Thursday, December 31, 2009

Uncle Sam’s New Guide to Mortgage Shopping

Original posted in the New York Times by James R. Hagerty:

My guess is that the typical American puts more thought into the search for a flat-screen TV than into the choice of a mortgage lender.

Shopping for a TV is fairly straightforward. You read reviews online or in Consumer Reports; you eyeball a few models in the store to see if the image looks sharp; then you buy from whichever merchant has the lowest price. If the TV doesn’t work, the merchant gives you a new one.

Shopping for a mortgage is more complicated, less fun and infinitely more dangerous to your long-term financial interests. At the end of the process, you probably have no idea of whether you got the best deal available. Was the upgrade on those cherry kitchen cabinets really worth the high rate and fees you paid to the lender affiliated with your friendly home builder? Probably not, but that salesman sure was persuasive, and you were glad to be relieved of spending the next three days shopping for mortgages.

Now help is on the way from a most unlikely source: The U.S. Department of Housing and Urban Development, or HUD.

Federal rules that take effect Friday mandate a standard, three-page Good Faith Estimate that urges consumers to shop around for the best loan and helps them compare lenders’ offerings. The rules, announced by HUD in November 2008 but just taking effect this week, are an update of the Real Estate Settlement Procedures Act, a 1974 law known as Respa. (See WSJ story.)

One difficulty of shopping for mortgages is that the lender with the lowest rates often isn’t offering the best deal. High fees can wipe out the benefits of low rates, and little-noticed features such as prepayment penalties might blow up on you later on. Even for members of Mensa, it’s hard to compare different combinations or rates, “points” (paid in exchange for a lower rate), fees and other terms. Lenders often sprinkled in lots of confusing charges, such as processing and messenger fees, to pad their margins. Dickering over theses “junk” fees distracted borrowers from the bigger picture of total costs.

All of these complexities favor lenders, of course. The more confused you get, the less likely you are to realize you just got fleeced.

To address those problems, the new estimate form requires lenders to wrap all the fees they control into one “origination charge.” That lets you compare one lender’s fees with another’s. Jack Guttentag, a finance professor emeritus at the University of Pennsylvania’s Wharton School, recommends that borrowers focus on two items as they shop: the interest rate and the “adjusted origination charge,” which includes any points paid to lower the rate.

Good Faith Estimates have been around for decades, but there was no standard format. Under the new rules, lenders and mortgage brokers are required to give consumers the standard estimate forms within three days of receiving a loan application.

Lenders aren’t allowed to increase the origination fee from the estimate. Some additional charges, including title services and recording charges, can increase by as much as a combined 10%. Estimates for other charges, such as homeowner’s insurance and other services provided by third parties selected by the borrower, aren’t subject to such limits.

Title insurance typically is the largest fee, and the new forms let consumers know they don’t have to accept the insurer suggested by the lender. Mr. Guttentag says title insurance can be “vastly overpriced” and consumers should take the time to shop for it.

Settlement firms, which organize the closings of home sales, will be required to issue a new version of the HUD-1 form used in closings. This new HUD-1 includes a comparison of the estimated and final costs, as well as a summary of the loan terms.

Will all this make a big difference? Mr. Guttentag, who has been exposing the tricks of lenders and brokers for decades, thinks the new rules will help, though they aren’t a cure-all.

Much depends on whether Americans want to put in a bit of effort rather than simply accept the often biased mortgage advice of a real estate agent, home builder, broker or banker. The real estate agent may urge you to use an affiliate of his firm, or recommend the lender most likely to grant a loan quickly rather than the one with the best terms. The builder wants you to use his in-house lender. The brokers and loan officers are working for themselves, not for you.

When you’re trying to pick a new TV, you don’t rely on a TV manufacturer to give you an impartial review of the alternatives.

Comment originally posted on Reuters by Felix Salmon:

If you get one of these forms from three or four different lenders, and they all fill out this table, then being able to choose the best mortgage for you is going to be much easier than it has been until now.


It might have been nice to include “adjusted origination charges” along with “total estimated settlement charges” on this form, because a conscientious consumer should shop around in any case for things like title insurance. Still, bundling everything into one figure at least gives lenders an incentive not to rip off their borrowers too much on those fees.

Is this going to make a big difference in practice? Are homebuyers going to spend as much time comparing different mortgages as they do comparing different televisions? Or are all those numbers always going to be so confusing that many people will end up just doing what they’ve historically done, which is trust a mortgage broker?

My hope is that a few big lenders are going to take a leaf out of Progressive’s book, and encourage homebuyers to shop around, making it as easy as possible to compare different offers. But one thing’s for sure: if your mortgage broker doesn’t show you different options in this kind of ultra-clear standardized format, find a different mortgage broker.

Hefty (Negative Equity) Cleaning Bill

Original posted on American Banker:

A senior economist at First American CoreLogic Inc. has estimated that it would cost $858 billion to extinguish the negative equity of all underwater homeowners and give them a 5% stake in their homes.

Several analysts say one reason the Treasury Department pledged unlimited support to Fannie Mae and Freddie Mac last week is that the Obama Administration is planning to expand the Home Affordable Modification Program to allow servicers to reduce borrowers' principal balances. Mortgage experts say borrowers who get this type of modifications are less likely to redefault. That's particularly true for borrowers with no equity or even negative equity, who have little incentive to stay in their homes.

But the price is steep.

Nearly 10.7 million borrowers, or 23% of the residential mortgage market, owed more on their mortgages at Sept. 30 than their homes were worth.

Sam Khater, a senior economist with the unit of First American Corp. of Santa Ana, Calif., has estimated that the average value of mortgage debt for homes with negative equity was $280,000 in the third quarter. The average underwater borrower owed $69,700 more on her property than it was worth.

It would take $745 billion — more than the $700 billion the Treasury is spending to bail out the banking system throught the Troubled Asset Relief Program — merely to extinguish borrowers' negative equity and give them a 100% loan-to-value ratio, Khater said.

Default Mode

Default managers are becoming increasingly worried about strategic defaults, in which borrowers who are current on their mortgage and have the ability to pay nevertheless decide to stop paying in order to get a loan modification.

George Schwartz, an executive vice president and division president of default services at ServiceLink, a Pittsburgh unit of Fidelity National Financial Inc. of Jacksonville, Fla., said strategic defaults are "a much larger number than most people think," because there is no longer a stigma associated with foreclosure.

"There are many, many people that are going into default for the purpose of trying to get a modification and they flat-out don't need it," Schwartz said in a recent interview.

He likened strategic defaulters to investors seeking reimbursement for stock market losses. "If you made an investment that didn't pay out, you wouldn't expect that a bank would just write it off and make you whole again."

Schwartz, a former managing director at Bank of America Corp., is also becoming increasingly concerned about the "shadow inventory" of bank-owned homes that have not yet been listed for sale and are stuck in limbo as borrowers seek modifications under Hamp.

One reason the program has not worked well is that servicers put millions of defaulted borrowers into trial modifications without getting any financial information from them, Schwartz said. "Now they're collecting the data and seeing that borrowers don't qualify based on the rules they set up."

These properties will eventually end up on the market. A "number of real estate-owned properties have dried up across the country because they're just not coming out of the foreclosure process," Schwartz said. "They are sitting in limbo with servicers waiting to see what else Treasury says they have to do."

First American CoreLogic has estimated that 1.7 million homes make up the shadow inventory.

"Everybody thinks there's a dam ready to break and we're all wondering when it's going to happen and how long we can carry staff waiting for it to happen," Schwartz said. "We're all waiting for the bubble to burst."

Quotable ...

"The timing of this executive order giving Fannie and Freddie a blank check is no coincidence." It was designed "to prevent the general public from taking note."

Rep. Spencer Bachus of Alabama, the ranking Republican on the House Financial Services Committee, quoted in The Wall Street Journal about the Treasury's Christmas Eve announcement that it was lifting caps that limited the amount of available capital to the companies to $200 billion each.

