A friend of mine emailed that working paper to me a few months ago and asked me what I thought of it. My answer was 'not much' - that it assumed a whole lot of things not in evidence, and didn't address the most interesting issues, like how big are the spillover effects when a loan does go bad.
Nonethelss, Tanta does set up a bit of a straw man counter here. Their data is through 2000, and the worst crud didn't start until after that. I think it's justifiable to call them on the fact that they have data estimated in one environment and are trying to apply it to a completely different environment, and I think Tanta is right on the mark when she notes that Goolsbee (Austen, not Austan) is cherry picking quotes from the CRL study. But innovation in the 90's might very well have helped consumers - it's just the gonzo overdrive innovation post 2000 that's nailed them.
And the description of permanent income - "the borrowers belief that he will always be able to earn more money in the future" is an overstatement. The theory is based on expectations, and for 90% of the people in 90% of the time periods, income does go up. It's a reasonable expectation - only when you treat it as a certainty do pesky little things like risk management tend to disappear.
Nonethelss, Tanta does set up a bit of a straw man counter here. Their data is through 2000, and the worst crud didn't start until after that. I think it's justifiable to call them on the fact that they have data estimated in one environment and are trying to apply it to a completely different environment, and I think Tanta is right on the mark when she notes that Goolsbee (Austen, not Austan) is cherry picking quotes from the CRL study
mort_fin, I'm not trying to make a serious analysis of what Gerardi et al. were up to; I quit reading that paper (60 pp) on about page two. Life is too short. I think my take on Goolsbee's use of that paper is fair. Gerardi et al. are hardly responsible for what Goolsbee uses them for (as CRL is not).
And the description of permanent income - "the borrowers belief that he will always be able to earn more money in the future" is an overstatement. The theory is based on expectations, and for 90% of the people in 90% of the time periods, income does go up.
You note that I did offer, in my title, to stop getting involved in economic theory in which I have no credentials.
That said, what does it mean that "income goes up"? Expenses don't? There's no such thing as inflation? Seriously, are you telling me that in 90% of cases people who overconsume in the present will not be overconsuming in the future? I'm honestly willing to be enlighted here by the Real Economists.
What i don't see in the discussion about future income expectations is the shift from fixed rate products to ARMs that at the very least negate any benefits of increased income. Ii'm also mystified at the use of 1970-2000 with the unprecendented period of declining inflation that would have masked any problem loans as refinancing into proressively lower interest rate products would have been able to cure so many. We've run out of one trick ponies.
Right, the contention is that sub-prime is a GOOD thing, so shutting it down would be a negative. The fact that it blew up because the lenders underestimated/ignored/buried the risk is presumed to be something entirely different.
What is left out of the argument is when something happens to the system. Is it capable of bearing a minor or major shock without crumbling, and the answer is now shown to be no. Just like you can build a building which holds up to normal use for cheaper if you ignore earthquake safety codes, you can create a market which runs OK most of the time. But when a shakeout occurs, the results are not pretty.
Robert, I'd say it's the shift from FRM to ARM at the very bottom of a long rate cycle that's the issue here. It's not like putting people into ARMs in the 80s was, when I for example took one, because they really appeared to have nowhere to go but down and they did. Like thousands of other people I had no desire to "buy" rate protection at 18%. The point is that people who passed up 30-year rate protection at 5.75% to take an ARM were placing an odd bet.
mort_fin, the differences in mortgage markets are so huge between 2000 and 2005 that any economist should know that we cannot use any historical analysis of one to analyze the expected performance of the other.
Also, it is not a matter of incomes going up, but the percentage by which the mortgage is expected to go up within 3 years. Incomes may rise for 90% of the people 90% of the time, but when the mortgages for 35% of the people are confidently expected to rise over 25% in several years, everyone originating those loans expected that they would be refinanced in large numbers or they would default. So the point is invalid. In fact, such a situation is well known and well analyzed - it's called "predatory lending".
Furthermore, the nonsense about the areas that are showing the highest foreclosure rates is chilling. Loans with dramatic short-term payment increases are always going to default in large numbers unless the borrower can sell out or refi. As soon as appreciation stops, the ability to avoid default stops. The timing of the appreciation halt will be different for different communities, but that doesn't mean that it won't be reached.
Goolsbee can't possibly be this stupid, so he must be disingenuous in the extreme. There can be no economist who is too mentally limited to grasp the factors at work here. A high DTI origination on a fixed mortgage can be justified, within reason, as allowing a borrower to get into the market. That is because the borrower's mortgage payment is expected to decline over time in relation to the borrower's income. A high DTI origination on an adjustable rate mortgage structured so that payments will increase substantially within a few years whether interest rates increase or not cannot be justified on rational grounds except that such lending is extremely profitable because you have a captive refi.
The other thing that entertains me about this is that there's no mention by Goolsbee (I don't know what Gerardi et al. say because I stopped reading) about the NASDAQ bubble. All those self-certified traders wisely using those margin accounts . . .
I was just about to say what MOM said. If costs are going up at 3% a year and incomes at 4% a year, it makes perfect sense to give a strapped first time home buyer a mortgage that starts 10% lower and will go up 3% or 4% a year for a few years to help with affordability (FHA's old GPMs and GEMs come to mind). If the 'affordability products' on offer in the last 5 years looked like that we wouldn't be so freaked out right now. But they don't.
And tanta is right again. I've seen several conference announcements that listed his name as Austen - but his website says Austan - and that's good enough for me.
i'm a little like you, tanta. life's too short to read the details unless something screams, "read it!" i wasn't drawn in by the headline, four paragraphs of set up, emotion-grabbing data, or snappy last sentence. therefore, i didn't "hear" the contention jack points out. what i did read was his topic sentence and conclusion:
topic:
"New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much."
conclusion:
"When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages."
the guy is a chicago economist. i would expect no less.
he called them 'some of the leading housing economists in the country????' I've never heard of two at the Boston Fed, and Harvey Rosen's published a few good housing articles over the last 30 years, but he's pretty much a generalist - some housing stuff, some tax stuff, etc. I wouldn't call him a 'housing economist.'
ap, the last sentence of the op-ed was one of those things that makes me glad I read the NYT indoors. Had I yelped like that out on the patio, the neighbors might have dialed 911.
Took words outa my mouth and then some Tanta -- Two items-first, more CRL data not mentioned by this subprime cheerleader (from my post in prior thread -but fits better here) - from NY Daily News story yesterday:
"Industry defenders say subprime loans have democratized credit and given millions of people an opportunity at home ownership.
But the nonprofit Center For Responsible Lending challenged that claim in a report it released yesterday.
From 1998 to 2006, subprime lending enabled 1.44 million people to become first-time homeowners - but it led to 2.37 million foreclosures, a net loss of nearly 1 million, the center reported."
Second, another rare kudos for same reporter, Juan Gonzalez of Daily News, for today's offering about how bad loans get pushed onto unwitting consumers -- and sounds like the lenders here worked very, very hard to unwit:
In addition to what MOM said: the positive feedback loop tacitly recognized by both parties (that caused house prices to escalate out of control).
The borrower's relied on house appreciation to help augment their incomes which didn't quite do the job. Lenders relied on borrowers to use house appreciation and a flexible mortgage to take advantage of this income stream. Highly respected banking officials, most notably Greenspan in 2003 when the market was showing signs of falling demand, recommended ARMs. This same person (along with Kennedy) later documents the equity withdrawal from homes and becomes nervous at the size of an alternative banking system and the "conundrum" of mortgage rates not responding to FF rates.
Goolsbee can't possibly be this stupid, so he must be disingenuous in the extreme.
I so totally agree. His op-ed had me grinding my teeth yesterday -- it's nice to see it receive the reception it truly deserves here. Thank you, Tanta. Thank you, MOM.
My .02: Innovation can be good (i.e. sometimes we learn things). It is, however, important to remember that ofthen things are the way they are for a reason. Especially in the realm of RE which has been traded, regulated and adjudicated for how man hundreds of years? If one can cover all the bases and do it quicker, then fine and dandy.
ap - you might want to look up some of the research of John Weicher - a Chicago economist from an earlier era. Weicher has pointed out in past articles that most people who don't have a down payment this year can have a down payment in a year or two, and it often makes sense to wait, save, and qualify for a better mortgage in the near future, and that most people, if denied credit on soft terms today, see their entry into homeownership delayed, but not denied.
Charlie Stromeyer - wow, Bert Ely is applying for a patent on an idea that's been around for years! Some cajones there. Copyright 1993 right there at the bottom of the abstract.
The purpose of this article is to propose and price a new type of adjustable-rate mortgage: the FIREARM ("Falling Interest Rate Adjustable-Rate Mortgage"). The interest payments on this mortgage adjust downward whenever interest rates decline, while remaining stable when interest rates increase. The FIREARM is alternatively priced as prepayable and non-prepayable mortgage with a spread over the short-term interest rate. We price these two instruments and contrast their prices with those of fixed-rate mortgages using the parsimonious assumptions of a non-stationary arbitrage-free binomial term structure model. Copyright 1993 by Kluwer Academic Publishers
"It's not like putting people into ARMs in the 80s was, when I for example took one, because they really appeared to have nowhere to go but down and they did. Like thousands of other people I had no desire to "buy" rate protection at 18%. The point is that people who passed up 30-year rate protection at 5.75% to take an ARM were placing an odd bet."
Bingo!
A great bet then, but a really, really lousy bet when rates are at "historic lows". What were people thinking???
Tanta, The other thing that entertains me about this is that there's no mention by Goolsbee (I don't know what Gerardi et al. say because I stopped reading) about the NASDAQ bubble. All those self-certified traders wisely using those margin accounts . . .
Oh no. Then you get to hear the crap about how houses are real and yield rents and can never become worthless, unlike dot bombs with no income no revenue, and no product.
