Feb032015
Prime mortgage borrowers inflated the housing bubble
Subprime borrowers endured more painful consequences, but all borrower classes participated in the housing bubble debt orgy.
Yesterday I noted that most former subprime borrowers are no longer homeowners, but despite enduring most of the negative consequences, it wasn’t subprime borrowers that inflated the housing bubble: prime borrowers did that.
The common narrative is that subprime borrowers inflated house prices, then they quit making payments and caused a crash in house prices that dragged down everyone else. Unfortunately, this narrative lets off the middle and upper classes far too easily.
The reality is all borrower classes participated in the housing bubble equally, but when it came time to clean up the mess, the various borrower classes were not treated equally: low-end, subprime borrowers were foreclosed while mid- to high-end prime borrowers squatted or obtained loan modification deals to wait until prices recovered — to wait in houses they couldn’t afford but enjoyed anyway.
As Tanta from Calculated Risk pointed out in 2007: We’re all subprime now:
Let us … ask ourselves what constitutes the “upper and middle classes.” If they “moved up beyond their means,” then . . . their means are what, exactly? If 100% or near 100% financing is required to keep these neighborhoods stable (loans over $400,000 for houses in the $400,000-$450,000 price range), then in what sense are they neighborhoods of the “upper and middle classes”? Does our current definition of “middle class” (not to mention “upper class”) include having insufficient cash assets to make even a token down payment on a home? Things seem to have changed since I did Econ 101.
What is the utility of this kind of thinking?
The utility was political: foreclosing on poor, subprime borrowers doesn’t upset a major voting block; foreclosing on middle and upper class borrowers does. So rather than foreclose on better neighborhoods, under pressure from bureaucrats and legislators, lenders amended loans, extended foreclosure timelines, and pretended these borrowers would ultimately pay them back. The music still plays and the dance continues to this day.
Robert Samuelson: Challenging what we know about the housing bubble
By Robert J. Samuelson February 1 at 7:39 PM
… There’s a standard and widely shared explanation of what caused the bubble. The villains were greed, dishonesty and (at times) criminality, the story goes. Wall Street, through a maze of mortgage brokers and securitizations, channeled too much money into home buying and building. Credit standards fell. Loan applications often overstated incomes or lacked proper documentation of creditworthiness (so-called no-doc loans).
All of the above is true.
The poor were the main victims of this campaign. Scholars who studied the geography of mortgage lending found loans skewed toward low-income neighborhoods. Subprime borrowers were plied with too much debt. All this fattened the revenue of Wall Street firms or Fannie Mae and Freddie Mac, the government-sponsored housing finance enterprises. When home prices reached unsustainable levels, the bubble did what bubbles do. It burst.
This part is not true.
The poor were the main victims of the foreclosures, but everyone equally participated in the foolish borrowing.
Remember the adjustable-rate mortgage reset schedule from 2006? It tells the more nuanced story of what happened.
During the housing bubble subprime borrowers were primarily given a specific loan known as the 2/28, which provided an affordable 2-year payment followed by a crushing payment reset that caused most of these borrowers to default. Since their teaser rate period was two years rather than 5, these loans faced reset before the equally unstable loans given to prime and alt-a borrowers.
When the subprime borrowers defaulted, banks followed their standard loss mitigation procedures that included a speedy foreclosure. After foreclosing on millions of these borrowers, banks pounded house prices back to the stone ages in subprime-dominated areas.
Lenders knew their more affluent but equally foolish alt-a and prime borrowers were also going to be crushed by payment resets, and rather than repeat the price-crushing foreclosures of subprime, the lobbied Congress to set aside mark-to-market accounting procedures so they could amend-extend-pretend their way out of a crisis.
Therefore, while all borrower classes were equally foolish in their behavior, only the subprime borrowers endured the brunt of the foreclosure tsunami, and although the middle class took their lumps, they came out much better off than their subprime brethren: most middle-class borrowers are still in their homes.
Now comes a study that rejects or qualifies much of this received wisdom. …
First, mortgage lending wasn’t aimed mainly at the poor. … Borrowers were … much richer than average residents. In 2002, home buyers in these poor neighborhoods had average incomes of $63,000, double the neighborhoods’ average of $31,000.
