Warranty Fix for Mortgage Securitization Problems
This is not nearly as wonky as it sounds — see if you can follow the thought process to the end.
I continue to be surprised at the general criticism and misunderstanding of the securitization process. Some have blamed the repackaging of these debt instruments as an underlying cause of the housing boom and collapse. By extension, goes the thinking, we therefore should blame Fannie Mae (and Freddie Mac) for the collapse.
There are several problems with this explanation:
1) Fannie Mae has been securitizing mortgages for nearly three quarters of a century; If after 70 years of well functioning securitizations, how did this process suddenly cause a collapse? The short answer is it didn’t, something else was the cause;
2) Many parts of the globe where there is no Fannie Mae — from the UK to Spain to South Korea to Australia — had their own boom and bust. Where there is little or no securitization, but the same boom/bust cycle took place, there must obviously be another explanation for the root cause; As I made clear in Bailout Nation, it was ultra-low rates and an abdication of lending standards that were the causes — not securitization;
3) Securitization has, like all systems, a GIGO problem — garbage in, garbage out.
There have been several attempts to address this last issue. One of the fixes proposed is to require originators who sell mortgages to Wall Street securitizers to retain a portion of the mortgages:
“Lenders would be required to retain at least 5 percent of the risk of losses on each package of loan pieces, known as an asset-backed security. The employees and contractors who originate loans would be paid gradually, and they could get less if borrowers started to default.”
I don’t have a problem with that approach, but I would point out an even more egregious GIGO flaw in the securitization process: The absurd default warranties that the mortgages underwriters used. when selling these debt instruments to WallStreet. This is one of the ways we concentrated, rather than disbursed lending risks.
Let’s go to a book excerpt comparing the old securitization model with the 2002-07 version:
“This was very different from the way traditional banks operated. To your local banker, a mortgage is a reliable and secured for m of lending. With few notable exceptions, lending standards by banks had always been rigorous. When a traditional depository bank originated a mortgage, it assumed it would hold on to the loan for the full 15- or 30-year term; depository banks felt no compulsion to resell them. Guarding against default over the life of that loan was the key to not only being profitable, but staying in business.
That wasn’t how the newfangled lend-to-securitize originators worked. In one of many examples of misplaced compensation schemes we have seen, they were paid on the volume, not the quality, of their loans. Besides, they didn’t need to find a buyer who was a good risk for 30 years—they needed only to find someone who wouldn’t default before the securitization process was complete. Thus, they had very different standards from the traditional lenders. The sellers of these mortgages made warranties to the Wall Street buyers of this paper that the borrowers would not default for 90 days—enough time for the loans to be sold off and repackaged as residential mortgage-backed securities (RMBSs).
This was a radical change in lending standards.”
- Bailout Nation, The Machinery of Subprime,
Sure, we can make the originators retain 5% of what they have underwritten, but I have a simpler idea is to simply require a warranty that is mor ein line with the term of the loan.
A default warranty of 3 or 6 months on 30 year mortgages is utterly absurd; Instead, we should mandate a 5 year warranty on 15 year mortgages, and a 7-10 year warranty on 30 years. This way, we align the interest of the underwriter with the securitizer and the ultimate buyer of that structured product.
Garbage in, garbage out problem fixed!
>
Previously:
Paul Krugman is Wrong About Securitization (March 28th, 2009)
http://www.ritholtz.com/blog/2009/03/krugman-is-wrong-about-securitization/
Can There Be Market Solutions With No Real Markets? (March 30th, 2009)
http://www.ritholtz.com/blog/2009/03/can-there-be-market-solutions-with-no-real-markets/
Sources:
Regulatory Revamp Targets Securities at Heart of Crisis
Sellers of Mortgage Loans to Share In Losses Under White House Plan
Binyamin Appelbaum
Washington Post June 16, 2009
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/15/AR2009061502523.html
Understanding the Securitization of Subprime Mortgage Credit
Adam B. Ashcraft, Til Schuermann, Staff Report no. 318
Federal Reserve Bank of New York, March 2008
http://www.newyorkfed.org/research/staff_reports/sr318.pdf
Securitisation and financial stability
Hyun Song Shin
18 March 2009
http://www.voxeu.org/index.php?q=node/3287
June 17th, 2009 at 7:42 am
Retaining some small portion of the mortgages that are securitized at least requires the lend-to-securitize originators to have some capital in the game. The warranty extension idea does not necessarily require these operators to maintain capital to back up that warranty. That is to say, a warranty with no ability to honor the warranty has no value. The warranty approach seems to be just another way to wind up where we are.
