Posts tagged ‘HUD’

Fannie and Freddie: Worse Than We Thought

From Edward Pinto at the American

Fannie and Freddie entered into agreements accepting responsibility for misleading conduct discovered by the SEC, including:

1.    As of June 30, 2008, Freddie had $244 billion in subprime loans, while investors were told it had only $6 billion in subprime exposure.

a.    Freddie knew it was inadequately compensated for the risks it was taking. For example, it was taking on “subprime-like loans to help achieve [its] HUD goals” that were similar to private fixed-rate subprime, but the latter typically received “returns five to six times as great,” says the complaint.

b.    Freddie had concerns about risk layering on loans with an LTV >90% and a FICO <680. (Yet, in Freddie’s disclosures it only noted risk layering concerns on loans with an LTV >90% and a FICO <620. This is a major difference since only 10 percent of its loans fell into the LTV >90% and a FICO <620 category, while nearly half fell into the LTV >90% and a FICO <680 one.)

2.    As of June 30, 2008, Fannie had $641 billion in Alt-A loans (23 percent of its single-family loan guaranty portfolio), while investors were told it had less than half that amount ($306 billion, or 11 percent of its single-family loan guaranty portfolio).

3.    The SEC complaint disclosed that Freddie had a coding system to track “subprime,” “other-wise subprime,” and “subprime-like” loans in its loan guaranty portfolio even as it denied having any significant subprime exposure.

These suits are important because they demonstrate that Fannie and Freddie “told the world their subprime exposure was substantially smaller than it really was … and mislead the market about the amount of risk on the companies’ books,” said Robert Khuzami, director of the SEC’s Enforcement Division.

Hair of the Dog

This is pretty incredible.  It's like the last two years didn't even happen.

A national consumer coalition plans to file a series of landmark federal fair housing complaints beginning Dec. 6, challenging a widespread practice by banks and mortgage lenders: requiring borrowers who apply for FHA loans to have FICO credit scores well above the 580 minimum set by the FHA for qualified applicants with 3.5 percent down payments....

Because FHA insures lenders against losses from serious delinquency or foreclosure, there is "no legitimate business justification" for rejecting applicants solely on the basis of FICO scores that are acceptable to FHA, the complaints contend.

Subprime mortgage customers are generally defined as those under a credit score of 620.  I am surprised that anyone in this environment is offering 3.5% down to any buyer  (though here is the government actually advertising the fact).  But giving 3.5% down to subprime borrowers?

Even with the FHA guarantee, banks have learned that the cost of default for them is not zero.  Only someone who has been in a cave for two years could somehow ascribe this action to discrimination rather than an obvious reaction to the ongoing mortgage crisis.  The government is still out acting irresponsibly, and when private institutions (who actually have to live with the cost of their decisions) try to behave like adults, they get hauled into court.

By the way, this sure does seem to bolster the argument that community banking standards and the pressure from the government and community groups to drop lending standards played a large role in the housing crisis.  If we are seeing this kind of pressure even after the housing disaster, what kind of pressure was at work, say, in 2005?

Via Mark Calabria, who has more

Update: Flashback

"In 1995, HUD announced a National Homeownership Strategy built upon the liberalization of underwriting standards nationally. It entered into a partnership with most of the private mortgage industry, announcing that "Lending institutions, secondary market investors, mortgage insurers, and other members of the partnership [including Countrywide] should work collaboratively to reduce homebuyer downpayment requirements."

The upshot? In 1990, one in 200 home purchase loans (all government insured) had a down payment of less than or equal to 3%. By 2006 an estimated 30% of all home buyers put no money down.

"The financial crisis was triggered by a reckless departure from tried and true, common-sense loan underwriting practices," Sheila Bair, chair of the Federal Deposit Insurance Corporation, noted this June. One needs to look no further than HUD's affordable housing policies for the source of this "reckless departure." If the mortgage finance industry hadn't been forced to abandon traditional underwriting standards on behalf of an affordable housing policy, the mortgage meltdown and taxpayer bailouts would not have occurred."

A Down Payment is the Best Protection

I am a little behind on this, but Megan McArdle had this from Joe Wiesentahl, on the importance of loan down payments to prevent fraud and foreclosure:

The author, Michael Richardson, owned a Colorado mortgage company that was busted by HUD for processing too much fraudulent paperwork.  This caused him to discover that unbeknownst to him his employees were (on their own) engaging in mortgage fraud, prompting him to write this book and try to warn the industry.

