The dishonest brokers didn’t care who they approved for a mortgage because they were paid a fee for delivering the mortgage, not for having the mortgage actually work. The dishonest banks didn’t care about who they were approving, because they were planning to sell the mortgage before the first payment was even due. The investment banks that bought the mortgages didn’t care because they were pushing the risk onto MBS purchasers before the borrowers had a chance to default (even if they never made a single payment).
The Federal reserve should have been monitoring all this and should have noticed what was going on. But Alan Greenspan was too much of an Ayn Rand disciple to even consider regulating a market. So the banks went unregulated and free to make a mess with bad mortgages.
The other opportunity for the government to regulate the mortgage industry came from Fannie Mae and Freddie Mac. As the largest purchasers of mortgages, they got to set the standards that banks wanted to meet. The conforming limit represents the largest mortgages that they were willing to buy. But corruption and a desire for increased profits (to increase executive bonuses) led to lower and lower standards at the agencies. Whenever congress started asking questions, they provided the distraction of “look at how many low-income families can suddenly afford housing!”
The free-market self-regulation should have been low ratings on the bonds. How anyone could analyze a bond full of loans to people who provided no proof that they could pay them back and give it the highest credit rating available is beyond understanding. But that is exactly what the credit rating agencies did. With no pushback from the ratings, the investment banks saw no reason to demand higher standards from the banks. People trusted the ratings agencies to do their jobs properly, so they bought the bonds without asking any further questions.
So if that is how the free market failed to work, how can it be made to work better?
The first thing that should be done is to no longer allow anyone to pass on the risk completely. At each step of the way, anyone involved in approving or selling a mortgage should be required to hold onto some of the risk. The mortgage brokers should be required to put in some money to keep them honest. The banks should be required to hold a portion of the mortgage junior to what they sell (meaning that they take the first loss). The investment banks should be required to take a junior holding in their securities.
And then there are the credit rating agencies. Clearly something is wrong with them. They completely failed in the entire mortgage bubble. The only way to keep them honest would seem to be forcing them to take on some of the loss whenever they overrate a security. At the same point, even some AAA securities are expected to default. Perhaps their fee structure could be set up so that they will only make money if they accurately forecast the probability of a bond defaulting. Perhaps they should be fined for every bond that fails, with the fine being based on a formula that includes a term that shows their expected probability of default. So for example, if they estimate that a bond has a 4% chance of defaulting, then they would have to pay a fine of 20 times their fee if it does default. If they are correct or overly conservative, then they make money. If they underestimate the default risk by very much, then they will lose money.
Fannie Mae and Freddie Mac should have standards that are based on reasonable affordability guidelines. They should calculate an affordable payment based on the borrowers documented income. They should reject no-doc loans under all circumstances. Then they should refuse to buy any loan which has a maximum feasible payment (so at the highest possible adjusted interest rate for ARMs) below the affordable guideline. They should also require a downpayment paid with funds from the borrower, since that has been shown to reduce the risk of defaulting.
Deregulation let the housing bubble get out of hand. We need to reregulate the mortgage market to ensure that it doesn’t happen again.
Each of your laments is a righteous and valid sentiment with which I agree. Wholeheartedly. Shoulda coulda woulda.
<
p>Yet, every one of your statement belies your lack of understanding of how the home mortgage operates.
<
p>Brokers are simply sales intermediates who bring potential borrowers to the market. They do not approved the mortgage applications. They do not lend the mortgage proceeds. The simply “originate” the loan. Can’t blame them.
<
p>Banks, investment or commercial? Unlike 15 years ago, few if any loans are held in the basement of Bailey Savings and Loan. They are bundled, repackaged, and sold through investment banks as mortgage backed securities around the world. These investment banks are only providing a service (syndication) and a product (derivatives based upon mortgages.) Can’t blame them. They didn’t approve the loans.
<
p>Who then should be blamed?
<
p>How about Fannie and Freddie? They are the ones who, for the most part, set the mortgage lending standards. Every mortgage I’ve taken has always met FNMA standards. Conforming or Jumbos.
<
p>Except, under political pressure, Fannie and Freddie dropped their standards and allowed for the underwriting of sub-prime mortgages across the board … “stated income” loans, no-doc applications, sub-primes, ARMS, soft-second programs.
<
p>Who allowed this? Congress allowed this. Republicans and Democrats but a lot of Democrats:
<
p>
<
p>So before you start whining for “more regulation”, please stop to consider the government’s role in birthing this mess.
