Jan272017
Top ten ways to protect taxpayers against future mortgage bailouts
More than eight years after the government took over mortgage finance, the US taxpayer still insures the bulk of the loans in the housing market.
Prior to the collapse of the housing bubble, when lenders foolishly loaned money to people operating personal Ponzi schemes, it was theirs to give — and to lose. But when the losses overwhelmed our banking system, the government took conservatorship of the GSEs, and they backstopped the largest banks with our too-big-to-fail guarantees. With those two steps, the government now assumes nearly all risk of loss in the US mortgage market.
With taxpayers absorbing future losses through explicit and implicit guarantees, lenders have no reason to fear inflating another housing bubble. Another bubble would generate enormous fee income at origination and interest income through ever-increasing loan balances, and when the bubble bursts, the government pays the tab and lenders enjoy big bonuses for their financial prowess — at least if past history repeats itself. The current system laden with moral hazard actually encourages bubbles to form.
So how can taxpayers be protected?
The ten measures presented can be broadly categorized in two guiding principals:
- First, we must scale back or eliminate loan guarantees, and
- second, we must limit the growth of loan balances.
Scaling back loan guarantees is accomplished with five specific policies:
- Break up the too-big-to-fail banks,
- dissolve the GSEs,
- Tighten FHA guidelines further,
- raise FHA down payment requirements,
- restore mark-to-market accounting and require timely liquidation of REO.
Limiting the growth of mortgage balances is also accomplished with five specific policies:
- Cap secured borrowing at 80% LTV,
- limit appraised values by rental cashflow,
- permanently ban interest-only and negative amortization loans,
- base payment qualification standards on maximum allowable interest rate,
- limit debt-to-income ratios to 31%.
Let’s examine each of these in more detail.
Scale back or eliminate government loan guarantees
The surest way to protect taxpayers is to get them out of the loan guarantee business. Taxpayers currently insure over 85% of the mortgage market. In 2006, the US taxpayer was ostensibly covering about 2% of the mortgage market through the FHA, VA, and other government programs. We need to return to the days of near zero government guarantees, and we need to prevent the conditions where implied guarantees may become explicit as happened in 2008.
1. Break up the too-big-to-fail banks
Too-big-too-fail is too-big-to-exist. When banks no longer fear going bankrupt and losing money for their investors or depositors, they are likely to take unnecessary risks. This is an unconscionable risk for the US taxpayer to bear. Quite frankly, I can’t understand why there is even debate on this subject, nor do I understand why these banks were allowed to get even larger over the last eight years.
2. Dissolve the GSEs
As long as the GSEs exist in any form, they will have the implied guarantee of their entire portfolios. Politicians will try to suggest otherwise, as they did for nearly half a century prior to taking them into conservancy in 2008. Politicians proved without any doubt that no matter what promises they make, no matter what assurances they give, if the GSEs get in trouble, they will get bailed out. As long as these entities exist, the US taxpayer will have an implied guarantee on every loan they own or insure.
3. Tighten FHA guidelines further
In lending, defaults occur at the fringes of qualification. Borrowers with 800 FICO scores default much less frequently than borrowers with 500 FICO scores. Borrowers with 20% debt-to-income ratios default much less frequently than borrowers with 40% debt-to-income ratios. Whenever lenders draw lines in the shades of gray, the largest number of defaults will come from those people near the lines. For taxpayer-backed loans, these lines should be as narrowly construed as possible. The FHA should be the safest loan in the industry, not the substitute for subprime.
Currently, FHA will allow FICO scores down to 580. Default rates on FHA loans with FICO scores from 620-650 is 15%. That is far too high. Each standard for an FHA loan should be carefully examined, and qualification standards should be tightened to nearly eliminate risk on FHA loans. The effect should be to greatly reduce FHAs market share as private lenders willing to take more risk will provide competing loans. This has historically been the FHAs function. They are supposed to be the lender of last resort. We need to relegate them to that role again.
