Posts Tagged ‘Felix Salmon’

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.

Sunday, September 27th, 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.

Wednesday, 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.

Thursday, July 16th, 2009 | Tags: , , ,
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CRA’s legacy and future

Felix Salmon has been kicking butt in defense of the Community Reinvestment Act following John Carney’s determined attacks on the law as a proximate cause of the financial crisis. Salmon’s IM exchange with Carney is a great read for us geeks, with a fab coup-de-grace from Salmon: “the underwriting is hard. Finding the borrowers in the first place is easy[.] as someone who sits on the board of a cdcu [community development credit union] with effectively zero marketing budget, I can assure you of that” Also see CJR’s Ryan Chittum and Barry Ritholtz at The Big Picture with their own efforts to put the vile “CRA did it” myth to a quick death.

I drink my coffee most mornings from my National Training and Information Center “Celebrating 30 years of the Community Reinvestment Act” mug, and find Carney’s effort to revive the libel not only laughable, but downright alarming. Carney is no doubt writing now because the future of CRA will soon be up for grabs, as Congress decides how or even if to incorporate its fair lending mandates into a new regulatory framework for the financial system.

As an opening volley, Obama administration’s reform plan declares unshakable support of CRA and its important role in maintaining widespread and fair access to credit:

Rigorous application of the Community Reinvestment Act (CRA) should be a core function of the [Consumer Financial Protection Agency].  Some have attempted to blame the subprime meltdown and financial crisis on the CRA and have argued that the CRA must be weakened in order to restore financial stability.  These claims and arguments are without any logical or evidentiary basis.  It is not tenable that the CRA could suddenly have caused an explosion in bad subprime loans more than 25 years after its enactment.  In fact, enforcement of CRA was weakened during the boom and the worst abuses were made by firms not covered by CRA.  Moreover, the Federal Reserve has reported that only six percent of all the higher-priced loans were extended by the CRA-covered lenders to lower income borrowers or neighborhoods in the local areas that are the focus of CRA evaluations.

The appropriate response to the crisis is not to weaken the CRA; it is rather to promote
robust application of the CRA so that low-income households and communities have
access to responsible financial services that truly meet their needs.  To that end, we
propose that the CFPA should have sole authority to evaluate institutions under the CRA.
While the prudential regulators should have the authority to decide applications for
institutions to merge, the CFPA should be responsible for determining the institution’s
record of meeting the lending, investment, and services needs of its community under the
CRA, which would be part of the merger application.

Note that the plan puts the enforcement CRA under the control of the proposed Consumer Financial Protection Agency instead of its current home with banking regulators – an essential move to protect CRA from undue influence by lenders and the possibility of regulatory capture.

Just to add my two pounds to the Carney pile-on, the bulk of high-risk lending took place outside of CRA-regulated institutions. The great tragedy here is that untold numbers of subprime, Option ARM and other minimally underwritten mortgages were refinances of CRA loans that had they been left standing would have continued to perform just fine. Millions became first-time homeowners because of the end of institutional discrimination by lenders and the willingness of financial institutions to tap into a new market. Those new buyers then became sitting ducks for financial products that promised cash in their pockets in exchange for their hard-won home equity.

Saturday, June 27th, 2009 | Tags: , , ,
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