For many decades U.S. government policies have promoted housing in general and homeownership in particular. These policies have been very successful in raising the quality of our housing stock while extending the benefits of homeownership to more than two-thirds of American households.
They have? Homeownership? Can you cite two states, for example, where one actually owns their real estate?
(Hint: If you have to pay taxes on it every year in order to keep it, you don't actually own it. You're renting it - whether you have a note on it or not - from a government.)
There is no single fix that will restore confidence or immediately repair the dislocations that have taken place in housing and mortgage markets. But if we are willing to take bold steps, and return to the fundamentals of mortgage lending and securitization, we can get back to a more rational world where consumers are protected, risks are contained, and our scarce resources are allocated to their highest and best use.
Hmmm... that actually makes some sense. Wait a second... this is coming out of Bair's mouth?
First, we must recognize that the financial crisis was triggered by a reckless departure from tried and true, common-sense loan underwriting practices.
Traditional mortgage lending worked so well in the past because lenders required sizeable down payments, solid borrower credit histories, proper income documentation, and sufficient income to make regular payments at the fully-indexed rate of the loan. Not only were these bedrock principles relaxed in the run-up to the crisis, but they were frequently relaxed all at once in the same loans in a practice regulators refer to as "risk layering."
As all of you know, the long-term credit performance of a portfolio of mortgage loans can only be as sound as the underwriting practices used to originate those loans.
Ok, either Bair has been reading Tickers and has given up on her bull****, or she has suddenly come to the realization that all the crap she was trying to run, for whatever reason, was not only not going to work but, if we don't cut it out, we're going to wind up with an all-on political collapse.
In other words:
Those three points, remember? Uh huh. The three seminal points with which The Ticker began..... in 2007.
Let's look back for a moment to how the housing crisis unfolded. At the end of 2003, we were already well into a historic housing boom. Over the previous decade, nominal home prices had risen by 81 percent, while per capita disposable incomes were up by just over half. You might have expected a cooling off in home prices after this remarkable run. Instead, during the next three years we saw an acceleration of home price increases.
Between 2003 and 2006, average prices rose by another 38 percent, almost two and a half times faster than incomes.
Hmm.... this implies that houses were overvalued by half on average. That is, the total correction necessary to bring them in-line with incomes would be about 50%.
Uh, what have I been saying now for three years? Heh Sheila, when did you decide to start looking at the math?
These complex, opaque CDO deals obscured and spread the risks associated with subprime and Alt-A securities, but they certainly did not make the risk go away. By the summer of 2007, the capital markets began to realize the extent of these risks and the flaws in the securitization structures that had spawned them.
In other words, people got scammed. Soon we'll probably actually hear that come out of Bair's mouth. She's not there yet, but she's taking big steps forward.... and I'm reasonably impressed with them.
Third, the substantial risks associated with junior positions in subprime and Alt-A securitizations were obscured because they were packaged in complex CDO structures.
And, finally, many of these securities and CDOs were given overly optimistic agency ratings. Many investors relied too heavily on these ratings and failed to do their own due diligence.
How do you do "due diligence" when the documentation for a given deal is 100,000+ pages? You rely on the reps and warranties, primarily.
But there's a big problem lurking in here, and it ties into the second issue that I'll get to shortly.
This is where the story reconnects with loan underwriting. Had those MBS and CDO investors not been so passive, they would have pulled away and imposed the market discipline needed to uphold best practices at the front end of these deals, when the loans were made.
Had the investors not been SCAMMED, that is, led to believe that the paper they were buying was good when in fact it was composed of used dog food......
Remember that while a "Stated Income" loan is an instrument that invites fraud by the bucketload, the fact remains that for each loan there is a stated amount of income. If the lender has reason to believe that the borrower is lying, they can't represent an income level in the loan-level tapes that they have reason to believe is false.
In other words there's a huge difference between being scammed as a victim and intentionally averting one's eyes even though one has good reason to believe that deception (or even outright fraud) is taking place.
Instead, we need a whole new set of basic ground rules that go from origination, to securitization, to the servicing of the loans. These rules should create the transparency and incentives needed for this market to do what competitive markets do best – efficiently allocate resources and price risks.
Actually, we need some old rules - and laws - to be enforced. Specifically, we need the laws about fraudulent conduct enforced.
We can start by investigating and prosecuting all of the fraudulent activity that went on during 2003-2007 in the securitized lending marketplace from the top down.
Basic limits on loan-to-value and debt-to-income ratios, and consistent documentation requirements should be set for any loans held by a depository institution or sold to a securitization trust.
That would be nice. When do you intend to start enforcing those limits, since you're one of the primary regulators of those depository institutions?
Talk is cheap.
