May302012
Top ten ways to protect taxpayers against Ponzi mortgage theft
How do we taxpayers protect ourselves against Ponzi mortgage theft?
Prior to the collapse of the housing bubble, when lenders gave free money to loan owners, 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 and the dramatically increased market share of the FHA, 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 every reason to inflate another housing bubble. Another bubble would generate enormous fee income at origination and interest income through ever-increasing loan balances. When it all blows up, the government pays the tab and lenders get big bonuses for their financial prowess. None of the reforms enacted since the collapse of the housing bubble would prevent another housing bubble. In fact, the current system of incentives actually serves to promote one.
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.
Limit 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 to get them out of the loan guarantee business. Taxpayers currently insure over 95% 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. The too-big-to-fail banks should be broken up at the earliest possible opportunity — like today.
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 620. 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. 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. Over the last six years, money tied up in residential housing has been dead money contributing nothing to economic growth.
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. There is much misinformation in the mainstream media, and some politically motivated books on the subject have clouded the issue even further. The reality is quite simple: Desire for mortgage equity withdrawal inflated the housing bubble.
The real culprit in a housing bubble is expanding home mortgage balances — people take on more debt and bid up prices. The real question is, “why do people do it?” The short answer is to capture appreciation: kool aid intoxication. But the truth is more nuanced.
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. What would have been the point? Wealth you can’t spend doesn’t feel real.
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
In a recent post, 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 occurred because the comparative-sales approach enables prices to rise based on the irrational exuberance of buyers. If lenders would have limited their lending based on the income approach, and if they would not have loaned money beyond what the rental cashflow from the property could have produced, any price bubble would have to have been built with buyer equity, and lender and investor funds would not have been put 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. However, there are no regulations in place that would prevent these unstable loan programs from resurfacing. In fact, in the recent 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 lenders don’t lose their minds again and bring back these Ponzi loans. We need stiff regulations against such loans to prevent these Ponzi scheme loans from inflating future housing bubbles and putting taxpayer funds 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. 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 to 31%
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.
Right now, 31% DTIs are the standard because the government is the only game in town. However, there is nothing to prevent lenders from approving higher DTIs in the future. Since this will inflate prices, it will enable Ponzi borrowing, and the entire mortgage Ponzi scheme could inflate all over again. We need strict regulations limiting debt-to-income ratios on all residential home loans.
Would implementing these ten policies prevent future housing bubbles?
These policies wouldn’t necessary prevent future housing bubbles, but they will do 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.
It’s really quite simple….
Just say NO!
Since it’s irrefutable that the current price model is based on a fraudulant standard, the only way to protect yourself (thus taxpayers) from being defrauded is by refusing to participate in a purchase transaction.
That’s a lot easier when we’re talking about a luxury car being: 1) too expensive for your budget, 2) being over-priced, and 3) not worth the cost. It’s easy to say don’t buy a fancy car (“fancy” being relative to your income). But we’re all “buying” housing each month. It’s just not easy to be a non-participant to the madness.
“It’s just not easy to be a non-participant to the madness.”
Yep. Particularly since we all participate at some level unless we sleep in our cars. Renters and homeowners alike participate in the housing market. Plus, some amount of discretionary income may be put toward housing to secure a nicer property. What really muddies the water is when houses become viewed as an investment. How can anyone put too much toward investment? As soon as you see the house as an investment rather than consumption (which it is), then nearly any amount can be justified.
”We’re all buying houses each month”
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LOL
http://cdn.wallstreetpit.net/wp-content/uploads/2012/03/image128.jpg
When a property shifts from owner occupancy to a rental unit it is still owned by someone. I expect the rate of decline in home ownership to accelerate this year as hedge funds start buying SFRs.
4. Raise FHA down payment requirements
Probably the best one out there. Are people really putting 20% down on a purchase of a house $500,000 or more? I think not.
The current and still inflated prices are the primary reason the government won’t mess with down payment requirements. If 20% down were required, sales volumes would plummet because so few have that much saved.
Do you realize how hard it is for first time home buyers to come up with 20% down?
Yes, it’s horrible
That just shows how inflated the home values are. If there wasn’t a federal guarantee for FHA low down payment loans, values would have already dropped. Very few banks are doing these loans, but they know these loans have high defaults rates.
Background: A 20% down payment helps reduce default risk. We need to return to those days.
The purpose of FHA was help first time buyers, now it’s to extend the ponzi scheme.
1/5 of the buy price was always a significant nut, even at lower SFH market prices. But in 2012 it’s still ridiculous. A nice SFH in OC is $500K (at least). That’s $100K in down payment. Few have this kind of cash in the bank or in liquid stocks/investments. Let’s not forget that most Americans are at least $5K in the hole in credit card debt alone.
I do think a minimum 20% down payment is important in another sense. It shows “skin in the game” and a commitment. Today this is difficult since 95% of the workface is at will and companies downsize like the weather, etc. But these are the kinds of buyers that really deserve a discount in rates for alleviating some of the bank’s risk in the deal.
