Just went to a presentation at the Milken Institute on “Demystifying the Mortgage Meltdown: What It Means for Main Street, Wall Street and the U.S. Financial System” (video here). And it was v. interesting in a number of ways.
It also reminded me how toxic, partisan, and useless most of the discussion of the issue has been over the last month. On both sides.I’ll try and do a longer post on it (or add to this one) if I have time later, but for now one quote is worth noting immediately. In response to an audience question that asked, in short, whether the CRA requirements imposed by Congress were at the root of the problem, the answer was a resounding “no”.
We looked at CRA pools and the [post-default] returns on them is higher than the equivalent return on conventional pools.
In a nutshell, they blame the crisis on three things:
*A massively overleveraged financial sector (with FHLMC as the worst culprit);
*Horrible underwriting at every level from loan origination to S & P;
*’Toxic’ loan products which – combined with poor underwriting – allowed unqualified borrowers to take out loans they never could have been expected to repay.
Those loans were immediately securitized into the highly overleveraged financial institutions – instead of being held by the originating institutions which would have had skin in the game as to real loan quality – and when they unsurprisingly blew up, the negative leverage effects killed the institutions. This was, of course, made worse by the array of poorly designed (but fee rich!) risk-managing tools that made up much of the secondary markets (see Taleb’s Black Swan yet again)
Check out the pdf Powerpoint of their presentation.
One other note – in slide 78 they show a very disturbing survey which demonstrates how little consumers know about the loans they are taking out. I’ve been cynical about loan disclosure standards as a tool for improving loan quality, but this slide is seriously changing my mind.
Right now I’d love to ask the partisan hacks weighing in on these issues take a steaming cup of STFU and let the rest of us sit down and try as best we can to figure out what’s really going on.
One of those things is apparently a fairly healthy base economy – productivity of labor and capital continues to improve in the first part of 08, and their argument is that the ‘Main Street’ economy is not going to be nearly as badly hit as the ‘Wall Street’ economy.
That’s borne out by my personal experience; I’m in the middle of setting up some six-figure lines of credit for a company I’m a partner in, and we’ve received three attractive proposals in three weeks of looking.
More later…
AL, I think you missed the point about CRA. The CRA created the national housing bubble. Once banks saw how much money they made off on one form of bad loans they went nuts with many other types. Banks that did not do so where eventually bought up by banks that did.
The government distorted a very large market which delayed the normal market responses to bad investments. Bubbles are generally small and local and the US government (UK as well) created a national market distortion.
Listen I don’t blame people for taking bad loans. It’s very clear that people are not all the capable of saying no to easy money. Hence why we have a credit rating system and why it’s usually difficult to get a loan unless you are responsible. I don’t blame banks for grabbing easy money either. Markets normally make both of these groups pay for there mistakes rather quickly. But again, the distortion caused by the CRA (from the housing bubble it caused) extend the amount of time that people could make money from stupid things. A bubble that lasts many years is extremely hard to get people to think rationally about when everyone around them is flush in easy cash.
Again, this was not a moral issue and you can’t expect people to say no to easy money over the long term. It was a government created distortion of a basic market.
[The nickname “Grim” is already in use here. Please choose another nickname. You used “Derek” in the past; I suggest you stick with that unless there is a compelling reason not to. –NM]
I agree with Grim. Once the cat was out of the bag, that money was being made on bad paper that could be easily shifted to the next sucker down the line, things just went south. CRA started this mess.
Not sure this is the right place for this. It is a chart showing the collapse/bailouts? of major institutions. The quick eyeball says over a trillion so far:
“chart”:http://www.nytimes.com/imagepages/2008/10/01/business/20081001_GLOBAL_GRAPH.html
Grim and A Stoner:
Ask your self this question:• Did the 1977 legislation, or any other legislation since, require banks to not verify income or payment history of mortgage applicants?
Or this one: The four biggest problem areas for housing (by price decreases) are: Phoenix, Arizona; Las Vegas, Nevada; Miami, Florida, and San Diego, California. Explain exactly how these affluent, non-minority regions were impacted by the Community Reinvesment Act ?
Read the whole thing: “LINK”:http://bigpicture.typepad.com/comments/2008/10/misunderstandin.html#more
*#2 from Grim *
Is this Grim or the Other Grim?
bq. We looked at CRA pools and the [post-default] returns on them is higher than the equivalent return on conventional pools.
Uh, was anyone really suggesting otherwise? Even the most partisan talking heads acknowledge that higher beta (risk) is supposed to carry higher returns. Anyone want to hazard a guess at the average aggregate profitability of junk bonds?
And anyways, the blame-seeking question isn’t one of profitability, it’s one of _liquidity_. Post-default profitability may be positive *on the average* but that’s little consolation if you go bankrupt when your capitalization is wiped out by all the defaults happening at once.
And as the portfolio segment most responsible for said defaults, I think this is a little too thin evidence to let CRA paper off the hook.
