More Action From the Legislature Vis a Vis Mortgages

The Legislature just moved to open up FHA loans for many of the borrowers currently facing hardship.

The Senate moved Friday against the worsening mortgage crisis, voting to make it easier for thousands of homeowners with ballooning interest rates to refinance into federally insured loans.

The legislation, approved 93-1, would allow the Federal Housing
Administration to back refinanced loans for borrowers who are delinquent on
payments because their mortgages are resetting to sharply higher rates from low
initial "teaser" levels.

The bill also tries to make FHA loans more attractive than risky subprime loans by accepting lower down payments and expanding the eligibility for counseling for homeowners having difficult with their mortgage payments.

An estimated 2 million to 2.5 million adjustable-rate mortgages are scheduled to reset in the next year, jumping to much steeper rates that could cost borrowers their homes. The wave could crest during the presidential and congressional election campaigns next year, and politicians have been wrestling with what the government's response should be

A colleague of mine pointed out that there are several things that are currently different and still need to be worked out between the Senate and House version.

Downpayment/cash investment: Senate - 1.5% cash investment w/ maximum loan amount of 100% of sales price/value that includes the upfront MIP; House still has a 0% downpayment provision.

· Mortgage limit for “high cost” areas: Senate - $417,000; House – up to $729,000.

· Seller participation in down payment assistance programs:

· Moratorium on implementation of risk-based pricing: Expect a delay of a year before enactment..

· Broker surety bond in lieu of audit: It is in the House bill only. I will be shocked if this makes it in the final bill…Get those audits ready….

Just like every other government action in response to this crisis, this one is flawed and quite possibly counter productive. The main problem lies in the fact that most politicians have no idea how FHA works, and thus they can't possibly know if it will help. FHA has limits on debt to income that are much more stringent than most of the loans the sub prime borrowers are currently in. In other words, most of the borrowers currently struggling in these sub prime loans wouldn't qualify FHA if it is in its current form. If debt to income limits aren't adjusted this move is largely ceremonial.

If, on the other hand, the limits are adjusted so these borrowers would qualify for FHA, then we could be facing the same sort of crisis in FHA within a couple of years. Much of the reason that FHA has been a successful and profitable mortgage is the very limits that it has on debt to income.

Furthermore, the legislators want to increase the loan limits on FHA. What they don't understand is that FHA is a government bureaucracy. When I do an FHA loan, I am not only dealing with the bank but also the bureaucracy of the government. For instance, the FHA bureaucracy assigns a case number to each FHA loan. By increasing the limits, especially if they are increased dramatically to 700k, they will create too much demand for FHA loans for the bureaucracy to handle. FHA loans are already a bureaucratic nightmare for any loan officer to deal with. By expanding them this much, the nightmare will become obscene.

The limits on down payment are also largely ceremonial. Already, FHA only requires a three percent down payment. Dropping that requirement down to 1.5% is negligible.

Thus, the sixty four thousand dollar question is whether or not the debt to income limits will change. If they don't this is a largely ceremonial bureaucratic nightmare. If they do, this will eventually devastate FHA the way that subprime is currently being devastated.

Gotta love our elected politicians.

Alan Greenspan Tries to Rewrite History

One of my least favorite things about the mortgage business is how everytime something goes wrong each party blames another party. Almost never does someone take responsibility and fix the error. Instead, they try to blame someone else and act as though fixing the error is someone else's responsibility.

I bring this up because Alan Greenspan wrote a column in today's Wall Street Journal. Greenspan laid out a very interesting and detailed version of the events that lead up to the crisis...

The root of the current crisis, as I see it, lies back in the aftermath of the Cold War, when the economic ruin of the Soviet Bloc was exposed with the fall of the Berlin Wall. Following these world-shaking events, market capitalism quietly, but rapidly, displaced much of the discredited central planning that was so prevalent in the Third World.

A large segment of the erstwhile Third World, especially China, replicated the successful economic export-oriented model of the so-called Asian Tigers: Fairly well educated, low-cost workforces were joined with developed-world technology and protected by an increasing rule of law, to unleash explosive economic growth. Since 2000, the real GDP growth of the developing world has been more than double that of the developed world.

The surge in competitive, low-priced exports from developing countries, especially those to Europe and the U.S., flattened labor compensation in developed countries, and reduced the rate of inflation expectations throughout the world, including those inflation expectations embedded in global long-term interest rates.

Now, this might be the height of my own hubris, however I find his entire narrative to be nothing more than intelligent sounding nonsense. The reason is that he is trying desperately to avoid his own responsibility in the mess. I pointed out his responsibility in this piece. While Greenspan would like us to take the roots back twenty years, I think we can find something more important much closer to the present.

This is a chart of the Federal Funds Rate which as Head of the Federal Reserve Greenspan controlled until recently. As you can see between the middle of 2001 and the middle of 2003, the rate was absurdly low. It reached below one percent for a period of time. Greenspan can try and re write history however by lowering the rate that much he created loose and easy money. While he may not have predicted the mortgage mess per se, he should have anticipated the law of unintended consequences. He should have known that it was irresponsible to leave rates that low for that long. He should have known that if banks could borrow from the Fed (which is the purpose of the Federal Funds) for so little, that they were bound to act irresponsibly with the money.

He can pin this on some sort of a complicated alter universe in which a sophisticated network of globalization combined with asleep at the wheel credit agencies, arbitrage players, and poor savings. He can do this, but it still isn't going to tell the whole story. To add insult to injury, Greenspan actually tries to justify his irresponsibility while paying nothing more than passing lip service to what it actually caused.

and my colleagues at the Fed believed that the potential threat of corrosive deflation in 2003 was real, even though deflation was not thought to be the most likely projection. We will never know whether the temporary 1% federal-funds rate fended off a deflationary crisis, potentially much more daunting than the current one. But I did fret that maintaining rates too low for too long was problematic. The failure of either the growth of the monetary base, or of M2, to exceed 5% while the fed-funds rate was 1% assuaged my concern that we had added inflationary tinder to the economy.

The entire piece is full of technical language and it is told in a manner only fit for an expert. I don't know if Greenspan hoped to impress anyone or if he merely actually believes the load of bull that he is selling. I do know that China, credit ratings, and poor savings rates played a much smaller role in the crisis than the irresponsible and precipitous drop that the Fed took on the Fed Funds Rate.

The root of the crisis as I see it was loans that were created for irresponsible borrowers. These loans were created because banks suddenly had an infusion of loose money that they were able to borrow from the Fed. Because the rate was so outrageously low, banks felt more room to take risks. They did and that started the ball rolling. While Greenspan painstakingly tried to explain the root cause going back to right after the Cold War, he conveniently overlooked his own responsibility in the crisis. Unfortunately for Greenspan, I don't think that history will have such oversight.

...And You Remove All Reason and Logic

The New Yorker has this analysis of the rate freeze that Secretary Paulson has brokered. It focuses on only one of the five points of why I thought this rate freeze is bad and dangerous policy. It does concur on that point, which is that this rate freeze will only marginally help those it intends to anyway.

Although the plan will provide real relief for at least some homeowners, it’s more like a Band-Aid than like the major surgery that some of the hype makes out. That’s because at this point interest-rate resets are just a small part of the mortgage-market problem. Postponing rate resets doesn’t change the fact that too many people spent far too much borrowed money on houses with prices that were far too high, and that they are now stuck in homes that they can’t really afford and can’t sell. Even with the interest-rate freeze, foreclosures will keep rising

I believe the article is largely right, and from experience I believe that most sub prime borrowers just simply overbought. They took on property they couldn't afford. I believe that the rate increase would only perpetuate not create the problem. (Please note there is a great deal of debate on this point within the industry so my view is not a given. Some people do believe that it was in fact the rate increase that started the problem).

That said, there was something else in the article that is even more concerning.

Not for everyone, though. The plan sets up a system of triage, separating borrowers into three categories: those who will be able to keep paying after the rates reset, or else refinance their loans; those who can pay now but won’t be able to when the rates go higher; and those for whom even the current rates are too high. Only the second group will get help. Also, the plan doesn’t go into effect until next year—if your loan resets on December 31st, you’re out of luck.

