Wednesday, August 8, 2007

Larry Lindsey Gets it Right

I have been disappointed if not surprised by the media coverage of the sub prime crisis. It has been filled with political correctness, condescending nebulus terms that even mortgage brokers don't understand, and very short on any analysis that let's the people know what happened. That's why I was surprised by this article by Lawrence Lindsey. Before I talk about the article, I think it is time once and for all to lay out the mortgage crisis as an insider sees it.

The root of the crisis started with the refinancing boom from 2000-2003. At that time, mortgage brokers, like myself, were making money hand over fist lowering rates of people in the prime market. sub prime banks were being squeezed out. In order to get our collective attention, they began to loosen their restrictions. It worked. Suddenly, borrowers that we all thought couldn't get qualified were now being qualified.

I have long believed that for the most part my industry is filled with sociopaths. The reason that this is important is that while prime loans were plentiful during the refinancing boom, the margins were razor thin. In sub prime, the borrower is dumber and more desperate and thus the mortgage broker can and will take advantage of that knowledge by driving up the rate in ways they would never do with a prime borrower. Thus, with the restrictions loosening, mortgage brokers were perfectly happy to focus more and more on sub prime since they knew they could charge a heck of a lot more in that arena.

Everything was fine and dandy. Wall Street loved the sub prime loans and with property values going up these loans were profitable for them. With renewed vigor in the sub prime market so came new competition. In order to compete, banks each tried to one up each other in offering more and more aggressive loans. Lower and lower credit scores were allowed to buy property with no money down, and then with no money down and stating income (something I will explain and go into further later), and then overlooking bankruptcies, collections, charge offs, mortgage lates, and just about any negative one can find on a credit report.

At some point these loans went from being aggressive to being loans given to deadbeats. Let's say that again. The reason that we have a sub prime crisis is because a bunch of dead beats bought homes they couldn't afford from banks that should have never lent them money. The role of the mortgage broker in securing these loans shouldn't be understated and frankly I will never miss any opportunity to take a pot shot at my industry, however blaming this crisis on us frankly gives us too much credit. We have always been a collective group of sociopaths. That didn't start two years ago. That was always so. Thus, there was a new dynamic in play in the last few years.

The biggest problem loans are three interest only, no money down, and stated loans, and of course the biggest problems are those that combine several of those together. Basically what happened was that people with marginal credit scores, in other words a credit score of someone I would refer to as a dead beat, were able to not only buy a home, but buy one with no money down, by stating their income, and to lower their payment they got an interest only loans.

Now, the mainstream media would have you believe that evil mortgage brokers committed fraud on unsuspecting banks while innocent poor people stood by helplessly and put themselves in an untennable position that they had no control over. (This is a position that Hillary Clinton holds and one I will address later). Stated loans are those loans in which an income is stated but no proof is provided to verify it. They were initially created for self employed people who have great accountants, but they filtered to other borrowers, and even borrowers who have a simple salary. Why do you ask would someone need to go stated if they simply make a salary? Couldn't they simply provide their taxes? They could but then they wouldn't qualify for the house they want.

The banks are not without blame here either. Stated loans were excepted regularly with janitors supposedly making 60k per year and more, teachers making as much as a hundred thousand, secretaries north of 50k per year. These were common place. Now, if a bank is willing to believe that a janitor makes 60k per year in order to approve a loan, whose fault is it if that loan goes bad? To use a crude metaphor, this is like a girl getting naked jumping into my bed and then wondering why I tried to f$&k her. If a bank doesn't want to take on fraudulent loans maybe they shouldn't be so quick to believe janitors make 60k a year, maybe they should not allow for stated loans for salaried borrowers altogether.

The borrower is not without fault by a long shot. While the bank may think the janitor makes sixty thousand a year, the janitor knows what he makes. He knows if the mortgage payment is eating up to sixty percent of his monthly income. If this person goes ahead and accepts the loan anyway, is it really the fault of the mortgage broker when they go bad on it.

Yet, this is not the narrative you will hear. You will hear about evil, evil mortgage brokers praying on helpless poor people and unsuspecting banks. The reality is in six years in the business, 99 times out 100, whenever I tell someone how big a mortgage they can afford, they wind up bidding on house with a mortgage at least ten percent higher. Is that suddenly my fault?

