Thursday, January 31, 2008

Borrowers still largely unaware of workout options

(Housing Wire) Freddie Mac said Thursday morning that 57 percent of the nation’s late-paying borrowers still don’t know their lenders may offer alternatives to help them avoid foreclosure. The results, reported in a joint survey from Roper Public Affairs and Media and Freddie Mac, show that despite a historic surge borrower defaults and a resulting crush of press attention, many borrowers aren’t sure how to resolve financial difficulties involving their mortgage.

A previous study in 2005 found that 61 percent of delinquent borrowers didn’t know their lender offered workout options, equating to an improvement in awareness of 4 percent give or take a margin of error in three years.

The news wasn’t all bad, however; the survey also found an increase in the percentages of delinquent borrowers who recall their lenders reaching out to them (86 percent) and who in turn reached out to their lender (75 percent) to discuss workout options. And borrowers are becoming more aware of third-party counseling, with awareness increasing from 36 percent in 2005 to 44 percent today.

“This new survey shows efforts to get borrowers to call counselors are starting to work, but that too many at-risk borrowers are still unaware their servicers routinely provide alternatives that can help them stay in their homes,” said Ingrid Beckles, Freddie Mac’s vice president of servicing and asset management.

“This fact underscores the importance of convincing borrowers to pick up the phone, call their servicer, and find out whether they can avoid foreclosure.”

So why is it that some borrowers still won’t contact their servicers?
Freddie Mac said that one in four deliquent borrowers chose not to accept an invitation to discuss workout options, for one thing. (Fraud, anyone?) Those that didn’t return a servicer’s call because they said they didn’t have enough money to make a payment rose from 7 percent to 16 percent, and the percentage who denied they were having trouble making their payment doubled from six to 12 percent.

HOPE hotline having a positive impact
The survey found that collective awareness of the HOPE hotline at 888-995-HOPE has increased dramatically, signaling that at least some borrower outreach programs are having an impact.

According to the survey, nearly one in four delinquent borrowers (23 percent) report seeing the ads and one in ten (9 percent) who are aware of the HOPE Hotline have made the call. HPF says the toll-free number now receives between 1500 and 3000 calls per day, up from 250 per day one year ago. More than 200,000 homeowners have called the hotline since June 25 of last year, according to HPF.

“The public service campaign is working,” said Ken Wade, CEO of NeighborWorks America.
“Every day, through our partnership with the Homeownership Preservation Foundation, we’re helping thousands of homeowners in financial stress take steps to prevent foreclosure with the 888-995-HOPE hotline. Moreover, those homeowners who call and need additional counseling are being referred to local NeighborWorks organizations for one-on-one, face-to-face foreclosure prevention counseling.”

Click here to read the full survey results.

Cuomo using Martin Act to pursue subprime securities fraud

(Naked Capitalism) We had been wondering when subprime-related securities litigation would get going in earnest. New York attorney general, Andrew Cuomo, along with Connecticut attorney general Richard Blumenthal, has been investigating whether underwriters failed to disclose relevant information to investors in subprime deals.

The latest development, according to the Wall Street Journal, is that Cuomo has issued Martin Act subpoenas to Bear Stearns, Deutsche Bank, Morgan Stanley, Lehman, and Merrill. Predecessor Eliot Spitzer demonstrated that New York State's Martin Act is a potent weapon, since the plaintiff does not need to prove intent to defraud, merely that a fraud resulted. Put more simply, incompetence or negligence can be sufficient grounds for a successful case.

If these investigations result in lawsuits, the evidence presented in court would be a boon to individuals and funds who wanted to take action. However, Spitzer's playbook was to threaten criminal prosecution. Since no firm was willing to suffer indictment, they agreed on settlements. If Cuomo goes the civil prosecution route, we may see trials which would be of considerable assistance to other plaintiffs.

From the Wall Street Journal:
The New York attorney general's office, pursuing an investigation into whether Wall Street firms improperly packaged and sold mortgage securities, is latching onto a powerful regulatory tool: the 1921 Martin Act.

The state law, considered one of the most potent legal tools in the nation, spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud. As a result, the act has become an influential hammer in recent years for New York state prosecutors in cracking down on securities manipulation, improper allocation of initial public offerings of stock and misleading stock research on Wall Street....

The development comes as the attorney general's office has gained the cooperation of Clayton Holdings Inc., a company that provides due diligence on pools of mortgages for Wall Street firms. At issue is whether the Wall Street firms failed to disclose adequately the warnings they received from Clayton and other due-diligence providers about "exceptions," or mortgages that didn't meet minimum lending standards.

Such disclosures could have prompted credit-ratings firms to judge certain mortgage-backed securities as riskier investments, making them more difficult to sell, these people said. The attorney general is examining, among other things, whether some Wall Street firms concealed information about the exceptions from the credit-rating concerns, these people said, in a bid to bolster ratings of mortgage securities and make them more attractive to buyers, such as pension funds, which often required AAA, or investment grade, ratings on potential investments in securities containing risky mortgages.

The attorney general's office has issued Martin Act subpoenas, which don't spell out whether matters are civil or criminal in nature, according to people familiar with the matter. So far, the recipients include financial firms Bear Stearns Cos., Deutsche Bank AG, Morgan Stanley, Merrill Lynch & Co., and Lehman Brothers Holdings Inc., possibly among others. Representatives of Bear, Deutsche, Morgan, and Lehman declined to comment on the investigation. A Merrill spokesman said, "We cooperate with regulators when they ask us to," but declined to elaborate....

With data provided by Clayton, Mr. Cuomo's office is seeking to gather more information on how Wall Street firms purchased home loans that had been singled out as "exception loans" -- that is, loans that didn't meet the originator's lending standards. Data from Clayton, for instance, indicates that in 2005 and 2006, years in which the mortgage-securitization business was going full throttle, some investment banks acting as underwriters were purchasing large numbers of loans that had been flagged as having exceptions, these people said.

In 2006, according to the data, as much as 30% of the pool of exception loans was purchased by some securities firms, these people said. One likely reason: Flawed loans could be purchased more cheaply than standard loans could be, lowering a firm's costs as it sought to compile enough mortgages for a new security.

Tuesday, January 29, 2008

FBI Probing 14 Companies in Subprime Lending Crisis

(Bloomberg) -- The Federal Bureau of Investigation is investigating 14 corporations for possible accounting fraud and other crimes related to the subprime lending crisis, officials said.

Neil Power, chief of the FBI's economic crimes unit, wouldn't identify the companies, though he said the cases involve ``valuation-type stuff.'' The probes include reviews of subprime lenders, housing developers and Wall Street firms that package loans as securities, he said.

``We're looking at the accounting fraud that goes through the securitization of these loans,'' Power said at a briefing with reporters in Washington today. ``We're dealing with the people who securitize them and then the people who hold them, such as the investment banks.''

The probes add to federal and state scrutiny of the home- loan industry as prosecutors and regulators seek to assign culpability for the mortgage rout that has forced people from their homes and resulted in losses to investors. The biggest banks and securities firms have posted at least $133 billion in credit losses and write downs related to the loans, which are typically made to buyers with the weakest credit.

Separately today, Goldman Sachs Group Inc., Morgan Stanley and Bear Stearns Cos. said in corporate filings that they are complying with regulatory requests concerning investment products linked to home loans. The companies didn't specify which agencies asked for the information.

Civil Cases

The Securities and Exchange Commission, which brings civil cases, has about three dozen inquiries open, the agency's deputy enforcement director said earlier this month.

The FBI works ``hand-in-hand'' with the SEC, Power said today.

On subprime lenders, Power said the bureau has been ``looking over their books and of course there are some irregularities there that we're looking into.''