In other words, what this plan will do is punish responsible borrowers and reward irresponsible borrowers. Think about what this article is saying for a minute. If you happen to be holding onto a subprime loan and you can afford the new higher payment, the rate freeze doesn't apply to you and you are forced to take that higher payment. If, on the other hand, you could afford the lower payment but not the new payment, you will have your lower payment frozen for you. Does this make any sense? How could the government possibly institute a policy that rewards irresponsible borrowers and punish responsible borrowers and think this will have anything but a disastrous effect?

Furthermore, how exactly is one to determine who can and can't afford the payments? They are going to freeze rates that are going to reset in the future. We are talking about millions of loans. What are the parameters? Who will decide? How can this turn into anything but a bureaucratic nightmare? This is a process that will be ripe for fraud, manipulation, and chaos. Again, this is a textbook example of a moral hazard. Government continues to believe that they can create a moral hazard with a positive outcome, however they do it by removing all logic and reason.

This process is going to fraught with litigation. Imagine if you are one of the borrowers that is determined to be able to pay the new loan, what is the likelihood that you will look to sue to drop your rate? What if you were a borrower that was wise enough to take a higher fixed rate? What is the likelihood you will look to have your rate lowered artificially? How can anyone possibly justify rewarding the irresponsible while punishing the responsible? There is no way this would pass legal mustard. The worst part is the absurdity is spelled out in the plan itself.

Update on the Rate Freeze

Several business journals have recently come up with editorials that echo what I have been saying about the rate freeze. Here is a snippet from IBD...

The flaws of the plan are many and fatal.

First, the deal will reward irrational behavior and encourage such behavior by homebuyers in the future. It was not logical for people to take out mortgage obligations they couldn't afford, but it will become logical for them to do so in the future if they can reasonably expect that the government and their lender will later bail them out when the going gets tough.

Second, the deal will thwart the market by keeping home prices artificially high. In recent years, laughably easy credit has let many people "buy" homes who otherwise could not have done so, pushing up prices.

We've had "liar" loans, in which people could just state their annual income without fear that their mortgage lender would call their employer to check. We've had "Nina" loans, for "No Income, No Assets." And we've had "Ninja" loans, for "No Income, No Job or Assets." Consumers, armed with the easy money provided by these silly terms, have pushed home prices to record levels when they're measured against personal income, making falling home prices not only inevitable but healthy.

Here is the view from Forbes...

Decried as a bailout of irresponsible borrowers by some and a financial industry wrist slap by others, the plan is not mandatory for the financial industry, though more than three-quarters of lenders and servicers say they embrace the idea. The biggest, Countrywide Financial, Wells Fargo, Citigroup and JPMorgan Chase, who collectively service $4.3 trillion in mortgage loans, all support the plan.

Still, independent mortgage-servicing firms, some of which are not overseen by federal banking regulators, could opt out, leaving their borrowers still vulnerable to foreclosure.

And investors may not like it. The financial industry lobby worked aggressively to make sure the plan included indemnification for them so investors of bonds backed by these mortgages won't sue them after lenders change the terms of the loans. The more lenders who volunteer to join the program, the less vulnerable they'll all be to lawyers, saying it had become industry practice.

Another issue: The plan only applies to those who are current in their mortgage payments but who are determined to be unable to afford higher reset rates. It won't apply to those who are already faltering, and it won't apply to those who face resets but are deemed able to afford it.

That raises the inevitable moral hazard question. "I'm very skeptical of this," says Bert Ely, a banking regulation consultant in Arlington, Va., who was among the first to say in the 1980s that there would be a taxpayer bailout of the federal deposit insurance fund in the midst of the real estate lending crisis of that decade. "It's government-sponsored collusion."

Finally, here is the word from the Wall Street Journal

The next time we suggest that the government give advice to the private sector, tie us down until the fever passes. A couple months ago, we endorsed the idea of mortgage service companies voluntarily negotiating with subprime borrowers and investors to avoid a wave of defaults next year.

Now come the politicians to wrap their arms around the idea, and maybe give the U.S. a reputation for forcibly rewriting financial contracts. Don't cry for us, Argentina?
Both Treasury Secretary Hank Paulson and the White House are touting a plan to freeze interest payments on up to two million troubled mortgages.

This one from the New York Post falls into the category of why don't you tell me how you really feel...

Yet this plan, bad as it is, has little chance of helping most of the people who face the possibility of foreclosure - after all, 1.5 million Americans will see their mortgage rates "reset" to higher rates next year.

So Treasury Secretary Hank Paulson will propose to Congress to let cities and states issue tax-exempt debt to bail out even more borrowers.

Cities and states would borrow billions and lend the money to "homeowners" (in fact, these borrowers don't actually "own" their homes; they only own the mortgage). The "homeowners," in turn, would use the money to pay off the mortgages they can't afford - and take out new, more affordable mortgages with their city or state government. (Not all tax-exempt debt is guaranteed by the city or state that issues it, but this debt would have to be - no private investor will touch this risk right now for an interest rate that would be "affordable" to these borrowers.)

The whole idea is disastrous - and not simply because it is massive government interference in the private markets. The problems are almost too painful to describe:

Finally, in response to to my previous work on this, I received this ANONYMOUS comment...

As a threshold matter, I treat any comment that begins by citing a politician with a healthy dose of skepticism. I'm not knocking politicians for doing their jobs. I'm just stating the obvious--their views are extremely skewed.As for freezing Rates, while I respect the poster's opinion, it is built on a false premise. One artificially jaded by his admitted "insider" position. In plain English, the arguments seems to be as follows: Capitalism depends on freedom to contract. When this freedom is interrupted, the system breaks down and everyone suffers the consequences for a few bad decisions. In the poster's view, the present mortgage crisis was largely created by a few economically and intellectually inferior individuals taking on financial burdens they should have known they could not carry. Now, according to this view, the government is interfering with an important moral and intellectual lesson that the gullible, but benevolent lenders are poised to teach. Moreover, because of this, the banks will be forced to retaliate by raising everyone's rates.As previously stated,
this position is replete with foundational flaws. First, lenders may be gullible, but they are far from innocent. Brokers, Banks, and title companies have, for several years (at least), colluded to mislead so-called sub-prime consumers who approach them from a bargaining disadvantage due to their, again, so-called spotty credit profiles.

Tellingly, the prime/sub-prime distinction is a banking industy invention intended to allow banks to charge usurious interest rates. And, hidden finance charges, fees and penalties have increased the number of technical defaults (via hidden universal default provisions) and (along with other predatory practices) have resulted in an increasingly small prime consumer population. But, as of late, the mortgage industy has taken deception to a new low. Which brings me to my next point. Other than credit histories (many of which--despite the Fair Credit Reporting Act and consumers' diligent efforts to update the information--contain vague and/or incomplete negative references many years old), the vast majority of sub-prime homeowners are just as financially able as prime consumers. They are doctors, lawyers, accountants, CEOs, etc. The average sub-prime homeowner pays his mortgage, his HOA, and his taxes on time, despite paying, in many cases, twice as much as his counter-part for the same home.

Contrary to the most prevalent explanation, it is not their ability to pay for the house they purchased that is at issue. Instead, it is their ability to pay the concealed premium on that house that neither they nor their counter-part can afford.

Take for instance, the Jumbo two-year interest only ARM. If you believe the poster, these people were fully informed about the affect of the LIBOR index (or, at least, knew what it was) on their loans after the 2-year interest only period. They knew that the interest capped out at, say, 12.7% from a teaser of 7.0% and that the rate would reset multiple times (every six months). They were also informed that very few if any finance companies would refinance such a loan. I think not.