That the NASDAQ 100 was made up of 100 companies with real products, revenue and profits, and that the companies are still around, at half the bubble valuations seven years later, is a well kept secret.
Goolsbee's points out that access to subprime loans has increased minority home ownership. This is not inconsistent with minorities, all else constant, receiving higher rates.
A high rate can be better than not receiving a loan at all.
Certainly less rate discrimination would improve access even more.
Goolsbee's points out that access to subprime loans has increased minority home ownership
And CRL points out that access to subprime loans has increased minority foreclosure rates.
The point CRL makes is that these people are getting high-cost subprime loans even when they have the same credit profiles as people who get lower-cost prime loans. Are you suggesting that that's OK just because they got a house the numbers suggest they won't be able to afford at subprime carrying costs?
In great brushstrokes, Mr Ely sketched the expensive and time-consuming rite of refinancing a fixed-rate mortgage. He showed that neither the mortgage interest rate stated in the mortgage nor the APR quoted to prospective buyers is the true interest rate. The true rate is the all-inclusive sum of the mortgage contractual interest rate plus the amortization of the mortgage upfront transaction costs over the actual life of the mortgage.
What does our innovative Mr. Ely think an APR is?
Wow. The longer you carry a mortgage, the cheaper the upfront costs are. That's an amazing insight. Next thing you know we'll find out that old-fashioned ARMs won't go up on you if investors don't demand higher yields.
A great bet then, but a really, really lousy bet when rates are at "historic lows". What were people thinking???
I posted this up on my site a few weeks back.. Seems to fit, so I'll repost it here.
I seem to be noticing an odd misconception that ARM loans were created with the borrower in mind. As an affordability tool perhaps?
ARMs were created by the lenders in order to protect the lender or holder of the loan from the risk of rising interest rates. By making a mortgage adjustable, the lender has essentially passed the interest rate risk directly to the borrower. The increase/differential in rates between a ARM and Fixed product of the same duration is the price the borrower pays for not having to bear the interest rate risk.
Im sure CF can do a much better job describing the dynamics behind this, and how the prices/value of these mortgages will rise and fall along with current rates.
I wouldnt call an ARM exotic as much as Id call it a general fleecing. Borrowers thought they were getting a deal by choosing an ARM, because the rates were lower. Borrowers didnt realize that the bankers were pushing an enormous risk into their lap. While a banker can hedge interest rate risks, do you really think a borrower is savvy enough to do the same?
Part of what's outrageous about all this is that we're supposed to take for granted that it's inherently good for people to own their residences, and that society should turn itself inside out to facilitate this.
People don't need to own their own homes. They need decent places to live.
Especially in view of the high transaction costs to sell one home and buy another, it fundamentally makes no sense for people to own homes unless their employment and family situation is quite stable. But it exactly for someone who expects their income to increase significantly in coming years that that is not likely to be so.
We hear a lot about, "Don't throw your money away on rent," and hardly at all about, "Don't throw your money away on realtor commissions and closing costs."
There's a hidden underlying assumption in the thinking of many people that home prices always rise faster than the rate of inflation so rapidly that such transaction costs will be less costly than paying a landlord a profit able rent to avoid them.
jb, I don't disagree with you at all if you're talking about most borrowers. I have argued for some time that the popularity of ARMs was a matter of lenders shifting rate risk onto borrowers, and that that's exactly what Greenspan was up to. He was telling lenders to abandon the delta hedge and adopt the sucker hedge. I assumed he was suggesting that long rates were headed upward. He just didn't share that insight with consumers.
But you always get one or more mortgage salespeople pipe up with the "ARMs can too benefit borrowers" thing, and I see no reason not to concede that yes, in a very specific situation, they can. I haven't seen that situation in a while. I remember the carnage in 1994-1995.
The problem, of course, is that transaction costs and house price risk didn't get factored in. So everybody did the "ARM is good because I'll only be in the house two years" thing. When people are thinking like that, how can you expect them to see the risks in an ARM, let alone "hedge" them?
Lenders underwriting loans based on how much money the mark, err, borrower, will make in the "future". Yeah that's real great.
"Dude. I swear I'll pay you back the $3000 loan when I get my tax refund check in April."
Yeah right. These lenders should watch some Judge Judy and see how this usually plays out. It often doesn't end well for the lender.
I like how the lenders will allow for the possibility of higher income in the future, actually even expect it, even depend on it, but changes that lead to a reduction of income (or even stasis - horrors!) are the "exception" and are the cause of their simple plans falling through the floor.
Since we're busy flagging issues in this editorial, how about this quote.
"And do not forget that the vast majority of even subprime borrowers have been making their payments. Indeed, fewer than 15 percent of borrowers in this most risky group have even been delinquent on a payment, much less defaulted."
He doesn't provide a source for that statement. I've never seen a data set that tracked borrowers and delinquency history. I've seen data sets that tracked MORTGAGES and delinquency history. And for some vintages you see cumulative delinquency rates get up around 15%. But there's an enormous difference between 'mortgage delinquencies don't go past 15% cum' and the statement 'borrowers don't go past 15% cum.' Subprime mortgages tend to refinance pretty fast - average life is around 2 or 3 years. Say someone takes out a mortgage in 2002, goes delinquent in 2003, refinances in 2004, and is still current at the end of 2006. A dataset that trackes mortgages will show 1 mortgage with a delinquency, and one without, for a delinquency rate of 50%. A dataset that tracked borrowers would show one borrower with a delinquency, for a delinquency rate of 100%. Either he has access to a dataset that I've never heard of, tracking borrowers and delinquency, or he's made a leap that you just can't make, going from mortgage delinquency to borrower delinquency.
I may live in an insulated environment up here in the N.E. - but different rates for different races? All other things being equal? I don't quite understand that. I've never met my lenders face to face, and I don't recall ever checking a "race" box on an app. They don't know from beans what race I am, nor have I ever felt they cared. My current lender-to-be (yes, I am RENTING) posts their rates on their website. Every day. Black and white. Yellow and red. Whatever. It's all right there.
About the mind-over-matter, buy-what-you-want-to-earn-10-years-from-now, well, in a way that has worked, at least the past 7 yrs. I grew up under the mantra -- never a borrower nor a lender be -- live within your means --frugality -- pay with cash -- fiscal conservatism, etc. etc. And I've always underbought - what do we really need? Oh, I've always slept well, but I haven't had cash oozing out of my floorboards like my more speculative relatives. They've made a mint off housing, I've just slowly and steadily crept. Looking back, if we had made the plunge to adverse risk, we probably, no, definitely, would have made out better. But I am not a gambler. If you couldn't already perceive that. (I'm also content with where I am)
So get with the program you guys. Throw off that bulky outdated fiscal prudence restrictive clothing and jump in the pool! Last one in is a rotten egg! And remember - it's not where you are NOW. It's where you WANT to be in the future... whoo hoo!
The economist-underwritten world shrugs off racial discrimination/profiling as an 'economic inefficiency'. Who gets held accountable for these social evils? A bunch of economists in ivory towers?
In a lender-underwritten world, we at least have someone to hold accountable.
If it can be proven that applicants with similar credit, income, and equity profiles are not provided 'equal access' to credit, then regulations, lawsuits and all that should go forward.
I may live in an insulated environment up here in the N.E. - but different rates for different races? All other things being equal? I don't quite understand that. I've never met my lenders face to face, and I don't recall ever checking a "race" box on an app. They don't know from beans what race I am, nor have I ever felt they cared. My current lender-to-be (yes, I am RENTING) posts their rates on their website. Every day. Black and white. Yellow and red. Whatever. It's all right there.
Outsider, I do suggest that you look at the entire CRL paper.
Regulators have known for years that there's a difference between discriminatory intent and what they call "disparate outcomes." The idea is that certain lending practices that may not be intended to be racially discriminatory can have an unfair impact on some groups. Another way of saying this is that historically disadvantaged communities can pay more than their fair share of the "risk management costs."
The fact is, I don't have to know what color you are if I have the address of the property you wish to buy or refi and my geocoding software tells me it's in a low-to-mod income or minority-majority community. Similarly, we've seen how FICO calculations can penalize people for simply having credit from "disreputable" creditors--rent to own, payday lenders--even if they make payments on time. That's what I meant when I suggested that the problem is "reputable" lenders exiting these markets, so there's no one left but loan sharks.
Is this really an argument on the cost of money? If interest rates are set artificially low to bail out a previous mistake by the FED why wouldn't there be repercussions?
"And CRL points out that access to subprime loans has increased minority foreclosure rates."
Again, this is not inconsistent with Goolsbee's point. Ownership can increase and become more risky at the same time. Access to subprime loans creates a trade-off between increased ownership and the riskiness of ownership. Reasonable minds can disagree on what the magnitude of the trade-off should be.
"The point CRL makes is that these people are getting high-cost subprime loans even when they have the same credit profiles as people who get lower-cost prime loans. Are you suggesting that that's OK just because they got a house the numbers suggest they won't be able to afford at subprime carrying costs?"
No. It is NOT OK. However, the "first best solution" (in econ speak) would be to crack down on discriminatory lending practices, not restrict access to subprime loans.
Tanta - you sort of get at the point at the end of your comment, but you should probably be more explicit. The main source of difference between minority mortgage rates and non-minority mortgage rates (for the same credit characteristic) is the use of different lenders, not different rates from the same lender. If a prime lender is charging 6%, and a subprime lender is charging 9%, and prime white borrowers go to the prime lender, and prime minority borrowers go to the subprime lender, then prime minority borrowers end up paying more than do prime white borrowers. But each lender is charging the same rate to everyone. That's why a regulatory answer to the issue isn't particularly easy.
You're right, mort_fin, I should have been more explicit.