Second, borrowers were not saddled with progressively larger mortgage debt burdens. … In 2002, the mortgage-debt-to-income ratio of the poorest borrowers was 2; in 2006, it was still 2. …
Third, the bulk of mortgage lending and losses — measured by dollar volume — occurred among middle-class and high-income borrowers. In 2006, the wealthiest 40 percent of borrowers represented 55 percent of new loans and nearly 60 percent of delinquencies (defined as payments at least 90 days overdue) in the next three years.
The biggest travesty of the housing bubble was the unequal treatment of the rich and poor when it came to foreclosure. The wealthier your zip code the less likely you were to face foreclosure, mostly because lenders knew they couldn’t absorb the losses, but partly because wealthier zip codes have more political clout.
If these findings hold up to scrutiny by other scholars, they alter our picture of the housing bubble. Specifically, they question the notion that the main engine of the bubble was the abusive peddling of mortgages to the uninformed poor. …
Let’s not overlook the fact that abusive lending to the uniformed poor was a huge problem. It was. It just wasn’t responsible for inflating house prices. That was a team effort that required the participation of middle- and upper-income borrowers.
It is not that shoddy, misleading and fraudulent merchandising didn’t occur. It did. But it wasn’t confined to the poor and was caused, at least in part, by a larger delusion that was the bubble’s root source.
During the housing boom, there was a widespread belief that home prices could go in only one direction: up. If this were so, the risks of borrowing and lending against housing were negligible. Home buyers could enjoy spacious new digs as their wealth grew. Lenders were protected. The collateral would always be worth more tomorrow than today. Borrowers who couldn’t make their payments could refinance on better terms or sell. …
It’s tempting to blame misfortune on someone else’s greed or dishonesty. If Wall Street’s bad behavior was the only problem, the cure would be stricter regulatory policing that would catch dangerous characters and practices before they do too much damage. This seems to be the view of the public and many “experts.”
Wall Street greed was certainly part of the problem, and we need legislation to prevent the greed of the housing bubble from inflating another one, but it’s accurate to say Wall Street greed wasn’t the only problem. Unfortunately, legislators did little to curb the greed of ordinary borrowers.
The biggest mistake of Dodd-Frank was failing to limit the loan-to-value on cash-out refinances. Texas has such a limit, and it’s the main reason Texas didn’t participate in the housing bubble. Without access to their home equity with unlimited HELOC extraction like we have in California, Texans has no incentive to drive up prices.
But the matter is harder if the deeper cause was bubble psychology. It arose from years of economic expansion, beginning in the 1980s, that lulled people into faith in a placid future. They imagined what they wanted: perpetual prosperity. After the brutal Great Recession, this won’t soon repeat itself. But are we forever insulated from bubble psychology? Doubtful.
Greed and fear drive financial markets, and unless we radically change human nature, we will always have financial bubbles, and although the greed might have gone underground here in California, the chance of another kool-aid outbreak is always with us.
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The M O is to sweep reality under the rug (pretend everything is back to normal now), even though it is FAR from it; ie., SFR deliquency rates still >3x higher than pre-crisis avg.
http://www.acting-man.com/blog/media/2015/02/delinquency-rates.png
And that decline in delinquency rates was accomplished mostly by can-kicking rather than foreclosure, so if prices don’t get back to the peak, we can expect another wave of delinquencies when can-kicked loans go bad.
JPMorgan launching massive ARM-only jumbo RMBS
Ponzi scheme restarts
ARM loans expose borrowers to payment reset risk,” Fitch noted. “Therefore, all else being equal, ARM and IO products are assigned higher probability of default in Fitch’s prime loss model, compared with fully amortizing, fixed-rate loans. Fitch applied a probability of default penalty of approximately 2.02x to the loans with IO features and 1.95x to the loans without the feature.”
On the other hand, the borrowers have strong credit profiles, low leverage and substantial liquid reserves, which provides protection against defaults, Fitch said.
“The majority of borrowers in this pool are high net worth individuals with significant liquid assets,” Fitch said. “Borrowers with significant liquid reserves are generally better positioned to withstand a temporary income disruption and have a lower risk of default. Approximately 48.7% of borrowers have reserve amounts greater than their mortgage loan balance. The weighted average reserve-to-loan ratio is roughly 262%. The WA annual income is approximately $937,195 for borrowers in this pool.”