#7 is correct. It’s all about getting from A to B successfully–like the story of the 6′ tall man who drowned while fording a stream that _only_ “averages” five feet in depth.
“This summary”:http://thoughtrefuse.wordpress.com/2008/09/30/how-much-blame-to-throw-at-the-cra/ of the economic mess and the role of the CRA loans needs to be read by all who want to lay blame on a liberal policy they do not agree with out of political or economic principle. The key points are 1) that the number of CRA loans in default as a percent of the total is insufficient to account for the problem or even to base the claim that it is the source, and 2) that the Gramm-Leach-Billey Act, which I believe passed in 1999, inflamed the situation, as explained below.
bq. Some experts and some non-experts have pointed a finger at the Community Reinvestment Act as part of the reason behind the housing bubble bursting and setting off an economic crisis. I afforded it due consideration, but when all is said and done holds minimal blame in the grand scheme.
bq. The failures in government regulation undoubtedly played a part in the economic crisis. However, compared to other government action, the CRA accounts for a tiny share of the pie in more ways then one. It was a mistake to change CRA compliance requirements to be measured on a quantitative basis and away from a qualitative value judgement. This forced lending institutions to require meet an annual lending quota or risk jeopardizing government benefits. The CRA most definitely encouraged lending to those who could not afford.
bq. But looking at the percentage what the government qualified as CRA loans pales in comparison to the total share of outstanding subprime loans. Between 1993 and 1998, only $467 billion dollars qualified as CRA loans – a tiny slice of the trillions and trillions of dollars in outstanding home loan mortgages. Present day estimates indicate that CRA home mortgages only account for about 20% of all home mortgage loans. Even taking into account the higher default rates of subprime loans, a 9% default rate on CRA loans doesn’t even begin to approach the aggregate value in total defaulted home mortgages.
bq. Numbers aside, it’s questionable whether or not a repeal of the CRA would have stopped the subprime lending spree. In fact, two other government actions greatly encouraged subprime mortgage practices far more then the CRA.
bq. Combined, Freddie Mac and Fannie Mae has either bought up or issued nearly half of all outstanding home mortgages by buying up loans from other lending institutions. Freddie Mac and Fannie Mae were able to begin buying up large amounts of outstanding home loans because they could now sell mortgage backed securities. Prior to the passage of the Gramm-Leach-Billey Act(which repealed the Glass-Steagall Act), banks were prohibited from offering investment services. But now Freddie Mac, Fannie Mae, and all banks could begin leveraging their outstanding home mortgage loans to raise additional capitol.
bq. It was a new way to raise capitol revenue and a new way to increase profits. It’s natural for all businesses to exploit their profit margins while managing risks. However, the risks of mortgage backed securities were lessened by the nonbinding understanding in the financial sector that the government implicitly guaranteed the securities issued by Freddie Mac and Fannie Mae. The federal government has long provided these two instutitions with tax breaks, subsidies, low interest loans, and a reduction in capitol backing regulations.
bq. Believing the mortgage backed securities issued by Freddie Mac and Fannie Mae would always be liquid, believed, to some degree, that the risk of subprime lending were offset by the implicit government backing. With the ability to leverage loans as capitol and the perceived invunrability of Freddie Mac/Fannie Mae, fueled an increase in subprime lending. It was a fantastic short term way to spur growth in the housing market, but miscalculated the risk involved based on assumptions. It was not the need to meet CRA requirements that caused banks to make high-risk loans, it was the incentive to raise capitol. The CRA could have been nonexistent and lending institutions would have still pursued those avenues which appeared profitable.
bq. Government missteps played a role in where we are today. Banks should have never been allowed to enter the investment market through government deregulation. And the government never should have allowed Freddie Mac and Fannie Mae become the lynch pin in the home mortgage market.
bq. Instead of pointing our finger at a single, politically self-serving source lets all grow 90 more fingers, so we can point the blame in all directions where it rightly deserves to be. This wasn’t the CRA’s doing. This was a confluence of events ranging from government to free market to populace none of which are to be used to gain the political upperhand.
Robert, the key article you’re really looking for, by the same author, is this Barron’s piece. “A Memo Found in the Street”:http://online.barrons.com/article/SB122246742997580395.html
Which goes over a number of contributing factors, and says:
bq. “We could mention former Fed Governor Edward Gramlich, who warned about making home loans to people who could not afford them, and who said the runaway subprime-mortgage industry would create problems in housing and the credit markets.”
So, why was that a trend?
It is foolish to hold Wall Street blameless in this. It is equally foolish to say this is simply the result of under-regulation.
Leverage rules and corrupt appraisers played a role, and so did interest at 1% for a long period, creating a stampede for higher earning vehicles. Whereupon we have the CRA as a not-so-veiled threat, followed by a lot of loans and loan products to people who would have been denied credit before.