Tuesday, December 29, 2009

IMF Working Paper: A Fistful of Dollars: Lobbying and the Financial Crisis

By Deniz Igan, Prachi Mishra, and Thierry Tressel:

Abstract: Using detailed information on lobbying and mortgage lending activities, we find that lenders lobbying more on issues related to mortgage lending (i) had higher loan-to-income ratios, (ii) securitized more intensively, and (iii) had faster growing portfolios. Ex-post, delinquency rates are higher in areas where lobbyist' lending grew faster and they experienced negative abnormal stock returns during key crisis events. The findings are robust to (i) falsification tests using lobbying on issues unrelated to mortgage lending, (ii) a difference-in-difference approach based on state-level laws, and (iii) instrumental variables strategies. These results show that lobbying lenders engage in riskier lending.

The paper can be downloaded here.

Saturday, December 26, 2009

Fannie, Freddie and the Struggles of HAMP

Original posted on Calculated Risk:

It is possible that the Treasury directive on Wednesday to extend the review period for all active HAMP trial modifications until at least Jan 31, 2010, and the announcement on Thursday to uncap the potential losses for Fannie and Freddie are related.

There is a possibility that the Treasury is planning on introducing a principal reduction component to HAMP in January, and this could lead to significantly larger losses for Fannie and Freddie (just speculation on my part). There has been no announcement yet, and even if this is proposed it might only apply to Fannie and Freddie related loans, and not private MBS (the number of Fannie/Freddie loans compared to private MBS varies significantly by servicer).

Thursday, December 24, 2009

Foreclosure Challenges Raise Questions About Judicial Role

Original posted in the Wall Street Journal by Amir Efrati:

A group of state and federal judges presiding over foreclosures are wiping away borrowers' mortgage debt, invalidating foreclosure sales and even barring some foreclosures outright.

The decisions in recent months by a handful of judges in states including Massachusetts, New York and Texas mark a new phase in the judiciary's battle to stem the rising tide of foreclosures by punishing mortgage companies for paperwork mistakes and alleged mistreatment of borrowers.

The number of judges taking such action remains small, and most foreclosures go through without a challenge.

But the growing number of rulings against lenders' claims is raising questions among some legal experts about judges' impartiality.

"The question is whether judges are changing the rules in the middle of the game...just because there is a financial crisis," says Todd Zywicki, a law professor at George Mason University and a critic of policy initiatives aimed at curtailing lenders' ability to foreclose.

As early as 18 months ago, several judges in California, New York, Ohio and elsewhere would dismiss foreclosure cases if they could find reason to do so. But those judges often allowed the mortgage companies to refile their foreclosure claims after attesting to their ownership of the mortgage in the county in which the homeowner lives.

Now, after the country has been mired in a housing crisis for more than two years, more judges are calling these companies on their paperwork glitches, and in some cases going much further in their efforts to help homeowners.

It makes sense for judges to demand that mortgage companies follow the rules to the letter if they want to win foreclosure cases in court, says Raymond Brescia, an assistant professor at Albany Law School who has written about the role of the courts in the financial crisis. "I don't think that's a crazy idea," he says. "To expect plaintiffs to prove their case is what the judicial system is founded on."

But if judges decide to help borrowers in ways that overlook the merits of individual cases, Mr. Brescia adds, that would "undermine the integrity of the judiciary, and that's not going to help anybody." Instead, he says, it might trigger a backlash from legislators or regulators to rein in activist jurists.

At the heart of some of the court rulings is what became a common practice among mortgage companies: filing a foreclosure claim without showing proof that they actually own the mortgage and have the right to foreclose. This occurs in part because mortgages change hands multiple times after the original loan is made, but the mortgage documents and the contracts between borrowers and lenders are never altered to reflect those changes. Years later, it can be difficult to verify who is the owner of the mortgage.

That played a key role in a ruling in October by Keith Long, a state-court judge in Massachusetts. He invalidated two foreclosure sales that had occurred more than two years ago. The judge affirmed his own prior ruling that said units of U.S. Bancorp and Wells Fargo & Co. never had the right to sell the homes.

Judge Long ruled that even though the companies physically held the relevant mortgage documents, the mortgages were never legally assigned to them and recorded with the state.

"They're selling something they don't own," says attorney Paul Collier, who began representing the borrowers in the case last year.

Walter H. Porr, a lawyer for the companies, which are appealing the ruling, says his clients "operated in what had been an accepted industry fashion for the better part of 15 or 20 years." He adds: "We owned those mortgages."

In October, a federal bankruptcy judge in White Plains, N.Y., rejected a claim by a mortgage company that the debtor owed $460,000. The judge, Robert D. Drain, said the company, PHH Mortgage Corp., couldn't prove it owned the debt.

A spokeswoman for PHH, which is appealing, said the company is trying to resolve the case.

And in a prominent case in New York's Suffolk County on Long Island, Jeffrey Spinner, a state-court judge, canceled $292,000 in mortgage debt after he ruled the borrowers were mistreated by IndyMac Bank.

The judge said in a November ruling that the bank displayed "harsh, repugnant, shocking and repulsive" behavior by making no attempt to negotiate a settlement with Diane Yano-Horoski after she and her husband fell behind on payments, despite a state law requiring the company to try.

OneWest Bank, which purchased the debt from IndyMac, plans to appeal. In a statement, it said the ruling, "if allowed to stand, has sweeping and dangerous implications."

At least one judge has been admonished for appearing to favor borrowers. In September, a Florida state appeals court ruled that a lower-court judge, Valerie Manno Schurr, erred in routinely delaying foreclosure sales by several months. Her reasoning put concern for the homeowners ahead of the law, the appeals court said.

Judge Manno Schurr didn't respond to requests for comment.

Wednesday, December 23, 2009

Homeowners Get More Time for Home-Loan Modifications

Original posted on Bloomberg by Jodi Shenn:

Mortgage servicers must give U.S. homeowners more time before kicking them out of the government’s loan-modification program, reflecting further struggles in the execution of the plan.

Servicers can’t cancel an active Home Affordable trial modification scheduled to expire before Jan. 31 for any reason other than property eligibility requirements, according to a posting today on a government Web site. They must write to borrowers to inform them about missed payments or needed documents, and give them at least 30 more days to submit them.

“The Treasury Department believes that this further guidance and associated requirements will provide more certainty and transparency regarding the final determination of eligibility for borrowers in trial modifications,” Meg Reilly, a department spokeswoman, said in an e-mailed statement.

The extension follows the Obama administration announcing a “Mortgage Modification Conversion Drive” on Nov. 30, meant to aid borrowers with trial plans set to expire at year end. The drive began after servicers struggled to acquire the documentation from homeowners required by the government to make loan changes permanent under its $75 billion program. Officials have placed some of the blame on both servicers and borrowers.

In October, the U.S. loosened documentation requirements and said an initial round of trial modifications could be completed over an extra two months, rather than the three-month standard.

Through November, servicers have permanently modified 31,382 of as many as 4 million mortgages targeted by the Home Affordable program, the Treasury said Dec. 10. A total of 728,000 were under way. The Treasury said last month that 375,000 trial modifications were scheduled to be converted into permanent repayment plans or expire by the end of the year.

“Servicers have made substantial progress in staffing up and dedicating further resources in support of HAMP,” Reilly said.

The official message can be downloaded here.

Tuesday, December 22, 2009

Second Chances: Subprime Mortgage Modification and Re-Default

By Andrew Haughwout, Ebiere Okah, and Joseph Tracy:

Abstract: Mortgage modifications have become an important component of public interventions designed to reduce foreclosures. In this paper, we examine how the structure of a mortgage modification affects the likelihood of the modified mortgage re-defaulting over the next year. Using data on subprime modifications that precede the government’s Home Affordable Modification Program, we focus our attention on those modifications in which the borrower was seriously delinquent and the monthly payment was reduced as part of the modification. The data indicate that the re-default rate declines with the magnitude of the reduction in the monthly payment, but also that the re-default rate declines relatively more when the payment reduction is achieved through principal forgiveness as opposed to lower interest rates.

