The Mortgage Guy Blog

For months the Mortgage Guy has been fighting the flawed perception that those most culpable for the mortgage meltdown are the buyers, realtors and mortgage originators. Conventional wisdom would have you believe they are most and directly responsible for the real estate meltdown and the mortgage crisis.

My contention is that the home buyers, real estate agents and mortgage originators are being wrongly blamed for the mortgage meltdown. Sure they played a part, but I believe their respective responsibilities for the debacle is minimal and leaning toward innocence in nature and intent.

All political and regulatory emphasis to date, has been put on either adding to already burdensome lending regulations or bailing out the “greedy” home buyer. That is until the Securities and Exchange Commission set their sights on the mortgage securitization process. This is where the biggest, most serious and harmful crimes were committed.

A look at this recent Yahoo News article will give you an idea as to what the SEC is concerned with.

The Securities and Exchange Commission is investigating how banks, credit rating firms and lenders valued and disclosed complex mortgage-backed securities that ultimately led to the subprime crisis, a top agency enforcer said on Saturday.

The article points out that while the SEC didn’t name the companies involved, Merrill Lynch and Morgan Stanley have disclosed regulatory investigations pertaining to their role in the credit crisis. In all, there are over thirty firms being looked at. It goes on to say…

Banks, due diligence firms and credit rating agencies are being examined for their role in the securitization process, or how mortgages were sold, repackaged and bundled into special financial products.

The SEC is looking at the valuations and accounting treatments of mortgage-backed securities. It is looking at whether the securities were valued correctly in the first place, what was the level of risk and if that was adequately disclosed to shareholders.

In my opinion, the investment banks, with help from others, committed the fraud of labeling credit standard deficient loans as AAA investment grade paper. By doing so, they were able to feed a huge hunger for safe but uncharacteristically high yielding investments. Feeding this appetite for high yet safe yield, allowed for the spread of this toxic paper all over the world.

The investment banks could not pull off the crime of the century without having ample assistance. This is where the ratings agencies and due diligence firms/departments come into play.

It is up to due diligence entities to properly assess the risk and suitability of investments. Apparently, based on the total destruction of our credit markets, these due diligence “experts” couldn’t see that by mixing a pot of AAA mortgages with a pot of DDD mortgages one cannot expect an investment pool deserving a AAA rating as the end result. This is so even if you take into consideration that they bought “insurance” on the portfolio.

The final gate keeper responsible for safeguarding the investment public from misdeeds such as these, are the credit rating agencies. These so called “independent” firms really have the final say as to the grade of any debt security. Yet they also couldn’t see that an investment portfolio with a major exposure to credit standard deficient mortgages should not be rated AAA in safety.

A reasonable person would wonder why the ratings agencies would implicate themselves in what turns out to be the total destruction of our debt markets. The answer is the same for all involved. Money.

At S&P, for instance, no longer will they hand out triple-A’s to issuers who pay them boatloads of fees. They now will employ an ombudsman to listen to complaints about the agencies handing out triple-A’s to issuers who pay them boatloads of fees.

What if General Motors built cars that didn’t run, or your local dairy produced sour milk? What if your bank said it didn’t deposit your paycheck because it lost it, or the electric company just quit supplying your neighborhood?

Then, in response to it all, those companies said: good news, we’re hiring an ombudsman. The ratings agencies in the same fashion have failed on their intrinsic purpose: to judge the likelihood that a debt will default. As of Tuesday they’re about 0 for a few billion.

The quote is from an excellent MarketWatch article that gives insight into the role the ratings agencies played in the destruction of our credit markets. I owe a huge hat tip to The Common Sense Forecaster for bringing my attention to it.

It’s important to realize that events leading to the mortgage meltdown occurred on a “top down” basis. Buyers cannot buy from realtors unless mortgage originators have the loan programs to fit the buyer’s profile. The mortgage originators cannot offer loan programs unless lenders are providing them. The lenders will not provide loan programs unless the securitizers can turn the mortgages into marketable securities and the ratings agencies have the final say as to the grade (the likelihood of default) of those securities.

