Saturday, January 31, 2009

Why Be a Nation of Mortgage Slaves?

By Ramsey Su in the Wall Street Journal:

Preventing foreclosures has become a top priority of politicians, economists and regulators. In fact, allowing foreclosures to happen has merit as a free-market solution to the crisis.

If the intent is to help homeowners, then foreclosure is undoubtedly the best solution. Household balance sheets have been destroyed by taking on too much debt via the purchase of inflated assets. With so little savings, a household with negative equity almost implies negative net worth. Walking away from the mortgage immediately repairs the balance sheet.

Credit may be damaged, but homeowners can rebuild it. And by renting something they can afford, instead of the McMansion they cannot, homeowners are most likely to have some money left over each month that they can save toward a down payment on a house they can eventually afford.

If the intent is to help the credit markets, then foreclosure is undoubtedly the best solution. The securitization model has proven to be flawed. Slicing loans horizontally into tranches created asset classes that have conflicting interests in a dissolution strategy of the same underlying asset. The holder of a senior tranche would be agreeable to modification, since his position is secured; the holder of a junior tranche would essentially be wiped out. The lower tranches are worthless but are still legally an encumbrance, hindering any type of sale or work-out effort.

Consider a property that sold for $500,000 at the peak, financed with a $400,000 first lien and an $80,000 second lien, which is now worth $300,000. The second lien is worthless, but the lien will remain as a cloud which complicates any modification effort by the senior lien holder. There is no incentive for the junior lien holder to voluntarily agree to a modification. Foreclosure would be the best and finite action. It wipes the slate clean.

What is the market telling us? Dataquick recently released December sales data for Southern California, once the hotbed of speculative excesses supported by nontraditional financing. Foreclosures now dominate sales. Prices are down. Sales volume is up. New home construction is down. These are beautiful textbook illustrations of supply and demand driving price and market equilibrium.

Toxic financing abruptly stopped during the spring of 2007. By that summer, there were no more 100% financing, negative amortization option ARMs, piggyback seconds, or the now-infamous NINJA (no income no job no assets) loans. Even though real-estate prices have continued to decline, post summer 2007 purchases are by a different class of buyers financed by loans with much tighter underwriting guidelines. We are at a crossroads. The time line of the default and foreclosure cycle is about to hit 2007 vintage loans. If the default rate on them is lower than for loans made from 2004 to early 2007, it would be the confirmation of a turning point.

Foreclosures provide the foundation of recovery, both for Main Street and Wall Street. As properties are foreclosed, they can move from weak hands to strong hands. Households that have been foreclosed upon today are the buyers of tomorrow, when given a chance to recover.

The replacement of credit flow is not all about money. It is about a new system of delivery that will provide clean guidelines, so there will be a reliable source for borrowers based on sound underwriting standards and a product that fixed-income investors have confidence in buying.

With the government in total control of the Federal Housing Administration, Fannie Mae and Freddie Mac, this is the perfect opportunity to reform the secondary market.

Finally, loan modification is not only ineffective, it is evil. Coercing borrowers to continue paying a mortgage on a home that is hopelessly overvalued and not informing them of alternatives is predatory lending.

The media should interview those who had been foreclosed upon. Do they feel sorry or relieved? Are they rebuilding their credit, not to mention their lives? Do they miss the pressure of having to make payments they cannot afford on a McMansion that belongs to the lender?

The intent of modification programs to date is to create a generation of mortgage slaves. Fortunately, mortgage slaves can free themselves via foreclosure, and the masses are choosing to do so.

Friday, January 30, 2009

Are you a bankruptcy risk? Enigmatic score may tell lenders

By Jeremy M. Simon at

It's a number that lenders may consider when deciding whether or not to lend you money, but it isn't the well-known credit score. Meet the bankruptcy score, the credit score's more mysterious cousin.

While the popular FICO credit score gives lenders an indication of how likely a borrower is to repay a loan, a bankruptcy score -- as the name implies -- suggests how likely a consumer is to file for bankruptcy. "Lenders are in business to extend credit to borrowers, not to refuse them credit. Lenders use tools like bankruptcy scores to protect their ability to stay in business and continue offering credit at competitive rates," says Craig Watts, spokesman for FICO score creator Fair Isaac Corp., which also produces bankruptcy scores. Fair Isaac's Web site notes that its bankruptcy scores can be used in combination with FICO scores to "sharpen" a lender's risk assessment.

Bankruptcy scores remain secret
What gives the bankruptcy score its air of mystery? For one, bankruptcy scores, unlike credit scores, remain unavailable to the general public. The credit industry isn't hiding the score's existence. For example, Fair Isaac's Web site says, "Like FICO scores, Fair Isaac Bankruptcy Scores include reason codes that can be used in notifying the consumer about the factors that led to a credit decision."

But unlike its credit scores, which can be purchased many places, the company won't tell consumers their bankruptcy scores. Other companies that have their own versions of these scores take a similar approach.

"Financial institutions do not normally provide bankruptcy prediction and other internal management scores to their customers," says Steven Wagner, president of Experian Consumer Information Services. Still, Wagner says financial institutions are required to let consumers know the reason their application for credit was denied, such as due to a deficient bankruptcy score.

Meanwhile, lenders are also hesitant to discuss their use of these scores. Banks contacted for this article were unwilling to provide much comment on the subject. "We use various analytics and look at a number of factors to determine credit risk. We do not comment, however, on our proprietary modeling," says HSBC spokeswoman Cindy Savio. Nevertheless, it seems clear that bankruptcy scores are used when considering credit card applications: Fair Isaac's Web site promotes its bankruptcy score as "an effective tool for retail cards, bank cards and other revolving accounts, as well as for installment loans, telecommunications/utilities accounts and other credit portfolios."

Further complicating the picture is that, unlike with credit scoring, there isn't a single, commonly used bankruptcy score. "There are a lot of bankruptcy scores out there," says Gregg Weldon, chief analytical officer with AnalyticsIQ Inc. in Atlanta. For example, credit bureau Equifax's Bankruptcy Navigator Index (BNI) uses scores that range from 1 to 300, with a higher score indicating a lower predicted risk, according to a report by personal finance writer Liz Pulliam Weston. Meanwhile, Experian and Visa offer BankruptcyPredict, a bankruptcy score that "uses patented technology and processes to create a more comprehensive view of consumers most likely to drive bankruptcy losses over the next 24 months," according to its Web site. BankruptcyPredict scores range from 50 to 950, with a lower number indicating a higher risk of bankruptcy, Experian's Wagner says.

Improving your bankruptcy score

Because borrowing behavior plays into the calculation of both traditional credit scores and bankruptcy scores, credit cardholders may want to take the following steps to lessen the odds a lender will view them as a bankruptcy risk:

  • Make on-time payments. A rash of recent delinquencies can signal that a consumer is headed for bankruptcy. By staying current with their credit card bills, cardholders should be able to improve their bankruptcy score.
  • Maintain a low credit card balance. Consumers who go bankrupt tend to borrow up to their credit limit in order to pay for expenses. Therefore, a cardholder's bankruptcy score may benefit from keeping a low utilization ratio, or the amount of credit used compared to the amount of total credit available.
  • Don't apply for too much credit in too short a time. A rush to secure additional lines of credit can signal danger to potential lenders. Consumers should therefore spread credit applications out over a longer timeframe if at all possible.

All of this is proof that the bankruptcy score remains far less mature than the credit score. "Bankruptcy scores are where traditional risk scores were 20 years ago," says Weldon, who built generic and custom models for Equifax in the mid- to late-'90s. He says that while developments in the economy and bankruptcy law have brought about changes in the number of bankruptcy filings -- nearly 2 million bankruptcy petitions, a record number, were filed in 2005 ahead of the enactment of a bankruptcy law reform -- bankruptcy scores remain more "piecemeal," with various private companies and credit bureaus using their own bankruptcy scoring models, Weldon explains.

