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Friday, December 28, 2007

The Whole Entire Government Responds to the Mortgage Mess: Another Study in Cynicism, Opportunism and Incompetence

There is a saying in sales: throw enough s$%t at the wall and some of it sticks. It means that in order to get business try as much as possible and that is the way to ensure success. It appears that the government among most of the branches believes that in order to resolve the mortgage crisis we also need to follow the same philosophy. That's because we have had so many proposals, bills, law changes, and policy actions, that it appears the government believes that as long as they try everything something will work. Of course, policy is not like sales and trying every policy imaginable in the hopes that one will work is not quite the same as calling everyone you can think in the hopes that some of them will become clients. A while back, I pointed out that the entire fiasco surrounding the alternative minimum tax is a study in cynicism, opportunism and incompetence, and unfortunately the entire response to the mortgage mess can be qualified much the same.

I first noticed the cynicism, opportunism and incompetence when several Presidential candidates came out with plans to fix the mortgage mess. First, there was Hillary. Her plan involved five main points. First, she wanted to create yet another disclosure and the worst part is that this disclosure already existed as part of several other disclosures. She wanted to eliminate pre payment penalties which I continue to point out the market has long ago eliminated for her. She then wanted to force escrows upon mostly poor folks. Here is the problem with forcing escrows upon mostly poor folks...

Here is how escrows work. The account needs to be filled up at the closing, be it a purchase or a re finance. There must be enough in the account to cover the tax bill. Let's look at an example. Let's say someone has a yearly tax bill of three thousand, or fifteen hundred every six months. Let's say the taxes are due September and March first. Let's say the closing is in May. This means the first payment is July 1st. That means there would be three payments before the taxes are due. This means the account would need to be filled up with three months worth of taxes. There is just one more thing. Banks require an extra two months of taxes as cushion. This means this particular borrower would need an extra five months worth of taxes, $1250 brought into closing. Keep in mind this $1250 is on top of everything else. Sub prime borrowers routinely struggle to make ends meet to figure out how to get a loan closed, and now the Fed has made that process even harder.

In other words, Hillary wants to force poor folks to come up with one or more thousands in EXTRA dollars at each closing. Finally, she wanted to establish a fund to bail out the very folks that took on loans they couldn't afford. Never mind that this policy is counter productive and the ultimate example of throwing good money after bad, Hillary saw a cynical opportunity to score cheap political points and she took it.

Next, it was Obama's turn to offer his two cents in the mortgage debate. Obama's first action was also to create yet another piece of useless documentation that the borrower would need to sign and this piece of useless documentation was also a rehash of other documents already created.

Obama then made the bold proclamation that fraud would no longer be legal. This is frankly a stunning and obscenely naive statement. Fraud is now and always has been illegal. The problem with mortgage fraud has never been about making new laws but rather enforcing the laws already on the books. First, the governing bodies of mortgages, the office of banks and real estate for me, are usually weak and understaffed. Second, it is the bank itself that is charged with the responsibility of reporting fraud. The problem is there is no win and only loss for banks to aggressively report fraud. If they do that, that becomes known in the mortgage broker community and brokers are less inclined to send that bank business. Of course, Obama didn't address, and likely know, those issues.

Obama then took a few shots at his villain, in this case lobbyists, and made some vague references to the vague and nebulous term predatory lending. Predatory lending has become a theme for most of the government agencies and I will go into a much further discussion of it in a bit.

Of course, the mortgage nonsense was bi partisan. The President was next to spring into action.

Urge Congress to pass legislation that would give the Federal Housing Administration more flexibility in assisting mortgage holders with subprime mortgages. — Pledge to work with Congress to reform the tax code to help troubled borrowers rework their loans.— Call for rigorously enforcing predatory lending laws and strengthening lending practices...

On the first idea, the President showed the same type of naivety that the other pols did. FHA loans by nature are more conservative. They have significantly stricter guidelines on such things as Debt to Income. They haven't been affected by the crisis for exactly this reason. It is unclear what the President wants to do, however this point will have one of two effects: either he will create a situation in which the next crisis is in FHA itself, or it will have negligible effect.

The second idea maybe a good idea however I don't see how it will have one iota of effect on people struggling to pay their mortgages. The third idea revisits the nebulous and mysterious predatory lending. We will find a theme from all politicians about this term, and I will show just how absurd it is.