According to Fitch’s report, the underlying borrowers carry weighted average liquid reserves of $2,731,108.
Fitch awarded AAA ratings to the largest of the offering’s tranches, citing the offerings 15% credit enhancement as a positive.
“The CE levels reflect the very strong credit attributes of the pool,” Fitch said. “Borrowers in the pool have significant equity in their property as reflected in a weighted average original combined loan-to-value of 62.6%.”
The weighted average original FICO score of the underlying borrowers is 759.
Well, that’s good news, and illustrates to whom these types of loans should be made available.
The problem is it won’t remained limited to those borrowers. Over time, lenders will expand the limits of who’s available and begin the Ponzi scheme all over again.
The first groups of these bonds will do well because while credit is expanding, house prices go up, and risk is limited. This will prompt more money to flow in to these RMBS pools, drive house prices up further, and make the increasingly risky pools look less risky than they really are. It’s the exact same cycle as last time, and since this is non-QM mortgage money, there is nothing to prevent it from escalating into the same disaster as before.
DBRS: Housing sales will pick up in 2015
if mortgage rates stay below 4%
DBRS is confident that despite a slow start to 2015, the year will be a solid one for home price recovery and a decline in mortgage delinquencies.
“DBRS believes that 2015 will be a year of further recovery as home prices continue to rebound,” said Kathleen Tillwitz, Managing Director of Operational Risk at DBRS, in a client note.
“Delinquency trends are expected to further decline as successful modification plans continue and foreclosure rates stay at their lowest levels in years. Short sales will remain a common loss mitigation practice; however, strict credit underwriting standards will continue to make finding borrowers that are approved for short sales more difficult,” Tillwitz said.
Stringent underwriting guidelines will continue to make it more difficult for borrowers with less than pristine credit and a substantial amount of reserves to obtain a mortgage in 2015.
“Even though DBRS has seen a few lenders implementing non-QM programs that allow for back-end ratios as high as 50% and FICO scores as low as 600, DBRS expects that larger lenders, who are still recovering from the massive fines they had to pay for making subprime loans, will not be originating anything but QM loans in 2015,” Tillwitz said. “Therefore, DBRS expects the availability of credit to continue to be constrained in 2015 for borrowers with blemished credit, resulting in another year of low organic growth for servicers.”
Survey: Americans Unconcerned About Mortgage Rates
Americans shockingly ignorant
As housing market analysts keep a close eye on interest rates and consumer attitudes, a new survey finds many Americans aren’t especially concerned about mortgage rates.
In findings released Monday, Bankrate.com revealed that out of 1,000 adults polled last month, more than three in five would prefer to own a home instead of renting, even if mortgage rates jump by more than a full percentage point above their current level. As of last week, Bankrate’s measure for the average 30-year fixed mortgage rate was 3.80 percent.
Furthermore, about one in three say they would still consider buying a home if the 30-year fixed average shot up past 10 percent.
“This refinances or confirms that despite the trauma and the drama that we have seen in the real estate market in 2007, people still want to own a home, even if you are looking at potentially higher rates,” said Daniel Roccato, assistant professor of economics at Rutgers University.
However, he added that there’s a difference between Americans’ willingness to pay a higher rate and their ability to actually afford it.
Duh!
What a surprising find the public only cares about how much it costs them a month.
And nobody makes the connection between how much they can finance today and how much their take-out buyer will be able to finance 10 years from now.
As mortgage rates rise, everyone hopes rising wages will compensate, but wages will need to rise a great deal in order to allow people to finance today’s prices many years from now at higher mortgage rates. The monthly cost of ownership will rise with wages, but the amount people can finance may remain the same, which will make it much more difficult for people to sell for a profit later on.
Homebuilding declined in West in 2014
Within Metrostudy’s national footprint, housing starts rose 2.5% between the fourth quarter of 2013 and the fourth quarter of 2014. This was a very uninspiring “top line” number, but beneath that number there is a great deal of regional variation, … the western U.S. saw a decline….
Although “The West” showed a decline overall, that mostly reflected Phoenix (down 16.6%), Salt Lake City (down 11.9%), as well as Boise (down 16.3%) and Tucson (down 8.1%). California was a mixed bag, with gains in the Los Angeles area, and declines in the Bay Area.
