Friday, February 29, 2008

Homebuyers and Sellers Blacklisted By Lenders

(eFinance) As home prices fall across the nation, lenders are becoming more unwilling to write loans for home purchases in some geographical regions. The result is that financing is almost unattainable in certain areas.

Some of the nation's largest lenders have found an old, but useful way to protect their capital-impaired behinds: blacklists.

BankUnited, Wachovia and Washington Mutual are among the lenders who are shying away from writing loans in areas with declining home values. And they're considering more than just location. Some housing types or projects are also being put on the no-no list--namely condominiums.

The lists aren't widely circulated and usually go under another name. 'We don't call it blacklisting,' a banking official told CNN Money. 'We just don't write the loan.'

Although some banks don't call it blacklisting, there are actual blacklists that contain non-permissible housing projects and geographical areas. To see an example, check out the BankUnited list of non-permissible condominium projects in Miami and Las Vegas.

The practice isn't abnormal, particularly in a housing downturn. The lenders who aren't blacklisting entire areas have pulled back on the amount of money they are willing to loan. For example, CitiMortgage and JPMorgan Chase both reduce the maximum amount they will loan in counties and states that are known to have declining home values. Reductions are usually between five and ten percent.

The Effect of Blacklisting

While it's good that the banks are doing what they can to protect themselves now, they are most certainly putting some people in a precarious position in the process. Anybody who owns a home--and especially a condo--will find it more difficult to sell in areas where credit has dried up.

The end result will be falling home prices. This is not necessarily a bad thing for regions with inflated home values. Prices are bound to decline anyway. The faster they fall, the faster things can get back to normal.

However, it will be interesting to see what kind of domino effect this might create. The banks that financed the now-sweating condo developers and current condo owners in Florida, Vegas and other shaky areas may end up eating the money loaned before the blacklisting began.

Facing Default, Some Walk Out on New Homes

(NYT) When Raymond Zulueta went into default on his mortgage last year, he did what a lot of people do. He worried.

In a declining housing market, he owed more than the house was worth, and his mortgage payments, even on an interest-only loan, had shot up to $2,600, more than he could afford. “I was terrified,” said Mr. Zulueta, who services automated teller machines for an armored car company in the San Francisco area.

Then in January he learned about a new company in San Diego called You Walk Away that does just what its name says. For $995, it helps people walk away from their homes, ceding them to the banks in foreclosure.

Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. The old house is now the lender’s problem. “They took the negativity out of my life,” Mr. Zulueta said of You Walk Away. “I was stressing over nothing.”

You Walk Away is a small sign of broad changes in the way many Americans look at housing. In an era in which new types of loans allowed many home buyers to move in with little or no down payment, and to cash out any equity by refinancing, the meaning of homeownership and foreclosure have changed, economists and housing experts say.

Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989, according to a survey by the National Association of Realtors. Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, said in an e-mail message.

For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.

“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

In recent months top executives from Bank of America, JPMorgan Chase and Wachovia have all described a new willingness by borrowers to walk away from mortgages.

Carrie Newhouse, a real estate agent who also works as a loss mitigation consultant for mortgage lenders in Minneapolis-St. Paul, said she saw many homeowners who looked at foreclosure as a first option, preferable to dealing with their lender. “I’ve had people say to me, ‘My house isn’t worth what I owe, why should I continue to make payments on it?’ ” Mrs. Newhouse said.

“You bought an adjustable rate mortgage and you’re mad the bank is adjusting the rate,” she said. “And sometimes the bank people who call these consumers aren’t really nice. Not that the bank has the responsibility to be your friend, but a lot are just so uncooperative.”

The same sorts of loans that drove the real estate boom now change the nature of foreclosure, giving borrowers incentives to walk away, said Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania.

“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

In the boom market, homeowners took their winnings, withdrawing $800 billion in equity from their homes in 2005 alone, according to RGE Monitor, an online financial research firm.

Since the Depression, American government policy has encouraged homeownership as an absolute good. It protects people from increases in rent and allows them to build equity as they pay off their mortgages. And it creates stability in communities, because owners are invested in their neighbors.

But new types of loans like interest-only mortgages and cash-out refinance loans mean buyers do not pay down their mortgages. And adjustable rate mortgages, which accounted for 39 percent of mortgages written in 2006, expose owners to rent-like rises in their housing costs.

The value of homeownership, then, has increasingly shifted to the home’s likelihood to rise in value, like any other investment. And when investments go bad, people tend to walk away.

“When people don’t have skin in the game, they behave like they don’t have skin in the game,” said Karl E. Case, a professor of economics at Wellesley College, who conducts regular surveys of borrowers as a founding partner of Fiserv Case Shiller Weiss, a real estate research firm.

Though many states give banks recourse to sue borrowers for their losses, Mr. Case said, in practice it’s not often done “It’s tough to do recourse,” he said. “It’s costly, and the amount of people’s nonhousing wealth tends to be pretty slim.”

Christian Menegatti, lead analyst at RGE Monitor, said the firm predicted more homeowners would walk away from their homes if prices continued to drop, regardless of their financial circumstances. If home prices drop an additional 10 percent, Mr. Menegatti said, 20 million households will owe more than the value of their homes.

“Will everyone walk out?” he said. “No. But there’s been a cultural shift. Buying a house used to be like entering a marriage, a commitment for life. Now, if you see something better, you go back into the dating market.”

When homeowners see houses identical to their own selling for much less than they owe, Mr. Menegatti said, “I wouldn’t be surprised to see five or six million homeowners walk away.”

For Raymond Zulueta, the decision to go into foreclosure, and to hire You Walk Away, brought him peace of mind. The company assured him that in California he was not liable for his debt, and provided sessions with a lawyer and an accountant, as well as enrollment with a credit repair agency. He stopped paying his mortgage and used the money to pay down other debts.

Consumer advocates and others question the value of You Walk Away’s service.

“We are more interested in servicers and borrowers coming to mutual resolutions through loan remediation,” said Kevin Stein, associate director of the nonprofit California Reinvestment Coalition. “Even though we are not seeing good outcomes, we’re not willing to throw up our hands and say people should walk away from their homes based on the advice of a company that stands to profit from foreclosure.”

Jon Maddux, a founder of You Walk Away, said the company’s services were not for everybody and were meant as a last resort. The company opened for business in January and says it has just over 200 clients in six states.

“It’s not a moral decision,” Mr. Maddux said of foreclosure. “The moral decision is, ‘I need to pay my kids’ health insurance or my car payment so I can get to work.’ They made a bad decision, but they shouldn’t make more bad ones just because they have this loan.”

Mr. Zulueta said he felt he had let down the lender, himself, and his family.

“But you got to move on,” he said. “I know in a few years my credit’s going to be fine. If I want to get another house, it’s going to be there. I’m not the only one who went through this. I know I’m working the system, but you got to do what you got to do. There’s always loopholes.”

Borrowers Abandon Mortgages as Prices Drop

(WSJ) As home prices plummet, growing numbers of borrowers are winding up owing more on their homes than the homes are worth, raising concerns that a new group of homeowners -- those who can afford to pay their mortgages but have decided not to -- are starting to walk away from their homes. [Chart]

Typically borrowers who turn in their keys are those who have run into financial trouble or need to relocate but can't sell their homes. But mortgage-industry executives and consumer counselors say they are starting to see people who aren't in dire financial straits defaulting on their mortgages because they don't want to pay for properties that have negative equity.

Many are speculators who had planned to quickly flip the home, but others appear to be homeowners who had second thoughts about their purchase.

"It may not be a big thing yet, and hopefully it won't be," says David Berson, chief economist for mortgage insurer PMI Mortgage Group Inc., of Walnut Creek, Calif. But if it turns out to be a significant trend, he says, it means that "delinquencies and defaults could be higher than the industry is estimating."

Some borrowers feel they have no good alternative. A tight credit market has made it tough for would-be sellers to find buyers or for borrowers looking to lower their mortgage costs to refinance.

Other borrowers are walking away in frustration because they can't arrange a workout with their lenders, says D.J. Enga, director of outreach services for Auriton Solutions, which counsels homeowners nationwide. Mr. Enga expects that 10% to 15% of the roughly 4,000 callers counseled this month by Auriton, of St. Paul, Minn., will walk away from their mortgages.

Sgt. First Class Nicklaus Skaggs is among those looking to walk way. Mr. Skaggs bought his home in April 2005 shortly after returning to California from a one-year tour of duty in Baghdad.

The $455,000 three-bedroom home he and his wife purchased in Vacaville, about one hour northeast of San Francisco, is worth an estimated $285,000 today, well below the $453,000 he owes on his mortgage. The monthly mortgage payment, which jumped after its interest rate increased, is now $4,000, up from $2,980 when he bought the house.