The traditional regulatory answer has been the Community Reinvestment Act. CRA basically says to banks that if they accept deposits in a certain neighborhood, they must be willing to extend (prudent) credit there. You can't take low-to-mod income people's money and use it solely to lend to wealthier suburbanites.
Of course, CRA came from the lend-and-hold era. Now that banks have other sources of capital besides deposits to lend with, CRA has less impact. And a whole lot of lenders got around it by simply closing deposit-taking branches in low-to-mod areas. I've known some who pulled their ATMs to get out of CRA requirements. Hence, you see borrowers in these areas without entry-level credit accounts offered by depository lenders.
So, yes, we need a real good-faith overhaul of CRA. My breath is not being held, unfortunately.
Third, access to credit in lower-income communities is obviously much greater today than when the CRA was enacted. This greater access has had tangible benefits, such as the increase in homeownership rates (Joint Center for Housing Studies, 2006). However, recent problems in mortgage markets illustrate that an underlying assumption of the CRAthat more lending equals better outcomes for local communities may not always hold.12 Whether, and if so, how to try to differentiate good from bad lending in the CRA context is an issue that is likely to challenge us for some time. One possible strategy is to place more weight in CRA examinations on factors such as whether an institution provides services complementary to lendingfor example, counseling and financial education.
(emphasis added)
Rather than the "economist mortgage" type proposed by Tanta I would recommend the term "political mortgage" as a more comprehensive label for the next wave of, ummm, "innovation" in home finance.
In his 1987 book, Hard Heads Soft Hearts, Alan Blinder reformulated a couple well-known American sayings to apply to economics as follows: "Murphy's Law of Economics: Economists have the least influence on policy where they know the most and are most agreed..." and "O'Connor's Corollary: When conflicting economic advice is offered, only the worst will be taken."
There seems little reason to doubt these 'laws' will, once again, be confirmed. The impulse to make liabilities public while privatizing profit seems overwhelmingly powerful these days (before we even get into the "politics-of-division") but, really, what will we do when there is no public commons left to refi?
Thanks, jb, I'll take His Excellency's comments out on the patio; I know the risks.
The fact that increased mortgage lending didn't necessarily help these communities out does not surprise me much; my point remains that without banks doing entry-level credit--CCs, car loans, small installment/personal--that can create a class of "seasoned" prime customers, they'll always be overrepresented in the subprime mortgage market.
MaxedOutMama wrote: Furthermore, the nonsense about the areas that are showing the highest foreclosure rates is chilling....Goolsbee can't possibly be this stupid, so he must be disingenuous in the extreme. There can be no economist who is too mentally limited to grasp the factors at work here.
Exactly! Perfectly countered. Last week Hamilton wrote that exact thing as a real argument showing that there is no housing bubble. I think he is a joke of an economist if he can't correlate lack of appreciation and foreclosure rates. So the bubble zones have less foreclosure, duh!! That will change when appreciation doesn't save the next underwater borrower with a refi. Incredible ignorance.
Too many of these ivory tower eCONomist have lost all touch with common sense along with their lost touch of common man. And the Chicago school has sure pumped out a frightening number of them.
There's too many morons at the pulpits, I'm afraid.
So, if I want a plasma TV, I can get one now on the stated expectation I will be making more money next year? And the credit card companies, why don't they understand I will pay them when I make more. After all, I deserve it now, not when I can actually pay for it.
Austan is smarter than Tanta, and Tanta isn't doing much to show otherwise.
Goolsbee's point is that we shouldn't lose sight of the fact that innovations in credit scoring and the like that enabled a lot more liquidity in the mortgage market are by-and-large good things, and good for the poor, too. As Goolsbee rightly points out, the vast majority of subprime borrowers don't even default, much less go into foreclosure.
In the short run, of course, new innovations, especially financial innovations, can produce bubbles, mainly because they introduce new situations and many people aren't very good at abstraction and some people have to learn things the hard way. This goes for both lenders and borrowers.
There will be some pricking of the bubble and some lessons learned, but the benefits are real and here to stay.
My critique of Goolsbee here is that he should realize that regulation that does prevent some true predation could improve the situation and entrench the benefits of financial innovation.
But I do think Goolsbee's larger message is absolitely dead on: The dangers of overreaction are larger than the dangers of underreaction.
mort_fin, yeah I thought it was weird that Bert Ely is trying to patent the idea. He says "Several earlier attempts to offer automatic-rate-cut mortgages did not succeed because they were hard to fund.
The RM is different because it would be funded using Ratchet Pass-Thrus (RPTs) or Ratchet Bonds(RBs)."
So I assume his patent includes the funding proposal but I don't know how to use the uspto.gov website at the bottom of his presentation.
Goolsbee's point is that we shouldn't lose sight of the fact that innovations in credit scoring and the like that enabled a lot more liquidity in the mortgage market are by-and-large good things, and good for the poor, too.
No, really? You mean all those millions of serious economists and industry participants who have been given acres of op-ed space at the NYT to argue for years now that innovations are always and everywhere terrible are missing some key fact that only Goolsbee is wise enough to grasp?
And I'm setting up a strawman?
Strange how Goolsbee likes liquidity and credit scoring and such like but finds Gerardi et al.'s contention that the GSEs have done nothing for the poor folk to be credible. Odd. Only some innovations and liquidity are OK.
I'm perfectly happy to concede that Dr. Goolsbee--sorry, I[m not on a first-name basis with him--is smarter than I am. The world is full of people who are smarter than I am, and there's a whole bunch of them I wouldn't hire as a mortgage underwriter.
If you have anything newer and smarter than this, lay it on me:
From 1998 to 2006, subprime lending enabled 1.44 million people to become first-time homeowners - but it led to 2.37 million foreclosures, a net loss of nearly 1 million, the center reported."
Assertions that someone is "dead on" with arguments require some "dead on" data, dude.
His real mistake is to take credit constraints as exogenous.
The constraints (down payment, debt-to-income ratios) are there because a lender cannot distinguish between the borrower who really does have a steep income profile and the borrower who just thinks that he does.
When you relax these constraints without acknowledging these underlying information problems (like was done over the last five years), you end up lending to both types.
If the supply curve for housing was flat (so builder could make new houses immediately without increasing price), this would have just been a mess for people who thought too highly of their own future income prospects and those that lent to them.
However, since the supply curve is upward sloping (at least in the short run), we ended up with a big increase in the net demand for housing, with much higher prices.
Goolsbee most likely treats the credit constraints you mention as exogenous because he doesn't believe they are set optimally. If you believe these constraints are set optimally to achieve some separation between "bad" and "good" borrowers, then yes, allowing "bad" borrowers into the market can only be sustained through continual price appreciation. If, however, the constraints are not set optimally, then "good" borrowers might be pooled with "bad" borrowers and be shut out of the market. I think this is Goolsbee's point. Expanding access to credit will allow a new class of "good" and "bad" borrowers into the market. What remains to be seen is the proportion of "good" and "bad" new borrowers in the market. The main problem is that, as many have pointed out, Goolsbee looks at backwards looking data to support his claim that the ratio of good to bad borrowers is high. What will that ratio look like next year? in three years? And of course, will these ratios be "acceptable", which of course is a matter of preference.
"The constraints (down payment, debt-to-income ratios) are there because a lender cannot distinguish between the borrower who really does have a steep income profile and the borrower who just thinks that he does.
When you relax these constraints without acknowledging these underlying information problems (like was done over the last five years), you end up lending to both types."
And worse, bad money drives out good money: as increased demand drives up home prices, "sensible" borrowers drop out (or are overbid) by the most deluded, I mean, optimistic.
Hmmmm, I will put on my professional hat for a moment. One of the difficulties in using the Miller-Modigliani permanenet income hypothesis is that the intertemporal solutions can be upset by conditions that mask the true income growth expectations. Now in an environment where the growth in the money supply is 6% annually, and you can expect progressive taxation, counting on real increases in income starts to look fallacious.
I would love to see a paper regarding real income hypothesis versus inflation expectation anchoring, exploring intertemporal failure in the model through suboptimal choices.
Anybody game? Or is this possible intractable with the current models?
Of course I am betting on this failure in real life with the boomer retirement fiasco theory;-}
You see! Construct a random pattern of toad bones around the document or object in question, then sprinkle on some ground-up dog balls, have a few beers and wait. Anything and everyone, including "Dr." Goolsbee, makes perfect sense.
Well, Allenm, I'm nearly always game for something, but since I understood approximately 37.625% of what you just said, I think I should stick to the quarter slots. Now there's risk I understand.
ZWINKY? It's not one of those toys that walks itself down the stairs? Then it must be some new CDO tranche.
No mention of the time sensitive nature of "financial innovations" from Keith who's first insecurity is to down someone for not being as smart as somebody else...we are supposed to defer to his smartness in being able to adjudicate this...but we are way smarter than that.
How crummy does an innovation have to be to look successful in the early going of a boom? How spectacularly good does it have to be to survive the onslaught of a bust?
Similarly, Keith may look not so smart now, but just you wait and see...
If accurate inflation expectations are thrown into the mix, the young should borrow as much as they can service (Note this extremely important caveat), as inflation will bail them out, even if the explicit real return is slightly negative, as the nominal return will still be positive.
This argument only really applies to the stockholding class- note the caveats in the paper as used in real world data- *workers facing educational constrainst will face gains of only 1.5% real wage increases per year over their lifetimes...but in their case the ability to borrow with little margin will increase the numbers willing to take the risk, as the reward will still outweigh the costs. This is shown in the conclusions:
"We find in all cases that the imposition of the borrowing
constraint reduces the risk-free rate and increases the risk premium,
in some cases quite significantly. However, the standard
deviation of the security returns remains too low relative to the
data. On a qualitative basis, our results mirror effects in the
larger society: the decline in the premium documented in Blanchard
[1992] has been contemporaneous with a substantial increase
in individual indebtedness."