The paper can be downloaded here.

Hamp, what is it good for?

Original posted on FT Alphaville by Tracy Alloway:

In addition to the difficulty of converting temporary mortgage modifications into permanent ones, one of the big question marks hanging over the US Treasury’s Home Affordable Modification Plan is the redefault rate. That is, the percentage of homeowners who redefault on their modified mortgage.

FT Alphaville has mentioned before that in cases of severe negative equity, it might make more sense for a homeowner to make a couple of Hamp-reduced interest payments on his or her mortgage and then walk away. The US Treasury hasn’t given an official default rate for the programme yet, but figures like 25 per cent and 50 per cent have been bandied about.

In their US Securitised Product Outlook for 2010, however, Barclays Capital take a slightly more negative outlook on the redefault rate. It might be better than previous mortgage modification plans — but it’s still likely to be pretty dismal, they say:

Re-default performance for loans modified in Q3 08 has been dismal, with more than 60% relapsing into deep delinquency already. However, HAMP has been more aggressive than earlier mods – reducing borrower payments by 30-40%, compared with earlier modification efforts that typically reduced monthly payments by 15-20%. As Figure 6 shows, higher payment reductions reduce re-default rates, but only by 5-10% for that magnitude of payment change . . .

On the flip side, HAMP does not address the issue of negative equity, which is one of the primary drivers behind default . . . Taking these factors into account, we expect overall HAMP re-default rates to show not more than a 10-20% improvement over the default rates seen in past mods.

With the redefault issue then, plus the conversion rate for permanent modifications and various servicer problems, BarCap thinks we’ll see some sort of revision or significant tweaking of the programme.

Possible changes could include further streamlining the documentation requirement for Hamp applications, creating a lower debt-to-income target or second-lien programme, or, perhaps most significantly, starting principal forgiveness instead of just forbearance.

Here’s a summary:

Finally, watch out for new policy changes from Washington on the mortgage front. If HAMP does not work well (as we expect), and foreclosures keep rising, Congress might revisit some of the more radical suggestions from earlier this year, such as cram-downs, forced debt forgiveness, etc. On the agency MBS side, one tail risk is the prospect of an off-market, low mortgage rate provided by the government. MBS investors fearful of this shift compressed the coupon stack sharply in Q1 09 – if such an off-market rate is actually offered by the government, it could greatly hurt premiums and, thus, all agency MBS valuations

. . .

A greater share of debt forbearance mods would lead to upfront losses on the pool, in turn leading to higher initial [constand default rates]. However, since debt forgiveness mods typically perform better than comparable rate reduction mods, re-default rates would be lower (Figure 27). Higher losses upfront on the forgiven amount would imply that subordinates would be written down faster on subprime deals, causing crossover to occur sooner. This would benefit the second and third cash flows at the expense of the first cash flow bond as the principal waterfall switches from sequential to pro rata.

Given all of the above, readers might well be scratching their heads as to what the Hamp is actually good for. And on that point Barclays is very clear — shadows and cans:

To be clear, the modification program (HAMP) is not a silver bullet. As Figure 6 shows, historical re-default rates for all types of modifications are high – HAMP should be better, but not hugely so. But the process of modification buys time. It increases the number of months between the borrower turning delinquent and the home hitting the market. This is shown in the REO (real estate owned) line in Figure 5; even as foreclosures keep rising, the REO bucket has gone down. So kicking the foreclosure ‘can’ down the road has helped prices stabilize.

Intuitively, if there are millions of foreclosures to still work through the system, it is better to spread them over a few years than have them hit the market in six months – this prevents prices from over-correcting to the downside. And with the Administration focused on modifications, we expect long delinquency-to-liquidation timelines to help home prices.

As a result, our forecast calls for prices to drop 8% from current levels, before stabilizing in Q2 2010. The macro impact of this decline should be muted. After all, a house worth $100 is now worth $67 (prices have fallen around 33% from peak in Case Schiller). A further 8% decline from current levels is simply another $5.3. As every month passes without a sharp increase in the REO bucket or a sharp drop in home prices, the tail risk posed by housing declines ever so further.

REO vs Foreclosure - BarCap

`Real estate owned’ means the properties owned by banks and mortgage companies — the stuff we call `shadow housing inventory‘ since it’s not included in official measures of unsold housing inventory.

Monday, December 21, 2009

Reducing the shame of default

Original posted on Reuters by Felix Salmon:

Steve Waldman has been doing a spectacularly good job of teasing out the moral and financial implications of homeowners walking away from their mortgage obligations, and delivers another great post today:

I think that underwater homeowners ought to walk away from their loans for the very same reason McArdle want us to consider them jerks for doing so. We both want to see norms we consider valuable enforced. I think that banks violated a great many norms of prudence and fair dealing in their practices during the credit bubble, and that they violate the fundamental norm of reciprocity by fully exploiting their own legal rights while insisting that borrowers have a moral obligation not to exercise a contractual option. In order to strengthen norms I consider crucial, I hope transgressors face legal and social consequences (strategic default and reduced shame attached to default) that will alter their behavior going forward…

McArdle favors a world with both easy credit and easy bankruptcy. I favor the easy bankruptcy, but not the easy credit. I think that debt arrangements are hazardous and should be entered into only with great care. I don’t consider increasingly leveraged homeownership and aggressively accessible consumer credit to have been positive developments. As a practical matter, I think we must rely on creditors rather than potential debtors to differentiate between wise and unwise loans. So I consider it a feature rather than a bug that holding creditors accountable will encourage them to think twice before sending out convenience checks.

While you’re chez Steve, you should also check out the letter he got from a soldier on the same issue. The basic insight here is that if a large number of morally serious individuals refuse to walk away from their debts, then we as a society are essentially letting banks off the hook for systemically-dangerous atrocious underwriting. Meanwhile, the banksters are grinning from ear to ear: to the extent that they haven’t been bailed out by the government, they can happily get bailed out by individuals who will end up paying hundreds of thousands of dollars just so they don’t need to worry about being considered to be “jerks”.

If there’s less shame attached to default, we will end up with exactly what we want — less badly-underwritten credit, a more solvent society, and much less tail risk. We went far too many years believing without really analyzing the proposition that credit is nearly always a Good Thing. Now that we’ve learned just how harmful it can be, it makes sense to reorient our aspirations and norms in the direction of a world where credit is both rarer and safer than it is right now.

Estimated Impact of the Fed’s Mortgage-Backed Securities Purchase Program

By Johannes C. Stroebel and John B. Taylor

Abstract. We examine the quantitative impact of the Federal Reserve’s mortgage-backed securities (MBS) purchase program. We focus on how much of the recent decline in mortgage interest rate spreads can be attributed to these purchases. The question is more difficult than frequently perceived because of simultaneous changes in prepayment and default risks. When we control for these risks, we find evidence of statistically insignificant or small effects of the program. For specifications where the existence or announcement of the program appears to have loweredspreads, we find no separate effect of the size of the stock of MBS purchased by the Fed.

Download the paper here.

Securitization: BIS Examines New Century Capital

Original posted on Prefbog:

The Bank for International Settlements has released a working paper by Allen B Frankel titled The risk of relying on reputational capital: a case study of the 2007 failure of New Century Financial:
The quality of newly originated subprime mortgages had been visibly deteriorating for some time before the window for such loans was shut in 2007. Nevertheless, a bankruptcy court’s directed ex post examination of New Century Financial, one of the largest originators of subprime mortgages, discovered no change, over time, in how that firm went about its business. This paper employs the court examiner’s findings in a critical review of the procedures used by various agents involved in the origination and securitisation of subprime mortgages. A contribution of this paper is its elaboration of the choices and incentives faced by the various types of institutions involved in those linked processes of origination and securitisation. It highlights the limited roles played by the originators of subprime loans in screening borrowers and in bearing losses on defective loans that had been sold to securitisers of pooled loan packages (ie, mortgage-backed securities). It also illustrates the willingness of the management of those institutions that became key players in that market to put their reputations with fixed-income investor clients in jeopardy. What is perplexing is that such risk exposures were accepted by investing firms that had the wherewithal and knowledge to appreciate the overall paucity of due diligence in the loan origination processes. This observation, in turn, points to the conclusion that the subprime episode is a case in which reputational capital, a presumptively effective motivator of market discipline, was not an effective incentive device.

