Mortgage Market Failure Pin the Tail on the Donkey

Yesterday’s New York Times had a four (4) page article, written by Gretchen Morgenson the NYT’s business and financial editor, which alleges to have pinpointed the underlying weak link which resulted in the mortgage market collapse, and that if the early warning sounded by one Nye Lavalle had only been acted upon, the financial markets would not be in the pickle they currently are in.

The NYT article is titled A Mortgage Tornado Warning, Unheeded and it opens with this bold statement.

YEARS before the housing bust — before all those home loans turned sour and millions of Americans faced foreclosure — a wealthy businessman in Florida set out to blow the whistle on the mortgage game. (bold by ed.)

Morgenson’s article goes on, at length, enumerating on Lavalle’s investigation (147 pages), and Fannie Mae’s seeming dismissal of Lavalle’s investigation, but the many words strung together by Morgenson all lead to the erroneous conculsion that if only the foreclosure filing irregularities discovered by Lavalle would have been judiciously addressed then the economic issues the world is contending with would not exist, and the dream of American homeownership would still be a dream worth having.

While there is no doubt what-so-ever that irregularities have occurred, and still do, in the mortgage foreclosure filing process, it is simple minded to conclude that the mortgage market meltdown, and the resulting worldwide financial mess, would have been averted if only Lavalle’s “mortgage tornado warning” would have been heeded.  It’s a pleasing theory to distribute to the masses, but it’s akin to a William K. Black peddling of theoretical blame.

The collapse of the mortgage lending industry did not require the sounding of a tornado warning.  The probability of the mortgage market collapse was clearly viewable as soon as one looked upon one single solitary subprime loan.

The stage was set for the collapse of the subprime lending industry with the origination of the individual subprime loan underwritten to foolish; one could say incompetent; underwriting guidelines.  As more and more of these structurally deficient loans piled up in lenders’ servicing portfolios, to be mined again and again for any remaining equity subprime borrowers may have retained in their homes, the swiftness of the final collapse lacks any astonishment.  The subprime lending business model was fundamentally flawed and myopic.

Posted by .(JavaScript must be enabled to view this email address) on 02/05 at 08:58 AM

  1. Subprime loans are the problem and the reason for the collapse.  Suprime loans are a product of government regulation primarily pushed through congress by Barney Frank and Chris Dodd.  Banks wanted nothing to do with subprime loans and were forced into by congress and activist groups like ACORN.  It is worth noting that 100% of subprime loans were fully insured by the government.  This insurance was mandated by government and paid for by the buyer (or less often the seller). 

    Often irregularities in the forclosure process are cited as being the “the problem”.  That is not the case.  The so-called irregularities are the result of inconsistencies in the law between the different states and the federal government.  During the 90’s and afterwards the federal government pushed for and even forced banks and mortgages lenders to bundle and sell their loans so that more money could available for more loans.  The various state and federal laws aound this process and the subsequent forclosure process proved a difficult terrain to travel when the SHTF.  Many banks and other holders of mortgages made misteps in the process of foreclosing those loans.  The facts are clear; that is they owned the loans, the loans were in default and they went through the “correct” process to forclose on the loans.  But the ever crafty lawyers found the inconsistencies in the various laws of the various legal domains and judges amiable to those crafty lawyers muddied the waters by denying the banks the right to foreclose on properties without onerous paperwork and procedure burdens.  The federal government forced the banks to bundle the loans under existing laws then the banks were left flopping in the wind when red tape and lower court justices interpreted the mish mash of local, state and federal laws to the banks disadvantage.  These judges won popular support but destroyed the system.  Now the banks have become the whipping boy and they will have to pay.  Obama wants to punish them (for following congresses mandates) with a huge tax.  Who could have seen that coming?

    Posted by .(JavaScript must be enabled to view this email address)  on  02/05  at  11:23 AM

  2. It is worth noting that 100% of subprime loans were fully insured by the government.  This insurance was mandated by government and paid for by the buyer (or less often the seller).

    GWTW.  I don’t know where you obtained that bit of information, but I am quite certain it is incorrect.

    While conventional, as opposed to FHA/VA, subprime loans did become packageable and saleable on the secondary market to FannieMae and FreddieMac, whose purchaseable loan standards were heavily influenced by governmental policies, they were not 100% insured by the government.

    Posted by John Venlet  on  02/06  at  09:01 AM

  3. I would gladly accept any evidence to the contrary but as anyone who has bought a home and put less then 20% down can tell you mortgage insurance is required and has been since the last mortgage debacle of the late 70’s.  Typically that insurance is paid in some combination of an up-front payment and a monthly payment added to the mortgage payment.

    Posted by .(JavaScript must be enabled to view this email address)  on  02/06  at  11:10 AM

  4. I would gladly accept any evidence to the contrary but as anyone who has bought a home and put less then 20% down can tell you mortgage insurance is required and has been since the last mortgage debacle of the late 70’s.

    GWTW, what you state is correct, for a standard conventional loan, but incorrect for a subprime loan.  The insurance you speak of was known as PMI insurance, the PMI standing for private mortgage insurance.

    Subprime loans did not carry PMI insurance, and were not required to by any law or regulation instituted by the government.

    In subprime lending, the risk for having less than 20% equity in a property was putatively “covered” by the interest rate charged and points paid up front to the lender, not by PMI insurance.

