Agencies Seek Comment on Subprime Mortgage Lending Statement
Submitted by
CalculatedRisk on Fri, 03/02/2007 - 9:51am (34 comments)
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I can't wait to read the comments. I fully expect the words "American dream" to appear at least 300 times.
jb
CR - an analtyic question. Why have the regulatory agencies waited until now to raise standards and tighten credit ? Looking the graphs of rates, sub-primes, housing prices, etc. etc. it was clear that (another) speculative bubble was underway in '05. Perhaps that's pure retrospect and therefore moot.
But it seems to me that, while necessary, many of the horses are already out of the barn. Perhaps this is to prevent the infected rates from escaping as well ? Clearly the industry was not going to be self-regulating. As you and Our Goddess point out as long as the funds were readily available they'd sell 'em on bad paper.
Any comments or observations ?
DaveL-
The Bush administration and the GOP in general, are openly and aggressively hostile to regulation of any stripe.
We had six years of a GOP controlled Congress and executive branch.
We need to hold the Democrats feet to the fire (especially the DLC crowd) to make sure they're not bought off by some of the same interests.
A ton of money was made on all this bad paper, and that is the explanation for it all right there.
DaveL, I've been disappointed at the slow pace of regulation. We are still waiting for the CSBS guidance to be adopted by all 50 states (especially California, Nevada and Florida).
I thought lending standards were too loose a few years ago (like when DAPs first appeared).
All; I'm going to copy a few comments from the previous thread to this thread.
Best to all.
From MaxedOutMama (from previous thread):
Tanta, what did you think of it? I read it as a face-saving exercise, particularly with reference to the following questions upon which the public is invited to comment:
"1. The proposed qualification standards are likely to result in fewer borrowers qualifying for the type of subprime loans addressed in this Statement, with no guarantee that such borrowers will qualify for alternative loans in the same amount. Do such loans always present inappropriate risks to lenders or borrowers that should be discouraged, or alternatively, when and under what circumstances are they appropriate?
Calc,
Believe it or not, California put in the bill to have the guidance adopted (as a regulation I believe) it is SB 385 or some such. But the pace is extremely disapointing.
I would recommend that everyone email the FDIC and urge speedy adoption pointing to how slow the last guidance is being adopted (the length of time from submission to adoption).
Email a comment, it makes a difference.
From Tanta (previous thread):
MOM, I printed the damned thing and took it out onto the patio with a pencil. (It's that warm here in DC today.) So I sure startled a flock of geese when I started yelling "Haloscanned! You jokers are HALOED!"
They want comments, by cracky, there're gonna get comments. I suggest we start working out a process whereby the CR Irregulars who want to participate in this can start sharing ideas with each other.
We could start with the idea that they're actually, apparently, worried that any new guidance would impact a lender's ability to refi a current subprime customer out of a toxic loan. Well, you dumbasses, put something in the guidance that says that the one acceptable "extenuating circumstance" for not qualifying a borrower at fully-indexed fully-amortized fully-documented is that the borrower is currently in a toxic loan (as defined in the guidance), and so as long as the lender can prove that 1) there is still a commitment to homeownership on the borrower's part and 2) the new loan is a clear improvement to the borrower's ability to repay and 3) nobody took this as an opportunity just to extract more fees, it's acceptable. WHY IS THIS SO HARD?
And, yes, I can think of ways one could document "continued commitment to homeownership." Show a credit report that proves that the borrower is not in trouble because of consumer-debt loading after the original loan closure. Show a payment history where the borrower wasn't in trouble until the rate increases came into play. Show evidence that the borrower was current on the mortgage before the mortgage being refinanced--i.e., show that you had a perfectly good homeowner who got refi'd into a toxic loan, not a marginal homeowner wannabee who shouldn't have purchased. All this kind of stuff is easy to demonstrate.
But noooo, they're worried about making the guidance too firm because it might prevent someone from taking a borrower out of an exploding ARM. So they're willing to risk continuing to originate junk in order to prevent anyone from making some limited amounts of lemonade. ACK.
