What do we do about the Mortgage Mess?

Great Debates
1

Previous attempts to start a thread on this were eaten by the SDMB goblins, so here’s hoping the third time’s a charm

So let me get this straight:
[ul]
[li]Mortgage brokers in the ‘90’s/early 2000’s made a substantial number of sub-prime loans to borrowers with fair-to-poor credit. This increase was due in part to elimination of many states’ interest ceilings on loans–justifying the “riskiness” of the loan–and an increase in access to capital markets, i.e. these loans could be re-sold as investment securities. Most of these original loans were (1) adjustable rate mortgages, where after 2-5 years the rate ratcheted upward and increased the expected payment, or (2) interest-only loans with a large balloon.[/li]
[li]Said brokers then sold the loans to investors–who could repackage the securities so that they received a higher investor rating–and they in turn sold them to hedge funds.[/li]
[li]An increased number of original borrowers–not unexpectedly–begin to default on the loan as interest rates increase. Although some try to re-negotiate the terms of the loan, the number of parties involved with the mortgage–one company owns the mortgage, another processes the payments, another is a trustee for the investors, and all most likely in different states–makes re-negotiation next to impossible.[/li]
[li]Mortgage brokers and associated hedge-funds begin to go bankrupt. Amazingly, some of these bankruptcies are liquidated in the Cayman Islands, which allows the bank to invoke the 2005 bankruptcy law and so block lawsuits against the fund. That same law can make it more difficult for the original home owner to declare bankruptcy. There is even talk of a government bailout similar to the S&L crisis of the 1980’s.[/li][/ul]

Does anyone here substantially disagree with the above analysis? I’m no finance expert–and perhaps I have some of the details wrong–but this is essentially the problem, isn’t it?

If so, I say screw the lenders/hedge funds/investors. These guys knew or should have known exactly what the risk of this kind of “investment” was; the fact that they lobbied Congress so hard for the very laws that allowed this mess proves that.

I would love it if we could just tell these guys to pound sand, but I’m aware that this will likely cause severe hardship for the original borrowers–yes, they shouldn’t have overextended, but the entrapping lenders bear some of the responsibility here, and I don’t think the penalty of forclosure fits the crime. I’m also aware that these guys have tangled so much of this up with the rest of the economy that it’s impossible to just cut them off without (perhaps; this is where I need expert help) substantially damaging our financial system.

Which brings me to my discussion point: How, exactly, do we fix this mess, bring the “right” people to justice for it, and prevent it from happening again? I mean, the S&L crisis was only 20 years ago, and although criminality in the mortgage mess is hazier than it was then, we seem to be taking the same ride yet again…

2

[QUOTE=CJJ*]
If so, I say screw the lenders/hedge funds/investors. These guys knew or should have known exactly what the risk of this kind of “investment” was; the fact that they lobbied Congress so hard for the very laws that allowed this mess proves that.

I would love it if we could just tell these guys to pound sand…
[/QUOTE]
Your analysis is pretty much as I understand it as well.

Aren’t the original lenders pretty much getting fat off of this clusterfuck though? If they sold the loans to investors, they have already made a profit, and if the borrower defaults, the investors who bought the loans take the hit, not the lender. Sounds like the investors and hedge funds are the ones who overestimated the market, and will be the losers.

3

[QUOTE=Fear Itself]
Aren’t the original lenders pretty much getting fat off of this clusterfuck though? If they sold the loans to investors, they have already made a profit, and if the borrower defaults, the investors who bought the loans take the hit, not the lender. Sounds like the investors and hedge funds are the ones who overestimated the market, and will be the losers.
[/QUOTE]

The only reason I’m unsure about that is because I don’t know who would actually foreclose on the homes and flip them to settle the debt. I doubt it’s the hedge-fund, and wonder if the mortgage insurer–in many cases a local bank–will be stuck with the loss.

4

I’d focus on prevention of the problem in the future. How about this for a start, trying to balance access to credit against predatory lending:

  • require lenders to evaluate the borrower’s ability to pay based on the fully amortized and indexed rate on an adjustable mortgage, as opposed to the initial ‘teaser’ payment;

  • some reasonable limits on such things as financing fees, prepayment penalties, balloon payments, negative amortization, and inequitable arbitration clauses;

  • require borrowers to display knowledge of the features of complicated sub-prime mortgage instruments such as variable interest rates, balloon payments, prepayment penalties, negative amortization and availabilty of mortgage insurance. Personally, I don’t think disclosure forms are enough - I’d prefer some sort of mandatory course on the subject of “how a mortgage works” and “ways to qualify in this jurisdiction for less onerous loans”.

