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Thursday, April 3, 2008

Frank's Raving Mad Mortgage "Solution"

Among the most cluless and arrogant politicians when it comes to the mortgage crisis there are very few that challenge Barney Frank. Last year, he insisted on moving H.R. 3915 all the way from his banking committee to the full House even though the bill was dead on arrival as soon as it got to the Senate. The bill was so wraught with problems that it took me dozens of posts to explore them all. Now, while the Senate recently introduced a bi partisan fix for the mortgage crisis, Frank is working on his own version.

Mr. Frank's idea is that, for mortgages originated between the start of 2005 and mid-2007, a lender and borrower would be able to agree on a federal refinancing plan. Lenders would have to write down their loan to no more than 85% of the current appraised value of the property – which means the banks will use this opportunity to unload the biggest stinkers in their loan portfolios.

For the borrower, the deal is even sweeter: a low fixed monthly payment and a reduction in the principal to market value. The Federal Housing Administration would then guarantee the loan, up to a total of $300 billion in total Frank Refis. The deal is so sweet that even Mr. Frank is concerned that otherwise reliable borrowers may "purposely default" to be eligible for assistance. His solution is to require borrowers to "certify" that they really, truly aren't doing this simply to get on the taxpayer gravy train.

On this portion, Frank is merely adding his own version of the subprime rate freeze, rate reduction, and loan reduction plans that every pol seems to think is a good idea. Frank implicitly admits that his plan goes too far when the article says this...

The deal is so sweet that even Mr. Frank is concerned that otherwise reliable borrowers may "purposely default" to be eligible for assistance.

Now, let's break this down one by one. What Frank wants to do is take troubled mortgages originated between the beginning of 2005 and mid 2007, renegotiate them, and have the federal government provide new attractive loans for them. Not only would these troubled borrowers receive interest rates the market would never allow, but beyond that, their balances would be artificially reduced. Most of the loans that would qualify for this program are at or even beyond the value of the property. In other words, if the loan amount is 250k, the property is worth no more than that. Frank wants the federal government to take these loans off the hands of the banks and he wants the federal government to artificially reduce the loan amount to only 85% of the value of the property.

Now, let's look at exactly what Frank is trying to do. Imagine there was a borrower that bought a property they couldn't afford and they bought it with little or no money down. Now they are struggling to make the payment and they can't get out of the mortgage because it is larger than the value of the property. If this is the situation, then the borrower engaged in reckless and irresponsible financial behavior. For this behavior, Frank wants to reward said borrower with a new loan at a reduced rate and loan amount. In fact, this deal is so good that Frank worries many borrowers that aren't struggling will start to miss payments so they can get the same deal. Why not? What good is a good credit score worth, if missing payments produces a much better deal.

Rewarding the most irresponsible around us while totally ignoring the responsible carries with it all sorts of unintended consequences that aren't going to go away just because a politician wants to pretend they aren't there. This plan will do three things: transfer bad debt from private companies to the tax payer, create class warfare between good and bad borrowers, and create a litigation and bureaucracy nightmare in trying to implement.

Of course, this part of the plan is actually good when you compare it to the next part.

Traditionally, lenders making a commitment to finance your home have demanded that you make a commitment as well: a down payment. But during the credit boom, the shrinking market share of FHA-insured loans demonstrated how much the world was changing. FHA was intended to help moderate-income borrowers afford homes by requiring merely a 3% down payment.

When subprime lenders started offering loans with zero down, FHA asked Congress to let their lenders do the same. Fortunately for taxpayers, Congress resisted. In the fourth quarter of 2007, FHA loans were one mortgage category that actually enjoyed a decline in foreclosures.That trend may not last, because Mr. Frank's bill waters down FHA underwriting standards. Today, the FHA tells lenders that a borrower should not have debt payments amounting to more than 43% of monthly income, but Mr. Frank's bill allows this figure to rise as high as 55%.

Now, among the few loan portfolios that weren't affected by the meltdown is FHA, a government loan. The reason is that, as the article points out, FHA only allows debt to income levels to reach 43% and no more. Debt to income is measured simply like this. Take every payment found on the credit report plus all housing related payments, figure all out monthly, and divide that by Gross, NOT NET, income monthly. FHA loans limited the debt to income to 43%. Keep in mind that dti doesn't take into account normal expenses like gas, food, etc. They only account for what is listed on the credit report.