~~~
BR: How is retaining a 5% exposure better aligned than a 100% exposure ?
June 17th, 2009 at 8:00 am
BR offered:
A default warranty of 3 or 6 months on 30 year mortgages is utterly absurd; Instead, we should mandate a 5 year warranty on 15 year mortgages, and a 7-10 year warranty on 30 years. This way, we align the interest of the underwriter with the securitizer and the ultimate buyer of that structured product.
comment:
——————-
Ways for banks to get around new rule
1) New form of CDS
[BR: Preclude sellers of mortgages to securitizers from hedging or buying CDS]
2) Borrower insurance paid for by borrower
[BR: Its called PMI]
3) Make all loans through newly formed mortgage subsidiary, which is kept as far away as necessary to avoid potential blowback biting bank on ass
[BR: Make that illegal]
4) Contract language in securitization sale that indemnifies lender from new warranty requirement
[BR: That violates the warranty rule]
5) Use offshore facilities as required and permitted
[BR: Make that illegal]
6) Ghost Syndication: Create syndicate for purpose of raising funds, making loans, selling loans, and dissolving after loans sold, returning profits to investors. (My personal favorite)
[BR: By definition, illegal]
Given at least an hour, I could probably come up with several more work-arounds.
[BR: Great, give me the list, and we make all of it unlawful]
June 17th, 2009 at 8:03 am
After watching Jim the Realtor’s shadow inventory video and getting a feeling for the cash-outs, I can’t help but think that making all residential mortgage loans recourse would help a lot.
June 17th, 2009 at 8:08 am
Need to keep in mind that a warranty without some rational amount of capital to back it up is likely not worth much. Recall many originators could not even meet their 90 day repurchase obligations and ultimately filed for bankruptcy.
~~~
BR: Create a reserve requirement (like any bank) against future losses
June 17th, 2009 at 8:18 am
Absolutely.
And the New AIG has just announced a new warranty program called Securitized Home Insurance Term (15) that fully insures against any loss on securitized mortgages, and they will also be working to sell policies to guarantee against counter-party losses, since that insurance is not backed by any reserves other than the rather iffy full faith and credit of the US government. Only available right now in Iceland, but coming soon to Irvine.
June 17th, 2009 at 8:21 am
Here’s another one:
Bank no longer originates loan. Bank just performs mortgage interview and form filling assistance … becomes a mortgage broker.
A company renting space in bank performs evaluations and approves applicant. This is a fee service.
Third company underwrites according to program borrower applies for. Loan sold.
Who made the loan???? Who warrants it???
June 17th, 2009 at 8:56 am
I’ll note in passing that the author claimed yesterday to be a libertarian, and today is advocating regulation to ‘fix’ the securitization process. I make no such ideological claim, but I do find his comments humorous.
Addressing the main point of the thread, I disagree that it was either securitization, Fanny or Freddie, warrenties etc that ’caused’ the problem. It was and always will be the implied bailout of the offending parties (defined as those who have access to the money, hence the power) who create the hazards in the first place.
If you indeed wish to be a ‘libertarian’, then Government regulation of private enterprise should be the last choice of any number of options. The market is fair, and it is brutal: extend loans to unworthy creditors, accept loan ‘books’ that you have not vetted to be worthy of investment, write insurance policies against said loans without vetting the underlying quality, buy stock or bond of said loans or insurance policies without due diligence to prove their worth and you lose your entire investment IF you have bought crap.
Mumble if you must about systemic risk, or threats to the world economy, or Keynes or Austrian economics or any other justification for Government involvement you would like, but the bottom line is if you remove the risk from the originator, you’ve removed any semblance of ‘ethical’ behavior from the system.
As should be obvious by now, it’s not the ‘regulations’ which caused the problem. Unless Ireland, UK, Spain, Germany et al all have the exact same regulatory scheme as the US.