Power said another area of criminal inquiry is insider trading -- whether executives sold shares when they knew loan defaults were going to surge.

The FBI also investigates other mortgage-fraud crimes, most centering on individuals such as brokers, appraisers, realtors, developers or straw buyers who illegally obtain loans.

The bureau has 1,210 pending mortgage-fraud cases, officials said.

House to limit FHA expansion to 1 year

(AP) - Under pressure from the Bush administration, House lawmakers have scaled back a piece of an economic stimulus package designed to boost the ailing housing market, an aide said Tuesday.

A deal reached last week between House Speaker Nancy Pelosi and Republican Leader John Boehner of Ohio -- and endorsed by the White House -- raises the limit on Federal Housing Administration loans from $362,790 to as high as $729,750 in expensive areas, allowing more borrowers with weak credit to refinance into federally insured loans.

Democrats believed that the Bush administration was amenable to making that limit permanent. But the Treasury Department insisted over the weekend on making the new FHA limits expire by year-end, Steve Adamske, spokesman for Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said Tuesday.

The administration also swayed House lawmakers to narrow the legislation so that it focused on hiking the loan limits, rather than establishing a broader overhaul of the agency, which was created during the Great Depression to aid cash-strapped borrowers.

'We're baffled by this,' Adamske said, noting that the Bush administration has been advocating similar legisltion for months. 'When push came to shove, they didn't want to pass it as soon as it was possible.'

Jennifer Zuccarelli, a Treasury Department spokeswoman, said in an e-mail message that legislation overhauling the FHA and government sponsored mortgage companies Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) 'should be completed as soon as possible on a separate track from the stimulus package.'

FHA, a government agency that has insured mortgages for risky borrowers 1934, has for more than two years been pushing Congress for the ability serve more borrowers.

The stimulus bill to be considered by the House also boosts the cap on loans that Fannie Mae and Freddie Mac can buy, from $417,000 up to $729,750 in high-cost markets until year-end.

Sen. Charles Schumer, D-N.Y, said Tuesday that he plans to ensure that provision is in a stimulus bill that Senate leaders aim to pass by week's end.

'This measure goes to the bulls-eye of the economic slowdown, which is the housing crisis,' Schumer said in a statement.

"Is foreclosure right for you?"

(Housing Wire) There has been plenty of attention given lately to the idea of the so-called “ruthless default” — hat tip goes to Tanta at Calculated Risk here — which says that borrowers are becoming increasingly more likely to simply walk away from their mortgages, even if they may have the ability to pay or otherwise have other workout options available to them.

Call it jingle mail. Call it the mortgage put option. Call it what you will, but mortgage lenders are becoming increasingly concerned over bad borrower behavior. Countrywide, for example, said in a recent letter that went with new “soft market” policies that “mortgage professionals must strive to ensure that borrowers do not take on loans that they do not have the ability or economic interest to repay.”

It’s the “economic interest to repay” that’s now got the industry’s attention. And for good reason.

Consider the case of You Walk Away LLC –a counseling agency (I’m using that term very loosely here), dedicated to helping (I’m using that term loosely here, too) borrowers walk away from their mortgage debt obligations. From the company’s Web site:

Is Foreclosure Right For You?

Ask Yourself …

Are you stressed out about your mortgage payments?
Do you have little or no equity in your home?
Have you had trouble selling your house?
Is your home sinking under the waves of the real estate crash?
What if you could live payment free for up to 8 months or more and walk away without owing a penny?

I don’t even know where to start with this one. There’s the inanity of paying this company $995 dollars for a “walk away plan,” for one — a “kit” that instructs borrowers on how to game the foreclosure process. There’s also the thought that this “counseling agency” has no interest in helped borrowers — whether troubled or not — understand their options, but to help borrowers drive increasingly greater losses for lenders, while ruining their credit in the process.

The company says it’s helping “homeowners who purchased their homes at the peak of the real estate market to take control of their financial future.”

A sign of the times, indeed.

Option theory and mortgage pricing

(Calculated Risk) One of the hot topics of conversation lately is the idea of a mortgage “put option.” There seem to be more than a few people—including those who don’t exactly use the language of options contracts, like that weird couple featured recently on 60 Minutes—who are slightly confused about what the “optionality” of a mortgage contract is. There are also lots of folks who are wondering what will happen to mortgage pricing in general should a substantial number of folks decide to “exercise the put” on their mortgages. It seems wise to me to try to tease out what’s going on here.

First, mortgage contracts in the U.S. are not, actually, options contracts. You may peruse your note and mortgage at length now, if you didn’t do so when you signed them, and you will not find any “put” or “call” in there. Your note is a promise to pay money you have borrowed, and your mortgage or deed of trust is a pledge of real estate you own (or are buying with the borrowed money) as security for that note. That means, in short, that if you fail to keep your promise to pay the loan in cash, the lender can force you to sell your property at auction (to produce cash with which to pay the loan in full). Because the mortgage instrument gives your lender a “lien,” any sales proceeds are first applied to the mortgage debt before you get any of it.

People get very confused about this because it is often the lender who ends up buying the property at the forced auction. When that happens, it is basically because the lender simply wants to put a “floor” bid in the auction: the lender bids an amount based on what it is willing to lose (if any). Typically, the lender bids its “make whole amount” or the loan amount plus accrued interest and expenses. If someone else bids more than that, the lender is happy to let the property go to the higher bidder.

The lender might bid less than its make-whole amount; it might bid its “probable loss” amount. If the lender is owed $300,000 and doesn’t think it could ever end up recovering more than $200,000, it might bid $200,000 at the FC auction. The lender doesn’t actually want to win the auction; lenders are not really in the business of real estate investment or property management. However, the lender would rather buy the home at the auction and pay itself back eventually by re-selling the property later (as a listed property in a private sale instead of a courthouse auction) than let the property go for $50,000 (meaning the lender would recover only $50,000 on a $300,000 loan instead of $200,000). Nothing ever stops any third party from bidding $1 more than the lender’s bid and winning the auction (except, of course, any third party’s own inclinations).

We need to remember, then, right away, when anyone talks about “giving the house back to the bank” or “mailing in the keys,” we are already in the land of metaphorical language. The only situation in which “giving the house back to the bank” would literally be possible is if you bought the house from the bank (say, it was REO) and the contract explicitly gave you an option to sell it back to the bank, whenever you wanted to, at a price equal to your loan balance. Nobody writes REO sales contracts that way. In most cases, of course, you bought the house from someone other than a bank. You have no option to “put the house back” to the seller. You win only if it's "heads."

A “put option,” in the financial world, is a contract that gives the buyer of the put the right, but not the obligation, to sell something (a commodity, a stock, a bond, etc.) in the future at a predetermined price. On the other side of the deal, the “writer” of the put is obligated to buy the thing in question if the put buyer exercises the option. Some of you may already be a bit confused about “buyer” and “seller” here, but that’s an important point. You don’t get “free puts.” You buy puts. There is a fee or a “premium” that you pay for the option contract. If you do not exercise the option, the put-writer pockets that fee. If you do exercise your option, the put-writer pockets that fee (to offset his loss on the deal) and your gains on the ultimate sale of the thing are net of the option premium.

The point of a put is that you buy them when you want to be protected from falling prices: if you think there is a good chance that the value of something will fall in the future, buying a put that allows you the option of selling it next month at this month’s price might well be worth paying that option premium. But you do always pay an option premium and you do not get it back.

The opposite of the put option is the call option: it is the option to buy something in the future at a predetermined price. You buy calls when you think the value of the thing is likely to rise. You also always pay some premium or fee for a call.