Credit score versus bankruptcy score
Although they attempt to predict different outcomes, credit scores and bankruptcy scores have much in common. "Fair Isaac's bankruptcy scoring models use consumer credit reports as input, just as the FICO score does," says Fair Isaac's Watts. Other bankruptcy scores also incorporate information from the credit bureaus. BankruptcyPredict, which became commercially available as a subscription service in early 2008, uses a "combination of credit reporting agency attributes and trending data, as well as transactional behaviors such as credit card transaction amounts, merchant category codes and cash advances," according to Experian's Web site.

"By using both credit data from Experian and transaction data from Visa, a financial institution can make more informed account management decisions, including when to intervene with education or other actions that may relieve financial distress and prevent a consumer from filing bankruptcy," says Susan Henson, Experian's director of public relations."With greater risk information, financial institutions can better target incentives such as reduced fees and financial education for those having financial difficulties," Henson says. According to Wagner, that Visa transactional data includes date and time of transactions, whether a transaction was approved or denied, merchant category codes and the transaction's dollar amount.

The overlaps mean certain behaviors -- such as keeping balances low, making payments on time and avoiding too many applications for new credit -- should benefit both types of scores. "When it comes to improving bankruptcy scores or any other type of credit score, consumers should follow the same golden rules ... since almost all credit scores, in some fashion, measure how consumers pay their bills, the length of time they have managed credit well and the types of credit they are managing," Experian's Henson says.

Despite the common ingredients, the "two types of models evaluate credit information differently since they are designed to predict different things," Fair Isaac's Watts says. According to Weldon, the "strength of those variables is different for bankruptcy models."

For example, the number of recently delinquent accounts (such as during the past six months) may be more closely watched by bankruptcy models, Weldon says. He also says bankruptcy scores may put added weight on carrying a heavy debt burden from month to month. In the case of people who go bankrupt, "they are actually utilizing their credit much more than the traditional 'bad'" credit borrower, Weldon says, noting that these borrowers tend to live on their credit cards until they can no longer make payments and then file for bankruptcy. This fact is reinforced by research conducted by Weldon and David R. Kelly showing that the typical bankrupt consumer utilizes 65.99 percent of their revolving credit, compared with the typical bad credit borrower who uses 52.71 percent.

Weldon says bankruptcy models also stress the application for new lines of credit, since borrowers who end up bankrupt typically scramble for added funds as earlier sources of money dry up. His research shows that the typical bankrupt consumer initiates 3.77 new lines of credit in the 24 months leading up to his bankruptcy filing. That's compared with 2.78 new lines of credit in a 24-month period for the typical bad credit borrower. When it comes to bankrupt consumers' credit lines, "they've maxed out all the previous ones, and they've maxed out the new ones as well," he says.

Bob Lawless, a bankruptcy expert and University of Illinois law professor, agrees with those conclusions. Since consumers will attempt to borrow until they can no longer do so, "the inability to borrow further often determines the timing of their filing" for bankruptcy, he says. Lawless says there is no disincentive for consumers to stop borrowing as they approach a bankruptcy filing. "You can't become more bankrupt by borrowing more," he says.

Lenders are in business to extend credit to borrowers, not to refuse them credit. Lenders use tools like bankruptcy scores to protect their ability to stay in business and continue offering credit at competitive rates.

-- Craig Watts
Spokesman, Fair Isaac

The unique traits of potentially bankrupt consumers mean the added scoring models are needed by lenders. "The FICO score is really good for telling you who will pay on time and who won't. But it won't tell you who is going to pay on time and who is also going to go bankrupt," Weldon says.

Lenders pay the costs for consumer bankruptcy
Bankruptcy scores attempt to predict an outcome that costs lenders much more than a mere charge-off. When an account gets charged off, the lender can still attempt to collect the money associated with that account, or the outstanding debt can be sold to a debt collection agency. "There is a lot of flexibility with what you can do with someone like that," says Weldon.

Not so when the borrower goes bankrupt. In cases of bankruptcy, the consumer's debt becomes a legal issue. "Once the court gets involved, your hands are tied," Weldon says. Although Weldon says bankruptcy models usually don't distinguish between the two main types of consumer bankruptcy, whether the borrower files for Chapter 7 or Chapter 13 bankruptcy does matter, Lawless says, with the lender able to recover some funds under a Chapter 13 filing. "It seems what the lender really wants to know is how much money they are going to recover," he says.

Furthermore, the lender stands to lose a significant amount. Bankruptcies tend to involve much larger amounts of money than charged-off accounts, since the borrower often runs up the maximum amount of his or her credit line before declaring bankruptcy, Weldon says.

Role of the bankruptcy score
Scoring models attempt to help lenders head off these threats. Fair Isaac's scores "are designed to predict bankruptcy far enough in advance for action to be taken, while there are still losses to be prevented," according to the company's Web site. Meanwhile, Experian and Visa's BankruptcyPredict enables lenders to take "preemptive actions to minimize bankruptcies that erode your profits," according to Experian's Web site. The product lets customers "choose daily monitoring to take immediate action on high-risk accounts and mitigate exposure. Utilize month-to-month management across your entire portfolio to assess where changes are occurring and apply the most appropriate strategies." That means more risky borrowers get watched more closely.

The scores do not only aim to reduce losses, but to help the lender maximize profits as well. "Fair Isaac Bankruptcy Scores enable you to separate accounts with a high risk for large bankruptcy losses from accounts that look risky but will be highly profitable accounts," the Web site says.

Lawless sees bankruptcies rising to 1.4 million for 2009, up from around 1.1 million last year. If his and other expert predictions are correct, lenders will undoubtedly rely on bankruptcy scores to help chart the most profitable passage through rough economic seas.

The creators of bankruptcy scores agree. "In these challenging economic times, it is critical for banks to be able to discern real risks and to be able to continue to lend to those that pose less risk," says Experian's Wagner. "Lending needs to continue -- for the good of the economy, our financial system and consumers."

The ultimate mortgage loan modification scheme!

(AP) A fired Fannie Mae contract worker pleaded not guilty on Friday to charges he planted a virus designed to destroy all the data on the mortgage giant's 4,000 computer servers nationwide, according to federal prosecutors.

If the virus had been released as planned on Saturday, the Justice Department said the disruption could have cost millions of dollars and shut down operations for a week at the largest U.S. mortgage finance company.

Rajendrasinh B. Makwana, 35, of Glen Allen, Va., pleaded not guilty Friday in U.S. District Court in Baltimore to one count of computer intrusion, the U.S. attorney's office said.

Makwana's federal public defender did not immediately return a call seeking comment on the allegation.

Makwana, a citizen of India, was fired early on the afternoon of Oct. 24 from his job at Fannie Mae's data center in Urbana, about 35 miles from the company's Washington headquarters, according to court records. An affidavit states he was fired for erroneously writing programming instructions two weeks earlier that changed the settings on high-speed computers called servers that are connected to multiple network users.

Before surrendering his Fannie Mae badge and laptop computer at the end of the day Oct. 24, Makwana "intentionally and without authorization caused and attempted to cause damage to Fannie Mae's computer network by entering malicious code," according to an indictment returned Tuesday.

The code, if executed this Saturday as planned, "would have resulted in destroying and altering all of the data on Fannie Mae servers," the indictment states.

According to the affidavit signed by FBI Special Agent Jessica A. Nye Jan. 6, a Fannie Mae engineer discovered the malicious instructions by chance Oct. 29. The programming instructions were removed that day and did no harm, according to the affidavit.

Had the virus been released, "it would have caused millions of dollars of damage and reduced if not shut down operations" for at least a week, Nye wrote.

The damage would have included cleaning out and restoring all 4,000 servers, restoring and securing the automation of mortgages and restoring all data that was erased, the FBI agent wrote.

The charge carries a maximum sentence of 10 years in prison.

Makwana was arrested Jan. 7 and released on $100,000 bond Jan. 8, according to court records.