It is greed, pure and simple. Risk tempers greed, because it puts the weight of failure squarely on the shoulders of the person issuing the money. Remove that weight, and bubbles will blow.
~~~
BR: You suffer from a form of cognitive dissonance — your ideology precludes form seeign facts that challenge that belief system.
Greed is a human emotion as old as mankind. Why did it suddenly cause the crisis? Besides, you cannot do away with greed anymore than you can remove happiness, love hate or jealousy.
We must recognize that Humans need rules, supervision and oversight. And when you put these Humans in groups, and incentivize the wrong way, let them run amuck with no oversight and little rules, you get disaster. This is what occurred at investment banks, commercial banks and insurers
June 17th, 2009 at 8:58 am
I agree that the financial thiefs will find ways around anything.
I believe that any product they dream up must come under some sort of scrutiny.
The product needs to be regulated, the effort of these bankters goes into finding ways around any rules.
They do nothing in good faith. Regulatory arbitrage is a growth industry for them.
June 17th, 2009 at 9:14 am
For the general public, there is no upside to the sale, securitized or otherwise, of debt obligations. In addition to the obvious moral hazard of overstating the quality of the loans being made and sold, there are also chain-of-ownership issues (a problem for both the courts and the borrowers).
Banks should be required to hold their loans to maturity. If the rates they charge aren’t lucrative enough for them (and if not for them, why would they be for anyone else?), they can raise them (crimping the volume of loans made) or get out of the mortgage business all together. If the banks need liquidity after making a certain amount of loans, then they have made too many loans and should be allowed to fail (fractional reserve banking be damned). Requiring 100% responsibility over the life of the loan would ensure 100% responsibility in making and servicing the loan (and that responsibility should extend to both the borrower and the lender, until and unless bankruptcy is declared). There is no better insurance. There is no more rational policy.
Why should society be left holding the bag for anyone? Why should we enable and condone deceit, fraud, and criminality?
June 17th, 2009 at 9:22 am
How about a warranty process that remains in tact for the life of the loan, however reduce exposure gradually rather than a cliff process. This would insure that underwriters/issuers remain vested for the life of the loan and mortgage brokers would be hit with “charge-backs” if they “helped” an applicant complete an application with erroneous information.
Too late to fix our current problem, but might help in eliminating future issues.
June 17th, 2009 at 9:26 am
Mish, who I think is many times spot on, pulls out a doozy today.
My Comment: The CRA is blatant stupidity as well as hypocritical. Banks were forced to make loans where they made absolutely no sense and in doing so created the mess of inner city subprime loans that we see. Now the solution is to force more stupid lending on the basis of where people live than on the merits of the loan. This is asking for more trouble and it is a certainty more trouble will be found.
June 17th, 2009 at 9:33 am
And who would be there to honor the warrantee?
June 17th, 2009 at 9:41 am
grumpyoldvet i think you will find that BR has no patients for folks who think the CRA had any thing to do with the mess. at the very least understand that it was the banksters who made the loans to begin with and they are the ones who are subject to CRA. and is nothing more than suggestions and keeping track of what the banksters are doing.
when I was at a captive, we securitized our loans and leases. but we were on the hook for the entire live of the loan or lease (we either had to replace the loan/lease or buy it back). which made us very conscious of the lending standards as you might imagine. and knowing that we followed the biggest company in how things were organized, we were probably following their methodology for securitization. we also had to prove that we actually did charge offs if things went south on the loans or leases too.
but this wasn’t the method that the mortgage broker and companies used. they were into if you could breathe you could have a loan. and there were no Federal laws about this, and what state laws existed were ignored for the most part (and it some cases the state regulator was allowing felons to be brokers. even bank robbers on occasion!)
June 17th, 2009 at 9:45 am
Re: Mish pulled a doozy:
Regardless of how much or how little impact the CRA had overall in this fiasco, Mish is correct. It is the height of stupidity to require lending based on geography and not on ability to pay.
In an era where cities are debating the advisability of bulldozing whole sections of themselves to avoid the cost of services to blighted areas, requiring that banks make loans into these places is comically absurd.
