This weekend a top reporter, Teri Buhl at the New York Post, wrote about one of my weekly research reports to clients that I put out a couple of weeks ago. In it, I talk about terrible bank- and regulator-led mortgage mods, Indymac and my solution. Most regular Mr. M readers already know my views, as I have been very vocal on this topic for months. Here is the Post story:
From the New York Post by Teri Buhl: Reworked Loans Aren’t Working Out at Indymac Bank
Below is the full write-up of my views on the mortgage market, mortgage modifications and where this has to go. Not included are the proprietary default and foreclosure data released in the original report.
Before I start, I believe that the housing market will ‘fix’ itself over time. But regulators, politicians and banks are hell-bent of ‘saving’ us all with programs that will just not work. In my opinion, the only way to ‘fix’ the housing and mortgage markets is to undo 2003-2007. To ‘undo’ means to:
- a) force de-levering the home owner/consumer through mortgage principal balance reductions based upon what the borrower really earns using market-rate financing
- b) make it so home owners can freely refinance and sell their homes
- c) make it so the vitally important move-up buyer comes back
- d) stop defaults and foreclosures without making home owners underwater, fully-leveraged, renters for the rest of their life as the present mortgage modification plans do
- e) allow home prices to fall to historic multiples of incomes and rents without exotic loan programs or artificial, temporarily, government induced low mortgage rates.
This can all be accomplished quickly if the right steps are taken. Below is how I believe we can get there.
HOME OWNERS AS A GROUP ARE NOT TO BLAME
The reality is that at the time most troubled loans were made, the borrowers really could afford their payments. This is because everyone made $150k per year for the purposes of qualifying for a loan due to the way the loans were structured.
This greater housing and mortgage crisis is not a result of millions of borrowers going wild, buying beyond their means blinded by greed or some massive consumer driven multi-year mortgage fraud era where everyone lied to buy a home. Nor was it caused by gangs of mortgage brokers who cruised the streets with 1003′s and pens in hand recruiting straw buyers to steal homes. This crisis was caused by fraud alright – but not by the consumer or loan officer to any great degree.
The greatest real estate bubble of all time was only able to occur because of the unregulated investment and commercial banks’ insatiable thirst for parts for their Frankenstein securities. As parts ran low when housing stretched or interest rates rose to levels that made the asset class unaffordable every few months, the constant re-engineering of loan programs focusing on low monthly payments and the elimination of income and assets as a variable brought affordability back in check. This continually repeated for years until virtually anyone with a heartbeat and a hand needed to sign the loan documents were active participants in the market. By turning a blind eye, regulators turning a blind eye endorsed their actions.
The problem going forward is that most don’t realize that during the bubble years, everything was exotic – even 30-year fixed rate fully documented loans.
PEOPLE VIEW THEIR HOME AS AN INVESTMENT – NOT A PLACE TO LIVE
What’s worse is that over the past five years there was a fundamental shift of how people viewed their home – from ‘a place to live’ to their single ‘largest investment.’ How could they not when all loan programs from Subprime to Prime allowed 50% of gross income (greater when considering limited income doc loans) to be used towards debt. In the good old days, when housing was viewed as a place to live, financing was sound; down payments were required and no more than 28% of gross income could go towards housing debt. When homes prices fell, it was alright because home owners could still save money and do the things they wanted to in life. 50% debt-to-income ratios changed the game.
Make no mistake about it – MOST ALT-A, JUMBO PRIME AND PRIME BORROWERS ARE NOT WALKING BECAUSE THE CAN’T TECHNICALLY AFFORD THE PAYMENTS. They are walking because all of their after-tax income each month is going out in bills and the largest portion is going to a home worth half of what they owe. When they are spending such a large portion of their income on such a massively depreciating asset, it makes good financial sense to dump that asset. When you can’t sell, you walk away.
That said, there are many who can’t afford their payments because of an ARM adjustment. But at one time they were qualified by the bank, and given the way the loan was structured, they could in fact afford the home. Banks and real estate professionals in every city in the nation used high-leverage, exotic loans in order get people to qualify for ever-increasing loan amounts. By 2005, interest-only was industry standard, as was stated income. You could not turn on the radio or television without being inundated with ads for $350k mortgage loans for 1% and $1000 monthly payments.
