60 Days to Tighter Lending?

Submitted by Rich Toscano on August 29, 2006 - 12:41pm

Fellow blogger Calculated Risk, who has tenaciously followed the developments of the federal regulation on non-traditional mortgages, tells us that the guidelines will be put in place within 60 days.

For those who are unfamiliar, I wrote a piece on the new lending guidelines back in December when a draft version was released.

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Submitted by IONEGARM on August 29, 2006 - 12:47pm.

I'm trying to figure out how this wont be the final nail. Unless the government completely waters down their proposal, the credit tightening will just blow out the market.

Submitted by John from Doom on August 29, 2006 - 12:53pm.

I was appalled a couple of weeks ago when I learned that private label lenders had been "stealing F&F's lunch" (their assessment!) by taking on the large proportion (well over half) of loans during the bubble that didn't meet the GSEs' standards. Now the regulators are (rather desperately) trying to put this process into reverse before Congress is faced with the prospect of an impossibly large bailout. Will they have enough time is the question. The bubble is unwinding awfully fast.

Submitted by John from Doom on August 29, 2006 - 1:13pm.

OCC 21Mar05 backgrounder. Your post from last December looks pretty good. Just 1 comment, though. The issue is certainly hotter in August! Six months prior to your post acting/OCC Julie L. Williams made these remarks (PDF), where she's saying "c'mon, guys, tighten up!" I should have been paying more attention then.

Submitted by no_such_reality on August 29, 2006 - 1:15pm.

It won't have any impact.

In fact, it'll allow the mortgage brokers to work a bigger spread because it'll essentially take the major banks and CU's out of the game.

Submitted by IONEGARM on August 29, 2006 - 2:39pm.

If the GSEs wont take the loans on the secondary market, and the banks wont be allowed to take them, that significantly tightens up the people underwriting them.

Submitted by tickets on August 29, 2006 - 4:40pm.

It's guidance. It's not a regulatory prohibition. Depositories will respond by cutting back 10% or 20%, or tightening up the underwriting a little. You can't have the loan with 5% down, but you can with 10%. Are you sure that the private label market can't absorb 10% of what the depositories are doing? If it can, then this won't have much effect.

Submitted by no_such_reality on August 29, 2006 - 4:42pm.

"If the GSEs"

That's a big if. A large portion of the credit bubble is due to the trade imbalance and the desire of the import partners to continue the US consumption engine.

Submitted by IONEGARM on August 29, 2006 - 4:49pm.

What do the GSEs have to do with our import partners buying mortgage debt?

Submitted by powayseller on August 29, 2006 - 5:09pm.

guidance means nothing. to have an effect it must be requirement for banks and private lenders.

does the gov't control private lenders - i think not; they can only give guidance and regulation to banks.

h&r block's option one, etc. won't be affected right? They are the worst culprits. as long as mbs buyers exist, the private lenders will make the loans.

anyway, it's too damn late. the bailout is in the pipeline. Think $2trillion or more.

it's very disappointing that this necessary proposal is merely GUIDANCE. IT WILL BE IGNORED. guidance means voluntary.

Submitted by rockclimber on August 29, 2006 - 6:03pm.

What do you mean by, "... the bailout is in the pipeline" ?

Submitted by MaxedOutMama on August 29, 2006 - 6:29pm.

This will not have near as much effect as most folks think. Most of the loans that are being edged out are not being written by the institutions subject to these line of authority by regulators, and the regulators already have the authority to shut down lending programs under safety and soundness exams for the institutions subject to them.

And they do. What will have far more effect on practices at these institutions will be when the examiners pull up a chair and start examining appraisals for properties securing their loan portfolio.

The concentration of bogus loans lies outside of the the traditional bank/GSE pipeline. Within the last five years there has been a radical change in the national real estate market. The regulators don't control this market. Greed and uninformed investment does.

I recommend this paper:

Btw, it's not that banks won't be hit hard by the downturn, and I can personally testify that some banks have been unwilling to recognize the risks of lending in this market. In part that is because if they tighten their standards, they have a non-bank competitor down the street who will get the loan or LOC. And for certain product lines, such as HELOCS, you can expect the risk factors to increase with age, so to balance your risks you want to keep writing new ones.

Submitted by MaxedOutMama on August 29, 2006 - 6:42pm.