June 17th, 2009 at 9:45 am
Hope is not a strategy. Hoping for good faith amongst self-interested economic players is a fool’s errand. That said, no amount of regulation, save suffering market failure for foolish behavior, is capable of regulating any market. We need less government, not more.
Along those lines, this:
“it was ultra-low rates and an abdication of lending standards that were the causes”
You should have stopped at “ultra-low rates”. It was the sole cause. Abdication of lending standards was one of many effects. And with the currencies of all the US’s trading partners implicitly, if not explicitly tied to the dollar since Bretton Woods “II”, it did not matter that regulatory regimes differed amongst different countries. Their regulations were feckless as well, in the teeth of a ballooning supply provided by the Fed and an increasing velocity of money brought about in part by technological advancements and financial innovations that made chasing yield ever cheaper.
The only “regulation” needed is regulation of the currency. It was THE (sorry CVIENNE) central government failure, as it tried to manipulate economic outcomes through manipulation of the currency. Monetarists should now be proved as wrong as Keynesians. Monetary manipulations only serve to change the accounting, and to force money into places where it shouldn’t and wouldn’t go save the fact there is so much of it sloshing around. And contrary to Greenspan’s cheery assessment of financial innovations, they just facilitated the monetary mischief upon which the excesses of the 90’s and 00’s were built.
June 17th, 2009 at 10:01 am
BR,
You are correct, you cannot do away with greed.
Which is exactly the point.
Greed is the root of the problem, not regulation. Not ’systemic’ risk. Not government, not the CRA or Barney Frank or Glass Steagall repeal.
You want to re-regulate, or make better regulations. So you post a ‘cure’ for securitization.
Three comments in, someone posts 6 work arounds to your ‘cure’.
Because greed is the motivator, no regulation will work. Because someone will come along and re write the regulation, just a litttttle bit, and then they are off to the races again.
What you can do, and the only thing the Government should do, is prevent systemic risk. Which means they should not be a guarantor of any form of financial service, except for their own debt.
You cannot prevent bad investments. You cannot prevent bad economic conditions. You cannot prevent war, or desease, or poor outcomes for some of humanity.
We regulate ourselves to death in an attempt to literally cheat death. We regulate ourselves to the point where only lawyers trained in certain specialties can understand the contracts we sign to buy houses, or cars, or toaster ovens. And even then the next lawyer can find a way to invalidate the existing contract.
Yes, we need a system of laws (regulations if you will) by which we co-exist. Those laws should never put the wealth of the nation at risk to cover the bad bets made by it’s citizenry in the housing market.
June 17th, 2009 at 10:01 am
BR,
A warranty period by definition is not a life-time guarantee and any arbitrary point in the sand (3 months, 10 years, 15 years) still results in the same issue of a smaller magnitude…which will ultimately lead to a similar crisis when the system is many times larger in size.
Your response to an earlier post nailed it: “Greed is a human emotion…when you put these humans in groups and incentivize the wrong way”. Isn’t there an easier solution than a complicated warranty requirement? The anti-trust laws that should have ensured the same greedy humans didn’t congregate in too a large group that was too big to fail looked the other way in the last decade when the banks went into an M&A orgy and Fannie and Freddie became obese with China-surplus and carry-trade dollars?
You’re right in that securitization by itself is not to blame and Fannie and Freddie have played a vital role by using securitization as a tool in getting credit to flow to and from the housing market. But, the Fannie, Freddie, and banks of the last 70 years started to look very different in their last few years of non-zombie existence.
If none of the greedy entities were too big to fail, we might have had a functioning market to liquidate the bad risk takers and reallocate the capital to good firms.
June 17th, 2009 at 10:07 am
marcus Says-
“Why should society be left holding the bag for anyone? Why should we enable and condone deceit, fraud, and criminality?”
well said
June 17th, 2009 at 10:14 am
Barry’s idea is good, but unfortunately politics are at play. Does anyone believe that a representative government without the balance of an uncompromising press could possibly solve this problem?
June 17th, 2009 at 10:15 am
@leftback
Morning move today is winking at 932-938 on Friday/Monday (we’d been discussing that with Andy T)
…then……….