Residential real estate sales and mortgage loans do not, actually, literally, have puts and calls in them. If you buy a home today, you assume the risk that its price may fall in the future. Your contract does not include an option for you to sell the house at the price you paid for it. Nor does the seller of the house have a “call”; the seller cannot force you to sell the house back to him at the original price if its value rises.

Your mortgage loan contract does not give you the right to simply substitute the current value of the house for the current balance of the loan: you do, in fact, risk being “upside down.” (The only time this isn’t true in the U.S. is with a reverse mortgage; those are written explicitly to have this kind of a feature, where the balance due on the loan can never exceed the current market value of the property. But of course reverse mortgages aren’t purchase-money loans.) Nor does the mortgage contract give your lender the right to buy your house from you for the “price” of the loan amount when that is less than its value. Mortgage lenders never do better than paid back. If the real estate securing your loan increases in value, that appreciation belongs to you (as long as you make your loan payments).

So why is it that people keep talking about “puts” and “calls” in terms of mortgage loans? That’s because mortgage contracts have features that can affect their value to the writer of the contract (the lender or investor) in a way that is analytically comparable, in some ways, to classic options. Options theory is applied to mortgages in order to price them as investments. (Strictly speaking, this is a matter of analyzing them so that a price can be determined.) The interest rate, then, that you get on a mortgage loan will depend, in part, on how the lender/investor “priced” the implied options in the contract.

The “implied put” in a mortgage contract is the borrower’s ability to default (walk away, send jingle mail, whatever you want to call it). We do not, generally, consider “distress” (that’s actually the formal term in the literature, for you Googlers) as an “implied put.” Some borrowers will fall on hard times and be unable to fulfill their mortgage contracts. This is a matter of “credit risk” and it is, analytically, a different matter of mortgage contract valuation. The “implied put” analysis is trying to capture the possible cost to the lender/investor of what we call the “ruthless” borrower. “Ruthless” isn’t really intended to be a casual insult; it is in fact the term we use to describe borrowers who can pay their debts but choose not to, because there is a greater financial return to that borrower in defaulting as opposed to not defaulting. It is “ruthless” precisely because there is not a contractual option to do this: the only way you can exercise the “implied put” is to default on your contract.

Many many people are very confused about this. When we talk about the “social acceptability” of jingle mail, what we are talking about is at some level the extent to which there is or ought to be some rhetorical or social “fig leaf” over ruthlessness. It seems to be true, after all, that most people are more likely to behave ruthlessly if they can call it something other than ruthlessness. (There are always people who have no trouble with ruthlessness; they often get the CEO job. Most of us have at least moderately strong inhibitions about ruthless behavior.) There is, therefore, a process in which the ruthless put is re-described in various alternative terms, or has alternative narrative contexts built up around it, such that it no longer “feels” ruthless. The borrower was victimized (by the lender, the original property seller, the media, the Man). The put premium was actually paid (“they charge me so much they can afford this”). The ruthless borrower is actually the distressed borrower (redefining what one can “afford” or what is necessary expense so that a payment you can make becomes a payment you “can’t” make).

Before anyone starts in on me, let me note that these fig leaf mechanisms are effective precisely because victimization, predatory interest rates, and truly distressed household budgets do really exist. They wouldn’t be very convincing otherwise. (Very few ruthless borrowers will claim it’s because of, say, alien abduction or something equally implausible.) I am not, therefore, asserting that all claims of predation or distress are “false.” I am simply pointing out that it is, after all, a hallmark of the not-usually-ruthless person who is nonetheless acting ruthlessly to rationalize his conduct.

I don’t offer that as some startling insight into human psychology. I offer it as an attempt to get some analytic clarity. When CR talks about lenders fearing that jingle mail will become socially acceptable, he’s not exactly saying that lenders fear that society will no longer stigmatize financial failure (“distress”). They are afraid that rationalization mechanisms will become so effective that true ruthlessness (which is historically pretty rare in home mortgage lending) will become a significant additional problem (in addition to true distress). And they fear this because, delusions to the contrary, those loans did not have enough of a “put premium” priced into them to cover widespread “ruthless default.”

In fact, the very language of options theory can function, for a certain class of ruthless borrowers, as the fig leaf. To say “Hey, I’m just exercising my put” is a retroactive reinterpretation of your mortgage contract to “formalize” the “implied put” so that you do not have to describe what you’re doing as “defaulting.” This strategy is apparently popular with folks who have some modest exposure to financial markets jargon and an unwillingness to lump themselves in with the “riffraff”—victims of predators and financially failing households and other “weaklings.” (Sadly, a lot of people who have a very high degree of exposure to financial markets jargon don’t need no steenkin’ rationalization. Like most sociopaths, they don’t understand why “ruthless” would be considered insulting or what this term “social acceptability” might mean. So if you’re hearing the “put” excuse, you are probably in the presence of a relative amateur.)

The other side of the problem in valuation of mortgage loans and mortgage securities is the “implied call.” The “call-like feature” in a mortgage contract is the right to prepay. In the U.S., all mortgage contracts have the right to prepay. (Some, but not all, have a “prepayment penalty” in the early years of the loan, but “penalty” here means a prepayment fee, not an actual legal prohibition on prepayment.) The reason the right to prepay functions like an implied call is that it gives the borrower the right to “buy” the loan from the lender at “par,” even if the value of the loan is much higher than “par.” If you refinance your mortgage, you are required only to pay the unpaid principal balance (plus accrued interest to the payoff date) to the old lender in order to get the old lien released. Unless the loan specifically has a prepayment penalty, you are not required to further compensate the old lender for the loss of a profitable loan. So a loan with a prepayment penalty has an implied call and a real call exercise price. A loan without a prepayment penalty, or past the term of its prepayment penalty, has a “free call.” (In the original lender’s point of view. There is always some price to be paid to get a new refinance loan; the borrower’s calculation of the value of refinancing always has to take that into account. Among other things, this fact results in mortgage “call exercise” being much less “efficient” than it is on actual call contracts, which makes the call much more difficult to value, analytically, for mortgages.)

While ruthless default might, historically, be rare, refinancing has been ubiquitous for decades now. It wasn’t always so easily available; your grandparents might never have refinanced a loan not because their existing interest rates were never above market, but just because there weren’t lenders around offering inexpensive refinances. In fact, refinances have been so ubiquitous for so long now that many people have come to think of the availability of refinancing money as somehow guaranteed. This isn’t just a naïveté about interest rate cycles, although it is that too. It is a belief that credit standards and operating costs of lenders never change, so that if someone thought you were “creditworthy” once, they’ll automatically think of you as creditworthy again, and that lenders can always afford to refinance you without charging you upfront fees.

People who price mortgage-backed securities have always known that the prepayment behavior of mortgage loans is impacted not just by prevailing interest rates, but also by the borrower’s creditworthiness, the lenders’ risk appetites, and the cost (time and money) of the refinance transaction. We were talking the other day about the prepayment characteristics of jumbo loans in comparison to conforming loans; the fact is that people who have the largest loans are the most likely to refinance at any given reduction in interest rate, since a reduction in interest rate produces more dollars-per-month in savings on a larger loan than it does on a smaller loan. Considering these types of things is very important to people who price MBS, because in fact prepayment behavior is both hard to “price” and absolutely critical to “pricing” mortgages as an investment.

MBS, unlike other kinds of bonds, are “negatively convex.” I have been threatening to talk about convexity for a while and I keep chickening out. It’s actually useful to understand it if you want to understand why mortgage rates (and the value of servicing portfolios) behave the way they do. The trouble is that convexity involves a whole bunch of seriously geeky math and computer models and normal people probably don’t want to go there. (I don’t even want to go there.) So as a compromise, this is a very quick and simple explanation of convexity.