In other words if you offer young folks a flyer through low down payments, they will play the game of equity ownership, whereas if they have to raise capital the old fashioned way through savings they will be slow to enter the games.
Now throw that nasty inflation/fed reflation game on top of this and you have a great bubble recipe.
Tanta,
Does this help?
I play an economist at work too!
OK, it's Friday, I'm going there: Has anyone created a Zwinky yet? CR, did you ask for this ad to reward us for reading to the bottom of the haloscan page?
Allen, I think I understand that. For just being a mortgage punk.
Certainly, the traditional argument for, say, FHA credit guidelines was that it was acceptable to let young first time homebuyers take a fixed rate with little down and high (but technically servicable) DTIs since inflation was their friend and earnings were expected to follow predictable patterns on aggregate.
But they were never considered to be also bond-holders. As an empirical matter, don't they all fund their own retirement accounts with bond-heavy mutual funds these days? I understand that that's playing the game with income rather than borrowing; my point was simply that they are lenders as well as borrowers and have some interest in that risk premium, right?
In any case, the FHA model requires the "moderately priced property" since that's a program definition. What I'm curious about is how the intergenerational model changes when we talk specifically about owner-occupied real estate. The middle-aged consume at their higher rate by trading up; it appears that the retired are either "house rich" or are trading "down" (I can't figure that one out: the numbers I've seen on "downsizing" versus those expensive "adult communities" are puzzling). So if the young don't take the other side of the trade--say because of credit constraints--this passes the consumption contraint to the middle-aged. No? And if the young who are credit-constrained save up by buying Ginnie IIs . . .
I have no idea what you people are talking about. I see an ad for Cursors that has boobies on it. Being a straight chick who already has a cursor, I wasn't tempted.
I wasn't going to mention the babe with the boobies but, yes, you are absolutely correct. Cursormania. It replaced Zwinky. I'm definitely not clicking Cursormania because it is probably the first step on the road to pornography and Hell.
mp, a professor of mine once defined the difference between "sensuous" and "sensual" by pointing out that "sensual" ends in 'ell, and that's where you're going to go if you do it.
I'm sure that's perfectly irrelevant too, but what were talking about? Oh, yeah, the idea that some advertiser could get rich of the CR crowd . . . sure, that'll happen.
Tanta, I read your piece early this morning while my brain was still working. It is thought-provoking, as your stuff always is.
Unfortunately, I spent the day playing with my chain saw and a very old, tall, dead and un-cooperative walnut tree. I promise to keep my future musings on-topic.
And the description of permanent income - "the borrowers belief that he will always be able to earn more money in the future" is an overstatement.
Not only that, but GRW seem to be ignoring the screening problem in arguing from observed consumption to presumed ex ante expectations, at least if they want to say something about the optimality of credit markets.
As for data catching up to regimes, looks like PSID, which is biennial, is just beginning to catch up to us (Panel Study of Income Dynamics.
Tanta, sorry, but I missed the '60s and '70s completely. And most of the '80s. However, I've been listening to a lot of Prince (Freddie Mercury) lately. Wow! Very talented guy.
Have a great weekend, and don't blast out your neighbors!
"But the nonprofit Center For Responsible Lending challenged that claim in a report it released yesterday.
From 1998 to 2006, subprime lending enabled 1.44 million people to become first-time homeowners - but it led to 2.37 million foreclosures, a net loss of nearly 1 million, the center reported."
This study is flawed and not at all viewed as credible by any industry expert I am aware of...
"Goolsbee most likely treats the credit constraints you mention as exogenous because he doesn't believe they are set optimally. If you believe these constraints are set optimally to achieve some separation between "bad" and "good" borrowers, then yes, allowing "bad" borrowers into the market can only be sustained through continual price appreciation. If, however, the constraints are not set optimally, then "good" borrowers might be pooled with "bad" borrowers and be shut out of the market. I think this is Goolsbee's point. Expanding access to credit will allow a new class of "good" and "bad" borrowers into the market. What remains to be seen is the proportion of "good" and "bad" new borrowers in the market."
Some short points. (1) Goolsbee did not write the paper. It is his former colleague from Chicago -- Paul Willen -- who wrote the paper, and Goolsbee just wrote the op-ed. (2) I read the paper and the model assumes there are no information problems but does put constraints on borrowers. This is lazy. You really can't evaluate outcomes without explicitly modeling these problems. (3) I agree that relaxing constraints can improve outcomes, but you need to do it with sensible products: stated-income loans are not the way to go. In fact, a lender really needs to go with more income documentation if he (or she) wants to lend on the basis of current income.
AllenM - hopefully someone will take up the challenge of intertemporal portfolio allocation and real vs. nominal projections, but I wouldn't count on it from any of us - we're just mortgage hacks.
producer - you state that industry types don't regard the CRL study as credible. a) they would hold that opinion, wouldn't they? b) you don't state any reason for the lack of credibility. Since the study uses standard industry data (Loan Performance) and standard industry techniques (logit termination models) stating reasons for the lack of credibility might prove challenging.
produce - you state that default rates on subprime must be well under 50% or there wouldn't be a market in the stuff. Care to explain that? I certainly don't see why that would be the case.
abamitphd - the NBER study assumes a world of no externalities and constraints, and then relaxes the constraints, and finds that things are better. Didn't LeChatelier do that over 100 years ago, using X and Y instead of housing and mortgages . The whole reason the market is interesting is that there are all sorts of information externalities, principal agent problems, spillover effects from foreclosed properties on neighboring properties, etc. - all of which are conveniently assumed away before they get to their results. Hence my lack of enthusiasm for the work.
"produce - you state that default rates on subprime must be well under 50% or there wouldn't be a market in the stuff. Care to explain that? I certainly don't see why that would be the case."
First, You are in the mortgage biz right? You must know non prime paper is running at a 13 to 14% default rate currently.
Second, you have seen investor reaction to this spike in default rates?
It doesn't take a mortgage MBA to conclude if 50% of ypu assets loose money, you would not have a market.
I'm in the mortgage biz, but based on your last post I seriously wonder if you are. You are aware, I presume, that the 13% default rate that you're quoting refers to MORTGAGES CURRENTLY in default, not BORROWERS EVER in default? You do know that borrowers sometimes go delinquent, then cure, then go delinquent again, right? So that the number currently delinquent could be much smaller than the number ever delinquent? And you do know that there's this thing called refinancing, where a borrower trades in one mortgage for another, so that a borrower who was current on one of their mortgages might not have been current on the mortgage prior or the mortgage post, right? And you do know that only about 25% of notices of default foreclose (75% cure), don't you? So that you could have 50% of borrowrs getting NODs but only 12.5% generating losses (not 50%), or is this news to you? You do know that with collateralized lending losses are mitigated by recoveries from the sale of collateral, or at least I hope you do, if you're in the mortgage biz. With a recovery around 60%, that 12.5% foreclosure rate would get you losses of only 5%. You can work a mortgage spreadsheet to get there, I hope. And if you're in the mortgage biz (or any biz for that matter) you do know that participation is grounded in profit, and that to calculate a profit you need to know something about revenue, not just cost. Or is this all coming as an education to you? With a spread of 300 basis points, and a couple of points upfront, if the average mortgage lasts for more than a year (the average subprime lasts for almost 3 years) then mortgages with 5% losses would be profitable, wouldn't they? So why, exactly, would someone who purports to know the mortage biz claim that lenders wouldn't participate in a market with 50% of the borrowers defaulting? Could you share your logic with us?
The payday loan industry has been the prime target for corrupt politicians, from all sides, seeking an increase in voter support at the expense of whats best for their citizens. Governors of several states including, Georgia, North Carolina, and Oregon completely drove payday loan companies out of their states. The negative effects of driving out payday loan companies from these states, appears to have not been what was best for its citizens. For instance, in Georgia, the bankruptcy filings, bounced checks and foreclosures all skyrocketed after the cash advance product was done away with. In spite of these negative statistics, following the closure of payday loans in these states, several other governors continue to try and follow suit. Top national politicians, such as presidential hopeful Barack Obama, are now stepping into the arena in hopes of wiping the industry completely off the map. Should such efforts deem successful, the possibility is very real for increased unemployment rates, more debt, more foreclosures and an even more crippled economy.
all he's saying is to beware of the unintended negative consequences of trying to fix a problem few people truly understand.
A friend of mine emailed that working paper to me a few months ago and asked me what I thought of it. My answer was 'not much' - that it assumed a whole lot of things not in evidence, and didn't address the most interesting issues, like how big are the spillover effects when a loan does go bad.
Nonethelss, Tanta does set up a bit of a straw man counter here. Their data is through 2000, and the worst crud didn't start until after that. I think it's justifiable to call them on the fact that they have data estimated in one environment and are trying to apply it to a completely different environment, and I think Tanta is right on the mark when she notes that Goolsbee (Austen, not Austan) is cherry picking quotes from the CRL study. But innovation in the 90's might very well have helped consumers - it's just the gonzo overdrive innovation post 2000 that's nailed them.
And the description of permanent income - "the borrowers belief that he will always be able to earn more money in the future" is an overstatement. The theory is based on expectations, and for 90% of the people in 90% of the time periods, income does go up. It's a reasonable expectation - only when you treat it as a certainty do pesky little things like risk management tend to disappear.
I thought of adding "First!" Good thing I didn't.
If a company sells overpriced mortgages to people who shouldn't be able to get one for the amount???
