Subprime

How to Ruin a Good Announcement

Ellen Seidman — Wed, 12 Nov 2008 16:51:00 -0500

The announcement yesterday of new procedures for streamlined modifications of primarily prime mortgage loans in trouble was a perfect example of a good (albeit overdue) program being drowned by a really inept rollout.

Briefly, Fannie Mae, Freddie Mac, their conservator the Federal Housing Finance Agency, the Hope Now Alliance and a group of large banks announced standard procedures to do quick modifications-involving primarily an appraisal and verification of income-of seriously delinquent loans in either Fannie or Freddie MBS, or in the portfolios of either the GSEs or the banks. There are clear limits on what is involved. The big one is these are largely prime loans, and loans for which the servicer has relatively undivided loyalties. They are not the privately-securitized sub-prime and Alt-A loans that have caused the bulk of the problem to date, especially in lower income communities. That's a big limitation, but the fact is that the prime foreclosure rate is increasing steadily. And as of June 2008, there were about 373,000 Fannie and Freddie owned or guaranteed loans (many of them prime) that were seriously delinquent, and the number was climbing fast. That's Fannie and Freddie alone, not counting loans held in bank portfolios.

A second limit is that the borrower must be 90 days delinquent for the procedure to come into play, thus not helping borrowers who know they're about to get into trouble and want to proactively solve their problem before their credit is shot. Finally, the program doesn't really deal with the situation in which there are second and further junior liens on the property. A 38% housing-debt-to-income ratio may work if that loan is the only housing debt; it will strain any budget where there are additional liens.

The rollout was marred (that's being kind) by the Treasury trying to sell this for far more than it is, intimating that it is a substitute for aggressive action on a broader range of loans, including sub-prime and Alt-A loans and loans not yet seriously delinquent, such as the guarantee program that FDIC Chairman Sheila Bair has been pressing the Treasury to implement. The fact that the Chairman Bair wasn't around for the announcement and the Treasury spokesmen literally ran out of the briefing room to avoid answering questions didn't exactly help the picture.

Nevertheless, there is substantial value in what was announced. First, it may well break a log-jam with respect to Fannie Mae MBS in particular. Lenders have been complaining for some time that Fannie has been reluctant to participate in modifications in any meaningful way. Second, the program applies to all loans in Fannie or Freddie MBS, no matter who owns the MBS. This is a critically important point that the announcement essentially buried. Third, any deferred principal will not earn any interest. While the borrower will still ultimately be on the hook for it, the lender will lose all benefit of that part of the loan being outstanding. In some ways, this isn't really very different than the Hope for Homeowners combination of a big guarantee fee and a requirement that any equity gain be shared between homeowner and the party funding the loan (in that case in effect the government). Finally, if both the GSEs and the banks keep and make public careful records of what happens with these loans, and the program is successful (with limited re-defaults), those who want to apply similar broad standards to securitized loans will have a good case that doing so is in the investors' interest as well as the borrowers' and the country's.

On a related note, all the programs so far have carefully concentrated on owner-occupied primary residences. What that is understandable as a moral matter, especially in the face of substantial evidence of investor fraud in the single family market, it ignores two critical facts. First, each additional foreclosure, no matter who the owner, furthers the downward spiral of house prices, affecting everyone nearby. This is especially a problem in communities where there are a large number of foreclosures. Second, where the investor has rented the property out (common, of course, for 2-4 unit homes), a foreclosure puts the tenants on the street, even if they have been faithfully paying their rent. To some extent this is a matter of changing local laws and lender practices, but if we thought somewhat more broadly about the role played by good owners of small-scale rental housing, which is usually unsubsidized and affordable, we might be able to avoid the trauma in the first place.

*Update*: On Thursday, November 13, as FHFA James Lockhart discussed these and other topics relating to the conservatorship. He was joined by Barry Zigas of the Consumer Federation of America and Gregory Baer of Bank of America. Listen to or view the event.

Stop Calling it the Subprime Crisis!

Reid Cramer — Thu, 18 Sep 2008 14:27:00 -0400

I think it is pretty safe to say that we can stop calling it the subprime mortgage crisis. I went to an event at the Hudson Institute this week with this title. Robert Edelstein from UC Berkeley had a good presentation which provided an informative review of the issues but the dramatic events of this week were making understanding the crumbling system more of an historic exercise. Many of the actors in the play were already being played by understudies and the script was being rewritten on the fly.

