Sep252015
Prime mortgage borrowers caused the housing bust
Prime borrowers using negative amortization loans were largely responsible for inflating the housing bubble, and their defaults lead to the crash.
Most people believe the housing bubble and bust was caused by subprime lending.
It was not.
The housing debacle was caused by a rapid expansion of credit to prime borrowers, particularly through the proliferation of negative amortizations loans. The housing bubble inflated because too much money was loan to everyone, not just subprime borrowers.
Since bubble-era home prices depended on unstable loan products, the collapse was inevitable. Although the subprime borrowers defaulted first, all borrowers defaulted in large numbers because the loans there were given were toxic; in fact, delinquency rates were many times normal for prime borrowers as well as subprime.
Ben Bernanke famously (and inaccurately) quipped that the housing bust was “contained” to subprime and it wouldn’t bleed over to prime borrowers. He was either knowingly lying or astonishingly ignorant; neither alternative casts him in a positive light.
While bankers clung to wishful thinking and feeble hope to stop foreclosure in Phoenix, their alt-a and prime borrowers also defaulted in large numbers, a fact often overlooked by those who want to characterize the housing bubble as a subprime problem.
Besides the hidden racial bias, the worst part about the “blame the poor subprime borrower” meme was the gross distortion of truth. This wasn’t primarily a subprime problem that caused problems with better borrowers — the problem with delinquency was primarily a problem of higher wage earners and wealthy borrowers; in fact, the bigger the loan, the more likely the borrower was to become delinquent.
At first banks allowed these borrowers to squat because foreclosing on them assured the banks of losses far in excess of what they could afford; thus you get borrowers like Peggy Tanous who lived payment-free for over six years. It was the prime borrowers taking out huge loans that were responsible for the housing bubble.
Turns Out the Housing Crisis Wasn’t All About Subprime
When we talk about the past decade’s housing crisis, it’s natural to talk about subprime loans. Subprime loans give us a convenient, conventional story: predatory lenders charging people unconscionable interest rates, forcing innocent people into foreclosure and the rest of us into the worst financial crisis since the Great Depression.
There is only one small problem with this story, which is that lots of prime borrowers defaulted too. In fact, according to a new paper by Fernando Ferreira and Joseph Gyourko, subprime loans accounted for only a bare majority of defaults at the beginning of the housing crisis. Between the third quarter of 2006 and the third quarter of 2012, twice as many prime borrowers lost their homes as subprime borrowers. …
Subprime loans certainly caused a lot of problems, but they did not cause all the problems by any means. They could not have driven us into crisis if the rest of us had not so eagerly gone along.
So what role did they play?
Subprime lending fueled demand that pushed prices higher. This prompted “innovations” in mortgage lending to allow both subprime and prime borrowers opportunities to buy even at ridiculously inflated prices. The toxic mortgage products developed in response to affordability problems inflated the bubble, which is why they were banned by Dodd-Frank.
I think we can tell a very plausible story that still assigns subprime loans a central role:
Once upon a time, there was a country with a housing market that started to rise. As the market started to rise, housing defaults started to fall. They fell not because people had gotten wiser about borrowing, or better at managing their money, but because borrowers in a rising housing market virtually never need to default; they can always simply sell the house, walking away with whatever equity is left over after paying off the mortgage.
Lenders loved this. “Splendid! If default has become less likely,” the lenders said, “we do not need to worry so much about things like down payments or credit histories. Who cares if they can’t pay the mortgage each month; if they get into trouble, they’ll just sell the house and pay us.”
This is exactly the mindset that lead to destruction.
Now, a housing market is sort of like a room with two doors. On the one side people are entering; on the other side of the room, people are exiting. The more people there are in the room, the more valuable your little patch of ground to stand on becomes. The effect of expanding subprime loans was to make the entrance door wider, allowing a lot of people in who had not previously been able to secure a spot inside. This made spots inside even more valuable, and drove defaults even lower, encouraging the bankers to make even riskier loans.
Unfortunately, there were only so many people in the waiting room who wanted to get in. Once they’d all passed through, two things happened: The number of people bidding for spots fell, and people started to notice that it was getting kind of crowded in there. Prices stopped rising inside.
