Saturday, November 24, 2007

The Mortgage Crisis, Part 2

Because all the mortgage lenders could easily sell the loans to other investors, often packaged up with many other loans, they had plenty of incentives to drum up more and more business. Any time you have this situation, people tend to abuse it. How do you offset that?

A savvy consumer should partly offset it; if it's too expensive he theoretically doesn't buy. That didn't happen, partly because the borrowers also had a strong desire to buy property they could not in reality afford. Home ownership is, after all, the American Dream.

The credit rating agencies should partly offset it. They're supposed to be the ones that protect the buyers, valuing the loans properly (i.e., more risky therefore less valuable). Lower value on the loans means less incentive for the lenders to cheat. They could have stopped this thing cold if they rated the loans properly.

Of course since at least some lenders were fabricating income numbers, the rating agencies may not have had the ability to catch all those problems.

All in all, a bunch of lawyers are probably salivating over the prospects. Some of the lenders are bankrupt, others are on thin ice, so the ratings services with deep pockets ought to be getting uncomfortable about now.

It's also interesting to note that surely the top executives of lenders knew interest rates were going up and would continue to do so for a long time -- but the borrowers didn't. As far as they knew, rates could go either up or down. Oops.

The solution? Complex and in dispute. Some say the borrowers were stupid and should pay the price, emphasizing personal responsibility. Others say the lenders misled the borrowers and they have responsibility. Still others say the ones buying the loans are rich and can pay the price, and so on. As usual in a situation with so many moving parts, the answer is probably a mix of the above.

As a part of the solution, I favor allowing the borrowers to renegotiate at a lower (fixed) rate. (The Federal Reserve has already made this course of action more reasonable by cutting overall rates.) Of course this means the value of those loans would drop, but surely it would be less than the loss due to nonpayment and foreclosure. And the amount of the loss would be predictable -- not like the panic we've see this year. There's a saying that Wall Street can price in anything but uncertainty.


Sunday, November 18, 2007

The Mortgage Crisis, Part 1

I happened to see that last Friday's episode of the "Now" program on PBS had a segment on the mortgage crisis. Normally this program is far too liberal for me, but I decided to see what they had to say. Here are a few notes:
  • Potential loan losses of $400 billion, twice the S&L crisis, before this is done. (Although I presume this is not adjusted for inflation. A wild guess would be prices have doubled since then, so in that case these losses would be equal to the S&L crisis.)

  • Housing prices projected to drop an aggregate $2 trillion across the nation.

  • It was reported Countrywide sales reps made up income numbers to help close loans. They often didn't even ask the borrower what his income was.

  • An ex-Ameriquest sales rep said they routinely forged documents to inflate income. They were told "say anything, do anything, to get the sale."

  • Borrowers were told they could refinance before the rates went up, but when that time came, something prevented them -- such as high prepayment penalties, falling property value, a blotch on the borrower's credit record, etc.

  • Lenders would not negotiate payments -- not accepting, for instance, a series of payments throughout the month which would equal the payment that had been due at the first of the month. (Of course they don't have to, but hey, it would be better than foreclosure. I'm reminded of Biff knocking on George McFly's head in "Back to the Future," saying "Hello, anybody home in there?")
My take on this is there's blame to go around. Some or many lenders played fast and loose, the investors bought the repackaged loans without sufficient due diligence, the credit rating agencies assured the buyers the loan packages were safe, and the consumers didn't pay enough attention and didn't do budgeting. Many violated the precept of not signing anything you don't read and understand, and many violated the precepts of having a good-size emergency fund, and not putting yourself out on a high-risk limb.

Many borrowers also had inferior credit (the very definition of "sub-prime"), without which they wouldn't have been going to these lenders and paying elevated interest rates in the first place. And that doesn't speak well of their native financial management skills, does it?

This shows the necessity of being financially well-informed, and conservative (even reluctant) when taking on debt. It's been commented that many people spend more time analyzing the purchase of a wide-screen TV than their mortgage, when the latter is far more important. If you don't do your homework the result is all too predictable.

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