239,000 Foreclosures Prevented in December (HOPE NOW Press Release)

HOPE NOW, the private sector alliance of mortgage servicers, counselors, and investors that has been working aggressively to prevent foreclosures and keep homeowners in their homes, today announced that its members and the larger mortgage lending industry completed a record-high 239,000 foreclosure prevention workouts in December 2008. This is the first time since HOPE NOW began to compile data in July 2007 that the number of workouts exceeded 200,000 in 4 consecutive months and is the latest indication that the mortgage lending industry is continuing to increase its foreclosure prevention efforts.

The new monthly record number of workouts exceeds the previous high set in October 2008 by more than 5 percent. The 671,000 workouts completed in the last quarter of 2008 were the most in any three-month period since July 2007.

Including the December results, almost 2.3 million foreclosure prevention workouts were completed by the mortgage lending industry in 2008. Almost 3.2 million were completed between July 2007 and December 31, 2008.

The December 2008 results also show that the mortgage lending industry is continuing to shift its efforts to help homeowners from repayment plans to loan modifications. For the first time since July 2007, the number of loan modifications was more than half of all workouts completed in a single month. The 122,000 modifications completed in December 2008 are 19 percent higher than the previous record set in October 2008. HOPE NOW expects that the increasing reliance on loan modifications rather than payment plans will continue as economic conditions warrant.

HOPE NOW defines workouts in its data as both modifications to the terms of existing mortgages and repayment plans. Barring a life event such as a job loss, death, or illness, repayment plans and loan modifications are intended to enable a homeowner who has the financial capacity to make monthly payments to remain in his or her home as long as he or she wishes to do so.

According to Faith Schwartz, HOPE NOW's executive director, the December results show that the industry is continuing to focus on the pace of help for homeowners. "HOPE NOW members know they have to keep doing more to keep up with the growing needs of homeowners at risk of losing their homes," she said. "The December results demonstrate that HOPE NOW members are moving aggressively to do what's needed to avoid preventable foreclosures."

According to Steve Bartlett, president and CEO of The Financial Services Roundtable, a HOPE NOW founding member, the December results are a ray of good news for homeowners. "When coupled with the report from the National Association of Realtors earlier this week that existing home sales in December were higher than expected, HOPE NOW's record-high number of foreclosure prevention workouts should provide some optimism for homeowners about the future."

The HOPE NOW December data also shows:

-- 37% of homeowners with prime loans who received workouts in December received modifications.
-- 85% of homeowners with subprime loans who received workouts in December received modifications.
-- For the seventh consecutive month, the number of foreclosure starts for prime loans exceeded those for subprime.
-- The number of foreclosures started in December increased by 34,000 over the previous month. More than 75% of this increase was in prime loans.

A summary table of the results can be found here.

Option ARMs blowing up

By Rolfe Winkler on Option ARMageddon:

The data below demonstrates how this blog got its name. WSJ:

Nearly $750 billion of option adjustable-rate mortgages, or option ARMs, were issued from 2004 to 2007, according to Inside Mortgage Finance, an industry publication. Rising delinquencies are creating fresh challenges for companies such as Bank of America Corp., J.P. Morgan Chase & Co. and Wells Fargo & Co. that acquired troubled option-ARM lenders…

Option ARMs, which have been largely abandoned, give borrowers multiple payment options, including a minimum payment that often was less than the monthly interest due. Borrowers who made the minimum payment on a regular basis often saw their loan balances grow, also known as “negative amortization.” And with home prices falling, more than 55% of borrowers with option ARMs owe more than their homes are valued at, according to J.P. Morgan Securities Inc…

As of December, 28% of option ARMs were delinquent or in foreclosure, according to LPS Applied Analytics, a data firm that analyzes mortgage performance. That compares with 23% in September. An additional 7% involve properties that have already been taken back by the lenders. By comparison, 6% of prime loans have problems. Problems with subprime are still the worst. Just over half of subprime loans were delinquent, in foreclosure, or related to bank-owned properties as of December. The nearly $750 billion of option ARMs issued from 2004 to 2007 compares with roughly $1.9 trillion each of subprime and jumbo mortgages in that period.

Nearly 61% of option ARMs originated in 2007 will eventually default, according to a recent analysis by Goldman Sachs, which assumed a further 10% decline in home prices. That compares with a 63% default rate for subprime loans originated in 2007. Goldman estimates more than half of all option ARMs outstanding will default.

This is news?

Large option ARM lenders like BankUnited, Downey, FirstFed, and GoldenWest (acquired by Wachovia) have all dropped like flies over the past few months. GoldenWest is likely to take down not just Wachovia, but also Wells Fargo, which, in a stupendously foolish move, acquired Wachovia without government support. The wild card, of course, is government. Will Obama establish a “Bad Bank” and if so how much toxic trash will it buy and at what price?

Wednesday, January 28, 2009

The Fed to Modify Mortgages

By Diana Golobay on the Housing Wire:

The Federal Reserve may soon begin modifying mortgages it owns within the mortgage-backed assets it has purchased from government-sponsored entities, according to a letter written Tuesday by Fed chairman Ben Bernanke and addressed to Committee on Financial Services chairman Barney Frank, D-Mass. “The goal of the policy is to avoid preventable foreclosures on residential mortgage assets that are held, owned or controlled by a Federal Reserve Bank and that are subject to the policy through sustainable loan modifications and other actions that are consistent with the Federal Reserve’s obligation to maximize the net present value of the assets for the benefit of taxpayers,” the letter read, in part.

Read the letter.

The modifications will likely come in the form of “rewritten” loans as far as terms, interest rates and principle balances are concerned. Sources have said the Fed’s modification policy will focus on reducing the principal amount for homeowners at risk of foreclosure on mortgages with balances of more than 125 percent the estimated value of the home, according to a Washington Post report published Wednesday. It was unclear at the time this story was published how many Fed-owned mortgages have fallen so far underwater as to be eligible for the program.

The Federal Reserve Bank of New York has reported so far taking on some $52.6 billion from Freddie Mac (FRE: 0.6449 +5.72%), Fannie Mae (FNM: 0.649 +4.68%) and Ginnie Mae through its agency $500 billion MBS purchase program. Although not all of the transactions reported had closed at the time this story was published, the Fed had so far claimed approximately $28.2 billion from Freddie’s sheets, $20.2 billion from Fannie and another $4.2 billion from Ginnie. As of Jan. 22, the Fed reported having completed transactions valued at just under $6 billion.

WSJ on Jumbo Loans

From the WSJ: Banks and Investors Face 'Jumbo' Threat (hat tip Calculated Risk)
About 6.9% of prime "jumbo" loans were at least 90 days delinquent in December, according to LPS Applied Analytics, a mortgage-data research firm. The rate was up sharply from 2.6% a year earlier. In comparison, delinquencies of non-jumbo prime loans that qualify for backing by government agencies climbed to 2.1% from 0.8% in December 2007.
Conforming-loan limits top out at $625,000 in the highest-cost housing markets. To buy a more expensive home, buyers must put up larger down payments -- between 30% and 40% -- and pay higher mortgage rates. Rates on 30-year fixed jumbo mortgages stood at 6.87% last week, compared to 5.34% for conforming mortgages, a difference of 1.53 percentage points, according to HSH Associates, a financial publisher.

Mortgage cramdowns are a bad option

By Megan McArdle in the Atlantic's Brave New Deal:

I greatly admire the work of John Carney. But I was bemused on Friday by his Clusterstock headline:
New Worry: Mortgage Cram Downs Could Set Off Huge Bank Losses
This seems to me to be a very old worry--I've been voicing it for months. Why do people want to do mortgage cramdowns? They want to bail out distressed homeowners. And because this will be very expensive, they want to do so in a way that does not involve a direct government outlay of cash. The normal way that the government gets what it wants without paying for it is to make a rule forcing someone else to shell out.

We're fundamentally having an argument about who should bear the systemic risk of a fall in housing prices. There is a sizeable constituency that wants to put the entire price on the banking system, both because they think bankers are ultimately responsible for the problem, and because they think of banks as rich corporations that won't be hurt the way ordinary homeowners or taxpayers would.

This belief seems odd to me, given that we're in this mess in large part because the banking system is in such parlous shape. Moreover, the history of financial crises amply illustrates that ordinary taxpayers and homeowners can end up in pretty dire straits when the banks are too screwed up to lend.