Tanta
These new guide lines have nothing to do with helping the RE borrower subprime or not. Rather it is the beginning of a series of attempts to save the banks, MBS bonds and related financial instruments used within the lending industry. The 800lb gorilla in the room is the booked value of RE based on the 2001-2006 boom cycle.
this comment by Kash yesterday reflects the national nature of this housing cycle:
"One slightly worrying aspect to me about this most recent data is that the fall in appreciation rates (or the move toward real price declines in several cities) is that it is now starting to look like it is not limited to those regions that enjoyed a big house price appreciation episode during 2002-2005. Many interior metro areas in the US missed out on the big house price boom, but are still suffering from a decline in their very modest appreciation rates, as the following picture shows."
The real question is how to protect the national banking and related financial services sector from a possible major drop in RE assest price declines that is currently in progress and may actually go on for a long period of time.
Well, without stating the obvious about barns and horses and such, how many of us actually wanted the regulation in place ASAP simply to get this crash going already? Isn't the current implosion doing exactly what we had thought we'd have to wait for reg's to do? I for one thought that sanity would never return and that we could actually fly this debt kite forever and all this time bloggin would have been for naught.
I frankly am no longer waiting for the "guidlines" with baited breathe as the life-long smoker/patient is already on life support and a bigger font on the surgeoun general warning is too late to do any good. Nature has finally stepped in.
CR
DAPs? Down payment Assistance Providers? If that's who you mean, have you noticed that a) IRS said in May that they would do something, and still hasn't b) on National Mortgage News - mortgage industry news | mortgage information | commercial real estate there is still a headline saying that HUD (Finally) has a rulemaking in progress on them and c) also on nationalmortgagenews, that HUD has abandoned the zero down payment legislation (apparently preferring a 1% down payment provision )?
Just for the record, the initiative to increase home ownership (read loosening lending standards) began under the Clinton administration. Barney Frank, about as liberal a Democrat as you will find, is one of the top defenders of Fannie and Freddie's loan portfolios.
I say this as an avowed Bush basher living in one of the fiercest Bush-bashing enclaves in the great Commonwealth of Massachusetts, and as a card carrying member of the ACLU (OK, the card's expired....)
OK, preview isn't working, so forgive me for what is about to happen with the following long comment.
On page seven, under the definition of predatory lending, you find:
Making mortgage loans based predominantly on the foreclosure or liquidation value of a borrowers collateral rather than on the borrowers ability to repay the mortgage according to its terms.
Now, theyve been using this kind of language for years; its not like this is new to this document. The problem is that, for years, some of us have wanted them to go on to the next logical step, which is to explain just how a loan can be based on the borrowers ability to repay if it doesnt include verification of income and assets. What we have found over the years here, you know, is that lenders have come to think that they can just verify the borrowers willingness to repay, which is what a FICO score and a down payment proxy, but not the ability to repay out of either income or assets. So they keep using that word ability, and then they keep going on as follows:
Risk-layering features in a subprime mortgage loan may significantly increase the risks to both the institution and the borrower. Therefore, an institution should have clear policies governing the use of risk-layering features, such as reduced documentation loans . . . an institution should demonstrate the existence of effective mitigating factors that support the underwriting decision and the borrowers repayment capacity.
OK, so which is it? Is the absence of documentation of ability to repay mitigated by the appraised value and the FICO score? How is that, exactly, different from making a loan based on collateral value?
Continued:
The higher a loans risk, either from loan features or borrower characteristics, the more important it is to verify the borrowers income, assets, and liabilities. When underwriting higher risk loans, stated income and reduced documentation should be accepted only if there are mitigating factors that clearly minimize the need for direct verification of repayment capacity. For many borrowers, institutions should be able to readily document income using recent W-2 statements, pay stubs or tax returns. A higher interest rate is not considered an acceptable mitigating factor.
I put that last sentence in bold because it is the only outright statement of something you could call an actual rule in this document. But notice how theyre still waffling about the issue of collecting those W-2s, pay stubs, and tax returns. Look, any underwriter worth her salt will tell you that there are, in fact, good credit risk borrowers out there whose income cannot be easily read off one of those documents. The classic self-employed borrower with odd cash-flow patterns comes to mind. But theres just a world of difference between telling a bank it can, if it finds mitigating factors, override the numbers on the documents, and telling the institution that it can get away with not asking to see them. The whole stated income thing gets to be a problem because the industry decided there were only two choices: use the numbers on the tax returnseven if they dont make much sense as a measure of GMI, and resulted in terrible-looking DTIsor just let the borrower make things up.