Now to Mr. Lindsey, who does get what happened. He takes to task a proposal by Chuck Schumer known as Senate Bill 1299,

One leading proposal is a bill called S. 1299, offered by Sen. Chuck
Schumer of New York. Mr. Schumer is a senior Democrat on the Banking Committee
and the third-ranking member of his party in the entire Senate, so any proposal
he makes should be taken seriously. His proposal represents a regulatory and
litigious approach to mortgage-market reform.
The bill requires that each
mortgage originator act with "reasonable skill, care, and diligence" and in
"good faith and fair dealing." It also requires that all loans are "reasonably
advantageous to the consumer." Surely these are noble sentiments. But they are
also vague and ill-defined legal requirements that open up the mortgage industry
to endless litigation in an environment where juries comprised of homeowners
must decide between families in the process of losing their homes and mortgage
brokers, investment bankers and other financial intermediaries.
The key to
getting America out of its current housing and mortgage market mess is to do
everything possible to maximize the availability of credit.
Mr. Schumer's
bill makes the ultimate lenders legally responsible for "acts, omissions, and
representations made by the mortgage broker." Remember that in the modern
mortgage market, the mortgage broker is unlikely to be under the employ or
control of the lender. The mortgage may be "owned" by someone who has never seen
the borrower or the originator. So, anyone supplying money to the mortgage
market may well be taking on uncontrollable and unquantifiable risk in the
The legislation also prescribes some regulatory tightening that will
block access to mortgages for some key segments of the population, or at least
make those mortgages more expensive and less appropriate. The bill would require
that all borrowers qualify for a mortgage at the fully indexed long-term rate
that would apply when a variable-rate mortgage converts to its long-term

he continues,

Locking in a long-term fixed rate is risky for the lender, and so he must charge
more. Borrowers can obtain a mortgage with a lower monthly payment or qualify
for a larger home if they choose a variable-rate loan. Equally important, in a
country where the average household moves every seven years, it seems foolish
for everyone to pay for "interest rate protection" they may not need. The
Schumer bill requires that they do.
One other factor needs be considered:
Incomes rise over time, particularly for people in the prime home buying ages of
25 to 40. The typical family will see its income rise in excess of 5% a year as
inflation, promotions and real wage gains take effect. Why should a family be
forced to qualify for a monthly mortgage payment today that it won't have to
face for another two to five years, when its income is likely to be
substantially higher?

he is absolutely right on all counts. Anyone who is veteran of my work knows my favorite quote and is probably sick of it but with respect to Ronald Reagan, "the nine most dangerous words in the English language are 'I'm from the government and I'm here to help'"

Let's take things one at a time. First, "mortgage originator act with "reasonable skill, care, and diligence" and in "good faith and fair dealing." It also requires that all loans are "reasonably advantageous to the consumer". Talk about nebulus and vague. This is either a throw away line or even worse the beginning of a new government bureaucracy to enforce something that no one can define. Will HUD or some other group now oversee to make sure that originators (a fancy word for mortgage broker and an example of the condescending term I was talking about)
mortgage originator act with "reasonable skill, care, and diligence" and in "good faith and fair dealing." It also requires that all loans are "reasonably advantageous to the consumer. Is this what we want, another government bureaucracy overseeing another industry to enforce nebulus rules and regulations.

Furthermore, Lindsey is right. This crisis is not merely a crisis of economics, but a crisis of culture. We are going to be dangerously close at the end of this crisis of being like most nations, where only the elite own. If Schmur et al have their way, the middle class will never own their own property because they won't ever qualify for a loan. The answer isn't to reduce the number of loan products but to do everything we can to keep as many as possible. We have the biggest most sophisticated loan market in the world, and this crisis may end all that. Gone will be days when someone can buy a home with no money down. That is a bad thing not a good thing. Just because dead beats were able to do it, doesn't mean the answer is to disqualify everyone from doing it.

Finally, Lindsey says this...

The legislation also prescribes some regulatory tightening that will block
access to mortgages for some key segments of the population, or at least make
those mortgages more expensive and less appropriate. The bill would require that
all borrowers qualify for a mortgage at the fully indexed long-term rate that
would apply when a variable-rate mortgage converts to its long-term level.

Whatever the merits of the idea in the long run, this is precisely the
wrong time to add this requirement. Three-quarters of the subprime mortgages
issued in 2006, along with other variable rate mortgages, will reset in 2008.
Borrowers who had planned on refinancing then may be stopped by the requirements
in S. 1299. Unable to pay the new reset rate and barred by law and regulation
from easy access to refinancing, many or most of these borrowers could have
little choice but to give up their homes. This in turn would put further
downward pressure on all home prices.