Mr. Skaggs expects to be redeployed to Iraq again later this year. But he can't sell his home, since there are few buyers, and he can't refinance because lenders require a large down payment he doesn't have. Now, the 18-year Army veteran has decided to walk away from his mortgage. He hopes in a few years lenders see his decision as a unique situation created by the housing meltdown. "I don't think that house is going to recover in value any time soon," said the 40-year-old. "I'd just be throwing the money away."

A rise in the number of people choosing to default on their mortgages would represent a significant departure from past behavior of American homeowners, who during past housing downturns tended to walk away only as a last resort, often because they couldn't afford to pay because of unemployment, illness, divorce or other life-altering changes that reduce income. And even then, the number of people who walked away was relatively small. During the oil bust in the Houston area during the 1980s and in California during the early 1990s, for instance, there was a brief spate of people sending in their keys to their lenders.

What's different now, analysts and economists say, is that home prices have fallen so far so quickly that some homeowners in weak markets are concluding that house prices won't recover anytime soon, and therefore they are throwing good money after bad. Also, many borrowers who bought in recent years have put down little if any equity. "If they haven't lived in [the home] very long and haven't put any cash in it, it's a lot easier to walk away," says Chris Mayer, director of the Milstein Center for Real Estate at Columbia Business School. He also notes that new homeowners may not have strong ties to the community.

Some borrowers, says Mary Kelsch, senior director at Fitch Inc., are less willing to make the sacrifices needed to stay in their homes, given the current environment. "It's a change of mind-set" she says. They are "looking more at their home as an investment that has lost its appreciation potential and don't really want to continue to pay."

Some in the industry want to toughen the consequences for borrowers who walk away. Executives at Fannie Mae say they are working to create harsher penalties for people who walk away from mortgages, and they plan to pursue some borrowers in court. They also want to extend the amount of time between when borrowers default and when they become eligible again for a Fannie Mae-backed loan.

"Of course, we will make exceptions for extenuating circumstances, like divorce or death," says Mike Quinn, a Fannie Mae executive. "But who we are trying to get are the people who can afford to make payments but have decided not to."

Goldman Sachs economists estimate that as much as $3 trillion in mortgages could be underwater by the end of the year, leaving 30% of the country's outstanding mortgages in negative equity. Since there is roughly $1 trillion in subprime mortgages outstanding, that means a large amount of better-quality mortgages, such as prime and Alt-A -- a category between prime and subprime -- will be attached to negative equity.

"The focus has been on the [interest rate] resets," said Goldman Sachs economist Andrew Tilton. "But if you're in a deep enough negative-equity position, defaulting has its own kind of logic."

In the Phoenix area, where home prices were off 15% in the fourth-quarter when compared with a year ago, accountant Steven Ulrich says several of his clients have recently said they plan to walk away. One client's home is now worth $100,000 less than the mortgage and the other is $60,000 underwater.

"It surprised me," said Mr. Ulrich, who works at The Focus Group in Scottsdale. "I'd never had people doing that before, if they had to it was something they were forced into. But these people are choosing it as a strategy, and I think it's going to be happening a lot more."

Some financial advisers are even encouraging homeowners who are upside down to consider foreclosure, which they see as a purely financial decision with limited negative consequences., a Web site started in January that offers foreclosure counseling to homeowners, advises that borrowers who default on one mortgage can typically get another mortgage between two and four years after a foreclosure. Then, "before you know it, you will have this behind you and a fresh start!" the site says.

A foreclosure will stay as a "strong negative" on your credit report for as long as seven years, though the impact on a borrower's credit score declines over time, says Mike Campbell, chief operating officer of Fair Isaac Corp., maker of the popular FICO credit score.

"Every single person we talk to either owes 100% [of their equity] or is upside down anywhere from $10,000 to $300,000," says John Maddux, co-founder of, which charges borrowers about $1,000 for advice. Mr. Maddux says the site has received more than 190,000 visits and about 20% of their clients are investors.

Thursday, February 28, 2008

As America's mortgage mess worsens, radical solutions are gaining appeal

(Economist) With brick-fronted townhouses and old-fashioned street lamps, Faulkner's Landing in Ashburn is one of hundreds of new developments that sprouted across the farmlands of northern Virginia during America's housing boom. Less than three years old, these houses originally sold for around $550,000, but are now worth some 40% less that that. Foreclosures are rising. For owners who put little or no money down, points out Danilo Bogdanovic, a local estate agent, it is often not worth paying a mortgage far greater than the value of the house.

As America's house prices slide, fears are growing that more people will post the keys to their lender and walk away. The practice, already common among speculative buyers, has a nickname, “jingle mail”. For a fee, websites such as, explain what to do. Laws on repossession differ by state. But thanks to high legal costs, mortgage firms have historically not chased borrowers even when the law allows it.

It is easy to paint grim scenarios. Repossessions are soaring, up 90% from a year ago according to RealtyTrac, a seller of foreclosure statistics. According to the S&P Case-Shiller index, average house prices fell by 9% in 2007 (see chart), and the pace of decline is accelerating. Mark Zandi of Moody's reckons that 8.8m mortgage-holders, 17% of the total, have home loans that are greater than the value of the house. If house prices fall by another 10%, as he expects, Mr Zandi expects almost 14m mortgages to be underwater in a year's time.

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Given that the typical mortgage is worth $225,000, over $3 trillion of debt would be affected. Since the costs of foreclosure can eat up 25% or more of the value of a loan, the losses could be enormous if a large fraction of these borrowers walk away. Nouriel Roubini, one of Wall Street's most pessimistic seers, worries that the “forthcoming jingle-mail tsunami” could spawn $1 trillion-2 trillion of financial losses, creating a systemic banking crisis.

Experience from previous regional housing busts suggests most people with negative equity do not simply walk away from their houses. But much about today's situation is unprecedentedparticularly the high initial loan-to-value ratios. On February 27th Fannie Mae, the government-backed mortgage giant, announced an unexpectedly big loss of $3.55 billion for the fourth quarter of 2007 because of increased foreclosures.

Until recently, Washington's main fear was that foreclosures would soar as the low initial interest rates on some 2m adjustable subprime mortgages reset. In December 2007, to great fanfare, the Bush Treasury cajoled the mortgage industry into promising a (voluntary) temporary rate-freeze for certain groups of borrowers. So far, these efforts have yielded little. But thanks to big rate cuts by the Federal Reserve, resets are becoming less of a problem. One analysis suggests that the typical reset now involves a jump in monthly payments of just over 10%, compared with 25-30% six months ago.

But even as resets become less painful, analysts are realising that they are not the main cause of foreclosure. An influential study from the Federal Reserve Bank of Boston points to falling house prices, and the resultant negative equity, as a far bigger trigger. Stemming foreclosures, points out Paul Willen, an author of the study, will depend on reducing the size of mortgages relative to the value of a house.

One approach under consideration in Congress is to adjust America's personal-bankruptcy law so that judges can “cram down” a mortgage to the market value of a house. Under current law, judges cannot reduce the debt on someone's main residence, though they can do so for holiday homes or investment properties. Proponents of the legislation reckon 600,000 people could avoid foreclosure if the rules were changed.

The mortgage industry is vehemently opposed. And many economists worry that allowing cram-downs will worsen the drought of credit in America's mortgage markets. Chris Mayer of Columbia Business School points out that some $750 billion of annual mortgage lending has dried up as the securitisation of subprime and jumbo loans has collapsed. Changing bankruptcy rules, he argues, would make matters worse by raising the cost and reducing the supply of mortgage credit. Several studies have shown that borrower-friendly laws lead to more restricted credit. However, a new paper by Adam Levitin of Georgetown University Law School and Joshua Goodman of Columbia University finds scant difference in interest rates on mortgages that can already be crammed down (such as holiday homes) and those that cannot.

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Unsurprisingly, bankers are lobbying for a different approach, one where the government stems the foreclosure spiral (and limits losses) by buying and refinancing whole swathes of mortgages. One idea, championed by Chris Dodd, the chairman of the Senate Banking Committee, is to recreate a modern version of the Home Owners' Loan Corporation, a Depression-era institution that refinanced mortgages in the mid-1930s when almost half of all home loans were in default. Other proposals have similar aims. A government institution, such as the Federal Housing Administration (FHA), would buy mortgages at a discount and refinance them into new loans with a government guarantee. Credit risk for the refinanced mortgages would shift to Uncle Sam.

How much of a “bail-out” this implies depends on the discount at which the mortgages are bought and on their subsequent performance. Most proposals suggest using the market price; Mr Zandi wants the government to buy mortgages by auction. Some plans are ambitious: Alan Blinder of Princeton University foresees an institution that takes over between 1m and 2m loans, worth $200 billion-$400 billion. Other schemes are narrower. Democratic congressmen talk of an initial capitalisation of around $20 billion.