The risk has to be handled somehow, and a combination of looser regulatory rules, and items that nobody in their right mind would expect Washington bureaucrats to understand and regulate competently (derivatives), allow them to be securitized away from the loaning banks. The stampede for better returns creates a tidal bore headed into real estate backed paper, to float those loans. Divorced from the risks, but receiving the monthly payments, the loaning banks do well.
A trend is born, complete with all of its ancillaries – from more banks following that path, to associated 3rd party services in securitization, et. al. Fannie Mae and Freddie Mac, who have paid millions to Democrats and to a number of Republicans as well, help this trend along and create an illusion of overall security, while working hard to shield themselves from oversight. To the point that after they collapse, removal of their lobbying capability is a condition of their bailout.
Eventually, the bubble begins to burst. And the level of leverage out there drags many institutions down, creating a wider credit crisis that threatens to start dragging the Main Street economy with it.
The CRA is not wholly responsible for all this. But neither is it blameless. What this shows is that positive attempts to manage and supervise the economy, and areas where regulation was withdrawn, and private decisions, all played strong roles in creating this financial storm. No leg of the triad performed significantly better, or significantly worse. They were all equally in over their heads, and reinforced each other.
The performance of active management and regulation in this crisis creates zero confidence in me that active regulation would have extricated us. Restoration of some of the hard limits re: cash et. al. certainly make sense to me, precisely because it does not involve attempts at management.
I do take some comfort from the fact that many of the people who led these institutions had large portions of their own net wealth tied up in those same institutions. See also the jobs subtracted from Wall Street slides.
That is not true on the political end, note, where many of the people whose decisions and non-decisions made large contributions here will suffer no consequences.
_One other note – in slide 78 they show a very disturbing survey which demonstrates how little consumers know about the loans they are taking out. I’ve been cynical about loan disclosure standards as a tool for improving loan quality, but this slide is seriously changing my mind._
Do I understand slide 78 correctly? People could not identify certain information using the disclosure forms in front of them? That is, they didn’t know the “loan amount” even though one of the forms in front of them gave that figure?
I bought my home within the last ten years and have refinanced twice to catch lower rates. At closing, I just signed what was in front of me without reading it. The banker gave some general explanation. But who has a few hours to read all of that? Disclosure has to be at a meaningful time that would permit someone a reasonable opportunity to change their mind.
We looked at CRA pools and the [post-default] returns on them is higher than the equivalent return on conventional pools.
What does that mean, post-default returns?
PD, er… do you have some other activity that you engage in such that spending a few hours to peruse the legal details of a financial transaction involving hundreds of thousands of dollars is a waste of your time? If you’re really that wealthy, -hire a lawyer to parse it for you-. If you’re not, sit down and read the damned paperwork! ;p
There’s other factors involved in the real estate mess that aren’t even being mentioned. Local regulations limiting new construction, an increase in immigration (legal and otherwise), the shift of residents from the northeast to the southwest… all of this stuff factors in to why the prices started rising as quickly and consistently as they did.
And once they did, small wonder that it distorted various markets, especially after 2000 when the tech bubble popped and large amounts of capital were set loose seeking a new place to stay. It’s not that the actors in question were blind to the possible risks – it’s that they were processing those risks in an environment where the traditional risk of a mortgage (i.e. you foreclose on a house not worth what you loaned the money for) was simply absent. Sure, everyone knew in theory that prices of homes couldn’t continue to increase 10% a year forever, but they did so for quite some time, and there was an awful lot of money made on the way up…
Of course, there were a few adults in the room who saw the crash coming and didn’t indulge in the risk themselves. But there were others who made that decision, then were replaced because they weren’t bringing home the same profit margins that the risk-insensitive competition was enjoying. Bad decision-makers drove out good, as it were.
In a way, it’s important that there be a bloodbath on Wall Street now. Lots of firms have acted in ways that, in retrospect, are clearly really stupid; we need a generation of managers who can remember this incident, and respond to a trader saying “the market will keep going up, so who cares about the risk?” or “what do we care about the underlying financials if it has the rating we’re looking for?” by backhanding them through a fourth-story window over a busy street. What we can’t afford are a bunch of financial managers who take a lesson home to the effect that they can sail as close to the rocks as they want, because the government will come lift them off if things go sour.
Joe: _so did interest at 1% for a long period_
If I understand slide 11 (these slides are kewl BTW), the 1% interest rate didn’t have much effect at least on 30 year mortgages (or 10-15 year mortgages I bet). It did help reduce the interest rate charged on a 1 year ARM by a couple percentage points. But I think that raises the question, who is financing a home purchase with a one-year teaser rate? Insanity.
#7 and #14 – the ‘post default’ return is the current return adjusted for defaults – i.e. we loaned out $100, got $10 in interest, and wrote off $2, so the post-default return would be 8%.
If the CRA loans were really so crappy relative to conventional loans, the post-default returns would be lower b/c the implication of CRA is that they loaned the money without adjusting the interest rate for real risk.
Not what happened, apparently…
A.L.