Powayseller, you are correct that the regulatory agencies don't control this aspect of private lending. Congress would have to pass a new law to give them the legal authority.

You wrote: "it's very disappointing that this necessary proposal is merely GUIDANCE. IT WILL BE IGNORED. guidance means voluntary."

First, guidances on these topics were published and are in effect already. They aren't ignored, but can be complied with by balancing risks. This is basically a safety and soundness issue.

Second, what outsiders don't understand is that the agencies know very well that imposing too-stringent guidelines might worsen the position of both banks and increase the riskiness of private lending by making it temporarily more profitable due to lowered bank competition.

For example, let's say the agencies put out a standard saying no more HELOC's at greater than 90% LTV. Well, the REIT down the road will write it if the bank can't and the borrower wants to get it. This shifts more risk to originators subject to less scrutiny and regulation, and means that the regulated entities cannot compete in a marketplace in which their better credit risks can pay down or refi their HELOC's elsewhere. Their portfolios end up degrading, and ultimately those taxpayer-guaranteed deposits are at risk at some institutions.

I believe Congress needs to act.

Submitted by carlislematthew on August 29, 2006 - 8:01pm.

This is very welcome news indeed! I humbly recommend that we implement this in early 2004, if at all possible...

Submitted by nhamlin on August 29, 2006 - 8:40pm.

I am successor trustee for an estate that includes several low end condos and single family dwellings. I am in process of liquidating these properties to settle the estate. The way these deals are put together makes my hair curl. I had become accustomed to transactions where buyers came in with a few thousand dollars and the seller credited as much as $10,000. I have a done enough of those that they seem normal.

I recently received an offer with a $1.00 good faith deposit! When I suggested at least $500 I was told that the only way the buyer could come up with that kind of money would be to go to an ATM and put it on a credit card. That would have made their credit look worse and might have kept them from qualifying for the loan. That transaction actually closed!!

The only thing supporting the high price of San Diego housing is the high price of San Diego housing. When foreclosures go up, lenders will tighten lending standards and increase down payment requirements. That will decimate the low end of the market

A slight tightening of lending standards at the bottom of the market will bring the gravy train to a halt.

Consider the San Diego Market that has been propped up by speculators andfunny money financing for so long. Imagine a real estae market that depends on people who are able to make a reasonable down payment and actually want to live in the property they are buying.

Norman Hamlin
nhamlin [at] pacbell [dot] net

Submitted by no_such_reality on August 29, 2006 - 9:22pm.

It's not so much that FF&G won't buy, they probably won't under the guidelines. I don't know if that will really tighten supply. Part of the reason money is so cheap is our trading partners, or more accurately, other countries that dump their cheaply manufactured goods on the US consumer, flood the credit market.

Submitted by powayseller on August 29, 2006 - 9:59pm.

rockclimber, I mean that it's too late for the guidance; the damage of loose lending has been done, and the consequence will be a huge government bailout of any large entities hit by MBS losses (pension funds, GSEs, companies' pension funds), and the derivatives collapse. Even if the guidance were a requirement, and effective tomorrow, it won't matter, because the collapse of the subprime lenders and banks such as WaMu and GMAC and others, is in the pipeline, and so is the gov't bailout. I am guessing we will be surprised how deep the tenacles of the derivatives and hedging run throughout our economy.

Submitted by powayseller on August 29, 2006 - 10:01pm.

Maxedout, since the guidance was issued, loans have become even more lax, as lenders have made it easier for anyone who hadn't bought a house already, to do so. What do you mean the rules are being followed? As nhamlin wrote, the one guy couldn't even put $500 down on the condo, and got the loan anyway.

Submitted by CAwireman on August 29, 2006 - 10:54pm.

Since financial institutions are governed by Sarbanes Oxley and a) If publicly owned, must comply or b) if they have public debt, must comply; then, this new guidance could be forced upon banks to pass SOX audit. SOX and GLB are forcing all manner of best practices upon companines, like it or not.

If somehow the new guidance holds water, it forces lots of people out of the home-buying market becuase the exotic loans were their only hope of qualifying - thus, inventories continue to rise as buyers are set adrift. More sellers are stuck with property, walk away, or are foreclosed upon.

Its shutting the barn door after the cows have left the building. But, if it pans out, it would protect people
(more so than today at least) from buying in over their heads. (Protects future buyers, hurts current sellers) and deals the final blow to the housing market.