There are two very, very important issues underlying this false dichotomy. One, weve seen in action lately, and you can call it the rep and warranty problem. If I see your tax returns, but approve you anyway because I did an operating income analysis, looked at the value of your assets, and decided that you should get a loan even though technically your DTI calculates too high, then it is the quality of my underwriting decision that is at stake here. If, however, I tell the LO to throw those tax returns away and resubmit the file as stated, then I still get to make the loan, but if it turns out to be a bad idea after all, I can claim to have been defrauded by the borrower. It remains a major mystery why the regulators havent caught on to this yet.
continued:
mort_fin, when I first saw the Down Payment Assistance Programs, I knew we had a more serious problem than I had originally thought. and yes, I saw that the IRS called DAPs a "scam" last year ... I thought that was the end of those programs.
DAPs were a very small part of the lending problem, but they appeared to be outright fraud. I'm sure there was plenty of fraud in other lending programs too.
Best Wishes.
Two, there is actually some research out there on the question of lender-chosen versus borrower-chosen documentation reductions. Moodys, for instance, has found that programs in which the lender expects documentation from all borrowers, but, after analysis of the application, credit report/FICO, and any other supporting documentation, may waive the income or asset documentation requirement for higher-quality borrowers, perform much better than programs in which the borrower can withhold documentation from the lender and get qualified on a presumption of reduced documentation. Fannie Mae and Freddie Mac, for instance, do this with their automated underwriting systems: the originator enters the application data into the system, which automatically provides itself with a credit report and (usually) data about the property and plausibility of the sales price/appraised value (an internal AVM). It then evaluates the loan, and if it likes what it sees enough, it may report back to the originator that, say, the loan can be counted as full doc with just the last pay stub (no W-2s for the last two years), or with just one bank statement showing enough funds to close (instead of three months worth of bank statements showing funds to close plus reserves). The point here is that the borrower doesnt get to walk in the door and say, I want one of those loans where I dont have to give you my W-2 or my bank statements. That latter thing would be the borrower-chosen approach, and those are the ones that perform really poorly. Of course, a lender-chosen program will also perform really poorly if the underwriting analysis gives too much weight to DTI or down payment in the initial analysis. (That is, if youre hanging your hat on DTI, its not wise to waive the documentation of the income. If youre hanging your hat on down payment, its not wise to waive the documentation of the source of those funds. You have to do a demonstrated holistic approach in order to do a lender-chosen program correctly.)
I honestly cant see any reason why the regulators wouldnt at the very minimum require that institutions making reduced doc subprime loans handle this the way the GSEs do, namely only as lender-chosen, not as borrower-chosen, programs which require documentation for most borrowers and waive documents only after a holistic review. But they dont even raise the issue in the guidance. Whats with that?
done
We are alone no longer, the oracle of Omaha has spoken!
"Warren Buffett, chairman of Berkshire Hathaway, told shareholders in his annual letter that the slowdown in residential real-estate markets partly stems from weakened lending practices in recent years." (Mkt.Watch)
Listen up FED et al, the way to resolve the housing mess we face is to clean house, NOT double up!
"CR irregulars" you say? How dare you? I vehemently resemble that remark!
The Agencies recognize that the structural evolution of subprime mortgage lending in recent years has introduced some products that are intended at their outset to be temporary credit accommodations in anticipation of early sale or refinancing, rather than longer-term amortizing accounts. Such loans typically involve terms that exceed the borrowers ability to service the debt without refinancing or selling the property. The motivations for these arrangements vary. They may include financing in anticipation of the borrowers intended temporary residency, expected future earnings growth, or need for a period of credit repair.
First, would somebody explain that thing about "anticipation of the borrower's intended temporary residence" to me? Are they really taking seriously the idea that people get put into 2/28s because they 'splained to the lender that they really only intend to live in this house for two years anyway, so . . .? That's my Fed, refusing to have an opinion on the idea that it makes sense for borrowers to underwrite their own loans.
But about that "credit repair" thing. We hear that one a lot: these noble subprime lenders are just giving these borrowers a chance to "repair their records," so the 2/28 makes sense, because they can repair in 2 years and refi to avoid that reset.