Digging through the Senate financial “rescue” bill in more detail, I find, amongst other “stuff”
Sec. 101: Extension of alternative minimum tax relief for nonrefundable personal credits.
Sec. 102: Extension of increased alternative minimum tax exemption amount.
Sec. 201: Deduction for state and local sales taxes.
Sec. 202: Deduction of qualified tuition and related expenses.
Sec. 203: Deduction for certain expenses of elementary and secondary school teachers.
Sec. 204: Additional standard deduction for real property taxes for nonitemizers.
Sec. 205: Tax-free distributions from individual retirement plans for charitable purposes.
Sec. 304: Extension of look-thru rule for related controlled foreign corporations.
Sec. 305: Extension of 15-year straight-line cost recovery for qualified leasehold improvements and qualified restaurant improvements; 15-year straight-line cost recovery for certain improvements to retail space.
Sec. 307: Basis adjustment to stock of S corporations making charitable contributions of property.
Sec. 308: Increase in limit on cover over of rum excise tax to Puerto Rico and the Virgin Islands.
Sec. 309: Extension of economic development credit for American Samoa.
Sec. 310: Extension of mine rescue team training credit.
Sec. 311: Extension of election to expense advanced mine safety equipment.
Sec. 312: Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico.
Sec. 314: Indian employment credit.
Sec. 315: Accelerated depreciation for business property on Indian reservations.
Sec. 316: Railroad track maintenance.
Sec. 317: Seven-year cost recovery period for motorsports racing track facility.
Sec. 318: Expensing of environmental remediation costs.
Sec. 319: Extension of work opportunity tax credit for Hurricane Katrina employees.
Sec. 320: Extension of increased rehabilitation credit for structures in the Gulf Opportunity Zone.
Sec. 321: Enhanced deduction for qualified computer contributions.
Sec. 322: Tax incentives for investment in the District of Columbia.
Sec. 323: Enhanced charitable deductions for contributions of food inventory.
Sec. 324: Extension of enhanced charitable deduction for contributions of book inventory.
Sec. 325: Extension and modification of duty suspension on wool products; wool research fund; wool duty refunds.
Sec. 401: Permanent authority for undercover operations [as related to tax provisions].
Sec. 402: Permanent authority for disclosure of information relating to terrorist activities [as related to tax provisions].
Sec. 501: $8,500 income threshold used to calculate refundable portion of child tax credit.
Sec. 502: Provisions related to film and television productions.
Sec. 503: Exemption from excise tax for certain wooden arrows designed for use by children.
Sec. 504: Income averaging for amounts received in connection with the Exxon Valdez litigation.
Sec. 505: Certain farming business machinery and equipment treated as five-year property.
Sec. 506: Modification of penalty on understatement of taxpayer’s liability by tax return preparer.
Sec. 601: Secure rural schools and community self-determination program.
Sec. 602: Transfer to abandoned mine reclamation fund.
Sec. 702: Temporary tax relief for areas damaged by 2008 Midwestern severe storms, tornados and flooding.
Sec. 704: Temporary tax-exempt bond financing and low-income housing tax relief for areas.
Sec. 709: Waiver of certain mortgage revenue bond requirements following federally declared disasters.
Sec. 710: Special depreciation allowance for qualified disaster property.
Sec. 711: Increased expensing for qualified disaster assistance property.
Really?
“Increase in limit on cover over of rum excise tax to Puerto Rico and the Virgin Islands”? “Seven-year cost recovery period for motorsports racing track facility”? “Extension and modification of duty suspension on wool products; wool research fund; wool duty refunds”?
Really?
Then there’s Section 115, allowing the Secretary of the Treasury to have up to $700 Billion “outstanding at any one time.” What does that mean? Churn & burn with taxpayer dollars? Who knows.
This looks like politicians playing all their standard games. If this is an “emergency,” Congress are not acting like it is one … In fact, let’s be blunt. This is why Congress’ current approval ratings are about half that of Mr. Bush.
We are led by mice.
#5 Dave:
That was “The Other Grim”.
“Other Grim”: Please pick a different nick. “Grim” is already in use here.
Apologies for the minor glitch in comment numbers.
Avatar: if you want emphasis, try underlines. Leading and trailing hyphens here do strikeout.
*#12 from Marcus Vitruvius*
_What does that mean, post-default returns?_
If you were to package together two portfolios otherwise the same (number of loans and total loan value):
* one with all prime and their 1.5% default rate, and 1% prepayment rate
* one with all subprime and their 10% default and .1% prepayment rate
You would expect the Subprime to still return greater value than prime, due to the higher amount each loan paid each month.
*#7 from The Unbeliever*
_And as the portfolio segment most responsible for said defaults, I think this is a little too thin evidence to let CRA paper off the hook._
Not so much anymore. “Prime walked up over subprime”:http://seekingalpha.com/article/93341-prime-foreclosures-now-greater-than-subprime as a whole, though not when adjusting for market share.
