by Anonymous on 4/23/2007 06:43:00 AM

In late 2006, the Massachsetts Commissioner of Banks convened a "Mortgage Summit" to address issues of foreclosures, predatory lending, and mortgage fraud. The report of the working groups formed at the summit was published on April 11, 2007, and is definitely worth a read for anyone interested in the issue of regulating lending practices or dealing with a foreclosure epidemic.

I will say, as I've said before, that one frequently sees--and the Massachusetts report is no exception--the objection arising to certain legislative or regulatory reforms that it involves the potential for increased costs of mortgage credit. In the Massachusetts example, the proposal to require judicial foreclosures in all cases is met with the utterly predictable response from the lending industry that such a requirement makes foreclosures more expensive, and that lenders would pass such costs on in the form of marginally more expensive mortgage rates.

What frustrates me is that no one--including the Massachusetts task force--is coming back with the response of "And so?" I have some dusty old Econ 101 textbook that is probably filled with a fair amount of nonsense, but I remember it implying that moral hazards can be dealt with by imposing failure costs on the risk-taker. From a rather different economic perspective, I note that extremely cheap mortgage credit, backed by cheaper non-judicial foreclosure options, has really done a lot for us lately.

There is also the predictable claim that regulation of predatory or potentially predatory loan products or brokering relationships would "hurt the poor." This, coming out of the mouths of for-profit lenders, is pretty rich. The idea seems to be that "suitability standards" are OK for middle-class financially-literate people, but they get in the way of making loans to low-to-mod income wage earners who may not have been through Econ 101 and don't run Excel. I'll go on record with the thought that anyone who believes that "democratizing" homeownership means that the poor are helped most by getting loans at any cost is full of MBS.

For discussion purposes, here are a few of the recommendations the working groups were able to agree on (which doesn't mean they'll happen, of course, unless and until not just MA but other states get on board with regulating and legislating these issues).

• Pre-payment penalties should not be charged after the initial reset period of an ARM product.

• Full, simple, and clear disclosure of all the features of the loan that might affect the monthly payment and borrower equity, should be provided.

• Full, simple, and clear disclosure of the incremental cost of each of the risk layering features of the approved loan should be provided.

• Changes in loan terms at or just prior to closing that adversely affect the borrower by increasing costs, fees, or rates or changing other terms are inappropriate and should be considered predatory.

• Require that the name and license number of the mortgage broker be added to the mortgage so that it becomes a public record.

• Require all licensed mortgage lenders and mortgage brokers to report through the annual report to the Division of Banks the number of loans that they originated that went into foreclosure.

• Require all licensed mortgage lenders and mortgage brokers to report through the annual report to the Division of Banks the number of loans originated in Massachusetts that meet the definition of a high APR loan (HAL) under the Home Mortgage Disclosure Act (HMDA)7 and the percentage of all loans originated in Massachusetts that are HALs.

• Based on the HAL data reported by mortgage lenders and mortgage brokers, consideration should be given to the following:

1. If the majority of a lender’s or broker’s business are HALs, the lender or broker must disclose this to the customer in writing, along with information that better pricing and terms may be available from another lender.
2. If the majority of a mortgage lender’s or broker’ closed loan business is defined as HALs, a separate license designation could identify them as a High APR lender or broker. This High APR identification would also have to appear in all advertising.

by Anonymous on 4/21/2007 10:30:00 AM

. . . my name is Alt-A.

That pretty much sums up the message this earnings season from the mortgage lenders.

Yes, if I could have found a YouTube of Jessi Colter, or even Erika Jo, I'd have chosen it. So sue me. Let me remind you that if you are looking for good taste in music, you should go bug Barry Ritholtz.

Oh yeah, and "rock" means whatever I say it means. I'm a mortgage lender, dudes.

by Calculated Risk on 4/20/2007 08:15:00 PM

IndyMac provided an (pdf) Update on First Quarter Mortgage Loan Production today. Here are a couple of interesting tables.

Click on graph for larger image.

This shows the breakdown of loans by documentation. Most of their loans fall into Type 2:

Borrower states income and documents employment and assets. Lender assesses income for reasonableness and verifies employment, assets, credit history and home value (by appraisal).

Click on graph for larger image.

The second image (two tables) shows the actual loan production in Q1 by documentation type, and the Proforma Loan Production had their new guidelines been in place on Jan. 1, 2007. Overall production would have declined by about one third. Type 2 loan production would have decreased from $13.161 Billion to $8.066 Billion.

by Calculated Risk on 4/20/2007 06:49:00 PM

Every month, for most of the last year, we have seen some prominent economist, analyst, or government representative call the housing bottom. My only regret is I didn't keep a list of their erroneous calls!