June 17th, 2009 at 10:17 am
@kstills:
Hopefully you acknowledge that the first principles of the US Constitution inc0rporate a Hobbesian vision of humanity. Checks and balances in the form and substance of the government is an attempt to account for selfish/irrational/inefficient tendencies in human nature.
Radical deregulation is not merely discredited doctrine now — it is a disavowed doctrine. Even Richard Posner has capitulated and publicly (and repeatedly) admitted that his deregulation beliefs have been proven wrong. That puts your position on the quixotic side of history at this point.
Removing government backstopping does not remove “systemic risk” when deregulated financial institutions have been permitted to grow to such a size and intertwine with one another to such an extent that failure of one or a few threatens to bring down the whole house. Analogous features in the insurance industry with intertwined re-insurance practices to distribute risk.
In sum, ya got nothin’.
June 17th, 2009 at 10:23 am
“It was and always will be the implied bailout ……” kstills
Exactly.
Unless every player in the system has skin in the game, with no chance of a bailout–the fabled “Greenspan Put” , there is no system immune from a bubble. There were rules and regs aplenty, what there was not enough of was personal risk during the decision making process.
Write all the new rules and regs you want to fight the last war but we will be here again in new garb as long as the government promises to be the lender of last resort. All things, and I mean all things, must be allowed to fail. By the time this mess is over that will be the lesson learned–hopefully!
June 17th, 2009 at 10:24 am
This is achievable under the existing securitization apparatus. Every originator in a deal would have its loans assigned to its own group. Unique B-pieces (first loss credit support tranches) would be created for each group.
Five percent is probably too big for stuff that is underwritten well, but something in the 2-4% region would do for most good underwriting. For bad underwriting and subprime/Alt-A, 5% would be too low.
I would require the originators to hold their B-pieces for 5 years, after which they could trade them if they wanted.
This would force originators to be better capitalized, and probably, more risk-conscious. It would not be perfect, but it would be better. I can live with better.
June 17th, 2009 at 10:25 am
Tranzor,
Sigh.
And why have financial institutions grown to such as size as to intertwine with one another to such an extent that failure of one or a few threatens to bring down the whole house?
How many banks failed during the great depression?
Yes, the framers believed humans were imperfect and needed to be put in conflict with each other. Checks and balances is a creation, Madison believed power should rest with the assembly.
What you call radical deregulation is a call to abolish the Fed. As a constitutional scholar, you know already that the framers demanded our currency be based on gold or silver, and that no outside entity would have the power over the federal money supply.
Indeed, removing government backstopping does remove systemic risk. The first failure of a ‘new financial service’ is the last. Absent the fed, interest rates are not manipulated to improve economic conditions at the whim of the Politicians. Economic conditions remain mated to fundamentals.
In sum, I got everything.
June 17th, 2009 at 10:34 am
Hopefully you followed my call from last week with $DUG (long) and $COF (short). Both are looking great today. I was waiting for this reversal.
June 17th, 2009 at 10:39 am
Barry,
Requiring a warranty from the lender would, I believe, void sale treatment for a securitization, requiring the securitization to remain on the bank’s balance sheet for the warranty period (assuming a warranty for the full principle balance). This would eliminate bank’s major reason for securitization and put us back into the pre-MBS world of mortgages either being left on the lender’s balance sheet or being sold on a whole loan basis. This outcome might be OK but it would sharply reduce the amount of securitizations being done.
June 17th, 2009 at 10:46 am
@kstills:
With hundreds of trillions of USD in notional obligations floating around, governments cannot backstop systemic failure without destabilizing currencies. For conspiracy theorists, this is evidence that the grand plan of the Illuminati/Bilderberg Group/Freemasons is succeeding. Soon there will be a New World Order in which everyone is issued a spandex unitard, uses a common currency and speaks Esperanto.
Note to the return-to-the-gold-standard crowd: the Roman empire debased its precious-metals based currency by lowering % precious metal content to pay for wars/far-flung garrisons/bread & circuses. Ain’t no such thing as a currency that can’t be manipulated/debased to monetize debt.
Back to the hundreds of trillions in notional obligations. Assuming not-Bilderberg and going more Occam’s Razor, screwy executive compensation, greed and stupidity had more to do with it. Why? Because any bank that thought systemic collapse could be adequately backstopped/monetized thought wrong. The fact that individually the greedy pigs lost sight of the big picture implications of what they were doing collectively tells the tale.