There was a wide divergence of results in the west:
· Denver up 14.9%
· Northern Colorado up 10.7%
· Bay Area down 8.5%
· Sacramento down 2.4%
· Inland Empire up 4.5%
· LA County up 48.1%
· Orange County up 12.8%
· San Diego County down 20.2%
HUD Provides Guidance for Use of Progressive Slush Fund
In December, Federal Housing Finance Agency Director (FHFA) Director Mel Watt lifted the suspension of the allocation of GSE funds for the HTF – a controversial move given the fact that the GSEs remain under the conservatorship of the FHFA. While the decision to reinstate funding of the HTF using GSE money was heavily criticized by conservatives – some of whom introduced legislation last week to try to prevent it – it was widely heralded by progressives as a path for low-income families to achieve the dream of homeownership.
“Affordable housing is about opportunity. Today’s action is the latest step toward important progress for the American people,” HUD Secretary Julián Castro said on the day the suspension of funding was lifted. “Once fully implemented, the Housing Trust Fund will help folks across the nation secure a decent place to call home. We look forward to working closely with our partners across the nation to implement this critical resource to expand the circle of opportunity for current and future generations of Americans.”
According to HUD’s announcement, eligible grantees for HTF include states and state-designated entities. Eighty percent of the annual formula grants must be used for rental housing, 10 percent must go to homeownership, and 10 percent must go to cover reasonable administrative and planning costs assumed by the grantee. States will submit their HTF Allocation Plans, developed with input from constituents, and 2016 Annual Action Plans to HUD sometime in 2015.
The target date for the grantees to receive their HTF allocations is the summer of 2016. Some of the eligible activities and expenses for the use of HTF funds may include: Real property acquisition, site improvements/development hard costs, related soft costs, demolition, financing costs, relocation assistance, and operating cost assistance for rental housing.
Hearing politicians talk about affordable housing it becoming increasingly annoying. After the real estate melt down we had affordable housing and they did everything possible to push prices sky high.
Ability-to-Leverage Drives Foreclosure Risk
CoreLogic research highlights four key findings. First, while homeownership rates today are the same level as five decades ago, foreclosure risk is two to three times higher. Second, the primary driver of default risk over this period has been leverage. Leverage has played such a strong role that has rendered changes in income and savings as insignificant drivers of default from a long-term macro perspective. Third, the stabilization in foreclosure rates in the 1970s and 1980s was driven by high inflation rates, which propelled nominal home prices and reduced aggregate LTV, thus lowering default risk – a reminder of real estate’s role as a hedge against inflation. Fourth, the centerpiece of government regulations to help make the mortgage market safer for consumers was an income based ability-to-pay rule manages delinquency risk, but is less aimed at the market’s foreclosure risk. Therefore, leverage as the most important driver of foreclosure performance over the last five decades remains unaddressed for the market. In the future, policy makers may need to consider exploring their ability to manage the leverage cycle to promote residential financial stability.
Most of the subprime loans that reset in 2008-09 saw a decline in their payment amounts due to rapidly falling interest rates. The 2/28 loans were typically tied to the 6 Month LIBOR which dropped from 5.35% in early 2007 to 1.75% by December 2008. Even for those subprime borrowers that initially had a payment shock in 2007, their payments rapidly declined over subsequent rate adjustments.
http://www.macrotrends.net/1433/historical-libor-rates-chart
So the real problem wasn’t payment shock, but rather that the ability to continuously serial refinance dried up. These borrowers couldn’t afford their payments to begin with, but they always had the option of refinancing and “starting over” with a new loan between 2003 and 2007.
Once Wallstreet cutoff the warehouse lines to the subprime lenders, it was no longer possible to refinance into a subprime loan, so you had all these borrowers with no ability to pay and poor credit that were trapped. Since the option to refi dried up and home price declines made selling impossible, the only other alternative was to default and get foreclosed.
Likewise, the prime, alt-a, and option ARM loans that reset also saw their payments decline, but as opposed to subprime, these borrowers could mostly afford their payments. Instead, it was either job loss or more often than not, strategic default due to rapidly falling home prices that led to that wave of defaults. Payment shock wasn’t an issue.
BTW, your description is accurate, but it also describes a Ponzi scheme, which by definition, is not sustainable.