The convexity of mortgages is a result of the “implied options” in them. Most people understand intuitively that the higher the interest rate on a loan, the more an investor would pay for that loan: if you had the choice today of buying a bond that paid you 6.00% and one that paid you 6.50%, you would probably not offer the same price for each of them. With a classic “vanilla” bond, the price you would offer would be a matter of looking at the term to maturity, the frequency of payments, the interest rate, and some appropriate discount rate.

The trouble with mortgages is that while they have a maximum legal term to maturity, they have an unpredictable actual loan life, because they have the prepayment “calls” implied in the contracts. The return on a mortgage is uncertain, because you might get repaid early, forcing you to reinvest your funds at a lower rate. On the other hand, the loans might just stay there until legal maturity, at an interest rate that is now below the market rate on a new investment. The problem, obviously, is that borrowers refinance most often when prevailing market rates have dropped (right when the investor might want the loans to be long-lived) and don’t refinance when prevailing rates have risen (right when the investor would like to see you go away). “Vanilla” bonds don’t behave this way. Vanilla bonds, like Treasury bonds and notes, are “positively convex.” Mortgages are “negatively convex.”

Here’s a comparative convexity graph prepared by Mark Adelman of Nomura (do pursue the link if you want more detailed information about MBS valuation). This graph plots three example instruments all with a face value of $1,000 and a price of par ($1,000) at 6.00%. The vertical axis reflects the change in price of the bond. The horizontal axis reflects the change in prevailing market yields. As you move to the left of 6.00%, you see that the price of the bond increases (it has an above-market yield); as you move to the right it decreases.

However, the three instruments do not increase or decrease in price in the same way. The 30-year bond has a steeper curve than the 10-year note, which is a function of the difference in maturities of the two instruments. The MBS isn’t just not as steep; it is a different shape. The 30-year bond and the 10-year note price functions create an upward-curving slope when you plot them against price/yield changes like this, and the MBS price functions create a downward-curving slope. The term “negative convexity” means, exactly, that downward curving slope.

What’s going on here is that when market yields fall (moving to the left in the graph), average loan life in an MBS pool will shorten markedly, as borrowers are “in the money” to refinance. At a relatively modest fall in market yields, the price of the MBS does increase (but the increase is much less than the increase in the other bonds). At a larger drop in market yields, the MBS price gets as high as it will ever get and then stops increasing at all. What happens here is that the underlying mortgage loans have become so “rate sensitive” that any additional decrease in market yield (increase in the spread between the bond’s coupon of 6.00% and current market coupons) is entirely offset by shortened loan life: loans will pay off so fast at this point that this “officially” 30-year bond really returns principal to the investor the way a 1-year or even 6-month Treasury bill would. No investor is going to pay more for the MBS at this point than it would for the very shortest-term alternative.

On the other side of the graph, you see that the MBS price declines more slowly than the vanilla bonds, although its curvature at this point is very like the 10-year. At this side of the chart, average loan life is increasing. (Mortgage bonds never go to zero prepayments or actual average loan life = 30 years.)

What all this implies is that, analytically, mortgages do have some sort of “option price” built in. (There is actually a name for this, the OAS or Option Adjusted Spread, a method of comparing cash flows of a mortgage bond across multiple interest rate and prepayment scenarios. It’s heavy math and modeling.) In the case of voluntary prepayment (refinancing or selling your home, basically), your “call” option has, in fact, been priced—it’s in the interest rate/fees you pay to get a refinanceable mortgage loan. Investors accept the uncertainty of mortgage duration by (attempting to) price it in.

All that, however, is about trying to price the full return of principal (which, in the case of a mortgage loan, is also the point at which interest payments cease). It isn’t trying to model the return of less than outstanding principal, which is what the “put” or ruthless default is. A refinancing borrower pays you back early at par. A defaulting borrower pays you back early at less than par. Standard MBS valuation models that were developed for GSE or Ginnie Mae securities (that are guaranteed against credit loss) do not “worry” about ruthless puts in terms of principal loss, since that loss is covered by the guarantor. What is causing some trouble these days with the “ruthless put” in the prepayment models is simply that this is an unexpected source of prepayment that isn’t correlating with “typical” interest rate scenarios. (We are seeing increased defaults in a very low-rate environment, because of the house price problem, which isn’t built into the prepayment models for guaranteed securities. Historically, prepayment models “expect” non-negligible numbers of ruthless puts only in higher-rate environments.)

It may help you to understand that we have been talking about how an investor might price an MBS coupon, which isn’t the same thing as the interest rate on a loan. In a Fannie Mae or Freddie Mac MBS, the “coupon” or interest rate paid to the investor might be, say, 6.00%. That means that the weighted average interest rate on the underlying loans in the pool is substantially more than 6.00%. There is the bit that has to go to the servicer, and there’s the bit that has to go to the GSE to offset the credit risk. The mortgages must pay a high enough rate of interest to provide 6.00% to the investor after the servicing and guarantee fees come off the top. In essence, then, MBS traders set the “current coupon” or the coupon that trades at par, the GSEs set the guarantee fee and/or loan-level settlement fees that cover the credit risk, the servicer sets the required servicing fee, and all that adds up to the “market rate” for conforming mortgage loans (plus mortgage insurance, if applicable, which is conceptually an offset to the guarantee fee).

One way of describing the situation we’re currently in is that borrowers are continuing the short loan life of the boom (which was made possible by easy refi money and hot RE markets) by substituting jingle mail for refinancing. That increases credit losses to whoever takes the credit loss (the GSEs and the mortgage insurers), decreases servicer cash flow (a refi substitutes a new fee-paying loan for the old loan; a default substitutes a no-fee-paying problem for the old loan), and makes everyone’s prepayment models go whacky-looking. This is one reason why it obviously wasn’t a good time for MBS traders to be told they’d be suddenly getting jumbos in their conforming pools; at some level the response to that could be summed up as “we don’t need one more thing that defies analysis.”

Ultimately, there is no way anyone can mobilize “social acceptability” as a defense against the ruthless put (even if you wanted to). The industry has, in fact, created the conditions in which it’s rational, and as long as it’s rational it will go on. Just as it was rational to buy at 100% LTV. The only possible way to get back to an environment in which ruthless default is rare is to abandon the “innovations” that give rise to them: no-down financing, wish-fulfillment appraisals, underpriced investment property loans, etc. The administration is currently pushing for increasing the FHA loan amounts and the FHA maximum LTV up to 100%. This is not likely to remove the incentive to take another reckless loan on a still-too-high-priced house. If we aren’t going to ration credit with tighter guidelines and loan limits, then it will have to be rationed with pricing: eventually the models will “solve” the problem by increasing the costs of mortgage credit. You cannot simply keep writing “free puts.”

Countrywide concerned about "borrowers' economic interest to repay"

(Calculated Risk) Countrywide sent out a letter on Jan 18th with their new Soft Market policies (hat tip ck).

... 2008 is forecasted to be a challenging year for the mortgage industry, characterized by a declining Housing Price Index in a wide variety of metropolitan markets. In the context of the prominent threat to our industry of collateral values falling below outstanding loan balances, mortgage professionals must strive to ensure that borrowers do not take on loans that they do not have the ability or economic interest to repay.
Note that last phrase: "borrowers do not take on loans that they do not have the economic interest to repay". Countrywide is clearly concerned about the new trend of buyers "walking away" from their mortgages.

The policy basically reduced the maximum LTV for various loans based on the county risk level. Countrywide's ranking of risk, by county, is available online Countrywide Soft Market County Index.

