreclosures, surveys by the Mortgage Bankers Association show. In the fourth quarter, it came in third, behind Ohio and Indiana, with 2.39 percent of its loans in foreclosure.

Many economists say, and union officers agree, that those hardest hit are not auto workers who lost jobs. Many received buyouts that should keep them afloat for a while. And because they tend to be older, some have paid off their mortgages.

Those feeling the worst squeeze, rather, are workers at the auto supply companies, such as Max, 44, an engineer who spoke on condition that his last name not be used because he is embarrassed by his situation.

Max bought a condominium in the Detroit suburb of Plymouth using a traditional fixed-rate mortgage more than five years ago. But three years later, his firm took away company cars from its workers, hiked insurance premiums and cut raises and bonuses -- raising Max's monthly living expenses and reducing his pay.

Max responded by refinancing his condo twice. Though he did not realize it then, the second loan was adjustable. Over time, his monthly payments rose from $1,500 to $1,800 to $1,950.

"I wasn't even reading the paperwork," said Max, who makes $106,000 a year.

Weeks ago, Max turned in his keys to his lender. The bank paid him $500 and took possession of the condo earlier than it otherwise could under Michigan law.

by Anonymous on 3/31/2007 08:46:00 AM

Hat tip to jmf!

Fulton Financial reports on repurchases of loans originated through its Resource Bank subsidiary:

In recent months, Resource has experienced an increase in the rate of EPD and corresponding requests to repurchase such loans, primarily related to one specific product sold to one investor. This product, referred to as the 80/20 Program, involves financing of up to 80% of the lesser of the purchase price or appraised value for a first lien mortgage loan and up to an additional 20% of the lesser of the purchase price or appraised value for a second lien home equity loan. Investor underwriting requirements for the 80/20 Program do not require independent verification of the borrower's income. To be eligible for loans under the 80/20 Program, borrowers are generally required to have a credit score of 620 or greater.

Fun facts:

• Loans originated for sale under the 80/20 Program in 2006: $247MM
• Pending repurchases of 2006-originated 80/20 Program loans: $22MM
• Remaining 2006 80/20 loans still subject to potential repurchase: $72MM
• Average FICO on requested repurchase loans: 653
• Percent of repurchase requests due to Early Payment Delinquency: 80%
• Date Resource quit offering this loan program: February 2007

These are fairly small absolute numbers for a lender of this size. The point is that this is under any definition Alt-A, not subprime.

by Calculated Risk on 3/30/2007 07:16:00 PM

From Reuters: M&T Bank says Alt-A loan woes will hurt earnings

M&T Bank Corp. said on Friday that problems with mortgages that have limited income documentation will hurt first quarter profit.

The bank, based in Buffalo, New York, said the carrying value of its Alt-A loan portfolio that had been held for sale was reduced by $12 million in the first quarter.
...
Meanwhile, the bank also said it would have to repurchase problem loans sold to investors.

Added: Just to make this clear, the problem loans that M&T will repurchase are Alt-A. From the M&T Bank press release:

In addition, M&T is contractually obligated to repurchase previously sold Alt-A loans that do not ultimately meet investor sale criteria, including instances when mortgagors fail to make timely payments during the first 90 days subsequent to the sale date. Requests from investors for M&T to repurchase Alt-A loans have recently increased. As a result, during the first quarter of 2007, M&T accrued $6 million to provide for declines in market value of previously sold Alt-A mortgage loans that are expected to be repurchased.

by Calculated Risk on 3/30/2007 02:17:00 PM

OCC Reports Record Bank Trading Revenues of $18.8 Billion for 2006

Insured U.S. commercial banks posted a record $18.8 billion in trading revenues in 2006, up 31 percent from the previous annual record of $14.4 billion set in 2005, the Office of the Comptroller of the Currency reported today in the OCC Quarterly Report on Bank Derivatives Activities. In the fourth quarter, commercial banks generated revenues of $3.9 billion from trading cash instruments and derivative products, off slightly from the $4.5 billion in trading revenues for the third quarter of 2006.

“Bank trading revenues have been strong the past few years due in large part to robust client demand, especially from large institutional investors such as hedge funds,” said Deputy Comptroller for Credit and Market Risk Kathryn E. Dick.

