by Calculated Risk on 9/13/2007 12:51:00 PM

From the WSJ: ‘60 Minutes’: Greenspan Praises Bernanke

Greenspan says he knew about the questionable subprime lending tactics that gave loans to homebuyers and investors with low adjustable interest rates that could rise precipitously, but not the severe economic consequences they posed. “While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late,” he tells Stahl. “I really didn’t get it until very late in 2005 and 2006.”

And from October 2006:

Former Federal Reserve Chairman Alan Greenspan said the "worst may well be over" for the U.S. housing industry that's suffering its worst downturn in more than a decade.

I hate to pick on Greenspan (too easy of a target), but it was his job to know about the loose lending practices. And no matter how he tries to rewrite history, Greenspan didn't "get it" even in October of 2006.

by Anonymous on 9/13/2007 12:45:00 PM

Regular commenter bacon dreamz sent me the following artistic production--undoubtedly produced with his employer's equipment on his employer's time--which I hasten to share with you all.

This will either fix those of you who complain that my posts are too text-heavy, or it will not.

by Anonymous on 9/13/2007 09:17:00 AM

A lot of this we've already seen in various news reports, but since it always comes up for discussion, I thought it might be helpful to look at the various moving parts of CFC's operational changes:

Addressing liquidity and funding needs by accelerating our plans to migrate the funding of our mortgage originations to Countrywide Bank, and our borrowing of $11.5 billion under our lines of credit. Additionally, the Company recently arranged for $12 billion in additional secured borrowing capacity through new or existing credit facilities

I did an UberNerd post the other day on "origination channels," one purpose of which was to explain the difference between a mortgage banker and a bank. What CFC is doing is (attempting to) transform itself from primarily a mortgage banker (with a small bank) to a big bank. Instead of borrowing money to make mortages with in the capital markets, and selling them immediately, as a mortgage banker does, CFC is "migrating" to depository banking, using deposits and the kind of borrowing that is available to banks (interbank loans, for instance) to fund mortgages.

Materially tightening product and underwriting guidelines such that all loans the Company now originates are eligible for Fannie Mae, Freddie Mac or Ginnie Mae securitization programs, or otherwise meet Countrywide Bank's investment criteria.

This is more of the implications of moving from mortgage banking to banking: CFC will still sell loans, but only to the GSEs/Government-insured market. The "nonagency" loans will have to be "portfolio" quality (even if they do not always remain in the investment portfolio). What this excludes is, precisely, the kind of loans that you would be willing to sell but not to hold, or a big chunk of what got made in the last 5 years or so under the private-issue Alt-A/subprime rubric. That's one of the costs of being a bank. Of course, since the bottom fell out of the Alt-A/subprime market, it's not much of a "cost" today. Except that:

Taking advantage of reduced primary market competition to adjust pricing, which is expected to have a favorable impact on mortgage banking gain-on-sale margins and result in greater returns on the high-quality loans originated for our Bank's investment portfolio.

Profit margins for good old-fashioned GSE swap/portfolio hold depositories have never been quite as rich as the profit margins for high-rollin' Alt/Subprime mortgage bankers. What you are being told here is that CFC plans on being "the last man standing," and therefore to use the "pricing power" this provides to be a bank that makes money like a mortgage banker. However, that still requires something like a bank's expense load:

Announcing plans to reduce expenses in response to lower expectations for mortgage origination market volume. These plans include workforce reductions of up to 20 percent.

So. Welcome to Main Street, Countrywide. Lay off the high-flying sales force, hire tellers to take deposits, make Your Dad's Mortgage Loans, and start calculating your gain on sale and net interest margin in nickels and dimes. Just like the old fogie bankers on Elm and Maple you've been stomping all over for years. Hope it works for you. Can I get a free calendar?

by Anonymous on 9/13/2007 08:20:00 AM

The NYT has an article on prepayment penalties this morning, that almost but not quite arrives at the core issue:

The lenders say the trade-off is the only way to offer low monthly payments initially because otherwise borrowers would flee when rates adjust upward and make the loan a losing deal. The fees usually equal several months’ interest, and they decline over a few years before disappearing altogether.