Once that happened, the risk of those subprime loans became apparent. They’d always been bad credit risks, but that risk had been masked by the rising prices. Defaults started going up. The folks in the waiting room decided maybe they’d wait a little while to see how it settled out. Lenders didn’t have money to make new risky loans. The subprime borrowers were the first to go, and the hardest hit.
In March of 2008, I first wrote about the problems with the subprime business model:
There is an important distinction that must be made between the default rate on a mortgage loan and the resultant loss incurred when a default occurs. High mortgage default rates do not necessarily translate into high mortgage default losses and vice-versa.
Subprime loans have had high default rates since their introduction. When subprime mortgages began to capture broader market share starting in 1994, the rate of home ownership in the United States began to rise. The increasing use of subprime loans and the subsequent increase in home ownership rates put upward pressures on house prices. As house prices began their upward march, the default losses from subprime defaults began to fall because the collateral was obtaining more resale value. This made subprime lending, and its associated high default rates, look less risky to investors because these default rates were not translating into default losses. As time went on and prices continued to rise, subprime lending established a track record of investor safety which drew more capital into the industry; however, since the relative safety of subprime lending was entirely predicated upon rising prices, it was an industry doomed to fail once prices stopped rising.
Take this phenomenon to its extreme and its instability becomes readily apparent. Imagine a time when prices are rising, perhaps even due to the buying of subprime borrowers, and imagine what would happen if 100% of the subprime borrowers defaulted without making a single payment. It would take approximately one year for the foreclosure and relisting process to move forward, and during that year, the prices of resale houses would have increased. When the lender would go to the open market to sell the property, they would obtain enough money to pay back the loan and the lost interest so there would be no default loss. What just happened? Lenders became de facto real estate speculators profiting from the buying and selling of homes in the secondary market rather than lenders profiting from making loans and collecting interest payments. This profiting from speculation is the core mechanism that disguised the riskiness of subprime lending. When these speculative profits evaporated when prices began declining, the subprime industry imploded and its implosion exacerbated the decline of home prices.
It’s taken seven years, but academics conducted a study confirming what I wrote back in 2008. I hope this leads to a broader and better understanding of what really happened.
The middle class is responsible
Far too much money was loaned to middle-class borrowers who didn’t have the capacity to pay it back. These middle-class borrowers never had the capacity;
it wasn’t a matter of rich people losing wealth in the stock market or high wage earners getting laid off. People with modest incomes who didn’t lose their jobs were given debts they could never repay — loans in excess of $750,000 — and they defaulted.
To characterize this as a problem of rich versus poor isn’t accurate either. These were middle-class borrowers pretending to be rich, aspiring to be rich, borrowing money to speculate in the can’t-lose real estate market. Many of the households given $750,000+ loans had combined family incomes of less than $100,000 thanks to the Option ARM, teaser rates, liar loans, and the general insanity of lending during the 00s.
The housing bubble was not a subprime problem: it was a middle-class prime borrower problem. It’s time for everyone to quit blaming subprime borrowers and look in the mirror.
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Housing Recovery Linked Directly to Credit Loosening, Report Says
A bullshit report telling the industry what it wants to hear
he next phase of the housing market recovery will be dependent upon looser credit standards.
Pro Teck’s Home Value Forecast (HVF) found that in markets like San Francisco and Detroit are experiencing different recoveries and one reason for this is the credit availability.
The forecast found San Francisco, California buyers have averaged 20 percent of more down over the last 14 years, with loan-to-value (LTV) ratios between 67 percent and 82 percent. On the other hand, Detroit, Michigan buyers’ average LTV ratios between 86 percent and 101 percent.
Pro Teck also outlined the top 200 core-based statistical areas (CBSAs). Leading these areas was Bellingham, Washington; Boise City, Indiana; Durham-Chapel Hill, North Carolina; Mount Vernon-Anacortes, Washington; and Oak Harbor, Washington.
At the bottom of this list were: Midland, Texas; Atlantic City-Hammonton, New Jersey; Hagerstown-Martinsburg, Maryland-West Virginia; Jacksonville, North Carolina; and Saginaw, Michigan.