Of course someone will eventually be correct, and maybe it will even be Treasury Secretary Hank Paulson, from MarketWatch 4/20/2007 (hat tip Anthony Fleming):

In a question-and-answer session, Paulson delivered an upbeat assessment of the economy, saying growth was healthy and the housing market was nearing a turnaround.

"All the signs I look at" show "the housing market is at or near the bottom," Paulson said.

This is the start of a list of bottom callers. Please post any other prominent bottom calls (not Lereah!).

by Calculated Risk on 4/20/2007 05:32:00 PM

From MarketWatch: California home prices to weaken further: Goldman

Investment bank Goldman Sachs is increasingly concerned about the health of California's real estate market ...

Mortgage delinquencies jumped 46% in California last year, vs. a 5% increase nationally, Goldman said in a note to clients late Thursday.

Delinquencies on prime and subprime adjustable-rate mortgages in California soared by 78% and 60% respectively, vs. 33% and 24% across the U.S., the bank added, citing recent data from the Mortgage Bankers Association.

Median California home prices are still creeping up, and the state's strong employment trends should support the real estate market. But Goldman is worried that surging prices in the state in recent years weren't driven by traditional factors such as strong employment and income growth. Instead, the bank reckons an increase in ARM mortgages offered to borrowers who were already stretching to buy high-priced homes fueled the boom.

Now that lenders are cutting back some of these types of loans and regulators are beginning to crack down, California home prices could begin falling later this year, especially in high-price cities and towns, Goldman said.

by Calculated Risk on 4/20/2007 04:08:00 PM

UPDATE: A couple of commenters believe I misinterpreted the excerpted sentence. I agree, but I'm not sure of the correct interpretation. Apparently the writer meant that the average unemployment rate for the current decade (since 2000) is the lowest for any decade since 1970. However, doesn't the "past four decades" still include the '60s? The average for the '60s was lower than the current decade.

This article from the AP: Factory jobs: 3 million lost since 2000 contains the following claim:

"Even though manufacturing jobs have been declining, the country is enjoying the lowest average unemployment rates of the past four decades."

Click on graph for larger image.

This graph shows the monthly U.S. unemployment rate for the last four decades. The red line is the current unemployment rate of 4.4%.

At no time, during the "past four decades" did the blue line dip below the red line - or so the AP claims.

by Calculated Risk on 4/20/2007 01:30:00 PM

Here are some excerpts from Governor Frederic S. Mishkin speech today: The U.S. Economic Outlook

Regarding the housing adjustment ... At the beginning of the year, the ongoing cutbacks in starts of new homes, together with a lowered but fairly steady pace of home sales, were beginning to reduce the elevated backlog of new homes for sale. However, a further weakening in sales of new homes in January and February reversed some of the progress in reducing those inventories. As a result, cutbacks in new residential construction may well persist for a while.

Towards the end of last year, the Fed's view was that the housing market was near the bottom for this cycle. That viewed seemed to ignore housing fundamentals (like, say, record supplies and falling demand), and now the Fed is finally acknowledging that problems in housing "may well persist for a while."

More recently, developments in the subprime mortgage market have raised some additional concern about near-term prospects for the housing sector. The sharp rise in delinquencies on variable-interest-rate loans to subprime borrowers and the exit of a number of subprime lenders from the market have led to tighter terms and standards on such loans. While these problems have caused undeniable hardship for many families and communities, spillovers to other segments of the mortgage market or to financial markets in general appear to have been minimal.

The spillover is minimal if you ignore Alt-A, prime HELOCs, and C&D loans to condominium developers. As an example, here is an excerpt from Corus Bankshares' press release this morning:

"With a loan portfolio consisting, almost exclusively, of condominium construction and conversion loans, the nationwide slowdown in the residential housing market is impacting Corus' business. Evidence of this slowdown is clear from the decline in loan originations, the resulting decline in loans outstanding and an increase in problem loans. The current quarter's earnings declined as a result, and it would not surprise us to see an even greater impact on earnings over the next several quarters, or even years, depending on when the market improves," said Robert J. Glickman, President and Chief Executive Officer.

And back to Mishkin:

I should note some positive news for the housing sector. Sales of existing homes strengthened a bit during January and February, and the Mortgage Bankers Association index of applications for home purchase suggests that demand has been fairly steady through early April. Also, mortgage rates are still at historically low levels, and mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to show low rates of delinquency.

