A Lot More

Observations on housing's wreckage and recovery

Vanilla fudge

There’s much lamentation in the econoblogosphere about the demise of the “plain vanilla” mandate, which was part of the Consumer Financial Protection Agency legislation and deeply despised by banks. Last week Barney Frank let it drop, and Felix Salmon, Mike Konczal, and many others have responded with eulogies for consumer reform itself.

Losing the plain vanilla mandate sucks deeply, but the really important battle regardless is what will happen to the secondary market. Fannie and Freddie and their regulators made plain vanilla the standard for decades – CRA activists in the 1980s actually used “plain vanilla” as an epithet, describing how the GSEs’ strict underwriting standards for this mortgages excluded minority/urban borrowers. It was only with the entry of essentially unregulated secondary market actors following 1980s deregulation that subprime and other gotcha mortgages came on the scene.

Good secondary market regulation can reward lenders for doing plain vanilla and make it discouragingly expensive for them to venture into exotica. That was essentially the case during the 1990s, as investment banks entering the mortgage-backed securities market struggled to make a dent in Fannie Mae and Freddie Mac’s market share because of the GSEs’ advantages of implied government backing and monopoly on plain vanilla. Predatory lending was a problem then, of course, but it was not yet a mainstream market and thus could have been contained had regulators (Greenspan!) chosen to act.

There’s still ample opportunity for the feds to push plain vanilla, if they choose to seize it. Bankers don’t necessarily mind, either – after all, they did very well for themselves selling plain vanilla backed by the GSEs. The Mortgage Bankers’ Association’s proposal for GSE reform contemplates explicit government guarantees on mortgage pools that meet regulators’ specified standards. With the right standards and incentives, a mechanism like that can promote plain vanilla as once again a dominant market presence. Think of it as the “public option” for mortgage credit, and perhaps other forms of credit too.

September 27th, 2009 | Tags: , , , , ,
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Reality-based ratings agencies

In the Washington Post, Ezra Klein takes on the vital question of ratings agency reform. He contends that it’s not enough to restructure the payment system so that investors, not securities issuers, are the ones paying for the ratings – and that this calls for a public utility-type system:

Buyers need to fund the ratings. But since there’s no particular buyer anymore — instead, the information is public — then the public needs to be the purchaser, turning the rating agencies into something akin to public utilities.

A good idea, just one that stops short of the fundamental issue that needs to be tackled whether the ratings agencies are public or private, utilities or corporations, or paid for by investment banks or investors. “The information is public” in theory only – requirements for data and disclosure on mortgages and mortgage-backed securities is pitifully thin. The SEC expanded them in 2005 or 6, adding a helpful lode of detail about stuff like borrowers’ credit ratings, debt-to-income ratios, and other risk factors  but right now there’s simply no way for an investor to fully understand the underwriting of mortgage-backed securities or derivatives, because they don’t have anything close to full information. The securities industry, through the American Securitization Forum, is developing its own disclosure regimen that deliberately keeps public information about what’s in the securities sausage limited.

What’s ultimately needed is a 21st century Home Mortgage Disclosure Act. HMDA, a relic of 1975, gathers extremely basic info at the census tract level, broken down by race and a few characteristics of the loans themselves – are they for a home purchase, refinance, renovation or whatever. Now just think about all the data that could be part of a 2009 HMDA, and how much that sunlight would serve investors and the public alike. Without violating the privacy of borrowers or restraining the business of bankers a public database could include home sales prices, links to images of deeds and other property records, info on patterns and density of high-risk loans, so investors can see what’s in the sausage and watchdogs can be alert to patterns of discriminatory, fraudulent and other bad lending – exactly what HMDA was designed to do in the first place. Whether public or private, the ratings agencies need outside accountability that only public, transparent information can provide.

September 22nd, 2009 | Tags: , ,
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Foreclosure graveyards

In the new issue of The American Prospect, I write about the latest phase of mortgage crisis fallout: the mass dumping of vacant, foreclosed real estate onto already devastated city streets. My article is set in Atlanta but it could as easily be about St. Louis, Jacksonville, Akron, and many older midsize cities whose modest older houses are caught in literal shell games played by mortgage servicers and real estate speculators. It’s all a tragic waste. HUD is spending billions on programs to help neighborhoods recover from mass foreclosures, but it’s no match for mortgage servicers’ maneuvers to cut their losses.