Sure, the earliest indicators of pervasive financial distress began when the performance of subprime loans started to sour last year. But I think it is safe to say now that the financial turmoil which is unfolding in real time extends well beyond the subprime mortgage market. It never really made sense to begin with anyway since the fall of home prices from their precipitous heights was hardly unexpected, especially in the areas where the run-up had been so steep. Increasing default rates should have been predicted as a nature course of events when the housing bubble eventually popped. This sound has been heard of before. It is a dynamic that has been studied and observed. Yes, gravity is just a theory but we still know that the apple will eventually fall.

However, I have no problem with calling what we are experiencing a mess. I just think it is a bit unfair to lay the blame at the feet of subprime borrows. Even the unscrupulous purveyors of subprime products should not be entirely blamed. In theory, risk-based pricing has the ability to get people into good loans and good homes than they otherwise would be able to do, but all too often it lead to getting people into good homes and bad loans, that they either did not need to be in or could not afford to stay in. Certianly many subprime lenders had a business model that was offensive. And yet regulations were lack, the risks they faced were low, few people were paying attention, and they were told there was nothing wrong with the profit motive.

Unfortunately, despite our need to find resolution in assigning blame, I believe there have been too many culprits at work. Clearly a role was played by the lenders, the banks, the formerly Government Sponsored Enterprises of Fannie and Freddie, the accountants, the insurers, and just about all of the major players in the global financial system. Perhaps we will look back in hindsight and marvel that our national system for financing homeownership became one of the foundations for conducting global finance. The drive to create financial products such as mortgage-backed securities that could be sliced, diced, and sold got away too far ahead of the ability to estimate and understand their underlying value, risk, and ultimately price.

As we watch the financial unraveling, the complexity of the arrangements is maddening. Steven Pearlstein makes a useful attempt to explain the current state of things in today's Washington Post. He calls it a category 4 financial storm. It seems to me, though, that most of the experts are just as confounded as those of us reading the new stories. What I do know is that the roots of the problems were structural. They emanated from the policy choices we made to govern financial markets. These choices should be revisited structurally as questions of governance and government (our U.S. federal government) will have to establish the new rules for the market which provide protection and security for consumers, small investors, and big investors alike. The era of small government and deregulation is over.

Regulating Fannie and Freddie

Sam Sherraden — Wed, 10 Sep 2008 13:56:00 -0400

What I said is that they were adequately capitalized. And they were adequately capitalized according to the law on June 30th.
-James Lockhart, Federal Housing Finance Agency Director (September 8, 2008)

This was not the case according to Morgan Stanley, which was pulled in by Treasury Secretary Hank Paulson to analyze the health of Fannie and Freddie in early August.

After the Fannie and Freddie bailout, many law makers will try to create independent oversight over these large Government Sponsored Enterprises (GSEs). But Morgan Stanley reported that a bailout would cost upwards of $50bn, while William Poole estimated it may be as high as $300bn. Furthermore, the bailout will not turn around falling house prices, which are more the result of a massive price correction and not of the price of mortgages.

Given that the tax payer will ultimately foot this bill--and the liklihood that home prices, which represent a significant portion of Americans' savings--will continue to fall, removing Fannie and Freddie from the fray of politics will be extremely difficult.

Snapshot asks, given the large financial drain of Fannie and Freddie, will the government be able to create a body with independent oversight?

Ashraf Laidi - GSE Bailout Good for Confidence Not for Fundamentals
BNP Paribas - Market Implications of Conservatorship - Initial Thoughts
James Lockhart - Nightly Business Report
Henry M. Paulson - Statement Sept 7, 2008
New York Times - New Agency Proposed to Oversee Freddie Mac and Fannie Mae

Banks Propose Higher Credit Market Standards

Ian McAllister — Thu, 07 Aug 2008 16:11:00 -0400

Senior executives from the world's largest investment banks recently released a report suggesting new regulations of global credit markets. On Wall Street, there is a widespread loss of faith that the financial system can adequately assess and price risk. The report proposes stringent standards within banks for reporting the value of complex securities on balance sheets and recommends the creation of a market clearinghouse to allow quick exchange and valuation of such investments.

Snapshot asks, are these regulations cosmetic and an attempt to fend of heavy government regulation?

Financial Times - US banks urge sweeping credit market reform
Counterparty Risk Management Policy Group - Official Report

Japanese Banks back on the World Stage

Ian McAllister — Tue, 01 Jul 2008 16:59:00 -0400

On Wednesday, Sumitomo Mitsui Banking Corporation pledged to invest $945 million in a plan by Barclay's to raise almost $9 billion in fresh capital. This follows a $1.2 billion investment Mizuho Financial Group made in Merrill Lynch in January.