The MBA index has held up pretty well, probably due more to how their survey is conducted than any real strength in the housing market. On the existing home news, Mishkin is simply looking at the data incorrectly. And yes, delinquency rates are rising for all borrowers, including prime borrowers and those with fixed rate mortgages.

And away from housing:

The second major area of concern in the near-term outlook, and one that perhaps could pose noticeable downside risks, is business investment.

A downturn in business investment definitely wasn't a surprise since that is the normal historical pattern (non-residential investment follows residential investment). There is much more in the speech, especially concering inflation expectations.

by Anonymous on 4/20/2007 01:21:00 PM

Loyal reader Brian (thanks, I think) sent this one for today's edification. Bloomberg gives us "Subprime Brokers Seek Solace at Two-Day Loan Pep Talk (Update1)":

April 20 (Bloomberg) -- Mortgage brokers and bankers at a conference in Orange County, California, the center of the subprime lending industry, were told to prepare to make more fixed-rate loans now that lending standards are being tightened.

``Some of the underwriting guidelines just got too aggressive, that's the bottom line,'' Dale Vermillion, a Chicago-based mortgage consultant, said at the event in an area where subprime lenders including New Century Financial Corp. are based. ``The problem is the borrowers weren't thinking, the lenders weren't thinking.''

The $899 two-day seminar was being given by a lending expert who has advised more than 100 mortgage providers, including New Century, Ameriquest Mortgage Co. and ABN Amro Holding NV, on how to win more business in the housing boom. Now that at least 50 subprime mortgage lenders have closed, gone bankrupt or sought buyers, the tenor of this year's event was more subdued than previous years, some brokers said. . . .

The event was part informational, part motivational pep talk. Vermillion at one point had attendees applaud themselves because they ``are already among the leaders in the industry'' and encouraged them to help their customers buy homes because ``that is the American dream.''

Several times during the seminar, Vermillion led attendees in a call and response, and once asked for an ``amen.'' At a session following the formal presentations, Vermillion, who wears a cross-shaped earring, talked about becoming a born-again Christian in his early 30s. More than half of the attendees attended the session, which ended with a prayer.

``We as an industry provide a vital, vital service. Who here wants to be an agent of change?'' Vermillion asked during a session on company infrastructure and marketing. Hands around the room went up. ``Give me a `Yee-ha.''

``Yee-ha,'' attendees responded.

``Louder?''

``Yee-ha!''

I may change my mind on whether someone needs to "stabilize" this market.

by Anonymous on 4/20/2007 06:05:00 AM

Our last installment went into some fair detail on the old-fashioned single-class pass-through MBS as practiced by Ginnie Mae and the GSEs. These securities always had a huge advantage: they’re cheap to produce and easy to understand. Back in the days when there wasn’t much about the underlying loans that was hard to understand—you had your basic fixed rate, your basic amortizing one-year ARM—you could master the cash-flow issues over lunch.

The big drawback of the pass-through was always its prepayment and duration problems. The actual dollar yield on a bond—or a mortgage—is a matter of how long you earn interest at a given rate. If the loan prepays much earlier than you expect, you get your principal back, but you must now reinvest it somewhere else, and loans generally prepay fast when prevailing market rates are lower, putting the refinance “in the money” for the borrower and forcing the prepaid investor to buy a new lower yield. When market rates rise, prepayments slow considerably, but this extension means an investor has funds sunk in a low-yielding bond when new ones yield much more. Some investors, of course, would want to be prepaid more quickly or more slowly than average, if they were using MBS to hedge some other investment risk or just needed very high liquidity. The trouble with the single-class pass-through is that it’s just too unpredictable.

The big innovation in the MBS world was the CMO (Collateralized Mortgage Obligation, not to be confused with the CDO, or Collateralized Debt Obligation, which we’ll get to later). A CMO is also often called a REMIC (Real Estate Mortgage Investment Conduit) since that is the legal structure on which most of them are built. REMICs were developed in the 1980s, and the advantage (or disadvantage) to an issuer or investor of owning part of a REMIC has a lot to do with tax treatment of certain kinds of investment income. That is a level of detail into which I will not get. Suffice it to say that most CMOs work like REMICs even if they aren't true REMICs, and that I prefer to use the term REMIC here to keep from getting lost in the CMO-CDO confusion weeds.