Fannie Mae has had a product out for some time called "Timely Payment Rewards" for poor-credit borrowers. The interesting thing about this product is that it has a built-in feature: if you make 24 consecutive on-time payments, you get a modification to a lower rate. In other words, this product doesn't just "motivate" the borrower; it obligates the lender to use the carrot instead of the stick if the borrower makes like a nice donkey.
So I'm back to wondering how our fearless regulators don't seem to have an idea in their head when it comes to ways to structure subprime products to allow "credit repair" without putting the borrower at undue risk. How about requiring the lenders using the "credit repair" argument to make such loans only with a commitment to modify the rate if the borrower does indeed repair themselves in two years? Don't tell me Wall Street can't make up a security structure that can accommodate such loans, because that's nonsense. Fannie Mae is doing it today.
http://www.efanniemae.com/sf/mortgageproducts/pdf/mpeatprconsumer.pdf
I never want to see the word "done" just above Tanta's name again.
Perhaps an addendum of "for now" would prevent repetative and panic filled page refreshing.
Tanta,
Is there anything in there that raises the issue of whether FICO scores are an adequate metric of the borrower's ability to pay? I'm not an expert on FICOs, but from what I've read their failing as a mortgage risk metric is that they don't put enough weight on the total debt load of the borrower, and they seem to be much more of a backward looking than prospective metric. Seems to me they worked pretty well for revolving credit, but they probably need some tweaking to produce better results for mortgages.
No, Brian, there isn't anything on FICOs. I theorize that this is because a pattern is emerging the more time I spend looking at this document, which is that the DAMNED REGULATORS don't seem ever to have engaged with any actual research or alternative industry practices. It reads like a review of erotic literature by a bunch of 12-year old virgins. Except, of course, it isn't that amusing. Consider this, page 11:
Should the principles of this proposed Statement be applied beyond the supbrime ARM market?
No, of course not. We don't want to see anybody preventing abusive loan terms for prime customers. That's fair, because prime customers have a running start, and it's therefore funny when the lender manages to hunt them down like dogs. We only want the guidelines to apply to the technically speaking old, sick, and poor, because you don't get enough points for running over people with handicaps.
Bang goes the head on the desk.
A side comment on why the auditors might be having trouble coming up with a value on some of the loans on say, Fremont's books (St. Pete Times story on the travails of developer John Loder):
"The banks seek to recover nearly $90-million in mortgages for Seaside Villas, the 198-unit Shore Club Pasadena and the 272-unit Snell Isle Club in St. Petersburg, all of which were being converted from apartments to condos....
And according to lawsuits filed by Wachovia Investment Holdings LLC and Fremont Investment & Loan - a Brea, Calif., bank that funded the Gulfport and South Pasadena projects - the developers didn't simply miss a few mortgage payments.
Fremont alleged that its loans went into default when Loder and his partners failed to pay subcontractors, property taxes, utility bills and certain insurance premiums. The partnership also missed promised completion dates and minimum sales targets. On-site sales offices and model condos were shuttered.
The evidence of neglect was visible at times. Earlier this month, Fremont alleged, the South Pasadena property was beset by trespassers, exposed wiring, broken windows, asbestos warnings, open or missing doors, dangerous balconies, and dozens of washer-dryers left sitting in a parking lot. "The project is in an abandoned state," Fremont wrote.
Infighting has been a problem. Loder and former partner Steven Gianfilippo, who was a guarantor of the Gulfport and South Pasadena loans, are in litigation. A Sarasota investor reportedly fought with Loder over control of the Gulfport project, according to a Fremont lawsuit. Stanford Solomon, the St. Petersburg lawyer who represented Loder and his partnerships in all of these cases, sought to withdraw as counsel last week, citing "irreconcilable differences."
Aviram, whose ANB Enterprises pursued six separate deals with the partnerships in 2005, has been battling them in court ever since. Both parties blame the other for scuttling a $65-million mobile-home park acquisition on which each lost a $1.5-million deposit."
So this is a lick your finger, stick it in the air and come up with a number kind of valuation exercise. I'm guessing there are plenty of these in the FMT portfolio.
And for a little comic relief, here's the last paragraph of the story - you can't make this stuff up!