<
p>And more “regulation,” does that mean we return underwriting standards of 1985? I, for one, would look forward to the days of requiring 20% down, meeting a 28% AGI threshold, providing proof of employment, and submitting paystubs and 3-years of tax returns.
<
p>But, then again, I’m well-off and can afford this.
<
p>How ’bout you?
In 1999, I bought my first condo with 3% down.
<
p>I was introduced to that option through a home buying course in Boston. I needed to complete that course and meet with a financial counselor prior to getting my loan.
The amount of the downpayment was the only difference from conventional requirements. I still needed to prove employment, submit paystubs and tax returns.
<
p>I also had to pay for mortgage insurance until I reached 20% equity in my home.
<
p>Were these 0% loans given without any education? Where does the mortgage insurance come into play in all of this? I thought it was there to protect lenders.
<
p>The 80/20 loans were invented to avoid the PMI. The 80% is the 1st; the 20% is the 2nd and bears a higher rate. Same with the 80/10/10 loans. Then, to compete, a lot of companies were waiving the PMI. Also, remember that AIG was and is pretty big in the mortgage insurance market.
I do like the requirement from jkw that originating banks take back a positions in mortgage sold, however Agency sold loans originating at banks is only a small portion of the problem. Also, I can’t find the statistics, but I think there are a large number of mortgages sold to FNMA where the originating institutions have already guaranteed the default rate. Right now that uncertainty is complicating the credit crunch.
<
p>It does appear that the Agencies, and lack of oversight both DEM and REPUB were the epicenter of this entire problem because they just kept buying the stuff, because that was why they were created. I’ve recently thought they should bust them up into little Freddies and Fannies, and pull the government credit line over time–a dozen or so–so there’s some true repurchase competition in the future.
Thank you for a partisan-bias-free evaluation of what went wrong. I have been shotgun blasting our entire Congress for not paying attention to the problems but I appreciate you putting some sniper shots in there. The good news in looking at your comments is after we solve this credit problem we can allow banks to go back to work lending money but with a clear eye as to who gets money and how much they get.
<
p>In addition to your observations and suggestions for mortgages from this point on… I would like to suggest that we also go back to the practice of mortgagees getting a lawyer before they sign any dotted line. My first few home purchases were reviewed by “my attorney” and not just the bank’s lawyer. Had this practice been continued, many many loans would have been stopped before they started.
<
p>Do the country a favor and publish your observations/comments where the greater public can see them.
Did you actually read my post? How can you claim that I don’t know how the mortgage markets work and then describe it almost exactly the same way as I did?
<
p>Here’s what I wrote:
<
p>Here’s what you wrote:
<
p>So it would seem that we have the same understanding of the mortgage market. The only difference in our descriptions is that I claimed that the banks were holding the mortgages for a few weeks at most, while you didn’t specify how quickly they unloaded them.
<
p>Then you go on to say that Congress allowed this mess by lowering the lending standards set by Fannie Mae and Freddie Mac. Again agreeing with me. At this point I’m really not sure that you have sufficient reading comprehension skills to have an intelligent conversation online, but I’ll try anyway.
<
p>The problem extends beyond Fannie Mae and Freddie Mac. Otherwise it would have been solved by taking over those companies. The government did not force any banks to make loans. The government did not force the investment bankers to produce CDOs. I seriously doubt you would be able to find any banker that was complaining in 2004 about how much money they were going to lose because of the bad loans the government was forcing them to make. The banks were happily going along and writing as many loans as they could. The free, unregulated market did not self-govern effectively. If we don’t do something about that, then this will happen again.
<
p>My proposed regulations do not specify underwriting standards. They specify that the parties who approve a loan should have to suffer losses if the loan doesn’t work out. Banks would still be allowed to give people loans without knowing how they will repay them. They just wouldn’t be able to dump the risk onto someone else.
<
p>I also proposed having the agencies only buy loans that could reasonably be considered affordable. I didn’t propose specifying that they had to be fixed rate or for some specific term. Just that under worst case scenarios the maximum monthly payment would never go above some reasonable concept of affordable. For ARMs, that would mean looking at how high the monthly payments could go if interest rates rise drastically (every ARM I’ve seen has caps on how much the rate can adjust). The government should not be granting loans to people that won’t be able to repay them. It wastes taxpayer money and hurts the people getting the loan.