From Boon to Crisis Revisited...

A few months back I wrote about the symbiotic relationship that ultimately lead to the mortgage crisis. I identified a symbiotic relationship between five players. Here is how I wrote about it...

I identified five players: the banks, the borrower, the mortgage broker, Wall Street and Congress that contributed in their own way to the crisis. The crisis WOULDN'T have happened had not ALL these groups worked together to create an environment of excess and irresponsibility. Each entity has its own role in the mess and good policy would address all its root causes. Everyone was seduced by a real estate market that conventional wisdom believed would go up forever. Banks created loan programs that were irresponsible. Irresponsible borrowers took on loans they couldn't afford. Wall Street created a market for such loans for such borrowers. Mortgage brokers took advantage of this environment to place millions of folks into loans they couldn't afford. Of course, let's not forget Congress which created a bunch of laws that lead to a bunch of paperwork which made it easier to pull the wool over naive borrowers. That's what happened in a nutshell and each party deserves blame...

Unfortunately, our politicians aren't interested in good policy but good politics. As I pointed out, this fiasco would have one victim, the borrowers, one villain, the mortgage broker, and the pols would act accordingly to this narrative.

As such, I pointed out that because of the narrative that is being created the borrowers would be rewarded and protected while the mortgage broker would be punished and every other party would be ignored. I was largely correct however I failed to foresee the full frontal attack that most of the politicians would have on the concept of sub prime along with their attack on mortgage brokers. Of course, it should be pointed out that sub prime is nearly extinct without any government intervention. While the pols pile on the concept of sub prime, it is ironic that the market itself has already implemented many of the things the legislature is trying to implement.

Again, the pols were out to exploit the narrative that helpless borrowers were taken advantague of by unscrupulous mortgage brokers, and it was the job of every good pol to protect the borrowers and punish the broker. Let's rundown some of the major pieces of legislation and see how they went about doing this.

First, let's start with the abomination known as H.R. 3915 which thankfully looks to be collecting dust in committee in the Senate. This bill became the standard bearer for accomplishing all three things at once.

It attempted to protect the borrower by including language like "reasonable ability to pay" and "net tangible benefit". It even foolishly attempts to force education upon borrowers by creating a system of counsel for certain loans. (This counseling portion is no different than SB 1167 in Illinois. Read this link to see how its practical effect was disastrous to real estate values.) It also created all sorts of new language giving the borrower even more rights when facing foreclosure.

When the holder of a mortgage loan or anyone acting on behalf of the holder initiates a judicial or non-judicial foreclosure, (1) the consumer who has a rescission right under this bill may assert such right as a defense to foreclosure against the holder to forestall foreclosure, or (2) if the rescission right has expired, the consumer may seek actual damages (plus costs) against the creditor, assignee, or securitizer.

Obviously, the language is confusing and thus its actual effect is equally as confusing but confusion is a small price to pay when politicians are paying lip service to identified victims.

The bill also put new restrictions on sub prime loans: elimination of Yield Spread on sub prime, elimination of financing of points, so called anti steering (putting a borrower into a sub prime loan when the qualify for prime), as well as an end to so called stated loans and prepayment penalties. Stated loans along with pre payment loans are now currently nearly extinct as a result of market pressures. The rest of the regulations will merely make it even more difficult to do sub prime loans at a time when they are nearly extinct.

The bill punishes mortgage broker by creating all sorts of new licensing for mortgage brokers as well as all sorts of new paperwork. Here is an example.

Provides for licensing and registration of individual mortgage brokers and registration of bank employees that originate mortgages, as well as the establishment of a Nationwide Mortgage Licensing System and Registry (NMLSR).

Ø Applicants for State license and registration will furnish certain information to the NMLSR, including fingerprints and personal history and experience, and meet minimum standards including pre-licensing education and written tests.

Here is some new regulation with a likely effect of creating a mountain of new paperwork.

