Wednesday, November 7, 2007

H.R. 3915: Opening Up The Closet Full of Skeletons

I received an interesting comment to one of my previous posts on this topic that I want to now share.

Mike, both you and Jonathan are spot on. Here's the rest of the story, as it were.Mortgage Brokers originated loans for submission to underwriters at lenders who then sold the loans to Wall Street mandarins who then chopped them up into acronyms with Triple A ratings and sold them at great profit to institutional investors. Brokers just sold the programs offered by the lenders. Lenders just offered the products that Wall Street demanded.

Since Wall Street could redefine crap as investment grade secured debt obligations 'til the cows came home, The spigot of cheap money for unqualified borrowers stayed on WAY too long.

The cows have come home, and the guys who essentially said 'approve everything, ask no questions, we just need product' aren't being investigated. It's the guys at the mouth of the pipe who read the UW guidelines, shrugged, and submitted.Why is the broker industry being closed rather than the wall street packagers being jailed?

To anyone outside the industry, this may seem confusing however the author is absolutely correct. I will get back to their thoughts in a minute. First, a lot of people ask me why banks are immune from things that brokers have to follow. A great example is the current use of YSP. Currently, a retail bank doesn't even disclose how much YSP they have made on a loan whereas it is there in black and white for the broker. There are one of two ways to look at this phenomenon. The first is that banks require hundreds of millions of dollars in capital and so Congress, erroneously, believes that they are trustworthy enough not to follow the same rules as brokers. The second reason is more realistic. They have a huge lobby. The reality is that banks have money and they have power so anytime Congress does anything the banks spring into action and more times than not they aren't affected. Brokers don't have the same kind of money and power. This is important because money, power and perception ultimately drive the narrative on the mortgage crisis and especially on this bill.

This brings me back to the comment. Before, I explain the comment let's take a quick history lesson into the evolution of the mortgage market. Way back when, if you wanted to buy a home, you had to have a minimum of twenty percent down. The mortgage market was revolutionized with the introduction and explosion of mortgage backed securities. This was documented in the book, Liar's Poker. By creating a secondary market for mortgages, the liquidity in the market exploded. In layman's terms, because banks had a whole new arena which loans could be taken off their hands (these new mortgage backed securities) they had a lot more money to give loans to people. While the market initially exploded and continued to be strong, its real explosion happened just as the refi boom was taking off and the housing market exploded a few years. Wall Street, through the securitization of thes mortgages, had an insatiable appetite for mortgage backed securities. Why wouldn't they? As housing prices rose almost non stop, these securities became a cash machine. As a result, Wall Street couldn't get enough of mortgage backed securities.

There was no loan that was out of bounds. I know this because 620, stated, stated, to 100% became the standard. What this means is a borrower with a 620 credit score (in the fifty percentile at best) stating (really meaning lying) their income and stating (certainly lying) about how much money in the bank. They did all of this while requiring that the borrower put absolutely nothing down. Since this was the industry standard, that could only mean that Wall Street created a market for it. Without Wall Street there is no market, and with no market this loan doesn't exist. Thus, ultimately it was Wall Street responsible for the ridiculously loose standards and the point of the comment.

The loose borrowing at the behest of Wall Street came to an end when the housing spike came to an end. Suddenly the bond traders noticed that the loans they had were full of borrowers that weren't paying back their mortgage. (these loans were being paid back while the market was hot through a very complicated set of events that I can explain however it will detract from the overall point so just take my word for it) Suddenly, mortgage backed securities went from heroes to zeroes nearly overnight. The most insidious part is that once Wall Street realized the mess that was created, with them in the middle, they washed their hands of mortgages entirely. The market dried up and banks could no longer sell their mortgages to Wall Street. That is the main reason why so many banks went out of business. They were holding onto way too many mortgages and couldn't sell them for anything but a huge loss.

Now, unlike what the commenter indicates, Congress has come out with punitive action in H.R. 3915 against Wall Street. It is not only vague but doesn't address the issue properly

the bill also bars any liability for "pools of loans" or "securitization vehicles". The critical language is buried in proposed Section 129B(d)(9). For most subprime mortgages, trusts, which are nothing more than pools of mortgage loans, are the entities that are the legal owners of the mortgage, and the only entity with any assets or ability to provide consumer redress. This is particularly true when the original lender has filed bankruptcy, as in the case of New Century and countless others.

This gets technical however what this bill does is promise to hold Wall Street responsible and ultimately let's them off the hook. Here is the important part. It doesn't much matter. Congress could outlaw mortgage backed securities entirely and no one would care. Wall Street has essentially done that themselves. If Congress wants to punish Wall Street for their role, they are a couple years too late. Wall Street has moved on to whatever is the chic investment of the day and that is no longer mortgage backed securities.

What is important is that no one outside the industry ever talks about Wall Street's crucial role in the whole mess. The entire blame is laid directly at the feet of the mortgage broker. Here is why. It is political suicide to blame the borrower. Imagine a politician actually having the gumption of accusing poor folks of being irresponsible and saying tough. What are the chances that politician gets re elected? Most politicians don't have the courage to take on the behemoth of the banks. Thus, no politician will ever say that the programs created were irresponsible. Instead, they will say that irresponsible brokers put borrowers into programs they couldn't afford, as if the broker came up with the program themselves. Finally, no politician knows or cares about the role of Wall Street. That would mean actually understanding the situation and if you understand the situation, you may not be able to demonize as well.

Finally, Congress would never blame itself even though they probably share the brunt of the responsibility. Does anyone know why it is so easy for a scummy mortgage broker to pull a fast one on unsuspecting borrowers? That's because the borrower is expected to sign almost one hundred separate documents. Those documents didn't just appear out of thin air. They were created in response to a plethora of prior legislation that was supposed to deal with whatever problem Congress deemed necessary at the time. It is really easy to hide a bad deal when there are ninety nine useless documents. Most people are not going to know which one is the important one.

Guess what, there is only one group left. It is a group with an awful reputation. It doesn't have a behemoth lobbying apparatus, and most politicians think that taking on the group will be something most people like.

The insidious nature of the bill is it has absolutely nothing to do with fixing any problems. All it does is pick good political targets and attacks them. Banks and borrowers aren't held responsible at all, even though there were plenty of irresponsible borrowers that got loans they knew they couldn't afford and plenty of banks willing to give them the loans. Furthermore, all this bill does is put unnecessary burden and tightening at a time in which I illustrated that the when the market has already severely tightened it on its own. Congress now wants to put in place all sorts of rules and regulations that ultimately will mean even less loans are approved at the exact time that less and less loans are being approved on their own. How does that make sense? They outlaw pre payment penalties even though it is exactly those types of loans that maybe the only choice for many borrowers. They outlaw YSP even though ultimately that produces less options for the consumer and the broker. Finally, they create all sorts of new vague language which will have the practical effect of meaning YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET. I already showed how that played in the overall mess.

The industry along with good folks that actually care about good policy not just good politics can fight back. I hope everyone goes to this petition and also that they go here and write their Rep and tell them that it is time to make good policy and just policy that they think is good politics.

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