This alone is interesting -- that even on the small-time level, there was an information problem (bosses not knowing what the underlings were doing) -- and the book is rich with details about the nuts and bolts of mortgage fraud.

But beyond that, one point he makes clear -- and remember, this is before 2005, so before the crash and before conservatives blamed government intervention in the housing market for the crash -- is that the FHA's subsidization of $0-down loans made it all possible.

If you make someone pay 10% or 20% of a house's cost upfront, then there's no way you can alter the paperwork enough to make an ineligible buyer buy a house for an inflated price. But once you drop that requirement, everything goes. You can sell any house to any buyer for any price as long as you put in the effort to falsify documents and go through the cumbersome legwork.

The CRA and the Mortgage Meltdown

There always have been good, logical reasons to discuss the Community Reinvestment Act (CRA) as one contributor to the mortgage meltdown last year.  After all, the act is effectively a prod to banks to lend to people who would not normally meet their lending criteria, and to do so on terms (e.g. no money down) they might not usually offer.

The usual response from supporters is that the numbers are too small to matter.  I tended to agree with this -- until I saw this graph, from Peter Schweizer via Carpe Diem.

chart_398x249

Unfortunately he does not have a source or methodology, so I have to retain some skepticism, but if true these numbers are far from trivial.  He writes:

According to the National Community Reinvestment Coalition, in the first 20 years of the act, up to 1997, commitments totaled approximately $200 billion. But from 1997 to 2007, commitments exploded to more than $4.2 trillion. (Keep in mind this is more than four times the size of the current health bill being debated in Congress.) The burdens on individual banks can be enormous. Washington Mutual, for example, pledged $1 trillion in mortgages to those with credit histories that "fall outside typical credit, income or debt constraints," and was awarded the 2003 CRA Community Impact Award for its Community Access program. Four years later it was taken over by the Office of Thrift Supervision.

This effort was backed by a parallel effort at Fannie Mae and Freddie Mac to buy up these loans:

Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target "” 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of  billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down.

Fannie and Freddie also purchased hundreds of billions of subprime securities for their own portfolios to make money and to help satisfy HUD affordable housing goals. Fannie and Freddie were important contributors to the demand for subprime
securities.

Obama has a personal history with this effort, actually suing banks who would not provide the sub-prime lending that he later, as President, blamed them for undertaking

Obama's battle against banks has a long history. In 1994, freshly out of Harvard Law School, he joined two other attorneys in filing a lawsuit against Citibank, the giant mortgage lender. In Selma S. Buycks-Roberson v. Citibank, the plaintiffs claimed that although they had ostensibly been denied home loans "because of delinquent credit obligations and adverse credit," the real culprit was institutional racism. The suit alleged that Citibank had violated the Equal Credit Opportunity Act, the Fair Housing Act and, for good measure, the 13th Constitutional Amendment, which abolished slavery. The bank denied the charge, but after four years of legal wrangling and mounting legal bills, elected to settle. According to court documents, the three plaintiffs received a total of $60,000. Their lawyers received $950,000.

Now, Congress and Obama want to strengthen the CRA -- talk about not learning from mistakes.

Now comes Rep. Eddie Bernice Johnson, D-Texas, and 50 other co-sponsors (all Democrats) of H.R. 1479 the "Community Reinvestment Modernization Act of 2009," who want to expand the CRA to include not just banks but also credit unions, insurance companies and mortgage lenders. Congressman Barney Frank, chairman of the House Financial Services Committee, has supported the idea in the past. The SEIU and ACORN, along with a host of other activist groups, are also behind the effort.

President Obama has been a staunch supporter of the CRA throughout his public life. And his recently announced financial reforms would make the law even more onerous and guarantee an explosion in irresponsible lending. Obama wants to take enforcement of the CRA away from the Federal Reserve, the FDIC and other financial regulators who at least try to weigh bank safety and soundness when enforcing the law, and turn it over to a newly created Consumer Financial Protection Agency (CFPA). This agency's core concerns would not be safety and soundness but, in the words of the Obama administration, "promoting access to financial services," which is really code for forcing banks to lend to those who would not ordinarily qualify. Compliance would no longer be done by bank examiners but by what the administration calls "a group of examiners specially trained and certified in community development" (otherwise called community activists). The administration says, in its literature about the reforms, that "rigorous application of the Community Reinvestment should be a core function of the CFPA."

Looks like there may be jobs available after all for all those folks who got fired from ACORN.