This characterization strains credability and common sense. No one would knowingly agree to such terms. The Brokers and the lenders with their secret kick-back deals assured these consumers that, though the loan would reset (giving no mention of multiple resets or the actual dollar value of the payment increase), the consumer would refinance before then. They also routinely fail to explain the variabl interest rate provision of the contract, in part, because they can't understand the LIBOR themselves. If they do understand, they know that the deal would be dead on the table if they told the customer that his payments would go from $3700.00 per month to $5000.00. So, instead, they point to the page and vaguely reference a reset at the end of the 2-year period, skipping any details. If, by chance, they are selling to an attorney, they simply let the person read it. But, unless you work within a lending institution and regularly deal with such provisions, even an attorney will be completely lost (One does not usually have the final documents until he is sitting at the table at the title company). So, most will rely on the broker's interpretation, thinking, "at worst, I will have to refinance at the end of the term." So, the customer is a little gullible too.

Finally, as to the legal implications--and I'm an insider on this issue--this country has not seen the magnitude of litigation against major banking institutions that is currently in in the pipeline since Worldcom.

Now, this is naive and misleading on several levels. First, clearly this poster hasn't read all of my work, but just this piece. Had they read this piece, they would have known that I blamed five entities working in cohesion: the banks, Wall Street, the mortgage broker, the borrower, and the Legislature. Had they read this piece, they would have known that I even laid much blame for starting this crisis on Alan Greenspan.

Now, since the poster naively claims that my claim is flawed because I only blame the borrower, which I don't, I can stop now in the analysis, however I won't. They falsely claim that sub prime and prime don't have any difference in terms of income. While it is true that income is, in and of itself not the factor that determines prime or subprime (debt to income is), it is just a plain lie to claim that sub prime is not much more skewed towards the poor. Through logic and experience I have learned that while sometimes wealthy people have as poor a credit profile as poor people, I have learned that on the whole wealthy people have a much easier time paying their bills and thus have better credit.

They claim that it is the hidden part of the contract that sub prime borrowers can't pay. Again, in my six years, I know that overwhelmingly people buy homes at a higher price than they intended. That is my back up for my supposition, the poster gives no evidence for their hypothesis. They also claim that the paperwork is too difficult and thus the borrower is then not held responsible for the signature they gave to it. First, I pointed out that Congress has created an atmosphere in which it is easier to rip someone off. Second, that is pure hogwash. If you can't understand what you are signing, don't sign it. I had a twenty three year old that spent nearly six hours at the closing because he literally read and understood every word in every document before he signed. Good for him because he wasn't "gullible". To claim that the language was to complex and thus people agreed to things they wouldn't have is not only fellacious but irrelevant. They agreed to them and their signature is proof.

Then, he claims that sub prime is nothing more than a means for banks to charge outrageously high rates. While the rates are much higher, this poster would be surprised to learn that banks use a sophisticated manner in which to reach those rates. For the most part, borrowers get what they deserve. While sub prime is higher, it also excuses such things as bankruptcy, foreclosure, multiple mortgage lates, low credit scores, and sparse credit history. No one is forced to take on any rate, however if someone gets a sub prime loan it is almost always because that is exactly what they deserve.

Finally, they claim that my concern of the litigation nightmare in unwarranted because it won't rival Worldcom. That absurd statement speaks for itself and needs no counter.

Why Freezing Rates is Bad and Danerous Policy

According to Fox News, the President has reached an agreement to freeze rates on Adjustable Rate Mortgages for five years.

Congressional aides say the Bush administration has hammered out an
agreement with industry to freeze interest rates for certain subprime mortgages
for five years in an effort to combat a soaring tide of foreclosures.

These aides, who spoke on condition of anonymity because the details have not yet been released, said the five-year moratorium represented a compromise between desires by banking regulators for a longer time frame of as much as seven years and industry arguments that the freeze should only last one to two years.

Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.

This is a dangerous and bad policy on several levels.

1)Whenever the government steps in on a private contract and renegotiates it, it leads to all sorts of unintended consequences. In this case, banks use extremely sophisticated modeling techniques to determine the interest rate that borrowers receive. Those models take into account whether or not a rate will eventually begin to move or not. By freezing rates for five years, he has thrown those models totally out of whack. In other words, the risk profile of these loans no longer matches the rate as determined by the models. This not only throws banks out of whack but Wall Street as well that turned those mortgages into bonds.

Whatever liquidity problems are currently in the market, those are nothing like the liquidity problems that will be created when loan terms are changed wholesale. If banks don't receive the rate, and the underlying payment, that they expected, then we will really see some liquidity issues. Remember, one, banks expect to take homes when payments aren't made, and two, they expected certain interest rates and payments from mortgages. Now, they will get neither, and their money is tied up expecting both.

This nightmare is further perpetuated because the definition of sub prime is not clearly defined. For instance, one of the big problem mortgages are option arms. Many of these mortgages are what we refer to as monthly ARM's. That means their rate changes every single month. If Bush includes these into sub prime, he will simply create a nightmare for the banks. Since they are monthly ARM's you can bet that much of the underlying rate was based on a model that had that rate moving every month. If that rate is now frozen for five years, you can bet that banks will take a giant financial hit.

Keep in mind that if you don't care if banks take a hit, you should. If they take a hit, they will pass that hit onto the consumer in terms of higher rates on all future mortgages.

2) Bush has now also created a moral hazard. The folks that he is saving took on a mortgage profile, a rate that adjusts, that they shouldn't have. This was entirely by choice. Now, he is stepping in and stopping an event that is supposed to happen to an Adjustable Rate Mortgage. Instead of learning a difficult and valuable lesson, these folks will now get the message that risky financial moves can be met with government interference to save them before those risky moves turn into consequence.

3)Bush has now created a litigation nightmare. There are all sorts of folks that are currently in fixed rates, five year Arms, and other loans in which their rate either doesn't adjust or hasn't yet adjusted. Those folks are holding onto mortgages with higher rates than the folks who's rates he has artificially frozen. They will all scream bloody murder and demand that their rates be adjusted downward. They will be right. Imagine if you took on a fixed rate which was a higher rate than the equivalent adjustable rate. You did this with a certain financial loss, at least initially, because that rate was higher and with it the payment. Now, you hear that folks that didn't take the same precautions as you are now having their rates frozen for them artificially and will now enjoy lower rates, artificially again, for at least five more years. You would, rightfully so, feel entitled to the exact same rate. You would likely get a lawyer and I firmly believe that Bush has now opened banks up to all sorts of lawsuits.

4)Finally, and this is coming from an insider. This rate freeze isn't going to do anything of substance. The people that Bush thinks he is helping are in over their heads. I know because 99 times out of a 100 my borrowers always bought a property that was more expensive than one they claimed they wanted to buy. The sort of sub prime borrowers that Bush thinks he is helping are irresponsible. They bought 250,000 dollar homes when they could only afford 200,000 homes.

That dynamic is not going to be changed by freezing rates. These folks maybe able to afford to make these payments for a while longer but not forever. They are still in over their heads. Also, what about all of those folks that are in Prime loans that are adjustable rates. Won't they also demand that their rates be frozen? Won't everyone who is on time demand that their rate either be frozen or lowered? By helping the most desperate and the most irresponsible, Bush has now opened up a can of worms that he frankly can neither predict or control.

EPILOGUE:

Now, a mortgage colleague of mine tells me that a radio report says that the only loans that will be affected will be those that are according to him, "on time". On time is rather nebulous. For instance, on time could mean current. It could also mean always on time. If he is only helping those that are always on time, then he is frankly taking all sorts of profit potential away from banks, because those folks most likely would have continued to be on time with or without the freeze. If he is talking about those that are on time now, but have been late, then he is delaying the inevitable. Either way, if it isn't defined clearly, I can assure all that it will be another litigation nightmare.

Hillary Clinton Decides to Mix Chemicals in a Lab Vis a Vis Mortgages

If anyone wants to know how dangerous it is for uninformed politicians to make policy suggestions that have political goals, they need to look no further than this proposal by Hillary Clinton in response to the mortgage crisis.

Democratic presidential candidate Hillary Clinton called for a 90-day moratorium on foreclosures for homeowners who default on subprime mortgages.

The New York senator, is also seeking a five-year freeze on the monthly rate for subprime adjustable mortgages and a requirement that the industry report how many mortgages have been modified. In a letter to Treasury Secretary Hank Paulson, Clinton said she may consider legislation to protect lenders from lawsuits and let them convert certain mortgages into ``stable, affordable loans.''