Another complementary idea, touted by the Office of Thrift Supervision (OTS), is to give mortgage lenders a share of the upside if properties appreciate. Under this scheme, the FHA would insure a new mortgage at a house's current value. The existing lender would get a “negative equity” claim for the difference between that and the original loan, which could be exercised if the house later sold at a higher price. Some proponents of bankruptcy reform want to attach similar provisions to the cram-down. But the details of any “shared appreciation” devices are tricky. If homeowners have little hope of building equity in their house, the incentive to default remains.

All told, all the plans are fraught with problems. Bankruptcy reform will help some of today's borrowers while hurting tomorrow's. Government refinancing potentially puts taxpayers' money at risk. For the moment, the Bush administration opposes both and pins its hopes on voluntary loan modifications. Public opinion is also against any “bail-out”. But the climate in Congress is shifting. As the housing market worsens, bigger government intervention is becoming ever more likely.

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Surprise!!! You've earned a discharge and a foreclosure

(Credit Slips) Tomorrow, the Senate is expected to vote on the Foreclosure Prevention Act of 2008, Title IV of which would permit bankruptcy courts to modify home mortgages in certain ways if the loan and the debtor met specified criteria. We've described that idea before, but the bill has crucial implications for bankruptcy that are not related to loan modification. Specifically, take a look at section 421, which proposes a solution to a problem with current bankruptcy law. Many Chapter 13 debtors pay for 3 to 5 years on a repayment plan, doing everything the law requires of them, and only a week or two later, face a foreclosure. How does this happen? Because the mortgage servicers frequently assess charges during a bankruptcy case, but fail to disclose these fees. Courts don't approve them; trustees don't adjust the debtor's payments to account for them; and debtors aren't even given notice that these charges are piling up. Instead of emerging from bankruptcy with a fresh start, homeowners find themselves defending a foreclosure or having to immediately pony up hundreds or thousands of dollars. Just last week, Judge Brendan Shannon of the Delaware Bankruptcy Court addressed this issue, challenging lenders to disagree that these undisclosed "surprise" fees don't "frustrate" bankruptcy's home-saving purpose. The Foreclosure Prevention Act of 2008 tackles this problem by requiring mortgage companies to disclose all fees within the earlier of 1 year of assessing the charges or 60 days before the end of the bankruptcy. The law also specifies that a lender may only charge such fees if they are lawful, reasonable, and provided for in the contract. It's sad that this latter requirement is even necessary--it essentially just prohibits mortgage servicers from violating existing law by overcharging consumers, a problem that an increasing body of case law and research suggests occurs with alarming regularity. I see lots of reasons why permitting bankruptcy courts to modify mortgages may be the best comprehensive solution to the foreclosure crisis, but I also hope Congress takes a hard look at the rest of the bill and considers its overall importance. If consumers do their part in bankruptcy and make every payment required by law, the system should honor its promise to give them a financial fresh start.

Paulson says no go on housing bailouts

(Naked Capitalism) Treasury Secretary Hank Paulson has thrown a bucket of cold water on a number of proposals being floated in Washington to rescue troubled borrowers via the explicit use of public funds, such as the idea of reviving the 1933 Home Owner's Loan Corporation to buy underwater mortgages and renegotiate them.

In some respects, Paulson's tough stance is welcome, because many of these proposals would do more for banks and investors than borrowers. Many homeowners, including ones who are capable of servicing their mortages, are walking away because they deem them an unattractive investment. There is now a large class of nominal homeowners who in fact are more akin to renters with a home ownership option that is now deeply out of the money. And they can often rent more cheaply too.

But unfortunately, what is driving Paulson isn't a pragmatic assessment of what measures might be cost effective and not involve undue moral hazard. Instead, he is guided primarily by the ideological imperatives of this Adminsitration, which is to favor so-called private sector solutions. But that construct is dishonest and limiting. For instance, the Journal reports that Paulson maintains that "market-based approach will be enough to keep the situation under control."

If Paulson considers the worst housing market since the Depression to be under control, I shudder to think what an unmanaged situation would look like.

However, a grey area in "private sector solutions" is a willingness to rack up government contingent liabilities. The portfolio ceilings on Fannie Mae and Freddie Mac were lifted Wednesday, and OFHEO's James Lockhart had said earlier this month that the two GSEs could add $100 billion in mortgages in the next six months without running into capital limits. The plan now in place is to keep Fannie and Freddie in remediation mode, setting aside reserves 30% higher than the usual minimum. However, fi the GSEs come under increasing pressure to take on weaker mortgages to salvage the housing market, even those higher reserves may prove insufficient.

Similarly, the Treasury has not nixed some proposals to increase the role of the FHA. The FHA is the historical source of mortgages to middle and lower income borrowers, so an increased role for the FHA could well make sense. But again, it may be subject to pressures to relax its standards and become a warehouse for mortgages on the brink.

The dead body in the room that Pauson has addressed only in part, by his cosmetic Hope Now Alliance plan, is that securitization impedes the traditional practice of having the lender restructure mortgages for those borrowers who can be salvaged. In fairness, due to high loan to value ratios on new mortgages and the heavy use of cash out refinancings and home equity loans, many of the stressed borrowers may in fact not be able to afford even a generous mod. That poses a conundrum: does the collateral damage to communities and lenders warrant rescuing them anyhow? This tradeoff isn't discussed honestly, as it should be; instead all troubled borrowers are wrapped in the mantle of "about to lose their homes."

And the problem with the failure to acknowledge the major impediment, in combination with the Administration's ideological fixation, is that the best available solution is likely to be blocked. The Democrats have proposed changes to bankruptcy laws to give judges more authority to modify mortgages, While this may sound overreaching, in fact this simply puts residential mortgages on the same footing as commercial mortgages and vacation property. In effect, judges will do the mods that the mortgage services are either unwilling or unable to make. But the bill has already been watered down in the House and faces opposition in the Senate.

From the Wall Street Journal:
In an interview yesterday, Treasury Secretary Henry Paulson branded many of the aid proposals circulating in Washington as "bailouts" for reckless lenders, investors and speculators, rather than measures that would provide meaningful relief to deserving, but cash-strapped, mortgage borrowers....

Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee and typically an ally of Mr. Paulson's, said that, until now, he had supported the Treasury's steps to address mortgage delinquencies and the credit crunch they have spawned. "But they're not helping enough people," Mr. Frank said yesterday. "We're not going to get out of the crunch until we stop this cascade of foreclosures."

The Fed's Mr. Bernanke appeared to take a slightly more flexible position than Mr. Paulson, telling a congressional committee yesterday that the turmoil in the housing market doesn't yet merit large amounts of public money. "I don't think we're at that point, but I do think it's worthwhile to keep thinking about those issues," Mr. Bernanke said....

Administration officials "have been willing to broker deals, but they haven't been willing to put taxpayer money on the line," said Mark Zandi, chief economist at Moody's, a West Chester, Pa., consulting firm. "I think they're trying to stick to those principles, and now they're running out of ideas that are consistent with those principles."....

"I'm seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes," Mr. Paulson said. "Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street."

The secretary added one caveat: "It would be imprudent not to have contingency plans, but we are so far away from seeing something that would have me calling for a bailout that I don't see it."

Mr. Bush is threatening to veto a Senate bill that includes $4 billion to help states and localities redevelop abandoned and foreclosed houses. "I believe the evidence is clear that these [voluntary industry] initiatives alone will not steer enough families away from foreclosure or our country away from further economic weakening," Mr. Reid wrote in a letter to the president yesterday, referring to the main element of the White House-backed industry plan. "In my view, the enormity of the foreclosure crisis requires a much more aggressive response."

The Reid bill also includes a provision -- opposed by many Republicans and the White House -- that would allow bankruptcy judges to alter the terms of mortgages.

Wednesday, February 27, 2008

Frank: Bailout-as-you-go

This is what the Financial Times is reporting:

A leading Democratic lawmaker on Tuesday called for $20bn in public funds to be made available to the Federal Housing Administration to purchase and refinance pools of subprime mortgages. . . .

Mr Frank said “we can do it through an existing vehicle rather than a new vehicle”. But the underlying logic of the two proposals is similar.

Mr Frank said that under his plan, the FHA would “buy up packages of mortgages but at a substantial discount”. It would then refinance the loans.

This would require about $20bn up front, but Mr Frank stressed that “the FHA would be repaid” as the loans were refinanced. The ultimate cost of the scheme to US taxpayers, under Congressional scoring practices, would probably be about $3bn to $4bn.

Mr Frank also called for between $5bn and $10bn in loans to the states, which would be used to purchase and refurbish foreclosed homes, and extra funding for counselling services.

Mr Frank said the “lesser efforts” to tackle the mortgage crisis to date “have not been very successful”. The housing crisis was “getting worse not better”.

The externalities involved in foreclosures justified the commitment of public funds. “We are talking about terrible impact on society.”

The main difference between the Frank plan and some of the other proposals circulating is the scale of the intervention envisaged.