The "traditional" prepayment penalty is, indeed, a way of putting an "exercise price" on the "imbedded call" in a mortgage loan. A mortgage borrower always has the right to prepay the loan (in options lingo, that's a "call"). Without a prepayment penalty, the price of that call is always par: you may refinance at any time by paying the lender just the principal due (and any accrued interest to the payoff date).

A prepayment penalty, in essence, forces you to "buy" your loan from the original lender at an above-par price. Looking at it in terms of yield, which is more a more everyday way of going at it, the prepayment penalty collects the interest that the lender gave up by making the loan at an originally discounted interest rate. If you "survive" the prepayment penalty period, the discount is in your pocket; if you don't, the lender is "reimbursed" for the discount out of the penalty interest. You give up mobility in return for lower interest costs. Is the theory.

In an environment of "traditional" underwriting in which people actually qualify for the loans they get, prepayment penalties can certainly be construed as "fair" (assuming they're fully disclosed and the penalty is no more than the value of the initial discount). The problem we have here is that the "discount" is a teaser: it crosses the line from "initial rate break" to "hook," as qualifying on the teaser rate is the only way the borrower can get the loan. Then it becomes just "back-loaded" interest payments, because these loans are structured to either force the borrower to refinance (and pay the penalty) to avoid the way above market reset, or to pay the way above market reset, which quickly "erases" the initial discount. That's some "call option."

The Nontraditional Mortgage Guidance, insofar as it put paid to qualifying borrowers at anything other than the fully-indexed, fully-amortizing loan payment, has already indirectly cut out most toxic prepayment penalties, since it takes away the incentive to artificially discount the start rate of the loan. Indeed, the 2/28 expired as a product not all that long after widespread adoption of the Guidance. From a certain perspective, this does, exactly, mean what all the industry lobbyists so plaintively warned us it would mean: the cost of mortgage credit went up in response to regulatory action.

But it is always worthwhile to look at it from another perspective, which is that the cost of mortgage credit just got smoothed out, not increased: borrowers are now paying their interest load from the beginning, at a tolerable level, rather than paying it "at the back of the loan" in a way that breaks the borrower's back. Insofar as it is still "unaffordable" to get a mortgage loan, we can return to the subject of insane home prices and lagging incomes.

We close, as does the Times article, with words of wisdom from a mortgage broker:

That is what happened to Dorinda Weisman, a social worker in Elk Grove, Calif. In 2005 she borrowed $353,000 from Pacific American Mortgage to buy a home in Sacramento with a small down payment. The prepayment penalty, of $9,000, expired in just a year.

“One of the things I always wanted was to own a house,” Ms. Weisman said in a telephone interview. “I was a single parent, and my son is a hemophiliac. I had been living in a middle-class African-American neighborhood that went downhill after the drugs came in.”

By the time the penalty expired, her house had declined in value. Refinancing was no longer possible.

Her interest rate had shot up to 9.8 percent from 4.75 percent. She says about 85 percent of what she brings home — her salary is $60,000 as a social service consultant with the state government — now goes to the mortgage.

She is trying to negotiate a new loan with the help of the Neighborhood Assistance Corporation of America, a nonprofit home ownership organization based in Jamaica Plain, Mass.

“Like a lot of people, the adjustable ate up her equity,“ said her mortgage broker, Antonio Cook of Toneco Financial. “She’s got to ride it out and sacrifice. I tell people, ‘I don’t care if you eat bologna sandwiches, just pay your bills on time.’ If she can ride it out, things start coming up good.”

by Calculated Risk on 9/13/2007 03:04:00 AM

From Bloomberg: First Data Loans Delayed as KKR, Banks Keep Talking, People Say

Kohlberg Kravis Roberts & Co. may delay the sale of loans to fund its $26 billion buyout of First Data Corp. until at least next week after failing to agree on terms with its bankers ...

KKR ... and banks led by Credit Suisse Group couldn't agree today on pricing or how much of the debt lenders will try to sell ...

Demand for LBO debt has evaporated. After buying a record $754 billion of leveraged loans this year, investors are balking at debt without covenants, or restrictions, that give them greater power over a company's finances.