REMICs are very complex, and so we’re just going to skim here. The basic idea is that the cash-flow from an underlying pool of whole loans—even one or more underlying pass-through MBS—can be sliced up or “tranched” into separate securities with differing cash-flow characteristics and time-to-maturity horizons. The simplest approach is “sequential pay”: a structure of classes is set up, with each tier getting its scheduled pro-rata share of the pool interest, but the top tier getting all the scheduled (and all or most of the unscheduled) payments of principal, until that tranche or class is paid off. Then the next tier gets principal payments, and so on. This lets you take an underlying pass-through with an expected maturity of 25 years and turn it into one 2-5 year bond, one 5-7 year bond, one 7-10 year bond, and so on. It also creates a “yield curve” within the REMIC, as the shorter-maturity classes earn a lower rate of interest than the longer ones. This is true even if the underlying loans are all 30-year fixed rates.

Remember that individual loans are not assigned to tranches or classes; what is being “allocated” in a REMIC is the total cash flow of principal and interest from the aggregated underlying loans. The underlying loans can be “grouped” in certain ways—they can be already securitized into pass-throughs, and you can have a group of loans or MBS assigned to a set of classes or tranches, but legally the REMIC trust owns all the underlying loans, and all underlying loans are available to pay whatever any given tranche-holder is owed.

But even a sequential-pay structure allows some unpredictability in the repayment characteristics of each tier. So most REMICs improve on the simple sequence by further refining the cash flow characteristics of each tranche. There is the “stripped” tranche: an IO strip pays interest only (on a nominal balance) while the PO strip pays principal only (the investor buys that bond at a deep discount). There are PACs and TACs (Planned or Targeted Amortization Classes) which pay principal according to a schedule that may have nothing to do with the actual amortization of the underlying loans. There are floaters and inverse floaters—tranches that pay interest that increases with a rise in an underlying index or the inverse (the yield decreases when the index rises, making these hedge vehicles). There are “accrual bonds,” which pay no cash flow for the initial years of the REMIC (the “lockout period”), although they accrue interest during that period.

There are also several kinds of “support bonds,” which is a generic term for a tranche needed to do or get the opposite of what one of the above tranches does or gets. An amortization class, for instance, generally needs a corresponding support bond that will get excess or shortfall prepayments of principal “left over” from the principal allocation to the PAC or TAC. There is always, finally, a “residual” bond, at the bottom of the whole elaborate structure, that gets whatever is left. Residuals are nearly impossible to accurately value. With a true REMIC, the residual is generally held by the security trust. (Other kinds of structured MBS can generate a residual that can trade in the junk bond market.) The expected yield on any given class or tranche can vary widely, based on how close to expectations the actual payment and prepayment characteristics of the underlying loans end up being.

Having fun yet? For our purposes, here’s the point of caring about this: first, the original idea of the REMIC is to make mortgages a more attractive investment by controlling their repayment characteristics (just as single-class pass-through MBS made mortgages more attractive by controlling their credit risk). Over time, however, tails can start wagging dogs, and some of us are firmly convinced that mortgages started to become originated in products that would make a great REMIC. Imagine trying to do a simple pass-through MBS with interest-only hybrid ARMs combined with amortizing true ARMs. Or a pass-through with Option ARMs. Or HELOCs with an initial interest-only draw period followed by an amortizing repayment period. You need, basically, an exotic security in order to successfully originate exotic loans. Or, perhaps, you need increasingly exotic loans in order to feed the increasingly exotic securitization machine.

Second, the notion of a multi-class security is generally premised on the happy assumption of a bunch of different investors with different investment needs—fixed income, hedges, what have you—all of whom can come together, take the piece they want, and play “support bond” for each other, while the REMIC issuing trust happily takes the leftovers in the residual out of the kindness and generosity of its heart. What lurks beneath this premise—and will get crucial when we start talking about credit risk again—is that multi-class can introduce “class warfare.”

One thing you can say about the various part-owners of a big single-class pass-through is that they’re all in the same boat, since they’re all getting a pro-rata share of whatever is going on—fast prepayments, slow prepayments, high-coupon, low-coupon—in the underlying pool. In a multi-class REMIC, fast prepayments could be great for me and tough luck for you. Changes in the underlying interest rates on the loans could be tough for me and great for you. Theory says this is fine, because you are a rational informed agent, as am I, and we are buying whatever tranche we picked in order to hedge some risk we perceive, accurately, that we have. Besides the obvious retort to that—rational? bond investors?—there is the question of further, possibly quite unpleasant, effects on what the underlying mortgages have to look like to support all these harmoniously opposing classes.