    Posted by John Venlet  on  02/06  at  11:43 AM

  5. With all due respect you are wrong.  By definition a loan with less the 20% down IS a subprime loan.  Everyloan where the buyer puts down 5% or 3% or 0% IS a subprime loan.  By law every mortgage loan with less the 20% down required mortgage insurance.  There was no opt out. 

    It seems that you are implying that in addition to all the various mortgages that there was a “special” one that not only did not require 20% down but was also exempt from the PMI requirement.  Not true!  Who would make it?  The banks weren’t allowed to.  Fannie Mae and Freddie Mac weren’t allowed to.  Hud, VA, and private non-bank lendors still had to obey the law about PMI’s.  So who made such a loan?  Parents, perhaps…

    Posted by .(JavaScript must be enabled to view this email address)  on  02/07  at  01:43 PM

  6. GWTW, with all due respect to you, I am not incorrect.  I first began working in the mortgage industry in 1987 and finally exited for good from the industry sometime in 2003 or 2004.  I was a mortgage originator, mortgage brokerage owner, wholesaler of mortgages, and branch manager, for a short time, of a branch office for the largest subprime lending corporation in the nation.  I know of what I am speaking.

    Posted by John Venlet  on  02/07  at  02:27 PM

  7. If it were easy or possible for the bank to make you a no money down loan (or low money down loan) and not purchase a PMI policy why then would mortgage lenders have ever come up with a “80-10-10” loan?  A complicated loan that requires considerable effort to create but you say the lender could just choose not to comply with the law on a PMI.  The “80-10-10” loan was created to get around the law that requires a PMI. 

    If, as you say, some loans were made without a PMI by your own definition this was unusual and the number would be very small (since the law requires a PMI) how could this very small numer of loans be responsible for the collapse?  (I concede that it is possible to get a mortgage without a 20% down payment and still not require a PMI.  However banks, mortgage companies FHA and VA were not allowed to make these loans.  I could make that loan to my child but the bank could not.) 

    I actually don’t dount that somewhere somehow some loans were made without the PMI but that was contrary to the intent of the law and the exception and not the rule.  And that when the media or others refer to “subprime” loans they do not mean some extremely small percent of loans made without PMI but in fact refer to every loan made with less the 20% down.  The term “subprime” never referred to loans made without a PMI they simply refered to loans with a sub-down payment, i.e. a down payment less then 20%

    As you know, because you were in the business, what makes a mortgage loan “prime” is:  1. 20% down payment.  2. The borrower has a good credit score.  3.  The down payment was verified to originate from the borrowers own assets and not be a loan, gift or from unverifiable sources.

    Posted by .(JavaScript must be enabled to view this email address)  on  02/09  at  10:25 AM

  8. GWTW, I think we, very unfortunately, are talking past each other a bit.

    In one of your previous comments (#5) you stated, By definition a loan with less the 20% down IS a subprime loan.

    That is incorrect.  A subprime loan, in its original sense, was a loan made to a borrower who had poor credit, no matter how much down payment or equity they may have had.

    A loan made to a borrower with less than 20% down, was still “prime” if they had good credit (meaning 1 or less late pays on their current mortgage or rent payment history) and very few, if any, late pays on their credit cards or car payments.  This type of mortgage was simply referred to as a PMI (private mortgage insurance)loan, and this type of loan was easily packaged and sold to Fannie or Freddie.

    Though a “prime” borrower could take out a subprime loan, say if they did not want their income and assets verified, a “subprime” borrower could not take out a prime loan even if they had 20% or more down, and cash reserves in the bank.

    In true subprime lending, there was no PMI.  Period.

    Posted by John Venlet  on  02/09  at  12:55 PM

  9. For the sake of the arguement lets say I fully accept your definition of subprime loans:  Therefore all of these loans are loans that no bank or mortgage company wanted to make and 20-30 years ago would not have made.  The only reason a loan like the one you describe was made was because the government forced it.  In 1979 Barny Frank and Chris Dodd pushed through legislation that required banks make these loans even if it was contrary to good business practices.  Additionally it required these loans to be bundled and sold to investors for the express reason of making even more money available to mortgage lenders.  I.e. this problem was 100% the fault of the federal government and not banks, mortgage companies or Wall Street.

    If on the other hand I disagreed with your definition I would point out that the number of these specific loans was very small and that in general when a news reporter or commentator refers to “subprime” loans they in fact meant all of the loans that were in trouble especially those loans with little or nothing down (which encourages the borrower to simply walk away from the home when they get into trouble).  The vast majority of the loans which went into default were the loans made with less then 20% down and when anyone on TV or the print media refers to this vast majority of loans they use the phrase “subprime”.  Are they technically “subprime”?  perhaps not but this is not the first time the meaning of a word is changed because of the common usage.

    AIG got into trouble early on in this because they insured (PMI) a lot of these loans.  In fact the massive defaults pointed out the weakness of the government mandated and regulated PMI system.  The simple fact is there was not enough money in the system to pay for a massive default.  The government set up the system and they set the premium amounts.  They compromised on this and this set the premiums too low in the event of a massive default.  This is why they were eager to bail out insurance companies and of course they knew in the end the government would be on the hook as the insurer of last resort.  They created the system they created the situation that lead to the default and if there were any true justice in our legal system the government would have had to make all the parties in this whole.  As it stands now the government has spent the last three years demonizing banks, Wall street and the rich.  So here we are today with 90% of the population thinking it is all the banks or Wall Street’s fault and the real culprits are scot free.

    Posted by .(JavaScript must be enabled to view this email address)  on  02/10  at  11:03 AM

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