Phydeaux
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Joined: 1/4/2004 Status: offline
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ORIGINAL: mnottertail Yeah, no. It 'requires' no such thing. Read it. from 2000 to 2007 (when it hit) the house was republican (sometimes a lot, some times a little) and the senate was back and forth but pretty much a toss up. In the old days, banks used to make mortgages in house and keep them on their books. Because they held onto the loans they made, stringent guidelines were put in place to ensure quality loans were written. After all, if something went wrong with the loans, they’d be accountable. And they’d lose lots of money. Recently, a new phenomenon came along where banks and mortgage lenders would originate home loans and quickly resell them to investors in the form of securities on the secondary market (Wall Street). This method, known as the “originate to distribute model,” allowed banks and lenders to pass the risk onto investors, and thereby loosen guidelines. The result was casual underwriting, less oversight, and more aggressive financing, which ultimately led to a lot of bad loans being made. [See the latest mortgage rates from dozens of lenders, updated daily.] Banks and lenders also relied on distribution channels outside their own roof, via mortgage brokers and correspondents. They incentivized bulk originating, pushing those who worked for them to close as many loans as possible, while forgetting about quality standards that ensured loans would actually be repaid. Because the loans were being sliced and diced into securities and sold in bulk, it didn’t matter if you had a few bad ones here and there, at least not initially… Fannie Mae and Freddie Mac Of course, banks and lenders modeled their loan programs on what Fannie and Freddie were buying, so one could also argue that these two “government-sponsored enterprises” also did their fair share of harm. In short, if the loan conformed to the high standards of Fannie and Freddie, it’d be easier to sell on the secondary market. And it has been alleged that the pair eased guidelines to stay relevant in the mortgage market, largely because they were publicly traded companies steadily losing market share to private-label securitizers. At the same time, they also had lofty affordable housing goals, and were instructed to provide financing to more and more low- and moderate-income borrowers over time, which clearly came with more risk. However, the private mortgage market took control during the lead up to the eventual crisis thanks to their bevy of high-risk mortgage products, so Fannie and Freddie had to ease their own guidelines to maintain market share. As a result, bad loans appeared as higher-quality loans because they conformed to Fannie and Freddie. And this is why quasi-public companies are bad news folks. Bad Underwriting That brings us to bad underwriting. Now it wasn’t that underwriters didn’t know what they were doing, it was more a matter of influence from upstairs. They were often told to make loans work, even if they seemed a bit dodgy at best. Again, the incentive to approve the loan was much, much greater than declining it. And if it wasn’t approved at one shop, another would be glad to come around and take the business. After all, the loans weren’t being held for more than a month or so before they were the investors’ responsibility. Faulty Appraisals Going hand-in-hand with bad underwriting was faulty appraising, often by unscrupulous appraisers who had the same incentive as lenders and originators to make sure the loans closed. If the value wasn’t there, it only took a little bit of tinkering to find the right comparables to get it right. If one appraiser didn’t like the value, you could always get a second opinion somewhere else or have them take another look. Home prices were on the up and up, so a stretch could be concealed after a few months of appreciation anyways. And don’t forget, appraisers who found the right value every time were ensured of another deal, while those who couldn’t, or wouldn’t make it happen, were passed up on that next deal. No Skin in the Game Another big issue was the lack of a down payment in the most recent boom. Back when, it was common to put down 10-20 percent when you purchased a home. In the last few years, it was increasingly common to put down five percent or even nothing. In fact, zero down financing was all the rage because banks and borrowers could rely on home price appreciation to keep the notion of a home as an investment viable. However, it wasn’t long before prices began to peak and eventually fall, causing all types of problems for borrowers with little or no equity in their homes. Those that purchased with zero down simply chose to walk away, as they really had no skin in the game, nothing to keep them there. Sure they’ll get a big ding on their credit report, but it beats losing a whole lot of money. Conversely, those with equity would certainly put up more of a fight to keep their home. Aggressive Financing Playing off the lack of a down payment, aggressive loan programs like the pay option arm and other interest-only options also contributed to the mortgage mess. As home prices marched higher and higher, lenders and builders had to come up with more creative financing options to bring in buyers. Because home prices weren’t going to come down, they had to make things more affordable. One method was lowering monthly mortgage payments, either with interest-only payments or negative amortization programs where borrowers actually paid less than the note rate on the loan. Some banks, like now-defunct Bear Stearns, actually offered a pay option arm at 100% LTV, meaning you could come in with zero down and make a super low payment, often as low as one percent, for several years before the loan adjusted to a more realistic rate. This of course resulted in scores of underwater borrowers who now owe more on their mortgages than their current property values. As such, there is little to any incentive to stay in the home, so borrowers are increasingly defaulting on their loans or walking away. Some by choice, and others because they could never afford the true terms of the loan, only the introductory teaser rates that were offered to get them in the door. Limited Documentation Home loans used to be underwritten full doc, meaning you would need to provide pay stubs or W-2’s, along with asset and employment information. This would give the bank or lender plenty of reliable information to make an underwriting decision. Then came limited documentation loans, such as stated loans, now known as “liar’s loans,” which were intended for people like doctors and the self-employed who had complicated tax structures. Eventually, everyone seemed to be taking advantage of limited documentation underwriting, often because they couldn’t meet guidelines legitimately. After all, your interest rate would only be another quarter-percent higher in many cases, so why provide real income if you can fudge the numbers a little and get approved? More troubling were no-doc loans, where borrowers only provided a credit score. No income, asset, or employment information was provided, allowing virtually anyone with a decent credit history to get their hands on a new home. none of which is 'required'. Deregulation was a great deal of the trouble. Thanks for a lucid post mnotter. I agree with a lot of what you said. I have read the CRA. While most of your post is pretty fair, saying its not 'required' is a dodge. If banks did not perform under CRA standards, regulators could deny bank branches, license applications etc. The CRA compliance record was also taken into account in banking regulatory agencies, such as the Office of thrift supervision, FDIC, Federal Reserve, Comptroller of the Currency etc. There has only been one bank that chose to not comply with the CRA - and that was E-trade. Fannie and Freddie relaxed their credit scores required - I remember the newspaper and interviews, and discussions with Raines.. Previously, with downpayments the standard was 620. The fact that Fannie and Freddie did not buy or fund all the loans understates their importance in the marketplace. The overwhelming majority of loans were done by brokers or originators who wanted to quickly turn them over. Having loans that conformed were marketable - and could be marketed in CDO's. Loans that couldn't - weren't. And it is still true that by 2007 the CRA was requiring 55% of loans to be LMI/CMI, as I said in my previous post. Best to you mnotter.
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