Monday, January 28, 2008

ASF mulls support for expanding FHASecure

(Housing Wire) The American Securitization Forum, which represents the interests of the secondary mortgage market, is considering support for the expansion of FHASecure to include all delinquent borrowers, as it’s becoming clear that the original program’s scope isn’t having the impact that many had hoped for.

Via Reuters, who obtained a study circulated within the ASF:

The current FHA Secure program is only poised to help around 44,000 subprime borrowers, or 5 percent of those who are more than two months behind in their payments, according to a study circulated by the American Securitization Forum.

That’s a far cry from the 240,000 borrowers touted by HUD and government officials when the program was first launched in late August of last year. HW was among the first to note problems with the current FHASecure program last December, which has sent HUD officials scrambling to shift the focus away from delinquent borrowers and instead to “at-risk” borrowers who are current on their existing mortgage.

The memo also suggests — as many commenters have noted — that the voluntary “rate freeze” program isn’t likely to be of much help, either:

In its memo, the investor group said the “rate freeze” plan does not reach enough troubled borrowers and that a reform of FHA Secure could aid a very distressed segment of homeowners.

The ASF suggested that opening up FHASecure to all delinquent borrowers, including those with fixed-rate mortgages, would reach 607,000 troubled subprime borrowers — 68 percent of severe delinquencies, according to Reuters.

The ASF report does not consider the impact of a potential raise in the FHA loan limit, as is now being mulled over by the Senate after a tentative economic stimulus deal was reached last week between Bush admistration officials and the House, which included provisions to nearly double current FHA lending limits.

Sunday, January 27, 2008

Welcome to

" is the only place where you'll find complete up-to-date information on every foreclosure opportunity available in California, including exclusive daily updates on every auction. And we're the only foreclosure service that provides a comprehensive set of professional tools for Realtors and Investors to find, evaluate, and track the best foreclosure opportunities."

Welcome to

" is the only place where you'll find complete up-to-date information on every foreclosure opportunity available in California, including exclusive daily updates on every auction. And we're the only foreclosure service that provides a comprehensive set of professional tools for Realtors and Investors to find, evaluate, and track the best foreclosure opportunities."

New Trend: Intentional Foreclosure

(Calculated Risk) From CBS: New Trend In Sacramento: 'Intentional Foreclosure' (hat tip Shawn)

Linda Caoli helps lots of families on the verge of losing their homes, including a single mom working two jobs to pay her mortgage.

"She says Linda the house across the street, same model, with more upgrades sold in foreclosure for $315,000!" explains Linda.

Her client isn't the only one thinking about ditching her house to buy the better deal across the street. A number of realtors CBS13 talked to say it's already happening.
This is similar to Peter Viles' story in the LA Times: A tipping point? "Foreclose me ... I'll save money".

Wachovia is seeing this too (from their Jan 22nd conference call):
“... people that have otherwise had the capacity to pay, but have basically just decided not to because they feel like they've lost equity ...”
And from BofA CEO Kenneth Lewis in December:
"There's been a change in social attitudes toward default. We're seeing people who are current on their credit cards but are defaulting on their mortgages. I'm astonished that people would walk away from their homes."
This change in social attitudes could lead to a flood of foreclosures. The following is from my post last December: Homeowners With Negative Equity

The following graph shows the number of homeowners with no or negative equity, using the most recent First American data, with several different price declines.

Homeowners with no or negative equity At the end of 2006, there were approximately 3.5 million U.S. homeowners with no or negative equity. (approximately 7% of the 51 million household with mortgages).

By the end of 2007, the number will have risen to about 5.6 million.

If prices decline an additional 10% in 2008, the number of homeowners with no equity will rise to 10.7 million.

The last two categories are based on a 20%, and 30%, peak to trough declines. The 20% decline was suggested by MarketWatch chief economist Irwin Kellner (See How low must housing prices go?) and 30% was suggested by Paul Krugman (see What it takes).

Intentional foreclosure. Jingle Mail. Negative Equity. All terms that could be common in 2008.

Friday, January 25, 2008

More on homeowner walkaways

(Calculated Risk) Yesterday Peter Viles at the LA Times brought us a story of a homeowner planning to use "jingle mail": A tipping point? "Foreclose me ... I'll save money"

A commenter on L.A. Land this morning writes, "I am one of these people. My condo has dropped in value from $520K in 5/06 when I bought it to $350K now. My ARM payment will probably go up $900 per month in June.
"I have purchased a cheaper place in a nearby area now, while my credit is good, and will stop making payments on house #1 after house #2 closes. I know the foreclosure will be on my credit for 7 years, but I will have saved a lot of money.
Today Viles has a poll: Is walking away irresponsible? Or smart?

There are other issues to consider than just a wrecked credit rating. There are possible tax consequences. And it is possible, depending on whether the loan is recourse or non-recourse - and the frame of mind of the lender - for the lender to seek a deficiency judgment against the homeowner. Also it appears the homeowner has not properly disclosed the planned foreclosure on his current home with his new lender.

I'm not a lawyer or a tax advisor, and there may be other issues too. Hopefully the homeowner mentioned above has obtained tax and legal advice.

OFHEO Statement on potential conforming loan limit increase

We are very disappointed in the proposal to increase the conforming loan limit as we believe it is a mistake to do so in the absence of comprehensive GSE regulatory reform. To restore confidence in the markets we must ensure that the GSEs’ regulator has all the necessary safety and soundness tools.

Yesterday Chairman Dodd talked about moving a GSE reform bill early this year. We are ready to work with him and the Senate Banking Committee. We will also be working with Fannie Mae and Freddie Mac to ensure that any increase in the conforming loan limit moves through their rigorous new product approval process quickly and has appropriate risk management policies and capital in place.

Crashing the Subprime Party

How the feds stopped the states from averting the lending mess.

(Nicholas Bagley in
As the federal government scurries to prevent the subprime mortgage crisis from sending the economy into a deep recession, many of us are asking why it waited so long to intervene. As it turns out, the government wasn't exactly sitting on its hands. Instead, for reasons that now appear hopelessly shortsighted, an obscure federal agency torpedoed legislation from a handful of states that would have made institutional investors far charier of buying mortgage loans that were likely to go belly-up. If the legislation had been permitted to go into effect, the crisis we now face would probably look a lot less grim. The right question, then, is not why the feds did so little. It's why they did so much.

Historically, few lenders would make subprime loans—that is, mortgage loans to borrowers with poor credit. The risk of default was simply too great. For a variety of reasons during the 1990s, however, major institutional players became more willing to purchase subprime loans as investments. Those loans would be pooled with similar subprime loans, and slices of that pool would be bought and sold as mortgage-backed securities. With the rise of this new secondary market, a lender could issue a subprime loan and immediately sell its interest in that loan for a lump sum. The ready flow of capital from the secondary mortgage market led, predictably, to an explosion in subprime lending. Unscrupulous lenders could reap the greatest profits by issuing subprime loans packed with unfavorable terms and subject to exorbitant interest rates, and only then selling them for cold, hard cash. A rash of borrowers found themselves saddled with predatory loans they had no hope of paying off.

To combat this surge in predatory lending, several state legislatures decided to stanch the flow of easy credit to subprime lenders. In 2002, Georgia became the first state to tell players in the secondary mortgage market that they might be on the hook if they purchased loans deemed "predatory" under state law. This worked a dramatic change. Before, downstream owners of mortgage-backed securities might see the value of their investments drop, but that was generally the worst that could happen. Under the Georgia Fair Lending Act, however, players in the secondary mortgage market could face serious liability if they so much as touched a predatory loan. The AARP, which drafted the model legislation that formed the basis for the Georgia law, explained that imposing liability on downstream owners would "reduce significantly the amount of credit that is available to lenders who are not willing to ensure that the loans they finance are made in accordance with the law."