The end of the road for New Century came when:

Purchasers of New Century’s loan production normally conducted a due diligence examination after a sales agreement had been reached. The investor, or a due diligence firm hired by the investor, would review loan files to determine whether the loan was underwritten according to the pool’s guidelines. Loans not meeting guidelines could be excluded from the loan bundle (kicked out) and returned to the originator.

Once kicked out, the mortgages were known as a “scratch and dent” (S&D) loans, which were purchased by specialised investors at a large discount to their principal balance. Consequently, one measure of the deterioration of the quality of New Century’s loan production is the percentage of S&D loan sales. In 2004 and 2005, such sales amounted to less than 0.5% of New Century’s secondary market transactions. By contrast, in the first three quarters of 2006, S&D loan sales accounted for 2.1% of such transactions (Missal (2008, p. 68)).

The upsurge in loan repurchase requests to New Century coincided with a change in the methodology employed to estimate its allowance for loan repurchase losses. New Century’s board learned of the change after a considerable delay. This discovery was followed, after a few days, by a public announcement on 7 February 2007 that New Century’s results for the three quarters of 2006 needed to be restated. It also noted an expectation that losses would continue due to heightened early payment default (EPD) rates.

New Century’s announcement prompted margin calls by many of its warehouse lenders and requests for accelerated loan repurchases. Soon, all of New Century’s warehouse lenders ceased providing new funding. Because simultaneous margin calls by its warehouse lenders could not be met, New Century filed for bankruptcy on April 2, 2007. It ceased to originate mortgages and entered into an agreement to sell off its loan servicing businesses.

Amusingly, in the light of the current bonus hysteria:

The examiner’s access to internal New Century documents provided valuable insights into how the appearance of the warning flags influenced, or did not influence, management. For example, the examiner could find no reference to loan quality in the internal documents that described New Century’s bonus compensation system for regional managers for 2005 and 2006 (Missal (2008, p. 147)). The examiner says that the compensation of New Century’s loan production executives was directly and solely related to the amount of mortgage loans originated, loans that, in turn, were subsequently sold or securitised.32 Likewise, the examiner found no mention of penalties (reduced commission payments to loan production staff) that would be assessed against defective loans that required price discounts for secondary market sale.

Heightened investor concerns about the performance of subprime loans were reflected in changes in their due diligence processes (Missal (2008, p. 165)). Historically, investors would ask due diligence firms to examine, on their behalf, only a small sample of loans in a particular pool. The character of the process first changed in 2006 when most investors began to look at the appraisal documents in all loan files in a loan pool. Investors then increased the share of loan files examined. This intensification of due diligence efforts was responsible for a sharp increase in New Century’s kickout rate from 6.9% in January 2006 to 14.95% in December 2006 (Missal (2008, p. 161)).

The author concludes:

The examiner’s report suggests that some of the actions undertaken to improve loan quality in late 2006 and early 2007 were designed to anticipate new credit risk concerns among New Century’s counterparties. Nonetheless, when New Century announced a need to recast its financial reports, there had not yet been a defection by any of its largest counterparties. Not surprisingly, defections ensued immediately after the announcement. In those circumstances, the bunching of defections probably signalled an absence of attention on the part of counterparties to the mounting risks of ongoing transactions with New Century. In turn, the evidence of ineffective counterparty risk management has led to concerns about the effectiveness of existing governance structures (corporate and regulatory) and, in particular, reputational capital as an incentive device. Can those structures now be relied on to discipline the risk-taking incentives of those involved in underwriting securities backed by subprime (and other risky) assets?

OCC and OTS: Foreclosures, Delinquencies increase in Q3

Original posted on Calculated Risk:

From Jim Puzzanghera at the LA Times: Foreclosures for major sector of bank industry topped 1 million in third quarter, report says

The number of home foreclosures for a major sector of the banking industry topped 1 million for the first time in the third quarter of the year as struggles spread to homeowners with prime loans and modified mortgage payments, according to new data released today by ... the Office of the Comptroller of the Currency and the Office of Thrift Supervision.
The report highlighted some troubling trends as ... Difficulties increased for holders of prime mortgages, with the percentage of those loans that were 60 days or more delinquent increasing to 3.2%, up almost 20% from the second quarter and more than double the rate of a year ago.

In addition, holders of mortgages whose payments had been lowered through government or private modification plans re-defaulted at high rates. More than half of all homeowners with modified loans fell 60 days or more behind in their payments within six months of the modification taking place.
Here is the press release and report.

Much of the report focuses on modifications and recidivism, but this report also shows how the foreclosure problem has moved to prime loans.

Seriously Delinquent Loans Click on graph for larger image.

This report covers about 65% of all mortgages. There are far more prime loans than subprime loans - and the percentage of delinquent prime loans is much lower than for subprime loans. However, there are now significantly more prime loans than subprime loans seriously delinquent. And prime loans tend to be larger than subprime loans, so the losses from each prime loan will probably be higher.
Overall, mortgage performance continued to decline as a result of continuing adverse economic conditions including rising unemployment and loss in home values. The percentage of current and performing mortgages fell to 87.2 percent of the servicing portfolio. Seriously delinquent mortgages loans 60 or more days past due and loans to delinquent bankrupt borrowers—rose to 6.2 percent of the servicing portfolio. Foreclosures in process increased to 3.2 percent, while new foreclosure actions remained steady for the third consecutive quarter at 369,209. Of particular note, delinquencies among prime mortgages, the largest category of mortgages, continued to climb. The percentage of prime mortgages that were seriously delinquent in the third quarter was 3.6 percent, up 19.6 percent from the second quarter and more than double the percentage of a year ago.
emphasis added
Seriously Foreclosure Activity
The second graph shows foreclosure activity.

Notice that foreclosure in process are increasing sharply, but completed foreclosures were only up slightly.

The next wave of completed foreclosures is about to break, but the size of the wave depends on the modification programs.

There was some good news on redefaults:
The percentage of modified loans 60 or more days delinquent or in process of foreclosure increased steadily in the months subsequent to modification (see Table 2 [see below]). Modifications made after the third quarter of 2008 appeared to perform relatively better than older vintages. The most recent modifications made in the second quarter of 2009 had the lowest percentage of mortgages (18.7 percent) that were 60 or more days delinquent three months subsequent to modification. This lower three-month re-default rate may be an early indicator of sustainability for loan modifications that reduce monthly payments.
OCC Table 2 For earlier modifications, the redefault rates was around 60% after 12 months, but the little bit of good news is "only" 18.7% of recent modifications have redefaulted with 3 months (this is lower than the previous modifications). I expect a large percentage of the homeowners to redefault eventually because the modification efforts still leave the homeowners with significant negative equity (they are more renters than owners).

Fed's Flow of Funds now using Case-Shiller - Not!