Things derailed fast when the least creditworthy were allowed to put the least skin in the game and still be granted the deepest rate discounts. Some viewed this as a helping hand to the downtrodden so that they could participate in the American Dream too. Except it was simultaneously a triple bitch slap to the face of everyone else who also worked hard, did the right things and maintained excellent credit.
“Except it was simultaneously a triple bitch slap to the face of everyone else who also worked hard, did the right things and maintained excellent credit.”
To provide the American Dream to anyone is to destroy it for everyone. Hard work, saving, and foregoing immediate consumption for future gains is supposed to lead to wealth and stability. Lenders perverted that and created a culture of consuming Ponzis who priced out those trying to do the right thing.
Prepare For The Coming Housing Collapse Or Face Possible Financial Ruin
The trade-up buyer of the past – ages 30-60 — has disappeared.
That leaves first-time buyers and investors. According to Inside Mortgage Finance, their survey of roughly 2,500 brokers nationwide finds that roughly 30% of all purchases nationwide are by investors, many paying all-cash. Some analysts have argued that this is a good thing for housing markets. This is rubbish. There aren’t enough potential all-cash investors to make-up for the collapse of the trade-up market.
http://www.businessinsider.com/another-housing-collapse-is-coming-soon-2012-5
IR, (also from the article above)
You HELOC abuse reporting goes mainstream….
What has been almost completely overlooked by the media is the enormous number of properties with second liens. There are still nearly 12 million home equity lines of credit (HELOC) outstanding. It’s safe to say that 98 percent or more of these properties are underwater. Roughly 30 percent of all HELOCs were originated inCalifornia. There are millions of owners there with HELOC balances in excess of $100,000.
“The HELOC boom began in 2003. Most of these revolving lines of credit were interest-only loans for the first ten years. After that, they convert into 15-year fully amortizing loans. This means that beginning next year, these loans start to transform into a fully-amortizing loan. The number of HELOCs which do this increases in 2014 and even more in 2015 and 2016.
What will these homeowners do when their HELOC payment soars from a few hundred dollars per month to more than $1,000. The monthly payments that will go into effect in California are mind-boggling”
Keith and I talk frequently. I hope he calls more attention to the reality of HELOC abuse and how far underwater loan owners really are. Most reports of underwater homeowners are only measuring against the first mortgage not the total amount of indebtedness.
He’s my post tomorrow.
Although I agree with you, there is no way the top ten is going to be implemented because the following principles will have to take place:
1. Responsible accounting/lending practices (Too much profit in today’s system…privatized gains and socialized losses)
2. End of 30-year debt inflation since Nixon took us off the gold standard
Unfortunately…Ben likes the “kick the can down the road” policy. Americans. Responsible? I think they are too busy watching American Idol and looking up Gucci bags than worry about the deterioration of their living standard.
Unfortunately, nobody in power wants to do the right thing. None of the ten items I mentioned will be implemented, and we will inflate a bubble to make up for the deflation of the last one.
All ten would be impossible, but I would be happy with starting with my favorite of your comments:
-limit appraised values by rental cashflow
Rents are based somewhat on incomes (not as much speculation) and this adjustment would bring us closer to “real world” valuations.
That one item would make it much more difficult to inflate a bubble with lender (now taxpayer) money.
With respect to Europe, it’s interesting how Obama’s message to Germany has been the importance of “growth measures” (stimulus) versus “austerity measures” (balanced budgets, reforms, debt paydowns).
These requirements will never be implemented because US lawmakers are hell bent on “stimulating” us out of every malinvestment scheme, only to create more malinvestment.
The result will be double the pleasure for US taxpayers: pervasively sick economy and ever rising federal and state income taxes.
I get the sense that after Greece and Spain panic starts to die down, everyone will start rearing their heads westward to the US, the 2012 elections and the stench of the U.S.’s own financial and economic problems.
Uh..oh.. current 10yr yld now 1.63
The 3mo thru 5yr ylds all sub1
Remember, if bonds return 0, the only way to earn a return is by currency appreciation.
tic..tic..
Currency appreciation will be great for those with a mortgage and will kill those who are prudent savers on the sidelines. These people are already getting killed with low interest rates.
Expiring Mortgage Debt Relief Act Fuels Strategic Default: Survey
A foreclosure prevention agency found that the pending expiration of the Mortgage Debt Relief Act of 2007 is prompting struggling homeowners to strategically default on their loan.
YouWalkAway.com conducted a national survey and found 34 percent of respondents indicated that the act, which is set to expire December 31, 2012, contributed to their decision to walk away sooner rather than later from their property. Those surveyed were YouWalkAway.com clients who were actively considering or navigating through the foreclosure process.