Nonethelss, Tanta does set up a bit of a straw man counter here. Their data is through 2000, and the worst crud didn't start until after that. I think it's justifiable to call them on the fact that they have data estimated in one environment and are trying to apply it to a completely different environment, and I think Tanta is right on the mark when she notes that Goolsbee (Austen, not Austan) is cherry picking quotes from the CRL study
mort_fin, I'm not trying to make a serious analysis of what Gerardi et al. were up to; I quit reading that paper (60 pp) on about page two. Life is too short. I think my take on Goolsbee's use of that paper is fair. Gerardi et al. are hardly responsible for what Goolsbee uses them for (as CRL is not).
The NYT writes "Austan." Click the link.
And the description of permanent income - "the borrowers belief that he will always be able to earn more money in the future" is an overstatement. The theory is based on expectations, and for 90% of the people in 90% of the time periods, income does go up.
You note that I did offer, in my title, to stop getting involved in economic theory in which I have no credentials.
That said, what does it mean that "income goes up"? Expenses don't? There's no such thing as inflation? Seriously, are you telling me that in 90% of cases people who overconsume in the present will not be overconsuming in the future? I'm honestly willing to be enlighted here by the Real Economists.
all he's saying is to beware of the unintended negative consequences of trying to fix a problem few people truly understand.
How do you get that? It seems to me he's arguing that the consequences are neither negative nor unintended.
What i don't see in the discussion about future income expectations is the shift from fixed rate products to ARMs that at the very least negate any benefits of increased income. Ii'm also mystified at the use of 1970-2000 with the unprecendented period of declining inflation that would have masked any problem loans as refinancing into proressively lower interest rate products would have been able to cure so many. We've run out of one trick ponies.
Tanta,
Right, the contention is that sub-prime is a GOOD thing, so shutting it down would be a negative. The fact that it blew up because the lenders underestimated/ignored/buried the risk is presumed to be something entirely different.
What is left out of the argument is when something happens to the system. Is it capable of bearing a minor or major shock without crumbling, and the answer is now shown to be no. Just like you can build a building which holds up to normal use for cheaper if you ignore earthquake safety codes, you can create a market which runs OK most of the time. But when a shakeout occurs, the results are not pretty.
Robert, I'd say it's the shift from FRM to ARM at the very bottom of a long rate cycle that's the issue here. It's not like putting people into ARMs in the 80s was, when I for example took one, because they really appeared to have nowhere to go but down and they did. Like thousands of other people I had no desire to "buy" rate protection at 18%. The point is that people who passed up 30-year rate protection at 5.75% to take an ARM were placing an odd bet.
mort_fin, the differences in mortgage markets are so huge between 2000 and 2005 that any economist should know that we cannot use any historical analysis of one to analyze the expected performance of the other.
Also, it is not a matter of incomes going up, but the percentage by which the mortgage is expected to go up within 3 years. Incomes may rise for 90% of the people 90% of the time, but when the mortgages for 35% of the people are confidently expected to rise over 25% in several years, everyone originating those loans expected that they would be refinanced in large numbers or they would default. So the point is invalid. In fact, such a situation is well known and well analyzed - it's called "predatory lending".
Furthermore, the nonsense about the areas that are showing the highest foreclosure rates is chilling. Loans with dramatic short-term payment increases are always going to default in large numbers unless the borrower can sell out or refi. As soon as appreciation stops, the ability to avoid default stops. The timing of the appreciation halt will be different for different communities, but that doesn't mean that it won't be reached.
Goolsbee can't possibly be this stupid, so he must be disingenuous in the extreme. There can be no economist who is too mentally limited to grasp the factors at work here. A high DTI origination on a fixed mortgage can be justified, within reason, as allowing a borrower to get into the market. That is because the borrower's mortgage payment is expected to decline over time in relation to the borrower's income. A high DTI origination on an adjustable rate mortgage structured so that payments will increase substantially within a few years whether interest rates increase or not cannot be justified on rational grounds except that such lending is extremely profitable because you have a captive refi.
The other thing that entertains me about this is that there's no mention by Goolsbee (I don't know what Gerardi et al. say because I stopped reading) about the NASDAQ bubble. All those self-certified traders wisely using those margin accounts . . .
Well,
I was just about to say what MOM said. If costs are going up at 3% a year and incomes at 4% a year, it makes perfect sense to give a strapped first time home buyer a mortgage that starts 10% lower and will go up 3% or 4% a year for a few years to help with affordability (FHA's old GPMs and GEMs come to mind). If the 'affordability products' on offer in the last 5 years looked like that we wouldn't be so freaked out right now. But they don't.
And tanta is right again. I've seen several conference announcements that listed his name as Austen - but his website says Austan - and that's good enough for me.
i'm a little like you, tanta. life's too short to read the details unless something screams, "read it!" i wasn't drawn in by the headline, four paragraphs of set up, emotion-grabbing data, or snappy last sentence. therefore, i didn't "hear" the contention jack points out. what i did read was his topic sentence and conclusion:
topic:
"New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much."
conclusion:
"When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages."
the guy is a chicago economist. i would expect no less.
he called them 'some of the leading housing economists in the country????' I've never heard of two at the Boston Fed, and Harvey Rosen's published a few good housing articles over the last 30 years, but he's pretty much a generalist - some housing stuff, some tax stuff, etc. I wouldn't call him a 'housing economist.'
ap, the last sentence of the op-ed was one of those things that makes me glad I read the NYT indoors. Had I yelped like that out on the patio, the neighbors might have dialed 911.
Took words outa my mouth and then some Tanta -- Two items-first, more CRL data not mentioned by this subprime cheerleader (from my post in prior thread -but fits better here) - from NY Daily News story yesterday:
"Industry defenders say subprime loans have democratized credit and given millions of people an opportunity at home ownership.
But the nonprofit Center For Responsible Lending challenged that claim in a report it released yesterday.
From 1998 to 2006, subprime lending enabled 1.44 million people to become first-time homeowners - but it led to 2.37 million foreclosures, a net loss of nearly 1 million, the center reported."
Second, another rare kudos for same reporter, Juan Gonzalez of Daily News, for today's offering about how bad loans get pushed onto unwitting consumers -- and sounds like the lenders here worked very, very hard to unwit:
Single mom sucked in by home sellers
In addition to what MOM said: the positive feedback loop tacitly recognized by both parties (that caused house prices to escalate out of control).
The borrower's relied on house appreciation to help augment their incomes which didn't quite do the job. Lenders relied on borrowers to use house appreciation and a flexible mortgage to take advantage of this income stream. Highly respected banking officials, most notably Greenspan in 2003 when the market was showing signs of falling demand, recommended ARMs. This same person (along with Kennedy) later documents the equity withdrawal from homes and becomes nervous at the size of an alternative banking system and the "conundrum" of mortgage rates not responding to FF rates.
Goolsbee can't possibly be this stupid, so he must be disingenuous in the extreme.
I so totally agree. His op-ed had me grinding my teeth yesterday -- it's nice to see it receive the reception it truly deserves here. Thank you, Tanta. Thank you, MOM.
My .02: Innovation can be good (i.e. sometimes we learn things). It is, however, important to remember that ofthen things are the way they are for a reason. Especially in the realm of RE which has been traded, regulated and adjudicated for how man hundreds of years? If one can cover all the bases and do it quicker, then fine and dandy.
MOM - never underestimate the mental limitations of (REAL) economists.
I agree with Journeyman that innovation can be good. The best new mortgage financing idea I have come across is the concept of the ratchet mortgage:
Ely Rapporteur
ap - you might want to look up some of the research of John Weicher - a Chicago economist from an earlier era. Weicher has pointed out in past articles that most people who don't have a down payment this year can have a down payment in a year or two, and it often makes sense to wait, save, and qualify for a better mortgage in the near future, and that most people, if denied credit on soft terms today, see their entry into homeownership delayed, but not denied.
This paper will make good reading for a political undergrad class somewhere.
Charlie Stromeyer - wow, Bert Ely is applying for a patent on an idea that's been around for years! Some cajones there. Copyright 1993 right there at the bottom of the abstract.
The Pricing of FIREARMs ("Falling Interest Rate Adjustable-Rate Mortgages")
The purpose of this article is to propose and price a new type of adjustable-rate mortgage: the FIREARM ("Falling Interest Rate Adjustable-Rate Mortgage"). The interest payments on this mortgage adjust downward whenever interest rates decline, while remaining stable when interest rates increase. The FIREARM is alternatively priced as prepayable and non-prepayable mortgage with a spread over the short-term interest rate. We price these two instruments and contrast their prices with those of fixed-rate mortgages using the parsimonious assumptions of a non-stationary arbitrage-free binomial term structure model. Copyright 1993 by Kluwer Academic Publishers
"It's not like putting people into ARMs in the 80s was, when I for example took one, because they really appeared to have nowhere to go but down and they did. Like thousands of other people I had no desire to "buy" rate protection at 18%. The point is that people who passed up 30-year rate protection at 5.75% to take an ARM were placing an odd bet."
Bingo!
A great bet then, but a really, really lousy bet when rates are at "historic lows". What were people thinking???
Tanta,
The other thing that entertains me about this is that there's no mention by Goolsbee (I don't know what Gerardi et al. say because I stopped reading) about the NASDAQ bubble. All those self-certified traders wisely using those margin accounts . . .
Oh no. Then you get to hear the crap about how houses are real and yield rents and can never become worthless, unlike dot bombs with no income no revenue, and no product.
That the NASDAQ 100 was made up of 100 companies with real products, revenue and profits, and that the companies are still around, at half the bubble valuations seven years later, is a well kept secret.
Tanta,
Goolsbee's points out that access to subprime loans has increased minority home ownership. This is not inconsistent with minorities, all else constant, receiving higher rates.
A high rate can be better than not receiving a loan at all.
Certainly less rate discrimination would improve access even more.
Goolsbee's points out that access to subprime loans has increased minority home ownership
And CRL points out that access to subprime loans has increased minority foreclosure rates.