IOW, show me the email or memo or phone conversation transcript between TBTF CEOs saying all of this is “nothing that can’t be stabilized with $10 or $20 or $100 trillion in bailout funds.” Didn’t happen. That’s the point.
June 17th, 2009 at 10:47 am
Barry
I want to reiterate past requests/suggestions to have a daily market banter thread so that those who want to (myself included) can do so in a continuous thread and without cluttering up the other threads.
This would serve everybody well; those who want to chat about the market intraday, and those who don’t want to have to sort through it.
Thanks
June 17th, 2009 at 10:55 am
Laws and work-arounds are just cat and mouse. Imagine squeezing a balloon. Every squeeze somewhere makes a different bulge somewhere else. You can’t get rid of the bulges without expending a lot of unproductive effort.
One big problem with the CDS business is that there are no reserve requirements and collateral value may be subjective.
Thr problem is not the mortgage sale business, the problem is the CDS business. If it were properly regulated so that took on the characteristics of regulated insurance, a lot of problems would go away. Costs would be higher up front. But I don’t think the costs being covered now are evidence that the low price up front option is always best or even a good one.
June 17th, 2009 at 10:56 am
Transor Z, you seem to have a lot of faith that humans who are stupid, selfish and evil as individuals somehow become saintly, smart and good as a group when trying to regulate itself. Of course free marketers believe that humans are stupid, selfish and evil, too, they just believe that you most effectively counterbalance one person’s stupidity and selfishness with the other’s.
Who knows? But I do know that cheap money caused the crisis. Regulate all the rest if you wish, but first, quit allowing the Fed to fuck around with the currency everytime there is a whiff of changing prices or output in the air. At least then, the delusions provided by debased currency can be vanquished.
June 17th, 2009 at 11:02 am
Congrats Barry, this sounds like a well-thought-out plan that is simple to implement (for new mortgages and refi’s) and would stop the risky madness in its tracks — at least for those banks who have a shred of self-preservation, and supposing that the gummint would not bail out each and every bank that drove itself into collapse by continuing their former practices.
But back here in the “Real” world, such a scheme would never pass the Congress or be signed into law by the president, because it would be vetoed by their bankster masters.
To paraphrase the Bard, “First, we kill all the banksters”.
June 17th, 2009 at 11:04 am
Tranzor,
***Assuming not-Bilderberg and going more Occam’s Razor, screwy executive compensation, greed and stupidity had more to do with it.***
Yes, which I believe was the point I made to the author.
Since we are in agreement, how is the weather where you are?
June 17th, 2009 at 11:05 am
@ Michael Marin 10:39 am
“it would sharply reduce the amount of securitizations being done”
And that’s a bad thing? How did we ever survive before mortgages were sliced and diced and packaged and re-sold?
June 17th, 2009 at 11:08 am
how about no insurance at all!?!?
i’m surprised no one has mentioned that every product traded in our markets is a securitized version of something. why is no one proposing that investment banks be required to hold 5% of the stock in equity IPO’s that they underwrite? or hold 5% of the bonds they sell for a corporation?!?! why should they hold 5% of MBS/CDO’s etc?
in our capital markets, buyers buy securities from sellers – the middle man is not the one to blame when the buyers fail to adequately assess their risks.
if we want to regulate something, make sure that people can’t buy too much of something with money they don’t have – attack the LEVERAGE!
ps – i blogged about this today
June 17th, 2009 at 11:12 am
Thanks ahab.
Re: CRA
I don’t think the CRA required anyone to lend to anyone (although I could be wrong). I believe it required banks to do business in certain geographic areas. No one ever required a bank to make a loan it thought would not be repaid. If I’m wrong, could someone please point me to the chapter and verse of the CRA that required bad loans be made to unqualified borrowers?
~~~
BR: “The CRA caused it all” is a thoroughly discredited talking point.
I’ve addressed it many times previously.
June 17th, 2009 at 11:17 am
BR: Because it’s related to your views on the matter, you’ll appreciate this excerpt from Arnold Kling’s take on the federal regulation white paper now being finalized by the Obama administration:
The rest is pretty good too – highly recommended.