The OCC also reported that the notional amount of derivatives held by insured U.S. commercial banks increased $5.3 trillion, or 4 percent, to a record $131 trillion in the fourth quarter, 30 percent higher than year-end 2005.

The report noted that a fast-growing area has been credit derivatives, which increased to $9.0 trillion at year-end 2006, representing a 55 percent increase from the $5.8 trillion reported at year-end 2005. ...

Here is the report: OCC’s Quarterly Report on Bank Derivatives Activities: Fourth Quarter 2006

by Calculated Risk on 3/30/2007 11:42:00 AM

From the Census Bureau: February 2007 Construction Spending at $1,170.8 Billion Annual Rate

The U.S. Census Bureau of the Department of Commerce announced today that construction spending during February 2007 was estimated at a seasonally adjusted annual rate of $1,170.8 billion, 0.3 percent above the revised January estimate of $1,167.7 billion. The February figure is 2.4 percent (±2.2%) below the February 2006 estimate of $1,199.9 billion.

During the first 2 months of this year, construction spending amounted to $159.9 billion, 2.4 percent (±2.2%) below the $163.8 billion for the same period in 2006.

Click on graph for larger image.

This graph shows the YoY change for the three major components of construction spending: Private Residential, Private Non-Residential, and Public.

While private residential spending has declined significantly, spending for both private non-residential and public construction have been strong. This will probably be one of the keys for the economy going forward: Will nonresidential construction spending follow residential "off the cliff" (the normal historical pattern)? Or will nonresidential spending stay strong. I'll revisit this discussion soon.

by Anonymous on 3/30/2007 09:31:00 AM

I have described borrower-initiated fraud-for-housing loans as “self-underwritten.” The idea is that the borrower knows what the lender’s qualification standards are, knows he doesn’t meet those standards, and knows he cannot negotiate those standards away. His choices are, then, to accept the denial of credit, buy a cheaper house, or to lie or misrepresent the facts of his income, assets, employment, occupancy, and so on such that he appears to meet the standards. I call this “self-underwritten” because it rests on the borrower’s belief that he is a better judge of his prospects for carrying the loan successfully than the lender is; this belief allows him to justify his behavior as something other than criminal.

The fact that there have been so many “self-underwritten” loans in an environment of exceptionally lax standards for lender-underwritten loans is the key to puncturing this self-justification. It isn’t like we’ve had a credit crunch for years perpetuated by extremely risk-averse lenders, so that only perfect borrowers—or those who misrepresent themselves as perfect—can get a mortgage loan. Another way of putting this is that given how ugly so many of the lender-underwritten loans have been lately, there’s reason to think the self-underwritten ones are mostly butt-ugly. I take data on EPD rates for stated-income and zero-down loans, for instance, as some confirmation of this view.

Such a simple-minded perspective on things does, however, beg for additional complexity, and where else would you go for such additional analytic firepower than the New York Times? I offer you a third option: economist-underwritten loans.

Dr. Austan Goolsbee, a Real Economist™, presents the third way of understanding the issue in “’Irresponsible’ Mortgages Have Opened Doors to Many of the Excluded":

A study conducted by Kristopher Gerardi and Paul S. Willen from the Federal Reserve Bank of Boston and Harvey S. Rosen of Princeton, "Do Households Benefit from Financial Deregulation and Innovation? The Case of the Mortgage Market" (National Bureau of Economic Research Working Paper 12967), shows that the three decades from 1970 to 2000 witnessed an incredible flowering of new types of home loans. These innovations mainly served to give people power to make their own decisions about housing, and they ended up being quite sensible with their newfound access to capital.

These economists followed thousands of people over their lives and examined the evidence for whether mortgage markets have become more efficient over time. Lost in the current discussion about borrowers’ income levels in the subprime market is the fact that someone with a low income now but who stands to earn much more in the future would, in a perfect market, be able to borrow from a bank to buy a house. That is how economists view the efficiency of a capital market: people’s decisions unrestricted by the amount of money they have right now.

And this study shows that measured this way, the mortgage market has become more perfect, not more irresponsible. People tend to make good decisions about their own economic prospects. As Professor Rosen said in an interview, “Our findings suggest that people make sensible housing decisions in that the size of house they buy today relates to their future income, not just their current income and that the innovations in mortgages over 30 years gave many people the opportunity to own a home that they would not have otherwise had, just because they didn’t have enough assets in the bank at the moment they needed the house.”