Proof for this observation is the current state of the mortgage industry. Despite the current demand, no longer are 100% financing for credit damaged borrowers and stated income and asset programs available. This is because lenders cannot securitize these types of loans. They cannot securitize these loans because it has become painfully apparent to investors that these once called AAA investments are nothing of the sort.

Also evidenced by the current state of the mortgage industry, is that without the securitization of mortgages, no one lends and thus, no one buys real estate or borrows money against their house. This makes it clear that it is the securitization engine that drives the entire mortgage process and in turn the real estate markets.

The demand still exists for 100% financing, no income, no asset loans and subprime/alt A loans in general. Being that these programs are no longer available, makes clear that the mortgage business is not driven from the bottom up. The demand is still there, yet it goes unanswered because the securitizers cannot sell the mortgage backed securities. The business is indeed driven by top down forces.

Realizing that the mortgage industry runs on securitization, it’s plain to see who the real criminals are in the mortgage crisis. It is clearly the securitizers, due diligence firms and ratings agencies. They are the major force behind the mortgage industry and it’s destruction.

Without the securitizers lying about the credit quality of the subprime mortgages being securitized, and the winks and the nods from the due diligence firms and ratings agencies, the securitizers could have never sold anywhere near the amount of toxic debt that has been polluting investment portfolios and economies around the world.

The fraud committed by these criminals created the immense capital that led buyers and originators to use the unsuitable mortgage products that have led us into this world wide crisis. They enabled the lenders, originators, realtors and buyers in committing their misdeeds which have led to the total seizing of our credit markets. This in turn has thrust our economy into recession and potentially much worse.

Now it should be clear to all, the buyer, realtor and originators were simply responding to demand that was met by capital that was fraudulently raised. All the buyers wanted was a piece of the “American Dream”. Realtors sought to help them get it and the originators were empowered to provide the financing by the capital raised through fraudulent means.

These subprime/alt A, toxic loan programs simply appeared on our rate sheets. The guidelines specifically allowed for damaged credit, no down payments, no proof of income, assets and in some cases no proof of having a job. There was no fraud involved because the product guidelines allowed for these aspects specifically.

Originators who realized these types of loans were time bombs waiting to explode, could not refuse to sell them. If they did, the consumer would just go to another originator offering these programs. Believe me, there were many originators who saw the writing on the wall two to three years ago. Yet we were powerless to do anything about it. It wasn’t our money being lent, thus we had no say and market forces worked against dissent.

It’s time to end the mis-perception that it was the greed of buyers, realtors and originators that led us into the subprime/credit crisis. Yes to a degree this element played a part in the dilemma but this is not the real cause of the meltdown. It was the titanic greed of the securitizers and their “assistants” that fraudulently created the capital and market forces that have led us to the historic break down of our credit markets and economy.

The first step in restoring confidence in the debt markets shouldn’t be bailouts for the investment banks and insurers. Nor should it be bailing out homeowners through rendering legal contracts as useless. The healing will begin when the real criminals are outed and the perp walks proceed down Wall Street.

Then the world will know our markets are governed by the rule of law, one set of laws for all and no one above the law, as opposed to political cronyism. The perception of political and regulatory cronyism will undoubtedly taint our securities markets forever. This will further weaken the United States’ ability to be a world class economic player.

Tags: Current Events, Finance & Economy, Mortgages, Real Estate by The Mortgage Guy
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For a while now the Mortgage Guy has been posting that our product shelf is about 20% of what it used to be. Further we’ve stated that underwriting requirements (credit standards) have been tightening on all types of mortgages and that this trend was spreading to credit cards and consumer debt. The Fed released a survey yesterday that documents these very disturbing trends.

Banks are raising their credit standards for mortgages, consumer loans and commercial real estate loans at a pace never seen in the 17-year history of the Fed’s quarterly survey of senior bank loan officers, the Fed said.