It Took Two Ingredients to Make this Financial Crisis

After having time to think more about the current crisis, I think the reason it is confusing is that it is the result of two parallel but largely independent causes that worked together to create this mess.  I told my mother-in-law in an email last week that the financial crisis would likely be a Rorschach test where everyone sees the crisis caused by all the things they opposed before the crisis.  Conservatives will see government intervention, liberals will see greed and deregulation.

What makes this situation particularly confusing is that of the two causes I believe led to the crisis, each has been embraced by one of the two parties as the only cause.  It's a case where everyone is half right, but the other half is important too.  It's a two part recipe, with neither active ingredient causing much of an explosion until mixed with the other. (special thanks to the folks at Q&O who have had a lot of good posts on these issues).

Cause 1:  Creating the Asset Bubble

The first thing that had to happen for the crisis was the creation of an asset bubble.  We need some type of over-valued asset whose prices crash to earth to spark the crisis.  So we begin with housing.

Home prices have gone through boom-bust cycles for years, just as have many commodities.  There is a whole body of literature on such cycles, so we will leave that aside and accept their existence as a feature of markets and human behavior. 

But this housing bubble had a strong accelerant, in the form of the Federal government.  For years, this nation has made increasing home ownership a national goal and many laws and tax policies have been aimed at this goal.  The mortgage interest deduction on personal income taxes is just one example.

Starting in 1992, Fannie Mae and Freddie Mac, which were strange quasi-public / quasi-private entities, came under pressure from the Congress (e.g. Barney Frank) and the Clinton administration to add increasing home ownership to poorer people part of their missions.

Fannie Mae, the
nation's biggest underwriter of home mortgages, has been under
increasing pressure from the Clinton Administration to expand mortgage
loans among low and moderate income people and felt pressure from stock
holders to maintain its phenomenal growth in profits.

In
addition, banks, thrift institutions and mortgage companies have been
pressing Fannie Mae to help them make more loans to so-called subprime
borrowers. These borrowers whose incomes, credit ratings and savings
are not good enough to qualify for conventional loans, can only get
loans from finance companies that charge much higher interest rates --
anywhere from three to four percentage points higher than conventional
loans.

''Fannie Mae has expanded home ownership for millions of
families in the 1990's by reducing down payment requirements,'' said
Franklin D. Raines, Fannie Mae's chairman and chief executive officer.
''Yet there remain too many borrowers whose credit is just a notch
below what our underwriting has

The results were astonishing:

Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to
increase their purchases of mortgages going to low and moderate income
borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target "” 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005,
Fannie and Freddie met those goals every year, funding hundreds of
billions of dollars worth of loans, many of them subprime and
adjustable-rate loans, and made to borrowers who bought houses with
less than 10% down.

Fannie and Freddie also purchased hundreds
of billions of subprime securities for their own portfolios to make
money and to help satisfy HUD affordable housing goals. Fannie and
Freddie were important contributors to the demand for subprime
securities.

Simultaneously, the 1977 Community Reinvestment Act was pushing private banks to make more loans to less qualified borrowers:

The Community Reinvestment Act (CRA) did the same thing with
traditional banks. It encouraged banks to serve two masters "” their
bottom line and the so-called common good. First passed in 1977, the
CRA was "strengthened" in 1995, causing an increase of 80% in the
number of bank loans going to low- and moderate-income families.

These actions had a double whammy on the current crisis.  First, by pushing up housing demand, they inflated the housing pricing bubble.  Second, it meant that these inflated-price homes were being bought with lower and lower down payments.  In effect, individuals were taking on much more leverage  (leverage is a term that I will use to mean the percentage of debt used to finance a set of assets -- more leverage means more debt and less equity.  The term comes from the physics of a mechanical lever, in that more debt, like a lever, can magnify force.  Profits from assets are multiplied by leverage, but, alas, so are losses.) 

When the economy softened and the housing bubble started to burst, these new mortgage customers the government went out of its way to bring into the system did not have any resources to handle the changes -- they did not have the down payment to cushion them (or the banks) against falls in asset value and did not have the cash flow to cushion them against falling income in the recession and/or rising interest rates. 

The result:  Huge portfolios of failing loans with rapidly falling collateral values.

Cause 2:  Over-leverage of Risky Assets and Related De-regulation of Capital Requirements

I think the word "greed" was used about a zillion times last night in the Vice-Presidential debate.  But what does it mean in this context?  After all, we are all greedy in one way or another, if one equates greed with looking after one's self-interest.