...

Clinton also proposed a fund of as much as $5 billion to help communities suffering from high rates of foreclosures. The moratorium on foreclosures would be at least 90 days and only apply to owner-occupied homes.

I have already pointed out Hillary Clinton's disastrous mortgage bailout plan. This is frankly more of the same.

It seems that Hillary Clinton has forgotten several simple business rules. The first rule is that contracts have stipulations and each party must meet their end of the contract or face consequences (no matter how sympathetic each party is). A mortgage is a contract and there are certain stipulations. For instance, the bank stipulated that they would shell out the entire sum of the original mortgage amount, almost always six figures and more, up front. They stipulated that the borrower would pay that mortgage back one month at a time. It also stipulated that if said borrower failed to repay then the home would be taken from them. The borrower signed that mortgage and thus agreed to that contract.

Despite what Hillary Clinton believes, changing any contract in a wholesale manner, as she wants with mortgages, is neither good policy, nor good for the economy. Banks paid out hundreds of thousands of dollars up front with the intention of receiving that money back one month at a time. If that money wasn't received, the banks would take the collateral, the property. That is how banks expected to make that transaction profitable for themselves. Hillary Clinton wants to take away the entire profit structure away from the banks and she thinks there are no unintended consequences to it.

There are. If banks happen to lose a lot of money in a wholesale manner as Hillary Clinton intends, they will pass those losses onto us, in the form of higher interest rates on future mortgages.

Finally, and here is the worst part, the people that Hillary wants to save from foreclosure, for 90 days at least, are almost entirely in over their heads. They bought property they simply can't afford. I don't care if her moratorium is 900 days, this dynamic isn't going to change. If you can only afford a home that is 200K and you buy one for 250k, no moratorium is going to save you from yourself.

Second, Hillary Clinton wants to freeze ARM's (Adjustable Rate Mortgages). This is ludicrous. The reason that any loan has the rate that it has is ALL the factors that went into that loan, including the fact that the rate on that loan would move later. (In other words an ARM almost always has a lower rate than a fixed rate everything else being equal) Hillary Clinton wants to freeze rates even though banks offered a lower rate with the intention of having that rate move in a future period.

The manner in which banks determined the rate that borrowers received is extremely sophisticated and far past the grasp of Hillary Clinton, with all due respect. Yet, that, to her, matters not. She wants to, in a wholesale manner, freeze rates when the banks intended to have them move (and in exchange offered an initially lower rate). This of course totally disrupts the models that banks used in order to determine that rate. This means that banks will lose millions of dollars. That means that future rates will be that much higher to make up the difference.

Furthermore, there are people currently holding onto mortgages with fixed rates with each of these banks that Hillary Clinton wants to freeze the ARM's of. If I were holding onto a fixed rate (one that stayed the same over the life of the loan), I would be screaming bloody murder. I took a higher rate so that I wouldn't risk a future rate even higher, and now all those that didn't take the precaution I did get to have their rates frozen. I would be saying screw that and demand that my rate be lowered to their level since I only took the higher rate because I wanted my rate fixed for life. If Hillary Clinton is fixing their lower rates, then I would want my rate lowered and fixed as well. This is what is referred to as a moral hazard. Hillary Clinton is rewarding those that took on a risk they shouldn't have with an artificially fixed rate. By doing so she invites more people to take on ARM's when they shouldn't in hopes of getting the same doeal. I wonder if Hillary Clinton has a solution to that.

The worst thing about this is that Hillary Clinton is doing this strictly for political reasons. In sales, I always look to find my way on the same perverbial side of the table with my client against a chosen villain. Usually, I choose the bank (though not always), and I make the process me and the borrower against the bank. Hillary Clinton is using the same technique only it isn't to sell a mortgage, but to propose bad policy. She wants to find herself on the same side of the table with the poor borrowers against the bank. This may very well be a good political strategy however it is disastrous policy, and I hope everyone reading my analysis can see why.

A Sad Story About a Mortgage Broker

Here is how my August went. I started out with ten loans that I thought I was going to close. Five of them were with one borrower which is one reason why things unraveled the way they did. My borrower has an excellent credit profile. He holds onto nine mortgages, a car loan, a couple student loans, and several credit cards and never in his life has he been late on anything. Now, because he has so much outstanding credit his score is good not great. Also, he is in sales and owns multiple properties so it is virtually impossible to ever show any documentation to verify his income. Still between his strong credit and the fact that he has money in the bank, his loans were always difficult but doable.

Right around my thirty third birthday, his loans started dropping one at a time. The worst thing about it is that they were dropping for newly made up reasons. While he had money in the bank, it wasn't "congruent" to the amount of money I claimed he made. In other words, he didn't have enough money in the bank for the amount of money I claimed he made in income. While this is a reasonable way of judging things, it was NOT any of the bank's guidelines when I submitted the loan.

I kept trying to find new banks for his loan. I found one and the next day they announced they were shutting down operations. I found another and they changed guidelines right after I found them. I finally found one that I thought would work. They fumbled around with it for five days. Then, while I was driving to a wedding in Minnesota, I got the news on Blackberry that they too were denying the loan, and also because his so called liquid assets weren't congruent to his income.

By the end of the month, the ten loans I thought I was going to close wound up being zero and this is a story that most mortgage brokers will tell you about the month of August and even into September. In those two months, banks were looking for reasons to deny loans. It was near impossible to close anything, and thus, it was near impossible to do what I had dedicated the last six years of my life to. The industry was in turmoil and there was confusion and fear everywhere. Almost no one was sure they would even stay in the business and no one knew what would happen next.

I bet I know your reaction. Who cares? You are a scummy mortgage broker and your excess brought this upon yourself. I have no sympathy for you and I hope that your next year is like August. If you think this way, then ask yourself why you sympathize with the people in this article.

This is an article about people about to face foreclosure. There stories are no less heartwrenching, but frankly no more. If you think it is tough facing the reality that you can't afford to pay for your house, try facing the reality that your industry is in such a state of chaos that you can probably no longer afford to be in it. Losing a house is bad, however losing a career is much worse.

Yet, there is NOT one article about any mortgage broker and the difficulties we have faced in these months. That is despite the fact that our stories are no less poignant. That's because unlike homeowners we aren't sympathetic.

Thus, newspapers like Chicago's Daily Herald, and this one from the New York Times, print stories in which borrowers are portrayed as empathetic victims. Their stories are heartwrenching and we are supposed to feel sorry for them. No one feels sorry for the mortgage broker, even though it is no less heart wrenching to watch your career go up in smoke.

That is frankly not the point. I don't much care if anyone has sympathy for me or my industry and I certainly could care less if any newspaper ever wrote a sympathetic piece about us. Unlike the borrowers, most of my industry could care less if the world has any sympathy for us and we don't seek attention at these times. The reason for this piece is that policy is being determined based on the misleading narrative that borrowers are sympathetic and mortgage brokers and banks are bad. Policy can't be determined based on this principle. Yet, newspapers are hammering this theme home.

The politicians are responding. They have responded with H.R. 3915, which attacks predatory lending, and provides even more protection for borrowers in case they go bad on the loan. In other words, based on the narrative that borrowers are good victims and brokers are evil predators, the pols will design a bill that protects the borrower and punishes the broker.

While this may be good politics, especially when it is egged on by the media, it is terrible policy. Borrowers signed paperwork and they agreed to certain conditions. They aren't meeting those conditions, and now the legislature wants to provide extra protection in case they won't meet those conditions. That is called a moral hazard.

It is hard to know exactly how the final version of H.R. 3915 or its equivalents and cousins will look like, however there have already been several scary things being floated. For instance, Senator Dick Durbin wants to allow for bankruptcy courts to be able to renegotiate the terms of mortgages. In other words, if you go into bankruptcy, you will be rewarded with a better mortgage.

The borrower is actually able to sue the securitizer, Wall Street, if their loan goes bad, and the borrower is afforded all sorts of new protections if they go bad on a loan. Here is the language vis a vis securitizers...

