The Federal Reserve last week proposed new rules to go in effect this week that are intended to curb certain abuses of mortgage brokers by limiting broker compensation and increasing transparency in the entire mortgage process.  But as well meaning as the Fed may be, these changes will hurt brokers, won’t homeowners very much, if at all, and may lead to a reduction of competition and therefore higher mortgage costs.

The basic idea behind the new rules is that mortgages and the mortgage process are complex and brokers can take advantage of this to make more profit from the homeowner than originally expected.  So the new rules take two basic actions: 1) they give homeowners three days, instead of the current one day, to look over the final paperwork before closing the loan; and, 2) they require that the final closing documents list all costs within a slim percentage of the original Good Faith Estimate.  Final costs can be LOWER than expected under the new rules, but they aren’t supposed to be HIGHER, thus keeping unscrupulous brokers from shifting unaware homeowners into a different mortgage that makes more money for the broker.  No bait and switch.

While this all looks fine on the surface, it shows a naive lack of understanding of the mortgage business on the part of the Federal Reserve which, after all, hasn’t traditionally touched this sector.

The first problem with these new rules is the likely effect they will have on mortgage rate locks.  When a homeowner “locks” a rate it is typically for up to 30 days, though often less.  If the loan doesn’t close by the time the lock expires, that rate is gone.  Giving homeowners three days instead of one to read the paperwork inserts an almost automatic two day wait in the process without an accompanying two day extension of the lock.  This will increase, perhaps dramatically, the percentage of mortgages that fail to close.  Remember that at this time most mortgages DON’T close (only about 35 percent of loans actually close) and this process will make the condition even worse.

Those who are determined to buy or refinance a home may well be forced by these new rules into multiple cascading Good Faith Estimates that will just increase the complexity, overhead, and cost of their eventual mortgage.

The answer probably isn’t to make the paperwork examination process shorter, however, but to extend the lock, though the Fed is reluctant to do that because of possible financial implications for the lender — implications that would again make mortgages more, not less, expensive.

Extending the process by another two days also makes it more difficult to fairly calculate the Annual Percentage Rate for the loan — that actual cost of borrowing that takes into account all the tiny details including the cost of carrying the loan for those extra two days.  The result of this mandated uncertainty is that APR estimates will tend to go up and loans will look less attractive than they really are.

This latter effect is an artifact of the new rule that penalizes brokers for setting estimated closing costs too low but doesn’t penalize them for setting them too high.  So the result will be estimate inflation when it comes to those closing costs.  Where the broker thinks the appraisal might cost $350 they’ll put $400 just to be safe.  Where the interest payments to carry the loan until the first payment might be $700, maybe $800 or $850 will be used.  And while this seems harmless it isn’t in two respects: 1) inflated numbers tend to be self-justifying (final numbers will rise over time to meet the projected closing budgets), and; 2) all lenders aren’t equally subject to these new rules, as I explain below.  The competitive environment suggests that lenders not required to release as much information under the new rules will either gain more business as a result or — more likely — will increase their own charges to keep pace, therefore making mortgages cost slightly more overall.

None of this might matter if the new rules were broadly successful in accomplishing their true underlying task, which is showing homeowners just how much the broker is making from the loan.  True it gives a little insight into broker fees (while pushing them slightly higher in the process) but it has no such effect on banks that lend directly like a CitiBank, Wells Fargo, or Bank of America.  Nor does it have any impact on correspondent lenders — mortgage companies who fund loans through their own lines of credit then sell them on again within 24 hours generally to those same big banks.

This is because neither of these other two classes of lenders is required, for example, to disclose the size of their Service Release Premium — what they are paid to hand over the loan to a new servicer.  How much are these other lenders — who represent the major of U.S. mortgages — making on loan origination?  There is no way of knowing.

So prices go up, failed closings go up, the big get bigger, and both brokers and homeowners are squeezed.

This is progress?

cringely Blog closing costs, Federal Reserve, Good Faith Estimate, mortgage brokers, mortgages, rule changes

One casualty of the mortgage crisis that we’ve covered here before is the jumbo mortgage — loans over $417,000 in some jurisdictions and over $729,000 in others.  If you are (or were) a millionaire with a big house and a big mortgage, chances are it was a jumbo.  In the mortgage bubble days jumbos generally carried a half-percent interest rate premium over conventional (non-jumbo) loans. Then all heck broke loose and jumbos disappeared entirely only to reappear recently, though after a somewhat different fashion.

