The Ironies of H.R. 3915

Upon reflection, I was just slightly in error in my analysis of the mortgage crisis and the subsequent political opportunism currently being displayed by the politicians. While I believed banks provided easy targets, I also expected that politicians would never attack them because banks have two resources that make attacking them risky and unwise: money and power. For this reason, I thought banks would remain largely unscathed with responsibility and most of the punitive action would fall on the easier target: the mortgage broker.

I was only about 90% correct in my prediction. In fact, the politicians have figured out how to attack banks without necessarily picking a fight that might get messy. They have chosen the sub prime market. In layman's terms sub prime loans are those give to people with poor or mediocre credit profiles. Sub prime lending has revolutionized not only how we lend but who we lend to. The sub prime concept has also been one of the fall guys in the mortgage crisis. (Once again I recommend the book, Liar's Poker, which details how the market for these sub prime loans was created)

As I have already pointed out in previous posts, the market makers of sub prime loans created a market for so many ridiculous loans that just about anyone with a pulse could get qualified. Since merely having a pulse doesn't guarantee that you can pay your loan back, we are finding that many of these loans aren't being paid back. Since foreclosure is the ultimate punishment for non payment, and the borrowers aren't much of a target politically, the concept of sub prime has become the target of politicians everywhere.

There were layer and layers of irony in John Edwards being being attacked for his links to a sub prime mortgage provider. First, Edwards wouldn't know the difference between sub prime and a submarine ship. Second, the reason he was attacked was because this lender had the "audacity" to try and foreclose on borrowers that didn't pay. Again, it seems no one had one problem with sub prime lenders when they were creating markets for all sorts of poor and middle class folks to buy properties that never even dreamed of owning homes before.

It was only when we all realized that everyone was acting irresponsibly, and ultimately lending to irresponsible people, that everyone decided to turn certain groups into villains. Since it makes no political sense to blame the poor folks, the politicians needed an easier target. They chose the sub prime lending concept.

Thus, while I didn't initially predict the draconian ways in which Congress, lead by Barney Frank, plans on dealing with sub prime, they should have been altogether easy to predict. Make no mistake, if the remedies currently in H.R. 3915 are passed then sub prime will be eliminated.

There are four different things that H.R. 3915 does that deals with sub prime.

1) It eliminates Yield Spread Premium on sub prime loans. The great fear for all mortgage brokers is that YSP will be eliminated, however if I read the bill correctly, it is only on sub prime that it will be eliminated.

Since Congress knows very little about my industry and even less about what created this crisis, they think that YSP is what has caused the widespread delinquency on sub prime loans. The reality is that banks and their partners on Wall Street created loans for irresponsible borrowers and we, sociopathic mortgage broker, had absolutely no problem putting the three of them together. The problem is not and never has been YSP, but rather 620, stated, stated, to 100%, a loan in which a borrower with the marginal credit score of 620 could state their income, their assets, and still buy a property with no money down. YSP had absolutely nothing to do with this concept or the fact that Wall Street decided to make this concept into a market. Yet, it is YSP that is being blamed for the excesses of the mortgage dynamics.

By eliminating YSP on sub prime but not on prime, Congress merely makes even more incentive for someone like me to focus on good borrowers. If I know that I can make money on good borrowers without necessarily charging extra fees but not on marginal borrowers, guess which borrowers I will focus on. Furthermore, sub prime was never meant to be a long term loan. It was meant to be taken on while the borrower's credit was being turned into that of someone that would qualify for a prime loan. That being the case, why would it ever make sense for that borrower to pay anymore costs than they absolutely have to. By eliminating YSP, I am forced to make all my money in up front fees. Thus, borrowers with loans intended for short periods are now forced to take on extra fees.