Plain-vanilla business loans were also much harder to obtain, the Fed said. Banks expect more delinquencies and charge offs for most types of loans to consumers and businesses, the survey said. Banks said they were tightening their lending standards in response to weaker economy, reduced tolerance of risk, and decreased liquidity in secondary markets.

Consequently, we’ve been urging our clients, both current and prospective, not to delay any financing activity that they have been contemplating. Such as refinancing to make budgets more manageable for the rough times ahead.

One of the biggest reasons for the current procrastination on borrower’s parts, is the prospect for even lower interest rates in the future. We feel this could be a trap. By waiting for lower rates, home values continue to decline and credit standards continue to tightened dramatically.

Any potential gain from lower interest rates can be more than offset by falling home values and tighter credit policies. Waiting for lower rates not only can make refinancing more expensive, it may make it impossible.

This is also from the Fed survey…

For consumers, banks are tightening up on all types of mortgages, not just subprime loans. And banks are less willing to approve consumer installment loans.

More than 80% of banks - the largest percentage ever — said they had tightened lending standards for commercial real estate loans in response to a weaker economy. Nearly 60% of the banks reported falling demand for commercial real estate loans, and 87% expect the quality of such loans already made to worsen.

Clearly the United States is entering a very severe and equally dangerous credit crunch. It started in subprime mortgages and spread to all types of mortgages and now it’s spreading to installment loans and credit cards. Credit card issuers have tightened their standards just like the mortgage lenders as evidenced by this article in the Wall Street Journal.

Big card issuers such as Citigroup Inc. are requiring higher credit scores before issuing new cards, particularly in states that have been hit hard by the housing downturn, including California, Arizona and Florida. Some lenders, including Bank of America Corp., are offering lower initial credit lines. Other lenders, such as Capital One Financial Corp., are limiting credit-line increases or reducing credit lines for existing customers if they see signs that they are suddenly applying for more credit or are having trouble paying down their balances. And many card issuers are raising late fees and other charges to help offset what they see as higher risk.

Also from the article, this synopsis of various credit card lender initiatives.

Naturally, for an economy that is already reaching recessionary levels, these developments prove to be quite serious. John Mauldin at Minyanville states the following about recessions and depressions.

I have long contended that a recession is a normal part of the business cycle, but it takes a major policy mistake by a government or central bank to create a depression.

The Mortgage Guy has maintained that this recession is due to systemic causes rather than cyclical causes. In our view this recession is being brought on by debt markets that are not functioning properly or at all.

We have criticized the Fed, the Treasury Department and politicians for focusing on monetary policy and stimulus packages as opposed to focusing on the dysfunctional credit markets. Lenders, at this point in time, cannot effectively securitize the loans they are originating thus they are cutting back and refusing to lend.

Monetary policy won’t work in this environment because with failing debt markets and banks refusing to lend, there is no way to get the cheap money that a loose monetary policy provides, to the people who need it most.

Could this be the “major policy mistake” that morphs this recession into a depression? We think it could be and history is our guide. Consider this snippet from Wiki on the Great Depression.

In the face of bad loans and worsening future prospects, banks became more conservative in lending money. They built up their capital reserves, which intensified the deflationary pressures. The vicious cycle developed, and the downward spiral accelerated. This kind of self-aggravating process may have turned a 1930 recession into a 1933 depression.

These parallels are much too close for comfort. What is even more disturbing, is that as I write this today, there is still a lack of attention to our malfunctioning credit markets. All of the initiatives put forth so far by Congress, the Fed and Treasury Department all focus elsewhere and we think this is a major mistake. Perhaps the mistake that transforms the current recession into a future depression.

We have a lot of rough sledding ahead. Will you be prepared or will you become a victim? Now is the time to take a hard look at your financial situation and to make adjustments accordingly. Your financial alternatives are shrinking everyday.

Just because you might be the proverbial AAA rated borrower, doesn’t mean you won’t be affected by this credit squeeze. I’ll close this post with how the Fed Survey illustrates this tightening of credit standards affects all borrowers.