So I will translate "greed" for you:  When you hear "greed on Wall Street", think leverage.  Remember, we said above that as long as the underlying asset values are going up, leverage (ie more debt) multiplies profitability.  [Quick example:  Assume a stock that goes from $100 to $110 in a year.  Assume you pay 5% interest on money.  No leverage, you make $10 on a $100 investment.  With 95% leverage -- ie buying $2000 worth of the stock with $100 equity and $1900 debt -- you would make $105 on the same $100 equity investment.  Leverage multiplied your returns by more than a factor of 10]

Remember that around the year 2000 we had the Internet bubble burst in a big way.  A lot of companies not only dropped, but went to $0 in value.  This was painful, but we did not have a cascading problem.  Why?  In part because most of the folks who invested in Internet companies did not do so in a highly leveraged way.  The loss was the loss, time to move on.  Similarly in this case, if these mortgage packages had been held as a piece of a un-leveraged portfolio, like a pension fund our an annuity, the loss would not have been fun to write off but it would not have cascaded as it has.  The government would have had to bail out Fannie and Freddie, a few banks would have failed, but the disaster would have been limited.

One reason this problem has cascaded (leaving aside blame for Henry Paulson's almost criminal chicken-little proclamations of doom to the world) is that many of these mortgage packages or securities got stuck in to highly leveraged portfolios.  The insurance contracts that brought down AIG were structured differently but in the end were also highly leveraged bets on the values of mortgage securities in that small changes in values could result in huge losses or gains for the contracts.   (Some folks have pointed to actual securitization of the loans as a problem.  I don't see that.  Securitization is a fabulous tool.  Without it, we would be seeing a ton more main street bank failures, as they would have had to keep many more of these on their books.) 

If this all sounds a bit like cause #1 above, ie buying inflated assets with more and more debt, then you are right.  There is an interesting parallel that no one wants to delve into between the incentives of home buyers trying to jump into hot housing markets with interest-only loans and Wall Street bankers putting risky securities into highly leveraged portfolios.  Leverage is really the key theme here.  In a sense, houses were double-leveraged, bought the first time around with smaller and smaller down payments, and then leveraged again as these mortgages were tossed into highly-leveraged portfolios.  Sometimes they were leveraged even further via oddball derivatives and insurance contracts whose exact operation are still opaque to many.

Those who have read me for a while know that I am in the "let them die" camp.  These Wall Street guys have been living high on the extra profits from this leverage in the good times.  They knew perfectly well that leverage is a two-edged sword, and that it would magnify their losses in a bad time.  But their hubris pushed them into doing crazy things for more profit, and I am all for a Greek-tragedy-like downfall for their hubris.  The sub-prime, first-time home buyer can claim ignorance or unsophistication, but not these guys.

During the Bush Administration, these bankers came to the SEC trumpeting their own brilliance, and begged to be allowed to leverage themselves even more via a relaxation of capital requirement rules.  And, in 2004, without too much discussion or scrutiny, the SEC gave them what they wanted:

Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis
since the 1930s. But decisions made at a brief meeting on April 28,
2004, explain why the problems could spin out of control. The agency's
failure to follow through on those decisions also explains why
Washington regulators did not see what was coming.

On that
bright spring afternoon, the five members of the Securities and
Exchange Commission met in a basement hearing room to consider an
urgent plea by the big investment banks.

They wanted an
exemption for their brokerage units from an old regulation that limited
the amount of debt they could take on. The exemption would unshackle
billions of dollars held in reserve as a cushion against losses on
their investments. Those funds could then flow up to the parent
company, enabling it to invest in the fast-growing but opaque world of
mortgage-backed securities; credit derivatives, a form of insurance for
bond holders; and other exotic instruments.

In part they traded capital requirements for computer models, a very dubious decision in the first place, made worse by the fact that most of the banks were gaming the models to reduce the apparent risk.  The crazy thing is that, in gaming the models, they really weren't trying to fool regulators, who pretty much were not watching anyway, but they were fooling themselves!  Certainly I would not expect government regulators to do a better job of risk assessment in this environment, which argues for a return to the old bright-line capital requirements that are fairly simple to monitor.  Investment banks played a game of Russian Roulette, and eventually blew their own brains out.  Which begs the question of whether the government's job is to protect consumers at large or to protect financial institutions from themselves.

