I’m getting the creepy feeling of major financial scandal brewing. The familiar pieces of the story are: (1) lenders who abandoned generally accepted lending standards to write loans they probably shouldn’t have written; (2) major marketing campaigns to pull people into the system and get them to stretch beyond their means (see especially home equity loan ads); (3) a secondary securities market on Wall Street to package up loans and sell them to investors, with hefty fees to Wall Street firms; (4) Those same firms having analysts tout the stocks of the subprime lenders.
My questions are whether you all see the same signs of trouble I do, what you anticipate the impact will be on our communities and their tax bases; what the impact will be on ordinary people, and finally, are there steps our state government can take to mitigate some of the harm I fear is coming?
…We are insufficiently familiar with the high-risk mortgage market (why euphemize it by calling it other than it is?) since we paid off our mortgage several years ago. I’ll merely point out a couple of things.
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There has long been a secondary securities market in federally-guaranteed home loans, via Fannie Mae and Freddy Mac. And VHA loans for veterans. And this, that, and the other. Securitizing home-loan morgage lending goes way back.
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The issue isn’t the securitizing. The issue is the subterfuges that go on to get people into the mortgage markets over their heads. There used to be some rather stringent (not overly stringent, but somewhat) that would result in loan denial. Apparently, financial institutions have figured out ways to get even marginal borrowers into the market, and that is what has led to the high-risk mortgage problem.
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NB, the financial institutions aren’t really lending their own money, they are operating as brokers to sell off mortgages into the secondary “securitized” market, and make their money off of brokering the loan and servicing the receipt loan payments. So, since they aren’t risking their own money, they have every incentive to try to broker a loan to anyone they can, to maximize their up-front “broker” fee and to increase their servicing fee.
When I bought my house, you needed 20% down to get past the bank…then it was 10%. Now, my teeth grind as I drive to work and listen to radio ads featuring feckless young things prattling about how they were fired, have no credit history, etc., and they STILL got a mortgage with Mr. Friendly’s Mortgage and Aluminum Siding Company with NO MONEY DOWN.
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CONCEPT – save for your deposit. THEN buy the house. You begin with a pool of equity.
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This is the reason for the ‘rash’ of foreclosures by Mr. Friendly who has pocketed his fees and closing costs. There is a REASON these loans are called ‘sub-prime’, and it ain’t all the interest rate.
consider how many months payment the down payment is.
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My wife and I just bought a home. We were able to scrounge up 20% down, but just barely*. How many years’ salary does a home cost people now as compared to 30 years ago?
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My point is that 20% down is really hard to do. I don’t have any sense for just how hard it was to pull off 30 years ago. Any ideas?
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We actually put 10% down and got a loan for another 10% which we paid off within six weeks of moving in; we didn’t want to liquidate investments until early 07 (instead of late 06), etc.
…when we bought our house in 1983, but we bought just before the 1980s bubble. That bubble began literally a few months after we bought. And collapsed–kind of–in 1987.
I have to agree about the teeth grinding problem. It’s a barrage of inducements to irresponsible behavior. If I ever get pulled over for road rage, it will be a result of hearing one more “It’s the biggest no brainer in the history of earth.”
…but the fact is that, the government-interfered-with mortgage market has been good for all concerned, except possibly for putative buyers, and maybe even for most of them.
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Good for seller? Yes, indeed. It pumps up housing values.
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Good for buyers? Yes, indeed. It gets them into houses. (Note to Ms. Porcupine: high risk “sub-prime” lending allows people who are unable to initially come up with the down payment to get into the housing market. Increasing the demand, and probably increasing the prices.)
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Good for the mortgage brokers–the so-called financial institutions that first broker, then securitize, then service the mortgages, at government expense? Oh, most definitely yes.
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Who are the losers? The people who get suckered into high risk mortgages that they don’t have a hope of repaying.
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I don’t have a particular issue with people offering or taking high-risk mortgages, providing they take on the mortgages with informed consent.
…the seller, the real estate agent, and the mortgage broker. It might also help the insurance company who’s providing the mortgage insurance (low-money-down mortgages usually require mortgage insurance–or at least they used to).
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See? The seller gets a higher price than he should otherwise. The real estate agent gets a higher price than he should otherwise. The mortgage broker gets the commission on completing the mortgage. The mortgage insurance company gets its insurance payments. The only party that might–just might–get screwed is the buyer/borrower.
the mortgage insurance company starts paying out more, making them unhappy in the long run. They have to charge more for PMI, which makes the total monthly payment more expensive — driving potential buyers away, thereby reducing commissions for mortgage brokers and real estate agents.
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Somebody has to eat the defaults, and with no money down the lending agents (insurer and mortgage lender) are much more at risk for the bad loan costing them capital in addition to the man-hours necessary to deal with the default.
“No money down”, “no credit, no problem” sub-prime loans are designed by predators, for the benefit of predators.
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Desperate people are routinely steered toward these snake pits by unscrupulous debt collection attorneys and mortgage brokers. (whether kickbacks are involved, I can only speculate)
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The long-term, damaging effects to the credit, financial health, and the self respect of predatory lending victims is huge.
…but, in the short term, the people I mentioned benefit. In the long term, if mortgage insurance companies weren’t making a profit, it seems to me that the insurance companies (that’s what they are) would stop offering mortgage insurance. Their re-insurers would stop re-insuring them. There would be no mortgage insurance market. Hence, no zero-down-payment market.
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Moreover, what is the profit to the high-risk lender in the situations you’re positing? If the lender is not going to be re-paid, the most he will get is a house, whose probable value on the non-high-risk lending market is less than the no-down-payment amount that he lended*. How would the lender profit from that?