More than half of the banks tightened their standards for prime mortgages, by far the highest percentage in the 17-year history of the survey. Seventy percent expected the quality of prime mortgages to worsen.

More than 80% of the banks tightened their standards for nontraditional loans, including jumbo loans and other loans that do not conform to standards set by Fannie Mae and Freddie Mac. A similar percentage expected more delinquencies.

For subprime mortgages, about 70% of banks that offer such loans had tightened their lending standards, but more than 90% of the banks responding to the survey said they do not offer any subprime loans.

About 60% of banks tightened their standards for home equity lines of credit.

Tags: Current Events, Finance & Economy, Mortgages by The Mortgage Guy
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Due to the holidays, year end house cleaning and illness, I haven’t posted in a couple of weeks. Well the new year is here and having taken care of the above issues, I am back to posting.

The question mark in the post title is no accident. This will be, without a doubt, the most challenging year we have ever faced in the mortgage industry. Will it be happy? Only time will tell.

The mortgage industry continues to shrink with the lender implode list reaching 210. Subprime product offerings remain slim. Essentially, there is no subprime as we once knew it. I have clients and friends that I cannot help due to products being discontinued. It literally keeps me up at night, knowing that a year ago, their problems would be solved but now they will only get worse and there is nothing I can do about it.

Alt A isn’t much better. The jumbo price spreads remain unusually large and product offerings in this class of loans are shrinking like the subprime offerings.

That leaves conventional loans. Fannie and Freddie pricing is pretty attractive right now. However, underwriting in this class of loans has tightened significantly as well. We are not an FHA shop so I won’t address that market other than to say, it’s not a panacea for the ills the industry faces, not that anyone said it was.

Let’s not forget that mortgage lending is collateral based. The collateral being real estate, the value of which is plummeting at record paces. Without adequate collateral, mortgages cannot be made. I don’t know how far real estate prices will fall but I can tell you this. Until the mortgage industry is repaired, values will decline in a historic manner.

In order for this year to be good for the mortgage industry, the process of securitizing mortgages must be repaired. The mortgage industry cannot survive without it. Real estate prices will need firm up as well. However as long as the mortgage industry is broken, that will not happen.

Another ingredient for a good year is for our government leaders to get a clue about what is going on and how to deal with it. Every government action to date clearly miss the marks needed to turn the situation around. Their so called solutions reveal their total lack of understanding of the situation at hand. It’s all show. “I care so re-elect me.” Meanwhile their actions will shrink an already devastated industry making consumer choices fewer and more expensive. It’s good thing they care.

Let me just say that when I started this blog it wasn’t my intention to become a gloom and doomer. That isn’t my nature. I am and always have been a “can do”, optimistic guy. But I am foremost a realist. I accept reality at face value in order to deal with it efficiently. The reason for the negativity in this blog is because in reality, we are faced with a very negative outlook.

There’s more to come. So let’s work at making 2008 a happy year. Good luck, we are all going to need it.

Tags: Current Events, Finance & Economy, Mortgages, Real Estate by The Mortgage Guy
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If it makes for good press, you can bet your last dollar that politicians will jump on the band wagon. This is so even if what makes good press, is a disaster in disguise. Saving people’s homes from foreclosure is good press.

Having said this, does it come as a surprise that Hillary Clinton is joining the chorus for a socialistic mortgage bailout? If it does, it shouldn’t. The following is a 4 minute video of Clinton’s speech to Wall Street, brought to you by Marketwatch.

Hillary Clinton’s Financial Ineptitude Documented

Some of her statements are correct. For example, Wall Street’s role in the mortgage meltdown and that it will impact the broader economy. However, she goes downhill fast after that.

Here is where she is dead wrong with her most dangerous statements listed first.