2) Fees and points can no longer be financed. I have already explained that all new sub prime loans will be hit with even more up front fees than normal. Now, Congress is forcing that the borrower rather than the loan pay for these extra costs. Keep in mind that sub prime tailors to the poor. It is ludicrous to believe that poor folks be forced to take on extra fees, pay for those fees up front, and not have any unintended consequences. Financing of points and fees is an old trick that scummy brokers use to hide those fees. If someone isn't paying for something out of their pocket, they simply usually don't realize that they are still paying for it. By simply rolling fees and points within any new loan, brokers are able to use slight of hand so to speak to make people believe they aren't paying costs or merely not paying that much.

It is used much more often, though, by scrupulous brokers to make sure that borrowers that have little or no funds are able to get loans without going broker. What the politicians have never figured out is that despite our reputation the overwhelming majority of loans that are done are done with the borrower's best interest in mind. Thus, while there were plenty of brokers that abused rolling points and other costs into loans, the majority did it with the borrower's interest in mind. By throwing the baby out with the bathwater so to speak, all the politicians will really do is make it that much more difficult to do loans. Since most poor folks, the overwhelming majority of sub prime's target market, don't have thousands lying around, it is going to be very hard to do a loan for them that involves coming to closing with thousands of dollars. That is ultimately the practical effect of no longer allowing rolling in closing costs into the loan. Poor folks will just have to bring the closing costs and points to each closing they have.

3)Anti Steering. Here is another vague and very important part of the current bill.

steering any consumer from a prime loan to a subprime loan,

Now, what this means, I assume, is that anyone who qualifies for a prime loan has to go into a prime loan. While this may sound good and well to a politician, there are times when a non prime loan makes more sense for the borrower. For instance, Fannie Mae loans actually have three levels, called expanded approval 1,2, and 3, besides their standard approval. These are much like the minor leagues of Fannie Mae loans (with EA 3 being like single A). Anyone that only qualifies for EA3 would most likely be better off getting a sub prime loan especially those where the loan to value is high thus making their mortgage insurance expensive as well. Again, it is unclear if EA3, for instance, is considered prime. Thus, it is unclear if someone could be sued for steering a borrower away from it in favor of a sub prime loan.

Whenever it is unclear or murky, either new disclosures are created, or banks and brokers simply stay away from such borrowers. Either thing is ultimately not good for the fate of poorer borrowers as well as sub prime altogether.

4) This bill introduces loan counseling for borrowers in sub prime loans.

This was tried here in Illinois with HB 4050. Here are the real estate sales in the zip codes it was tried in.

Compared to August 2006, sales were down 45% in the target zip codes. The breakdown by zip code:

60620 experienced a 43% drop in sales
60621 experienced a 25% drop in sales
60623 experienced a 57% drop in sales
60628 experienced a 15% drop in sales
60629 experienced a 63% drop in sales
60632 experienced a 34% drop in sales
60636 experienced a 41% drop in sales
60638 experienced a 54% drop in sales
60643 experienced a 49% drop in sales
60652 experienced a 43% drop in sales

Compared to September 2005, one year ago, sales were also down 45% in the target zip codes. So, we can say with near certainty that the plummet is not strictly seasonal. The breakdown by zip code:

60620 experienced a 28% drop in sales
60621 experienced a 37% drop in sales
60623 experienced a 61% drop in sales
60628 experienced a 17% drop in sales
60629 experienced a 70% drop in sales
60632 experienced a 54% drop in sales
60636 experienced a 1% drop in sales
60638 experienced a 65% drop in sales
60643 experienced a 49% drop in sales
60652 experienced a 41% drop in sales

Counseling brings with it extra fees and extra paperwork and most of all it brings with it a lot of confusion. Some thirty lender decided to pull out of zip codes in which HB 4050 applied. Many lenders will simply pull out of doing loans wherever this sort of counseling is done.

Everyone needs to keep in mind that if sub prime was a boxer it would be taking a standing eight count after taking a huge upper cut. Now, Congress is coming in reigning haymakers with H.R. 3915. If this bill gets passed in a form even close to what it is now, it WILL end the area of sub prime. This WILL hurt the poor the most, and ultimately Congress WILL blame someone else for it.