Original posted on Calculated Risk (see here for the original incorrect post):

Here is what actually happened (ht Nancy):

1) Starting with the Q3 2008 report, the Federal Reserve switched from the OFHEO / FHFA house price index to the LoanPerformance house price index. From the Fed in the notes to the Q3 2008 report:
The market value of residential real estate (B.100, B.102, and B.103) has been revised from 2000:Q1 forward to reflect improved data sources. The value of owner-occupied housing in 2001:Q3, 2003:Q2, and 2005:Q2 is now benchmarked to data from the American Housing Survey, and changes in the value of single-family homes in non-benchmark quarters are now estimated using a repeat-sales house-price index from LoanPerformance (a division of First American CoreLogic). Previously we used a price index from the Federal Housing Finance Agency (formerly the Office of Federal Housing Enterprise Oversight).
2) LoanPerformance revised their index in Q3 2009, and this showed up as a substantial change for household real estate value. From the Q3 2009 report:
The market value of residential real estate (B.100, B.102, and B.103) has been revised from 2000:Q1 forward to reflect revised data for the repeat-sales house-price index from LoanPerformance (a division of First American CoreLogic).
The reason this change wasn't obvious in Q3 2008 was that the value of household real estate didn't change significantly for the most recent quarters (although using the LoanPerformance index showed a larger bubble).

The following graph shows the value of household real estate from the Flow of Funds report for all the reports since Q2 2008.

Q2 2008 was based on the FHFA / OFHEO index (blue).

All other reports were based on the LoanPerformance index.

The LoanPerformance index was revised significantly in Q3 2009 (red).

Flow of Funds, Household Real Estate Click on table for larger image in new window.

When the Fed switched to the LoanPerformance index there was a relatively small change to the value in Q2 2008, so I missed this change.

However when the LoanPerformance index was revised in Q3, the value of household real estate plunged by over $2 trillion in Q2 2009! That stood out.

Sunday, December 20, 2009

Fed's Flow of Funds now using Case-Shiller

Original posted on Calculated Risk:

From a newsletter by John Mauldin:

Frank Veneroso noticed something unusual in the latest Federal Reserve Flow of Funds report. They changed their methodology for analyzing housing prices to a model more like the Case-Shiller index, which most believe to be more accurate. That meant they deducted another $2 trillion from household net worth than in the previous quarter. They just caught up with reality, so no big news there. But there is some big news if you look closely.

About one-third of the homes in the US have no mortgages. Typically, these are nicer homes, as the "rich" have paid off their homes. So you can estimate that to be somewhere between 35-40% of the total value of US homes. Writes Frank:

"So now the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."
On the first point it does appear the Fed is now using the Case-Shiller index for the Flow of Funds report, as opposed to the FHFA index. This change happened in the Q3 Flow of Funds report.

The second point is probably a little inaccurate. According to the most recent American Community Survey, approximately 31.7% of homeowners have no mortgage. Although the "rich" frequently have no mortgage, homeowners without mortgages tend to own less expensive homes than homeowners with mortgages.

Homes with and without Mortgages by Value Click on graph for larger image in new window.

This graph is based on the American Community Survey data for homeowners without a mortgage, and for homeowners with mortgages.

The median value (not average) of homes without a mortgage is $148,100, and the median for homes with a mortgage is $214,400.

My estimate is that homeowners without mortgages own about 26% of all household real estate (by value), and this suggests homeowners with mortgages have about 85% loan-to-value in the aggregate. This includes homeowners with 90% equity (almost paid off), and homeowners with substantial negative equity.

Negative equity is a serious problem, but according to First American Core Logic, about 23% of homeowners with mortgages have negative equity - and that is probably closer to the actual number.

Note: here is much more on negative equity with several graphs.

Wednesday, December 16, 2009

Debtor's Dilemma: Pay the Mortgage or Walk Away

Original posted in the Wall Street Journal by James Hagerty:

Should I stay or should I go? That is the question more Americans are asking as the housing market continues to drag.

In good times, it would have been unthinkable to stop paying the mortgage. But for Derek Figg, a 30-year-old software engineer, it now seems like the best option.

Mr. Figg felt trapped in a home he bought two years ago in the Phoenix suburb of Tempe for $340,000. He still owes about $318,000 but figures the home's value has dropped to $230,000 or less. After agonizing over the pros and cons, he decided recently to stop making loan payments, even though he can afford them.

Mr. Figg plans to rent an apartment nearby, saving about $700 a month.

Strategic Defaults by State

See data on "strategic defaults" -- homeowners who choose to default on their mortgage even though they could still afford to pay it.

A growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a "strategic default," walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.

A standard mortgage-loan document reads, "I promise to pay" the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient.

George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.

Walking away isn't risk-free. A foreclosure stays on a consumer's credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.

In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.

Even so, in neighborhoods with high concentrations of foreclosures, "it's going to be really difficult to prevent a cascade effect" as one strategic default emboldens others to take that drastic step, says Paola Sapienza, a professor of finance at Northwestern University. A study by researchers at Northwestern and the University of Chicago found that as many as one in four defaults may be strategic.

Driving this phenomenon is the rising number of households that are deeply "under water," owing much more than the current value of their homes. First American CoreLogic, a real-estate information company, estimates that 5.3 million U.S. households have mortgage balances at least 20% higher than their homes' value, and 2.2 million of those households are at least 50% under water. The problem is concentrated in Arizona, California, Florida, Michigan and Nevada.

Josh Cotner, who owns an insurance agency, says his mortgage balance is about $100,000 more than the market value of his home in Gilbert, Ariz. Mr. Cotner could rent a bigger home nearby for $600 a month, far below the $1,655 he now pays on his mortgage, home insurance and property tax. He says he recently stopped making mortgage payments because his lender wouldn't help him reduce the principal on his loan under a federal program in which he believes he is qualified to participate. Given the sometimes lengthy legal process of foreclosure, he may be able to stay in the home for at least another nine months without making any payments.

Banks warn they may get tough with strategic defaulters by pursuing legal claims on a borrower's other assets. "We will try to reduce people's payments if they have a hardship," says Thomas Kelly, a spokesman for J.P. Morgan Chase & Co. "But we have a financial responsibility to get people to pay what they owe if they can afford it."

Steven Olson, a loan officer and roof installer in Roseville, Minn., defaulted in 2007 on a plot of land in Florida he had bought as an investment. "I thought I could move on with my life," he says. But the lender, RBC Bank, a subsidiary of Royal Bank of Canada, sued him, seeking to make him pay more than $400,000 to the bank to cover its losses on the loan. Mr. Olson has hired a Florida lawyer, Roy Oppenheim, to resist the claim. An RBC spokesman declined to comment.

[The Burning Questions]

States where lenders generally can pursue such legal claims include Florida and Nevada but not California and Arizona, where laws generally prohibit lenders from pursuing other assets of mortgage borrowers. A new Nevada law will protect many borrowers from these judgments if they bought a home for their own use after Sept. 30, 2009.

Another risk for defaulters is that banks could sell the rights to pursue claims to collection agencies or other firms, which could then dun the borrowers for up to 20 years after a foreclosure. Such threats appear to deter some borrowers. A recent study from the Federal Reserve Bank of Richmond found that under-water borrowers were 20% more likely to default in a state where mortgage lenders can't pursue claims on other assets than in those where they can.

Brent White, an associate law professor at the University of Arizona who has written about this issue, says homeowners should make the decision on whether to keep paying based on their own interests, "unclouded by unnecessary guilt or shame." He says borrowers can take a cue from lenders that "ruthlessly seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility."

But it isn't just a matter of the borrower's personal interest, says John Courson, chief executive of the Mortgage Bankers Association, a trade group. Defaults hurt neighborhoods by lowering property values, he says, adding: "What about the message they will send to their family and their kids and their friends?"

In Mesa, another suburb of Phoenix, low prices are helping to draw buyers who may walk away from other homes. Christina Delapp bought a house out of foreclosure in July for $49,000 in cash. She says she will stop paying the mortgage on another home she still owns in Tempe if she can't sell in the next few months for more than the $312,000 that she owes.

Ms. Delapp, who has been jobless for 18 months, says that the new home is part of her survival strategy. "I feel very fortunate," she says. "Regardless of what happens to my credit, we've managed to put together the best safety plan that I possibly could."