4. Raise FHA down payment requirements
The FHA guideline which exposes taxpayers to the most risk is the low down payment. Since it costs a buyer at least 6% (probably closer to 9%) to liquidate a property when factoring in discounts, commissions, and closing costs, any down payment of less than 10% is exposing taxpayers to risk of loss. The risk of loss goes up exponentially as down payment requirements drop. This exponential increase in loss severity is due partly to liquidation costs as described above, and partly due to the fact that default rates go up significantly as down payments decrease.
5. Restore mark-to-market accounting and require timely disposition of REO
Once the loan guarantees are scaled back or eliminated, lenders must be forced to endure the full brunt of the losses for their foolishness.
One of the main reasons the economy has suffered since house prices collapsed is because so much capital is tied up in unproductive uses. Part of the economic cycle is to purge bad business models and Ponzi debt and reallocate capital to more productive uses. That’s what recessions are for.
We have not gone through the necessary purging in this recession, so rather than endure a short deep recession, we have endured a somewhat less deep but much longer one followed by a tepid recovery. To restore the engine of economic growth, we need to return to mark-to-market accounting, and force lenders to take their write downs and dispose of their REO. That frees up capital for better uses.
Limit the growth of mortgage balances
The other necessary component to taxpayer protection from Ponzi mortgage theft is to limit the growth of mortgage balances. This concept is sacrilege to the lending industry which wants to divert every penny of borrower income to debt service payments. Without limits to mortgage loan balances, we are certain to have Ponzi borrowers who game the system to get free money they never intend to repay.
6. Cap secured borrowing at 80% LTV
Many people don’t understand what caused the housing bubble. The mainstream media contributes much misinformation, and some politically motivated books on the subject clouded the issue further. The reality is simple: Desire for mortgage equity withdrawal inflated the housing bubble.
Lenders and borrowers expanded home mortgage balances as people took on more debt and bid up prices to capture appreciation. However, in order for home price appreciation to motivate people to pay stupid prices and inflate housing bubbles, they need a way to access this appreciation. The more immediate and plentiful this access to money, the more motivated buyers are to borrow and cash out. Mortgage equity withdrawal is the doorway to appreciation; it makes houses very desirable and very valuable.
Texas was one of the few states which did not participate in the housing bubble. This was surprising because Texas was a major participant in the commercial bubble of the late 80s and early 90s. The reason Texas didn’t participate in the residential housing bubble is because they have laws prohibiting mortgage equity withdrawal beyond an 80% LTV. Since Texans didn’t have unlimited access to the housing ATM, they didn’t bother bidding up home prices. Wealth people can’t spend doesn’t feel real to them.
The Texas experience clearly showed the individual incentives matter a great deal. California inflated a massive housing bubble because we permitted unfettered access to HELOC booty, and as property values went up, property taxes didn’t, thanks to Proposition 13.
In addition to limiting mortgage equity withdrawal, California should consider changing Proposition 13 to trigger a reassessment with every refinancing of a residential property. A borrower would be hard pressed to argue the property isn’t more valuable considering they are borrowing against that increased value they just had appraised. If HELOC money cost the borrower more in property taxes, the State would benefit, and borrowers would have less incentive to hit the housing ATM.
7. Limit appraised values by rental cashflow
I noted that rental parity analysis in appraisals would prevent another housing bubble. Prices collapsed during the housing bubble because prices became greatly detached from their fundamental valuation of income and rent.
This disconnect occurred because the comparative-sales approach enables prices to rise based on the irrational exuberance of buyers. If lenders limited their lending based on the income approach, and if they refuse to loan money beyond what the rental cashflow from the property produces, any price bubble would require buyer equity, and lender and investor funds would not be at risk.
Since lender and investor risk is now taxpayer risk, every effort should be made to establish the rental cashflow value of real estate and limit loan balances accordingly.
8. Permanently ban interest-only and negative amortization loans
When the credit crunch hit as house prices collapsed, negative amortization loans were discontinued almost immediately. It took a little longer for the market to turn against interest-only loans, but those ultimately went away as well. Dodd-Frank effectively banned these products — at least so far.