Assignee/Securitizer Liability (does not extend to trusts and investors): Subject to exemptions below, for loans that violate the minimum standards (reasonable ability to repay and net tangible benefits), a consumer has an individual cause of action against assignees and securitizers for rescission of the loan and the consumer’s costs for rescission.

Here is the language vis a vis foreclosures...

When the holder of a mortgage loan or anyone acting on behalf of the holder initiates a judicial or non-judicial foreclosure, (1) the consumer who has a rescission right under this bill may assert such right as a defense to foreclosure against the holder to forestall foreclosure, or (2) if the rescission right has expired, the consumer may seek actual damages (plus costs) against the creditor, assignee, or securitizer.

This is a moral hazard and it is dangerous. If you give people an incentive to go bad, that is exactly what they will do. This is happening because newspapers are perpetuating a narrative. It is a narrative that gives politicians a political angle. None of the narrative is rooted in reality mind you. The reality is significantly more complicated. The reality is something that politicians and their partners in the media have no desire of discovering. Instead, they will pass laws that fit the narrative and perpetuate the very problems they claim to be attacking.

Here is the problem. They create vague concepts that fit their narrative. They are concepts like "predatory lending". Here is the problem with that concept.

There is no specific definition about what exactly predatory lending entails, though most observers believe that the description applies when lenders take advantage of borrowers by charging high interest rates and consider only the value of a borrower’s assets, as opposed to what the borrower can afford to pay.

In other words, politicians have created a concept they can't define. It is there solely to make them feel good and also so they can tell the masses they attacked the bad guys. The problem is that in my business there is only one practical effect of vague and undefinable concepts,

YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET

That's right. The practical effect of all of the legislation that is currently on the books is even more paperwork to sign during the process. Anyone who has closed a loan knows how much attention you pay to the paperwork you already sign, and now you will sign even more.

Why does this happen? That's because politicians are responding to political not policy opening, and that opening is created by one sided heart wrenching pieces in which certain groups are painted as victims and others as villains.

Imagine how much different the legislation would be if every newspaper published stories like the one that started this piece. They would of course be no less dangerous, but they would be different.

Trifecta from the New York Times vis a vis Mortgages

Either I have come late to the game or the New York Times used this week to come out swinging against the mortgage industry. In the last two days, I have featured two separate articles vis a vis mortgage from the New York Times. The articles follow a pattern of narrative of the mainstream and it is a dangerous pattern.

The New York Times takes on a populist message. They side with the borrower against the mortgage broker and the bank (and even against Wall Street). The propose all sorts of legislation that protects the borrower even more against foreclosure and the undefined "predatory lending". For instance they back a bill by Dick Durbin that gives an incentive to go into bankruptcy. Under his bill, a person that goes into bankruptcy can re negotiate the terms of their loan. I assume that means for the better. Not only does this give incentive to go bad, but frankly all good borrowers would scream bloody murder and it would create an obscene amount of legislation.

That is some of the legislation they support in the first and second installment. Here is their third installment. (I believe it is their first in chronology however I found it last). First, the New York Times laments a portion of H.R. 3915 that has been altered.

Industry has already scored some regrettable victories. It persuaded the bill’s backers to include a provision that would prevent borrowers from suing Wall Street firms in state court — where consumer protections are often stronger — for common abusive loan practices.

Here, the New York Times, much like most in the media and unfortunately in Congress as well is dealing with concepts well beyond their grasp. While it may make for a great populist message to say you back allowing borrowers to sue Wall Street if they suffer hardship, this is an absolute nightmare. The first problem is that most people don't understand Wall Street's role and of course the consequences of opening them up to suit. Wall Street creates markets for loans. Whereas banks deal in millions of dollars of loans, Wall Street turns those loans into bonds and deals in hundreds of millions. If each individual borrower could actually go to the securitizer (that is Wall Street or the folks that turn loans into bonds) and sue them because they felt they were wronged, that would open up the litigation floodgates with unknown results. That said, the practical results would be that Wall Street would simply not get involved in securitizing loans.

This is in fact what Wall Street has done already with no legislation. Long ago Wall Street soured on mortgage backed securities and without legislation they have washed their hands of the instrument. The sort of legislation the Times touts would give Wall Street even less incentive to get back into that market. Remember, it is those "evil" Wall Street folks that the Times is dying to attack, that created a market for most of the poor folks to get loans in the first place. Before there was such things as mortgage backed securities, the standard loan usually required 20% down and good credit. It was only the innovation of mortgage backed securities that lead to the revolution in mortgages and created the sophisticated system we have today.

Now, the market in the aftermath of the crisis is threatening that system. Sub prime, the outlet for loans for most of the poor folks the Times pretends to care about, is being threatened out of existence through market forces. By this I mean, Wall Street is refusing to make markets for those loans. Without a market, most of these banks will go under or move out of sub prime. Again, this is happening without the push of any legislation. Now, the Times is supporting legislation that would hold Wall Street liable for bad loans. This gives the folks on Wall Street even less reason to make a market. This is at exactly the time when we need to give them as much reason as possible.

Then, the Times says this...

Another must-pass amendment would adopt sensible underwriting standards for all nontraditional mortgages — not just subprime loans — including a rule that lenders must verify a borrower’s ability to repay. The amendment is crucial because it is not only subprime loans that have turned out to be toxic. Another important proposed change would give borrowers the right to modify an illegal loan, before they’re forced into foreclosure.

The first problem with this philosophy is that the word sensible is vague and difficult to define. In my business, whenever there is legislation that is vague and difficult to define what that means to the consumer is

YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET

If there is legislation passed and all it says is a reference to sensible underwriting standards, then banks will create a sensible underwriting standards disclosure. That is what banks do every single time there is vague legislation and the reason why there a hundred documents to sign and not ten or so. Second, the Times, with their cohorts in Congress, continue with their attack on stated loans. (these are loans in which income is claimed but not verified). While the concept of stated loans gets debated in the halls of the Times, the mortgage market has long rendered its verdict. Stated loans are virtually non existent. If Congress wants to outlaw them completely, that is their prerogative but they will only be following the market. The problem with outlawing stated loans is that it assures that the overwhelming majority of self employed borrowers and real estate investors never get a mortgage. Since they are able to take a plethora of write offs, proving income is virtually impossible. (for real estate investors, there is a complicated mortgage formula too boring to discuss that also makes it impossible)

By throwing out the baby with the bathwater so to speak and outlawing stated loans entirely, all Congress would do is remove their original intent. The market has long ago on its own returned stated loans to their original intent, self employed borrowers and real estate investors. The problem wasn't stated loans but rather that garbage men, secretaries, and janitors, could now claim income even though they were salaried and thus had only lying as a reason to go stated.

The New York Times, along with their cohorts in Congress, don't care much about that or frankly good policy. They have figured out which side they need to be on to look good. Keep in mind that while the Times looks to punish banks, brokers and Wall Street for providing loans to borrowers who "lacked a reasonable ability to pay". It was these same borrowers that willingly agreed to take loans that they either did know, or should have known, they couldn't afford. If the borrower themselves had followed their own reasonable ability to pay philosophy, we wouldn't have this mess. The blame isn't solely on their shoulders however, unlike what the Times, and the Congressional cohorts believe, they must shoulder some of the blame.

The reason this is important is because the crisis will affect everyone. The legislation that will no doubt follow must be sensible. Right now, it is not. The Times is effectively cheerleading for Congress to pass legislation who's sole effect is playing political games at the expense of good policy. Ultimately the only practical effect of these new laws will be that the borrower

HASN'T SIGNED ENOUGH PAPERWORK YET

There are two huge problems with this entire mortgage debate. The first is the naive and uninformed making statements, observations, and recommendations regarding the path forward. The second is the uninformed making policy on how to move forward. The New York Times represents the first and Congress represents the second. The mortgage market is at vulnerable state and the last thing it needs is the contribution of the uninformed.