Next, it was Congress' turn with the insidious H.R. 3915. My initial interest in the law came because it threatened to eliminate Yield Spread Premium, which is a tool I use to make money. Given that H.R. 3915 threatened to eliminate my industry entirely, my radar went way up. Here is how I described the ridiculous and counter intuitive nature of eliminating YSP.

Yield Spread Premium is the fee that the banks pay me, the mortgage broker, that is embedded in the rate that is charged to the client. At the risk of treating the reader like a third grader, the higher the rate the higher the YSP. Congress wants to outlaw any YSP that mortgage brokers can charge. The practical effect would put me specifically out of business. The bulk of my clients have excellent credit and at all times a great deal of my business is from refinancing those clients into lower rates. Many times I do this by paying for their closing costs. I accomplish this by raising the rate enough so that the YSP covers the closing costs and leaves enough for me. If this law is enacted, that entire portion of my business is gone.

For every mortgage broker, this means that the only way they can make money is by charging up front fees, or points, at the closing. Here is where the law is insidious. This law doesn't apply to any bank. That means that someone working for Washington Mutual, Countrywide, Chase, Wells Fargo, Bank of America (which all have retail divisions) is exempt from this law. In fact, banks currently are exempt from even revealing how much in YSP they charged as Baton indicated. In fact, banks are exempt from most laws and regulations that apply to brokers.

This latest law leads me to conclude only one thing. Congress has decided to make it their mission to end the industry of mortgage brokers altogether. They figure that if it is impossible for brokers to make money that there won't be any left. They are right. If this law is enacted, the industry will crumble. The key in my industry is flexibility and options. Some people look for the lowest rate possible and aren't as concerned with fees, and others are the opposite. This law would limit the options of mortgage brokers. Obviously, if they are forced to charge points to every borrower they aren't going to be able to compete. It is the equivalent of one basketball team only being allowed four players on the courty while the other has the standard five.I have already pointed out that I have no use for most of my industry.

Now, it is still unclear if Congress will in fact eliminate YSP and the bill has stalled in the Senate so for now, everything is in limbo. That said, YSP was one of several problems with the bill, and it really all starts with the title, Mortgage Reform and Anti-Predatory Lending. Once again, there is that nebulous term, predatory lending. Here is the problem...

There is no specific definition about what exactly predatory lending entails, though most observers believe that the description applies when lenders take advantage of borrowers by charging high interest rates and consider only the value of a borrower’s assets, as opposed to what the borrower can afford to pay.

We have now had multiple Presidential canididate, one house of Congress, and the President, all claim that they will make laws against "predatory lending" and none of them have defined it, and in fact, no one has. Now, it goes without saying that vague and undefinable terms are by nature a problem, however in my business there is a practical effect when they are legislated...


That's because banks must respond to the vague and undefined legislation. They have to cover themselves and there is only one way to cover themselves and that is to create more paperwork.

H.R. 3915 has several instances in which the practical effect would be more useless paperwork. It really should come as no surprise to anyone that Congress would propose or make legislation that would only create more paperwork. Why do you think there is already so much paperwork?

I recently discovered just how hypocritical this law is.

prohibiting the financing of points and fees,

(this particular portion applies only to so called sub prime loans) What this means is that if I charge points or other fees I can't merely increase the loan amount so that they can be rolled into the loan so to speak. In other words, all fees and points must be paid for by the borrower at closing. Keep in mind the logic behind such a law is that points and fees are easier to hide when they are financed, and thus, by disallowing it, mortgage brokers are less inclined to charge higher fees.

The reason that this is hypocritical is that this is the exact opposite of the way FHA, a government sponsored loan, works. I just ran into such a situation with FHA. Now, FHA requires a 1.5% Mortgage Insurance Premium. This is a fancy sounding word for a fee of 1.5% charged at closing that goes on top of all other normal fees. Where this is different than other points, is this fee doesn't go to me, the mortgage broker, but to FHA, or in other words the government itself. With FHA, current rules allow up to 97.15% loan to value. I recently closed a loan in which the property appraised for 195,000. I need every bit of that 97.15% in order to get the deal done. Now, 97.15% of 195,000 is 189,442.5. Yet, FHA allowed this loan to become 192,367. Why...because with FHA, that MIP is financed within the loan as a stipulation of the loan. In other words, FHA, the government sponsored loan, not only allows for its fee to be financed, it stipulates that it be financed.