Mr. Figg says that deciding to default on his loan was "the toughest decision I ever made." He worried that if he ever loses his job he would be marooned in a home that he couldn't sell for enough to pay off his loan, limiting his ability to find work in other parts of the country: "I couldn't move up. I couldn't move down. I couldn't move out of the city. It was a very claustrophobic situation."

By moving to an apartment, Mr. Figg expects to lower his costs by about $700 a month. He plans to put that into his savings account and says he is willing to rent for the next five years or so.

Lenders are guilty of having "manipulated" the housing market during the boom by accepting dubious appraisals, Mr. Figg says. "When I weighed everything," he says, "I was able to sleep at night."

BofA Lacks ‘Sense of Urgency’ to Convert HAMP Mods

Original posted on the Housing Wire by Jon Prior:

Two weeks after the Treasury reported Bank of America’s (BAC: 15.355 +1.09%) 98 permanent modifications eight months into the Home Affordable Modification Program (HAMP), BofA clarified the numbers.

According to the Treasury report, BofA has just over 1m HAMP-eligible loans in its estimated 60-plus day delinquency portfolio. Jack Schakett, the credit loss mitigation strategies executive at BofA, explained in a conference call that number is closer to 340,000.

The 1m figure, he said, is the total amount of loans that meet the basic criteria for the program. After speaking with customers and moving through that portfolio, BofA has crossed off borrowers who’ve vacated the home, are unemployed or have enough income to afford a payment – meaning their debt-to-income ratio is below 31%.

“Known customers not qualified goes to 600,000,” Schakett says. “As we go through the process of determining who isn’t eligible, we extrapolate that to the customers we haven’t talked to.”

So, Schakett argues, when looking at the more than 158,000 HAMP trials started under BofA, “it’s a better success rate.”

As far as volume, 98 permanent modifications is not “a better success rate” when compared to the 3,537 permanent modifications converted by Wells Fargo (WFC: 25.834 +0.68%), the 4,302 permanent mods converted by JPMorgan Chase (JPM: 41.3999 +1.32%), and even the 271 converted by CitiMortgage.

Schakett is quick to agree and said BofA has not created the right amount of urgency in customers to return necessary documents.

“All of us have very few conversions. It’s simply the process itself. We clearly did not create the sense of urgency we would like in these customers to get these documents in. The other is focus. As we’ve shifted focus away from the start process, we are obviously focusing now on conversion,” Schakett said.

When the Treasury released its report, more than 16,000 borrowers with an active HAMP trial under BofA had no documentation into the bank. After a wave of phone calls and express mail notifications of incomplete documentation (NOIs), that number is down to 2,000. Currently, there are 10,000 BofA borrowers with all of their documentation and underwriting done and are in the final conversion stages, according to Schakett.

But Schakett said that 70% of the delinquent loans will not be eligible for HAMP, pointing out the importance of the bank’s own modification programs. In the past two years, he said, more than 630,000 borrowers received a modification – 25% of the industry total, according to Schakett.

He said the bank is pushing to keep as many borrowers from falling out of the program at the Dec. 31 deadline. Borrowers without full documentation by that deadline could be dropped by the program, Schakett said.

“We’re in a full court press to have all docs in,” Schakett said.

He added that numbers will be better in December and will rise again in January.

HUD Proposes Rule for SAFE Act Enforcement

Original posted on the Housing Wire by Austin Kilgore:

The Department of Housing and Urban Development (HUD) proposed minimum standards for state compliance with the Secure and Fair Enforcement (SAFE) Mortgage Licensing Act of 2008.

The rule (download here) addresses the criteria to determine whether a state’s system for licensing and registering loan originators complies with the law. It also addresses HUD’s enforcement authority including the department’s power to issues summons for information on loan originators, establish systems in states with non-compliant programs and the ability to conduct cease-and-desist proceedings against anyone operating under a HUD-established system who violates the act. HUD is soliciting comments for 60 days on its proposal.

“By introducing nationwide standards of uniform licensing for loan originators, the SAFE Act is taking an important step in returning integrity and accountability to the residential mortgage loan market,” said Federal Housing Administration (FHA) Commissioner David Stevens. “Implementation of this act is a critical addition to our system of regulatory protections that will benefit both consumers and financial institutions.”

The SAFE Act legislation was included in the Housing and Economic Recovery Act of 2008 and is designed to enhance consumer protection and reduce fraud, HUD said. A compliant state program must require originators to take an education course, pass a test, and undergo civil, criminal and financial background checks. All states must have originators licensed by July 31, 2010.

Tuesday, December 15, 2009

Fannie, Freddie Set New HAMP Guidelines on Documentation

The mortgage giants Fannie Mae and Freddie Mac released new guidelines for their servicers modifying mortgages under the Home Affordable Modification Program (HAMP).

Under HAMP, the US Treasury Department allocates capped incentives to participating servicers for the modification of loans on the verge of foreclosure. According to the latest reports, 88 servicers have offered 1m trials and converted 30,000 of them into permanent modifications.

Through November, servicers for the government-sponsored enterprises (GSEs) have offered 33,021 trials for the 262,842 eligible loans in their portfolio, and 6,291 of those have been converted into permanent modifications, according to the latest Treasury report.

Effective Jan. 1, 2010, servicers for Fannie Mae can only evaluate a mortgage for HAMP after certain events occur, according to the new guidelines. The borrower must submit a written request for consideration that includes current borrower income and a reason for default or explanation of hardship, at a minimum. A borrower can also verbally provide sufficient financial information to the servicer to complete a net present value analysis.

Servicers must send a written notice to every borrower evaluated for HAMP without a trial period plan, permanent modification or at the risk of losing HAMP eligibility because of missing documentation. At a recent committee hearing, Congress heard testimony on why so few trial modifications have been converted into permanent status. The answer was often a lack of documentation, as servicers place borrowers in a trial plan and collect the information over the course of that trial.

According to Fannie Mae guidelines, its servicers must include a list of all financial documents needed to complete the HAMP evaluation and a deadline in its “Notice of Incomplete Information.” The notice must be sent no earlier than 30 days after the date of the borrower’s first written request. All other notices must be sent no later than 10 days after the servicer determines the borrower is ineligible for HAMP.

Effective immediately, a borrower facing imminent default is allowed to provide signed federal income tax returns to the servicer, but there remains no requirement.

Freddie Mac’s new guidelines revise some HAMP documentation, sets Jan. 1, 2010 as the deadline for servicers to begin sending timely notifications to borrowers who are not eligible for HAMP, and provides servicers more options for obtaining a net-present value for borrowers from the Treasury.

In addition, the guidelines increase the capitalization threshold from $20,000 to $50,000 when determining whether title insurance is required. The change applies to all modifications including HAMP.

Monday, December 14, 2009

What’s So Great About 30-Year Fixed-Rate Mortgages?

Original posted in the Wall Street Journal by James Hagerty:

One benefit of our financial crisis is that it gives us a chance to rethink the way Americans finance their purchase of homes. Congress and the Obama administration are starting to think about how to reform federal institutions–such as Fannie Mae, the Federal Housing Administration and the Federal Home Loan Banks–that were created during the Great Depression and somehow managed to stay with us into a new century.

But we may be starting that debate with a false premise: That we need to preserve at all costs the 30-year fixed-rate mortgage with an option for the borrower to prepay at any time. That is the assumption of a new set of mortgage-reform proposals released today by the Center for American Progress.

Questioning the sanctity of the 30-year fixed home loan is tantamount to proposing that the White House should be repainted pink. For Realtors, mortgage lenders and home builders, the fixed rate is nearly as sacred as the tax deduction on mortgage interest (an even more dubious American policy, but let’s leave that for another day).

Yet there are good reasons to wonder whether the 30-year fixed-rate mortgage deserves to be enshrined and protected in public policy.