The secondary market has an extraordinarily difficult time, however, distinguishing predatory loans (bad) from appropriately priced subprime loans (good). Even if the line could be drawn with confidence, the market lacked the resources to gather the necessary information. As the General Accounting Office noted in its comprehensive review of predatory-lending legislation, "even the most stringent efforts cannot uncover some predatory loans."

Inevitably, then, the secondary mortgage market in Georgia's subprime loans ground to a halt. And that was the point: If buyers couldn't satisfy themselves that the loans they bought weren't predatory, they should take their money elsewhere. Georgia understood that impeding the capital flow to subprime loans might raise the cost of borrowing for some state residents—those who, for one reason or another, had poor credit but could and would repay high-priced loans. But Georgia judged that this was more than balanced by protection for its most vulnerable from the scourge of predatory lending and the wrenching costs associated with overpayment and eventual foreclosure. New York, New Jersey, and New Mexico made the same judgment and within two years had enacted their own versions of laws exposing downstream owners of loans to fines if they bought predatory loans.

That's when the feds came in. Some of the biggest players in the secondary mortgage market are national banks, and the states' efforts to curb predatory lending clashed with the banks' fervent desire to keep the market in subprime loans rolling. And so the national banks turned to the Treasury Department's Office of the Comptroller of the Currency. The OCC is a somewhat conflicted agency: While its primary regulatory responsibility is ensuring the safety and soundness of the national bank system, almost its entire budget comes from fees it imposes on the banks—meaning that its funding depends on keeping them happy. It was unsurprising, then, that the OCC leapt to attention when the national banks asked it to pre-empt the Georgia-like subprime laws on the grounds that they conflicted with federal banking law.

While the banks' legal arguments were thin, the OCC issued regulations in early 2004 nullifying the state laws as they applied to national banks. In part, the OCC reasoned that the states just got it wrong: As the then-comptroller explained in a speech to the Federalist Society, "We know that it's possible to deal effectively with predatory lending without putting impediments in the way of those who provide access to legitimate subprime credit." With the state laws nullified, national banks were free to engage in the sharp practices the states were hoping to stamp out. (Indeed, Georgia scuttled its law because it didn't want to give national banks a competitive advantage over its state institutions.) Facing intense pressure from subprime lenders and Wall Street, and left without a real chance of holding investors responsible for purchasing ill-advised loans, state legislatures gave up.

In retrospect, the OCC's decision looks boneheaded. What the OCC took to be shortsighted consumer-protection laws laden with hidden costs turned out to be prescient market-correcting reforms. It's impossible, of course, to know for sure what might have happened had the OCC stayed its hand. Subprime lenders have lobbied hard against the state laws, and the incipient legislation could have been strangled in its infancy anyway. But the bottom line is that, had the state laws been permitted to go into effect, investors would now be sitting on fewer subprime loans that will never be repaid. The subprime catastrophe might have been more like a mini-crisis.

The feds really should have known better. Yet they ignored a basic principle—that no level of government has a monopoly on good policy—to brush aside state legislatures' thoughtful efforts to protect their citizens from rapacious lenders. As the feds move to clean up the subprime mess, it's worth remembering that they helped create it. Maybe the next time around, they'll remember that sometimes the states know best.

Tuesday, January 22, 2008

Buyer Pays Too Much for House, Sues Real Estate Agent

A lot of buyers paid too much for their house during the housing boom. Although most sit around lamenting their own folly, one California buyer is taking a different approach--she's suing her agent.

(eFinanceDirectory) After dismissing one agent and cancelling deals on two houses, Marty Ummel and her husband Vernon hired Mike Little, a veteran agent with ReMax Associates.

Little, who happens to be a broker as well, found the Ummels a $1.2 million cul-de-sac in a luxury development and encouraged them to get the loan through him.

The Ummels agreed to the deal in August of 2005 even though they did not get a chance to see the appraisal Little ordered. Marty Ummel claims Little assured her the house was a good buy.

Shortly after the Ummels moved into their home, they found a flier that had been tacked to their door by another real estate agent. The flier was an advertisement for a similar house in the same neighborhood. The house had recently sold for $105,000 less than what the Ummels paid.

As it turns out, there were several houses in the development that were comparable and selling for much less. One was sold the same day as the Ummels' for $175,000 less.

Upset with her agent, who made $30,000 in commission on the deal, Marty Ummel picketed ReMax on weekends for a year straight. She also filed a lawsuit against the broker and the appraiser. She received modest settlements from both.

Ummel is also suing her agent, claiming that he hid information on other homes in the neighborhood and withheld the inflated home appraisal until after the deal had been made.

In a telephone interview with The New York Times, Little maintained his innocence in the case, calling the lawsuit 'ridiculous.'

'The lady's a nut job. I didn't do anything wrong,' said Little.

The Tip of the Iceberg?

Although the real estate deal occurred in California (where property values have been inflated for years), it has national significance. Home prices are falling across the country. Real estate brokers and lawyers say the Ummel case, which is unprecedented, could encourage other buyers to cry foul.

The question is: who is really responsible in such cases? Is it the agent, whose job it is to guide the buyer within the constraints of the law? Or is it the buyer, whose job it is to show responsibility and due diligence when making a major purchase?

Wachovia: homeowners just walking away

(Calculated Risk) From the Wachovia conference call:
“Part of one of the challenges is, and we've mentioned this before, a lot of this current losses have been coming out of California and it's -- they've been from people that have otherwise had the capacity to pay, but have basically just decided not to because they feel like they've lost equity, value in their properties, and so in a way, we may have -- it's hard to know right now, but we may have seen somewhat of an acceleration problem loans as people have reached that conclusion and we're just going to have to see how the patterns unfold here.”
emphasis added
This echoes the comments of BofA CEO Kenneth Lewis last month:
"There's been a change in social attitudes toward default," Mr. Lewis says. ... "We're seeing people who are current on their credit cards but are defaulting on their mortgages," Mr. Lewis says. "I'm astonished that people would walk away from their homes."
In a previous post, I calculated that somewhere between 10 million and 20 million U.S. homeowners will owe more on their homes, than their homes will be worth, over the next couple of years. (See Homeowners With Negative Equity)

As I've noted before, one of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes. These are homeowners with the "capacity to pay, but have basically just decided not to".

Wachovia is seeing that happen now. Imagine what will happen as house prices fall this year and next.

Monday, January 21, 2008

Anatomy of a Downgrade

(Housing Wire) Catching up from last week, it’s worth noting a series of RMBS rating actions from last week at Fitch; the following are just from late Thursday and into Friday.

Add it all up, and Fitch knocked $431.1 million in RMBS value down right before the end of the week.

I wanted to take a quick look at the prospectus for one of the JPMorgan deals caught up in the downgrades above; I chose Series 2006-A4, although any of them probably would work. What becomes clear from the prospectus is that the aggregate pool consists of loans originated by one of three companies: PHH Mortgage, Countrywide, and/or Chase. What also becomes clear is that these are prime jumbos, with most of the loans well over the conforming limit and most given to borrowers with a FICO over 740.

I bring this up because it highlights something that I think merits some discussion; we’re seeing this deal downgraded because losses are now expected to outstrip expectations — but where, exactly, are those losses coming from?

This matters because deals such as this one aggregate mortgages out of the belief that the underlying assets are more or less uniform, and therefore amenable to a general set of assumptions that enable financial modeling. (If you didn’t follow that, read it again, or find your nearest applied stats geek).

One such assumption, for example, covers lifetime expected losses.

Taking a look at the prospectus, however, it becomes clear that the aggregate pool has some significant variability in it between originators — for example, while just less than half of the pool consists of full-doc loans, another 18 percent is “Simply Signature.”