Lenders are leaping into the jumbo mortgage business and offering aggressive rates — easily as aggressive as in the bubble days in terms of rate premiums.  But there’s a catch.  The catch is that jumbo mortgages today are a lot harder to qualify for than they used to be.

Want a jumbo loan?  Then be ready to make a 30-40 percent down payment on your new house.  This immediately eliminates refinancing most of the older jumbo loans in California, for example, where more than half of the mortgages were already of jumbo size.  If your jumbo mortgage is underwater don’t expect to be able to refinance — or even to apply for a mortgage modification, since the Obama plan, for example, doesn’t even cover jumbos.

The reason lenders are jumping into jumbo mortgages is because under these terms it is a great business.  Wall Street still won’t touch jumbos for securitization, but that doesn’t matter because the banks are tending to hold these loans in their own portfolios.  And for good reasons: 1) the lenders have plenty of equity down so the properties are worth more than the loans against them; 2) it costs little more to foreclose on a jumbo than on a conventional loan so for the lender the downside is the same while the upside is much larger, and; 3) under current Fed policy the banks are making these 6-percent jumbos with 0.25-percent money — a fantastic spread by historical standards.

So welcome back jumbo.  Too bad most of us can’t qualify.

cringely Blog banks, jumbo mortgages, mortgage crisis, mortgage rates, mortgages

Sales of existing homes in the U.S. rose in April as foreclosure auctions and cheaper prices spurred bargain hunters, butt those who think this signals a market bottom would be wise to also notice that inventories of unsold homes have gone up, portending more price drops to come.

Sales were still down 3.5 percent compared with a year earlier.

Purchases increased 2.9 percent to an annual rate of 4.68 million from 4.55 million in March according to the National Association of Realtors. The median price was down 15 percent from a year earlier, the second-biggest drop on record.

The average price of a U.S. home fell 7.1 percent in the first quarter, slower than the fourth quarter’s 8.3 percent drop that was the largest on record, the Federal Housing Finance Agency said in Washington.

A pick-up in sales may eventually help trim the glut of unsold homes and eventually stem the slump in property values. But the number of houses on the market climbed 8.8 percent to 3.97 million in April. At the current sales pace, it would take 10.2 months to sell those homes, up from 9.6 months in March.

Distressed properties accounted for 45 percent of all existing-home sales, but this was down a bit from March, the NAR report showed. First-time buyers accounted for about 40 percent of April sales, also down from March.

Foreclosure filings in the U.S. rose to a record in April for the second consecutive month, Realtytrac Inc., a seller of foreclosure data, said May 13, as the jobless rate climbed to its highest in more than a quarter century. Foreclosure filings jumped 32 percent from a year earlier, the group said.

Recent increases in mortgage rates have hurt owners looking to lower monthly payments. Mortgage applications declined 14 percent last week, led by a plunge in refinancing, a report today from the Mortgage Bankers Association also showed. Still, the group’s purchase measure rose 1 percent, indicating rates are still low enough to spur sales.

Lower mortgage costs are also helping to make buying more affordable. Rates on 30-year fixed loans fell to 4.78 percent in April, the lowest level since Freddie Mac began keeping records in 1972. Federal Reserve purchases of mortgage securities have contributed to bringing down rates, economists said.

“The housing market is beginning to stabilize,” Fed Chairman Ben S. Bernanke said in congressional testimony on May 5. “We continue to expect economic activity to bottom out, then to turn up later this year.”

cringely News FHA, home sales, housing prices, mortgages, National Association of Realtors, News

Banks don’t like home foreclosures.  Though losing your house is the inevitable result of failing to pay your mortgage that doesn’t mean bankers look on foreclosures as a way to make money.  Just the opposite; they lose money on almost every one.  There are legal costs, administrative costs, the loss of revenue (you’ve stopped paying, remember?), and because the eventual resale is rushed and distressed, the bank often sells for less money overall.  Add to this the fact that homes sit empty for months while the system churns away and there are issues of wear-and-tear or even vandalism.  Banks HATE foreclosures.

So there is a real incentive for lenders to work with homeowners to keep them in their homes through mortgage modifications.  Even though a modified mortgage costs lenders money through reduced payments, the cost is nearly always less than it would be if the property was foreclosed.  It’s simple math: if your lender loses less through modification, then they won’t foreclose.  Or that’s the way it is supposed to be.  Unfortunately there are way more foreclosures than ought logically to happen under these rules.