In the big picture, we have a security structure that biases the mortgage market to refinances rather than modifications, and to loans that really have to refinance in practical terms (ARMs, IOs, balloons) over those that don’t (fixed rates). The structure readily accommodates exotic underlying mortgage loan structures, and hence removes “complexity risk” from the investor side (if not the mortgagor side). Very importantly, it removes investor aversion to early payoff risk—there’s always a “support bond” to profit from prepayments—eliminating a great deal of a mortgage originator’s disincentive to keep refinancing the same loan. Prepayment penalties get put on loans that are destined to prepay, given their toxic adjustments, which appears to be the only way the servicing for these securities can stay profitable.

Some people like to focus obsessively on mortgage broker and mortgage originator culpability for the mess we’re in, and certainly it never pays to underestimate that. But no broker or correspondent lender can originate an Option ARM with a shockingly high margin (the rate that kicks in when the “teaser” is gone) with no points unless some aggregator or REMIC conduit or other investor is paying 105 cents on the dollar for it. You can ask why anyone would pay so much premium for such a loan, especially given the likelihood that it will, you know, refi and pay off early.

The claim that premium pricing prevents rate predation—that the investor doesn’t “gain” by having a borrower pay an above-market rate because it pays too much premium for the loan—is a mite disingenuous in the context of structured securities. If you are buying whole loans for an investment portfolio, or for inclusion in a simple pass-through, that might make some sense. But if you are buying loans for a security in which someone will benefit from the fast prepayment of that loan—and someone else will benefit if it stays on the books—you may well be paying up for that loan precisely because it has the payment and prepayment characteristics you want, not in spite of them. There is always someone on the other side of a hedge trade. If there were no incentive for conduits to pay 105 for a loan, I can assure you that they wouldn’t pay it, or not for long. (Note to self: why did Grant Thornton just walk out on a couple of its auditees when the subject of secondary market pricing strategies came up? Are all these Wall Street-inspired conduits really paying a perfect price for this stuff? Hmmm.)

Remember the average 200 bps note rate spread in an old-fashioned GSE MBS? I just looked at a Fannie Mae 2007 issue REMIC, backed by Fannie Mae pass-throughs, with a note spread of 275 bps. A private-issue REMIC backed by non-GSE loans can easily have a total spread on the underlying loans of ten points or more, with an age-adjusted spread of 500 bps. (Remember that you must look at the age of the loans in a REMIC pool. The pass-through MBS loans are originated into a current (par) coupon, but a REMIC with flow or seasoned loans will have loans that were originated into different current coupons. A mortgage note rate is “above” or “below” market only in reference to what the par coupon was that day.) How much of the note spread in a private-issue REMIC is a question of credit quality we will deal with in the next installment. For now, just note that a GSE REMIC will have those famous fairly uniform and geographically diverse loans in its pools, so that duration—sensitivity to market rate changes—is affected by loan quality, not just note rate. By and large, GSE loans are refinanceable, whether or not they’re in the money for a refi.

A private-issue REMIC backed by jumbos, Alt-A, subprime, reperforming, scratch & dent, or a mixture thereof can require exceptionally complex prepayment calculations, as these loans may be less sensitive to market rate changes alone. In the “old days,” the cruddier the credit, the longer the loan stayed on the books, since there were fewer refi options. Then we went through this period where there was a REMIC for every loan, cruddy or not, and so sensitivity calculations all of a sudden got “counter-intuitive.” One definition of a “credit crunch” is a giant blow-up in durations. When the music stops, everybody has to take a chair and then sit there. If you didn’t get a chair, you default, the lender forecloses, and losses are dealt with somewhere. But if you did get a chair—and I continue to think that most prime borrowers will get one—you will, if it makes you feel any better, possibly be sticking it to some bondholders just by paying your loan back as agreed.

Whether all of these REMICs were structured carefully enough that they can fully survive a “crunch” is a good question. But it also depends on how REMICs deal with credit risk once we get away from the GSE ones and into the private-issues, where there is no GSE to guarantee the investor against principal loss. That part of the “musical chairs” game awaits the next installment.

by Calculated Risk on 4/20/2007 12:15:00 AM

From the WaPo: 'Upside Down' Home Sellers Owe More Than They Get

Jeffrey Taylor and his wife bought their dream home in Purcellville for $538,000 last August. Now they have to sell it because they are getting divorced and neither one can afford the mortgage alone.

The most they could get for it was $430,000. After paying all the real estate commissions and taxes, they will still owe the bank $118,000.

These stories are similar to the one I posted last month: Escrow to Seller: "Bring Money".