If payment shock wasn’t an issue, why were so many loan modifications granted? It wasn’t unemployment that drove these modifications, it was the fact that these people couldn’t afford the loan payments because they were never properly qualified for the loan. Nearly all of these loan modifications fail to meet the current standards under the QM rules, and they will nearly all fail in the end.
Since the ability to serial refinance went away, it took a couple of years, but loan mods stepped in to fill that gap. You could stretch the term, defer the principal, whatever it took to get the payment affordable… And if the borrower defaulted, you could serial re-modify the loan several times. After a few modifications, if the loan still isn’t performing you can just grant a short sale.
However, a lot of the modifications are performing just fine because their payments are now lower than comparable rents. So why would a borrower default if their payment would only go up by becoming a renter? May as well continue renting from the bank.
Asset Price Bubbles Since 1976
http://www.macrotrends.net/1311/asset-price-bubbles-since-1976
Since this is inflation adjusted, you can see that the recent bubble in gold is comparable to the 1980’s bubble.
Great chart. Thanks for sharing
Mellow Ruse says:
June 28, 2013 at 12:43 pm
“el numeraire is toast.
Gold is a bubble. The selloff is not recent. It has been going on for two years. What has changed is that we’ve entered the acceleration phase of the decline.
My prediction: Gold will bottom at $500 and stay there.”
Price of gold in Euros on June 28, 201, the date of your post, was 949.00.
Price of gold in Euros today is 1100.00.
Gold has appreciated 19% in Euros since Mellow Ruse said, “we’ve entered the acceleration phase of the decline.”
Even in dollars, it was $1,230 when you made your “acceleration phase of the decline” observation, and it is today $1,265.
What exactly is the acceleration phase of the decline?
You obviously data mine anything which fits your contention of the day, but you have yet to answer the questions above, the answers of which show how wrong you were and are.
Great chart, but what about the questions?
You obviously data mine anything which fits your contention of the day
LOL!
Go reread your entire post to see the irony.
So why can’t you answer the questions?
Talking about gold is like discussing abortion – only extremists have strong opinions and want to share them. Nobody else wants to talk about it…
We both know you aren’t interested in honest debate, so answering the questions would be a waste of time. I’m pragmatic like that.
It’s official: S&P to pay record-breaking fine for misleading RMBS investors
oops
It’s official, a credit ratings agency is finally facing the music.
As was first rumored in early January, Standard & Poor’s will indeed pay $1.375 billion as part of settlement with the U.S. Department of Justice and nearly 20 states over claims that S&P knowingly misled mortgage bond investors by issuing trumped up ratings for pre-crisis residential mortgage-backed securities.
Attorney General Eric Holder announced the massive settlement Tuesday morning, calling it a “major step forward in the Justice Department’s ongoing effort to safeguard the American people from financial fraud and misconduct; to protect the integrity of our financial system; and to hold accountable any individual or institution that violates the law and abuses the public trust.”
While, mortgage bond settlements are not unusual in the years since the subprime bust, credit ratings agencies were typically spared regulatory wrath. Until now. The settlement stems from claims that were first levied against S&P two years ago. The latest word is that Moody’s Investors Service may be next.
In 2013, the DOJ and the group of states filed a civil suit against Standard & Poor’s, and its parent company McGraw-Hill, for allegedly misleading investors who put money behind RMBS and collateralized debt obligations.
Each of the lawsuits alleged that investors incurred substantial losses on RMBS and collateralized debt obligations because S&P issued “inflated ratings that misrepresented the securities’ true credit risks,” the DOJ said. The DOJ also accused S&P of falsely representing that its ratings were objective, independent and uninfluenced by S&P’s business relationships with the investment banks that issued the securities.
Remain Calm. Nothing to see here. Move along….
When S&P was pressured to assign AAA ratings to mortgage bonds it was called financial fraud. When the Treasury Secretary pressured S&P to assign AAA ratings to the United States debt, it was in the name of “doing a service to your country”.
Angry Geithner once warned S&P about U.S. downgrade
http://uk.reuters.com/article/2014/01/21/mcgrawhill-sandp-lawsuit-idUKL2N0KV1O120140121
Doesn’t that mean Fitch and Moody’s should be sued for fraud for caving to this pressure from the US Treasury?
Great point.