You guys have already discussed the problem from the point of view of perverse incentives in the subprime market - the people selling the mortgage flip it to the secondary market. To my mind, the root of the problem from the borrower’s point of view is the basic fact that the very people most likely to use these instruments are the people least likely to know how they work and the real dangers associated with them.

This leads to the situation where people are in effect sucked into a mortgage relationship they cannot afford, in many cases because they don’t understand how it works.

5

A couple more things, that make it even worse.

First, it seems lots of borrowers got loans on stated income without checking, I suspect this came a lot from the assumption that the market would always rise, so the lender would never be at risk.

Since no lender had all of any mortgage (individual mortgages got split up also) many weren’t concerned about defaults, since the damage would be small. They never thought of the impact of a massive number of defaults.

This is impacting the broader credit markets, which is where the real danger lies. The banks that financed the Chrysler buyout can’t sell the debt, and are stuck with it. Expect fewer mergers as debt gets harder to acquire - and also it will be harder to buy a house, which will make the market worse. This, more than the mortgage market, may affect the economy as a whole.

The investors deserve to lose their shirts. I think they believed that high interest investments came without real risk. Time for a reality check. Perhaps labeling mortgages better on the true creditworthiness of the borrower might help, but that will hurt the housing market, so I suspect things will be back to where they were as soon as the dust clears.

6

In an effort to revive tis discussion, I notice that Hillary Clinton is proposing a plan to curb mortgage abuse. Strict licensing of mortgage brokers, IMO, is an excellent idea, as well as eliminating pre-payment penalties. However, it is Hillary saying it, so I’m sure the usual knee-jerk Clinton-bashers will find something to carp about here…

[QUOTE=Malthus]
Require borrowers to display knowledge of the features of complicated sub-prime mortgage instruments such as variable interest rates, balloon payments, prepayment penalties, negative amortization and availabilty of mortgage insurance. Personally, I don’t think disclosure forms are enough - I’d prefer some sort of mandatory course on the subject of “how a mortgage works” and “ways to qualify in this jurisdiction for less onerous loans”.
[/quote]

I really don’t see how this solution could ever be implemented, much less helpful. First off, some of those complications were developed partially to keep borrowers in the dark about the “real” cost of the loan. Second, I doubt any such class would be effective; the example of traffic schools for driving tickets–nothing more than state-sponsored extortion under threat of higher insurance rates IMO–is enough to convice me that it would be a waste of time/resources.

Finally, loans really shouldn’t be so complicated to understand in the first place. Yes, the magic of compounding interest is something that goes against common sense, but I think most folks “get it” in the theoretical sense. The multiple complications, again, are designed only to make a mortgage look more attractive–a way to falsely differentiate one mortgage over another in the market. That’s OK up to the point where such diversity provides real consumer choice, but when it gets to the point that complications are added strictly to make the mortgage broker’s song-and-dance more effective, the problem is not consumer education.

[QUOTE=Voyager]
it seems lots of borrowers got loans on stated income without checking, I suspect this came a lot from the assumption that the market would always rise, so the lender would never be at risk.

Since no lender had all of any mortgage (individual mortgages got split up also) many weren’t concerned about defaults, since the damage would be small. They never thought of the impact of a massive number of defaults.
[/quote]

I agree 100% with this; IMO credit checks (and accurate home valuation, for that matter) were seen as a cost to be minimized in developing the loan product, rather than a way to guarantee and protect the bank’s investment. Part of this attitude comes from the belief that the loan would be sliced and diced amoung several different securities just a few months after closing–in short, it wasn’t going to be the banker/broker’s problem, so why bother making sure the loan would hold up over time?

7

[QUOTE=CJJ*]

I really don’t see how this solution could ever be implemented, much less helpful. First off, some of those complications were developed partially to keep borrowers in the dark about the “real” cost of the loan. Second, I doubt any such class would be effective; the example of traffic schools for driving tickets–nothing more than state-sponsored extortion under threat of higher insurance rates IMO–is enough to convice me that it would be a waste of time/resources.

Finally, loans really shouldn’t be so complicated to understand in the first place. Yes, the magic of compounding interest is something that goes against common sense, but I think most folks “get it” in the theoretical sense. The multiple complications, again, are designed only to make a mortgage look more attractive–a way to falsely differentiate one mortgage over another in the market. That’s OK up to the point where such diversity provides real consumer choice, but when it gets to the point that complications are added strictly to make the mortgage broker’s song-and-dance more effective, the problem is not consumer education.

[/QUOTE]

The difficulty here is how to achieve two goals: provide reasonable protection for the public, while not creating a mess of regulations that has the potential to eliminate some people’s access to credit, or outlaw what may in some cases be useful financial tools.