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(*The reason I write that is that, if the current owner is unable to keep up the payments, he could always sell the house at the current market value. If he couldn’t sell it for a price high enough to pay off the mortgage, the value of the house is less than the value of the mortgage. Econ 101)
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I see people continually prattling on about predatory lending practices profiting someone else. But for the life of me, I can’t understand who is supposed to gain. As my contracts professor put it 35 years ago, you can’t get blood out of a turnip, and turning people into turnips–which is what you are describing–profits nobody. In the long term, of course.
It isn’t the increased default rate alone, as these companies don’t hold the mortgages.
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Is it that, now that inflation and increasing oil prices have been looming for a few years, the appetitie of the secondary market for subprime debt is reduced, thus shrinking the market?
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Until just a few years ago, inflation was so nonexistent that interest rates were hitting all time lows. In that environment, investments in conventional mortgages was a crappy choice: the interest rates were as low as, and sometimes under, 5.00%! Investors wanted something to get that 5.00% number up, and looked to high risk lending. Now interest rates are up, so the market for conventional debt is better, and the risk inherent in high risk is biting.
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If AMC is struggling just because the secondary market has adjusted, then credit will tighten up. Indeed, this is exactly the process that has softened the housing market over the last year.
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So what is the problem, exactly? I don’t see scandal, I see a market correction.
In response to CentralMassDad, I’m not sure what factors specifically are driving what seems to be a problem of some immediacy. I’m thinking that part of the problem was the willingness of lenders to abandon lending guidelines in the race to generate more loans. This reminds me in part of the dot-com bubble, where internet companies trumpeted their growth rates or their revenue growth, without dealing with their cost increases. It also reminds me of the lending problems that led to the S & L scandals in the 80s. If I may quote an old folk song, “When will they ever learn…?”
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I’m also thinking that part of the problem lies with the thousands of messages consumers got that their homes were ATMs, usable for almost any purpose. The marketing of subprime loans has really been relentless. I still hear a lot of ads on WBZ for some of these companies, and still get a lot of solicitations to refinance my house or take out an equity loan. I wouldn’t mind having some of these lenders suffer considerable financial pain for their stupidity.
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If there’s a scandal, and I’m not sure there is, it might well lie in the circle of analysts recommending stocks in the lenders, and taking investment banking business from those same companies. I thought we were supposed to have stopped that behavior after the internet bubble. I’ll be very interested to see whether anything comes of Galvin’s investigation.
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What really worries me, though, is the impact of the correction on (1) people holding subprime loans, who will now face difficulty refinancing; (2) the price of real estate as more houses go into foreclosure; (3) property tax rates and revenues across the state (where we’re trying to find relief now); (4) new borrowers, who will face tightened guidelines and difficulty in getting mortgages; and (5) the lives of the families who will be losing the roofs over their heads because they are struggling financially, for good or bad reasons.
as the home value goes down, the tax rate will go up, so that the total receipts of all non-new property assessments will go up by 2.5% or less*. So, if the properties all fell in value by 10%, the tax rate would go up by about 14% (11% to make up for the loss of 10%, plus a little more for the 2.5% increase).
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* Unless there’s an override, of course.
Or a Community Preservation Act. Or a debt exclusion. Or a new local option tax. Or a new capital building fund to fill. Or a fee institution. Or a Mercury Retrograde….
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There’s a reason why local officials all over the state are tearing their hair out wondering what the damn Ch. 70, ch. 90, Add. Assistance, and Local Aid will be in July (or later) when DLS expects them to set the tax rate in the spring.
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From what I have read, those companies have to repurchase the loan the default rate on mortgages that they wrote exceeds a certain percentage. That’s the problem here — they are being overwhelmed with such requests, and can’t possibly repurchase so many defaulted mortgages.
That’s the answer. Thank you.
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The real bazillion dollar question is whether the mortgage-holders collectively keep or lose their heads. They could, in the face of rising deafults, use foreclosure aggressively. This makes sense if your collateral base is declining in value.
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But this has the effect of depressing real estate values generally, and has the potential of triggering further defaults, which, upon agressive foreclosure, further depress the market, etc., etc. The “death spiral.” RIP Bank of New England.
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The only good news is that this would probably be a rather deflationary influence on the economy, which should decrease the interest rates and may help some people re-finance their way out of the problem. But one sure hopes we don’t get to deflationary conditions: took the Japanese 15 years of pain to get out of that, and they’re not all the way there.
…RIP Bank of New England.
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There were too many regional banks that could not compete against the national ones. That was the reason for the demise of Baybank, BONE, BankBoston, and Fleet. They were absorbed, one by one, and finally into BankAmerica.
Didn’t get mergered away. It collapsed, requiring the FDIC to come in and take over.
…didn’t say why the BONE banks were insolvent, it just said that they were, when Fleet bought them
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http://www.bos.frb.o…
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Interesting page. Note the incredibly shrinking “other institutions” part of the pie charts.
When the FDIC takes over, it separates performing assets from the non-performing. The performing assets are generally sold to a solvent bank. That is why many people remember NONE branches turning intob Fleet virtually overnight. FDIC has many special powers to deal with the non-performing assets, all designed to cut losses and liquidate the assets ASAP. One of the more painful is that it can accelerate and collect on a debt regardless of the borrower’s defenses to payment, even including “Hey, I have made all my payments!” The result was, in the late 80s and early 90s, that certain peopel got a notice out of the blue that they had 90 days to pay off their mortgage or face forelcosure, even if they were current on their payments. It was an ugly situation, and I hope we don’t wind up there again.