Submitted by MaxedOutMama on August 30, 2006 - 4:17am.

All public companies are governed by SOX. That's true.

But the regulators don't have the legal authority to tell non-chartered financial institutions what to do, as long as they comply with the laws now in effect. Auditors can and well identify weaknesses in portfolios, but they cannot proactively prescribe lending rules. Because of the bubble, those financial weaknesses are only now beginning to emerge. To put it bluntly, there was little risk to the institutions in writing loans that were bad when they knew the borrower could turn around and sell the house to cover the loan even if it was a 100% financed and adjusted after a year or two to terms which the borrower was never going to be able to meet. Furthermore, when the REIT's were selling off these loans they didn't have a risk that an auditor could identify. Now as that begins to become more problematic, they do.

Many institutions which are writing these loans are not regulated by FRB, OCC, NCUA, OTS or FDIC. These interagency guidelines have no effect on them. Many lenders are not banks, or thrifts, or credit unions. FTC is the only regulator of such institutions and it doesn't have the same degree of authority. Furthermore, most of these non-conforming loans aren't going through the GSE's. They are being financed through MBS, and written by unregulated institutions. Not all, but most.

Submitted by John from Doom on August 30, 2006 - 6:36am.

maxi thanks for bis link. That Bank of International Settlements article nicely summarizes the important change in structure and quality of mortgage loans during the bubble.

Submitted by MaxedOutMama on August 30, 2006 - 7:02am.

Yes - and that's where the doom comes in. The traditional GSE/conforming market has largely governed the mortgage market in the US since the aftermath of the Great Depression. It was set up because of the collapse of the financial system during the Great Depression. And every time those basic standards have been violated (like the neg-am mortgages during the inflationary 80's), the results have been poor long-term.

This sudden and dramatic change in the mortgage financing system in five years is fraught with bad consequences and clearly evident risks. The problems of the GSE's are well-known, but really only because of the regulatory structure. There isn't a regulatory structure in place for more than half of the current mortgage market.

Furthermore, the damage won't be limited to the irresponsible lenders or the irresponsible buyers, because I think we are going to see a net decapitalization of a segment of consumers that were responsible. If you saved up a 20% downpayment, got a 30 year fixed-rate and bought in 2004 in many markets, you may well lose it all if you have to change jobs in 2007 or 2008. The loss of confidence and capital will be a drag on the economy for at least a decade.

Submitted by rockclimber on August 30, 2006 - 9:28am.

It's obvious a lot of you are "in the biz." So, here's a simpleton thought from someone in a different biz...

The problem seems to be that the loan originators don't carry much (or any?) risk burden.

I'm perfectly happy to let anyone, anywhere, take on any type of loan that anyone is willing to give them no matter how stupid it is... IF the person selling the loan (or institution they represent) has a financial stake in the loan being repaid.

In this situation it seems that regulations would not be needed.

Is the current environment of loans being bundled and sold as bonds on Wall Street really an improvement over the old days where the local bank took local money and loaned it out to local folks buying local property?

Submitted by MaxedOutMama on August 30, 2006 - 5:28pm.

Rockclimber, you wrote: "The problem seems to be that the loan originators don't carry much (or any?) risk burden."

I agree that a closer linkage of risk to decision to make the investment would instill more caution. However, the GSE system was set up in the wake of the Great Depression precisely to spread risk around, because in the environment investors simply would not lend and take all that risk.

I think the fix is that the market is becoming more leary of these investments. Buyback guarantees, etc, are becoming the norm. However the average borrower should receive far more detailed disclosures under law than they do now. They should receive sample amortization schedules, etc, for different payment streams. In quite a few cases, people don't understand what is going to happen. They are accustomed to looking at payments, not overall debt load.

I am very worried about what is going to happen to the small business market. We have a ton of small businesses and many proprietors do use their homes for working capital. (A lot of early, unwilling retirees work as consultants, for example.) What is going to happen if we have a severe credit crunch? I don't think anyone can properly predict the effect three years from now.