Worse, both walked up over expected averages and historic norms, and probably expected highs when adjusting for risk as well, though this was “somewhat expected”:http://seekingalpha.com/article/64392-are-higher-prime-mortgage-default-rates-around-the-corner.
And it’s still going up.
When I bought my homer in 2001 I got a loan from SunTrust Mortgage that allowed 100 percent financing. However, it was contingent upon middle and upper class people moving into lower class communities, or lower class individuals moving to middle or upper income communities. Do you really think the private sector was willingly engaging in social engineering projects, or were they “encouraged” to do so by the government?
I am currently pursuing a master in real estate and my professor said, just yesterday, that once the mortgages were sold into the secondary market they were “sliced and diced” so much that nobody can tell what is what. So, assuming my professor is right, I have to wonder what data forms a CRA Pool. After all the CRA rating was used to “encourage” lenders to make loans they previously felt were to risky. In addition, I have always known financial institutions to be very risk averse when it comes to potentially loosing money, some would say discriminatory.
Furthermore, politicians of both parties have pushed legislation to “encourage” people to become homeowners. I poster here yesterday opened my eyes to this by pointing out the following legislative manipulations of the private sector; Financial Modernization Act, the American Dream Downpayment Act, the Zero Downpayment Act. By no means am I partisan on this issue. I am more than willing to accept things that are logical. However, it is not logical to see government “nudging” the private sector, then when it screws up, to blame it all on the free market – it was not free, it was “nudged”. The fact is all of this leads into more government power and we are allowing our ignorance to be exploited by the political class to empower the political class.
One of the slides that I think bears scrutiny on the CRA issue is slide number 18. The slide seems to show that people with below average credit were getting 45.2% of the subprime loans. Presumably because they were probably ineligable for prime loans. However, that leaves people with above average credit scores getting more than half of the subprime loans.
bq. We looked at CRA pools and the [post-default] returns on them is higher than the equivalent return on conventional pools.
This just doesn’t sound right–I’d like to check the arithmetic. Could some parsing be taking place? E.g. are “CRA pools” the same thing as “loans approved under the standards set with the guidance of the CRA and related legislation and regulations”?
Comment #122 from “Grim’s earlier thread”:http://www.windsofchange.net/archives/tell_me_why_this_is_wrong.php has excerpts from speeches given by the late Fed governor Ned Gramlich from “2002,”:http://www.federalreserve.gov/BoardDocs/Speeches/2002/20020408/default.htm and another from “2004”:http://www.federalreserve.gov/boarddocs/speeches/2004/20040521/default.htm that would seem to address this point.
From 2002, a synopsis of a ~2000 study of [pre-default] returns:
bq. The study revealed that roughly 85% of respondents deemed CRA-related home purchase and refinance lending to be at least marginally profitable, as did 79% of those extending home improvement loans. These numbers compare with 99% of respondents reporting that overall home purchase and refinance lending was at least marginally profitable and 94% stating that overall home improvement lending was at least marginally profitable.
So CRA-related lending was less profitable than overall lending from a pre-default perspective, but turns out to be more profitable than conventional (non-interest only, non-ARM) lending, post-default?
From 2004:
bq. A review of subprime lenders identified by this list [from HUD] is informative. [The five largest subprime-specializing commercial banks] accounted for 27% of the mortgage loans of the subprime lenders. Similarly, affiliates of financial holding companies… constituted only 19% of these lenders but 43% of the subprime loans. On the other side, independent mortgage companies [accounted for only] 12% of subprime mortgage loans…
bq. All commercial banks, thrifts, and subsidiaries of banks undergo compliance exams on approximately a three-year cycle, with these three types of institutions constituting 45% of the identified subprime mortgage loans made in 2002. Affiliates of financial holding companies, covering an additional 43% of mortgage loans among these subprime specialists, can be revised for compliance with lending laws, though on a less thorough and less timely basis. Independent mortgage companies, covering 12% of these mortgage loans, are not systematically examined at all…
If I am interpreting this correctly, “compliance” refers, among other things, to compliance with the CRA and with subsequent laws and administrative rules that were enacted in the same spirit as the CRA.
Scooter: _Financial Modernization Act, the American Dream Downpayment Act, the Zero Downpayment Act_
I’m with you, but why not add the home mortgage deducation? We have a lot of bi-partisan policies intended to encourage home ownership for people that might otherwise have trouble affording a home. Either these policies work or don’t. And the downside to their working certainly has to include risk of default. We’ve been pushing the home ownership percentage higher and higher for decades. We might have reached a ceiling.
bq. #7 and #14 – the ‘post default’ return is the current return adjusted for defaults – i.e. we loaned out $100, got $10 in interest, and wrote off $2, so the post-default return would be 8%.
I already understood that, which is why I said the issue is _liquidity_, not profitability.
The banks may make back $8 on the original assets of $100, but if it takes them 30 years (life of the mortgage) to do so, then that missing $2 becomes critically important because it represents a significant portion of the bank’s operating funds for one of those years. Add in the fractional reserve system, and the effect gets magnified beyond the narrow question of the original loan’s profitability.