Alan Blinder, a professor of economics at Princeton, has called for a new government vehicle modelled on the Home Owners Loan Corporation of the 1930s to borrow between $200bn and $400bn to buy up and restructure distressed loans.

Mark Zandi, chief economist at Moody’s told the House financial services committee that it would take about $250bn in upfront funds to purchase all 2m loans expected to end in foreclosure by the end of this decade.

Mr Frank said “reality constrains” and his plan was limited to $20bn for the FHA because of the budget deficit and the need to meet pay-as-you-go spending rules.
So far this morning, my attempts to find more details on the Frank plan have not succeeded. I did, however, find this recently published statement of priorities for the House Committee on Financial Services, of which Frank is the chair:
The Committee on Financial Services urges the congressional budget resolution to prioritize the following critical issues:

(1) Housing Initiative. Over the last six months, the nation has experienced a significant increase in the number of homeowners facing the risk of foreclosure, with estimates of as many as 2.8 million subprime and “Alt A” borrowers facing loss of their homes over the next five years. We have already experienced declining home prices in many areas of the country, and the physical deterioration of certain communities, as a result of waves of vacant homes that were foreclosed or abandoned.

The Financial Services Committee is developing a number of proposals to address these growing problems. Given the urgency to take action, a significant portion of the cost of such proposals will likely be incurred in the current fiscal year. However, there would be some loan activities, FHA administrative costs, and additional housing counseling funding that would be needed over the period of the Budget Resolution.

First, the Committee is working on a proposal to provide refinancing opportunities to save as many as 1 million distressed homeowners from having their homes go into foreclosure. Such a proposal will likely involve using FHA and may involve the federal government purchasing loans. It would be implemented through separate authorizing legislation. Any proposal will require the existing holder to write down the loan to a level that is consistent with the homeowner’s ability to pay, and would exclude investor-owned and second homes. The estimated credit subsidy cost could be as much as $15 billion over the next five years. The Committee is also exploring options to limit federal government exposure and thus reduce costs. We could, for instance, require a limited soft second mortgage to the government that would enhance recoveries resulting from future property sales.

Second, the Committee is working on a proposal to provide as much as $20 billion in the form of grants, loans, or a combination of the two, for purchase of foreclosed or abandoned homes at or below market value. The purpose would be to help stabilize home prices and to begin to reverse the serious physical deterioration of neighborhoods with high numbers of subprime borrowers, defaults, and foreclosures. The structuring of such an initiative as a loan program would help to minimize the cost of the federal government, through net recoveries from the subsequent sale of properties.

Third, a substantial expansion of FHA to help keep homeowners in their home will require the contracting out by FHA for independent expertise for the development of underwriting criteria for refinanced loans and for quality control of the loans as they are being made, as well as increased FHA personnel costs for such activities as loan processing. This will require additional FHA administrative funding in the Budget Resolution for FY 2009 and possibly in subsequent years, in an estimated range of several hundred million dollars a year.

Finally, it is important for Congress to increase funding over FY 2008 levels by at least an additional $200 million a year for federal housing counseling grants. Such grants would increase capacity, in order to ensure that sufficient numbers of borrowers are assisted in implementing these and other initiatives to keep people in their homes.
I still have no particular idea where the "one million distressed homeowners" figure comes from, but we can, I think, conclude that it would be a total number of all FHA-related initiatives, including FHASecure and other kinds of fairly straightforward refinance programs, not just a program that involves FHA purchasing an existing loan in order to refinance it.

If the FT has the number right, we're looking at $20 billion for loan purchases. It's hard to calculate how many loans that would be without knowing just what kind of a discount is on the table. If you assumed a 10% discount and an average original loan balance of $200,000, you'd get just over 100,000 loans. At a 50% discount you could buy around 200,000 loans. That's a long way from a goal of one million loans, however you slice it.

On the other hand, there's the potential of several hundred million dollars a year on the table for independent experts who want to write FHA's credit guidelines for them. We knew that was coming.

The sanity level of this kind of plan still depends on why it is we want FHA to buy these loans and then refinance them, as opposed to simply refinancing them. The risk in the buyout, of course, is always that FHA pays too much for the loan; if buyer and seller need to do the full loan-level analysis to calculate the amount of the necessary loan balance to write off before establishing a price, then the practical thing to do at that point is simply a refinance, without FHA ever owning the old loan. If the point is that there isn't time or capacity for current loan holders to do that analysis, then the amount of the discounted price FHA would pay is uncertain at best.

I am also still eager to hear how this proposes to work from the perspective, specifically, of buying loans out of REMIC pools--and that is, presumably, where the problem loans in question are likely to be, not in bank whole loan investment portfolios. REMICs just cannot sell loans at less than par under current rules; without a change to those rules, it seems likely to me that in the process of selling defaulted loans to the government at a discount, the sponsors of these securities are committing themselves to bringing the deals onto their balance sheets, and possibly facing taxation of the trust itself (not just the investors receiving pass-through income). This is one of the several important differences between the current situation and the old HOLC situation in the Depression (where loans were being purchased from banks and were not securitized).

At this point I'm tempted to think it's a lot of additional mess for $20 billion. The Securities Lawyer Full Employment Act probably wasn't what anyone had in mind . .

Tuesday, February 26, 2008

Commentary: Not Your Garden Variety Foreclosures

(Housing Wire) RealtyTrac announced today that foreclosures are up markedly. While the number of foreclosure filings, which includes default notices, auction sales notices, and bank repossessions, rose 8% in January compared to the previous month, the new figures represent a 57% increase compared to a year ago.

While the number of subprime mortgages, especially those that were written in 2006 when rational lending guidelines took a hiatus, is a major factor contributing to this increase, another trend that’s emerging is painting a disturbing picture.

A few days ago, Global Economic Analysis (GEA) posted a screen shot from a particular Washington Mutual Alt-A mortgage pool known as WMALT 2007-0C1. The screen breaks down the pool of mortgages into the typical categories, including delinquencies. Here are some of the highlights from the pool:

Weighted Average LTV = 78%
Fico Score = 705
Full Doc Loans = 11%
Geography = 48% California, 15% Florida

The chart breaks down performance by month, starting with July 2007. By most standards, 705 is a respectable credit score, which makes the delinquency numbers all the more surprising. In a period of 7 months, this pool is showing a massive foreclosure rate of 13.17%. Add REOs into the mix and the figure goes to 15%. Even the vintage 2006 subprime pools didn’t default at such a rapid rate.

GEA poses an interesting question as to whether the FICO system has lost its mind or if maybe there’s a larger issue at work. Although it’s hard to imagine borrowers with a 20%+ equity stake (albeit phantom like) and strong credit scores defaulting at a rate that would lead any servicing portfolio manager to jump out of the nearest window, the numbers seem to indicate that borrowers may be walking away when they are 30 or 60 days delinquent, not even waiting for foreclosure. In December 2007, the 90 days delinquent category stood at 3.79%. Even if every one of these delinquencies became a foreclosure, the figure should only double to 7.58% in January. Instead, the foreclosure figure is 13.17%.

A look at the details shows that nearly 93% of the pool was rated AAA yet almost 15% of the entire pool is in foreclosure or REO after 8 months.

What does it all mean? Until recently, I may have been one of the last holdouts on the FICO bandwagon. I’ve seen enough delinquency reports to make me believe in the ability of FICO to accurately predict performance. But something is terribly wrong with this picture. Credit scores north of 700 have not, in my experience, shown such poor performance levels so quickly. While it’s possible that a deterioration in the underwriting guidelines (e.g. reverses after closing) that we saw on the subprime side became part of the fabric in Alt-A lending, it doesn’t explain these numbers, even if most of them were stated income loans. Unless of course, these were mostly No Doc loans, meaning that most of the borrowers didn’t have jobs. It’s hard to imagine just what was going on in the underwriting department.

If there was ever a doubt that the phenomenon recently dubbed as “jingle mail” actually exists, wonder no more. It’s alive and well. Hopefully, it won’t be still be around around come Christmas time. But given the recent trends, that may be wishful thinking.

OFHEO: HPA diverges between purchases and refis

(Housing Wire) U.S. home prices in the conforming mortgage market diverged sharply depending on whether the mortgage was a purchase or refinance transaction, according to data released Tuesday by the Office of Federal Housing Enterprise Oversight.

A price index looking only at conforming purchase transactions — excluding appraisals used for refinancing — found that prices fell dramatically, dropping 1.3 percent between the third and fourth quarters of last year. That’s a sharp decline when compared to the 0.3 decline posted between Q2 and Q3, and it led to a 0.3 percent annual price decline during 2007 for purchase transactions, OFHEO said.

The annual price decline was the first four-quarter decline in the purchase index since the series began in 1991.

Adding in refinancing appraisals, however, erased any evidence of a price decline: home prices actually appeared headed upwards when refinancing activity was included in the fourth quarter index. As a result, OFHEO’s all-transactions housing price index posted a 0.1 gain in the fourth quarter on a quarter-over-quarter basis, and 0.8 percent gain over the past year.