The New York Times Versus Brokers and Banks

The lines are drawn and everyone needs to understand the stakes. The mortgage crisis is crying out for action and everyone wants to pick sides. Congress has picked a narrative and that narrative is politically correct. The problem with a politically correct narrative is that it doesn't address any problems but rather it assigns victims and villains and protects the victims and punishes the villains. If you read any of my work on mortgages and H.R. 3915 you will see my business has complexities that are totally foreign to anyone in Congress. They are making laws about things they can't define like predatory lending.

For instance, with in H.R. 3915, there is something called anti steering. This means that if someone qualifies for prime they can't be steered into sub prime. Unfortunately, prime is a vast universe and it isn't always better than sub prime. For instance, within Fannie Mae (something most of Congress think is a candy company) there can be what we call expanded levels of approval called EA1,2, and 3. The third level is extemely aggressive and thus has a very high rate. Sub prime can very well offer a better deal than EAIII, as we call it. If I steer someone from EAIII to sub prime, can I be sued? No one knows including the representatives of my Congressman's office, Rahm Emanuel (I know because I called and was directed to a confusing website with a one hundred plus page "summary" of the bill)

This matters not to Congress because protecting the homeowners, the victims, and attacking the brokers, the villains is good politics.

The truth matters not to the New York Times either. Yesterday, they published a piece endorsing a bill that would create the "moral hazard" of encouraging bankruptcy. They did it because the bill protected the consumer again, and punished the bank again. Today, we have this piece by Bob Herbert. It tells the story of poor Rosa Dailey who was harrassed and manipulated into taking on a mortgage she couldn't afford. Apparently, she received a plethora of phone calls and the calls wouldn't stop. Apparently, Ms. Dailey never told them to take her off the list or put herself on the do not call list (the time frame is unclear so I don't know if the do not call list was in place yet). Instead, she succombed to the pressure of the phone calls and was put into a loan she couldn't afford.

They knew that the woman who owned the house was old and sick and that her two aging daughters were struggling with illness and poverty as well. That was all to the good as far as the lenders were concerned. The predator’s mission is to home in on the vulnerable.

“The people that wanted to put through the loan called me about a hundred times,” said Rosa Dailey, who is 65 and going blind and needs an oxygen tank at times to help her breathe. “I kept telling them no, because I didn’t think we could afford it. But they kept saying how it was to our advantage. So I finally said: ‘All right, let’s see what we can do.’ ”

That was the beginning of a tragic spiral, with one unaffordable loan following another. As Ms. Dailey put it: “I feel like they led me down a dark alley.”

I have no doubt that this story is essentially true, and I have no doubt that there are plenty of sociopaths that occupy my profession that would perpetrate such a heinous act. What isn't revealed is why Ms. Dailey who apparently had a loan ever agree throughout every part of a month process to take on a loan that was clearly worse for her. What possible motivation would Ms. Dailey have to change what I can only assume was an affordable loan into a loan that wasn't affordable? Despite what Mr. Herbert implies, the rate, monthly payment, and other terms, are all clearly spelled out in the documents. Furthermore, it is something every consumer should ask before signing any of the initial documents. Was Ms. Dailey taking out cash? Was she taking a payment that was initially lower but then grew? We don't know, but for some reason Ms. Dailey moved from a loan she could afford into one she couldn't (or maybe Mr. Herbert conveniently leaves out that the loan she had she couldn't afford either). Unless someone signed documents for her, she must take some responsibility in the process or frankly there is no contract (which is what a mortgage is) anywhere that is worth anything.

I am not excusing the broker or the bank. In fact, I never miss an opportunity to take pot shots at my business. Before doing this I was a stock broker. Stock brokers made fabulously wealthy people less wealthy. While it is no less scummy, it is at least a bit more challenging. Mortgage brokers absolutely prey on little old ladies like Ms. Dailey and take advantage of them. That is because our business is such that we can make just as much money taking advantage of the weak as trying to take advantage of the powerful (who ultimately are not nearly as easy to take advantage) Fraud is fraud and if this case is accurate there was fraud committed and despite what some think this sort of fraud is already illegal. It is just rarely enforced which is the crux of the problem. That said, to say that Ms. Dailey was nothing more than a helpless victim despite signing documents agreeing to pay a loan back and then not paying it back is very well the politically correct thing to say. It is NOT the correct thing to say. There is a reason why there are right to recission laws. If Ms. Dailey felt pressured, that is what the three days after were for.

Again, what Mr. Herbert conveniently left out is why Ms. Dailey initially agreed to refinance a mortgage that apparently she could afford into one that wasn't affordable. For some reason she signed documents changing her terms from those that were affordable into those that weren't. There are scum bags in every business. Mr. Herbert acts as though mine is special because we have those that take advantage of people. We aren't. Just like in any other area, the consumer protects themselves with knowledge. Ms. Dailey was taken advantage of because she was naive. While this maybe harsh, that is the ultimate problem.

My parents once almost walked away from a loan I did for them, their son, because they weren't convinced that I was actually going to pay for all of their costs. I initially tried to convince them by simply saying that I was their son. I eventually convinced them by changing the paperwork and making it accurate since it wasn't initially. My parents were absolutely correct and the whole episode taught me a valuable lesson. My parents would never wind up in the position of Ms. Dailey because they are educated consumers. Ultimately in the case of Ms. Dailey and every other consumer knowledge is power.

I also point out that it was much easier to take advantage of Ms. Dailey because the important documents were buried in a stack of useless ones. There is a stack of useless documents because of the never ending government regulation that Congress and others insist on the mortgage business. Ironically, Mr. Herbert is in favor of more government regulation which would lead to more signed documents for Ms. Dailey.

What is disturbing to me about this article is that it gives nothing besides telling a story that is meant to tug at your heart string. We now have the do not call list. I mentioned the right to recission, and of course, the plethora of paperwork is what the Congress has always done to "protect the consumer against the predator". All Herbert does is say this,

In some cases, corporate con artists have deliberately targeted and seized the equity of financially strapped and unsophisticated owners. In some cases, homes have been stolen outright.

This is an issue crying out for a thorough federal investigation.

This is nothing but nonsense. The idea that banks would ever do a loan where the goal is foreclosure is one made up by those that have it in for banks. I think banks are an evil creature: drunk on power and unwilling to do anything anyway but their way. That doesn't mean they think that creating a loan that would ultimately lead to foreclosure is something that would ever be in their best interest. Herbert provides no specifics of such. In the case of Dailey, it was NOT a bank creating a loan that they wanted to end up in foreclosure. These loans along with many others were created in what I refer to as irrational exuberance. Banks got caught up in the wave of the hot real estate market and ended up creating loans that were far too lenient and allowed for unverified income that was way out of line. They did this because of stupidity and irrationality not malice. Yes, the mortgage broker certainly manipulated the loose system of the bank and the naive client, however, we the sociopathic mortgage brokers, were taking advantage of a system set up by forces around us.

What is important is that the market, THE MARKET, has put an end to this. You need not worry about the likes of Ms. Dailey ever being taken advantage of because there are no longer any such loans. If he wants to investigate, he can, but he doesn't say what he wants to investigate. He gives no solutions. All he does is give a story that is meant to do nothing else but portray him as a populist and attack the easy targets, banks and brokers. This is dangerous because policy is decided based on this narrative.

New York Times Perpetuates Dangerous Politically Correct Narrative on the Mortgage Crisis

The New York Times has contributed their two cents towards analyzing the mortgage crisis with this piece. It is exactly this sort of politically correct analysis that leads to the dangerous legislative agenda that Congress currently is wrestling with regarding my industry.

The NY Times lays out several fundamentals. First, the rightly predict that the housing crisis will get worse before it gets better. The rightly predict that things will get even worse when ARM's (which are already adjusting) adjust to higher levels hit borrowers even more. That is the end of any correct assertions that they make regarding the housing market.

They blame Bush for not acting. The problem is there is absolutely nothing the administration or any other politician can do. The current problem is that there is a plethora of people currently in over their heads. They have bought homes they can't afford. There is no political fix for that and furthermore any bailout will only delay the inevitable and pour good public money after bad private money.