In a 2012 fed whitewash paper on housing, they actually defend the use of these loan programs — or at least their failure to regulate them. At this point, we can only hope investors don’t lose their minds again and bring back these Ponzi loans. While the US taxpayer wouldn’t be direcly liable on these loans, the taxpayer would be insuring other loans made on nearby properties, and if a crash ensued, these nearby government loans would be held against devalued collateral, and taxpayer money would be at risk.
9. Base payment qualification standards on maximum allowable interest rate
When qualifying people for loans, lenders are supposed to ensure they can afford to make the payments. In the promissory note, if the rate is adjustable, there is a cap on the maximum interest rate the borrower can be charged. This maximum theoretical payment is what lenders should be required to use when qualifying a borrower. Right now, they only must concern themselves with the maximum payment over the first five years of the loan.
As it stands, borrowers turn to adjustable-rate mortgages as affordability products without understanding their risks. When interest rates go up, payments can become unaffordable and the borrower may default. Right now that risk is ostensibly on the borrower, but since we know they can walk without recourse, that puts the risk back on the lender who in turn will transfer the loss to the US taxpayer.
10. Limit debt-to-income ratios
During the housing bubble, lenders allowed borrowers to pledge completely unrealistic portions of their income toward housing payments. Many borrowers in the early loan modification programs had debt-to-income ratios over 70%! After taxes, that leaves nothing at all. Only continued Ponzi borrowing sustains such high debt-to-income ratios.
The first round of loan modifications reduced borrowers DTIs to 38%, which was a significant improvement for many, but since the Ponzi loans were not forthcoming, even a 38% DTI proved too much. Nearly all of the early loan mods failed.
Finally, the government set loan modification targets and GSE loan qualification guidelines at 31%. This is still above the previous standard of 28%, but it is at least manageable without Ponzi borrowing, albeit with very little disposable income left over.
Dodd-Frank capped back-end DTIs at 43% of a borrower’s income. This was a huge step forward in protecting the US taxpayer — assuming Trump doesn’t gut Dodd-Frank and expose the taxpayer once again.
Would implementing these ten policies prevent future housing bubbles?
These policies wouldn’t necessary prevent future housing bubbles, but they will accomplish one very important thing: these policies will prevent the US taxpayer from picking up the tab for the next one. That alone makes these policies necessary for implementation.
Now we need to figure out a way to protect the taxpayers from theft by colleges and students.
Student Debt Payback Far Worse Than Believed
Many more students have defaulted on or failed to pay back their college loans than the U.S. government previously believed.
Last Friday, the Education Department released a memo saying that it had overstated student loan repayment rates at most colleges and trade schools and provided updated numbers.
When The Wall Street Journal analyzed the new numbers, the data revealed that the Department previously had inflated the repayment rates for 99.8% of all colleges and trade schools in the country.
The new analysis shows that at more than 1,000 colleges and trade schools, or about a quarter of the total, at least half the students had defaulted or failed to pay down at least $1 on their debt within seven years.
The changes could have implications for federal policy. Some lawmakers have endorsed the idea of punishing colleges if enough students aren’t paying back the loans.
A spokeswoman for the Education Department said that the problem resulted from a technical programming error.
Private sector underwriting is the only way to stop the theft cold in it’s tracks. Punishing a college for the actions of a student that graduated seven years ago is a ludicrous idea that only a lawmaker could conceive of.
I think this is an attempt to shut down diploma farms. Many for-profit colleges sprung up to dole out worthless degrees and collect student loan money. The students don’t realize they are getting a worthless degree as most assume any degree will help them get a job.
Another problem with purely private sector underwriting is figuring out which degrees have value relative to the money lent. Students do a very poor job of evaluating the benefits versus the costs, and colleges have zero incentive to help. I remember when I got my biology degree. Less than 60% found employment in the field upon graduation, but we were never told that. I knew I was going on to graduate school, so I didn’t worry much about it, but many who get degrees in psychology or history, or some other worthless course of study don’t realize they have very little chance of actually working in the field they study.
I guess that’s a good thing though. Most of these people who graduate with worthless degrees end up working in fields like insurance that almost nobody sets out to enter. If everyone ended up working in their field of study, we would have millions of psychologists and no insurance adjusters.