How bad might it be? Carney links to a post from HousingWire that lays out some of the potential pitfalls:

  • Mortgage insurance is concealing risks that won't get covered in a cramdown. In order to make highly leveraged mortgage backed securities more attractive to investors, bankers bolstered them with mortgage insurance. These mortgage backed securities based on bundles of mortgages that had a thin collateral margin were able to get higher ratings from credit agencies because of mortgage insurance. Banks could carry these on their books as less risky assets, and weren't required to reserve much capital against them. They haven't been written down as much as other MBS because the insurance was supposed to protect them from losses. But most mortgage insurance won't cover bankruptcy modifications. That means that assets on the books of banks could have far higher loss risks than they appear to on balance sheets. When the losses kick in, banks will once again have to raise capital.
  • Even the best, most highly rated paper will share in cramdown losses. Ordinarily, lower tier mortgage backed securities get whacked first by losses on the portfolio. High tier MBS with higher ratings can keep delivering revenues because they get the first claims on payments. But a good number of private-party MBS deals, pretty much every prime and Alt-A deal, have provisions that allow bankruptcy losses to be allocated among all investors. This means that highly rated paper, which has not been written down very much and is held on bank balance sheets at high levels could get hit. The capital reserved against these losses will be inadequate. You see where this is going, right?
  • Federal Housing Administration insurance does not cover bankruptcy. If you were a conservative banker who only bought MBS backed by FHU insurance, you probably think you're in good shape. Think again. The cramdown legislation will make those assets unsafe. "The reason is simple: FHA insurance does not reimburse servicers for losses on bankruptcy cramdowns on loans that are not in foreclosure. If servicers have been stretched thin already by this mess, the cram-down proposal currently being considered might serve as the final nail in the coffin for some," Jackson writes.
Think of these kinds of government cramdowns as doing it on the faux-cheap. It looks inexpensive, because the government isn't shelling out directly. But making things artificially cheap by hiding the pricetag from yourself encourages you to do things you oughtn't--just ask the current holders of "investment" properties purchased with "innovative" mortgages. In the end, the bill always comes due--and the accrued interest is usually a killer.

Tuesday, January 27, 2009

Securitisation: Laying new foundations after housing collapse

The US mortgage market was the epicentre of the earthquake that has shaken the global financial sector so badly, but finding ways to restore capital market funding for residential and commercial mortgages is crucial to reviving economic growth, writes Philip Alexander in The Banker.

Securitised US subprime mortgages understandably take a large share of the blame for triggering the global financial chaos that has unfolded over the past 18 months. But it would be a grave mistake if market abuses obscured the importance of capital market routes for financing residential and commercial real estate.

“People have to recognise that securitisation is a necessary product, it is funding about $8500bn in mortgages around the world. Without that, economies would just continue to shrink,” says Darrell Wheeler, head of securitised products strategy at Citi in New York. He has worked in almost every part of the industry, establishing his own commercial real estate mortgage brokerage earlier in his career.

As investors face redemptions and more banks take defensive positions by stepping back from market-making in residential and commercial mortgage-backed securities (RMBS and CMBS), illiquidity intensifies, and spreads in the secondary market have widened to levels that make new primary issuance prohibitively expensive.

“You can go into the RMBS market and buy bonds that, even assuming US house prices decrease another 30% to 40%, are still going to yield 20%. These are AAA bonds that have been downgraded to AA. And on the super-senior class of CMBS that have 75% credit support, yields have reached 12%. You would need three-quarters of the mortgage pool to default before you lost any money,” says Mr Wheeler.

Government guarantees

Given such depressed valuations, returning confidence to the MBS market is clearly part of the answer in the short term. In November 2008, James Crosby, the deputy head of the UK Financial Services Authority (FSA), released a report that suggested auctioning government guarantees on AAA tranches of RMBS.

Many countries have already started providing guarantees on banks’ issuance of plain vanilla unsecured senior debt, so a similar concept for the MBS market would seem “a simple and effective solution to restore investor confidence”, says Angela Clist, a partner in the international capital markets practice at law firm Allen & Overy in London. But she emphasises that the Crosby report details would need to be carefully thought through.

“As proposed, the guarantee would have to apply to new stand-alone issuances or new programmes – it would not be palatable to investors to have two tiers of bonds from one covered bond programme or master trust programme, some guaranteed and some not,” she says. “Furthermore, the proposal is to guarantee mortgages originated after a specified date, but of course existing programmes would contain assets from many different dates. The cost of setting up new ‘guaranteed’ programmes would put a lot of issuers off, and this aspect should be reconsidered.”

The more fundamental challenge, however, is to wean markets off their dependence on government guarantees and central bank liquidity. Asset-backed security (ABS) issuance in 2008 has actually been at record levels – but almost all of this paper has been structured for the sole purpose of qualifying as collateral for repo financing with the central banks.

“What issuers want is for the market to be able to stand on its own two feet, for investors to focus on the underlying mortgages and become comfortable with the product again, and the sooner that process starts, the better. The concern is that government guarantees on mortgage-backed securities would delay that process, by distracting the focus away from underlying asset quality,” says Conor Downey, partner at law firm Cadwalader, Wickersham & Taft in London.

Helping the homeowners

In western Europe, the damage to underlying mortgage pools has so far been manageable – even in the UK, one of the fastest-declining real estate markets, there have been no defaults at the AAA level on RMBS to date. But the US presents an altogether more severe problem. Delinquencies on subprime mortgages reached 17.85% in the second quarter of 2008, and although the overall mortgage default rate was only 4.5%, the vast majority of problems are occurring on a small vintage of mortgages – from 2005 to 2007, when underwriting standards were lowest, and loan-to-value (LTV) ratios were highest.

As house prices fall, recovery rates are also deteriorating rapidly. About one in six mortgages in the US have 100% LTV ratios. According to data provider First American CoreLogic, 18.3% of all mortgaged homeowners in the US were in negative equity by October 2008. In California and Florida, the rate is closer to 30%, and in Nevada, that figure rises to almost 50%.

In this context, Tonko Gast, co-founder of structured credit investor and adviser Dynamic Credit Partners in New York, warns that the downward spiral for RMBS may not be over yet, as the impairment spills over from subprime into Alt-A (often self-certified mortgages) and prime assets originated in 2005-2007. “We calculate that there could be another $700bn in RMBS to be downgraded from investment grade to speculative grade. The attachment point for credit enhancement on an Alt-A AAA tranche is typically 14%, but for 2005-07 vintage, delinquencies could go to 20% or higher, so the value will break into the AAA,” he warns.

With so many properties in negative equity, it makes more economic sense for lenders to renegotiate mortgage terms and keep borrowers current, rather than foreclosing and being left holding a depreciating asset. However, where mortgages have been securitised, that may not be possible, as some RMBS contracts expressly forbid mortgage modification, or allow the servicer some authority to seek to mitigate losses, but without clear instructions as to how.


Even where mortgage modifications are technically possible, the incentive is unclear in securitised transactions. “A direct lender such as Citi or Bank of America has a reputation in the market, and they want to keep their customers. But a servicer does not have a retail brand to protect in the same way,” says Glenn Snyder, a real estate lawyer in the California office of Pillsbury. He believes this could have been an advantage of the Troubled Asset Relief Program (TARP) as originally conceived, before US Treasury secretary Henry Paulson announced in November 2008 that it would not be directly buying RMBS after all. “If the government had become the single owner of a transaction, they could have chosen to unravel the underlying mortgages to modify them. It is much harder to do that if the RMBS remain held by a wide group of investors,” says Mr Snyder.

Furthermore, some plan is still needed to fulfil the original purpose of TARP, says Mr Wheeler, namely to begin purging the system of existing depressed assets so that healthy financial institutions can begin lending again. “Given the size of the discount in the market, each time a bank books a new mortgage, the equity analysts value it at 70 or 80 cents on the dollar – that prevents financial institutions from lending. Only the government-supported entities (GSEs) are doing new lending. We need to ring-fence the legacy assets so that people can understand that banks will do new lending, and not every new loan in this environment is going to be worth only 70 cents on the dollar,” he explains.