In contrast to most developed world banks, which have been relegated to life-support by immense subprime losses, Japanese banks emerged almost unscathed by subprime debt. Along with various sovereign wealth funds, Japanese banks appear poised to become major investors in distressed Western financial institutions.

Snapshot asks, will Japanese investment be seen as less threatening than investment from the Gulf and China?

Sky News - Barclays Outlines £4.5bn Cash Injection
The Economist - Japanese banks: On the prowl again
AFP - Moody's upgrades Japan's debt rating
Mondo Visione - Japan's FSA Publishes English Translations of the Banking Act

The Color of Credit Turns Grey

Reid Cramer — Mon, 23 Jun 2008 15:07:00 -0400

A curious piece ran today on the Washington Post's opinion page.

President of the Southern Christian Leadership Conference Charles Steele Jr. wrote an article called the "The Color of Credit" which noted the racial disaprity of wealth in America. Good, that's a fact that needs some more attention. It highlights the history of housing discrimination, policy efforts to address it, and the rise in minority homeownership rates since the mid-90s. Fine, that's a story worth knowing. It then discusses how recent declines in the housing and mortgages market will erode these gains. Great, that's an essential perspective to have right now, especially as we think about crafting future policy interventions. It takes issue with proposed restrictions on credit providers that would cap their fees. Wait a minute, what's going on here?

Steele calls out a specific piece of legislation, something called the Credit Cardholders' Bill of Rights Act and even gives the bill number (HR 5244). It is being sponsored by Representative Carol Maloney (D-NY) who claims it will stop abusive practives by the credit card lending industry. He claims that passing this will force some subprime credit providers out of the market. For him, that's a bad thing. For me, I'm not is sure.

According to the good folks at Credit Slips, a blog run by respectable academic types interested in credit and bankruptcy issues, this bill takes aim at some of the most troubling and odious practices of the card industry. They provide a pretty good summary of the bill and its constructive provisions. Seems like the providers it will force out are ones we want out. Could it be that Steel has been unduly influenced by his partnership with credit card issuer CompuCredit? They announced a "partnership for economic security" last summer.

But this summer, just two weeks ago in fact, CompuCredit was accused by the feds (FDIC and Federal Trade Commission) of deceptive practices that trapped their customers into debt. It is one of the largest actions of its kind apparently and they are asking for $217 million in restitution and fines.

So, yes, I agree with Steele that access to credit is an important element of wealth creation and disparities should be considered as civil rights issues. But no, economic justice is not served by letting this industry police itself. Federal regulatory efforts can be troubling but it seems like Representative Maloney and her co-sponsors are heading in the right direction.

Bad Times for Bankers

Sam Sherraden — Mon, 02 Jun 2008 21:45:00 -0400

Three of the largest U.S. investment banks, Morgan Stanley, Merrill Lynch, and Goldman Sachs, had their credit ratings lowered by S&P on the concern that further writedowns lay ahead. Since the beginning of 2007, banks worldwide have written down some $387 billion and raised over $270 billion in new capital. Commercial banks also had a turbulent day with Wachovia's Chief Executive Ken Thompson ousted and Washington Mutual's Kerry Killinger stepping down from his position as chairman (he will retain his position as the CEO).

Snapshot asks, do you agree with the ratings agencies that financial institutions will face further trouble in 2008? Will it be less, more, or equal to trouble they faced in the past few months?

BNP Paribas - Financial Crisis: Banks in the Midstream
Bloomberg - Morgan Stanley, Merrill, Lehman Ratings Cut by S&P
Fitch Ratings - Securities Firms: 1Q08 Peer Data
Fitch Ratings - Subprime Mortgage‐Related Losses

Prices Fall and Sales Rise, Light at the End of the Tunnel for Housing?

Ian McAllister — Wed, 28 May 2008 16:06:00 -0400

Housing prices continued their downward slide in April with a monthly decrease of 2.2%, a decline of 14.4% from last year's levels. In an unexpected twist, monthly home sales actually rose by 3.3%. Some optimists see this as an indication that the market is nearing its bottom and beginning to work its way through a massive glut of unsold homes as sellers cut their overvalued asking prices and buyers open their wallets to bargains. Others point to worsening consumer confidence and tighter lending requirements as evidence that April's sales figures were a statistical blip in a market that has much further to fall.

Snapshot asks, to what degree will further credit turmoil stop buyers from clearing the housing market?