Not to mention theft by the multitude of tenured socialist/marxist fake LIBRUL professors.
Technical programming error?? HAHAHA, good one! It’s called sanctioned accounting fraud.
Far worse?? Of course it is! EVERYTHING is far worse.
Get that thru your heads…. lemmings.
I giggle when I read technical programming error. It was obviously an error everyone in the system wanted to believe, so despite the ridiculously understated result, nobody wanted to question it because it might slow the gravy train.
https://therealdeal.com/la/wp-content/uploads/2017/01/origins-of-the-housing-crunch-large.jpg
Pence, Hensarling: Dismantling Dodd-Frank remains a high priority
It’s been a busy first week in office for President Donald Trump, with executive orders on immigration, energy, trade, health care, and more being handed down daily.
But executive orders are just the preamble to the big initiatives that Trump and the Republican majority in Congress are expected to push for shortly.
Chief among those is the “dismantling” of the Dodd-Frank Wall Street Reform Act.
During the presidential transition, Trump’s transition team stated that dismantling Dodd-Frank would be one of the president’s main priorities.
And on Thursday, the American public got a reminder that the president and his party plan to keep that promise.
Speaking before the Congressional Republican Retreat, Vice President Mike Pence said that dismantling Dodd-Frank and its “overbearing mandates” remains a top priority for the Trump administration, a statement that was greeted by applause from the collected Republicans.
Expect a flurry of lawsuits against Trump administration policies from California’s new attorney general.
Xavier Becerra officially named California attorney general
California officially announced Rep. Xavier Becerra as the state’s new attorney general, approving Gov. Jerry Brown’s appointment, according to an article in the San Francisco Chronicle.
Becerra will serve the final two years of the position previously held by Kamala Harris, who was sworn in to the U.S. Senate earlier this month.
Harris spent a good portion of her six years in office fighting for California homeowners, such as supporting the California Homeowner Bill of Rights or fining major banks for their role in the foreclosure crisis.
From the article:
Becerra, a Sacramento native and son of Mexican immigrants, will take the helm as the state finds itself at odds with the proposals and policies of the Trump administration. The state’s anticipated battles with the federal government became a key concern for Democratic lawmakers, who pressed Becerra during confirmation hearings over the past two weeks on how he would handle those potential conflicts.
Republicans in both houses voted against Becerra’s appointment, saying they were concerned about the adversarial and partisan tone taken during the confirmation.
The attorney general position is considered the state’s second-most-powerful appointed position behind the governor.
California is already preemptively trying to build a strong defense against the Trump administration in case the state has to go to court.
At the start of this year, California announced it hired former U.S. Attorney General Eric Holder to “advise the state legislature regarding potential conflicts with the incoming Trump administration.”
“With the upcoming change in administrations, we expect that there will be extraordinary challenges for California in the uncertain times ahead. This is a critical moment in the history of our nation. We have an obligation to defend the people who elected us and the policies and diversity that make California an example of what truly makes our nation great,” a joint statement from California Senate President pro Tempore Kevin de León, D-Los Angeles, and California Assembly Speaker Anthony Rendon, D-Paramount, Calif., said.
I’m sure Trump is quaking in his boots about the prospect of being sued. It’s only happened about 1,000 times in his private life. Remember that lawsuits reaching the Supreme Court that go against plaintiffs can also set precedent.
Trump doesn’t fear the lawsuits, but dissuading him from trying isn’t the point. These lawsuits will be intended to merely slow him up.
It will be like the OJ Simpson trial. OJ’s defense challenged every piece of evidence and every piece of testimony looking for any grounds for reasonable doubt. The Democrat attorney’s general in New York and California will challenge everything Trump does just to slow him up and get small victories where they can. They won’t care if they lose the war as long as they make him pay a price and move at a snails pace.
They better get crackin’ then.. I think Trump has accomplished more in Week One than Obama in his entire second term.
Agreed. Everything should be accomplished via executive order. We could save a lot of time and pension expense if we simply eliminate Congress and SCOTUS.
https://www.youtube.com/watch?v=j-xxis7hDOE
This busted me up! Bigly!