This happens for two reasons.  Foreclosure is an EXTERNAL process handled mainly by outside lawyers working for the bank and there is always another lawyer.  So foreclosure is a process that SCALES — it can grow or shrink as needed.  Mortgage modification, on the other hand, is an INTERNAL process handled by the lender and there isn’t a lender in America who was prepared for an 8.1 percent default rate.  Many foreclosures are happening simply because the banks don’t have the trained manpower to do anything else.  That’s crazy.

But there is also a reason built into bank accounting rules why we have so many foreclosures and so few mortgage modifications.  If a lender modifies your mortgage the new reality of that arrangement is supposed to be reflected in the bank’s financial statements IMMEDIATELY, while the even greater hit to the bank’s books of a foreclosure only has to be reported EVENTUALLY and often hits a year or more after the event.  Bankers prefer some flexibility in giving bad news so even though foreclosures are worse for everyone in absolute terms, the lender will often opt for a foreclosure anyway.

cringely Blog, Library banks, financial crisis, foreclosure, mortgage modification, mortgage rates, mortgages

Mortgage rates are down, the refi market is booming, equity markets are edging up.  Is the worst over?

No.

House prices are still going down and a huge percentage of sales are short sales or foreclosures.  Millions of homeowners are still underwater and getting more so every day.  And all the while the promised mortgage modification programs aren't yet ready to go.

It isn't enough to just have a policy.  The policy must be implemented.

And now two new events are coming along that may make everyone rethink the sighs of relief we've started to give:

1) The big banks are talking tough about prices they are willing to accept for their toxic assets, figuring the Treasury and Fed will back down and pay more given;

2) The prospect of a major market correction driven by program trading (a replay of 1987).

If the equity markets hiccup the banks figure they can force the Obama Administration into paying closer to face value for those toxic assets, in which case the banks suddenly AREN'T over-leveraged, they pay back their TARP funds and resume being masters of a tighter and even cliquier universe.

We're in for a wild ride over the next 2-3 weeks with little prospect that the federal mortgage modification programs will move any faster as a result.

cringely Pulse LendersME, mortgage modification, mortgages, Pulse

When Barack Obama was running for President one of his favorite sound bites was that any financial bailout should not just involve Wall Street, but Main Street, too – that the government's responsibility was to help both bankers and homeowners. But now that the election is won and Obama is in office, the two streets are still being treated very differently, with Main Street getting a lot less help from Washington.

This is a HOUSING crisis, not a BANKING crisis, yet $700+ billion has gone to help bankers and only $75 billion to “help” homeowners. The banker's money has mainly been spent and the homeowner money has hardly been touched. If this is a HOUSING crisis, why aren't more resources being devoted to housing?

It comes down to an issue of morality, believe it or not, with homeowners expected to be moral and bankers not. Everybody blew it, but the homeowners are being disproportionately punished for their actions.

There is no morality issue in the bank bailout. Banks are having their capital boosted based not on whether they are well run or in some way “deserving,” but purely on the basis of whether they are viewed as being in three groups: 1) doomed; 2) capable of being saved through injecting government funds, or; 3) too big to be allowed to fail no matter how poorly run. This means the least-deserving banks tend to get the most help.

But the Obama Administration's attempt to help mortgage holders is different. If you hope for government help in restructuring your mortgage you'd better not be behind in your payments. If you missed a mortgage payment months into this crisis, you are out of luck. If your mortgage isn't guaranteed by Fannie Mae or Freddie Mac, you are out of luck. If your mortgage is jumbo you are out of luck. And if you owe more than 105 percent of the value of your home you are out of luck.

That's a lot of homeowners out of luck. No wonder the Obama Administration thinks it needs only $75 billion to do the job, it is excluding so many people.

Let's try applying the homeowner rules to the banks. If both played by the same rules, then banks with mortgage portfolios that have dropped by more than about 15 percent (are five percent or more underwater) would be ineligible for government assistance. Banks that MADE jumbo loans would be ineligible for assistance. Banks that made loans with private insurance or no insurance would be ineligible for assistance. Banks that had shown themselves unable to meet capital requirements (had effectively missed a payment) would be ineligible for assistance. In each case, these criteria define EVERY bank that has received assistance. They ALL have mortgage portfolios down in value by 15 percent or more, ALL made jumbo loans, ALL made uninsured loans, and ALL are under capitalized.

So if we apply to banks the same rules that are being applied to homeowners, then no banks deserve support and there should be no bank bailout. Well that can't be, can it? So screw the rules, screw the idea of there being a moral issue with bankers, just start handing out cash without even requiring that they use any of it to make or restructure loans.