The point CRL makes is that these people are getting high-cost subprime loans even when they have the same credit profiles as people who get lower-cost prime loans. Are you suggesting that that's OK just because they got a house the numbers suggest they won't be able to afford at subprime carrying costs?
In great brushstrokes, Mr Ely sketched the expensive and time-consuming rite of refinancing a fixed-rate mortgage. He showed that neither the mortgage interest rate stated in the mortgage nor the APR quoted to prospective buyers is the true interest rate. The true rate is the all-inclusive sum of the mortgage contractual interest rate plus the amortization of the mortgage upfront transaction costs over the actual life of the mortgage.
What does our innovative Mr. Ely think an APR is?
Wow. The longer you carry a mortgage, the cheaper the upfront costs are. That's an amazing insight. Next thing you know we'll find out that old-fashioned ARMs won't go up on you if investors don't demand higher yields.
A great bet then, but a really, really lousy bet when rates are at "historic lows". What were people thinking???
I posted this up on my site a few weeks back.. Seems to fit, so I'll repost it here.
I seem to be noticing an odd misconception that ARM loans were created with the borrower in mind. As an affordability tool perhaps?
ARMs were created by the lenders in order to protect the lender or holder of the loan from the risk of rising interest rates. By making a mortgage adjustable, the lender has essentially passed the interest rate risk directly to the borrower. The increase/differential in rates between a ARM and Fixed product of the same duration is the price the borrower pays for not having to bear the interest rate risk.
Im sure CF can do a much better job describing the dynamics behind this, and how the prices/value of these mortgages will rise and fall along with current rates.
I wouldnt call an ARM exotic as much as Id call it a general fleecing. Borrowers thought they were getting a deal by choosing an ARM, because the rates were lower. Borrowers didnt realize that the bankers were pushing an enormous risk into their lap. While a banker can hedge interest rate risks, do you really think a borrower is savvy enough to do the same?
jb
Part of what's outrageous about all this is that we're supposed to take for granted that it's inherently good for people to own their residences, and that society should turn itself inside out to facilitate this.
People don't need to own their own homes. They need decent places to live.
Especially in view of the high transaction costs to sell one home and buy another, it fundamentally makes no sense for people to own homes unless their employment and family situation is quite stable. But it exactly for someone who expects their income to increase significantly in coming years that that is not likely to be so.
We hear a lot about, "Don't throw your money away on rent," and hardly at all about, "Don't throw your money away on realtor commissions and closing costs."
There's a hidden underlying assumption in the thinking of many people that home prices always rise faster than the rate of inflation so rapidly that such transaction costs will be less costly than paying a landlord a profit able rent to avoid them.
James Bednar, very well said, thanks
jb, I don't disagree with you at all if you're talking about most borrowers. I have argued for some time that the popularity of ARMs was a matter of lenders shifting rate risk onto borrowers, and that that's exactly what Greenspan was up to. He was telling lenders to abandon the delta hedge and adopt the sucker hedge. I assumed he was suggesting that long rates were headed upward. He just didn't share that insight with consumers.
But you always get one or more mortgage salespeople pipe up with the "ARMs can too benefit borrowers" thing, and I see no reason not to concede that yes, in a very specific situation, they can. I haven't seen that situation in a while. I remember the carnage in 1994-1995.
The problem, of course, is that transaction costs and house price risk didn't get factored in. So everybody did the "ARM is good because I'll only be in the house two years" thing. When people are thinking like that, how can you expect them to see the risks in an ARM, let alone "hedge" them?
Looks like I'm channeling jm again.
Hahahaha!
Lenders underwriting loans based on how much money the mark, err, borrower, will make in the "future". Yeah that's real great.
"Dude. I swear I'll pay you back the $3000 loan when I get my tax refund check in April."
Yeah right. These lenders should watch some Judge Judy and see how this usually plays out. It often doesn't end well for the lender.
I like how the lenders will allow for the possibility of higher income in the future, actually even expect it, even depend on it, but changes that lead to a reduction of income (or even stasis - horrors!) are the "exception" and are the cause of their simple plans falling through the floor.
Innovation works both ways.
Perhaps the increase in innovation in the mortgage business simply allowed more people to buy bigger inefficient houses earlier in thier lives.
How much did this stifle innovation by homebuilders to design/build affordable, efficient housing that can actualy be purchased en mass?
Since we're busy flagging issues in this editorial, how about this quote.
"And do not forget that the vast majority of even subprime borrowers have been making their payments. Indeed, fewer than 15 percent of borrowers in this most risky group have even been delinquent on a payment, much less defaulted."
He doesn't provide a source for that statement. I've never seen a data set that tracked borrowers and delinquency history. I've seen data sets that tracked MORTGAGES and delinquency history. And for some vintages you see cumulative delinquency rates get up around 15%. But there's an enormous difference between 'mortgage delinquencies don't go past 15% cum' and the statement 'borrowers don't go past 15% cum.' Subprime mortgages tend to refinance pretty fast - average life is around 2 or 3 years. Say someone takes out a mortgage in 2002, goes delinquent in 2003, refinances in 2004, and is still current at the end of 2006. A dataset that trackes mortgages will show 1 mortgage with a delinquency, and one without, for a delinquency rate of 50%. A dataset that tracked borrowers would show one borrower with a delinquency, for a delinquency rate of 100%. Either he has access to a dataset that I've never heard of, tracking borrowers and delinquency, or he's made a leap that you just can't make, going from mortgage delinquency to borrower delinquency.
I may live in an insulated environment up here in the N.E. - but different rates for different races? All other things being equal? I don't quite understand that. I've never met my lenders face to face, and I don't recall ever checking a "race" box on an app. They don't know from beans what race I am, nor have I ever felt they cared. My current lender-to-be (yes, I am RENTING) posts their rates on their website. Every day. Black and white. Yellow and red. Whatever. It's all right there.
About the mind-over-matter, buy-what-you-want-to-earn-10-years-from-now, well, in a way that has worked, at least the past 7 yrs. I grew up under the mantra -- never a borrower nor a lender be -- live within your means --frugality -- pay with cash -- fiscal conservatism, etc. etc. And I've always underbought - what do we really need? Oh, I've always slept well, but I haven't had cash oozing out of my floorboards like my more speculative relatives. They've made a mint off housing, I've just slowly and steadily crept. Looking back, if we had made the plunge to adverse risk, we probably, no, definitely, would have made out better. But I am not a gambler. If you couldn't already perceive that. (I'm also content with where I am)
So get with the program you guys. Throw off that bulky outdated fiscal prudence restrictive clothing and jump in the pool! Last one in is a rotten egg! And remember - it's not where you are NOW. It's where you WANT to be in the future... whoo hoo!
The economist-underwritten world shrugs off racial discrimination/profiling as an 'economic inefficiency'. Who gets held accountable for these social evils? A bunch of economists in ivory towers?
In a lender-underwritten world, we at least have someone to hold accountable.
If it can be proven that applicants with similar credit, income, and equity profiles are not provided 'equal access' to credit, then regulations, lawsuits and all that should go forward.
I may live in an insulated environment up here in the N.E. - but different rates for different races? All other things being equal? I don't quite understand that. I've never met my lenders face to face, and I don't recall ever checking a "race" box on an app. They don't know from beans what race I am, nor have I ever felt they cared. My current lender-to-be (yes, I am RENTING) posts their rates on their website. Every day. Black and white. Yellow and red. Whatever. It's all right there.
Outsider, I do suggest that you look at the entire CRL paper.
Regulators have known for years that there's a difference between discriminatory intent and what they call "disparate outcomes." The idea is that certain lending practices that may not be intended to be racially discriminatory can have an unfair impact on some groups. Another way of saying this is that historically disadvantaged communities can pay more than their fair share of the "risk management costs."
The fact is, I don't have to know what color you are if I have the address of the property you wish to buy or refi and my geocoding software tells me it's in a low-to-mod income or minority-majority community. Similarly, we've seen how FICO calculations can penalize people for simply having credit from "disreputable" creditors--rent to own, payday lenders--even if they make payments on time. That's what I meant when I suggested that the problem is "reputable" lenders exiting these markets, so there's no one left but loan sharks.
Is this really an argument on the cost of money? If interest rates are set artificially low to bail out a previous mistake by the FED why wouldn't there be repercussions?
"And CRL points out that access to subprime loans has increased minority foreclosure rates."
"The point CRL makes is that these people are getting high-cost subprime loans even when they have the same credit profiles as people who get lower-cost prime loans. Are you suggesting that that's OK just because they got a house the numbers suggest they won't be able to afford at subprime carrying costs?"
Tanta - you sort of get at the point at the end of your comment, but you should probably be more explicit. The main source of difference between minority mortgage rates and non-minority mortgage rates (for the same credit characteristic) is the use of different lenders, not different rates from the same lender. If a prime lender is charging 6%, and a subprime lender is charging 9%, and prime white borrowers go to the prime lender, and prime minority borrowers go to the subprime lender, then prime minority borrowers end up paying more than do prime white borrowers. But each lender is charging the same rate to everyone. That's why a regulatory answer to the issue isn't particularly easy.
You're right, mort_fin, I should have been more explicit.
The traditional regulatory answer has been the Community Reinvestment Act. CRA basically says to banks that if they accept deposits in a certain neighborhood, they must be willing to extend (prudent) credit there. You can't take low-to-mod income people's money and use it solely to lend to wealthier suburbanites.
Of course, CRA came from the lend-and-hold era. Now that banks have other sources of capital besides deposits to lend with, CRA has less impact. And a whole lot of lenders got around it by simply closing deposit-taking branches in low-to-mod areas. I've known some who pulled their ATMs to get out of CRA requirements. Hence, you see borrowers in these areas without entry-level credit accounts offered by depository lenders.
So, yes, we need a real good-faith overhaul of CRA. My breath is not being held, unfortunately.