The first time I read this I was, actually, so speechless that I could only respond with a quotation from our wise commenter mp: toad bones. Also, dog balls.

After thinking about it overnight, I have come to the conclusion that that’s still the wisest response, but you don’t get a good blog post out of simple incantations. In the “permanent income hypothesis” on which the economist-underwritten loan is based, the borrower’s belief that he will always be able to earn more money in the future, which justifies over-consumption of housing in the present into which he will grow, renders mortgage market “efficient” to the extent that it does away with such artificial constraints as down payment and DTI requirements—which are based on “the amount of money they have right now,” and adopts innovative standards depending on an individual borrower’s confidence in the amount of money he might have in a couple of years.

The evidence for this view is that economist-underwritten loans in the period 1970-2000 didn’t do so badly. Sure, a few of them went down, but it’s important to understand why:

Of course, basing loans on future earnings expectations is riskier than lending money to prime borrowers at 30-year fixed interest rates. That is why interest rates are higher for subprime borrowers and for big mortgages that require little money down. Sometimes the risks flop. Sometimes people even have to sell their properties because they cannot make the numbers work.

The traditional causes of foreclosure, even before there was subprime lending, were job loss, divorce and major medical expenses. And the national foreclosure data seem to suggest that these issues remain paramount. The latest numbers show that foreclosures have been concentrated not in places where real estate bubbles have supposedly been popping, but rather in places whose economies have stagnated — the hurricane-torn communities on the Gulf of Mexico and the industrial Midwest states like Ohio, Michigan and Indiana, where the domestic auto industry has suffered. These do not automatically point to subprime lending as the leading cause of foreclosure problems.

So in this period of happily performing economist-underwritten loans, there were some losers. Apparently the causes, job loss, divorce, and major medical expenses, which could be understood to mean situations in which current expenses are substantially greater than current income—have nothing to say about the idea that it is wise to take a loan that ignores one’s current income and expenses. Lenders, it appears, may consider future income; servicers, it appears, still keep refusing to accept aspirations rather than negotiable instruments to apply to a past-due balance.

Of course it’s not surprising that Goolsbee ignores the evidence of a house-price bubble, since there can apparently be no bubbles in perfect markets. Theories do that to you. But I don’t think theory can really explain the revolting disingenuousness at the end of his op-ed:

The Center for Responsible Lending estimated that in 2005, a majority of home loans to African-Americans and 40 percent of home loans to Hispanics were subprime loans. The existence and spread of subprime lending helps explain the drastic growth of homeownership for these same groups.

“Drastic”?

This is actually what CRL has to say on this topic:

According to the Fed report, even after adjusting for differences in the borrower characteristics contained in the HMDA data, African-American and Latino borrowers were more likely to receive higher-rate loans. Furthermore, a recent study released by CRL shows that disparities tend to persist even after additional adjustments were made for differences in credit scores, equity, and other risk factors not available in HMDA data. The Fed authors also adjust for originating lender. Though this adjustment reduces the disparities substantially, significant differences remain. . . .

The CRL study found that, even after controlling for legitimate risk factors, African-American and Latino borrowers were still more likely to receive higher-rate subprime loans than similarly-situated non-Latino white borrowers. With raw disparities in higher-rate loans between groups basically unchanged from 2004 to 2005, there is little reason to believe that legitimate risk factors would account for all of the disparity evident in the 2005 data.

In other words, CRL is suggesting that a pattern of finding subprime loans given to minority borrowers with similar credit, income, and equity profiles to non-Latino whites who get prime loans may imply a certain “inefficiency” in the mortgage market somewhere. For Goolsbee to use this data to buttress an unregulated free-for-all by claiming that it helps out the traditionally disadvantaged is, well, dishonest.

If you look hard at the data compiled by folks like CRL, you do have to face the problems inherent in the lender-underwritten mortgage market: when lenders are allowed to apply standards without public review, they certainly can end up applying those standards in a discriminatory fashion. When “reputable lenders” are allowed to exit entirely certain minority markets, leaving them to the tender embrace of the loan sharks, the “innovative” subprime market can quickly become mere predation. I have no beef with anyone who wants to see regulation of lenders to prevent these social evils.

However, if I had to choose between lender-underwritten and economist-underwritten loans? No contest.