Lenders didn’t worry over what would happen to the loan after a few months because the loan was sold and they lose all liability after six months or so. The 2/28 Subprime ARM was a perfect example of a loan program not designed to hold over the initial teaser period. It was one that the lender didn’t care about because most were sold and securitized. Therefore, who cares about creating loans that will last? Just make loans that will last at least six months.
Even the securities investors never planned on holding these for very long. Exotic loans with teasers were sold as a ‘way to get into the home more cheaply’ or a ‘way to improve your credit before refinancing into something better a couple of years from now.’ The high churn rate of these loans was what kept MBS money flowing into this sector. They were short-term, high yield investments. This philosophy was not isolated to Subprime 2/28’s either – Prime 5/1 interest-only ARMs and Pay Option ARMs were also sold the same way. ARMs were the majority of mortgages in the bubble states through the bubble years.
EVERYONE EARNED $150K PER YEAR
Due to the way the loans were structured, from 2003 through 2007 everyone made $150k a year for the purposes of obtaining a mortgage loan. Teaser rates, interest only, negative amortization, high allowable debt-to-income ratios, zero down, stated income, and others made all homes affordable and all borrowers rich. Home prices responded by surging higher to meet the new-found national high affordability level. As home prices surged, new loan programs were rolled out to keep affordability in check.
Everyone was suckered as these loan programs became the norm. Folks who really earned $150k a year went out and bought over priced homes based upon flawed and temporary fundamentals not knowing they were being suckered. Now they too are upside down in their home by 50% and have seen their life savings go up in smoke. They overpaid because the hourly day-laborer was bidding against them using a stated income 100% interest only combo. Hey, the loan officer at the bank and the Realtor told the janitor that ‘based upon income and credit, you qualify for this loan.’ Why should he argue with his bank? They know best; they are the experts.
But now it is obvious that the past six years were an illusion and none of those easy credit, high-leverage programs exist any longer. Prices are coming down to the real affordability levels using 15 and 30-year fixed rate loans and a down payment This has rendered the nation’s financial institutions and millions of home owners instantly insolvent. The same household that earns $85k per year could have bought a $650k home with no money down two years ago. Today they can buy a $275k – $300k home with 10% down. It now takes at least $150k a year and a large down payment to buy a $650k home.
100% stated interest only and Pay option ARMs will not return. Nor will 100% HELOCs. They were doomed to fail from their creation. The banks had modeling systems that they never stress tested. You mean to tell me that the smartest guys in the room never thought to plug into the model that home prices could actually fall? That was a fatal error that the world is paying for.
This is why this crisis was never and will never be ‘contained’ to Subprime. This is why those who put down 20% are walking away from their homes – it makes for a sound financial decision. Negative equity is now the leading cause of loan default among higher paper grades. As house prices fall further, more will walk.
Yes, there were people who took advantage of the system. But, that was a small percentage of people who bought a home on flawed and temporary market fundamentals induced by easy credit and exotic loan programs that never should have existed in the first place. This five year period of absolute recklessness and blind greed on the banks’ part was the real driver of home prices. Taking that away is ‘going straight’ and the leading driver for the destruction of the housing market and consumer. It’s simple; housing prices are just going to the levels determined by incomes, rents, interest rates and the macro-economy.
ARTIFICIALLY LOW RATES WILL NOT HELP EITHER
Who Can Really Benefit From a 5% CONFORMING (=<$417K) Mortgage?
With a 69% home ownership rate at the peak and values at least 50% across the bubble states, who is left to take advantage of these low rates? While low rates are a great thing for those who qualify, it is very possible that the excitement over low mortgage rates will end up exactly like the excitement surrounding the previous 20 bailouts, acts, proposals and ‘lights at the end of the tunnel’ that ended up being trains over the past two years.
The reality is that rates for most are not as low as people think. In addition, too many home owners in the bubble states are underwater and therefore unable to refi or sell. Remember, selling is needed in most cases to get the down payment needed to re-buy.