They tout a bill by my Senator, Dick Durbin, that would allow rates to be rearranged as part of any bankruptcy. This bill is nothing short of dangerous. If borrowers are allowed to reset their rates artificially as a part of any bankruptcy, then that encourages someone to go into bankruptcy. It also leaves a lot of good borrowers screaming bloody murder.

Here is how the Times sees it.

The bill also undoes a longstanding injustice. Under current law, mortgages on primary homes are the only type of secured debt that is ineligible for bankruptcy protection. Owners of vacation homes, farms and commercial property can modify those debts in bankruptcy court. But not your everyday homeowner. Under any circumstances, that double standard should not be allowed. With a foreclosure debacle unfolding, it must be rectified.

Now, I didn't know that vacation homes and investment properties can be modified, however that is no less dangerous. If that is the case, the proper course of action is to close that loophole not open up a new one. By re arranging the mortgage so that the payment and subsequently the rate is lowered that encourages bankruptcies. Think about it. You have two borrowers. One borrower makes their payments on time and the other one falls behind. The second borrower files for bankruptcy and as part of that bankruptcy has their rate and payment lowered. Not only does that encourage bankruptcies, but frankly opens banks up to all sorts of suits. If you are a borrower that makes your payment on time, and you heard about borrowers having their rates lowered because they were late, what would you do?

This is what the New York Times is suggesting as a good idea. Again, the politically correct narrative has the borrowers as helpless victims that must be protected from future malfeasance. This is simply not true. The borrowers are for the most part irresponsible. The problem is that through irrational exuberance banks and Wall Street opened up a market so that irresponsible borrowers qualified for loans. We, the mortgage broker, gladly put many of these irresponsible borrowers into loans we shouldn't have. These people are no less responsible because of the dynamics I just described. That has long been corrected by the market, however those same people continue to hold onto mortgages that they can't afford.

No politician can fix this current dynamic no matter how much they claim they can. Providing extra protections for borrowers to take advantage of in case they default in the future only encourages more irresponsible borrowers to take on loans. Because no politician or politically correct news organization would ever dare put even a little responsibility on the shoulders of the borrowers, asinine proposals like the one that Durbin is touting are given credibility rather than ridicule.

H.R.3915: THE DEMOCRATS THINK YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET: The Political Reality if Republicans Choose to Take It

The full House voted on H.R. 3915 yesterday and the vote was almost entirely party line. Here are the final tallies.

Latest HR 3915 Vote in the House of Representatives
FINAL VOTE RESULTS FOR ROLL CALL 1109
(Democrats in roman; Republicans in italic; Independents underlined) H RES 825 YEA-AND-NAY 15-Nov-2007 11:36 AM QUESTION: On Ordering the Previous Question BILL TITLE: Providing for consideration of H.R. 3915, Mortgage Reform and Anti-Predatory Lending Act
Yeas Nays NV
Demsocratic
224 6
Republican

193 2 7




TOTALS
224 195 13

My initial interest in this bill was entirely self interest. The bill threatened to remove Yield Spread Premium, a tool that I use not only to make money but to provide better loans for my borrowers. There continues to be all sorts of confusion as to whether or not YSP has been eliminated. The members of my Representative's office (Rahm Emanuel) weren't sure themselves. His financial services specialist first sent me here ( this link was useless to me since I had already referenced it myself.) He then sent me here ( a document that is about one hundred and thirty confusing pages. You can take my word for it or open up the link and see for yourself). It was clear that my Representative and his office didn't have much more information about this bill than I already did on my own. I registered my extreme opposition to this bill to which his guy reminded me that Emanuel is NOT on the banking committee. It was typical politico. Whenever there is a bill they are proud of, the Democrats passed it. In this case facing an irate constituent, Emanuel is suddenly not on the committee. Those excuses are no longer acceptable since Emanuel voted for the bill.

What I have figured out is that YSP is NOT the best tool for political hay in this bill. YSP can be removed and added easily. There is another much more serious much more systemic problem with this bill and that can be used to make political hay. The bill is called The Mortgage Reform and Anti-Predatory Lending Act of 2007. Here is the first and main problem (from a Winston Salem newspaper regarding the North Carolina anti predatory lending law upon which this is modeled)

There is no specific definition about what exactly predatory lending entails, though most observers believe that the description applies when lenders take advantage of borrowers by charging high interest rates and consider only the value of a borrower’s assets, as opposed to what the borrower can afford to pay.

That's right, the Democrats (which we can now say since the vote was essentially party line) are attacking a problem they can't define. That should scare everyone. In my business if you can't define it, what that means is you, the borrower and consumer of loans, HAVEN'T SIGNED ENOUGH PAPERWORK YET. In practical terms, when someone is vague and cannot define an issue, it means they are actually quite ignorant to it.

What the Democrats are equivalent to is someone going into a lab and mixing chemicals even though we have no science background. We wouldn't accept that, but yet we sit by while totally clueless individuals mix perverbial chemicals with the loan process.

Let me lay out every instance within this law where I believe the practical effect will be YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET.

steering any consumer to a loan that the consumer lacks a reasonable ability to repay, does not provide net tangible benefit, or has predatory characteristics

There are at least three new disclosures just in this sentence. I know there will be a net tangible benefits disclosure because the Illinois Legislature has already created that for ALL loans in Illinois. There will no doubt be a reasonable ability to pay disclosure, and probably an anti predatory lending disclosure. In other words, without looking at any other part of this bill, THE DEMOCRATS THINK YOU DON'T SIGN ENOUGH PAPERWORK YET.

Safe Harbor: A presumption can be made that the minimum standards (reasonable ability to repay and net tangible benefit) are met for “qualified mortgages” and “qualified safe harbor mortgages.” Qualified mortgages (prime loans) are presumed to meet the minimum standards and this presumption may not be rebutted. For qualified safe harbor loans, the presumption may be rebutted only against creditors.

The term safe harbor is very important in this bill because "safe harbor" loans are excluded from much of the legislation. Since it becomes vital that a loan be a "safe harbor" loan, you can bet that banks will create however many disclosures they feel necessary in order to insure that each loan meets the vague definition that the law lays out. Since the law itself is vague and undefined, the banks can respond with whatever paperwork they deem necessary to make sure becomes defined as "safe harbor" in the closing documents. In other words, if we went no further, THE DEMOCRATS THINK YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET.

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

This sounds reasonable however "prime loans" can mean a lot. For instance, Fannie Mae is prime. Fannie Mae has several different categories. For instance, Fannie Mae has Expanded Approval levels, 1, 2, and 3. If someone is only approved for EA 3, their rate can easily reach 9% and beyond and if the loan to value is over 80%, there will be a large PMI payment as well. So, what if someone is only approved for EA 3, and I steer them toward sub prime (which very likely would have a better deal in such a scenario). Could I be sued? That question is very undefined. The most likely reality is that no one that voted for this bill even knows that there is such a thing as Expanded levels on Fannie Mae loans. I bet most of the legislators think Fannie Mae is candy. What is the practical effect of such vague and undefined situations, that's right, YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET.

You think I am at the end. Oh no, I am just getting started.

Assignee/Securitizer Liability (does not extend to trusts and investors): Subject to exemptions below, for loans that violate the minimum standards (reasonable ability to repay and net tangible benefits), a consumer has an individual cause of action against assignees and securitizers for rescission of the loan and the consumer’s costs for rescission.

Exemption from Liability: An assignee/securitizer will not be liable for a loan that violates the minimum standards if the assignee/securitizer provides a cure to make the loan conform to the minimum standards within 90 days of receiving notice from the consumer, OR (1) has a policy against buying mortgage loans that are not qualified mortgages or qualified safe harbor mortgages and exercises reasonable due diligence to adhere to such policy AND (2) has obtained representations and warranties from the seller or assignor of the loan regarding not selling or assigning loans that violate the minimum standards.

This wordy and most likely extemely confusing portion of the bill, first, actually allows that a foreclosed borrower can sue the securitizer (Wall Street or those that turn mortgages into mortgage backed securities). This is of course unprecedented and would open up a pandora's box that none of the legislators could possibly manage and control, however the second portion of this piece of the law lays exception to the suits. Since those exceptions are also vague and undefined (for instance it says as long as Wall Street did its "due diligence"...keep in mind mortgage backed securities have markets in the billions so we can assume that no law is necessary for there to be "due diligence") and the stakes are so high, we can expect that with this portion of the bill, THE DEMOCRATS REALLY, REALLY, THINK YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET.