In November 2008, the US Federal Reserve announced that it would purchase up to $600bn in mortgage-backed securities from the GSEs, including Fannie Mae and Freddie Mac that were effectively nationalised in August 2008. But many of the most troubled assets, including securities built from mortgages that had initial teaser rates with a sharp step-up (adjustable-rate mortgages, or ARMs), were not originated through the GSEs. The government also proposed using TARP to indemnify the Fed against losses on its $200bn term asset-backed lending facility (TALF) – but this does not yet accept mortgage-backed securities as collateral. This suggests that the US government may still need to expand TALF in 2009. “For MBS we still need another market-maker that can step in and play a stabilisation role. This would eventually restore confidence enough for private investors to take over from government assistance,” says Mr Wheeler.

New-look securitisation

Clearly, the commercial property sector will also suffer rising default rates in the economic downturn, as retailers shut their stores and companies vacate office space. But there is a consensus that in the future RMBS transactions may draw on CMBS as a structural template to tackle some of the problems thrown up over the past two years.

Mr Downey at Cadwalader says CMBS servicers have more flexibility to manage financial stress, including an enforcement period of at least two years to sell or refinance assets as required. However, when real estate values fall, the servicers still face the challenge in deciding whether the market will have recovered far enough in that time to pay off all classes of investors – and this has the potential to trigger disputes between the different creditor classes. “The more junior investors may be prepared to wait, particularly if they bought at a discount. But those holding senior tranches may prefer early repayment, so that they can reinvest in the secondary market at higher yields,” he explains.

Another vital lesson for RMBS that could be learnt from the CMBS market is the importance of greater transparency on loan-level data. “CMBS products start with three years of financial history for every loan in the pool, appraisal on every loan and updates every month on the performance of the pool. That sort of loan seasoning and flow-through of information is key to restoring confidence in RMBS,” says Mr Wheeler at Citi.

Jordan Schwartz, a lawyer at Cadwalader in the US and member of the board at the American Securitization Forum (ASF), is part of a team drawn from across the industry who have drafted a proposed RMBS disclosure package to deliver that kind of transparency. “This has 135 fields of loan level data, including documentation and verification, property valuation methodology, whether brokers were involved in the origination, whether the borrower is a speculator or a resident, and we have 30 fields on loan modifications,” he says.

Rebuilding servicing capacity

Changing RMBS documentation and pool surveillance cannot happen overnight, however. Alan Cleary, the CEO of UK mortgage asset quality assessment and servicing company Exact, notes the scale of institutional adjustment needed to provide extra information at the origination end of the system. “For example, there is a significant shortage of experience in managing mortgage arrears, because we have not had a sustained housing market downturn in the UK for 15 years or so,” he says.

After leading mortgage sales and intermediary teams at the Halifax Bank of Scotland group, Mr Cleary left to found his own company, Edeus, in 2006. Edeus originated non-conforming mortgages (buy-to-let, self-certification or to those with adverse credit histories) for selling on to investors. It had completed seven whole-loan sales and was on the brink of its first securitisation when the market shut down altogether in March 2008.

Mr Cleary was forced to put the company into administration in November 2008, returning the mortgage portfolio to the banks that had provided his funding lines, but he realised there was value in the servicing operations themselves. “We still retain all the technology to originate loans, but we don’t expect to return to that market for another two to three years, until we find funding that is cost-effective. In the meantime, we can generate positive cash-flow from the operational business alone,” he says.

To extend the work currently undertaken by the international credit ratings agencies, Exact offers 100% loan-level analysis of RMBS pools to investors on an ongoing basis. In the past, investors would be provided with analysis of a 10% to 15% sample, only at the time of origination. Exact has also introduced much more thorough fraud investigation, as well as cross-checking credit histories with other products such as credit card debt.

Distressed debt investors are already beginning due diligence on RMBS transactions in the secondary market to see if the current large discounts imply default rates on the underlying mortgages that exceed the actual rate of delinquencies. Indeed, Exact’s leading investor, the US-based distressed debt hedge fund Elliott Management, could be an early customer in this category.

Unsurprisingly, the banks are Mr Cleary’s first customers, as anxiety grows about the quality of their portfolios. Besides delinquencies, cases of fraud also rise in an economic downturn. Exact’s work exposed a lawyer in London who had single-handedly submitted fraudulent mortgage applications totalling £20m ($30.8m). “Almost every major bank had some of these loans on their books, but they did not know about them. Just one case of fraud exposed in the mortgage pool repays the cost of a full investigation, if the investor can find and exclude that mortgage before buying the pool,” says Mr Cleary.

Covered bonds diversify funding

As banks and RMBS servicers race to build the capacity to analyse mortgage pool behaviour more accurately, the covered bond structure could provide a route to diversify scarce funding sources in the meantime. “The principal difference between them is that with RMBS, it tends to be a static mortgage pool or available mortgage portfolio, whereas with covered bonds there is a requirement to keep on topping up the pool to maintain AAA ratings,” says Ms Clist at Allen & Overy. This shields investors to some extent from a general deterioration in mortgage asset quality, so she expects confidence in the covered bond market to recover ahead of RMBS.

At present, however, even covered bonds are struggling to find liquidity, as investors focus on the supply of bank debt that carries government guarantees. “We need to see some senior unsecured deals so the market can take a view on what the pricing is, then we can see what scope there is for tighter pricing using covered bond collateral,” says Derry Hubbard, head of covered bond marketing and execution at BNP Paribas. The French bank reopened the market for non-guaranteed bank debt in December 2008. “We will also need to increase the number of individual investors in covered bond deals, bringing order books back up to triple digits,” he adds.

In any case, says Tauhid Ijaz, partner in the capital markets practice of law firm Lovells in London, covered bonds do not fulfil the same function as MBS from the bank balance sheet viewpoint, as the mortgages in the cover pool remain on the bank’s own books. “On covered bonds, the banks do not have the regulatory capital relief under Basel II that they would have with a securitisation,” he says.

New buyers, new sellers

Consequently, MBS will still be essential to provide banks with a balance sheet exit for mortgage origination. And while covered bonds typically have three to 10-year maturities, MBS transactions usually last the length of the underlying mortgage, about 20 to 40 years. They therefore play a specific role on the buy-side as well. Real money investors such as pension and insurance funds have similarly long-term liabilities, and are seeking higher returns to meet the challenge of ageing populations in the Western hemisphere.

As originators now have to work so much harder to find liquidity, Mr Downey at Cadwalader suggests they will look at new structures designed specifically to appeal to the needs of pension and insurance funds that are increasingly pursuing liability-driven investment (LDI) strategies. “LDI investors like inflation-linked assets, so we could see more loans backed by real estate revenues that rise with inflation, sale and lease-back structures, or whole-business securitisations,” he explains.

However, these tailored deals are more labour-intensive than large-volume standardised transactions, at a time when investment banks are staging a wholesale retreat from the MBS industry. One market participant estimates that, of the 40 or so banks that had European CMBS programmes at the peak, only 10 still retain origination capability. Given this loss of investment bank capacity, together with investors’ desire for a deeper knowledge and valuation of the underlying assets, Mr Downey believes there may be a growing role in the market for specialist real estate advisory firms, such as CB Richard Ellis, Jones Lang Lasalle and DTZ.

Barry Osilaja, the director of European structured debt and equity solutions at Jones Lang LaSalle Corporate Finance, says the pension and insurance funds themselves will need to become better co-ordinated internally if they want to arrange deals directly with commercial real estate originators, rather than using investment bank intermediaries.

Historically, institutional investors’ real estate desks would only take direct investment positions, while bond desks have bought only MBS transactions, based on pricing relative to other asset-backed securities such as credit-card receivables. These bond investors often did not have in-depth knowledge of the underlying real estate assets – other than through credit ratings agency presale reports.