Exotic Loan Affordability Comparison
100k at 4.5% (5/1 interest only) = $375 per month or a 2.1% – 30-year fixed full doc
100k at 5% (7/1 interest only) = $417 per month or a 2.9% – 30-year fixed full doc
100k at 1.25% Pay Option ARM = $333 per month
For those who went “limited documentation” as with 83% of all Alt-A borrowers, affordability and interest rates and comparable affordability are moot points.
In the good old days, when rates dropped 50bps in a short period of time, the entire country would refinance for a lower rate, cash out or combine a first and second into a new first mortgage while adding a HELOC.
Back then, when values went up every month and there were hundreds of lenders with thousands of programs and interest rate structures, it was very easy to pump the mortgage money. Back then, the refi waves came every 6-8 months and within a few months after a wave began, it was noticeable how this injection rejuvenated the consumer. This can’t happen any longer.
Negative Equity- Within the states that need the most help and are most beneficial to the macro-economy, the vast majority can’t refi due to negative equity. In CA for example, 60% of all mortgagees are either underwater or ‘near’ underwater and will not be able to take advantage of the rates. NV, FL and AZ are even worse. Most home owners in the top 10 trouble states are underwater in their homes, rendering them unable to move or refinance.
Rates are lower than last week for sure, but these ‘low rates’ are ONLY for the best AAA Prime gold borrowers with 80% LTV’s and 740 scores. This represents a small fraction of borrowers. THE REST STILL GET RATES WELL ABOVE the rates being recklessly thrown around by the media. As a matter of fact, most borrowers with the previous profile may have not participated in the past several years of serial refinancing. Many already have low 30-year fixed rates at 5% attained in 2003-2004. These rates are not for anyone less than perfect.
Folks don’t qualify - ‘Back then,’ nearly everyone could benefit from a drop in rates because values always went up and stated income and interest only loans made it so everyone could qualify. Until mid-2007, lenders actually funded 75-80% of all loan applications!
Now, lenders are funding 40-50% of applications. That is serious fall out. Now, you must have two years tax returns, a current pay stub, great credit and sizable equity to take advantage of the best rates. This profile represents a small minority of borrowers.
Given that over half the market is distressed sales and foreclosure related properties, rates do not matter as much – home prices do. 6% or 5% will not change things – its about how cheaply they can buy. Everyone wants a ‘deal’ on a foreclosure. Many ‘investors’ pay cash and it is all about price, rents and cap rates.
Renters and first time home buyers are a different story and should see some benefit from lower rates if they hold. They will either save money or qualify for slightly more house. But remember, first time home buyers and renters are the weakest portion of the market and have always been.
What is missing is the all-important move-up buyer, which lower rates will not help to any great degree. This is because of the gross amount of negative equity already discussed. Without the exotic loan programs and easy qualifying, many can’t even afford to re-buy the home they live in now.
The solution is not for regulators to force interest rates down to artificially low levels for a brief period of time to sucker people into buying homes. That’s what got us here in the first place. That said, sustainable low rates are good for the housing market.
But low rates mean very little when millions will default and lose their homes over the next few years because all of that added supply can’t be absorbed by the available buyers. The fact is that there are fewer buyers than ever before given that home ownership was at 69% a couple of years back and now the largest sector of the purchase market, move-up buyers, are all but non-existent. Please see the stories below regarding this. It is my opinion that low mortgage rates do not mean what they used to.
- Bubble-States Awash in Negative-Equity (Revisited) (67)
Posted on December 5, 2008 12:35 PM
- Who REALLY Can Benefit From Lower Mortgage Rates? (69)
Posted on December 4, 2008 1:41 PM
- Mr Mortgage: In-Depth Look at Mortgage Rates…5.5% Does Not Exist For Most (45)
Posted on November 28, 2008 1:31 PM
- Mortgage Rates Drop! It Does Not Mean What it Used to (67)
Posted on November 26, 2008 1:09 PM
- Bubble-States Awash in Negative-Equity (Revisited) (67)
If not for the unregulated institutions providing unlimited and irresponsible credit and leverage to every household in America, this never would have happened.