Phoenix, Arizona metro held the sixth spot in the top ten CBSAs, with high demand and low inventory levels, the report noted. Within this metro, Scottsdale, Arizona home prices have been rebounding since 2011 and are now 20 percent below peak levels following a 37.5 percent drop. Scottsdale, Arizona
In Apache Junction, Arizona, at the height of the housing crisis, homes lost over half their value another city within the CBSA, is still 36 percent below its all-time high. At the height of the housing crisis, homes in Apache Junction lost more than half their value.
“Higher LTV has historically meant more foreclosures also — something we saw during the housing crisis,” the report explained. “Apache Junction has seen a steeper drop in home prices and a slower recovery, due to more foreclosures on high LTV loans. Just like Detroit and Cleveland, the town would benefit from higher LTV limits to spur the housing recovery.”
Pro Teck concluded that higher LTV ratios combined with many of the other credit safeguards that were initiated over the last five years should “protect banks and safeguard the economy from a repeat of 2007.”
New Home Sales Sales Climb to Seven-Year High in August
HUD and the U.S. Census Bureau jointly announced Thursday the new residential sales reached a seasonally adjusted annual rate of 552,000 in August 2015, the highest level since February 2008.
The report showed that sales increased 5.7 percent above the revised July rate of 522,000 and 21.6 percent above the August 2014 estimate of 454,000.
“The steady, albeit modest, progression of new home sales reflects the steady increase in economic improvement, in job additions and consumer confidence,” said David Crowe, chief economist and SVP, NAHB. “Home buyers are taking advantage of historically low mortgage rates, and pent up demand from years of a slow housing recovery.”
HUD and the Bureau found the median sales price of new houses sold in August 2015 was $292,700, while the average sales price was $353,400.
The seasonally adjusted estimate of new houses for sale at the end of August was 216,000, representing a supply of 4.7 months at the current sales rate.
“A faster sales pace and difficulties acquiring buildable lots and labor have constrained builders’ ability to respond to growing demand,” Crowe said. “However, the single largest constraint has been the lack of demand and the slow resale market which is the source of most new home buyers.”
At least The Big Short trailer at the very end, sprinkled in some borrower misbehavior – the dancer with five mortgage loans on investment properties. The book was great, but the movie will likely push the meme that “banks” are 100% responsible for defrauding 100% innocent borrowers. I’ll watch it, and very likely be annoyed the whole time.
I give Bernanke the benefit of doubt and believe he was lying attempting to contain the spread somehow. The Fed was well aware of the proliferation of negative amortization and NINJA loans. They just weren’t a big problem because house prices never decline.
It’s easier to blame the poor. That’s why we do it.
I hope you’re wrong about the slant of the movie, but such a populist theme would probably sell more tickets, so you’re probably right.
I also believe Bernanke knowingly lied. It’s just too frightening to believe the people in charge could have possible been that ignorant.
Look closely: This explosive mortgage lending article actually doesn’t make any sense
There’s a seemingly well-thought-out mortgage finance article on the Internet today.
The article explores potential threats to opening up the credit box for more mortgage lending.
And despite America’s mortgage market being more regulated today than at any point in the history of this nation, there is something very rotten at the heart of it: OBAMA!
This article, written by Chriss Street, on Breitbart offers an explosive headline (why I read it) which goes unproven by fact in the article itself (why I wrote this).
Here’s the gem of a headline:
“Obama makes new push for minority mortgages.”
In reading the article, this appears automatically to be a problem.
In the article, Street writes that Fannie Mae and Freddie Mac are moving “aggressively” to get home loans to blacks and Hispanics, which is of course a bad thing because loans to minorities ruined this country’s economy in 2007.
Here’s the lead paragraph:
“The Obama administration is demanding that minorities again receive preferences to qualify for mortgages–the same policy that helped trigger the sub-prime mortgage crisis and the 2007-8 financial crash.”
But look closely: This seemingly explosive mortgage lending article actually doesn’t make any sense.
For one, there is no proof of this demand. The article only includes a quote from Obama that’s five years old. Of course, one could make proof if looking the right places, but Street doesn’t go that route.
Instead the article meanders from Dodd-Frank to the Community Redevelopment Act, from the National Association of Realtors to the Federal Housing Finace Agency…and astonishingly from FICO to VantageScore. Links are substituted for proof of linear thought, which is unnecessary, as this blog proves.