What does all of this mean? It means the same government that wants to ban financing of closing costs on sub prime loans, not only allows it on its own loans, it stipulates that it work that way. In other words, the very same fees that they want to ban from being hidden, they themselves not only allow to be hidden but stipulate and demand be hidden. Keep in mind FHA loans are mandated to increase by 1.5%, the exact amount of the MIP, specifically so that the government fee be financed within the loan. In other words, for my loan, I couldn't balloon the loan amount to cover my fees as well, that wasn't allowed, but I wasn't only allowed but mandated to beef up my loan by 1.5% so that the government's fees be rolled into the loan amount.

The final blow came when the Fed weighed in and through their regulatory power imposed several rules and regulations of their own. While politicians naivety and ignorance is understandable if not excusable, the Fed's utter ignorance is troubling, mind boggling, and down right unacceptable.

Creditors would be prohibited from engaging in a pattern or practice of extending credit without considering borrowers’ ability to repay the loan.

Creditors would be required to verify the income and assets they rely upon in making a loan.

Prepayment penalties would only be permitted if certain conditions are met, including the condition that no penalty will apply for at least sixty days before any possible payment increase.

Creditors would have to establish escrow accounts for taxes and insurance.


Lenders would be prohibited from compensating mortgage brokers by making payments known as “yield-spread premiums” unless the broker previously entered into a written agreement with the consumer disclosing the broker’s total compensation and other facts. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans. The consumer’s written agreement with the broker must occur before the consumer applies for the loan or pays any fees.

Creditors and mortgage brokers would be prohibited from coercing a real estate appraiser to misstate a home’s value.

Companies that service mortgage loans would be prohibited from engaging in certain practices. For example, servicers would be required to credit consumers’ loan payments as of the date of receipt and would have to provide a schedule of fees to a consumer upon request.

Now, many of the mandates should be recognizable and have already been addressed. The first mandate is patently ridiculous and unless it is defined more narrowly will only lead to mountains of new paperwork. The mandate regarding YSP has already been addressed by several existing disclosures, namely the Good Faith Estimate. In other words, the Fed wants to create a disclosure that already exists because there are so many disclosures that even the Fed doesn't know which does what.

The Fed again naively believes that it is now legal for someone like me to in any way shape or form manipulate anyone else into producing false information. It isn't. Just like with other areas of fraud, the problem is NOT legislation but enforcement.

Now, one thing that you will notice in all of the plethora of ideas, regulations, and bills is that none of them in any substantive way addresses the crisis. That's because this crisis can't be legislated. First, the market long ago dealt with all the problem loans by eliminating them as any market will do. The current problem loans can't be dealt with through legislation because those folks are in over their heads. They over bought. They can't afford the home they live in. There is no legislation for that.

The nebulous and vague "predatory lending" is also something that can't be legislated because it results from stupidity and a lack of sophistication. You cannot legislate that someone become smarter when it comes to mortgages. The reason so many folks are ripped off is simply because mortgages are too damn confusing and complicated for them to understand and they are manipulated, and there is no law that can fix that. Creating more useless legislation which will create more useless documentation only contributes doesn't solve the problem. The problem is that most in government know how to get elected. They don't know mortgages. They can find legislation that will get them re elected but they can't necessarily find legislation that will make good policy in a field they know nothing about. Unfortunately, and this is scary, the Fed is no more wise on mortgages than the politicians.


timb said...

Mike, you nailed it!
Well said and spot on

People need to be responsible for their own individual actions.
At this rate the housing and lending markets will not easily recover.

Isn't there anyone in Government or the Banking and Housing industries willing to stand up and tell these yoyo's that these ideas are absurd?

Of course not, that would take balls, and courage to say what is right.

I am happy to hear you say it, keep up the great blogging.

mike volpe said...

I am different from policy makers in two ways. One, I am neither elected nor selected to my post. Thus, I don't have to please any sort of constituency in order to move up. I don't have to carry on a politically correct narrative in order to advance. Thus, I can speak the unvarnished truth without fear of political and professional consequences.

The other way I am different is that I work in the field. I know what happened because I was there when it happened. I know that people over bought because what happened almost every time was that my borrowers bought homes more expensive than what they claimed they were looking for. This became even more prevalent with folks doing the most extreme loans, the so called stated assets and stated income loans. Unfortunately, most of the policy makers, and scary enough that includes the fed, don't really understand the crisis, and they certainly don't understand the proper remedy for it.