June 17th, 2009 at 11:25 am
Grumpy – so created the mess of inner city subprime loans that we see. . .
I’m not sure how this makes sense when the subprime mess started in places like Las Vegas, Southern CA, and Florida. None of these places have “inner cities” it’s all suburban. The hardest hit areas like the Central Valley and Inland Empire in CA wouldn’t even qualify as suburbs . . .
June 17th, 2009 at 11:35 am
@TC: I agree, which is why I signed the Grayson bill petition to allow the CBO to audit the Fed.
The concept of regulation here is segregation of duties. Assuming a central bank has some role to play, federal regulators acting under “big picture” policy directives do their thing. Bank CEOs will never be paid to hold hands with their competitors and sing “Kumbaya” to promote the common good. With any industry whose components can do collective damage to the public good you have to have regulatory constraints on what they can/can’t do.
@kstills: I’m glad we agree on some points but you wrote Because greed is the motivator, no regulation will work. That just doesn’t follow and IMO goes overboard in its cynicism/breadth. It’s fallacious reasoning to say that, since regulation is flawed therefore we should have no regulation.
You sounded to me like an Efficient Markets ideologue, which is why I reacted the way I did. I’m sorry if I misunderstood you. But my point is that, since individual banks do not operate from positions of perfect knowledge, saying that the government will never backstop failure doesn’t solve all problems. Banks can still act like morons and cause massive destruction.
June 17th, 2009 at 12:12 pm
The CRA was signed into law in 1977 to prevent banks from redlining neighborhoods.
So some 30 years later it is the cause of the housing debacle?? How convenient….LOL.
I gotta bridge you’re going to love.
It’s a white bridge in an Amish community.
June 17th, 2009 at 12:20 pm
I agree in general with Marcus Aurelius that there is merit to having banks hold onto their loans to maturity. I’d like to hear someone’s explanation, at any rate, for why this is not desirable.
However, I think Marcus A is mistaken in assuming that the CRA doesn’t require banks to actually make loans in the underserved areas in which they are required to set up shop. Banks have developed an entire PR strategy, make hiring decisions and build business models around these legally mandated branches. Wouldn’t it be pretty easy to spot the Potemkin Bank model you seem to be advocating (where there is the shell of an active branch but no actual lending)?
Plus, at the end of the day, we WANT underserved areas to have access to credit and redevelopment potential, don’t we? Or are we just going to wall them off from the more affluent sections of our cities?
Clearly, the model we had in place failed everyone: banks, clients, shareholders, taxpayers–EVERYONE. But can’t anyone think of a way to fix it rather than just make it into a sham program?
June 17th, 2009 at 12:34 pm
Marie Antoinette:
Hi.
Lending is only one function of banking. Checking accounts, savings accounts, Notary Publics, safe deposit boxes, etc., are others. If there is no banking presence in poorer neighborhoods, the population is at the mercy of other financial service providers, such as check-cashing storefronts.
Again: there was never a mandate or requirement in the CRA (or any other law) that any bank lend to any unqualified borrower. Period. While some may interpret the mandate of the CRA differently, I’d like to see anything in the Act that would serve as a realistic basis for such an interpretation.
As Christopher and Thor point out, the subprime mess didn’t start, and does not persist in areas where a banking presence was mandated by the CRA. That argument will become stronger, and the argument against the CRA weaker, as we see resets in Alt-A, Option ARM, and Commercial RE loans and the subsequent financial fallout. Maybe we’ll have to ban banks in wealthy neighborhoods when we start paying for that chicanery.
June 17th, 2009 at 12:42 pm
To piggy-back on Marcus Aurelius’ comment: Large banks (over $1 billion in assets) have been permitted to meet a portion of their CRA requirements through a combination of lending, investment, and services to low-income and inner-city neighborhoods.
June 17th, 2009 at 12:57 pm
[...] A better way to fix the mortgage securitization process. (Big Picture) [...]