Street makes the argument that better credit scoring and the use of alternative models are actually less better than the systems they are updating.
“But President Obama and his community organizer allies complain that FICO 9 is still dependent on data submitted to the credit bureaus. They believe that credit scores should include the regular rental and utility payments history that are captured by VantageScore, but are not reported to credit bureaus unless there is a major problem.”
Street doesn’t name those organizers or define who “they” are, so you’ll need to figure that out yourself.
Street continues [italics are mine].
“The real issue is not easing of qualifying credit scores from the overly cautious FICO 770 back to a reasonable FICO 710. It is the promise by VantageScore’s CEO Barrett Burns that he can add credit scores for 30 million more people with 9.5 million being “Latino or African-Americans.” Burns believes about 2.7 million have credit scores above 600 and could qualify for a Federal Housing Administration single-family loan.”
Wait, the real issue is being able to get only one-third of all new mortgages to the two largest minorities in America?
So who gets the other two-thirds? Whites, then, right Street?
Well, by that stream of logic, thanks Obama for “demanding that minorities again receive preferences to qualify for mortgages,” as Strett writes.
Mr. President! Your attempts at creating workable, equal-rights housing policy will fail once again!
No wait, that makes no sense, so actually Breitbart just accuses Obama of doing something that’s not really a thing.
And that opinion is based on reading the Breitbart article, as it stands alone, with a catchy headline, but no real point.
Continuing the discussion on how low mortgage rates are nothing like affordability products (negative amortization, interest-only, teaser rates, NINJA loans, etc.), it’s about risk layering. Every loan carries the same risks – that the borrower will default due to death, divorce, or income interruption. Whether the rate on the mortgage loan is 3.50% or 7.50%, if it’s fixed and underwritten well, the default risk lies in the borrower dying, divorcing, or losing income, not in the product’s features.
With affordability products, you still have the typical default risks associated with the borrower, but you’re adding very dangerous risks within the product itself. You’re also increasing the risks with the borrower because the loan was made without real job, income, and/or assets.
There a few important risk management concepts that might help understand the difference between affordability products and low rates.
The first risk factor is capacity. The problem with bubble-era affordability products is that they only looked at a borrower’s present capacity to afford the loan. Fixed rate products look at present capacity, and assuming stable employment, prospective capacity over the life of the loan. With the new ATR requirements, ARMs and I/O loans also qualify the borrower over the loan period.
The second risk factor is character. It doesn’t matter how much a borrower makes if they don’t pay YOU back your money.
When you combine these two risk factors you arrive at the probability that the borrower will default. If you have the income and you pay your bills on time, there is a low probability that you won’t pay, or a high probability that you will. This means that the bank can charge a lower rate for this class of loans and still make the same amount of money.
The final thing to consider is the consequence of default. If low-down-payment loans default, the consequence is much higher than loans on homes with substantial equity. The rate is adjusted higher to cover default risk/cost.
The problem with bubble-era affordability products is that risk management was thrown out the window because the consequence of default was presumed to be zero. When people stop thinking bad shit happens. When the people at the large lending institutions who are in charge of risk management are marginalized in order to compete for market share, bad shit happens on an epic scale.
Those concerned about rising risk tried to lay off the risk in the form of collateralized debt obligations and credit default swaps. This only works if counter-party risk is properly vetted, or there is an endless supply of greater fools. If the insurer is in worse shape than the insured, then what good is insurance?
It wasn’t only bad government regulation, which was substantial, but also bad corporate regulation. Normally, this bad corporate regulation would result in bankruptcy (corporate and personal), and criminal prosecution for the exceptionally egregious displays of risk “avoidance”.
Tried and true risk management techniques existed during the bubble-era. What was missing was the discipline to use them. Now that we have eliminated one of the normal checks on risk (i.e. consequence of default via TBTF), probability of default needs to be much lower to maintain systemic risk at an acceptable level. This means that credit scores and income are even more important.
The banks can’t have it both ways. If they want to be protected from their own risky loans, then they can only be allowed to lend to highly-qualified borrowers.