One twist that didn’t make it into the story: When servicers get rid of their real estate for pennies on the dollar, the biggest losers are mortgage securities investors with the riskiest, most toxic stakes, and some, such as hedge fund manager Bruce Rose, have been fighting back in court and in their own business practices. As Ruth Simon reported recently in the Wall Street Journal [subscriber only - sorry], Rose’s Carrington Mortgage Services, which now manages the defunct subprime lender New Century’s portfolio, has been keeping real estate out of the foreclosure graveyard through aggressive loan modifications and by renting homes out directly to tenants. (It’s not clear whether some of those tenants are the homes’ former owners, but that certainly seems likely.) Rose believes, correctly, that the real estate will eventually sell for more than it does right now, and that it’s in his best interest to hold on to the property in the meantime.

What we’ve got here is an unlikely alignment of interests between do-gooder community development groups and high-flying financiers seeking to protect their losing investments. The two forces would do well to team up to help stop the insanity.

If you want to see my article in its printed form, with pix, or read more of The American Prospect – you should – it’s now available in free PDF download to registered users.

Thank you to the Nation Institute Investigative Fund for sponsoring the research for this article, and for my earlier “Predatory Lending With a Smiley Face” in Salon, about the loan modification industry.

August 18th, 2009 | Tags: , ,
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Seidman takes no CRAp

In The American Prospect, an excellent rundown by former federal banking regulator and now New America Foundation financial services policy director Ellen Seidman of research showing that the Community Reinvestment Act did not cause the subprime crisis.

August 11th, 2009 | Tags: , ,
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And then what happened?

I’ve been laying light on the blogging lately while working on a new book proposal, but this op ed in today’s New York Times by NYU social sciences dean Dalton Conley deserves an  addendum. Conley advocates for a renewed commitment to homeownership for low-income people, at a moment when it’s become all to easy to stampede in the other direction. As an example of how low-income homeownership can be done right, he points to a 1990s program launched by the North Carolina group Self-Help with investment funds from the Ford Foundation, which as Conley notes demonstrated that destructive subprime lending wasn’t the only way to get near-penniless buyers into homeownership.

But what Conley leaves out is what happened next. Researchers at the University of North Carolina’s Center for Community Capitalism have been following Self-Help’s borrowers to see how they’ve fared, and while Self-Help’s loans have indeed performed well and seen relatively few foreclosures, a significant minority of Self-Help borrowers ended up refinancing with other mortgages, often to get cash back out of home equity, or took out home equity loans or second mortgages. This otherwise successful program was sabotaged by a very rotten home lending market that in these low-income buyers saw a profitable opportunity for selling high-cost debt. Self-Help founder Martin Eakes went on to establish the Center for Responsible Lending and has said that he did so because he was tired of seeing the homebuyers Self-Help was helping go on to get stung with subprime loans.

So while I’d like to agree with Conley, this remains an uncertain time to be thrusting economically vulnerable people into a financial services market that hasn’t shown them much love. A strong Consumer Financial Protection Agency might make all the difference – that’s the horse that needs to come before Conley’s cart.

August 4th, 2009 | Tags: ,
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Subprime’s sucking sound

Via Mark Thoma, Federal Reserve Bank of Cleveland economist Yuliya Demyanyk gives us “Ten Myths About the Subprime Crisis.”

Myth 2: Subprime mortgages promoted homeownership

The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership.

The Center for Responsible Lending offered a rougher version of this analysis a couple of years ago, noting that subprime loans led to more foreclosures than long-term homeowners. Here are their numbers, which cover 1998-2006:

15,175,609 subprime loans originated

1,435,472 of these went to first-time homebuyers

2,366,90110 projected foreclosures, based on an anticipated rate of 15.6%

(931,429) net loss of homeowners.

So please, no more of this “don’t forget that subprime helped more people become homeowners” crap – it didn’t.

July 22nd, 2009 | Tags: ,
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The ratings game

Yesterday Treasury released its new regime for the ratings agencies that failed so badly to police the mortgage securities and other credit markets, and at first glance it looks pretty good, with measures to preclude conflicts of interest, new disclosures, and so forth. If Congress agrees to them these reforms will serve as a roach bomb to purge corrupt practices that had become endemic in the engineering of mortgage securities.