The Mortgage Debt Relief Act releases homeowners from the obligation of paying taxes on mortgage debt forgiven from a short sale, foreclosure, or modification. Taxpayers are eligible if the property is the primary residence.
“The survey results are not surprising; YouWalkAway.com saw a number of homeowners reach out to us in early and mid-2011 due to the impending 2012 deadline,” said Jon Maddux, CEO of YouWalkAway.com, in a release. “Many were prompted to begin the foreclosure process in 2011 in order to ensure their foreclosure is complete by the end of 2012.”
While the expiring act motivates homeowners to seek completion of the foreclosure process before the expiration date, for those who won’t qualify in time, Maddux said not extending the act will then cause short sales to stop immediately due to the fear of getting hit with a huge tax bill.
In addition, 78 percent of respondents from the YouWalkAway.com survey expressed intentions of walking away from their home. Of those, at least 74 percent would qualify for relief under the act.
“Potentially millions of people will find themselves stuck with a huge tax bill after foreclosure if the government doesn’t renew the Debt Relief Act at the end of 2012 or if they don’t finalize their foreclosure by that date. The bill may just expire, like when Congress chose not to renew the home buyer’s tax credit,” said Maddux.
Cheryl Gerhardt, a CPA who has worked with YouWalkAway.com clients, said about 80 percent of the people who approach her about foreclosure tax consequences qualify for the relief under the act.
“These are usually people who purchased during the height of the market from 2005 to 2007 and never had the opportunity to take out a second, whereas a few years ago clients who were getting foreclosed upon had made purchases in the early 2000’s, took out a home equity line of credit and could not qualify,” said Gerhardt.
In March, House Bill H.R. 4290, or Homeowner Tax Fairness Act, was introduced to extend the act to 2015. The bill is sponsored by Rep. James McDermott.
The Mortgage Relief Act was actually extended in October 2009, three months before the act’s expiration date.
YouWalkAway.com works with borrowers facing foreclosure as well as those opting to strategically default on their underwater homes. The survey the agency conducted reached out to 2108 borrowers and received responses from over 25 percent of those contacted.
Incredible effort by IR yet again. However, adopting any portion of these reforms a) will not happen in the upcoming Romney government (dominated by no regulation and continuing to do whatever the banks want to bail themselves out; like that isn’t happening enough already); b) Would cause perhaps a 5% drop in all economic activity and home prices in most markets outside of Boston-New York-DC.
Footnotes of interest:
http://www.huffingtonpost.com/2012/05/29/wells-fargo-discriminatory-lending_n_1554533.html
It seems one cannot be selective on foreclosing without attracting attention. It also seems there is great pressure to grant new mortgages (debt increase) to people who do not qualify who live in areas known for value decline. These new future mortgages in this Wells Fargo settlement will all be Federally insured, so this fictional “settlement” only helps accelerate taxpayer losses (more lending in areas of declining demographics, older homes, irresponsible borrowers…all Federally backed of course).
http://www.inlandnewstoday.com/story.php?s=24207 Details the foreclosures and values in some of the worst markets being hit. One can be skeptical of the projections of sudden price increases; only Salt Lake has a steady stream of young new marrieds. However, the ingrained beliefs that real estate is wealth (even when 97% on loan) and retirement security and is necessarily a no-lose “investment” to undertake due to inflation and tax benefits, still is central to 95% of investors and younger people. It is amazing how deep-seated those irrational beliefs are; then again, the people who play the State lottery the most in proportion to income (if any) are those who can least afford it.
People will continue to believe housing is an investment because it is the only way most people will every be given huge returns for simply playing the game. Our housing market has become another form of lottery.
Tain’t gonna happen. Wishful thinking at best, but given the headwinds of lobby groups all this is mere pixel killing. You’d find it easier to ban all of the Housing Porn shows like “Flip This House” than to get any of the above suggestions done. Unfortunate, but true.
Dodd/Frank and Federal Reserve rule changes were supposed to limit the abuses by mortgage lenders against the uninformed consumer pool, but most companies have found ways to circumvent the best intentions of the regulators.There’s a reason why there are so many lawyers graduating from college each year, the bankers need them to anticipate a way to slither around the Governments next move.
BTW There are legitimate reasons to fund loans at higher debt ratios. Because those reasons are today as loose as a $2.00 street walker, ANY reason is now a “good” reason to push ratios higher now.
Some hedgies are getting back into originating stated income loans (yes, AIG is reentering the sub prime market, but that’s another story). An insatiable thirst for yield in a ZIRP world is fueling this kind of nonsense, driven relentlessly forward by limitless power of human greed.
My .02c
Soylent Green Is People
That was the most depressing comment of the day — accurate, but depressing.
What’s wrong with another housing bubble? You can make a fortune if you play it right. I am all for it, please let’s re-inflate is ASAP!
I haven’t bought enough investment properties yet. Once i have loaded up, then lenders can reflate the bubble.
Same here. Deflation proceeds hyperinflation please.