by Anonymous on 3/28/2007 12:00:00 PM

There was some outrage in the comments recently about Sandra Braunstein’s recent testimony on subprime lending. Braunstein is the Director of the Division of Consumer and Community Affairs for the Federal Reserve.

There are many things one can say about Braunstein’s testimony. I want to drive a few little conceptual wedges into her nice smooth characterization of the current mortgage market in general and subprime lending in particular.

It starts early, in the fourth paragraph of the written statement:

Today, the mortgage lending business has changed dramatically with the development of national markets for mortgages, technological changes, and the advent of securitization. The traditional book-and-hold model of mortgage lending has shifted to an originate-to-distribute model.

So far, so good, except something important seems to be missing from the “national, technological, and securitized” holy trinity of major market forces. Braunstein continues:

While commercial banks still have a significant role in the mortgage origination and distribution process, they are no longer the leading originators or holders of residential mortgages. Securitization has allowed many financial institutions to use increasingly sophisticated strategies to package and resell home mortgages to investors. This has resulted in increased competition and a wide variety of mortgage products and choices for consumers, in a market in which mortgage brokers and mortgage finance companies compete aggressively with traditional banks to offer new products to would-be homeowners. [My emphasis]

In what strange world are mortgage brokers “competitors” of banks? Let us remember what a broker is: not a lender. A broker brings a borrower and a lender together, and pockets a commission of some sort for so doing. The broker has no capital to lend. The “competitors” of brokers are direct retail lenders, meaning those lenders with loan officer employees who offer loans directly to consumers without requiring the services of brokers.

But for any bank with a wholesale origination model (which could, you know, be related to its “securitization” model in some fashion), brokers are not competitors, they’re sources of business. The wholesaler’s competition is other wholesalers, some of which are not depositories. Why am I making such a big deal about this? Because brokers have no “new products” to “offer” to “would-be homeowners.” They go out and find products offered by wholesalers to offer to would-be homeowners. Is this an unimportant distinction? I don’t think so.

Two paragraphs later, the lurking problem gets even worse:

One of the products of this new mortgage market is subprime lending. Subprime lending has grown rapidly in recent years. In 1994, fewer than 5 percent of mortgage originations were subprime, but by 2005 about 20 percent of new mortgage loans were subprime. The expanded access to subprime mortgage credit has helped fuel growth in homeownership.

It’s certainly questionable that subprime has really directly fueled homeownership to the extent Braunstein here assumes. As commenters have pointed out, there is evidence that subprime is still mostly a refinance business, not a purchase money business. To say, for instance, that record numbers of new home purchases have been made with subprime loans is not to say that most subprime loans are for purchases. Subprime on the whole, as far as I can see, has been fueling the MEW machine, and only indirectly the ownership machine. It is hard to build a MEW market with a bunch of renters.

But that aside, I am puzzled by the phrase “expanded access to subprime mortgage credit.” This assumes that “access” is a question of borrowers having access to creditors, rather than, perhaps, a question of creditors having access to borrowers. The whole idea of “predatory lending,” which is a subset of subprime lending, is that there are lenders who want to lend going after borrowers who may not have supplied the “demand” until someone fast-talked them into it. Even in the more “respectable” parts of the subprime and Alt-A business, I would argue, the "disintermediation" of “national markets, technology, and securitization,” which rely to a large extent on the “intermediation” of brokers, can function as much as supply creating demand than the other way around.

Those who wish to throw the Econ 101 textbooks at me will have to explain to me just how, exactly, borrower demand for loans they obviously do not understand, and that are not anywhere close to being in their best interest, gets created. Are we talking about a demand for credit or a demand for income-substitutes? And those who want to say that it’s all a matter of borrowers substituting short-term interest for long-term interest need to explain this EPD epidemic to me. Either those EPD loans were 100% fraudulent—borrowers who never intended to own the property or make the payments—or some of them were borrowers who never stood a chance of receiving even short-term benefit from the loan. I’m not sure which case is more comforting, but I surely can’t see here unambiguous evidence for pent-up demand that simmered for years until the “new mortgage market” Braunstein discusses suddenly offered the product everyone had been waiting for. Next thing you know, someone is going to tell me about the invention of advertising.

Quite honestly, after the first couple of paragraphs I just lost interest in anything else Braunstein had to say. It isn’t even, in my view, that her other testimony is wrong or worthless. It’s simply that I no longer care to hear anyone, and especially regulators, continue to talk about the mortgage “market” without talking about the mortgage business. I’m not interested in people talking about securitization and other forms of “disintermediation” until they address wholesale and correspondent originations and telemarketers and other kinds of “intermediation.” At some point these regulators are going to have to quit with the executive summaries and get into the UberNerd weeds with the rest of us, or else we’re going to keep getting this "disclosure" regulation (you can do pretty much anything as long as you slip in a disclosure that says so in the mice type) that works nicely in Econ 101 and doesn’t do diddly when the Borg adapts. Until they’re willing to recognize that a demand “bubble” exists, and that intermediation is not "competition," nothing they come up with in the name of “consumer access” is going to help much.

by Calculated Risk on 3/28/2007 10:57:00 AM

Back in February, Bernanke suggested the following risks:

The risks to this outlook are significant. To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover effects from developments in the housing market onto consumer spending and employment in housing-related industries may be more pronounced than expected.
Chairman Bernanke, Feb 14, 2007

Now compare to Bernanke's testimony today:

This forecast is subject to a number of risks. To the downside, the correction in the housing market could turn out to be more severe than we currently expect, perhaps exacerbated by problems in the subprime sector. Moreover, we could yet see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far. The possibility that the recent weakness in business investment will persist is an additional downside risk.