Besides which your analogy is a little inaccurate. If that $100 loaned it is composed of 50 x $2 loans, a default causes you to lose the _principle_ plus the expected interest (minus the market price of the underlying repossessed asset after you dump it). So if you wrote off a single $2 loan, you also write off 1/50 * $10 = $0.20 in income. The end result is still profitable, but the loss in underlying capital plays havoc with heavily leveraged books.
(And of course this ignores the obvious role CRA enablement played with inflating the housing market overall, by driving up demand and contributing to the asset bubble of the late 90’s.)
In other words, when you’re looking for a root cause for what we’re broadly calling the “financial crisis” this month, you can’t defend the CRA behind claims of profitability. It’s just not that simple, and it’s a bit of a dodge around the core issues.
No, but if the CRA loans were the core of the problem, you’d see default rates and post-default returns below the typical portfolio – i.e. if they were the trigger, they’d be worse than the average loan pool – and they aren’t.
So that suggest another set of causes, no?
A.L.
“Loan Delinquencies Rear Their Ugly Head Again” gave a picture of what things looked like at the end of August. “WSJ 9/20/08 link; may require login.”:http://online.wsj.com/article/SB122186669697058789.html
The accompanying graphic reveals the severity of the problem, and how delinquency and default rates are dependent on loan type (sub-prime/option ARM/alt-A/jumbo prime/agency prime). “Link to graphic.”:http://i231.photobucket.com/albums/ee217/ammackay/Loan-Delinquencies-chart-080920.gif
Look at the awful performance of sub-prime loans, over time (2005 -> 2008) and in comparison to prime loans (end of August, >9% already defaulted versus ~1%). And the rightmost graph shows that 30-day delinquencies of subprimes originated in 2006, 2007, and 2008 were already over 25%, and still climbing.
A.L. #14 & #24 —
bq. the ‘post default’ return is the current return adjusted for defaults – i.e. we loaned out $100, got $10 in interest, and wrote off $2, so the post-default return would be 8%.
bq. No, but if the CRA loans were the core of the problem, you’d see default rates and post-default returns below the typical portfolio – i.e. if they were the trigger, they’d be worse than the average loan pool – and they aren’t.
There is no way — no way — that the subprime loans profiled in this WSJ piece are yielding positive returns, now or at any time in the future. Worse yet, the loan-to-value on many or most of these mortgages will be well over 100% (meaning that the property’s now worth less than the principal owed).
Investors who bought mortage-backed securities based on these loans are losing their principal, never mind profits. This is the stuff that can’t be sold for 40, 30, or 15 cents on the dollar.
So I’m perplexed as to why the Milken Institute seems to be talking about a completely different kettle of fish (but I haven’t looked through the slides, so maybe that’s a dumb question).
I think the point is that there was a need for investors to find more profitable vehicles with credit plentiful. One results was asset inflation, that is, the housing bubble, (which in turn encouraged HELOC abuse). I imagine the relatively low interest rates for conventional mortgages were another reason banks turned to baroque stuff, that they could later foist on others.
I want especially to credit #22. I wonder why encouraging home ownership among the middle class has never been controversial; any politician who suggested repeal of this loophole would be shot.
#26 AJL —
bq. I think the point is that there was a need [sic] for investors to find more profitable vehicles with credit plentiful. One result was asset inflation, that is, the housing bubble
Agree; this squares with assessments that I hear from well-informed people.
#22 PD Shaw —
Analysis of teasers by Theodore Seto: “The Financial Crisis: What Went Wrong”:http://understandingtax.typepad.com/understanding_tax/2008/09/7-the-financial-crisis-what-went-wrong.html
bq. The media talks about “sub prime mortgages†– by which it means mortgage loans to borrowers with less than stellar credit. The real problem, however, was the advent and widespread use of teaser-rate mortgages in both the prime and sub prime markets… at least $500 billion more of teaser-rate mortgages are scheduled to reset over the next several years. In all likelihood, they too will go into default and become toxic waste. Nothing in Mr. Paulson’s original proposal was intended to do anything about this next $500 billion installment – or, indeed, to prevent lenders from making more teaser-rate mortgages in the future.
AMac – Subprime =! CRA…unless there is some evidence somewhere that sets out that the subprime market was created in response to CRA standards?
My belief is that the subprime market came into being because the fee-generating engine that is the mortgage market is good at figuring out new ways to get fees…
A.L.
Being a cynic I think this is just the start of the coverup of the Fannie May/Freddie Mac debacle and the Democrats role in the mess.
The average person and every politician will wilt under the blizzard of technical papers, much like those published in 2002, minimizing the role of the CRA and FM/FM.
Robert M:
“The four biggest problem areas for housing (by price decreases) are: Phoenix, Arizona; Las Vegas, Nevada; Miami, Florida, and San Diego, California. Explain exactly how these affluent, non-minority regions were impacted by the Community Reinvesment Act?”
http://www.city-data.com/city/Miami-Florida.html
– Median household income at just over $27,000 is about 56% of the national median. (National median is $48k as of ’06.)