When the holder of a mortgage loan or anyone acting on behalf of the holder initiates a judicial or non-judicial foreclosure, (1) the consumer who has a rescission right under this bill may assert such right as a defense to foreclosure against the holder to forestall foreclosure, or (2) if the rescission right has expired, the consumer may seek actual damages (plus costs) against the creditor, assignee, or securitizer.

This portion of the bill could ACTUALLY be construed as motivating the borrower to get foreclosed because instead of punishing the borrower for not carrying out their end of the bargain (since a mortgage is a contract and a borrower agrees to make payments on time) the bill mostly lays out steps which the borrower can take action against their creditor. Since it goes without saying banks would never allow themselves to be sued by those they foreclose on, the practical effect of this portion of the bill is YOU REALLY, REALLY, REALLY, HAVEN'T SIGNED ENOUGH PAPERWORK YET.

Finally, there is this,

requiring pre-loan counseling.

We tried pre loan counseling here in Illinois. What it did was forced mostly poor folks to spend $300 extra dollars in closing costs (it was of course mandated that the broker pay but those costs are invariably then passed onto the consumer) to meet with a state sponsored counselor so some stranger can tell them if their loan is good for them. The practical effect was a significant drop in real estate sales, more bureacracy, and of course a handful of new disclosures specifically to address that portion.

Here is the bottom line. If I debated anyone, on either side of the aisle, about this bill they would be so embarrassed I could probably force them to resign. Most of the legislators are clueless about any part of my business. It is easy to pass legislation that only creates more paperwork if you never have to deal with any of it. By the time a loan is closed, it looks much like an edition of an encyclopedia. Those loans must be kept in storage since regulators can inspect any of them anytime. That means that a successful mortgage company has an overwhelming amount of paperwork to deal with. Again, it is easy for the legislators to constantly legislate more paperwork since they have no responsibility in managing it. I have no such luxury, and you the consumers don't either.

The only conclusion I can make is that clueless legislators from one party (the Democrats) have designed a bill that tackles a problem they don't understand or define. The only practical effect of this bill is YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET. Imagine any Republican running with that slogan. H.R. 3915 can become the symbol of the Democrat's entire domestic economic agenda if the Republicans want it to. Leaders like Barney Frank led in crafting it. Chris Dodd is leading the charge on the Senate side. The Republicans can add H.R. 3915 to their list of Democratic legislative failures. All they need to do is make a few commercials with this on the screen

THE DEMOCRATS THINK YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET.

This bill is the perfect test case to see just exactly how powerful the internet really is. While this bill may not be known by much of the mainstream, it is the equivalent of a rockstar on the internet. The blogosphere is abuzz with it and my own site's traffic has exploded with with people reading my work regarding it. The beauty is that on the internet, there is bipartisan opposition all over the internet. Whenever the crazies at Daily Kos find themselves on the same side of an issue as libertarians, small government conservatives, and of course mortgage professionals, you know you have a juicy opportunity. What needs to happen is for all the sides to get connected and to attack Congress at once.

The narrative is there for us to take. THE DEMOCRATS THINK YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET. The parties must meet and spread the message together. On the other hand, this bill has a populist message and good targets, however our side has the truth. The way for my vision to be realized is for all of the internet to relentlessly beat the message I am talking about,

THE DEMOCRATS THINK YOU HAVEN'T SIGNED ENOUGH PAPERWORK YET

This may sound self serving and egotistically but what if everyone knew about my article? What would they think of H.R. 3915 and the party that sponsored it? If I am wrong, please challenge me. The way for this to work is for everyone opposed to this bill to spread the message throughout the internet until the internet does what it is supposed to do, create a network. Once that happens this message goes from niche to mainstream and everyone behind this bill will have to answer why

THEY DON'T THINK YOU SIGN ENOUGH PAPERWORK YET

I can't say it enough.

Defining Predatory Lending

Justice Brennan once famously said this about pornography.

I shall not today attempt further to define the kinds of material I understand to be embraced . . . [b]ut I know it when I see it .

The Supreme Court has continued to this day to try and define what is free speech and what is obscene and pornography. While in the matter of pornography vague definitions may suffice, I have pointed out over and over that vague and undefined regulations always lead to disaster in mortgages. What it always leads to is more useless paperwork to sign. If you go to the previous link, you will see that it is all the paperwork already part of the process that leads to much of the fraud.

Enter the term predatory lending which is at the center of the new bill H.R. 3915. Here is what one Winston Salem paper said about predatory lending.

There is no specific definition about what exactly predatory lending entails, though most observers believe that the description applies when lenders take advantage of borrowers by charging high interest rates and consider only the value of a borrower’s assets, as opposed to what the borrower can afford to pay.

Keep in mind the full name of H.R. 3915 is the Mortgage Reform and Anti-Predatory Lending Act of 2007. In other words, the Congress is trying to legislate that which it can't even define. Look at what this paper describes it as. First, it says that it involves "high interest rates". That is of course in the eye of the beholder. How do we determine high? Is high the same for a borrower of a credit score of 800 as it is 500? Is it the same for an investment property as it is for a primary residence? No one knows because "high interest rates" is another dangerously vague term.

Look at the other part of the description. It is a loan that considers value and assets over their ability to pay. I once closed a loan for two borrowers in which their debt to income ratio was almost 100%. You read that right. Keep in mind that income is before taxes and I still was able to get them approved even though just the debts on their credit report amounted to their monthly mortgage. How did this happen? The wife was the breadwinner and she recently got laid off. That income wasn't allowed to be counted. Since they were actually well off, their credit score approached 800. They had about as much in liquid assets (checking, saving, investment, retirement plans, etc) as though owed. Also, they only owed about 200k on a property that was worth 450K. Was I doing predatory lending? By this description I was. This is despite the fact that in this case I was merely lowering their rate while paying for all their costs. In other words, all I did was lower their monthly payment from their previous one.

Yet, without a clear definition of predatory lending, this could be construed as "predatory lending". Even in the current bill there are all sorts of vague characteristics of predatory lending. For instance, there is net tangible benefit. I personally have no problem with net tangible benefit. I use that concept to sell. After all, I have to have a reason for the borrower to take the loan. To me that is their net tangible benefit.

Then, there is the anti steering portion of the bill. According to the bill, if I steer someone into a sub prime loan even though they are qualified for prime, that could be construed as predatory. The problem is that there are times in which sub prime loans are better for the borrower. For instance, Fannie Mae has several different levels. It has Expanded approval and that reaches three levels. By the time a borrower is only approved for Expanded Approval III, they are most likely better off going to sub prime. Yet, unless anti steering isn't better defined, this may also be construed as predatory.

There is more. Look at this portion of the bill.

engaging in abusive or unfair lending practices that promote disparities among consumers of equal credit worthiness but different race, ethnicity, gender, or age.

Abusive and unfair can mean just about anything and frankly any borrower can feel as though they were treated as such. By leaving the definition as this vague, it opens just about any behavior to "predatory".

This should scare everyone. Congress can't even define what they are trying to prevent. Then, they use vague and unclear language to describe it. If this bill gets passed in its current form, predatory lending will mean just about whatever anyone wants it to mean. If that is the case, it opens up the industry for all sorts of law suits. More than that, it opens the process up to all sorts of new paperwork to sign. In fact, the legislators think that more paperwork is the answer. Let's look at another part of the article from the Winston Salem paper.

We should have more disclosure about the loan terms that people are signing on to … a one-page summary that every borrower sees explaining everything,” he said.

That was said by Republican Patrick McHenry. Notice he never says what everything is. In his world, after getting everything out in over one hundred documents, we still need one more to summarize everything. This is the sort of nonsensical perspective that our legislators from both sides bring to this debate. All it will lead to is more vague language, more paperwork, and ultimately more confusion.

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.