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Sunday, December 23, 2007

Trifecta from the New York Times on Mortgages

Either I have come late to the game or the New York Times used this week to come out swinging against the mortgage industry. In the last two days, I have featured two separate articles vis a vis mortgage from the New York Times. The articles follow a pattern of narrative of the mainstream and it is a dangerous pattern.

The New York Times takes on a populist message. They side with the borrower against the mortgage broker and the bank (and even against Wall Street). The propose all sorts of legislation that protects the borrower even more against foreclosure and the undefined "predatory lending". For instance they back a bill by Dick Durbin that gives an incentive to go into bankruptcy. Under his bill, a person that goes into bankruptcy can re negotiate the terms of their loan. I assume that means for the better. Not only does this give incentive to go bad, but frankly all good borrowers would scream bloody murder and it would create an obscene amount of legislation.

That is some of the legislation they support in the first and second installment. Here is their third installment. (I believe it is their first in chronology however I found it last). First, the New York Times laments a portion of H.R. 3915 that has been altered.

Industry has already scored some regrettable victories. It persuaded the bill’s backers to include a provision that would prevent borrowers from suing Wall Street firms in state court — where consumer protections are often stronger — for common abusive loan practices.

Here, the New York Times, much like most in the media and unfortunately in Congress as well is dealing with concepts well beyond their grasp. While it may make for a great populist message to say you back allowing borrowers to sue Wall Street if they suffer hardship, this is an absolute nightmare. The first problem is that most people don't understand Wall Street's role and of course the consequences of opening them up to suit. Wall Street creates markets for loans. Whereas banks deal in millions of dollars of loans, Wall Street turns those loans into bonds and deals in hundreds of millions. If each individual borrower could actually go to the securitizer (that is Wall Street or the folks that turn loans into bonds) and sue them because they felt they were wronged, that would open up the litigation floodgates with unknown results. That said, the practical results would be that Wall Street would simply not get involved in securitizing loans.

This is in fact what Wall Street has done already with no legislation. Long ago Wall Street soured on mortgage backed securities and without legislation they have washed their hands of the instrument. The sort of legislation the Times touts would give Wall Street even less incentive to get back into that market. Remember, it is those "evil" Wall Street folks that the Times is dying to attack, that created a market for most of the poor folks to get loans in the first place. Before there was such things as mortgage backed securities, the standard loan usually required 20% down and good credit. It was only the innovation of mortgage backed securities that lead to the revolution in mortgages and created the sophisticated system we have today.

Now, the market in the aftermath of the crisis is threatening that system. Sub prime, the outlet for loans for most of the poor folks the Times pretends to care about, is being threatened out of existence through market forces. By this I mean, Wall Street is refusing to make markets for those loans. Without a market, most of these banks will go under or move out of sub prime. Again, this is happening without the push of any legislation. Now, the Times is supporting legislation that would hold Wall Street liable for bad loans. This gives the folks on Wall Street even less reason to make a market. This is at exactly the time when we need to give them as much reason as possible.

Then, the Times says this...

Another must-pass amendment would adopt sensible underwriting standards for all nontraditional mortgages — not just subprime loans — including a rule that lenders must verify a borrower’s ability to repay. The amendment is crucial because it is not only subprime loans that have turned out to be toxic. Another important proposed change would give borrowers the right to modify an illegal loan, before they’re forced into foreclosure.
The first problem with this philosophy is that the word sensible is vague and difficult to define. In my business, whenever there is legislation that is vague and difficult to define what that means to the consumer is

If there is legislation passed and all it says is a reference to sensible underwriting standards, then banks will create a sensible underwriting standards disclosure. That is what banks do every single time there is vague legislation and the reason why there a hundred documents to sign and not ten or so. Second, the Times, with their cohorts in Congress, continue with their attack on stated loans. (these are loans in which income is claimed but not verified). While the concept of stated loans gets debated in the halls of the Times, the mortgage market has long rendered its verdict. Stated loans are virtually non existent. If Congress wants to outlaw them completely, that is their prerogative but they will only be following the market. The problem with outlawing stated loans is that it assures that the overwhelming majority of self employed borrowers and real estate investors never get a mortgage. Since they are able to take a plethora of write offs, proving income is virtually impossible. (for real estate investors, there is a complicated mortgage formula too boring to discuss that also makes it impossible)

By throwing out the baby with the bathwater so to speak and outlawing stated loans entirely, all Congress would do is remove their original intent. The market has long ago on its own returned stated loans to their original intent, self employed borrowers and real estate investors. The problem wasn't stated loans but rather that garbage men, secretaries, and janitors, could now claim income even though they were salaried and thus had only lying as a reason to go stated.

The New York Times, along with their cohorts in Congress, don't care much about that or frankly good policy. They have figured out which side they need to be on to look good. Keep in mind that while the Times looks to punish banks, brokers and Wall Street for providing loans to borrowers who "lacked a reasonable ability to pay". It was these same borrowers that willingly agreed to take loans that they either did know, or should have known, they couldn't afford. If the borrower themselves had followed their own reasonable ability to pay philosophy, we wouldn't have this mess. The blame isn't solely on their shoulders however, unlike what the Times, and the Congressional cohorts believe, they must shoulder some of the blame.

The reason this is important is because the crisis will affect everyone. The legislation that will no doubt follow must be sensible. Right now, it is not. The Times is effectively cheerleading for Congress to pass legislation who's sole effect is playing political games at the expense of good policy. Ultimately the only practical effect of these new laws will be that the borrower
There are two huge problems with this entire mortgage debate. The first is the naive and uninformed making statements, observations, and recommendations regarding the path forward. The second is the uninformed making policy on how to move forward. The New York Times represents the first and Congress represents the second. The mortgage market is at vulnerable state and the last thing it needs is the contribution of the uninformed.

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