– Poverty rate is 26.9%.
– 78.1% of the population is Hispanic or Black.
Using the same site, the median household income in Phoenix as of ’06 is just a hair below the national median. Is that affluent?
Las Vegas and San Diego are better examples, but even San Diego is a majority minority city. (Barely, but it is.)
#28 A.L. —
Bernanke speech, 3/30/07:
bq. Deregulation also contributed to the changes in the marketplace. Notably, the lifting of prohibitions against interstate banking was followed by an increased pace of industry consolidation. Also, the preemption of usury laws on home loans created more scope for risk-based pricing of mortgages. Securitization of affordable housing loans expanded, as did the secondary market for those loans, in part reflecting a 1992 law that required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a percentage of their activities to meeting affordable housing goals (HUD, 2006) “link”:http://www.federalreserve.gov/newsevents/speech/Bernanke20070330a.htm
Angelo Mozilo, former CEO of Countrywide, 2/4/03:
bq. Our Nation took another important step in 1938 – in fact, 65 years ago this week – when Fannie Mae was created to buy those FHA loans, and as a result, the secondary mortgage market was born. We took a few more giant steps in the 1940s with the G.I. Bill in 1944 and the Housing Act of 1949, which stated the goal of “a decent home and a suitable living environment for every American family.” We witnessed the Fair Housing Act in the 60s, the creation of Freddie Mac in 1970, the expansion of Fannie Mae’s activities, the Community Reinvestment Act in the 70s, the introduction of adjustable-rate mortgages in the 80s, and more recently, the National Affordable Housing Act of 1990.
bq. We have traveled so far – thanks to a mortgage-finance system that remains the envy of the world; thanks to a constant stream of creative and innovative mortgage products, and efforts directed at encouraging the offering of loans to those who have been previously shut out; and simply put, thanks to housing being an enduring public policy objective and the lasting commitment to that objective symbolized by our partnership. “link”:http://www.financialsense.com/editorials/englund/2008/0128.html
Clearly, Mozilo, Raines, and their ilk sincerely believed that they were doing good. Doing well by doing good, to quote an old Tom Lehrer ditty. Clearly, too, the CRA and related legislative and administrative initiatives can’t by themselves fully explain the years-long chain of events that led to the admirable system that invented and marketed that increasing stream of creative and innovative mortgage products [sic].
But as the NTSB will tell you, crashes rarely if ever have a single cause–they are the nexus of a set of failures that work to reinforce one another. Assessing the role of the well-meaning but flawed social engineering hardly means excusing the Princes of Wall Street for the parts they played.
When it comes to the CRA, the strains of “doth protest too much” get loud, fast.
AMAC: _The media talks about “sub prime mortgages” – by which it means mortgage loans to borrowers with less than stellar credit. The real problem, however, was the advent and widespread use of teaser-rate mortgages in both the prime and sub prime markets…_
A.L’s powerpoint (slide 21) shows a strong corrolation between subprime loans and (one-year?) ARMs. I assume the point of that slide is that subprime loans contain risky features like this.
I viewed all the slides, but I don’t understand them well enough to make sense out of them. Maybe that’s because economic theory bores me to tears.
It’s my opinion that the cause of this crisis is complex and multifaceted, but I believe there are three major culprits; Congress, greedy bankers at many levels (not just Wall Street) and greedy individuals who signed loan papers for mortgages they knew full well they could never repay.
Congress allowed fraud and corruption to run rampant at Fannie Mae and Freddie Mac and some in Congress actively resisted any efforts to put a stop to it. Bankers foisted their stinky loans off on Fannie Mae and Freddie Mac knowing full well they would likely fail. An some individuals, poor, middle class and wealthy, took advantage, innocently or not, of the wild west lending atmosphere to buy more real estate than they could ever afford.
If you look at the slides, one thing stands out (at least to me). On slide #28, the preferred method of securitization of mortgages changed from “originate to hold” to “originate to distribute” (or perhaps more accurately originate to pass off on somebody else). The following slide (#29) shows a steady increase from 1994 to more than double (in 2008) what it was in 1994. I don’t know why 1994 was chosen as the beginning year, but clearly something changed. From that point forward, mortgage lenders increasingly foisted their loans off on other institutions (I would assume Fannie Mae and Freddie Mac were heavily involved). There has to be a reason for that, and I strongly suspect Congress was involved.
Another piece of the puzzle.
bq. Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming.
bq. …[The big investment banks] wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.
bq. The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.
NYT, “The Reckoning: Agency’s ’04 Rule Let Banks Pile Up New Debt”:http://www.nytimes.com/2008/10/03/business/03sec.html?pagewanted=1&_r=2&hp
To sum it up – socialism doesn’t work.