For one thing, it’s very awkward for lenders. Banks don’t get 30-year deposits at fixed rates and so aren’t in a position to count on being able to match the rates on their assets and liabilities if they are making and holding 30-year loans. The S&L crises of the 1980s resulted partly from a mismatch between low rates on loans and soaring rates for deposits.

One response, of course, was to rely more heavily on the use of mortgage-backed securities to provide funding for home mortgages. Banks and other firms could make the loans and then sell them to investors, who could worry about when (and whether) they would be paid back. That works, but only if properly regulated, as we learned when defaults began to soar in 2006.

With the 30-year fixed mortgage, the homeowner can count on paying the same rate of interest every month, even if the general level of rates jumps. But the risk of interest-rate fluctuations doesn’t go away; it just ends up with other people. Much of it ended up with Fannie Mae, Freddie Mac and other buyers of mortgage securities (who later passed on some of their losses to the U.S. taxpayer, typically a homeowner with a fixed-rate mortgage).

Holders of mortgage securities tend to hedge against the risks of rate gyrations by purchasing interest-rate swaps and other derivatives. All of this hedging, involving trillions of dollars sloshing around the globe, makes financial markets more volatile. It also leads to Byzantine accounting rules for the valuation of those derivatives. Those complex rules make it harder to understand what’s really going on at Fannie, Freddie and other buyers of mortgage securities. (Fannie and Freddie got into big trouble with regulators in 2003 and 2004 by trying to work around the accounting rules.)

Homeowners also pay for the security of fixed rates. In a normal market (unlike today’s government-dominated one), the fixed rate is well above the adjustable rate on offer. In a February 2004 speech, Alan Greenspan, then Federal Reserve chairman, noted that “many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade” as rates declined. That raised such an uproar among the fixed-rate priesthood that Mr. Greenspan soon felt compelled to add that he didn’t mean to suggest that everyone should have an adjustable-rate mortgage.

What about the argument that we need 30-year fixed-rate mortgages to ensure that more American households can hope to own a home?

Outside of the U.S. and Denmark, 30-year fixed-rate mortgages are generally unavailable. Variable rates are the norm, and people live quite well with them. The U.S. homeownership rate is around 68%. That is within a percentage point or two of the homeownership rates in Canada and in the European Union as a whole, where variable rates rule.

Yes, the risk of rising rates is real. Interest rates soared in the late 1970s and early 1980s as the Fed fought inflation. That could happen again.

But buying a home is never going to be risk-free. Buyers should be prepared for unexpected costs. It isn’t clear that the government needs to create subsidies to ensure that long-term fixed-rate loans will always be available to American home buyers. (If home buyers are treated like adults, they might even act like adults.) If demand for fixed-rate loans is strong enough, the market eventually will provide them – for a premium price to cover the interest-rate risk being shed by the homeowner.

If, however, we do decide that 30-year fixed rates are a national priority, we might want to look to the Danish model. The Danes have a system under which long-term fixed-rate mortgages are financed through the bond market without the need for government-backed entities like Fannie and Freddie. By all accounts, it has worked quite well for more than two centuries.

Support Grows for Fan-Fred Plan

Original posted on the Wall Street Journal by Nick Timiraos:

A consensus appears to be growing among academics, investors and housing experts that the federal government should retain a role in the U.S. mortgage market over the long term and that the public-private partnership that has defined Fannie Mae and Freddie Mac should continue in some form.

Policy makers are still unsure how to transform or replace Fannie and Freddie, the two main providers of funding for home mortgages, which were taken over by the government last year amid huge losses on defaults. Still, there is broad support from a range of groups for the idea that private companies should succeed or replace Fannie and Freddie, but with enough government involvement to ensure that 30-year fixed mortgages remain available to most Americans.

The idea isn't without opposition, though. Longtime critics of Fannie and Freddie, including some Republicans, argue that the government's ties to the companies or any successors should be cut and their federal subsidies ended.

Although the Obama administration isn't due to release its proposals for reshaping the mortgage market until February, several influential groups have outlined proposals.

The latest, to be released at a private meeting on Monday, is from a group assembled by the Center for American Progress, a think tank with close ties to the administration. It calls for explicit federal guarantees on certain mortgage-backed securities and robust federal regulation to ensure that mortgages offered to the public are safe. The group also wants to make sure that mortgages are available to low-income borrowers and others who may be spurned by private-sector lenders.

While the draft report didn't involve the participation of any administration officials, the liberal think tank has played key roles in shaping some of the administration's personnel and policy decisions. Its recommendations promise to be closely studied by Democratic policy makers.

A Treasury Department spokeswoman said the administration wouldn't comment on specific options until it puts forward its own recommendations.

Most proposals avoid the extremes of turning Fannie and Freddie into national agencies or leaving the market to the private sector, opting instead for a middle ground. While such an approach is easiest to achieve politically, it means the new structure would retain at least some of the public-private conflicts that bedeviled the old, such as tension between shareholders' desire for dividends and political pressure on the companies to support the housing market.

Restarting the government-run finance companies exactly "in their old forms would do nothing but ask for a repeat of recent history," Federal Reserve Governor Elizabeth Duke said in a speech last week, even as she said that recent history suggested that "some form of government backstop may be necessary" to ensure liquidity for home loans.

Try, Try Again

Proposals from the Center for American Progress for replacing

Fannie Mae and Freddie Mac with new entities.

  • Government-chartered firms, known as Chartered MBS Issuers, or CMIs, would finance home loans by selling securities explicitly guaranteed by the government, as opposed to Fannie and Freddie's implied guarantees.
  • CMIs would be privately owned, but regulators would limit their profitability. Fannie and Freddie had no explicit caps on profits.
  • Fees on mortgage securities would pay for insurance against defaults to lessen risks to the government. Fannie and Freddie currently pay dividends to the Treasury on preferred stock.
  • Regulators would set risk standards for all mortgage securities, including those issued by private entities. At present, regulators don't set standards for mortgage securities issued by Wall Street firms.
  • CMIs would have to support rental housing for low-income people.
  • CMIs could hold only limited amounts of mortgages and related securities. Fannie and Freddie have large holdings.

Source: Center for American Progress

The authors of the latest proposal want to move away from the current situation in which 90% of home mortgages are backed by government-related entities, including Fannie, Freddie and the Federal Housing Administration. They address the potential public-private conflicts by calling for much tougher regulation of the entire mortgage market.

"Federal support is not simply about providing liquidity" but should be also designed to ensure that credit flows to "underserved areas," such as inner cities, said Sarah Rosen Wartell, one of the report's authors and an executive vice president at the Center for American Progress.

Like other recent proposals, including one from the Mortgage Bankers Association and another by Credit Suisse analysts, the CAP proposal envisions the government providing an explicit guarantee on securities backed by certain types of mortgages. Without such a guarantee, the costs of a prepayable, 30-year fixed-rate mortgage might become too expensive for many homeowners.

To protect taxpayers, a fee paid on each issue of mortgage-backed securities would fund an insurance pool, and the government would step in to pay bondholders only if the companies and the insurance fund couldn't cover losses. A regulator would determine which mortgage products would be eligible for government backing and how large those mortgages could be.

That would replace the current system in which investors have long assumed that the government would stand behind Fannie and Freddie. While the U.S. government has propped up the companies, some foreign investors lost confidence in that implied guarantee and have reduced their holdings of the companies' debt.

But there are sharp differences among experts over how far the government should go in ensuring that mortgages are available to those who may not have access to purely private lenders. The CAP paper says that, in exchange for the government backstop, the companies' profits would have to be regulated, akin to a public utility. The companies would also be required to lend during periods of financial shock and to support affordable housing, including multifamily rental housing.

While the new companies shouldn't be allowed to hold large investment portfolios of mortgages, the report says, they should maintain smaller, heavily regulated ones to support their public purposes. The debt issued to fund those portfolios wouldn't carry any government backing.

Under their current structure, Fannie and Freddie are directed to target a big portion of their investment activities toward low- and moderate-income borrowers and communities. Republicans and other critics have argued that these mandates helped encourage Fannie and Freddie to loosen their standards, leading to massive taxpayer losses.