This is absolutely right. To add to the crisis, variable rates are adjusting. If you think people couldn't afford their mortgages wait till the mortgage are two, three and four hundred dollars higher. Some of these people can get into a new lower mortgage and some can't, but Senator Schumer will ride on his white horse and insure none of them can by disqualifying all of them from qualifying for a new loan. Since Schumer's proposal hasn't been flushed out, we can only infer. The maximum on a variable rate can be up to six percentage points higher than the original rate. If that is the case, and new qualification rules would have to be at the maximum rate, that would for all intense and purposes eliminate variable rate loans as any sort of viable product. Thus, even if you only planned to live in a house for three, five, seven or ten years, you would go ahead and be forced to take a fixed rate.

Now, let's examine some things Senator Clinton said.

"Today we have a clear choice: We can look at the statistics, wring our hands and continue to do nothing, or we can do what America has done in times of difficulty, acknowledge we have a real challenge and confront it head-on with real solutions," Clinton said. "I think we need to act now with smart, practical solutions to strengthen our housing and mortgage markets"

Yes, that's right, Senator Clinton will be riding on her own white horse right behind her counterpart from New York.

The New York senator's proposal includes a $1 billion federal fund to help
homeowners avoid foreclosure, an end to prepayment penalties and more affordable
housing options.

Let's examine this. First, let's remember the overwhelming majority of people about to go into foreclosure are dead beats, and the Senator wants to use public funds to extend even more credit to these dead beats. Yes, this certainly sounds like a good populist proposal, but let me tell you how it will work in the real world.

Here is an example of a dead beat I ran across. This couple was struggling to pay their mortgage, and they should have, since it was eating up almost 70% of their total income. The only thing they weren't paying was the taxes on the home. In the middle of the loan, they went and bought a car. Yes, that's right. They couldn't afford to pay their taxes, their mortgage ate up 70% of their budget, and they saw fit to buy a car. You think this is out of the ordinary, not that much, and Senator Clinton proposes that we extend one billion dollars in public money to exactly these types of dead beats.

She goes on,

It's a combination now, of economic conditions that are not working for the
majority of Americans, and unsavory practices that are undermining the dream of
home ownership," Clinton said.
When Congress returns from its summer recess,
Clinton said she will introduce legislation targeting "fly-by-night mortgage
lenders" who make "really seductive offers."

Now, again, Senator Clinton will ride in on her white horse and save the world from unscrupulous mortgage brokers. It is exactly these sorts of nebulus promises that Ronald Reagan warned us against, when he said what he said.

She continues,

Clinton also proposed banning contracts that trap borrowers in "unworkable"
mortgage scenarios in which nothing is budgeted for taxes and insurance
There are no such contracts. There is no bank in the world that ignores taxes when figuring out ratios. What Senator Clinton is talking about is of course stated loans. Again, she puts the blame squarely on people like me. Think about the story I told. Do you think that couple is just an innocent victim in devious plot of some sociopathic mortgage broker? How exactly, folks, was a borrower forced into an unworkable contract? They weren't. What forced them into it was the irresistable urge to buy a house that they couldn't afford.

The article finishes like this,

In March, Clinton called on a crackdown on predatory lending practices in the subprime market. On Tuesday, she said those loans were only the start.
"I think the subprime market, that was like the canary in the mine. It was telling us loudly and clearly, there are problems here," she said.
Rival John Edwards also has proposed cracking down on predatory lenders in a market he compared in June to "the wild West."

I will finish with this, "the nine most dangerous words in the English language are 'I'm from the government and I'm here to help''



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Anonymous said...

Sorry but you have no clue. Please delete this blog

mike volpe said...

Thanks for the vote of confidence. Criticism doesn't bother me, however for anyone to have any credibility they must be able to back their words up with evidence and facts. Just to say that I have no clue can be done by anyone, but if I really do have no clue, you will be able to back up your statement with examples of where I am going wrong. Since you can't, what you are really saying is that my point of view runs counter to yours. That isn't surprising since my point of view is not the conventional wisdom, just the one that an insider sees.

Mark F. said...

Hey Mike--did you see Bush on television just now? He pretty much stole Barack Obama's whole idea, point-by-point. Now what, buddy? Barack's an idiot, now Bush is an idiot too. Nobody gets it except you. Pretty soon, you'll be the only smart man left on Earth.

mike volpe said...


come back in about an hour after I get done cutting into Bush's plan.