The authority to sign executive orders comes from Congress. If the executive order oversteps the bounds of the law, then the SCOTUS or a lower court overturns the executive action as they did with Obama’s order letting illegal immigrants have pseudo-legalized status.
I think Trump intentionally overstepped with his travel ban. He made some unnecessary restrictions guaranteed to get the order shot down. He got a lot of attention, and his supporters ate it up, but in the end, as of right now, he’s no closer to banning travel from terrorist countries than when he started. My guess is that this is both a political gambit and part of a larger negotiation. He will issue another executive order that will stand up but isn’t as restrictive as his supporters would like. He can go back to his supporters and claimed he tried while simultaneously getting as much as he could out of the restrictions.
Tank farm developers share plans with Huntington Beach residents
HUNTINGTON BEACH When representatives of Shopoff Realty Investments scheduled the first community meeting to discuss their plans to transform a 29-acre former fuel tank storage facility into a housing, hotel and retail project, they expected a tough crowd.
“We didn’t expect to be greeted with joy and high-fives, but we’re really good at listening,” James O’Malley, Shopoff’s vice president of development, told a standing-room-only gathering at Eader Elementary School Tuesday night.
O’Malley described the plans for development of the southeast Huntington Beach parcel as “loosey-goosey” and subject to modification. The property, at Magnolia Street and Banning Avenue, is home to three unused storage tanks with a capacity of 500,000 barrels each, or roughly 63 million gallons of oil total.
The initial concept is to build about 275 housing units, including single-family homes and attached townhouses up to three stories tall, said Marice DePasquale, the outreach coordinator for the Magnolia Tank Farm.
The housing development would be about 20 acres, with four acres for a hotel and retail and the rest as park and and open space, she said.
The green space that runs along Magnolia, informally known as Squirrel Park, would be maintained. The housing area would be open to the public, not gated, she said.
The hotel, called an “eco-lodge” by developers, would have up to 200 rooms and an affordable group lodging component to accommodate 10 to 15 groups or families.
DePasquale said Tuesday’s meeting was the “first of many,” noting that plans for the project have yet to be submitted to the city.
When audience members spoke after the presentation, they expressed concerns about traffic and pedestrian safety, density and the hotel proposal.
This is an example of how developers can work to improve a community. Removing the oil tanks would be an improvement, but I still don’t see how the toxic waste dump to the immediate north doesn’t cause marketing problems for this development. “The world’s first eco-lodge built on a toxic waste dump.”
The waste dump to the north is certainly not a plus. The oil companies are supposed to create a giant dirt sarcophagus and entomb the waste in a makeshift landfill on the site. It’s a ridiculously expensive solution, but it’s cheaper than hauling the waste to Bakersfield, which is their other alternative. Eventually, there will be a park on top of the dirt. The landfill will be constantly monitored for leeching groundwater contaminants. The oil tank site itself is clean, but that site to the north certainly presents a potential problem.
There is already a huge park across the street. Gee, should I let my kids play at the Edison Rec Center or the toxic waste dump? Hmm…
“…eliminate government loan guarantees. Restore mark-to-market accounting and require timely disposition of REO. Once the loan guarantees are scaled back or eliminated, lenders must be forced to endure the full brunt of the losses for their foolishness.”
Absolutely! Occam’s razor – pretty much solves the “home affordability” problem right there.
Unfortunately, it will probably never happen. Once a government subsidy it put in place, it’s very difficult to get rid of.
On point Daniel,,,,, Thanks
Hey everyone, I saw this article. With raising interest rates and a Chinese sell off we might be in a price correction for Orange County but I’m not holding my breath.
https://cdn.ampproject.org/c/s/boingboing.net/2017/01/28/chinas-capital-controls-are.html/amp
Awesome article! Very educational!
We definitely need this to happen “California should consider changing Proposition 13 to trigger a reassessment with every refinancing of a residential property.“
Is there a way for anyone to perform a rental parity analysis on any property, anywhere? If so, how do we do it?
I think that if this method to appraise homes were easily and readily available, more people would use it and refuse to pay sellers “pie in the sky” asking prices.