• Her threat to introduce legislation to disallow mortgage backed securities investors from suing. This will undoubtedly destroy mortgage securitization which is the backbone of the industry. Who will buy mortgage securities knowing that the government can change financial contracts on a whim and without the investors having any legal recourse? Is this even Constitutional?
• The ninety day moratorium on foreclosures is nearly as dangerous. Perverting the foreclosure process will also prevent investors from buying mortgage paper. Further, by the their own admission, the bailout will only affect a very limited number homeowners. Yet she suggests a moratorium on ALL foreclosures.
• What is to stop other homeowners from suing for better rates on their mortgages? It is discriminatory to freeze or lower some payments and not the payments of all homeowners. Who decides who gets what and under what circumstances?
• She claims rate resets are responsible for the meltdown, yet it’s been pointed out that at least half of those in default today, are doing so on their initial low teaser rates. It’s also been pointed out that falling values play a significant role in the increase in defaults. When homeowners realize that they are massively upside down in value, they often choose to default on their loans.
• Her assertion that mortgage brokers have a significant role in the mortgage meltdown is also a flawed position as I point out in this previous post.

The video is proof that Hillary Clinton, like George Bush, Henry Paulson, Barney Frank and Chuck Schumer, et al, are severely ill equipped to correct the mortgage and real estate meltdown. This becomes more evident each and every time these people open their mouths.

They are simply politicizing the issue without providing real solutions. Remember, their number one goal in life isn’t to help American homeowners, but to get elected and maintain or increase their power.

The freeze will only make the problem worse. Don’t drink the kool aid and prepare for some very rough times ahead. Times made even rougher with do nothing, feel good and very damaging initiatives.

Tags: Current Events, Finance & Economy, Mortgages, Real Estate by The Mortgage Guy
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It’s about time the powers that be recognize who is really to blame for the mortgage crisis. Andrew Cuomo, who by the way I am no fan of, is sending out Wall Street subpoenas.

Finally reality is setting in with the realization that a mere middleman in the mortgage process, simply cannot be the primary cause of the mortgage meltdown.

I’ve maintained that real bad guys are the risk management departments and credit ratings agencies. Seems like Cuomo agrees.

Marketwatch provides coverage of this newsworthy event.

The office of New York Attorney General Andrew Cuomo has sent subpoenas to request information from severalWall Street firms, including Merrill Lynch & Co. (MER) , Bear Stearns Cos. (BSC) and Deutsche Bank AG (DB) , The Wall Street Journal reported, citing people familiar with the matter.

Prosecutors in a broader investigation of the mortgage business are looking into how well the banks examined the quality of mortgages before packaging them into products sold to investors, the report said. The probe also focuses on how the debt was pooled into securities, including banks’ arrangements with credit-rating firms, the newspaper reported.

Ratings companies are also under pressure after asset-backed securities that were rated investment grade plunged in value as a result of the turmoil on credit and mortgage markets.

Banks and lenders often package pools of mortgages, create securities from them and sell them to other investors, rather than keeping them on the balance sheet.

A step in the right direction as it shows an understanding of what really happened to the mortgage backed securities market. As you know, without securitization, there is no mortgage industry.

The people charged with fixing the issue should be focusing on fixing the debt markets, like right now. If they do, we have a shot at limiting future economic damage caused by this mortgage and real estate meltdown. I know, I’m asking for too much.

Tags: Current Events, Finance & Economy, Mortgages, Real Estate by The Mortgage Guy
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When the going gets tough, to hell with integrity, change the rules. We can file this under “the government in it’s attempt to fix a problem only perpetuates it”. Apparently the government and lenders are working out a plan to freeze mortgage payment resets. Here are some details on the mortgage payment freeze plan from Marketwatch.

The report said the gist of the plan was to extend the low introductory rates on home loans made to borrowers who will have trouble meeting higher reset rates. Under one scenario, the extension of lower rates could run as long as seven years, the report said.

This a marvelous way to fix the real mortgage meltdown issue, which is securitization. /sarcasm The government will restore efficiency and integrity to the mortgage securities market by telling current investors we are changing the rules on the investments they bought. We are changing them in a manner that will negatively impact their holdings. By the way, do you want to buy some more mortgage securities?