What’s “Simply Signature?” From the prospectus, it’s Chase’s stated income program:

“Stated Income Stated Asset Program” (which is sometimes referred to as “Simply Signature”) is CHF’s “reactive” program. While income and assets are not verified, eligibility and approval are determined by CHF’s automated underwriting system and are based on a stronger borrower credit history and profile.

Another 15.51 percent of the aggregate pool balance is “Preferred,” and it isn’t really clear what this is except to note that it appears as if it might be Countrywide’s equivalent to Chase’s stated-income product. There’s also 4.74 percent of the pool in “Alternative” — that’s PHH’s version of stated-income loan products — and 12.18 percent covering all sorts of other creative lending (no income, no assets; no income, full assets; no doc; reduced doc; no income; etc).

And that’s just variation in originators and programs — looking at loan purpose, 37 percent of the aggregate pool is refinancing activity, for example.

The point here isn’t to harp on whether one loan product is better than another, but to drive home the fact that there is an awful lot of potential variability in what is supposed to be reasonably uniform pool of mortgages. One could argue that refinancings perform very differently than purchases in a down housing market, for one. Or that stated-income loans in general perform worse than full-doc. Or that stated-income at Chase was more stringent than stated-income at Countrywide during the time these loans were originated.

Aggregation merely by credit score, LTV, and loan amount — as is usually the case for most deals — has got to be interpreted by market participants as a woefully inadequate thing. Investors are, in part, paying the price for such as simplistic view of mortgage banking, and for a lack of clear disclosures in the prospectus covering loss assumptions for each type of loan.

It’s been said that risk is commonly underestimated when it comes to mortgage banking. Nowhere is that sentiment more true, apparently, than in the very nature of how many RMBS have been created.

The Truth About Home Prices and Mortgage Bailouts

Murky news reports and freewheeling politicians have managed to create a lot of misconceptions about house prices and mortgage bailouts. The time has come to set the record straight. (eFinanceDirectory)

Falling Home Prices Are Bad for America

FALSE! The current market is artificial. Prices have been propped up for years, which means there is now a serious disconnect between house prices and fundamentals. In other words, home prices are too high and NEED to come down.

Regardless of what everyone is saying, there are millions of renters and potential homebuyers who would benefit from lower, more reasonable home prices. Current homeowners--not speculators who signed self-destructive mortgage agreements, but actual homeowners--would benefit as well.

When prices are low, everyone gets to pay less in taxes and less for their next house. Furthermore, it is easier to sell your house when it is affordably priced.

People Can Afford Current Home Prices

FALSE. If people could afford current home prices on current incomes, the word crisis wouldn't be used in conjunction with the housing market. Prices have become so high that most of the households earning the median household income for their area cannot legitimately afford to buy a median priced home where they live and work.

The reason is because incomes are stagnant. In the last decade median wages for workers have increased a mere ten percent. National median home prices, on the other hand, have increased by more than 45 percent (when adjusted for inflation.)

Because the cost of buying has more than doubled in the last ten years, there is now a huge gap between rents and house prices. There is no chance of rents and incomes increasing at a rapid pace in the near future, which means home prices MUST fall before the nation's affordability crisis can be solved.

A Mortgage Bailout Will Help to Prop Up Home Prices

TRUE. But despite what bailout-wielding politicians want you to think, this is not a good thing. Artificially propped up prices are good for no one. Compare it to the choice of ripping a Band-Aid off bit by bit or all at once. Either way there is pain.

Propping up prices will delay the inevitable correction, but it will not stop it. In fact, it will make it worse. Most of the proposed bailouts (example: Bush's Teaser Freezer) keep unqualified consumers in unaffordable homes. What is exactly does this do but create an artificial environment ripe with unfairness and inflation?

Taxpayers Aren't Funding the Bailouts

FALSE. Taxpayers will inevitably fund all of the mortgage bailouts that have been proposed. If you disagree with this and believe politicians who tell you otherwise, the time has come to step away from the Kool-Aid.

Let's look at a few examples:

  • State Government Bailouts: Over $1 billion has been pledged by various states to help people refinance out of current mortgage loans. State funds should never be used to benefit and reward lenders and borrowers who greedily dabbled in risky loans. This money should be used for things that do not penalize responsible homeowners and renters.
  • FHA Secure: The Bush Administration wants to bail people out using a taxpayer-guaranteed loan program. What people don't realize is that the FHA will be operating in the red this year because of their own irresponsibility and lax lending standards. Cash infusions from the government (i.e. taxpayers) will be necessary to keep the organization afloat. Allowing the FHA to guarantee even more loans will put taxpayers on the hook for millions more.
  • Freddie Mae and Fannie Mac Expansion: Policymakers are pushing for even less regulation for Fannie Mae and Freddie Mac so that the two companies can buy and make more loans. The catch is that these two companies are not fully privatized. If they fail--and without reform, there is a good chance that they will--taxpayers will be the ones left flipping the bill.
  • Federal Bailout Funds: Several presidential candidates, including Hillary Clinton and Barack Obama, want to create a taxpayer financed 'federal fund' to help struggling homeowners. The plans vary in scope, but all will cost taxpayers BILLIONS of dollars.

Congress' Response to the Mortgage Mess

(Credit Slips) Eric Sevareid once remarked that a "chief cause of problems is solutions."

From a libertarian perspective at least, I suspect that we will find "problems" in the "solutions" that Congress will enact to solve the sub prime mortgage mess. At this point it seems inevitable that the current Congress (and, even more so, the one that will likely sit in 2009) will be moved by heartrending stories of foreclosure of citizens’ residences at the hands of mortgagees who have charged excessive rates, misrepresented the terms of the loan and induced the debtors to take on too much debt.

It seems certain that Congress will allow stripping down of mortgage liens in bankruptcy. Doubtless Congress will try to shackle mortgage brokers with expensive certification and criminal liability. It may also go beyond abolition of holder in due course status for mortgage note holders to force persons in the chain of title of the notes to bear some of the credit loss that occurs when the debtor defaults. If Congress can find a way to do it constitutionally, Congress may also mandate some form mortgage modification. Congress might even take up my friend John's foolish idea that lending too generously be a tort. Congress will justify the legislation by anecdotal testimony in televised hearings from pitiful wretches who knew not what they were doing.

If my lugubrious predictions prove true, there will be a measurable--possibly quite large--impact on the market. Such rules will make mortgage lending less profitable to everyone in the system-so the number of mortgages written will decline and those that are written will be marginally more expensive. It will winnow the number of mortgage brokers and so remove some who have committed fraud in writing mortgages. It will make investors upstream think twice about buying a debt that carries not only a fraud claim but also the possibility of tort liability for too generous lending, and even a lasting stain (for debt liability) that cannot be removed by assignment to another.

I am quite clear about what Congressman Paul would do to solve this crisis- nothing. He would note that the interest rate on 30 year mortgages in late January 2008 was lower than any time since mid 2005. He would point out that many mortgage brokers have gone into bankruptcy and that the gushing market for mortgaged backed securities has gone dry. He would point out that Countrywide rewrote more than 83,000 mortgages to alleviate pressure on its debtors in 2007 and that it expects to modify even larger numbers of mortgages this year. In short he would argue that Darwin's rules are already at work and that, left to itself, the market will cure the excesses that we have observed. In his view adding harsh legislation on top of the market's Darwinian response would cause the number of home loans to decline well below the optimum number.

By now you will have understood that I am sympathetic to the libertarian position, and I wonder whether the debtors' friends in Congress have a covert agenda, namely to keep those with poor credit from taking on debt even when these debtors are fully informed of the risks and costs and quite willing to bear them. To protect consumers from fraud is worthy, but is it worthy to bar an informed consumer from economic behavior that Congress thinks too risky?