The reason many loans failed is because they allowed DTI levels to be too high and still approved the loan. FHA never succombed and kept their levels at 43%. Now, Frank wants many of these troubled borrowers to move into FHA loans. He wants to do it by expanding DTI levels so that they qualify. By doing this, he will force FHA to take on risk it was never meant to take on. The reason that FHA has continued to be financially solvent is at least in large part because it has strict guidelines for DTI. Frank wants to ignore this crucial fact and expand DTI levels without once thinking about the consequences.

The consequences are very simple. All he is doing is moving the crisis from sub prime banks to FHA. Since FHA is a government loan then ultimately he wants to transfer all of the risk of irresponsible borrowers to the tax payers. If this bill passes in its current form, then I predict no more than two years before FHA is in its own crisis. Keep in mind the federal government has already allowed FHA to take on loans of borrowers who were late on their mortgage as long as those lates were after an ARM adjusted upward. The federal government has in effect already added a layer of risk to FHA. Now, Frank wants to add even more risk. Frank isn't even done with layering the risk...

Under current FHA guidelines, lenders must also closely examine a borrower's credit history. Yet under the "flexible underwriting standards" in Mr. Frank's draft, borrowers can't be denied FHA insurance due to a low credit score. Delinquency on existing mortgages also can't be the sole reason to deny FHA insurance. Mr. Frank's bill authorizes the Secretary of Housing and Urban Development to contract out for a new underwriting system, and it should be entertaining to see what HUD's political minds can devise to appease pressure groups.

In sum, Mr. Frank is volunteering U.S. taxpayers to insure $300 billion in mortgages with underwriting standards to be named later. Connecticut Senator Chris Dodd thinks $400 billion is more like it. Quavering Republicans should do the political math. The Mortgage Bankers Association tracks 46 million mortgage borrowers, and 42 million are paying on time. More than 20 million households own their homes outright and, having worked for years to pay for them, probably don't want to pay for someone else's. Neither do 35 million renters who didn't take a flyer on nicer digs.

In other words, if Frank gets his way, FHA will increase their DTI limits, allow poorer credit, allow more mortgage lates, and of course, keep the rates the same. Now, I locked an FHA loan yesterday. That loan was locked in at 6.5%. In other words, if Frank gets his way a borrower with a 55% DTI and less than stellar credit can get a loan at 6.5%. This is nothing short of a recipe for disaster, and if Frank gets his way, we will have a total meltdown within two years.

2 comments:

casdealer said...

so you don't like Mr. Frank...when is the federal government going to start holding the credit bureaus accountable for inaccurate information? 70% of americans have inacurate information on thier credit reports and spend 6 mos. to 2 years trying to correct thier mistakes. but that is often 2 years of an americans life they are denied the american dream due to the mediocrity and incompetency we allow the credit bureaus to dictate. yes the same people who judge our lives cannot report correctly and cannot correct inaccurate information within 2years, so for many, FHA is the key to many achiving the american dream, and we should all be thankful it exists, as a self-funded program with no assistance from taxpayers, so that many hard working americans who deserve homeownership can enjoy the american dream until we decide to hold the credit bureaus accountable...maybe if there was more accurate information reported, sub-prime may have not had to be utilized as much. but borrowers were placed into a position and the lenders took advantage of it, and again it come back to the people who are judging our habits and lives, the credit bureaus, and that is where you will find reform will be most effective for future growth of this nation.

mike volpe said...

I don't believe that any of your numbers are accurate though I agree that the credit bureaus need some work. The worst part is that your guilty until proven innocent with the bureaus.

That said, it is a total misnomer to claim that folks wound up en masse in sub prime because of errors on their credit report. That is just plain nonsense. FHA, for instance, is not credit score driven and any inaccuracies could have been resolved through the loan process.

Folks wound up in sub prime because sub prime banks created lots of loans for folks that normally wouldn't have gotten one.

Finally, FHA isn't a self funded program. It is a government program. It is absolutely funded by the tax payer.