I’m not sure you can blame any particular group. The whole system was built to alleviate risk and accountability in all facets relating to real estate and real estate investment. The general population (at all levels) are ignorant sheep and will follow that seems to work well for their neighbors, friends and co-workers. The blame lies on the poor, the middle-class, the rich, the government, etc. etc. etc.
If I look toward a single reason the reason would be greed across all classes. Greed was the driving force that took the world to the brink of financial destruction and we’ve been walking along that edge ever since. Lately, it seems we’ve tip-toed back closer that cliff and are peeking over. Just hope we don’t lose our (global) balance!
You can’t blame the sheep for being eaten by the wolves. You can’t blame the wolves, either, they are doing what wolves do. You have to blame the shepherd sleeping behind the haystack.
Alan Greenspan unleashed the dogs of finance when he refused to regulate them, so his culpability is near the top of the list. If I were to put things in order I would probably rate as follows:
Alan Greenspan
Federal Reserve sycophants on FOMC
Lenders
Borrowers
Fact: blacks commit most of the crimes. They’re also most likely to be victims, but the first sentence sends people in a tizzy even though it is a verifiable, objective fact.
Similarly blacks are most likely to default. It’s an objective fact, even if it makes you uncomfortable, even if Irvine Renter calls you racist for saying it.
So more minority lending leads to more defaults. That’s an objective truth, even if you don’t like it. You can say that it’s a good policy for one reason or another, but any such program will lead to a higher default rate and it should be understood you’re trading off financial losses for something else.
It’s like how colleges have lower SAT scores for blacks and higher one for Asians.
Thank goodness for HD TV, because otherwise I couldn’t tell if Ted Cruz’ victory lap this morning after topping a non-Bible-Thumper was an SNL parody, or actually Ted Cruz. He sounds like a crazed Texas Baptist preacher.
Could you share a youtube link? I think Ted Cruz is a nut, and I would probably get a kick out of the video. I’m far more amazed at the things he says than I am the foolishness that comes out of Donald Trump’s mouth.
He seriously sounded like John Lithgow’s character in Footloose raging against dancing.
[…] See original here: Prime mortgage borrowers caused the housing bust – OC Housing News (blog) […]
Study of Yale law students helps explain economic inequality, authors say
http://www.abajournal.com/news/article/study_of_yale_law_students_helps_explain_economic_inequality_and_bernie_san/?utm_source=maestro&utm_medium=email&utm_campaign=weekly_email
“Elites—in both parties—remain baffled by Donald Trump and Bernie Sanders’ appeal; and they prayerfully insist that both campaigns will soon fade away. Our study suggests a different interpretation, however. These bipartisan disruptions of elite political control are no flash in the pan, or flings born of summer silliness. They are early skirmishes in a coming class war.”
IMO, the biggest disappointment of Obama was his unwillingness to take on the political elites. Both sides now belleve they can control the masses through mass media bullshit, but the political masses are sending a strong message that they are finally fed up.
It’s the same instinct that spawned the “Occupy” movement. They were rebels without a cause and couldn’t galvanize around any real leader or issue, but the fact that the movement existed at all shows the undercurrent of irritation with how the elites run our lives.
The revolution is coming.
It’s too bad they didn’t ask me to participate. I would have given away all the money to: a) screw with their metrics, and b) see if I could collapse their studies “economy” as infinite redistribution drives efficiency to zero.
September Home Sales: Something’s Gotta Give
The headlines react to volatile numbers prone to large revisions
Existing and new home sales moved in opposite directions in August with existing home sales coming in well below expectations, while new home sales strongly beat expectations. We expect this pattern to continue in September, but flipped. Our forecast for existing home sales suggests a slight 0.2 percent monthly increase to 5.32 million units at a seasonally adjusted annual rate (SAAR), while our forecast for new home sales suggests a 4.6 percent drop from August to 527,000 units (SAAR).
Our longer-term home sales forecasts, for September 2015 through February 2016, suggest existing and new home sales should continue increasing through this fall before retreating somewhat during the winter months.
Realtor survey: Millennials are no longer a renter generation
realtor.com Chief Economist Jonathan (blows) Smoke gets a nickname
Homebuying trends in 2015 are undermining the image of the Millennials as a generation of renters.
realtor.com Chief Economist Jonathan (blows) Smoke has argued for some time now that Millennials are not different than previous generations in homebuying, delaying homebuying decisions by no more than a year or two beyond the habits of Generation X of Baby Boomers.