For decades, the mortgage GSEs raised funds in global markets at preferred, near-government rates on the basis of their quasi-governmental status. For many years, this arrangement lowered the cost of mortgage credit to millions of homeowners without adding to the federal debt. However, in the aftermath of the mortgage credit crisis and the conservatorship of Freddie Mac and Fannie Mae, the implicit backing of these entities is now an explicit cost. Federal subsidies for the GSEs in 2009 and 2010 are estimated at over $300 billion.
That's because despite a black-letter disclaimer when the time came the Federal Government bailed out the holders of that paper. Not only did it have no obligation to do so, but each and every prospectus said it would not do so. Yet it did, and forced the taxpayers to eat the losses - a bill that still has not been tallied in full.
But what we cannot do is perpetuate their quasi-governmental status, which privatizes gains and socializes losses.
If our government will not adhere to a black-letter disclaimer in bold print on the front of every prospectus, what will it adhere to?
Homeownership is certainly a worthy national goal. But does it make sense for the federal government to subsidize homeownership in an amount three times greater than the subsidy to rental housing? In the end, these subsidies have helped to promote homeownership, but have failed to deliver long-term prosperity.
That's because it in fact delivered neither. Again: A thing you must pay taxes on every single year is not owned, no matter what sort of convenient socialistic fiction you or anyone else cares to apply.
I am not advocating a specific proposal. I'm only pointing out that where homeownership was once regarded as a tool for building household wealth, in the crisis it has instead consumed the wealth of many households
A house is a place to sleep, to crap, to eat and to hang one's hat. In short, it is shelter for one or more people living together, often (but not exclusively) in what we call "a family." It's utility value is invariant over time assuming it is maintained; if it is not it's utility value actually decreases with wear and tear.
Everything beyond that is speculative premium.
Recognition of this fact will cause prices to revert to the point where an average home can be purchased with a couple of man-years of average labor, which, incidentally, was true not all that long ago.
We need to get back to a world where our financial sector supports the functioning of our economy, and not the other way around. And we need to fix what caused the crisis by reforming our mortgage lending and securitization practices. Only by getting back to basics in these most fundamental areas of our financial system can we begin to restore balance to our broader economy and confidence in our economic future.
Really? Three years it took you to recognize this, and ten before that?
Better late than never.
Oh, and on that second point above? The fraud issue.
Let's talk about why government doesn't seem so interested in the securitization and foreclosure problems. Specifically, what's showing up now in places like Florida:
The civil investigation revolves around allegations that FNF and LPS may have engaged in creating and manufacturing "bogus assignments" of mortgage ownership in order to perform foreclosures quicker, the Florida AG's office said on its website.
The documents in question appear to be forged, incorrectly and illegally executed, false and misleading, the AG's office claims, adding the documents were used in court cases as "real" documents of assignment, used to expedite foreclosure proceedings in the state.
There's a bigger problem here than meets the eye.
In short, a final list of all of the mortgages in the bundle is set out. Each trust also has a Closing Date which is the date that the individual mortgages are transferred to the Trust Custodian, who must certify that for each mortgage, the custodian has a mortgage note endorsed in blank and proof that the ownership of the note has been transferred. This proof is most often an Assignment of Mortgage. Most trusts included the following or equivalent language regarding the Assignments: “Assignments of the Mortgage Loans to the Trustee (or its nominee) will not be recorded in any jurisdiction, but will be delivered to the Trustee in recordable form, so that they can be recorded in the event recordation is necessary in connection with the servicing of a Mortgage Loan.”
Three problems immediately arise:
So what happens when someone doesn't pay and the alleged "holder in due course" (the trust) tries to foreclose?
All three of these issues potentially give rise to a problem that the seller could have with the person who bought said mortgage-backed securities, because the prospectus in each of the offerings I've seen makes representations and warranties that none of the above is the case! In other words all have language in them that warrant and represent that the trust took in and has good recordable paper for each note and as a general rule you can't design a legal structure to do an illegal thing (that is, hold bearer paper if it's not lawful to do so.)
Sheila Bair is poking around the edges of this mess. She has correctly (but belatedly) come to admit that the underlying instability in the market was caused by a destruction of underwriting standards, which in turn allowed housing to transition from shelter to a speculative financial instrument.
She correctly (albeit belatedly) has come to the conclusion that I reached years ago, which is that we cannot get out of this mess and return to a stable and sound economy until housing reverts back to what it is (that is, shelter), along with whatever adjustments must be made through the financial and consumer sectors.
Now if she'll take the next (and final) necessary step, and start calling for all those who deceived investors across the board to be held to account for what, under any reasonable interpretation, looks like the largest fraud ever perpetrated upon the public in the history of the planet, we will finally be moving forward toward unwinding this mess and restoring our nation to economic health, and those who committed these acts will be headed to the dock where they will face a jury of their peers.
From there we might obtain both punitive sanction and orders of restitution (to the extent possible.)
Hope springs eternal.
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