First off, I am a fan of letting the market work and the housing/foreclosure crisis clearing itself up on its own. We are already seeing positive signs that the Subprime crisis is on the other side of the hill mostly on its own. The problem is that the Alt-A, Jumbo Prime and Prime mountains lie ahead. However, if the government and banks are hell bent on modifications and saving people, they ought to do it the right way. Their present ‘solutions’ only kick the can down the road and ensure housing is a lost asset class for many years.
This blame does mostly lie with the banks, law makers, and regulators (including Greenspan) who branded and endorsed exotic loans as mainstream until 80% of all loans in the state of CA in 2006 were exotic by definition. This is very similar to the cigarette makers not telling the American consumer for decades that cigarettes were highly addictive and cause cancer. They were branded as the ‘cool thing to do’ in the media. Then they lied about the health effects and addictive qualities in nicotine for two decades until science caught up.
To fix the housing market and greatly aid the economy, you must focus on two important segments that made up 80% of all housing activity: the refinance borrower and move-up buyer. Now they are the minority. This is a major problem. We need to get these people back into the market. Investors, vacation home buyers, renters and first-time home buyers have always been the smallest segments of the market and now they are its primary participants. Low rates may be great for low priced homes in foreclosure epicenters, but as the default crisis jumps tracks into Alt-A, Jumbo Prime and Prime, higher end areas will follow down the same path. Without any reasonable financing available for loans over $417k, it is already a foregone conclusion.
Prices are coming down fast, and the market will clear at some point and at some level. But that level could be years away. The banks, regulators and lawmakers with all of their highly exotic loan modification plans will ensure it takes two decades for this to happen. See The Great Loan Modification Pump- God Save Us All! for the reason why. The re-default rate after loan mod is over 50% because most loan mods keep the borrowers leveraged up and underwater in their homes. The plans by Fannie, Freddie, FDIC, banks and lawmakers do exactly this. My plan will achieve the same within a couple of years. Yes, there will be pain but much less.
As with the financial institutions, the quicker the borrowers de-lever and raise cash, the better for the housing market and macro-economy. It is worth spending a few more trillion on quickly de-leveraging US households so they are free to save and spend money on other things besides an underwater house. The present mortgage modification structure takes care of the institutions at the expense of the very same tax payer that is bailing them out in the first place. I relate it to how the taxpayer has given AIG $150 billion, much of it to pay off losing bets to other financial institutions. The reason AIG has a blank taxpayer check is because it passes right through them to the financial favorite children like Goldman Sachs and Chase.
Undoing the Past 5-Years
It is time for the very same financial institutions that created all of this to do what’s right and re-underwrite every loan originated between 2003 – 2007 using prudent underwriting guidelines. Then, they must reduce the principal balance to what the borrower really earns using a 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered to 28/36 DTI they are able to save money and live a decent lifestyle. If they go upside down in their property who cares – they are still able to save money and live the lifestyle their income level allows. At 28/36, their home once again becomes a place to live.
If reducing the principal balance to 28/36 on a market rate 30-year fixed loan winds up being $100k lower than the present value of the home, the bank should receive the differential through an equity warrant to 90% of the value of the property. This way the home owner is not upside down in the home, they can freely sell or refi, they are not getting anything more than they deserve and the bank is still protected. But the home owner gets all of the upside. Anything less and the program will fail. If the borrowers can’t prove income through bank statements at the very least, then they need to leave the house and rent. They should have been renters all along.
For the small percentage of folks who can afford the payments with DTI’s under 28/36 but are underwater solely due to house price depreciation, principal balance reductions to 90% of the present value of the property is likely in order WITH a full-recourse provision to thwart fraud.
For the minority with equity who may owe $200k on a $400k home or have no mortgage at all, you get a multi-year tax break and a lollipop. By de-leveraging and stabilizing the consumer, you will stabilize house prices much faster, which will benefit you. Left unchecked and the consumer de-leveraging and housing price depreciation will continue for years, which brings you down too. You may end up underwater in your home unless the right solution is brought forth.
These things will not prevent housing prices from coming down over the next few years to reach a level of affordability consistent with present mortgage rates and lending guidelines. But at least it would be the best way to begin to undo the irresponsibility of the past five years and get back to basics where house prices and affordability are based primarily on traditional factors such as rents, incomes, interest rates, macroeconomic conditions and sentiment. - Best, Mr Mortgage