“The more sophisticated institutional investors such as some life insurers are now looking at how to buy into hybrid transactions, where the real estate desk takes the direct asset, and the annuity division takes the securitised cash flow to meet their liabilities,” explains Mr Osilaja.

The simple things

Alongside this increased investor sophistication, however, Mr Osilaja emphasises that other aspects of deal structure will need to become simpler. “The pricing will be more attractive, and you will not have so many tranches of notes, it will just be senior and subordinated, so that people can see more quickly what they are buying,” he says.

Once those conditions are met, he sounds a rare note of optimism, suggesting that volumes in the CMBS market could arguably become larger even than before the crisis. “If you make the deal simpler, more transparent and easier to understand, it creates better liquidity. Once you are creating bonds that are liquid and listed, there should be no ‘black box’ that excludes some investors,” he says.

But as with all other market participants, he notes that there is still plenty of deleveraging and repricing to come before appetite for new deals will return. This means that 2009 will be a year to begin re-engineering the mortgage securitisation market from the bottom up, and only afterward will it be ready for any kind of revival. Even then, investors are sceptical about whether some parts of the RMBS market should ever recover.

“Teaser-rate ARMs, low documentation, high LTV, those assets cannot be securitised again,” says Mr Gast of Dynamic Credit Partners.

FHFA Announces New Mortgage Data Requirements

James B. Lockhart, Director of the Federal Housing Finance Agency, announced [on January 15] that, effective with mortgage applications taken on or after Jan. 1, 2010, Freddie Mac and Fannie Mae are required to obtain loan-level identifiers for the loan originator, loan origination company, field appraiser and supervisory appraiser....

“This represents a major industry change. Requiring identifiers allows the Enterprises to identify loan originators and appraisers at the loan-level, and to monitor performance and trends of their loans,” said Lockhart. “If originators or appraisers have contributed to the incidences of mortgage fraud, these identifiers allow the Enterprises to get to the root of the problem and address the issues.”

The purpose of FHFA’s requirement is to prevent fraud and predatory lending, to ensure mortgages owned and guaranteed by the Enterprises are originated by individuals who have complied with applicable licensing and education requirements under the S.A.F.E. Mortgage Licensing Act, and to restore confidence and transparency in the credit markets. In addition, the Enterprises will use the data collected to identify, measure, monitor and control risks associated with originators’ and appraisers’ performance, negligence and fraud.

For rhw full press release, go here.

Monday, January 26, 2009

Mortgage Cramdown--Layering On Complexity

By Jean Braucher on Credit Slips:

Chapter 13 is already too complicated, and cramdown legislation will make it more so and lead to a new round of litigation and expense that will stand in the way of keeping people in their homes. By all means, Congress should enact mortgage cramdown, but it should take up bankruptcy simplification immediately after that if it really wants people to hold on to their homes in chapter 13.

Katie Porter has already noted the problem of high noncompletion rates in chapter 13 as a reason for suspecting that mortgage cramdown will not “save” many homes. See Cramdown Controversy #2--Will I "Succeed?" The problem is that the impact of the pending cramdown legislation could be small given the messy state of bankruptcy law since the 2005 changes.

The 2005 law has substantially increased the expense of bankruptcy, deterring and delaying its use among the worst off. The chapter 13 filing fee has gone up to $274. “No look” attorneys’ fees of at least $3,000 are the norm in chapter 13 (see at 25-26), and this is a bargain price considering what lawyers are expected to do under the new law.

Mortgage cramdown will add the difficulty of a valuation hearing, with experts engaging in a swearing contest about the value of a home for which, in many cases, there currently is no market. Cars have various “book” values that can be used to set default measures of value in bankruptcy, but there is no similar simple approach to valuing homes to save on litigation costs.

The bills add a lot of complexity of various sorts. S. 61 and H.R. 200 both would layer on a ridiculous, unnecessary third “good faith” test in chapter 13. The debtor already must file in good faith and propose a plan in good faith, yet the bill’s drafters felt compelled to add an additional requirement that the modification be in good faith. This would stoke litigation over whether it is bad faith to pay the value of the home if the debtor could “afford” more (“afford” always being a malleable concept), with an open question about what other expenses should be taken into account when deciding what the debtor has available to pay for an underwater home.

It would be much better for Congress to explicitly state what it wants—for example, whether just paying the home’s value is fine, with excess disposable income (if any) going to other secured debts (such as cars) and then unsecured debts. Furthermore, it would be a good idea for Congress to state that if home and car payments use up all the available income over regular expenses, it is not “bad faith” to pay zero to unsecured creditors. Congress should be heading off the inevitable arguments that just paying for collateral in chapter 13 is not good faith. If chapter 13 is going to be a mechanism to save homes from foreclosure, many debtors will have nothing left to pay old unsecured debts. Unfortunately, some judges and trustees have used a good faith test to push for rule-of-thumb amounts of unsecured debt repayment in chapter 13 whether or not that is feasible, contributing to a high noncompletion rate (historically, about two-thirds of chapter 13 cases).

I agree with Katie Porter that the provision in the bills for direct payments by debtors to claim holders is a mistake. It is unclear whether this would always be required, or whether this language just gives courts discretion to allow direct payment. In most cases, Chapter 13 trustees are needed to make sure that payments actually get credited appropriately to debtors’ accounts. If the problem is feasibility of plans due to paying trustee fees on mortgage amounts, Congress could provide for a lower trustee fee on those payments. Without the trustees involved in record-keeping, debtors will face huge cost and difficulty at case closing to try to show that they really are current on their mortgages. Most trustees now make it a default practice that mortgage payments be made through them, and this has saved on trouble for debtors, trustees and judges.

Another aspect of the bills that is troublesome is that the debtor must have already received a notice of foreclosure in order to cramdown. This prevents debtors from taking charge of a hopeless situation and getting it resolved; they would have to wait for the lender to send a foreclosure notice before they could make use of chapter 13 to modify their mortgages.

The elimination of credit counseling for debtors who have received a notice of foreclosure is a step in the right direction, but if Congress paid attention to GAO reports, it would repeal the credit counseling requirement entirely. It represents a cost in money ($50 per debtor) and inconvenience way in excess of very minimal benefit.

Mortgage cramdown would also add to the complexity of other issues currently making their way through the appellate system, particularly issues concerning means testing and treatment of car loans. (For more discussion of these issues, see my recent paper, A Guide to Interpretation of the 2005 Bankruptcy Law at

Means testing allows above-median-income debtors in either chapter 7 or chapter 13 to include their secured debt obligations as part of their expenses, yet with cramdown on a home possible, the debtor might not have to pay the full secured debt in chapter 13. This will lead to a new round of litigation over additional layers of means testing, whether under the “good faith” or “totality of the circumstances” tests in chapter 7 or the “projected disposable income” or various “good faith” tests in chapter 13 when the debtor might be able to cramdown.

And then there will be the ironies of allowing cramdown on underwater home mortgages while perhaps not allowing cramdown on seriously underwater car loans, particularly the most risky subprime ones. If the car lender rolled in a big wad of debt from the last car (known as “negative equity”), making the debt severely undersecured from the outset, it doesn’t make a lot of sense to treat that debt as fully secured under the “hanging paragraph” while cramming down a similarly undersecured home loan. I am among those who think it is ridiculous—both as a matter of law (see and policy—to treat paying off your last car as part of the purchase money for your next one. As a policy matter, this is very risk credit, and it does not deserve preferred status (disallowing cramdown).

All this is to suggest that we desperately need a fresh start for bankruptcy reform, and layering mortgage cramdown on the 2005 mess will just make this more apparent. The complexity of the law stands in the way of its use at an affordable price and makes it hard to mobilize the bankruptcy system for this crisis.

Sunday, January 25, 2009

Mortgage Rates Soar - Fed Better Buy More

From Mr. Mortgage:

Rates have shot up considerably in the past week and a half from roughly 5% at 1 point to 5.5%-5.625% at 1 point to the borrower. This was despite the Fed in the market buying $19 billion in Agency MBS last week. In the months leading up to the Fed announcing their QE plans, rates got under 6% several times — the mid’s 5%’s really is not that great. One would hope that with the Fed in there buying Agency MBS at the pace it is, rates could hold — but they have not been able to. This spike in rates will have a serious impact on the weekly MBA mortgage applications data that come out each Wednesday. My guess is that they are down this Wed and plunge the Wed after next.