“AL, I think you missed the point about CRA. The CRA created the national housing bubble”
-Grim 2.0
Interesting. A program begun over thirty years ago to combat red-lining and which predates the arrival of the Greenspan Fed (Bubble Land’s groundbreaking ceremony), the repeal of Glass-Stegall and other FDR era regulations was the cause our present predicament? So sorry, but try as you may that “CRA dog just won’t hunt”:http://www.counterpunch.org/nader10022008.html
“To sum it up – socialism doesn’t work”
-Gbear
Tell that to Goldman Sachs.
I found the Milken Institute presentation worse than useless. They managed to take a complex subject and make it completely incoherent, simply by acting as though they were making sense, but failing to register the visual aids with the dialogue. It might as well have been presented in Russian or Ancient Greek. Well, given that a few people actually speak Russian that might not have been as bad. But as a pedagogic exercise, it was unforgivable. It was so awful that it can’t even be parodied.
When the substantive portion of a posting starts with something like this you know that the author is not taking a dispassionate stance.
I suspect the honesty of such people and don’t bother to read any further.
“Found this article with a map of San Diego foreclosure rates”:http://www.signonsandiego.com/uniontrib/20080423/news_1b23foreclos.html
bq. According to DataQuick statistics, the greatest concentration of foreclosures last quarter was in the eastern area of Chula Vista, home to a large number of planned communities that have attracted many first-time buyers. Closer to the border, San Ysidro also had a high proportion of mortgage failures.
Nice try BD. Who got the loans? Did you watch the other link I gave here it is again: “Inland Empire”:http://calculatedrisk.blogspot.com/2008/10/foreclosure-alley.html
AL
This is tiresome. The dogwhistlers keep blowing and they are only listening to themselves. Here is another analysis: “link”:http://www.alternet.org/story/101127/
No, Robert, you’re tiresome. And the next time you use ‘dogwhistle’ in a context outside of the Westchester Show, you’ll take some time on the bench.
And your comment is meaningless, b/c you’re suggesting that somehow the Inland Empire is proportionately more white than the rest of LA.
You’re wrong.
A.L.
*#19 from Scooter*
_I am currently pursuing a master in real estate and my professor said, just yesterday, that once the mortgages were sold into the secondary market they were “sliced and diced” so much that nobody can tell what is what. So, assuming my professor is right, I have to wonder what data forms a CRA Pool._
It depends on your view. A bank can set aside $XXX million for CRA investments, covering mortgage, small business and other loans.
More likely it is identified by zip code. If you check on page 76 of the PDF, you can see a pool exists prior to the Special purpose vehicle, bonds and securities. By creating these, and knowing about them, banks can hold this up as participating and use them to qualify. I think that investing in the bonds, as well as individual loans, also give credit.
Your professor is likely talking about the right half of that slide.
*#33 from Antimedia*
_I don’t know why 1994 was chosen as the beginning year, but clearly something changed._
“1994 was when subprime started to increase in volume”:http://gbr.pepperdine.edu/blog/index.php/2008/05/05/29/
It was used before that as well, but not to the same level – under 5% of volume.
_From that point forward, mortgage lenders increasingly foisted their loans off on other institutions (I would assume Fannie Mae and Freddie Mac were heavily involved).__
Yes and no. Non-Agency MBS existed earlier, I think in the late 70s but started in bulk in 1984, with another jump in 89. There were a series of tax and law changes:
> dropping usury laws
> allowing more institutions to hold securitized portfolios
> S&L cleanup
> increased use of FICO by the GSEs
> overriding state laws on securitization
> and then GLB.
Each of these removed constraints as well as providing some tax benefits to interest paid on mortgages.
Deregulation, so yah, Congress was involved.
“Interesting. A program begun over thirty years ago to combat red-lining and which predates the arrival of the Greenspan Fed (Bubble Land’s groundbreaking ceremony), the repeal of Glass-Stegall and other FDR era regulations was the cause our present predicament?”
Yes. You should go back and read all the comments and study up on the timeline of later legislation made regarding CRA. It was a bad idea, and got worse in the mid 90’s thanks to a desire by Dems to turn up the volume a notch. Problem was at least some Repubs weren’t trying so hard to stop them anymore.
But, go back and read before you comment.
One place I do agree with all of you is that the tax code is out of control. this is just sickening: “wellsfargo”:http://calculatedrisk.blogspot.com/2008/10/irs-tax-change-helps-wells-fargo.html
Having established that CRA is not responsible for this mess, it is time to take a look at how at how all the players are all involved:
“Big Picture”:http://bigpicture.typepad.com/comments/2008/10/fannie-mae-and.html#more.
This just keeps getting worse. Is Lehman’s failure a coup by JPMorgan?
“coup”:http://bigpicture.typepad.com/comments/2008/10/did-jpm-cash-ca.html#comments
Robert, if your trend of today continues — if you can’t do better at providing a bit more original, substantive content here — it is likely that you will be invited to take a time-out… possibly to concentrate on content for your own blog.