Yet the forecast remains the same: "the economy appears likely to continue to expand at a moderate pace".

by Calculated Risk on 3/28/2007 10:42:00 AM

From Federal Reserve Chairman Ben Bernanke: The economic outlook

The principal source of the slowdown in economic growth that began last spring has been the substantial correction in the housing market. Following an extended boom in housing, the demand for homes began to weaken in mid-2005. By the middle of 2006, sales of both new and existing homes had fallen about 15 percent below their peak levels. Homebuilders responded to the fall in demand by sharply curtailing construction. Even so, the inventory of unsold homes has risen to levels well above recent historical norms. Because of the decline in housing demand, the pace of house-price appreciation has slowed markedly, with some markets experiencing outright price declines

The near-term prospects for the housing market remain uncertain. Sales of new and existing homes were about flat, on balance, during the second half of last year. So far this year, sales of existing homes have held up, as have other indicators of demand such as mortgage applications for home purchase, and mortgage rates remain relatively low. However, sales of new homes have fallen, and continuing declines in starts have not yet led to meaningful reductions in the inventory of homes for sale. Even if the demand for housing falls no further, weakness in residential construction is likely to remain a drag on economic growth for a time as homebuilders try to reduce their inventories of unsold homes to more normal levels.

Developments in subprime mortgage markets raise some additional questions about the housing sector. Delinquency rates on variable-interest-rate loans to subprime borrowers, which account for a bit less than 10 percent of all mortgages outstanding, have climbed sharply in recent months. The flattening in home prices has contributed to the increase in delinquencies by making refinancing more difficult for borrowers with little home equity. In addition, a large increase in early defaults on recently originated subprime variable-rate mortgages casts serious doubt on the adequacy of the underwriting standards for these products, especially those originated over the past year or so. As a result of this deterioration in loan performance, investors have increased their scrutiny of the credit quality of securitized mortgages, and lenders in turn are evidently tightening the terms and standards applied in the subprime mortgage market.

Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear. The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency. We will continue to monitor this situation closely.

Business spending has also slowed recently.

by Calculated Risk on 3/28/2007 09:38:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Applications Decrease Slightly in Latest MBA Survey

The Market Composite Index, a measure of mortgage loan application volume, was 671, a decrease of 0.2 percent on a seasonally adjusted basis from 672.1 one week earlier. On an unadjusted basis, the Index decreased 0.2 percent compared with the previous week and was up 16.6 percent compared with the same week one year earlier.

The Refinance Index decreased 0.5 percent to 2197.7 from 2208.6 the previous week and the seasonally adjusted Purchase Index increased 0.1 percent to 411.1 from 410.6 one week earlier.

Mortgage rates were mixed:

The average contract interest rate for 30-year fixed-rate mortgages decreased to 6.04 percent from 6.06 percent ...

The average contract interest rate for one-year ARMs decreased to 5.84 from 5.88 percent ...

Click on graph for larger image.

This graph shows the Purchase Index and the 4 and 12 week moving averages since January 2002. The four week moving average is up 0.6 percent to 410.3 from 407.9 for the Purchase Index.

The refinance share of mortgage activity decreased to 45.1 percent of total applications from 45.3 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 20.2 from 20.9 percent of total applications from the previous week.

by Calculated Risk on 3/28/2007 12:30:00 AM

Here are two related stories: the first from the perspective of borrowers facing foreclosures, and the second from a macro perspective of the housing bust.

From Kareem Fahim and Ron Nixon at the NY Times: Behind Foreclosures, Ruined Credit and Hopes.

His monthly payments are now more than $2,600.

Earning about $2,000 a month on his salary, he quickly fell behind.

And from Rex Nutting at MarketWatch: Will 'lemming loans' drive economy off the cliff?

For the first time in the nation's history, a significant number of Americans are being threatened with the loss of their home even though they still have a steady, good-paying job.

It's not just an issue for people with poor credit, those with subprime loans. It also affects people with good enough credit to qualify for a prime loan. Known as Alt-A mortgages, these loans were written for 1 in 5 U.S. mortgages and could have a big impact on the economy and on credit markets -- bigger, perhaps, than the effects of the recent shockwaves buffeting the subprime-lender market, economists say.
...
In the past, homeowners have generally lost their home to foreclosure only when they suffered a major life-changing event, such as loss of their job, a major illness or death of a family member. A big jump in foreclosures was unheard of outside a recession that brought high unemployment.

But now, because of the recent popularity of loans geared to let people buy a more expensive home than they can truly afford, all it will take is the passage of time to trigger a default. At some point, all these loans are adjusted to switch from a low, subsidized monthly payment to the full amount required to pay off the loan.

Hmmm ... lenders making "loans geared to let people buy" more than they can afford? Like the example in the NY Times, with payments of $2600 per month and an income of $2000 per month? I'm still trying to do the math. How was that supposed to work?