Evidence of inflated appraisals?
OFHEO director James Lockhart only indirectly addressed the divergence in price trends, saying that the results illustrated greater stability in the conforming mortgage market.

“Both OFHEO’s purchase-only index and the all-transactions index show relatively greater house price stability than do other nationwide house price indexes,” he said. “That may reflect, in part, the greater stability in the prime, conforming mortgage market served by the Enterprises than in other segments of the mortgage market,” Lockhart said.

Or it may reflect inflated appraisals, according to sources interviewed by Housing Wire, who said that appraisers face greater pressure to be aggressive on their valuation opinions when the transaction is a refinance.

During the housing boom, that pressure was to hit a target value often so that the borrower could obtain cash-out from the transaction. During the bust, the new pressure appraisers face may be to hit a target value high enough so that the same borrower doesn’t lose their house.

“You’re not looking at the potential loss of a home if an appraisal comes in too low for a purchase transaction,” said one source, who asked not be named in this story. “So the appraisals are sort of more free there to come in where the appraiser really thinks market value is. That’s not always the case if we’re talking about refinancing in this market.”

The mortgage industry has been under intense pressure from the public and from government officials to help millions of borrowers that are faced with the prospect of a mortgage rate reset refinance into a GSE-backed or government-insured fixed-rate loan. But faced with prices that are declining in many neighborhoods, refinancing has become increasingly problematic as highly-leveraged borrowers find themselves owing more on their house than it is currently worth.

It’s pressure that some industry sources think appraisers feel, even if only indirectly.

“Do you think an appraiser wants to be the reason that someone didn’t get refinanced, and as a result lost their house? No way, no how,” said one source that spoke with HW on the condition of anonymity.

Both Fannie Mae and Freddie Mac, who are regulated by OFHEO, were subpoenaed in November of last year by New York Attorney General Andrew Cuomo, who is suing the First American Corp. over the appraisal practices of its subsidiary eAppraiseIT.

The Wall Street Journal reported Tuesday that both GSEs are nearing a deal with Cuomo’s office that would eliminate broker-ordered appraisals completely, potentially in response to claims that appraisals were being inflated as housing prices rose — and, now, that in some cases they’re being inflated as prices drop.

Monday, February 25, 2008

Reinventing securitization

(Andrew Davidson) ...the current senior/subordinated structure should be revised, simplified or, perhaps, even abandoned. The beauty of the senior/subordinated structure is that the credit quality of the senior classes is based on the quality of the underlying assets, not on the guaranty of any third party. In principle, the diversity of loans in a pool should create a better quality guaranty than even a highly rated corporate guarantor.

The structure works by locking the subordinate investments in place until the senior classes are assured of full payment. To increase the value of the subordinate investments, structures have been devised that allow payments to subordinate investors when that subordination is no longer needed. Herein lies the problem. Issuers, investment bankers, and investors in subordinate classes are always seeking to reduce the amount of credit enhancement and increase the early cash flow to subordinate classes. This has lead to complex overcollateralization targets, multiple triggers, and early step‐down dates. These structures are designed to meet specific rating agency scenarios and may not provide the desired protection in real world scenarios. In addition, the ratings process has lead to the creation of very “thin” classes of subordinate bonds. Some bonds may make up only a small percentage of the total collateral, so when losses rise they can face a complete loss of principal over a very small range of performance change. This makes these bonds extremely difficult to analyze as they may be worth near par or near zero.

The securitization market would function more smoothly if these classes were less complex and were not so finely divided. The “gaming” of rating agency models by underwriters needs to be eliminated. Perhaps it is time to consider whether newer financial tools, such as credit default swaps, could be used to design a more transparent and financially efficient structure.

[Also,] investor capacity to perform independent investment analysis [should be increased]. While there may not be a way to force investors not to rely ratings in making investment decisions, it may be possible to increase the amount of information available to investors to improve the quality of their decision‐making. Over the past few years, too many bonds were sold with insufficient information for investors to form independent views on performance. Ratings should not be a safe harbor against independent analysis. Without detailed loan level information, clear underwriting criteria, and assurances against fraud, it is nearly impossible to form an independent view of a security. The investor’s motto should be: If you can’t assess, then don’t invest.

From the New Deal, a Way Out of a Mess

(Alan Blinder in the NYT) The question of the day seems to be this: Are we in, or heading for, a recession? But so much attention is focused on that question that we may be losing sight of an even greater danger: the possibility that powerful headwinds may prevent a strong recovery from any slowdown.

Most of the potential headwinds stem from the housing slump and related financial crises that began — but, unfortunately, did not end — with the subprime mortgage debacle. Wounded financial markets are supposed to cure themselves: asset prices fall, bargain hunters rush in and markets return to normal. But so far, that doesn’t seem to be happening much. Instead, house prices keep dropping, the mortgage-foreclosure problem grows and new strains in the financial system keep popping up like a not-very-funny version of Whack-a-Mole.

While the problems are multifaceted, I have several reasons for focusing on just one aspect of the mess: the potential tsunami of home foreclosures. First, it strikes home, literally. Foreclosures throw families — some of whom were victims of deception — into the streets. They erode home values, damage neighborhoods and reduce the values of other properties, thereby intensifying the decline in housing prices that underlies many of our current problems. And they might even cut into consumer spending, which would really throw us into recession.

A second reason is that reducing the wave of foreclosures would mitigate the closely related financial crises in home mortgages and the alphabet soup of financial creations based on them (M.B.S., S.I.V.’s, C.D.O.’s, etc.). If those markets perked up, other beleaguered credit markets probably would, too.

A third reason for focusing on foreclosures is that we’ve seen this film before. During the Depression, President Franklin D. Roosevelt and Congress dealt with huge impending foreclosures by creating the Home Owners’ Loan Corporation. Now, a small but growing group of academics and public figures, including Senator Christopher J. Dodd, Democrat of Connecticut, is calling for the federal government to bring back something like the HOLC. Count me in.

The HOLC was established in June 1933 to help distressed families avert foreclosures by replacing mortgages that were in or near default with new ones that homeowners could afford. It did so by buying old mortgages from banks — most of which were delighted to trade them in for safe government bonds — and then issuing new loans to homeowners. The HOLC financed itself by borrowing from capital markets and the Treasury.

The scale of the operation was impressive. Within two years, the HOLC received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages. (Adjusting only for population growth, the corresponding mortgage figure today would be almost 2.5 million.) Nearly one of every five mortgages in America became owned by the HOLC. Its total lending over its lifetime amounted to $3.5 billion — a colossal sum equal to 5 percent of a year’s gross domestic product at the time. (The corresponding figure today would be about $750 billion.)

As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC’s borrowers defaulted anyway. So the corporation eventually acquired ownership of about 200,000 houses, nearly all of which were sold by 1944. The HOLC closed its books in 1951, or 15 years after its last 1936 mortgage was paid off, with a small profit. It was a heavy lift, but the incredible HOLC lifted it.

Today’s lift would be far lighter. And a good thing, too, because our government is far more timid and divided than Roosevelt’s.

Contemporary mortgage finance is also vastly more complex. In the 1930s, banks knew all of their customers, and borrowers knew their banks. Today, most mortgages are securitized and sold to buyers who do not know the original borrowers. Then mortgage pools are sliced, diced and tranched into complex derivative instruments that no one understands — and that are owned by banks and funds all over the world.

But this complexity bolsters the case for government intervention rather than undermining it. After all, how do you renegotiate terms of a mortgage when the borrower and the lender don’t even know each other’s names? This is one reason so few delinquent mortgage loans have been renegotiated to date.

Details matter, so here are a few: First, any new HOLC should refinance only owner-occupied residences. Speculators can fend for themselves — or go into default. Similarly, second homes or vacation homes should be ineligible, as should very expensive real estate. (Precise limits would vary regionally.)

Third, mortgages obtained via misrepresentation by borrowers should be ineligible for HOLC refinancing, but cases of fraud or deception by the lender should be treated generously. Fourth, as the original HOLC found, not all bad mortgages can be turned into good ones. Where families simply can’t afford to be owners, the new HOLC should not be asked to perform mortgage alchemy.

What about the operation’s scale? Based on current estimates, such an institution might be asked to consider refinancing one million to two million mortgages — proportionately less than half the job of its predecessor, and maybe less than a quarter. If the average mortgage balance was $200,000, the new HOLC might need to borrow and lend as much as $200 billion to $400 billion. The midpoint, $300 billion, is one-seventh the size of Citigroup and would rank the new institution as the sixth-largest bank in the United States.

Given current low interest rates, a new HOLC could borrow cheaply and should find it easy to earn a two-percentage-point spread between borrowing and lending rates, for a gross profit of maybe $4 billion to $8 billion a year.