Sunday, January 20, 2008

Will the "Real" Anti-Foreclosure Mr. Paulson Please Stand Up?

(Credit Slips) Yesterday's front page story in the Wall Street Journal was not the usual Paulson story about subprime mortgages---blah, blah Treasury Secretary Henry Paulson has organized mortgage companies to make blah, blah, blah unenforceable promises to offer short-term help to blah, blah homeowners. (Can you see that I share Prof. Elizabeth Warren's skepticism about the "Sandbag" plan?)

This story about Paulson and foreclosures was much more interesting. It profiled John Paulson (no relation), a hedge fund manager who bet big in 2005 that the mortgage market was heading sharply south. Paulson's take home pay in 2007 was reputedly $3 to $4 billion dollars (WOW!). What is he doing with all this money? Well, he's given $15 million of it to the Center for Responsible Lending to fund legal assistance to families facing foreclosure. This is a chunk of change, even for someone with his paycheck, and it is a momumental gift for direct legal services, which typically struggles along on small gifts. Another surprise--John Paulson says in the WSJ that "bankruptcy is the best way to keep homeowners in the home without costing the government any money." This bowled me over; a Wall Street maven backing the pending legislation that would let consumers modify their home mortgages in bankruptcy! I'd say this Paulson won't be making the speaker's list at the next Mortgage Bankers Association meeting, which has strenously opposed the legislation. They'll have to content themselves with the Treasury Secretary.

There are some cynical ways to view Paulson's actions. First, while he notes that he never made a subprime loan or even invested in that market (remember, he bet against it), he could still feel guilty. Every homeowner getting the boot translated to real dollars for his fund--and him as manager--as the value of the mortgage securities fell. Second, the WSJ speculated that, if enacted, the bankruptcy bill could reduce homeowners' payments to mortgage companies, rewarding Mr. Paulson's fund for betting that mortgage securities will take hit. (Paulson himself says such an effect is far from clear, and we've had prior debates on Credit Slips about whether the losses would be greater if these families didn't get this new form of bankruptcy relief).

John Paulson does go on the record saying that he "thinks a lot of homeowners have been victimized." And that's a lot more than much of Wall Street has been willing to admit so far.

Saturday, January 19, 2008

ResCap declining market indicator

This GMAC ResCap link seeks out declining real estate markets via zip code:

The problem is, there's no legend...

Friday, January 18, 2008

HOPE NOW: Number of borrowers helped rising rapidly

(Housing Wire) Taking issue with recent suggestions that mortgage lenders aren’t doing enough to help troubled borrowers, a report released Friday by the HOPE NOW Alliance suggests that servicers significantly ramped up loss mitigation efforts significantly during the fourth quarter.

Relying on data from nine of the nation’s largest servicers responsible for managing 4.1 million loans, or approximately 58 percent of outstanding subprime loans, HOPE NOW said that the mortgage industry assisted 370,000 homeowners during the second half of 2007. Of that number, 250,000 include formal repayment plans and 120,000 represent loan modifications.

“The number of borrowers being helped is accelerating rapidly,” said Faith Schwartz, executive director of HOPE NOW. “Our job is to get homeowners the help they need and we are doing that. HOPE NOW, which leverages the work already being done by servicers, is a program that yields significant results.”

HOPE NOW is an industry coalition comprised of counselors, mortgage market participants, and mortgage servicers to create a unified, coordinated plan to reach and help as many homeowners as possible; the coalition led efforts to formulate a voluntary streamlined mortgage-modification program (the so-called ARM freeze) in conjunction with the Treasury Department and officials within the Bush administration.

The HOPE NOW study follows a report by the Mortgage Bankers Association, which yesterday released similar data for the third quarter. MBA concluded 148,000 subprime homeowners were helped, including 120,000 formal repayment plans and 28,000 modifications. Modifications made in the third quarter were double those made in the first quarter.

Looking beyond the MBA survey, mortgage servicers were modifying subprime loans during the fourth quarter at triple the rate of the third quarter, HOPE NOW said.

Treasury Secretary Hank Paulson characterized the HOPE NOW report as “a promising development.”

“Entire industries do not adjust easily or quickly, even in times of market calm,” Paulson said. “But this alliance is demonstrating that an industry can improve its coordination and outreach to make a difference.”

In November 2007, HOPE NOW said it had sent out approximately 233,000 letters to at-risk homeowners asking them to call their servicer for assistance. As a result of these letters, more than 16 percent of borrowers responded by contacting their servicer, far more than the normal response rate of 2-3 percent.

Another 250,000 letters were mailed in December, the organization said.

Thursday, January 17, 2008

Housing prices: comparing OFHEO to Case-Shiller

(Calculated Risk) Last July, OFHEO economist Andrew Leventis wrote: A Note on the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes. The OFHEO note suggested that the primary reason for the difference between the national Case-Shiller and OFHEO price indices is geographical coverage (not the loan limitations for OFHEO).

Now Leventis has completed a more thorough analysis removing the geographical coverage by focusing on 10 MSAs: Revisiting the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes: New Explanations

The results are surprising, and the implications significant. Leventis found:

The empirical estimates suggest that, while the causes of divergence may have differed in previous periods, most of the current gap is generally attributable to three factors: OFHEO’s use of home price appraisals, differences in how much weight is given to homes that have lengthy intervals between valuations, and variations in price patterns for inexpensive homes with alternative financing.
emphasis added
Leventis analyzed the inclusion of non-agency financed medium and high prices homes, but this didn't have a large impact. This is contrary to the common view that the difference between OFHEO and Case-Shiller is because of the conforming loan limit.

OFHEO provides a Purchase Only index that eliminates the first factor (the use of appraisals). The second factor - the differences in weighting certain homes - is somewhat technical. But the third factor is clearly important:
The depressing effect of the inclusion of low-priced houses without Enterprise-related financing raises many questions. Some of these houses were undoubtedly financed with subprime mortgages and thus one might wonder whether some of the effect somehow relates to turmoil in that market. For example, subprime homes may be clustered in neighborhoods with relatively intense recent foreclosure activity. While this analysis attempted to rule out such “neighborhood effects” at the zip code level, zip codes are large areas and analysis of smaller geographic regions (e.g., census tracts) might reveal more localized differences. Another plausible explanation is that borrowers with subprime loans may not have spent as much on home improvements, maintenance or repair. If these types of expenditures were lower for subprime borrowers, then deprecation rates may have been greater for the homes with subprime financing.

A review of the impact of adding the low-end, non-Enterprise properties to OFHEO’s dataset suggests that, during the latter part of the housing boom, these properties may have appreciated significantly more than Enterprise-financed properties. Accordingly, it seems these properties are different from Enterprise properties in ways that are correlated with price trends.
This suggests that one of main differences between OFHEO and Case-Shiller was that Case-Shiller included many non-agency homes financed with subprime loans. These homes saw more appreciation during the boom, and are now seeing larger price declines.

Whatever the reasons, the Case-Shiller index seems to more accurately reflect the current price declines in the housing market, as opposed to the OFHEO index. And this has significant implications for the economy.

The Fed uses the OFHEO index to calculate the changes in household real estate assets. If the OFHEO index understated appreciation during the boom that means households have MORE real estate assets, and more equity, than the current Flow of Funds report suggests.

That sounds like good news, but ... that also means that during the housing boom, the wealth effect was larger, and the impact on GDP greater, than current estimates. This also means - if OFHEO understated appreciation - that the negative wealth effect, and the drag on GDP, will be probably be greater than expected during the housing bust.