All mortgage originators (including individuals as well as companies and banks that originate mortgages) will be subject to a federal duty of care that requires (1) licensing and registration, as applicable, under State or Federal law (including under subtitle A), (2) presenting consumers with appropriate mortgage loans (i.e., consumer has reasonable ability to repay and receives net tangible benefit, and loan does not have predatory characteristics), (3) making full disclosures to consumers, (4) certifying to lenders compliance with mortgage origination requirements, and (5)including a mortgage originator’s unique identifier in loan documents.

The reasonable ability to pay disclosure and the net tangible benefit disclosure, already used in my state Illinois, are just two likely disclosures that I thought of as a result of this portion.

The banks and Wall Street were largely unaddressed except for this peculiar part,

Assignee/Securitizer Liability (does not extend to trusts and investors): Subject to exemptions below, for loans that violate the minimum standards (reasonable ability to repay and net tangible benefits), a consumer has an individual cause of action against assignees and securitizers for rescission of the loan and the consumer’s costs for rescission.

Ø

Exemption from Liability: An assignee/securitizer will not be liable for a loan that violates the minimum standards if the assignee/securitizer provides a cure to make the loan conform to the minimum standards within 90 days of receiving notice from the consumer, OR (1) has a policy against buying mortgage loans that are not qualified mortgages or qualified safe harbor mortgages and exercises reasonable due diligence to adhere to such policy AND (2) has obtained representations and warranties from the seller or assignor of the loan regarding not selling or assigning loans that violate the minimum standards.[1]

This is another confusing part of the bill and again its effect is equally as confusing. Since it will likely never be law the effect of this portion will only likely be up for debate.

H.R. 3915 was only the beginning. Most of the Presidential candidates weighed in.

Hillary Clinton was most out front in trying to provide protections for the consumers, the group I identified as being the only sympathetic one. She wanted to create a ninety day moratorium on foreclosures, freeze adjustable rates, and even creating a fund to bail out struggling borrowers.

She wanted to outlaw all sorts of the most controversial portions of sub prime: stated loans, pre payment penalties, and she even wanted to mandate escrow accounts on all sub prime loans. (though her language was also vague and thus it wasn't totally clear if this is what she meant) She has currently made little mention of Wall Street's role, the banks, and Congress itself. She has, however, been hammering home her ideas for bailing out troubled borrowers.

Barack Obama was considerably less bold. He proposed some sort of new disclosure that he seems to believe will make the terms of the loan more clear. It never ceases to amaze me how much politicians want to create new disclosures despite the fact that borrowers already typically sign one hundred pieces of documentation already. He also boldly proclaimed that fraud would no longer be legal and that fraudulent loans would be illegal in his administration. As I have said over and over, fraud is now illegal. I, as a mortgage broker, can't lie about any of my borrower's personal finance information. The problem is not with laws but with enforcement. Obama clearly doesn't recognize that and so he went after the mortgage brokers with a promise of more legislation against fraud.

The President, himself, has proposed all sorts of new legislation. While the President hasn't jumped on top of the pile on in blaming and legislating against mortgage brokers, he has paid plenty of attention to the perceived victims, the borrowers. He has promised to freeze rates, expand FHA, and even suggested some tax breaks.

Finally, there is the Fed. Just like H.R. 3915, the Fed accomplished all three things: protect the borrower, impugn the broker, and attack sub prime, with their legislation. Here is how they attempted to protect the borrower.

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

Here is their new restrictions on mortgage brokers,

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.

Finally, here is how they managed to attack sub prime, (these are all things that would now only pertain to sub prime loans)

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.

As everyone can see, no matter where the legislation came from, we could count on it either: protecting the borrower, punishing the mortgage broker, or further restricting sub prime. The problem is that these tactics are purely political and not a matter of policy. There is nothing about this crisis that says that accomplishing these three things will solve it. It is only being done because that is the narrative being created, and the legislation in response to it clearly identifies this narrative.