Benny talked about the CRA today..
From the Fed:
The Community Reinvestment Act: Its Evolution and New Challenges
http://www.federalreserve.gov/boarddocs/speeches/2007/20070330/default.htm
This piece was most interesting..
Third, access to credit in lower-income communities is obviously much greater today than when the CRA was enacted. This greater access has had tangible benefits, such as the increase in homeownership rates (Joint Center for Housing Studies, 2006). However, recent problems in mortgage markets illustrate that an underlying assumption of the CRAthat more lending equals better outcomes for local communities may not always hold.12 Whether, and if so, how to try to differentiate good from bad lending in the CRA context is an issue that is likely to challenge us for some time. One possible strategy is to place more weight in CRA examinations on factors such as whether an institution provides services complementary to lendingfor example, counseling and financial education.
(emphasis added)
Rather than the "economist mortgage" type proposed by Tanta I would recommend the term "political mortgage" as a more comprehensive label for the next wave of, ummm, "innovation" in home finance.
Just as Laffer supplied the rationale and political foundation for Reagan-style (borrow and spend) economics so will articles such as Goolsbee's provide the rationale and political foundation for direct intervention in the mortgage markets by federal and state agencies alike; e.g., Ohio Plans Bonds to Bail Out Homeowners Strapped by Mortgages - Bloomberg.com and New Jersey Senator to Propose Plan Aiding Subprime Borrowers - Bloomberg.com
In his 1987 book, Hard Heads Soft Hearts, Alan Blinder reformulated a couple well-known American sayings to apply to economics as follows: "Murphy's Law of Economics: Economists have the least influence on policy where they know the most and are most agreed..." and "O'Connor's Corollary: When conflicting economic advice is offered, only the worst will be taken."
There seems little reason to doubt these 'laws' will, once again, be confirmed. The impulse to make liabilities public while privatizing profit seems overwhelmingly powerful these days (before we even get into the "politics-of-division") but, really, what will we do when there is no public commons left to refi?
Thanks, jb, I'll take His Excellency's comments out on the patio; I know the risks.
The fact that increased mortgage lending didn't necessarily help these communities out does not surprise me much; my point remains that without banks doing entry-level credit--CCs, car loans, small installment/personal--that can create a class of "seasoned" prime customers, they'll always be overrepresented in the subprime mortgage market.
MaxedOutMama wrote: Furthermore, the nonsense about the areas that are showing the highest foreclosure rates is chilling....Goolsbee can't possibly be this stupid, so he must be disingenuous in the extreme. There can be no economist who is too mentally limited to grasp the factors at work here.
Exactly! Perfectly countered. Last week Hamilton wrote that exact thing as a real argument showing that there is no housing bubble. I think he is a joke of an economist if he can't correlate lack of appreciation and foreclosure rates. So the bubble zones have less foreclosure, duh!! That will change when appreciation doesn't save the next underwater borrower with a refi. Incredible ignorance.
Too many of these ivory tower eCONomist have lost all touch with common sense along with their lost touch of common man. And the Chicago school has sure pumped out a frightening number of them.
There's too many morons at the pulpits, I'm afraid.
So, if I want a plasma TV, I can get one now on the stated expectation I will be making more money next year? And the credit card companies, why don't they understand I will pay them when I make more. After all, I deserve it now, not when I can actually pay for it.
Austan is smarter than Tanta, and Tanta isn't doing much to show otherwise.
Goolsbee's point is that we shouldn't lose sight of the fact that innovations in credit scoring and the like that enabled a lot more liquidity in the mortgage market are by-and-large good things, and good for the poor, too. As Goolsbee rightly points out, the vast majority of subprime borrowers don't even default, much less go into foreclosure.
In the short run, of course, new innovations, especially financial innovations, can produce bubbles, mainly because they introduce new situations and many people aren't very good at abstraction and some people have to learn things the hard way. This goes for both lenders and borrowers.
There will be some pricking of the bubble and some lessons learned, but the benefits are real and here to stay.
My critique of Goolsbee here is that he should realize that regulation that does prevent some true predation could improve the situation and entrench the benefits of financial innovation.
But I do think Goolsbee's larger message is absolitely dead on: The dangers of overreaction are larger than the dangers of underreaction.
Could be fleshed out more, but it's a nice way to clarify the chokepoints.
mort_fin, yeah I thought it was weird that Bert Ely is trying to patent the idea. He says "Several earlier attempts to offer automatic-rate-cut mortgages did not succeed because they were hard to fund.
The RM is different because it would be funded using Ratchet Pass-Thrus (RPTs) or Ratchet Bonds(RBs)."
So I assume his patent includes the funding proposal but I don't know how to use the uspto.gov website at the bottom of his presentation.
Goolsbee's point is that we shouldn't lose sight of the fact that innovations in credit scoring and the like that enabled a lot more liquidity in the mortgage market are by-and-large good things, and good for the poor, too.
No, really? You mean all those millions of serious economists and industry participants who have been given acres of op-ed space at the NYT to argue for years now that innovations are always and everywhere terrible are missing some key fact that only Goolsbee is wise enough to grasp?
And I'm setting up a strawman?
Strange how Goolsbee likes liquidity and credit scoring and such like but finds Gerardi et al.'s contention that the GSEs have done nothing for the poor folk to be credible. Odd. Only some innovations and liquidity are OK.
I'm perfectly happy to concede that Dr. Goolsbee--sorry, I[m not on a first-name basis with him--is smarter than I am. The world is full of people who are smarter than I am, and there's a whole bunch of them I wouldn't hire as a mortgage underwriter.
Keith, he's working with old data.
If you have anything newer and smarter than this, lay it on me:
From 1998 to 2006, subprime lending enabled 1.44 million people to become first-time homeowners - but it led to 2.37 million foreclosures, a net loss of nearly 1 million, the center reported."
Assertions that someone is "dead on" with arguments require some "dead on" data, dude.
His real mistake is to take credit constraints as exogenous.
The constraints (down payment, debt-to-income ratios) are there because a lender cannot distinguish between the borrower who really does have a steep income profile and the borrower who just thinks that he does.
When you relax these constraints without acknowledging these underlying information problems (like was done over the last five years), you end up lending to both types.
If the supply curve for housing was flat (so builder could make new houses immediately without increasing price), this would have just been a mess for people who thought too highly of their own future income prospects and those that lent to them.
However, since the supply curve is upward sloping (at least in the short run), we ended up with a big increase in the net demand for housing, with much higher prices.
"As Goolsbee rightly points out, the vast majority of subprime borrowers don't even default, much less go into foreclosure."
Keith - do you have evidence for this beyond Goolsbee's uncited assertion?
Abamitphd,
Goolsbee most likely treats the credit constraints you mention as exogenous because he doesn't believe they are set optimally. If you believe these constraints are set optimally to achieve some separation between "bad" and "good" borrowers, then yes, allowing "bad" borrowers into the market can only be sustained through continual price appreciation. If, however, the constraints are not set optimally, then "good" borrowers might be pooled with "bad" borrowers and be shut out of the market. I think this is Goolsbee's point. Expanding access to credit will allow a new class of "good" and "bad" borrowers into the market. What remains to be seen is the proportion of "good" and "bad" new borrowers in the market. The main problem is that, as many have pointed out, Goolsbee looks at backwards looking data to support his claim that the ratio of good to bad borrowers is high. What will that ratio look like next year? in three years? And of course, will these ratios be "acceptable", which of course is a matter of preference.
from abamitphd:
"The constraints (down payment, debt-to-income ratios) are there because a lender cannot distinguish between the borrower who really does have a steep income profile and the borrower who just thinks that he does.
When you relax these constraints without acknowledging these underlying information problems (like was done over the last five years), you end up lending to both types."
And worse, bad money drives out good money: as increased demand drives up home prices, "sensible" borrowers drop out (or are overbid) by the most deluded, I mean, optimistic.
Hmmmm, I will put on my professional hat for a moment. One of the difficulties in using the Miller-Modigliani permanenet income hypothesis is that the intertemporal solutions can be upset by conditions that mask the true income growth expectations. Now in an environment where the growth in the money supply is 6% annually, and you can expect progressive taxation, counting on real increases in income starts to look fallacious.
I would love to see a paper regarding real income hypothesis versus inflation expectation anchoring, exploring intertemporal failure in the model through suboptimal choices.
Anybody game? Or is this possible intractable with the current models?
Of course I am betting on this failure in real life with the boomer retirement fiasco theory;-}
You see! Construct a random pattern of toad bones around the document or object in question, then sprinkle on some ground-up dog balls, have a few beers and wait. Anything and everyone, including "Dr." Goolsbee, makes perfect sense.
What the hell is a ZWINKY?
Well, Allenm, I'm nearly always game for something, but since I understood approximately 37.625% of what you just said, I think I should stick to the quarter slots. Now there's risk I understand.
ZWINKY? It's not one of those toys that walks itself down the stairs? Then it must be some new CDO tranche.
No mention of the time sensitive nature of "financial innovations" from Keith who's first insecurity is to down someone for not being as smart as somebody else...we are supposed to defer to his smartness in being able to adjudicate this...but we are way smarter than that.
How crummy does an innovation have to be to look successful in the early going of a boom? How spectacularly good does it have to be to survive the onslaught of a bust?
Similarly, Keith may look not so smart now, but just you wait and see...
This paper helps explain some of what I am talking about- but the conclusions it reaches are wrong for the criticism I raised-
http://faculty.chicagogsb.edu/george.constantinides/documents/QJE_2002.pdf
If accurate inflation expectations are thrown into the mix, the young should borrow as much as they can service (Note this extremely important caveat), as inflation will bail them out, even if the explicit real return is slightly negative, as the nominal return will still be positive.