Ultimately, though, the ratings agency regulations will only be as strong as the oversight of  derivatives, because credit default swaps are the secret ingredient in cooking up a triple-A rating – they provide the insurance that lets the ratings agencies promise investors they’ll get paid. As James Kwak, Gretchen Morgenson and others have noted, the administration’s proposed credit default swap regulations exempt “custom” transactions from the proposed oversight-and-exchange system – meaning that AAA ratings could continue to be propped up by dubious derivatives.

July 22nd, 2009 | Tags: ,
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Five words from Warren

…And of course Elizabeth Warren lays out the bottom line better than anyone. Five words: Good regulations support product innovation.

July 22nd, 2009 | Tags: ,
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Define “innovation”

With Congress now reckoning with the proposed Consumer Financial Protection Agency*, Robert Shiller is the latest of a passel of commentators to point to subprime lending and the many risky (for the borrower) features that make it profitable – and which the new agency would have the power to ban – as an example of imperfect but positive example of financial innovation, in that subprime made property ownership possible for people who otherwise couldn’t have achieved it. I was surprised to see similar thoughts from The New Yorker’s James Surowiecki, less so to pick up on the same meme from John Carney and too many others to keep track of at this point.

Felix Salmon has one sharp take on why Shiller is wrong. I’ll offer another. The majority of subprime mortgages were refinances of existing mortgages – often of prime loans for people whose credit had deteriorated due to financial distress, or who really could have qualified for prime. In the 1990s, many subprime lenders were doing 90 percent refis of existing mortgages (just check out their Home Mortgage Disclosure Act data).

In the 2000s, with the advent of no/low doc mortgages and piggyback lending, where borrowers would take out two mortgages covering most or all of the purchase price, more borrowers used subprime loans to buy homes, but refis and home equity loans still represented about half of subprime lending – meaning that as fast as new borrowers were coming into the pool, they were taking out new mortgages to get cash back. Just look at New Century’s 2006 HMDA report: 76,442 purchase mortgages and 101,848 refis. (New Century did another 40,000 or so second mortgages for buyers who couldn’t muster down payments – as much as guaranteeing that they now owe more than the homes are worth.) In a report that year, the Center for Responsible Lending noted that at least 60 percent of subprime borrowers get another subprime loan when they refinance, severely increasing the likelihood they’ll go into foreclosure.

For too long, “financial innovation” has been code for exploitation of the vast gap in financial knowledge between lenders and borrowers, and for taking advantage of consumers’ short-term needs for cash in situations of economic distress. True innovation will involve figuring out ways to close that gap – to keep credit a profitable business without stealing home equity as a matter of course.

The proposed Consumer Financial Protection Agency is charged with striking exactly such a balance between protecting borrowers and supporting innovation and the availability of credit – and when there’s a tie, innovation is supposed to win. To ban a product or feature, the agency has to have (this is from the bill now in Congress):

reasonable basis to conclude that the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and such substantial injury is not outweighed by countervailing benefits to consumers or to competition.

That’s an awfully high bar. CFPA tilts in favor of financial innovation, for better and for worse.

* “Now” now turns out to mean in September – too many Dems balked.

July 22nd, 2009 | Tags: , , ,
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Renting from the bank

Via Felix Salmon, news that Sen. Chuck Schumer is signing on to a proposal to keep foreclosed borrowers in their homes as renters.

I love this idea in principle.  It renders literal the all-too-true idiom of overindebted homeowners: “They’re just renting from the bank.”

But in reality? The bill just intro’d in Congress, HR 6116, The Saving Families’ Homes Act, doesn’t come close to answering obvious questions. Who is going to be these now-tenants’ landlords – the mortgage servicers?? Good luck with that one.

And then are we to understand that the now-tenants are entitled to live in their homes indefinitely, for as long as they keep paying the rent? Why should former owners be entitled to a vital protection that most of the nation’s renters don’t have? This kind of unequal treatment is likely to lead to deep anger among many renters, who see homeowners who took excessive risks get benefits that those who prudently chose to rent — because they knew the numbers wouldn’t work — are denied. If you’ll recall, CNBC’s Rick Santelli tried to gin up a case for such resentments when the Obama administration announced its mild loan modification program. But here the sentiments would be real, and warranted.

July 16th, 2009 | Tags: , , ,
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