Who is the Fed Really Trying to Help

The rate spike goes along with the thinking many (guilty!) have that the only reason the Fed is in there buying MBS in the first place was not to give you and I the gift of lower rates — rather to provide a bid for the Foreign Central Banks and Bill Gross to hit. Agency MBS are time bombs with the underlying loans imploding like private label. Most think that Fannie/Freddie loans are the cream of the crop…the truth is far from it.

As a matter of fact Housing Wire did a great story on it today. If their 90-day delinquencies are rising at 20bps per month and they are in full loan mod mode catching most prior to the 90-day mark, we got big troubles ahead.

The number of mortgages 90 or more days delinquent continued to rise at Freddie Mac (FRE: 0.68 +3.03%) during December 2008, reaching 1.72 percent of the GSE’s total single-family mortgage portfolio, the company reported Friday morning. That’s a jump of 62.2 percent from year-ago levels, and up 20 basis points from a 1.52 percent level reported for November 2008 — not surprisingly, as the nation’s housing woes have spread, Freddie Mac has posted a monthly rise in delinquencies throughout the entirety of last year.

FCB’s and Gross are the very players needed to buy Treasuries. How does the Treasury make it easy for them to sell their Agency holdings and hopefully buy more Treasuries…the Fed comes in the market with a multi-quarter perma-bid — others front-run or try to chase the Fed — and large MBS holders lighten up into the action. We know they were sellers before the Fed jumped in the market. Now we have made it easy for them.

Agency MBS are still not ‘explicitly’ guaranteed rather ‘effectively’ guaranteed while the firms are in conservatorship. This presents a problem especially with the new cramdown legislation on tap. Large Agency MBS holders better hope that .gov takes a firmer stance because if not, this market could see some considerable widening in short order. Remember, present backing is only $100 billion per GSE. Funny, but if they do stand up and back the entire $4.5 trillion GSE MBS enchilada and the cramdown legislation comes through, .gov (taxpayer) will be cramming themselves. Just think the Treasury yield action if .gov decides to ‘explicitly’ back trillions in Agency MBS.

Wholesale (Broker) Mortgage Rate Expo

Below are wholesale Agency =<$417k conforming rates from a few select large-named lenders. Boxed is the rate level that would cost the home owner 1 point in fee. The numbers next to the rate are the ‘cost’ or ‘rebate’ at that particular rate level. For example from Citi at 5.5% for 30-days, the broker gets paid .109% of the loan amount as a fee.On a $400k loan, that would be a little over $400 to be used as commission, to pay closing costs etc.

To get a popular no-point loan, rates are back over 6%. Remember, the rates below are for a perfect 80% LTV, 740 credit score, full-doc borrower. If the borrower has a second mortgage behind the first, a lower score, is pulling cash-out etc the rate can shoot up considerably.

**PLEASE NOTE - I AM MOVING…please look to the right at the top of this site. Enter your email address in the box above ’subscribe’ or I may not be able to find you after the end of the month.

Below are the adjusters for anything other than a perfect borrower/loan. If the borrower fits within the outlined red box there are no adjustments. Everyone else gets hit. ‘A’ through ‘H’ are cumulative so it is obvious how quickly the rate and fees can get out of control. Two years ago 80% of these adjusters did not exist.

Below are Agency Jumbo to $625k pricing in the mid 6%. Citi has the best pricing but at 1.5 points, it is likely cost prohibitive for most.

The chart below is the past eight months mortgage rates. The last three months show what happens when a market loses its integrity and the government jumps in. And you thought stocks were volatile. This is a perfect shot of one of the reasons lenders are pulling their hair out - rates are so volatile borrowers keep re-applying with lender after lender trying to get the best rate. They better close one quickly - rates are going up.

Saturday, January 24, 2009

Cramdown and Future Mortgage Credit Costs: Evidence and Theory

By Adam Levitin at Credit Slips:

I've written extensively (see here, here, e.g.) on why permitting modification of mortgages in bankruptcy would generally not result in higher credit costs or less credit availability. As the debate over bankruptcy reform legislation to help struggling homeowners and stabilize our financial system moves to the fore, it's worth repeating some of the key points and making some new ones.

(1) The key comparison is bankruptcy modification versus foreclosure. Opponents of bankruptcy modification often misframe the issue, whether deliberately or ignorantly. It is not a question of bankruptcy losses versus no losses, but bankruptcy losses versus foreclosure losses. If bankruptcy losses are less than foreclosure losses, the market will not price against bankruptcy modification. This is an empirical question, and to date, my work with Joshua Goodman is the only evidence on it. Opponents of bankruptcy modification have only been able to respond with plain-out concocted numbers (e.g., the Mortgage Bankers Association) or insistence on applying economic theory that looks at the wrong question.

(2) Economic theory tells us that cramdown is unlikely to have much impact on mortgage credit costs going forward. The ability to cramdown a mortgage (reduce the secured debt to the value of the property) is essentially an option borrowers hold to protect themselves from negative equity. It is a costly option to exercise--it requires filing for bankruptcy, and that has serious costs and consequences. More importantly, though, cramdown is typically an out-of-the-money option. It is only in-the-money when (1) property values are falling enough that there's negative equity and (2) likely to remain depressed in the long-term. Long-term declining residential property values have been the historical exception. What this means is going forward there really isn't much for creditors to worry about with cramdown--homeowners can't exercise an out-of-the-money option.

Moreover, because the likelihood of the cramdown option being in the money is slim at origination, it is unlikely to be reflected in origination pricing. Instead, it is an option that is more likely to be valuable when default is imminent, at which point the loan is in the secondary market. So to the extent that the cramdown option does cost creditors, it is the secondary market, and the effects on credit availability and cost to homeowners would be diffused.

(3) Arguments about bankruptcy court capacity and bankruptcy transaction costs are made by people who have no experience with the actual bankruptcy system. A serious misconception about bankruptcy modification is the belief that the bankruptcy judge would decide how to rewrite the mortgage. That's not how bankruptcy works. The debtor (and debtor's counsel) would propose a repayment plan that includes a mortgage modification. The judge either confirms or denies the plan, depending on whether it meets the necessary statutory requirements. This means that bankruptcy judges can actually handle significant consumer bankruptcy case volume. If you want proof that the bankruptcy courts can handle a huge surge in filings, look at what happened in the fall of 2005, before BAPCPA went effective. The courts survived that flood of filings. Today the bankruptcy courts are better prepared; there are more bankruptcy judges (thank you BAPCPA) than in fall 2005. Nor would there be tremendous time and money lost in valuation disputes. After there are a handful of cases decided in a district, all the attorneys know what the likely outcomes would be in future cases and settle on valuations consensually. Court capacity and excessive transaction cost arguments are made by people who have never stepped foot into bankruptcy court.

(4) There's no other serious option on the table. Permitting bankruptcy modification of mortgages will not by itself solve the finance crisis. It will not stop all foreclosures. But it will help stop some uneconomic foreclosures, which benefits homeowners, investors, communities, and the financial system. And, more importantly, whatever imperfections bankruptcy modification has as a solution, it's the only real option on the table.

There is no other detailed legislative proposal. There are various economist pipedream proposals around, but even the best of them fail, either because they are politically unrealistic or because they are too rooted to a belief that the private market can solve problems with a tweak here and there. I believe that people and institutions respond to incentives, but market-based solutions haven't worked to date. How many times do we have to be burned by "market-based" solutions before we try something else? The unfortunate truth is that no one understands enough about various mortgage market players' incentives to properly align them. We can't follow all the trails of servicing contracts, insurance, reinsurance, credit derivatives, overhead, and litigation risk and know what incentives look like. Even if we did, it would take serious time for the market to correct itself and start doing large-scale loan modification. That's time that families don't have, and I don't think that anyone who is advocating a market-based solution is also pushing a foreclosure moratorium to allow the market to get its act together. Bankruptcy modification is the only game in town, and to pretend otherwise is disingenuous cover for opposing it in the name of "studying all the options."