The news is finally a departure from years of being told Americans prefer renting their homes. Is that attitude finally shifting?
Almost 65% of millennials aged 21 to 34 looked at real estate websites and apps in August, according to realtor.com analysis of data from comScore and current population estimates.
“Additionally, when we focus on 25-34 year olds we find that this group is 70% more likely than the average adult to be currently looking for a home to buy on realtor.com,” Smoke says. “While it is difficult to estimate the effect of millennial buyers in the new home market, one can infer that since prices over the year have trended towards the more affordable, that some of the growth in the new homes market is a result of builders providing more affordable supply.”
“People who believe that Millennials are disinterested in home ownership are grossly mistaken,” said Smoke. “This generation hit the job market during one of the largest recessions of all time and they’ve had to work hard to establish credit and save for a down payment.
“With the older segment just beginning to enjoy the life events that drive home ownership – marriage and children – now is the most appropriate time for them to consider home ownership, and that’s what we’re seeing,” he says.
Zillow and other sites also show rentals available. So, maybe millennials are still looking at rentals on these sites?!
Bush Vows to ‘Slash’ Regulation, Overhaul Dodd-Frank
http://www.nationalmortgagenews.com/news/regulation/bush-vows-to-slash-regulation-overhaul-dodd-frank-1062089-1.html?utm_medium=email&ET=nationalmortgage:e4010451:a:&utm_source=newsletter&utm_campaign=-sep%2025%202015&st=email
WASHINGTON — Former Florida Gov. Jeb Bush, a Republican candidate for president, has unveiled a broad plan to reform the regulatory process, including at independent agencies like the Consumer Financial Protection Bureau.
Bush outlined his agenda to cut government red tape and boost the economy in a Wall Street Journal op-ed posted online Tuesday night. He warned that President Obama has made it harder for workers to get jobs and for small businesses to open their doors, vowing to streamline the rulemaking system.
“If you’re wondering why it’s hard to get a mortgage, why no new banks are opening up, why your power bill will be going up, why your health insurance costs more, why we don’t build new highways, why you can’t get medicines that are available in Europe, Barack Obama’s rules are a big part of the story,” Bush wrote.
He said he would establish a new commission “charged with reviewing regulations from the perspective of the regulated and shifting more power from Congress back to states.”
New rules by independent agencies would also come under stricter White House review. The Office of Information and Regulatory Affairs, which is housed in the Office of Management and Budget, oversees the release of proposed rules and final regulations by executive agencies, it does not have any authority over independent agencies, including the banking regulators.
“In my administration, every regulation, including those issued by so-called independent agencies such as the Consumer Finance Protection Bureau, will have to satisfy a rigorous White House review process, including a cost-benefit analysis,” he said. “Regulations will be issued only if they address a major market or policy failure.”
While the banking agencies and other financial regulators, such as the Securities and Exchange Commission and the Commodity Futures Trading Commission, do use cost-benefit analyses in the writing of rules, some observers — particularly conservatives — have pushed for more comprehensive requirements.
Bush added that he would “work with Congress to repeal significant portions” of the Dodd-Frank Act in addition to changing “the complex set of rules that perpetuate too-big-to-fail financial institutions.”
The presidential hopeful also took to task the so-called revolving door between government and the private sector.
“Regulation feeds into Washington’s revolving-door culture. Regulators spend years writing complex rules, then leave for the private sector to sell their inside knowledge to the highest bidder — usually a big, well-entrenched company,” Bush wrote. “No wonder so many Americans are cynical about who Washington really works for.”
Critics across the political aisle have warned that movement between federal agencies and banks has weakened oversight of the financial system. Hillary Clinton, the leading Democratic presidential contender, backed a bill last month by Sen. Tammy Baldwin, D-Wis., that would overhaul lobbying rules in an effort to slow the pace of those moving between the business and government.
Bush added that he would require agencies to “create one dollar of regulatory savings for each new dollar of regulatory cost they propose.”
“We will eliminate and reform outdated and burdensome rules and, when necessary, work with Congress and the courts to overcome legal obstacles that stand in the way of sensible savings,” he wrote.