"We foolishly believed that the firms had a strong culture of
self-preservation and responsibility and would have the discipline not
to be excessively borrowing," said Professor James D. Cox, an expert on
securities law and accounting at Duke School of Law (and no
relationship to Christopher Cox).

The Dog that Didn't Bark:  Ratings Agencies

Clearly, ratings agencies have really failed in their mission during this fiasco.  Right up to the last minute, they were giving top ratings to highly risky securities.  But I think folks who want to lay primary blame on the rating agencies go to far.   Ratings agencies are for individuals and state pension funds and the like -- I have a hard time imagining Goldman or Lehman depending on them for risk assessment.  Its a nice excuse, and we may well have very different companies rating securities five years form now, but its just a small contributor.

The Fix

So you see what is going on.  Republicans are running around saying "the government caused it with the CRA" and Democrats are saying "it was greed and deregulation."  Incredibly, both parties seem to come to the conclusion that sickly mortgage securities need to be pulled out of the hands of the folks who created and bought them and put in ... my hands.  I had smugly thought that I had avoided buying a home with zero-down at the peak of the market, but I was wrong.  Via the federal government, I have bought a lot of them!

I personally would let the whole thing sort itself out, and live with the consequences.  My hypothesis is that much of the current credit squeeze in the money markets is due to Henry Paulson's clumsy public statements and the Fed's busting open the door to overnight borrowing.  Everyone is frozen not by the crisis, but by the prospect of some sort of government action.  Short term borrowers and lenders are doing their business with the Fed, as the government crowds out the private short term markets and causes the very problem it is trying to prevent. 

Without the government bending over backwards to take in short term money from lenders, private firms would be forced to find private options.  Lenders have to lend to stay alive financially, just as much as borrowers have to borrow.  Money may go into the mattresses for a week or two or three, but it can't stay there forever.

I do know that the fix is NOT

Fixing these financial problems listed above does not include:

Sec. 101. Renewable energy credit.
Sec. 102. Production credit for electricity produced from marine renewables.
Sec. 103. Energy credit.
Sec. 104. Energy credit for small wind property.
Sec. 105. Energy credit for geothermal heat pump systems.
Sec. 106. Credit for residential energy efficient property.
Sec. 107. New clean renewable energy bonds.
Sec. 108. Credit for steel industry fuel.
Sec. 109. Special rule to implement FERC and State electric restructuring policy.
Sec. 111. Expansion and modification of advanced coal project investment credit.
Sec. 112. Expansion and modification of coal gasification investment credit.
Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability
Trust Fund.
Sec. 114. Special rules for refund of the coal excise tax to certain coal producers
and exporters.
Sec. 115. Tax credit for carbon dioxide sequestration.
Sec. 116. Certain income and gains relating to industrial source carbon
dioxide treated as qualifying income for publicly traded partnerships.
Sec. 117. Carbon audit of the tax code. Sec. 111. Expansion and modification of advanced coal project investment credit. Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability Trust Fund. Sec. 115. Tax credit for carbon dioxide sequestration. Sec. 205. Credit for new qualified plug-in electric drive motor vehicles. Sec. 405. Increase and extension of Oil Spill Liability Trust Fund tax.Sec. 306. Accelerated recovery period for depreciation of smart meters and
smart grid systems. Sec. 309. Extension of economic development credit for American Samoa. Sec. 317. Seven-year cost recovery period for motorsports racing track facility. Sec. 501. $8,500 income threshold used to calculate refundable portion of child tax credit.

And, of course, the big one:

Sec. 503 Exemption from excise tax for certain wooden arrows designed for use by children.

All of these, however, are part of the bailout bill approved by the Senate.  Sources here and here.

If Only Abuse of Power Was Considered Worse Than Sex

In a previous post I lamented that Eliot Spitzer was lauded by the press as "Mr. Clean" despite (or because of) abuse of power, but was forced to quit within days of revealing an episode of consensual sex.  If only abuse of power had such an immediate impact on politicians as sex:

The Justice Department and the housing department's inspector general
are investigating whether the [HUD] secretary, Alphonso R. Jackson,
improperly steered hundreds of thousands of dollars in government
contracts to friends in New Orleans and the Virgin Islands.

On Wednesday, Democratic lawmakers also raised concerns about
accusations that Mr. Jackson threatened to withdraw federal aid from
the director of the Philadelphia Housing Authority after he refused to
turn over a $2 million property to a politically connected developer.

Update:  More on the press and its support for prosecutorial abuse of power, in Spitzer's case and others.