Submitted by tickets on August 30, 2006 - 6:00pm.

rockclimber, I'll disagree and probably get flamed. On several different grounds. First the idea that requiring originators to have a stake would make much difference. The unspoken presumption is that investors are being fooled, and that requirement would unfool them. I'm not so sure that the premise is true. I think people can buy conservatively underwritten MBS for low spreads, and some do, and others buy crazily underwritten MBS for high spreads. Whether or not they are fooled, a requirement that the originator hold a piece of the risk probably wouldn't fix things. Right now you can invest in risky mortgages by buying MBS from a risky originator, or by buying shares in a REIT that originates and holds risky mortgages. If people are fooled into buying the risky MBS, why can't they be fooled into buying the risky REITs? And the risky REITS meet your criterion. They originate the mortgages and hold a piece of the risk. So, unless there is some reason that an MBS structure makes it easier to fool people than a REIT structure, I predict that the market would simply shift from less MBS into more REITs if your proposal was adopted.

But my bigger disagreement is with the presumption that any loan is OK, so long as there is a willing and informed lender, and a willing and informed borrower. Foreclosures result in a lot of cost for the neighbors - weeds and trash, junkies and arson, unpaid property taxes. There's already one town in Indiana that started the process of passing municipal regulations against investors (only to be dissuaded), on the grounds of preventing foreclosures. My guess is that local governments will eventually want to limit toxic lending because of the damage it causes, not necessarily to the borrower or lender, but to the neighbors.

Submitted by MaxedOutMama on August 30, 2006 - 6:31pm.

tickets wrote: "But my bigger disagreement is with the presumption that any loan is OK, so long as there is a willing and informed lender, and a willing and informed borrower. Foreclosures result in a lot of cost for the neighbors - weeds and trash, junkies and arson, unpaid property taxes. ... My guess is that local governments will eventually want to limit toxic lending because of the damage it causes, not necessarily to the borrower or lender, but to the neighbors."

An excellent point. It's well documented that predatory lending will depress the prices of property overall in an area once it reaches a threshold level. As to ticket's solution, we now come into the great preemption debate. Because of various banking laws and the interpretations of them by the courts, state and local efforts to regulate many banking-type activities are legally limited. There is a Michigan case challenging the preemption exemption for a mortgage company that is a bank subsidiary which will be heard by the Supreme Court next year sometime. I have read it, and many of the briefs, and I don't think the the SC's eventual ruling will do enough to correct the situation.

I would very much like to see forums like these, with such an educated and varied active membership, discuss the consequences of current law. I think the era of wild, wild west lending will cause very widespread economic damage to the US over the next five years, and I think that restoring consumer confidence is crucial to mitigate that. However, to do that I believe federal legislation is necessary.

I believe in free markets, but a free market operates efficiently only when accurate information is available to all of the participants. I think information dissemination has not worked properly, and that an imbalance of power has developed which should be redressed.

Submitted by powayseller on August 30, 2006 - 8:31pm.

maxedoutmama, can yo e-mail me at schberkland [at] sbcglobal [dot] net? I have some MBS questions for some research I am doing.

Submitted by rockclimber on August 31, 2006 - 9:33am.

Very good points, worthy of consideration.

Submitted by powayseller on August 31, 2006 - 11:03am.

Nearly half of the homebuyers and thirty percent of people refinancing mortgages in California chose interest-only loans last year, according to research firm LoanPerformance.

If the lending guidelines are enacted as they should be, then 50% of homebuyers and 30% of refinancings are turned down.

Think that could happen?

Submitted by mbanker on September 6, 2006 - 1:03pm.

There are certain stop-gaps with front-line originators, despite the fact that mortgage brokers exist relatively unregulated. Case in point, I know of 2 loan officers here in San Diego who are now sitting in federal prison for mortgage fraud. These 2 are the stereo-typical 20-something bling-meister shiest-em-in-hell loan hacks that made millions in the last 5 years, probably by doing a lot of lucrative pay-option ARMs. I also know of a couple broker/banker shops that abrubtly closed their doors when they had to re-purchase sold loans. This is another ice-berg tip beginning to grow. Mortgage fraud/re-purchase demands. As with the dot.com bust, when the tide turns and the money stops flowing and the bleeding can't be stopped, people start going to prison. Unless you have $400 million to pay off the Feds.....

Submitted by RLA on September 6, 2006 - 8:10pm.

Would someone please provide information or a link that explains the guarantees that maortgage bankers or brokers are typically required to give on loan originations? Are most loans that are sold as MBS or other securities requiring a guarantee for some time period after the loan is funded or sold in the secondary market? Thanks for the info

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