What about loan losses? A 10 percent loss rate, or $20 billion to $40 billion, spread over the life of the institution, seems incredibly pessimistic. (The original HOLC experienced a 9.6 percent loss rate during the Depression.) So the new HOLC seems likely to turn a profit, just as the old one did. But even if it loses a few billion, we must remember its public purpose: to help the economy recover, not to make a buck. By comparison, the new economic stimulus package has a price tag of $168 billion.

It is said that history never repeats itself. But sometimes there are sequels. Now is the time to re-establish the Incredible HOLC.

Sunday, February 24, 2008

Larry Summers on preventing US foreclosures

(FT) The American economic outlook remains highly uncertain. But macro­economic policy is now properly aligned, as the economy will benefit over the next several quarters from fiscal and monetary stimulus. To the extent conditions warrant and inflation risks permit, monetary and fiscal policy are appropriately poised to provide further stimulus.

Policy towards America’s failing housing sector is in a far less satisfactory state. All honest analysts accept that policies adopted so far, such as the “teaser freezer” limits on resetting mortgage interest rates and increased federal support for mortgage lending, have had only a marginal impact on what may be the most serious crisis in housing finance since the Depression.

It appears house prices are down by 5-10 per cent from their peak, with derivatives markets predicting further declines of about 20 per cent. Price falls of this magnitude are likely to mean more than 10m would have negative equity in their homes and more than 2m foreclosures would take place over the next two years.

Foreclosures are extremely costly. Between transaction costs that typically run at one-third or more of a home’s value and the adverse impact on neighbouring properties, foreclosures can easily dissipate more than the total value of the home being repossessed. They also inflict collateral economic damage, as reduced wealth and diminished borrowing capacity in homes reduces consumer spending, increases credit market fragility and depresses local tax bases.

What can public policy do? It cannot and should not try to fix the fact that at current prices the supply of homes significantly exceeds demand or the reality that many own homes, often for speculation, that are no longer viable and should be back on the market.

But it can and should address a crucial issue: when the current owner is able and willing to pay more than the lender can get by foreclosing on a house, it makes no sense to go through with a foreclosure. Yet because of conflicts among lenders, legal uncertainties and concerns about encouraging defaults, there are grounds for fearing that wasteful and unnecessary foreclosures will take place on a large scale, hurting families, communities, the economy and the financial system.

How can this problem be addressed? The string has pretty much been played out on hortatory policy, to limited effect. Without finding ways of writing down mortgage liabilities, new finance will do nothing for the problem group that has negative equity. Direct government intervention in mortgage markets risks creating delays, burdening taxpayers and inhibiting necessary adjustments in house prices.

The right focus is on measures that will prevent unnecessary foreclosures by facilitating more efficient settlements between homeowners and their creditors. Legal changes currently being debated, to bring practice with respect to family homes into conformity with general bankruptcy practice in two areas, could make an important contribution.

First, remarkably, bankruptcy laws currently provide that almost every form of property (including business property, vacation homes and those owned for rental) except an individual’s principal residence cannot be repossessed if an individual has a suitable court-approved bankruptcy plan. The rationale is the prevention of costly and inefficient liquidations. It is hard to see why similar protections should not be prudently extended to family homes.

Critics worry that such measures will dry up the supply of mortgage credit. This is a legitimate concern and the reason why legislation should be carefully and narrowly drafted, to be applicable only to past mortgages where there has been no fraud and where foreclosure is otherwise imminent. But it is worth noting that: some inhibition on lending to those who seem likely to go bankrupt might be a good thing; also, there has been an adequate supply of capital and ability to securitise in the market for vacation and rental housing, where debtors are protected; and moreover, chapter 12 of the bankruptcy code enacted in the mid-1980s, which applied these principles to family farms, helped to resolve great financial distress without long-term costs in terms of reduced farm lending – despite protestations much like those that are heard today.

Second, methods need to be found to enable creditors who accept a writedown in the value of their claims to retain an interest in the future appreciation of the homes on which they have mortgages. This is standard practice in situations of corporate distress, where debt claims are partially replaced by equity claims.

Obstacles to such mortgages include uncertainties about tax and accounting rules. But at a time when there are great advantages to inducing lenders to let families to remain in their homes – and when families facing foreclosure are prepared to do things they might not do in ordinary times – it would be desirable to pursue suggestions by the Office of Thrift Supervision for so-called negative equity certificates to support shared appreciation work-outs.

Bankruptcy reform alone could, on some estimates, avert 500,000 foreclosures and, by establishing templates for renegotiation, aid a wider restructuring of mortgage debts. Proper support for voluntary restructurings involving interests in future appreciation should realise still greater benefits. As with fiscal stimulus, rapid bipartisan co-operation between Congress and the administration would benefit the financial system, the real economy and millions of Americans.

Recommendations for fixing mortgage securitization

(Tanta at Calculated Risk) I am generally impressed with the quality of Andrew Davidson & Co.'s analysis of mortgage securitization issues. This particular instance, however, leaves me shaking my head. Certainly I give them credit for trying to find constructive suggestions to make, but I don't think we've drilled down far enough into the issues yet.

This does start out right, I think:

The standard for assessing securitization must be that it benefits borrowers and investors. The other participants in securitization should be compensated for adding value for borrowers and investors. If securitization does not primarily benefit borrowers and investors rather than intermediaries and service providers, then it will ultimately fail.
The trouble is that the standard case for how securitization of mortgages benefits borrowers is simply the observation that it makes capital available for lending at reasonable rates of interest. But that's hardly a benefit if it makes too much capital available for lending at too cheap a cost: supply chases down ever more implausible types of borrowers with ever more implausibly "affordable" mortgages, with ever more aggressive solicitation tactics. We're all learning a lot about the costs to all of us of unlimited mortgage money being provided to the financially weakest of us. Therefore securitization's benefits have to be more than just the provision of capital and the lowest possible interest rates; if securitization cannot function to rationalize lending practices by creating "best practice" lending guidelines and loan product structures outside of which its generous capital is not available, then it always has the potential to blow devastating bubbles.

There's a lot in this essay, but for the moment I just want to focus on the analysis and recommendation for dealing with the front-end part of the problem:
At the loan origination stage of the securitization process, there was a continuous lowering of credit standards, misrepresentations, and outright fraud. Too many mortgage loans, which only benefited the loan brokers, were securitized. This flawed origination process was ignored by the security underwriters, regulators, and ultimate investors. . . .

First, originators should be held responsible for the quality of the origination process. Investors in mortgage‐backed securities rely on the originators of loans to create loans that meet underwriting guidelines and are free of fraud. Borrowers rely on originators to provide them with truthful disclosures and fair prices.
Notice how, in the first paragraph, we slip in the first two sentences from "the quality of the origination process" (something quite obviously under the control of the originator) to "underwriting guidelines," which in any securitization practice I know of are either outright stipulated by the issuer in all respects (Ginnie Maes, standard-contract Fannies and Freddies, a lot of private pools) or are at best negotiated between lender and issuer (most private pools, some GSE business). Once the guidelines are either published by the issuer or agreed to in negotiation between issuer and originator, then it is indeed the originator's job to meet them.

But a whole lot of these loans that are failing right now were originated as 100% CLTV stated-income loans, because the guidelines agreed to by the issuer allowed that. I am scratching my head over the logic here: I spent most of the early years of this decade, just as a for instance, blowing my blood pressure to danger levels every time I looked at the underwriting guidelines published by ALS, the correspondent lending division of Lehman. ALS was a leader in the 100% stated income Alt-A junk. And I kept having to look at them because my own Account Executives keep shoving them under my nose and demanding to know how come we can't do that if ALS does it. I'd try something like "because we're not that stupid," and what I'd get is this: "But if ALS can sell those loans, so can we. All we gotta do is rep and warrant that they meet guidelines that Wall Street is dumb enough to publish." Every lender in the boom who sold to the street wrote loans it knew were absurd, but in fact they had been given absurd guidelines to write to. What on earth good did it do to have those originators represent and warrant that they followed underwriting guidelines to the letter, when those guidelines allowed stated income 100% financing on a toxic ARM with a prepayment penalty?
Currently, investor requirements are supported by representations and warranties that provide for the originator to repurchase loans if these requirements are not met. However, when there is a chain of sales from one purchaser to another before a loan ends up in a securitization, investors may find it hard to enforce these obligations. Similarly, borrowers who have been victimized by an originator may have nowhere to go to seek redress if the company that originated their loan goes out of business. Some in Congress are proposing “assignee liability” as a solution to this problem.
Investors don't "find it hard to enforce these obligations" unless they did zero financial due diligence on the last party in the chain. The way it works, your contract is with the last party to own the loan. If you bought loans from Megabank who bought them from Regional Bank who bought them from First Podunk who bought them from Loans R Us who funded the application for a broker, your contract is with Megabank and if the reps are false, Megabank supplies the warranty (the repurchase or indemnification). Megabank can go collect from Regional, who can go collect from Podunk, as far back as it takes to find the original misrep. It's always possible, of course, that the broker made true reps to Loans R Us, who made true reps to Podunk, but it was Podunk who misrepped to Regional (because Podunk bought under a set of guidelines that might have worked with some other investor, but then decided to slip these loans into a deal with Regional, even though Regional published different rules). The assumption that it is in fact always the first originator (the one who closes the loan) who fails to follow guidelines is a huge logical flaw. The contract theory underlying this--that A in contract with B can enforce terms against D who was in contract with C who was in contract with B--startles me as well.