This argument only really applies to the stockholding class- note the caveats in the paper as used in real world data- *workers facing educational constrainst will face gains of only 1.5% real wage increases per year over their lifetimes...but in their case the ability to borrow with little margin will increase the numbers willing to take the risk, as the reward will still outweigh the costs. This is shown in the conclusions:
"We find in all cases that the imposition of the borrowing
constraint reduces the risk-free rate and increases the risk premium,
in some cases quite significantly. However, the standard
deviation of the security returns remains too low relative to the
data. On a qualitative basis, our results mirror effects in the
larger society: the decline in the premium documented in Blanchard
[1992] has been contemporaneous with a substantial increase
in individual indebtedness."
In other words if you offer young folks a flyer through low down payments, they will play the game of equity ownership, whereas if they have to raise capital the old fashioned way through savings they will be slow to enter the games.
Now throw that nasty inflation/fed reflation game on top of this and you have a great bubble recipe.
Tanta,
Does this help?
I play an economist at work too!
OK, it's Friday, I'm going there: Has anyone created a Zwinky yet? CR, did you ask for this ad to reward us for reading to the bottom of the haloscan page?
Alo, even though this is the CR blog, there are places where I fear to tread and buttons I fear to click.
I'm not the only one who's seen, witness Alo.
What the hell IS a Zwinky, anyway? Inquiring minds want to know. CR, is this some kind of plot by the National Association of Realtors?
Tanta, you're thinking of SLINKY, which is not a CDO tranche. Slinky works great, especially when the runner is removed from the stairway.
Allen, I think I understand that. For just being a mortgage punk.
Certainly, the traditional argument for, say, FHA credit guidelines was that it was acceptable to let young first time homebuyers take a fixed rate with little down and high (but technically servicable) DTIs since inflation was their friend and earnings were expected to follow predictable patterns on aggregate.
But they were never considered to be also bond-holders. As an empirical matter, don't they all fund their own retirement accounts with bond-heavy mutual funds these days? I understand that that's playing the game with income rather than borrowing; my point was simply that they are lenders as well as borrowers and have some interest in that risk premium, right?
In any case, the FHA model requires the "moderately priced property" since that's a program definition. What I'm curious about is how the intergenerational model changes when we talk specifically about owner-occupied real estate. The middle-aged consume at their higher rate by trading up; it appears that the retired are either "house rich" or are trading "down" (I can't figure that one out: the numbers I've seen on "downsizing" versus those expensive "adult communities" are puzzling). So if the young don't take the other side of the trade--say because of credit constraints--this passes the consumption contraint to the middle-aged. No? And if the young who are credit-constrained save up by buying Ginnie IIs . . .
I think I need a drink.
I have no idea what you people are talking about. I see an ad for Cursors that has boobies on it. Being a straight chick who already has a cursor, I wasn't tempted.
I wasn't going to mention the babe with the boobies but, yes, you are absolutely correct. Cursormania. It replaced Zwinky. I'm definitely not clicking Cursormania because it is probably the first step on the road to pornography and Hell.
mp, a professor of mine once defined the difference between "sensuous" and "sensual" by pointing out that "sensual" ends in 'ell, and that's where you're going to go if you do it.
I'm sure that's perfectly irrelevant too, but what were talking about? Oh, yeah, the idea that some advertiser could get rich of the CR crowd . . . sure, that'll happen.
Tanta, I read your piece early this morning while my brain was still working. It is thought-provoking, as your stuff always is.
Unfortunately, I spent the day playing with my chain saw and a very old, tall, dead and un-cooperative walnut tree. I promise to keep my future musings on-topic.
I promise to keep my future musings on-topic.
Why would you want to do that? It's Friday night, mp. If we can't wander off the serious stuff at this point, then hell with it.
I'm listening to '70s pop rock classics. Burn, baby, burn.
I promise to keep my future musings on-topic.
Why would you want to do that? It's Friday night, mp. If we can't wander off the serious stuff at this point, then hell with it.
I'm listening to '70s pop rock classics. Burn, baby, burn.
And the description of permanent income - "the borrowers belief that he will always be able to earn more money in the future" is an overstatement.
Not only that, but GRW seem to be ignoring the screening problem in arguing from observed consumption to presumed ex ante expectations, at least if they want to say something about the optimality of credit markets.
As for data catching up to regimes, looks like PSID, which is biennial, is just beginning to catch up to us (Panel Study of Income Dynamics.
Tanta, sorry, but I missed the '60s and '70s completely. And most of the '80s. However, I've been listening to a lot of Prince (Freddie Mercury) lately. Wow! Very talented guy.
Have a great weekend, and don't blast out your neighbors!
Sorry, brain melt. Queen.
"But the nonprofit Center For Responsible Lending challenged that claim in a report it released yesterday.
From 1998 to 2006, subprime lending enabled 1.44 million people to become first-time homeowners - but it led to 2.37 million foreclosures, a net loss of nearly 1 million, the center reported."
This study is flawed and not at all viewed as credible by any industry expert I am aware of...
"As Goolsbee rightly points out, the vast majority of subprime borrowers don't even default, much less go into foreclosure."
This is correct-- if it were not, there would not be non prime market makers...
"Goolsbee most likely treats the credit constraints you mention as exogenous because he doesn't believe they are set optimally. If you believe these constraints are set optimally to achieve some separation between "bad" and "good" borrowers, then yes, allowing "bad" borrowers into the market can only be sustained through continual price appreciation. If, however, the constraints are not set optimally, then "good" borrowers might be pooled with "bad" borrowers and be shut out of the market. I think this is Goolsbee's point. Expanding access to credit will allow a new class of "good" and "bad" borrowers into the market. What remains to be seen is the proportion of "good" and "bad" new borrowers in the market."
Some short points. (1) Goolsbee did not write the paper. It is his former colleague from Chicago -- Paul Willen -- who wrote the paper, and Goolsbee just wrote the op-ed. (2) I read the paper and the model assumes there are no information problems but does put constraints on borrowers. This is lazy. You really can't evaluate outcomes without explicitly modeling these problems. (3) I agree that relaxing constraints can improve outcomes, but you need to do it with sensible products: stated-income loans are not the way to go. In fact, a lender really needs to go with more income documentation if he (or she) wants to lend on the basis of current income.
make that last sentencte "future income"
AllenM - hopefully someone will take up the challenge of intertemporal portfolio allocation and real vs. nominal projections, but I wouldn't count on it from any of us - we're just mortgage hacks.
producer - you state that industry types don't regard the CRL study as credible. a) they would hold that opinion, wouldn't they? b) you don't state any reason for the lack of credibility. Since the study uses standard industry data (Loan Performance) and standard industry techniques (logit termination models) stating reasons for the lack of credibility might prove challenging.
produce - you state that default rates on subprime must be well under 50% or there wouldn't be a market in the stuff. Care to explain that? I certainly don't see why that would be the case.
abamitphd - the NBER study assumes a world of no externalities and constraints, and then relaxes the constraints, and finds that things are better. Didn't LeChatelier do that over 100 years ago, using X and Y instead of housing and mortgages . The whole reason the market is interesting is that there are all sorts of information externalities, principal agent problems, spillover effects from foreclosed properties on neighboring properties, etc. - all of which are conveniently assumed away before they get to their results. Hence my lack of enthusiasm for the work.
Cracks me up, producer, for straggling in at the tail end of the thread with a mighty "Nuh Uh!" to counteract CRL's data.
Thanks mort_fin and abamitphd -for steppin in, and mp for seeing what I see.
Behold the splendor of zwinky:
Zwinky Download
Thanks CR for a great post on this article. From the comments, I can see I wasn't the only one who was infuriated by it.
ZWInKY - Z-tranche Weighted Interest KablooeY security?
I hate it when halo does that.
ZWInKY - Z-tranche Weighted Interest KY security?
"produce - you state that default rates on subprime must be well under 50% or there wouldn't be a market in the stuff. Care to explain that? I certainly don't see why that would be the case."
First, You are in the mortgage biz right? You must know non prime paper is running at a 13 to 14% default rate currently.
Second, you have seen investor reaction to this spike in default rates?
It doesn't take a mortgage MBA to conclude if 50% of ypu assets loose money, you would not have a market.
producer
I'm in the mortgage biz, but based on your last post I seriously wonder if you are. You are aware, I presume, that the 13% default rate that you're quoting refers to MORTGAGES CURRENTLY in default, not BORROWERS EVER in default? You do know that borrowers sometimes go delinquent, then cure, then go delinquent again, right? So that the number currently delinquent could be much smaller than the number ever delinquent? And you do know that there's this thing called refinancing, where a borrower trades in one mortgage for another, so that a borrower who was current on one of their mortgages might not have been current on the mortgage prior or the mortgage post, right? And you do know that only about 25% of notices of default foreclose (75% cure), don't you? So that you could have 50% of borrowrs getting NODs but only 12.5% generating losses (not 50%), or is this news to you? You do know that with collateralized lending losses are mitigated by recoveries from the sale of collateral, or at least I hope you do, if you're in the mortgage biz. With a recovery around 60%, that 12.5% foreclosure rate would get you losses of only 5%. You can work a mortgage spreadsheet to get there, I hope. And if you're in the mortgage biz (or any biz for that matter) you do know that participation is grounded in profit, and that to calculate a profit you need to know something about revenue, not just cost. Or is this all coming as an education to you? With a spread of 300 basis points, and a couple of points upfront, if the average mortgage lasts for more than a year (the average subprime lasts for almost 3 years) then mortgages with 5% losses would be profitable, wouldn't they? So why, exactly, would someone who purports to know the mortage biz claim that lenders wouldn't participate in a market with 50% of the borrowers defaulting? Could you share your logic with us?
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God, I so hate numbskulls that come into a dead thread and post spam that contradicts everything in the post.
There is a special place in hell for you dumbass!