"Despite the apparent financial squeeze, another company led by Loder has recently purchased several luxury cars. Over the past 18 months, Lay Z Girl LLC - a company for which Loder is listed as managing member - acquired a Bentley, Hummer, Lexus and Range Rover, according to public records."
Wanna bet Loder has a FICO score over 700?
Business: Developer faces cash crisis
New thread
when will this go into effect, or is it implied that they follow them now?
Vegas, it would go into effect at some point after the close of the comment period, the internal scuffling over the comments, and the drafting of a final version. If it's like the Nontraditional Mortgage Guidelines, assume at least six months.
So, the sub-prime lending industry is falling to pieces. Its about time. Because what that group of charlatans brought to the party was a disgraceful bunch of predators and hacks the likes of which care only about lining their own pockets. The worst offenders were the biggest players the guys who started the whole thing.
While I am not going to focus on management at sub-prime companies I will say that if upper management at any company is operating with high ethical standards and projecting that philosophy downward amongst the ranks, then the ranks will follow. Unfortunately that was not the case with Sup-Prime lenders. But well leave that for another post. What I am going to talk about is the lowly loan officer and his or her employing broker. These were the people who did the most damage at the consumer level. I do need to remind everyone though that the majority of mortgage brokers are upstanding professionals however, there was an entire army of newly spawned brokers that followed in the wake of Sub-Prime lending. These are the guys Im aiming at.
Let me start with a group of guys in
Anaheim I came across who were just keen on sucking every penny out of every unsuspecting borrower they could get their hands on. Their aim, simply put, was to find credit challenged borrowers who they could easily convince that due to their bad credit did not have many options and by the grace of God this loan officer was there to save the day.
The first thing the loan officers at this hack shop were taught was to never ever talk to borrowers about interest rate, only payment. In other words, find out how much a borrower would save by consolidating all of their revolving debts into a new mortgage thereby resulting in one low monthly payment. It sounds good when I say it like that. It also sounded good when companies like Ameriquest put out national commercial spots spewing the same garbage. Heres the problem though. What this broker was doing was withholding proper Good Faith Estimate and Truth-In-Lending disclosures, being very vague about rate and costs and only focusing on the payment savings with the borrower. In reality, they were setting the borrower up for the kill.
By putting the borrower into a 2 Year ARM (fixed for 2 years then converting to a disgustingly high margined LIBOR adjustable a volatile index by the way that I would never offer to my worst enemy) the broker could offer what seemed to be an attractive payment to the borrower. Here is where it gets interesting. In reality what the broker was doing was offering the shortest term instrument to the borrower in return for the highest compensation from the lender. Furthermore, they would sell the maximum prepayment penalty allowed by law again guaranteeing the highest commission from the lender.
Another little tidbit that gets lost on even conventional borrowers is that this broker had what is known as an Affiliated Business Arrangement with a ti
I guess it appears there won't be any really meaningful changes until things are way past the point of recovery.
It seems the market is way ahead of the regulators.
Bob,
That's always the way it is. They are slow to act when they could be doing something to avoid future problems and then come in and impose restrictions when the fallout is in full bloom.
they still do 115 LTV:
Mortgage Grapevine: WHO DOES ABOVE 100% CLTV HELOCS/SECONDS?
maybe as far as guideline just outlaw HELOC and any mortgage over 50% LTV.
Truth and lending,
I think the end of your post got "haloscanned". Maybe break it into two parts.
Bob_in_MA
The intent was good, but got subverted. If the the lower economic classes cannot share in the American dream, then the wiliness of a substantial part of US citizens to support the government is compromised. Can you spell t-e-r-r-o-r-i-s-m?.
The problem would have been minimized, if it had been properly regulated. Folks at the margins would have made proper risks. But regulation was a bad word and the ideal of giving the poor a stake in heaven and the ideal of self regulated business, created a monster.
Okay, I can see a 2/28 as a tool for credit repair. Taking a couple of years and spending extra money paying down high interest debt would do many a world of good. Then they could get down to the business of paying off the mortgage. But how could that conceivably work if the borrower couldn't afford the amortizing payment? If there credit is so bad that managing to make a year or two of mortgage payments on time would significantly lower their interest rates they shouldn't be buying.
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