This necessity of "chained pushbacks" certainly does cause grief: eventually, bad loans get back to the originator, but not nearly soon enough. It could take two years for the thing to work through, and delaying negative consequences is never a good thing in terms of keeping incentives aligned properly. But it doesn't hurt investors: they get paid back at par right away from the first party in the chain. In fact, that may explain why, as a rule, they've never particularly cared about the whole problem of "aggregating," or having whole loans work their way from small local originators into the hands of large financial institution counterparties before they are securitized. The investors think, more or less correctly, that their risk is covered because while the loans might have been originated by Loans R Us, net worth $37,000, they were sold to the investor by Megabank, net worth o' billions, and that takes care of the counterparty risk. Which is to say, it puts the counterparty risk on Megabank, who puts in on Regional, etc.

The obvious thing for security issuers to do, if they want direct liability of the loan originator, is to buy the damned loan from the loan originator. Or, maybe:
Assignee liability, however, may create risks for investors and intermediaries that they are unable to assess. As an alternative to assignee liability, an updated form of representations and warranties – an origination certificate – would be a better solution. An origination certificate would be a guaranty or surety bond issued by the originating lender and broker. The certificate would verify that the loan was originated in accordance with law, that the underwriting data was accurate, and that the loan met all required underwriting requirements. This certificate would be backed by a guarantee from the originating firm or other financially responsible company.

The origination certificate would travel with the loan, over the life of the loan. By clearly tying the loan to its originators, the market would gain a better pathway to measure the performance
of originators and a better means of enforcing violations. Borrowers would also have a clear understanding of whom to approach for redress of misrepresentations and fraud.

While risk arising from economic uncertainty can be managed and hedged over the life of the loan, the risks associated with poor underwriting and fraud can only be addressed at the initiation of the loan. Such risks should not be transferred to subsequent investors, but should be borne by those who are responsible for the origination process.
Wall Street security issuers don't want to buy loans directly from any given originator, because that would require them to have loan purchase and sale agreements with a bazillion little counterparties. They like the idea that Megabank has agreements with one hundred counterparties, who each has agreements with one hundred counterparties, etc. The cost of all this managing of relationships and moving loans up into the biggest buckets--the "aggregator" bucket--never goes away, it just isn't carried operationally by Wall Street.

So the idea here is to keep the middle-men and intervening aggregation of whole loans, but to make sure the original party who closed the loan never gets off the hook by having that party issue some kind of surety bond that would be guaranteed by somebody. So Loans R Us, assuming it has enough capital to back a guarantee, issues this certificate stating that it followed ALS underwriting guidelines to the letter. The loan blows up because ALS underwriting guidelines are stupid. Now what?

And of course this is simply meaningless in the context of originators who go out of business. Go ask the monolines how much a credit guarantee is worth if the counterparty doesn't have any money. As it currently is, regulated depository loan originators are required to reserve for contingent liabilities on loan sales: if you have the risk you might have to repurchase a loan, you have to reserve something for that. State-regulated non-public non-depositories may not have such strict requirements, or may not have them enforced. So if you want to assure that originators appear to have the financial strength to make reps and warranties, then you need to look into financial and accounting requirements for originators. Forcing them to come up with a surety bond--putting investors ahead of the originator's other creditors in a potential bankruptcy because said investors don't want counterparty risk--is a bit much.

That's one of those few cases were you can, in fact, pretty much guarantee that credit costs to consumers will rise unnecessarily. If you just want originators to keep skin in the game, there's this old-fashioned way of securitizing loans called "participations" that you might look into. In that case, the investor only buys a fraction of the loan asset (not a fraction of a security, a fraction of a loan), with the originator retaining some percentage interest. That shares the risk between two parties, but also the reward: if you retain a 10% participation interest in a loan you sell, you get 10% of the monthly payment. If you buy 100% of a loan and collect 100% of the payment, and yet you force the seller of the loan to warrant its risk forever, that seller will find some way to be compensated for that--meaning more points and fees to borrowers.

The idea of assignee liability is that you did, in fact, agree to a set of underwriting guidelines when you bought loans or invested in a pool of loans. If you agreed to guidelines which are harmful to borrowers, then this capital you are pouring into the mortgage market is not helping borrowers. The essential confusion here is between failure to follow responsible guidelines and faithful following of irresponsible guidelines. My sad news for the investment community: a whole lot of what you are suffering from is the latter, not the former.

How can anyone possibly require more proof of that? Starting in 2007, investors rapidly pulled out of the 2/28 ARM subprime product. They just announced they wouldn't buy it any longer. And it went away. You do not have a bunch of mortgage brokers still selling 2/28s to borrowers, or correspondent lenders still throwing 2/28s into new securitizations. As you might have noticed, you don't have new securitizations. You always had the power to click your heels together three times and return to the land of just not buying the paper, but I guess you didn't know that until the pink witch showed up.

And you will note that what immediately happened after you all stopped agreeing to those goofball underwriting guidelines was that a bunch of marginal originators immediately went belly-up. That's all the business they could get: writing junk paper for foolish investors. You put them out of business. You should not be sorry about that, except for the part about how you did business with them for so long that now you might have a bunch of worthless contractual warranties. This is called learning by doing. The solution to it is not to go back to buying any old dumb loan that you can get someone to offer a warranty on.

The solution is for investors to refuse to get within 20 feet of a mortgage-backed security that is backed by dumb loans. If you do not know what a dumb loan is, you might want to consider investing in a different kind of instrument. If the guidelines are not dumb, then by all means hold those originators to every last dotted i and crossed t in their contracts, because it is true that the quality of the process is what the originators control. But if you tell them it's OK for them to make loans without seeing docs, without requiring down payments, without worrying about ability to repay, then that is what you get and what we all get.

ARMed and dangerous

ATHENS, Ga., Feb. 22 (UPI) -- A gun-wielding man in a ski mask robbing a Georgia bank told a teller he wanted payback for losing his house to foreclosure.

The robbery occurred at a Regions Bank branch in Athens just before noon Thursday, the Athens Banner-Herald reported.

"You took my house, now I'm going to take your money," the robber told the teller as he pointed a gun at her, Police Capt. Clarence Holeman said.

Holeman said that the FBI, which is investigating the robbery, would probably check bank records. Bank officials said they could not remember anyone who had been especially upset about losing a house.

Witnesses said the man was middle-aged and 5 foot, 9 inches to 6 feet tall. He took off the mask after leaving the bank, revealing sandy blonde hair.

A man who had been sitting in his truck filling out a deposit slip followed him but lost him when he entered a driveway a few blocks away.

Saturday, February 23, 2008

Stimulus Plan Aids Buyers of High-Priced Homes

(NY Times) Elizabeth and Ben Kilgore are back in the real estate market. All it took was a little-publicized section of the economic stimulus package President Bush signed into law last week that lowered the borrowing cost of buying a more expensive home.

The Kilgores, who live in Tiburon, Calif., just north of San Francisco, are looking for a larger home in town for their growing family. Three years ago, when they bought their first home, they resigned themselves to buying a condominium because it meant taking out a mortgage they knew they could manage.

“This will push us into a price range that’s now financially possible,” said Ms. Kilgore, a real estate agent in Marin County.

And if the limit on loans backed by a government-backed housing finance entity like Fannie Mae is raised from $417,000 to the full $729,750 she has been hearing about, Ms. Kilgore said, “we will be able to get a 30-year fixed mortgage for less than what we’re paying now plus our homeowner’s dues.”

The temporary change in the loan limits is not about to revive the housing market on its own. But in some of the higher-priced regions of the country that have been hit hardest by the flagging real estate market, it could make a big difference. For if anything is going to breathe new life into the local housing economy in places like the San Francisco Bay Area, San Diego, Washington and Boston, it is home buyers emboldened by the prospect of larger loans at lower interest rates.

Daniel Billett, a mortgage broker in Seattle, where homes in the downtown area sell for a median price of around $400,000, said that he, like dozens of people he knows, is poised to refinance an existing jumbo loan at a lower interest rate.

“As soon as the loan limits are implemented and lenders are accepting applications. I’ll be the first in line,” said Mr. Billett, whose company, Response Mortgage Services, has been receiving a steady stream of inquiries from clients in recent weeks. “I’m going to save hundreds, and I mean hundreds, of dollars every month on my current jumbo loan, by switching to a conventional loan.”