The second issue I have with this initiative is that the government shouldn’t be bailing out people who have very little invested in their homes. I’ve stated it before, there is a class of homeowner out there that is nothing more than a glorified renter.

If it turns out resources for this plan are finite and only some homeowners can get the prescribed payment relief, homeowners who put money into their purchase or have the most equity, should be first in line. Financial prudence should be rewarded over financial irresponsibility.

Graph courtesy of Credit Suisse
Furthermore, studies have shown that the mortgage payment reset phenomenon as it stands now, will last for the rest of this decade. By extending these resets for another four to seven years, without addressing the real issue of securitization, will only delay the inevitable and at a greater expense than currently faced with.

Without securitization, there is no mortgage industry. This bailout is contrary to saving the mortgage securitizaton process.

Tags: Current Events, Finance & Economy, Mortgages by The Mortgage Guy
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One can hear the cries loud and clear. Homeowners looking for relief from upwardly adjusting mortgages and the politician’s cries that they must be helped. While I agree the home owners should be helped, I do so for different reasons. My main reason is to save the mortgage and real estate industries and probably the American economy as well.

Even if there were the political and financial will to assist these home owners by freezing or lowering their payments, chances are it cannot be done. Imposing a modification of debt notes on note holders, in such a way that it depreciates their value, is a dangerous endeavor. Such an initiative can destroy our debt markets and perhaps the securities market in general.

If payment freezes or reductions were imposed, the value of the mortgage security would be negatively impacted. As it stands now, a dollar of an adjustable rate mortgage security yields “x” in interest. Furthermore, the adjustable feature is a hedge against interest rate movements, the yield is determined by the spread, which remains constant.

Lowering the payment lowers the yield thus lowering the value of the mortgage security. Freezing the payment removes the hedge aspect of the mortgage security and that too can depreciate the value of the mortgage note.

Forcing note holders into either or both of these scenarios is unfair and destroys the integrity of the mortgage security. In my opinion, the only way to accomplish either freezing or lowering payments is to do so in such a way whereby the mortgage security/note maintains it current and future values. That is to say in exchange for freezing or lowering the payment schedule, the note holder must receive something of parity.

Equity Sharing

That something of parity can be sharing in future appreciation of the borrower’s home. The potential for a return on capital in the form of sharing home appreciation could offset the affects of lowering or freezing payments.

It could work something like this. At the time the mortgage note modifications are agreed upon, the property is appraised to establish a base line value. At some point in the future, either when the loan is refinanced or the property is sold, the note holder would receive a portion of the home’s appreciation.

As long as the home doesn’t appreciate in value, it cannot be refinanced. It can only be sold either at a loss or break even. In this case, the note holder wouldn’t receive any compensation for modifying the note. Except the benefit of keeping the note current and the receipt of current yield. Additionally, the expenses of foreclosure and a short sale are also avoided.

Because there is little on the table for the note holder if the property doesn’t appreciate, some incentive needs to be added here. That something can be some type of agreement on the borrowers part to agree to a streamlined and discounted foreclosure process should a worse case scenario evolve.

Thousands of dollars in expenses are incurred during the foreclosure process. This diminishes the net benefit to the note holder. By agreeing to a streamlined process, thousands in fees and expenses can be avoided.

Problem Solved

The home owner wins because they get to continue to afford to stay in their home. The note holder gets something of parity for modifying the note. The debt securities market maintains it’s integrity because the note holders aren’t left holding the bag. Confidence returns to the mortgage securitization process and the industry is saved thereby saving the real estate industry and the American economy.

Politicians get to make themselves look good, oop I mean help, by making the proper legislative adjustments to facilitate the modifications. They can even throw a finite and defensible amount of money at the problem if needed.

I’m not a securities analyst. I cannot provide the details of what would be necessary to satisfy the parity needs of the note holder. None the less, this is a scenario that has the potential of working. It’s far better than any plan that I have heard floated so far. That’s because to date, there are no plans to fix our very broken system.

Tags: Current Events, Finance & Economy, Mortgages, Real Estate by The Mortgage Guy
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