The Emperer's new clothes

A new argument being advanced against bankruptcy modification is that it will result in trillions of dollars of losses and the collapse of the financial system. This is the "the sky will fall" argument.
Leaving aside the grossly inflated numbers, let's be really clear that these are not losses that would be caused by bankruptcy modification. These losses exist with or without bankruptcy modification. All bankruptcy modification does is force these losses to be recognized now, rather than at some point down the road. Bankruptcy modification doesn't change the underlying insolvency of many financial institutions. One way or another, there are a lot of financial institutions that have to be recapitalized.

Financial institutions want to delay loss recognition as long as possible. Maybe they're hoping that the market will magically rebound. Maybe they think that 2006 prices are the "real" prices and "2009" prices are a very short-lived aberration. But here's the crucial point: homeowners bear the cost of delayed loss recognition by financial institutions. Delayed loss recognition means homeowners floundering in unrealistic repayment plans and then losing their homes in foreclosure. Delayed loss recognition means frozen credit markets because no one trusts financial institutions' balance sheets. Delayed loss recognition means magnifying, shifting, and socializing losses. We only make matters worse when we try to pretend that these losses don't exist.

We all know the story of the Emperor's New Clothes, and how everybody plays along with the emperor's conceit until a little boy points out that the emperor is stark naked. To suggest that widespread financial institution insolvency would be caused by bankruptcy modification is akin to blaming the little boy for the emperor's nudity.

Friday, January 23, 2009

Cram-Downs Will Drive MBS Downgrades, Analysts Say

By Paul Jackson at the Housing Wire:

Key industry analysts have been raising a red flag in the past few weeks regarding the possible impact of a plan that would allow bankruptcy judges to modify the terms of mortgages during debt restructuring, suggesting that allowing so-called cramdowns to take place will likely lead to further significant write-downs in an already battered secondary mortgage market — leaving banks with even larger-than-expected holes on their balance sheets.

Analysts at Bank of America (BAC: 6.24 +9.28%), while suggesting on Jan. 13 that such provisions would likely lead to a spike in bankruptcy filings, also said that aspects of the proposed bankrupcy law would serve to limit potential investor losses. In particular, the legislation as proposed establishes a floor on how much debt could be crammed down by a judge, while the fact that all assets must be disclosed to the court in filing for bankruptcy would prevent borrowers from going BK purely to obtain a lower payment.

Nonetheless, many analysts remain concerned. Bloomberg’s Jody Shenn noted in a Jan. 12 story that analysts at Keefe, Bruyette and Woods projected that the cram-down legislation would speed losses to most MBS investors, driving downgrades anew and placing banks under renewed capital pressure.

There are other issues to be considered here, of course, that are more nuanced. Among them is the role of private mortgage insurers, who generally will not cover losses tied to a borrower bankruptcy. Bank of America analysts called attention to this issue on Jan. 21 — and it’s a vital issue for any investor. Here’s why: most MBS deals using mortgage insurance as a form of credit enhancement have thinner “padding” for investor losses, meaning that cram-downs would eat through overcollateralization at a faster rate for MI-enhanced deals than for other MBS deals. (Can you spell d-o-w-n-g-r-a-d-e?)

And just think of the perverse incentives here, too: on a mortgage involving MI, the servicer and investor must get the MI provider to sign off on any loan modification — how likely will the MI provider be to do so, when they just push losses directly onto the investor via a borrower bankruptcy?

Bloomberg’s Shenn addressed the ongoing buzz among analysts again earlier this week, noting that a good number of private-party MBS deals — viturally every prime and Alt-A deal done — also have so-called “carve-out provisions” in them that allocate some bankruptcy losses among all investors, rather than the traditional bottom-up, first-loss approach traditionally seen in most structured deals.

There is upside here, however, as analysts at BofA, and Barclays Capital have all noted in recent weeks: the downside risk of bankruptcy as contemplated under the proposed change would be so severe for investors and servicers that both parties would likely have a strong (and perhaps perverse) incentive to modify loans, without having to worry about violating the terms of the pooling and servicing agreements that bind their efforts. Of course, the question is which investors and what kind of securities, as always.

But the bottom line to be gleaned from the above is this: there is always a law of unintended consequences when large-scale and complex changes are contemplated by regulatory and government agencies. Cram-downs are clearly no exception.

Thursday, January 22, 2009

Record Home Price Decline in November, FHFA Says

By Paul Jackson on the Housing Wire:

A wealth of other home price data has shown that November and December were rough months for the nation’s varied housing markets; new data released Thursday morning by the Federal Housing Finance Agency shows that housing woes are continuing to extend their reach into conforming lending markets, as well.

U.S. home prices for homes with mortgage owned or backed by Fannie Mae (FNM: 0.66 -10.81%) or Freddie Mac (FRE: 0.66 -8.33%) fell 1.8 percent on a seasonally-adjusted basis from October to November, the FHFA said, more than the 1.1 percent decline in the prior month. For the 12 months ending in November, U.S. prices fell 8.7 percent; home prices have now fallen 10.5 percent since their peak in April 2007, under the FHFA data.

Across nine census divisions, four posted price declines between Oct. and Nov. of greater than 2 percent: Pacific, Mountain, West North Central, and South Atlantic divisions. In October, only one division — the long-suffering Pacific, which includes California — had posted such a steep drop. All nine divisions posted declines in November, the FHA reported.

Prices in November now roughly correspond to home values last seen in March 2005, according to the report. And if our premonitions are correct, we still have further to fall in the months ahead.

Read the full report here.

Housing correction nearing end?

(MarketWatch) And now for some good news: The mother of all housing corrections appears to be nearing an end.

Nationwide, prices of new and existing homes are now only about 7% away from being as affordable as they were during the 1980s -- when the housing market was booming. At that time, median home prices equaled 2.9 times median household incomes.

To put this in perspective, at the apex of the bubble back in 2006, median home prices sold for about 4.5 times median incomes. In some markets they were actually twice as high -- clearly an unstable level that required creative lending and a bubble mentality among buyers and bankers alike.

For this key ratio to fall this far this fast required a combination of rising incomes -- and sharply falling housing prices. During the past three years personal incomes rose a total of 10% while home prices dropped by some 23%, on average.

This implies that by the time home prices bottom out, they will have fallen a total of 30% from their 2006 highs. In those markets where housing really got overheated, prices are already down by as much as 50%!

When combined with today's ultra-low mortgage rates, homes in many parts of the country may already be as affordable as they were in the halcyon days of the 1980s. Don't forget, in some areas home prices never bubbled up in the first place, so they have been priced right all along.

All that is needed now is a good dose of buyer confidence -- and a willingness on the part of the banks to resume lending to those who qualify for a mortgage.

Needless to say, unlike their counterparts of the bubble era, today's home buyers will be required to have some skin in the game. In other words, they will have to put down 20% or more. They will be required to document their incomes and be sure that the home they wish to buy is appraised at a realistic price.

From a seller's perspective, homes that are priced realistically (say, 30% off their peaks, or in some cases not more than three times local incomes) will sell the quickest. Keep in mind that even at these seemingly depressed levels, most houses will still fetch prices well above what they were in 2000.

Another piece of good news is that once housing prices touch bottom, it follows that the value of mortgage-backed securities will materialize as well. This is the sine qua non for thawing out the financial markets, for it will make the banks confident enough to resume lending -- first to each other, then to business and finally to consumers.

And once money begins circulating throughout the economy, many businesses will revive; they will stop firing and start hiring. For their part, consumers will resume spending -- which, in case you did not notice, now accounts for 70% of our gross domestic product.

So the Obama administration may not have to devise another plan to fix the economy. It could well be on the way to mending itself.

Irwin Kellner is chief economist for MarketWatch, and is Distinguished Scholar of Economics at Dowling College in Oakdale, N.Y.