For years, rates on jumbo loans, those for more than $417,000, were only slightly higher than rates on conforming loans at or below that limit. But now, with the interest rate on conforming loans at around 6 percent, sometimes less, jumbo loans are at least a percentage point higher.

“The difference is as big as it’s ever been,” said Bart Welles, a mortgage broker in Larkspur, Calif.

For a high-priced home, 1 percent can make a big difference. A monthly payment on a jumbo 30-year loan of $729,000 at 7 percent would be $4,850. Monthly payments on a conforming loan of the same amount, at 6 percent, would be $4,371, a $479 difference.

As the credit squeeze deepens, lenders have been reluctant to underwrite jumbo mortgages. That leaves houses languishing on the market, further depressing an already distressed housing market.

The change in loan limits, which allows the federal housing agencies Fannie Mae and Freddie Mac to purchase or guarantee the mortgages, is intended to encourage lenders to write more mortgages because they can easily sell them to the agencies.

It should also stimulate house buying and mortgage refinancing. As the thinking goes, once people start borrowing money, they will set back into motion the economic machine of brokers, agents and lenders that has been stalled for the past year and has helped stall the overall economy.

“Of all the various strategies proposed to help the housing market,” said Gus Faucher, director of macroeconomics at Moody’s, “I think this one has the greatest potential, particularly for expensive housing markets.”

The change in loan limits will go into effect sometime in early March and will last at least through the end of the year. In areas where median prices do not exceed $271,050, such as the entire state of Alabama, the basic loan limit will be $271,050.

In areas where the median sales price is higher, the limits will rise to 125 percent of the median price, not to exceed $729,750. (The rules defining which locations qualify and where the borders of the areas will be drawn to determine the appropriate median price are to be written by the federal Department of Housing and Urban Development.)

High-priced housing markets — particularly much of coastal California, with some of the most expensive real estate in the nation — would benefit the most. In a state like California, or in the Northeast and Northwest, where home prices far exceed the national median of about $206,000, jumbo loans are a significant portion of the mortgage market.

In San Francisco, where the median home price is $777,000, 35 percent of all loans were nonconforming, according to First American CoreLogic, a data and analytics company in Santa Ana, Calif.

The anticipated stimulative impact is all the more important because prices are falling sharply. Prices have dropped 20.4 percent over the past year in Contra Costa County, east of San Francisco, and 13.1 percent in neighboring Alameda County, according to DataQuick Information Systems.

Indeed, California is probably the state hardest hit by the housing slump. As inventories rose in most cities, the median price dropped 16.9 percent from May to December, according to DataQuick. (Prices are still high; the California Budget Project, a public policy advocacy group, estimated that a family would need an annual income of $196,878 to afford the median-priced home in San Francisco.)

Across the state, homeowners stuck with high interest rates and potential homeowners who are still searching are watching the situation closely.

The window in the new law is short. But Mr. Faucher, the economist, said that if problems in the market continued, particularly in expensive markets, he would not be surprised to see the higher loan limits extended. “There’s nothing set in stone,” he said.

At first, the strongest interest is expected to come from people refinancing existing loans. In Berkeley, Calif., where the median home is worth about $776,000, MPR Financial, a mortgage brokerage firm, has received dozens of calls from clients asking about the possibility of refinancing their existing loans.

“Quite a few people who got their loans when the rates were higher have called in,” said Paul Riccardi, the firm’s president. “We tell them we have their application, and we’ll have it ready to go.”

In other places where housing prices are high, there is a similar anticipatory buzz about a change in the conforming loan cap.

In San Diego, real estate activity has dropped off noticeably in the past year. According to DataQuick, the number of homes sold in San Diego in January dropped 34 percent from a year ago. A change in the conforming loan limit could give a much-needed boost to the market, said Jim Abbott, a real estate agent there.

“The availability of jumbo loans was so easy,” Mr. Abbott said. “Now they’re not, and it’s really exacerbated the problem. But I don’t think anyone is counting on it until it actually happens.”

Jim Byrnes, a real estate agent in Palo Alto, Calif., where pegs the median home value at $1.4 million, said he had two clients who were first-time home buyers and were waiting for the new law to take effect.

“They’re literally waiting on the sidelines to see what happens,” he said. “If they can get a better interest rate it will make their path so much easier.”

Of course, prices for some houses in certain California enclaves and other luxury locations remain so stratospherically high that a change in the conforming loan limit, no matter how drastic, would have little effect.

“It won’t make so much difference here,” said Edna Sizlo, a real estate agent in Santa Barbara, Calif., where the adjacent suburb of Montecito has homes valued at a median $4.1 million, making them among the most expensive in the nation. “There’s nothing you can even live in for under $1 million.”

A ‘Moral Hazard’ for a Housing Bailout: Sorting the Victims From Those Who Volunteered

(NY Times) Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”

But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

But a growing number of policy makers and community advocacy activists argue that a government rescue may nonetheless be the most sensible way to avoid a broader disruption of the entire economy.

The House Financial Services Committee is working on various options, including a government buyout. The Bush administration may be softening its hostility to a rescue as well. Top officials at the Treasury Department are hoping to meet with industry executives next week to discuss options, according to two executives.

“There are a lot of ideas out there,” said Scott Stanzel, a spokesman for President Bush, when asked at a White House press briefing on Friday about a possible buyout program. “There are many different ways in which we can address this problem and we continue to look at ways in which we can do that.”

Supporters contend that a government rescue could be the fastest and cleanest way to force banks and investors to book their losses from bad mortgages — a painful but essential first step toward stabilizing the housing market.

The government would buy the mortgages at their true current value, perhaps through an auction, at what would probably be a big discount from the original loan amount. The mortgage lenders, or the investors who bought mortgage-backed securities, would be free of the bad loans but would still have to book their losses.

If the government took control of the bad mortgages, supporters of a rescue contend, it could restructure the loans on terms that borrowers could meet, keep most of them from losing their homes and avoid an even more catastrophic plunge in housing prices.

“Every citizen has a dog in this hunt,” said John Taylor, president of the National Community Reinvestment Coalition, a community advocacy group that has developed its own mortgage buyout plan. “The cost of spending our way out of a recession is something that everybody would have to bear for a very long time.”

Mr. Taylor estimated the government might end up buying $80 billion to $100 billion in mortgages. But he said the government could recoup its money if it was able to buy the mortgages at a proper discount, repackage them and sell them on the open market.

Surprisingly, the normally free-market Bush administration has expressed interest. Treasury officials confirmed that several senior officials invited Mr. Taylor to present his ideas to them on Feb. 15. Mr. Taylor said he had also received calls from officials at the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which is part of the Treasury Department.

But even supporters acknowledge that a government rescue poses risks to taxpayers, who could be left holding a very expensive bag.

Ellen Seidman, a former director of the Office of Thrift Supervision and now a senior fellow at the moderate-to-liberal New America Foundation, said the government’s first challenge is to buy mortgages at their true current value. If the government overpaid or became caught by an even further decline in the market value of its mortgages, taxpayers would indeed be bailing out both the industry and imprudent home buyers.

“It’s not easy, but it’s not impossible,” Ms. Seidman said. “There are various auction mechanisms, both inside and outside government.”

A second challenge would be to start a program quickly enough to prevent the housing and credit markets from spiraling further downward. Industry executives and policy analysts said it would take too long to create an entirely new agency, as Bank of America suggested. But they expressed hope that the government could begin a program from inside an existing agency.

But even if the government did buy up millions of mortgages and force mortgage holders to take losses, the biggest problem could still lie ahead: deciding which struggling homeowners should receive breaks on their mortgages.

Administration officials have long insisted that they do not want to rescue speculators who took out no-money-down loans to buy and flip condominiums in Miami or Phoenix. And even Democrats like Representative Barney Frank of Massachusetts, chairman of the House Financial Services Committee, have said the government should not help those who borrowed more than they could ever hope to repay.

But identifying innocent victims has already proved complicated. The Bush administration’s Hope Now program offers to freeze interest rates for certain borrowers whose subprime mortgages were about to jump to much higher rates. But the eligibility rules are so narrow that some analysts estimate only 3 percent of subprime borrowers will benefit.

Bank executives, meanwhile, warn that the mortgage mess is much broader than people with subprime loans. Problems are mounting almost as rapidly in so-called Alt-A mortgages, made to people with good credit scores who did not document their incomes and borrowed far more than normal underwriting standards would allow.

Borrowers who overstated their incomes are not likely to get much sympathy. But industry executives and consumer advocates warn that foreclosed homes push down prices in surrounding neighborhoods, and a wave of foreclosures could lead to another, deeper plunge in home prices.

Right or wrong, the arguments for rescuing homeowners are likely to be blurred with arguments for rescuing home prices. At that point, industry executives are likely to argue that what is good for Bank of America is good for the rest of America.