While there may be some predatory lending practices that should be curbed, I do not think that certain financial tools should be outlawed purely on the purely subjective grounds that they are too complicated for ordinary humans to understand, and thus must have no purpose other than confusion.

I also reject the analogy of state-sponsored traffic schools for tickets. What’s wrong with the more-valid analogy of state-required licences to drive? You have stated that Clinton’s plan to license mortgage brokers is an “excellent idea”. Why is licensing brokers okay but licensing borrowers akin to a species of extortion?

In my opinion, pretty well everyone could benefit from some education as to how financial instruments work. Just as driving a car without any education as to how to drive is dangerous to one’s physical safety, borrowing money without any understanding of how financial instruments work is dangerous to one’s financial safety, in my opinion.

8

[QUOTE=Malthus]

I also reject the analogy of state-sponsored traffic schools for tickets. What’s wrong with the more-valid analogy of state-required licences to drive? You have stated that Clinton’s plan to license mortgage brokers is an “excellent idea”. Why is licensing brokers okay but licensing borrowers akin to a species of extortion?

[/QUOTE]

Even licensed drivers speed. I’m sure there was fraud involved in some of these loans, but I suspect a lot less than what borrowers about to be foreclosed are saying. Someone who wants a house but can’t really afford one is told that rates will keep going down, so all they have to do is to refinance before their ARM balloons. Up until now, this wasn’t bad advice. In the mid-80s I had an ARM that kept going down - I finally got a fixed, but coming out of the high inflation of the period a fixed rate mortgage was stupid. And you don’t need a financial education to know that rates can go up as well as down. You also don’t need one to know that lying about your income on the mortgage application is not going to come out well.

Perhaps a requirement for full disclosure on the credit worthiness of the applicants might help. If those brokers who accept applications on faith can only sell their paper at high interest rates (deep discounts) they will either make a business out of it or mend their ways. But you can’t license away excessive risk taking, as my commute show me every day.

9

[QUOTE=Voyager]
Even licensed drivers speed. I’m sure there was fraud involved in some of these loans, but I suspect a lot less than what borrowers about to be foreclosed are saying. Someone who wants a house but can’t really afford one is told that rates will keep going down, so all they have to do is to refinance before their ARM balloons. Up until now, this wasn’t bad advice. In the mid-80s I had an ARM that kept going down - I finally got a fixed, but coming out of the high inflation of the period a fixed rate mortgage was stupid. And you don’t need a financial education to know that rates can go up as well as down. You also don’t need one to know that lying about your income on the mortgage application is not going to come out well.

Perhaps a requirement for full disclosure on the credit worthiness of the applicants might help. If those brokers who accept applications on faith can only sell their paper at high interest rates (deep discounts) they will either make a business out of it or mend their ways. But you can’t license away excessive risk taking, as my commute show me every day.
[/QUOTE]

Naturally. Nor should one attempt to licence away excessive risk-taking. I am also of the opinion that one should not attempt to outlaw all risk (using this analogy, outlawing the use of private cars and forcing everyone to take some safer form of transport). Neither is the proper role of the regulator.

The role of the regulator, in my opinion at least, is to ensure that everyone is, to the extent possible, taking informed risks, and to ensure that unnecessary and counter-productive risks are reduced to a minimum.

10

I see now the Fed is getting into the market:

I personally didn’t know the Fed had the ability to designate the type of securities that could be purchased (I thought they basically manipulated the funds in central banks to control the market rate on government bonds–i.e. they “set the rate at X%” by adding or subtracting money designated for the buyback of T-bills. I din’t know they bought other types of debt).

[QUOTE=Malthus]
I also reject the analogy of state-sponsored traffic schools for tickets. What’s wrong with the more-valid analogy of state-required licences to drive? You have stated that Clinton’s plan to license mortgage brokers is an “excellent idea”. Why is licensing brokers okay but licensing borrowers akin to a species of extortion?
[/quote]

Because mortgage brokers have far more power over the dangers inherent in the financial transaction than the borrower. The broker has a tremendous advantage because he works with mortgage instruments on a daily basis. There is no practical way any widespread mortgage-education program–one that eventually licenses borrowers–is ever going to place all or even most potential borrowers on a level playing field.

This was my point with the traffic-school analogy. It is a widespread program attempting to instill the habits of good driving by requiring someone who doesn’t want to be there to sit in a class for a few evenings a week (I actually took one of these on-line some years ago, clicking thru page after page of a website as quickly as the program would allow me). It takes a lot more than that to transform bad driving skills into good ones, about the same amount as it would take for many people to get savvy about all mortgage instruments. And this is something most people to only a few times in their entire life, as opposed to the daily activity of driving.