June 17th, 2009 at 1:11 pm
If it hadn’t been houses it would have been something else. The problem is treating ANY asset class as simply a way to generate money without considering the actual true value of the asset itself. Why would someone be buying mortgages that were obviously inflated in value? If you had a brain and knew anything about the housing market, you would know it is cyclical and that prices would soon be falling. There were a lot of people pointing this out a couple years before housing peaked, and it should have been obvious within the industry. They thought their hedges and CDS swaps would save them, and didn’t really care about the value or any possible defaults, since they were just treating the mortgages as a package of assets and splitting them out into the ridiculous tranches and playing games with them. The ridiculous loans wouldn’t have been made if someone had just simply said “we’re not buying them, they aren’t worth it.”
When greed gets out of control in any asset class someone is going to take the fall. The real sin is the rest of us being forced into bailing out the financial industry. My trust in the banks has been completely destroyed, and I will never ever deal with one again, at least by choice.
June 17th, 2009 at 2:18 pm
This post is what blogging is all about, a clear-headed, fact-based, simplified-to-the-point-of-understanding-and-no-further writing.
I can’t wait for the hedgehogs to come out with the “…but banks holding onto these products were the cause of their collapse…”
This blog is simply “too GOOD to fail”
June 17th, 2009 at 2:41 pm
Marcus A
“Maybe we’ll have to ban banks in wealthy neighborhoods when we start paying for that chicanery.”
Wouldn’t mind that a bit. I have to walk 2 miles for a decent cup of coffee in my neighborhood but can’t spit without hitting a bank (which I don’t do, since I am a lady).
June 17th, 2009 at 2:49 pm
Does anyone know how long zero down loans have been available in the US?
June 17th, 2009 at 3:39 pm
@kstills:
The biggie was the GI Bill of 1944, which provided guaranteed zero down mortgages for WW II veterans.
Garn-St Germain Act (1982) permitted ARMs.
Notable for not passing: Zero Downpayment Act of 2004, provided FHA guaranties for zero-down mortgages. Oddly enough, was supported by NAR and home builders across the land.
June 17th, 2009 at 4:07 pm
As always the biggest problems originate in counterproductive incentives.
Amazing how often these little “box-diagram leaders” at the top forget the most important step for turning their fancy diagrams into something that works; a top-to-buttom incentive analysis.
grumpyoldvet; kstills:
The institutions subject to CRA did much less of the stupid loans than those mortgage institutions that where not “forced” to make loans to poor people (and that is a documented fact). You can make responsible loans to poor people and irresponsible loans to middle class and rich people. The issue is not how much money the borrower has, it is whether you let people borrow more than they can be expected to pay back.
kstills; By the way you are completey wrong; the only effective counter to the motivator of greed is fear. So you need very upleasant consequences for those who’s greed drive them to do things that have bad consequences for other people or society as a whole. So society needs to make laws (also called regulations) that prohibit such bad behaviour and severly punish those who violate those laws/regulations. Anything over a billon should automatically give you 30 years with a cell-mate called Brian (or Bruce) who is > 6 feet and >250 lb. and although not bright very “sexual”. Funny how those who are not poor think that government “regulation” of “armed self service” at businesses is great and should be kept, but the “regulations” that may prevent them and their middle/upper class friends from robbing others blind “will never work”.
The idea that somehow if there is no backstop of the consequences of taking risk then people will not take risk is absurd and counter to everything we have observed in the last decade. People took huge risks and lost huge sums of money, the fact that a few of them had some of their loss limited by government intervention did not play a role in them taking the risk, because at the time they did, they could not have predicted who the government would come and save from completely loosing everything.
June 18th, 2009 at 9:28 am
[...] Posted by Alexandra on June 18, 2009 What’s wrong with Securitization? [...]
June 18th, 2009 at 1:05 pm
1) Saying that FNM & FRE were working for 70 years without any problems so why would there be a problem now is like saying GM was making profitable cars for a 100 years so why are they BK? It’s an absurd rationale when how companies are run and the rules in which they are run change.
2) Lenders would not have made the loans if they could not resell them so securitization of bad loans was indeed a BIG problem although not the root cause of this entire mess.
The root cause is bankers having an air of infallibility knowing that no matter how badly they screw up Uncle Sam will bail them out at the expense of everyone else. Hopefully this is the thesis of your book otherwise you should have picked a different title.