Wall Street Journal - Home Sales Rise in Hard-Hit Areas
Bloomberg.com - U.S. Home-Price Index Fell 14.4% in March
Washington Post - Existing Home Sales Rise as Prices Plummet
New York Times - Home sales post unexpected April increase
Yahoo News - Home sales unexpectedly rise in April

The FDIC Does It Again

Ellen Seidman — Wed, 07 May 2008 21:28:00 -0400

FDIC Chairman Sheila Bair has struck again-with yet another creative response to the ongoing mortgage crisis. Chairman Bair has a history of being ahead of just about everyone else in Washington with proposals to respond to the crisis in a manner that is doable and fair. This time it's the Home Ownership Preservation or HOP loan, and the FDIC estimates about one million loans-make that one million homeowners in trouble-might be eligible.

Any mortgage loan taken out between January 1, 2003 and June 30, 2007 by an owner-occupant at a level below the FHA conforming loan limit that was unaffordable at origination would be eligible. What does "unaffordable at origination" mean? According to the FDIC website, it means that when the borrower took out the loan, his or her total housing payment-for principal and interest on the loan, taxes and insurance-exceeded 40% of income. And, according to an FDIC conference call May 7, that does not mean that the amount the borrower actually paid at origination exceeds 40%; it means that the amount the borrower would have paid had escrows for taxes and insurance been included and had the initial payment been for both principal and interest, at the fully-indexed rate, not the teaser rate. This makes the proposal far more powerful than it appears at first glance.

The way HOP would work is that a servicer would apply to Treasury for a loan to the borrower that would pay down 20% of the current mortgage. In exchange, the servicer would agree to modify its loan into a fully-amortizing fixed rate mortgage for the balance of the mortgage term, with interest set so that the borrower's monthly mortgage payment, including taxes and insurance, would not exceed 35% of the borrower's verified current income. Interest on the modified loan could be no higher than Freddie Mac's published rate for 30-year fixed rate mortgages, and if that interest rate were not low enough to get down to 35% of income, the lender would have to set a lower rate. And no negative amortization, prepayment penalties or deferred interest would be allowed.

The lender would pay the Treasury the first five years of interest on the Treasury loan up front, and would also subordinate its interest to the Treasury's. Thus, if the borrower defaulted or the property was transferred, the Treasury would get paid first-giving the lender a real incentive to make the loan work. The borrower would not pay anything on the Treasury loan for the first five years, and then would pay off the entire principal (with interest at Treasury's rate) during the remaining 25 years of the larger mortgage.

In addition to creating affordable mortgages the appeal of the HOP program lies in three primary characteristics:

It leaves the mortgages in their existing pools, and, according to the FDIC, requires alterations that are totally consistent with current Pooling and Servicing Agreements (PSAs)
It does not affect the interest of subordinate lien-holders, which means they can't hold up the process of modification
The amount of and interest rate on the modified mortgage are not dependent on appraisal of the property, but rather only on the borrower's verified current income

Like all proposals that attempt to deal with this difficult situation, HOP has its flaws:

Eligibility is dependent on information that lenders should have in their files, but may well not, at least not accurately, as we know that at origination of many loans now in trouble there was either no verification of income, and/or the amount "verified" was incorrect
To retain consistency with the PSAs, this proposal, like many before it, requires the servicer, not the borrower or someone acting on the borrower's behalf, to initiate the process; so far, servicers have been slow on the draw, to put it mildly
The Treasury loan could, in some circumstances, generate an unaffordable "payment shock" in the fifth year when the borrower needs to start paying it down; the FDIC's own examples would take the borrower up to a 40% debt to income ratio, even assuming that the borrower's income grew 1.5% annually

But HOP is a creative, constructive addition to the dialog. Maybe its largest flaw is one that Chairman Bair desperately wanted to avoid: it requires legislation. Let's hope it gets serious consideration by Congress and a fair hearing by the White House.

Is London Loosing its Edge?

Ian McAllister — Wed, 07 May 2008 18:35:00 -0400

A proposal by Gordon Brown's government to up the taxes paid by resident foreigners and demand greater transparency in their offshore dealings has many fearing an exodus of London's international financiers. This comes at a time when increasing numbers of businesses in London are also moving their headquarters to countries with lower taxes. Layoffs by banks in the wake of the subprime crisis are further damaging the City's reputation as a vibrant financial center. A loss of foreign residents and international business would be devastating for a city that has emerged as New York's greatest rival for global preeminence.

Snapshot asks, could New York reclaim the top spot if London falls?

The Times - Nondom Raid will Lead to Capital Exodus
Financial Times - Big Companies Consider Domicile Status
International Herald Tribune - Job Losses Feared in British Financial Sector
Financial Times - City Job Vacancies Down by a Quarter
Bank for International Settlements -Intl. Financial Centers: A Network Perspective