As far as comparing the licensing of borrowers to that of drivers, an unlicensed driver is immediately dangerous to others on the road. Buying a mortgage, on the other hand, is a few-times-in-a-lifetime activity, and unlike an out-of-control vehicle the fact that my neighbor’s home is foreclosed upon doesn’t mean that he’s putting mine in any danger.

A more practical solution might be the creation of state-supported financial advocates, similar to public defenders in the legal system. This would meet the goals of licensing potential borrowers in a far more practical way. The state recognizes that most folks are unfamiliar enough with the legal system that if they do not have the resources to use a personal advocate they are put in an unfair position. Why can’t something similar be said about complicated financial negotiations?

11

[QUOTE=CJJ*]
Because mortgage brokers have far more power over the dangers inherent in the financial transaction than the borrower. The broker has a tremendous advantage because he works with mortgage instruments on a daily basis. There is no practical way any widespread mortgage-education program–one that eventually licenses borrowers–is ever going to place all or even most potential borrowers on a level playing field.
[/QUOTE]

Indeed you are correct. Mortgage brokers aren’t known to be the most honest folk to begin with, and many of them (in my experiance with working with hundreds of different brokers over the years) view the business as a game, with regulatory rules and banking standards as things to be manipulated and avoided so that they could pocket a few measly thousand. There are hundreds of thousands of examples of mortgage brokers changing information on loan applications before submitting them to lenders, since they quickly learn what buttons to push to get “yes” answers. They will lean on vendors such as property appraisers and title insurance companies to get results that reflect desire over truth and in the long run many of them are sharks that are knowingly screwing over people ignorant of complex mortgage products to make short term gain.

There have been several high profile sub-prime lenders that have gone down as of recent, largely due to their lack of in house mortgage origination and their dependance on brokerages to find and sign up customers. Bad paper begits more bad paper until the lenders are forced to buy back poorly written loans from investment firms, effectively maxing out their credit lines and causing instant financial insolvency as is what happened to New Century Mortgage in California two months ago.

There is a bill on the table in my state that would mandate credit council to anyone applying for a loan via a mortgage broker, which has them freaking out. I for one say good riddance to the entire profession. With the advent of on-line applications and businesses like Lending Tree the mortgage brokering profession is becoming increasingly outdated and useless.

The real trick will be passing legislation that allows class action lawsuits on behalf of the mislead borrowers and to allow punitive damages to be levied against the brokers themselves.

12

My question is, will this help a guy like me out? Hopefully, I’ll be getting out of school and into a job next year and would like to eventually buy a house. However, I had no interest in those wacky mortgages even before this whole mess and am perfectly willing to rent for a while longer (including several years up to the entirety of the first job, more or less, not including other major changes) while building up enough in savings to afford a traditional mortgage on a nice, small place. I realize it will be partially dependent on the exact market, but how about an overall trend? I figure, if nothing else, that at least the property values ought to come back down to a realistic amount.

13

Bush to homeowners facing foreclosure: no help forthcoming.

On the other hand, if you’re a speculator in the subprime mortgage market:

[QUOTE=CJJ*]
I see now the Fed is getting into the market:

[/QUOTE]

Ah. So the feds will bail out lenders and speculators, but as for homeowners? Well, it’s not the federal government’s job to bail them out.

14

[QUOTE=asterion]
My question is, will this help a guy like me out?
[/QUOTE]

In the long term, I believe it will. By the time you’re ready to enter the mortgage market many of these issues will have played themselves out and the market will have regained some stability. The end result is that your loan package might contain two or three extra pages to sign and your loan might take an extra day to be approved. No biggie. Not that there’s ever been much risk associated with 30 year fixed mortgages to begin with. The real danger has been with people who are either fraudulently applying for mortgages with fudged numbers or people who were willing to live far beyond their means purchasing property they never should have been allowed to by only being able to afford the interest, not the principal payment. As a matter of fact, with the rising numbers of homeowners approaching retirement age, purchasing a single family home in most major metropolitan areas* should become easier and cheaper in the next 10 to 15 years as those folks begin to move somewhere “nicer” and leave a glut of homes on the market according to the material I’ve read. The pricing issue has already worked itself out.

The exotic mortgages that exist are legitimate products, but they were designed with very specific circumstances in mind, not for first time homebuyers. There will always be exotic products, but as someone who’s looking to simply purchase a home and not try anything too tricky you should be fine.

*Excepting Florida, Arizona and other retiree friendly places and California, home of the totally alien real estate laws.