But the CAP paper places much of the blame for the current wave of mortgage defaults on the lending practices of Wall Street firms that during the housing boom sold mortgage securities not backed by any government-related entity. Irrational pricing in that market led Fannie and Freddie to make bad decisions as they lowered their standards in an effort to compete with Wall Street, the paper says.

To keep that from happening again, the white paper calls for heavy regulation not only of the new government-backed entities, but also of all private issuers of mortgage-backed securities.

That proposal isn't likely to sit well with industry groups, which say that that more regulation will only raise costs for borrowers. The industry has opposed efforts, including one in the financial regulatory overhaul bill that passed the House Friday, to require financial firms to retain a portion of the loans that they bundle and sell off as securities.

"In retrospect, some very sophisticated investors made poor investment decisions, but the government can't legislate or mandate investment decisions," said Tom Deutsch, deputy executive director of the American Securitization Forum.

The U.S. government took control of Fannie and its rival Freddie in September 2008 through a legal process known as conservatorship. To keep the companies afloat, the Treasury has agreed to purchase up to $200 billion of preferred stock in each company. By year's end, the companies will have taken a combined $112 billion in taxpayer money.

Saturday, December 12, 2009

Rates Are Low, but Banks Balk at Refinancing

Original posted on the New York Times by David Streitfeld:

Mortgage rates in the United States have dropped to their lowest levels since the 1940s, thanks to a trillion-dollar intervention by the federal government. Yet the banks that once handed out home loans freely are imposing such stringent requirements that many homeowners who might want to refinance are effectively locked out.

The scarcity of credit not only hurts homeowners but also has broad economic repercussions at a time when consumer spending and employment are showing modest signs of improvement, hinting at a recovery after two years of recession.

Refinancing could save owners hundreds of dollars a month, which could be spent, saved or used to pay down debts. Extra spending would help lift the economy, and lower payments might spare some people from losing their homes to foreclosure.

The plight of homeowners has become a volatile political issue. On Friday, as the House passed a series of new financial regulations, it narrowly defeated a provision that would have allowed bankruptcy judges to modify the terms of mortgages. The measure was strongly opposed by the banking industry.

President Obama, in his weekly address on Saturday, placed much of the blame for the recession on “the irresponsibility of large financial institutions on Wall Street that gambled on risky loans and complex financial products, seeking short-term profits and big bonuses with little regard for long-term consequences.”

The president is scheduled to meet with banking executives at the White House on Monday in another administration effort to increase the flow of loans to consumers and small businesses. Among those expected to attend are representatives from Citigroup, JPMorgan Chase, Bank of America, Wells Fargo and Goldman Sachs.

An estimated six of 10 homeowners with mortgages have rates that exceed the 4.8 percent rate currently available on 30-year fixed mortgages, the least risky form of home loans.

Nevertheless, only half as many refinancing applications were reported last week than were reported at the beginning of January, the peak level for the year. The total dollar volume of refinancing activity in 2009 will be about $1 trillion. In 2003, another year when rates fell, it was $2.8 trillion.

(Mortgage applications to purchase houses showed modest improvement for much of the year, but recently fell sharply to their lowest level in 12 years.)

“The government has succeeded in driving mortgage rates down to their lowest level in our lifetime,” said Guy Cecala, the publisher of Inside Mortgage Finance magazine. “That hasn’t been a big home run, because a lot of people can’t take advantage of it.”

It is highly unusual for mortgage money to be available below 5 percent. Average rates fell as low as 4.7 percent in the 1940s, as the government held down interest rates to finance World War II, and stayed just below 5 percent until the early 1950s. Rates went above 5 percent in 1952 and stayed there — until this year.

The super-low rates are not likely to last much longer. The Federal Reserve program that has driven rates to such lows, which involves buying $1.25 trillion in mortgage-backed securities, is scheduled to expire in March, and Fed leaders have said that it would not be renewed.

Some analysts believe rates could jump as high as 6 percent in the spring. On a $300,000 mortgage, such a jump would cost an extra $225 a month.

Andrew Knapp, a sales executive in Bartlett, Ill., has tried twice to refinance, which would save his family several hundred sorely needed dollars every month. Lenders said the house had lost value and the Knapps had too much debt. “There was no urgency for them to do anything,” Mr. Knapp said.

The most recent Federal Reserve survey of lenders found that they were continuing to tighten terms for business and household loans. Banks say they are under pressure from regulators to raise their cash reserves, which means fewer loans. They also argue that a troubled economy breeds extreme caution.

“More than ever before, lenders are very conscious of making good quality loans,” said Michael Fratantoni, the vice president for research at the Mortgage Bankers Association. “They are looking at the value of the collateral and the credit quality of the borrower.”

But some borrowers argue that more refinancings now might well forestall losses for the banks later.

Mark Belvedere bought a condominium in a San Francisco suburb in early 2004 and refinanced it in 2005. He now owes $235,000 on a property that would sell for barely half that today.

Mr. Belvedere said he would be willing to live with all that lost equity if he could refinance his loan from a variable rate, which could eventually go as high as 12 percent, into a 30-year fixed term.

His lender said no, citing the diminished value of the property. “It makes no sense and is so frustrating,” Mr. Belvedere said. “I’m ready and willing to pay the mortgage for the next 30 years, but they act like they’d rather have me walk away.”

When Mr. Belvedere refinanced four years ago, the process was so easy he hardly remembers it.

“In those days, a refinance was like a free weekend in Vegas,” said Mr. Cecala of Inside Mortgage Finance. “Now it’s between an Army physical and a root canal — and that’s if you’re successful.”

The current lending freeze owes much to the excesses of the boom. Mr. Belvedere’s lender, IndyMac, failed in 2008 from too many bad loans.

“The system was abused, so they threw it out the window,” Mr. Cecala said. “Now lenders are paranoid about every loan unless it is guaranteed to be the safest deal on earth.”

An Obama administration program to encourage the refinancing of loans owned or guaranteed by Fannie Mae and Freddie Mac, the government-controlled mortgage giants, is off to a slow start.

The Home Affordable Refinance Program, known as HARP, was designed to benefit between four and five million homeowners whose loans exceeded the value of their property by as much as 5 percent. But as of Sept. 30, only 116,677 loans had been refinanced.

“We’re refining our understanding of borrower behavior,” said a Treasury Department spokeswoman, Meg Reilly.

The program was modified during the summer to refinance homes where the loan exceeded the value of the property by as much as 25 percent. But since lender participation is voluntary, they have the option of rejecting these loans — and they often do, mortgage brokers say.

Jeff Jaye, a mortgage broker in Danville, Calif., said only three of the refinances he submitted to the program were successful. More than a dozen were rejected for various reasons, including the existence of second loans or the borrower’s lack of equity.

“It seems that the lenders are choosing which components of the HARP program to offer to consumers, which is unfortunate,” the broker said.

When it comes to refinancing loans that are too big to be in the government system, Mr. Jaye knows the difficulty first-hand.

“I have a perfect credit score, I make a good living and I’ve never been late with my mortgage in my life,” he said. “But as a self-employed businessman, there is no loan for me.” He plans to dispose of his house in what is known as a short sale, where the lender agrees to accept less than it is owed.

At an industry conference last week, the Illinois Association of Mortgage Professionals, a brokers’ group, proposed a federal program that would allow streamlined refinancings up to 175 percent of the median price in a local market. A quarter of the savings from the lowered payments would go into an escrow account to reduce the principal balance.

“The theory is simple,” said Jeri Lynn Fox, the association president. “If people have jobs and are making their payments at 7.25 percent, they will make their payments at 5 percent.”

For Mr. Knapp, the sales executive, any such program would be too late. He has given up on the possibility of refinancing and is trying for a loan modification. If that does not work, there is one more solution: walking away from his home.