So that's what the Treasury and the Fed have done – bailed out the bankers without regard to their past OR FUTURE behavior. And $700+ billion later do we really truly feel better as a result?

Hell no we don't, because we still can't pay our mortgages!

This bailout is broken, it is unfair, and it is incredibly inefficient as a result. The bank bailout is based entirely on providing INCENTIVES to the banks – bribing them to THINK ABOUT doing the right thing. The government won't MAKE the banks do anything. They just ENCOURAGE the banks by giving money.

Where are the incentives in the much smaller housing bailout? There are incentives. THEY ARE ALL BEING GIVEN TO THE BANKS. It is very difficult to find in the new Federal mortgage modification rules much of anything that truly helps homeowners. Banks aren't REQUIRED to do anything; they can reject any mortgage holder for any financial reason. The banks are PAID to restructure the mortgages and the way those mortgages are being restructured (primarily through increasing term and adding balloon payments) not only costs the banks nothing, it tends to make them MORE money over the life of the loan.

So that $75 billion allocated to modifying mortgages and keeping people in their homes, how much of that $75 billion will actually go to homeowners? About 25 percent, or $18 billion almost entirely in first-time buyer tax credits. This means the bank bailout isn't $700+ billion, it is $758+ billion or FORTY-TWO TIMES the size of the housing bailout.

And why only first-time buyers? What makes them more deserving of help? The theory is that these are new homeowners so they'll be buying-up excess inventory and helping to firm prices. They aren't people selling one house to buy another. In another view they are virginal and uncorrupted by the housing bubble. It wasn't their fault, so they are being rewarded. More morality, inequitably applied.

Main Street isn't doing very well under this policy. Main Street is being cheated.

This is a bad plan, unfair and poorly executed. It places a moral burden on individuals and not on banks, yet there is no good explanation for why it has to be so.

What is it about banks that make them deserving of 42 times as much support as your Mom?

Nothing.

Like the Bush Administration before it, the Obama Administration has a bias for helping Wall Street. They couch this as a claimed inability to come up with any better ideas. Yet better ideas – ideas NOT couched in moral argument (or more appropriately couched in EQUAL moral justification) were presented right in this spot in the post titled The Not So Bad Bank. That's a plan that helps banks and homeowners equally, doesn't require incentives to work, acts faster, and costs a tenth as much.

What's wrong with doing the job better, faster, and cheaper?

cringely Blog, Uncategorized bank bail-out, banks, financial crisis, foreclosure, mortgage modification, mortgages, Obama Administration

When is a hedge not a hedge? When it is hedging an Alt-A or Sub-prime mortgage, according to Democrats who are proposing that lenders not be allowed to substantially shift repayment risk from such exotic loans.

The legislation proposed this week in the U.S. House of Representatives would prohibit lenders from “directly or indirectly” hedging or transferring a minimum retained credit risk on most nontraditional mortgages, including some loans that have adjustable interest rates or require little documentation of a borrower’s income. The bill, introduced yesterday, is being sponsored by Representatives Barney Frank of Massachusetts, and Melvin Watt and Brad Miller of North Carolina.

The bill is designed to curb “predatory” lending and encourage the use of traditional 30-year, fixed-rate loans. “The growth of exotic, non-traditional mortgages was a major factor in the current housing and foreclosure crisis,” Frank, Watt and Miller said in a statement.

Alt-A loans were primarily sold to borrowers who wanted atypical terms such as proof-of-income waivers, investment- property collateral or delayed principal repayment, without enough positive compensating attributes. Subprime loans were made to people with poor or limited credit histories.

About 20 percent of Alt-A mortgages securitized with bonds not backed by Fannie Mae, Freddie Mac or the federal government are at least 60 days past due, in foreclosure or already seized. The Alt-A market expanded to $400 billion in 2006 from $55 billion in 2001, according to newsletter Inside Mortgage Finance.
The legislation would make permanent rules that prohibit lending to borrowers who don’t have a “reasonable ability” to repay. It also restricts so-called yield spread premiums, which are upfront commissions paid to mortgage brokers when a loan is closed. The legislation builds on a measure Frank said lacked political support last year to pass.

“We don’t know whether this would work for individual mortgage lenders” that rely on warehouse lines of credit — a form of interim financing — to fund the loans they originate, said Francis Creighton, the chief lobbyist for the Mortgage Bankers Association in Washington. For smaller independent mortgage firms, it may be difficult to repay those credit lines if they cannot sell off 100 percent of the loan, Creighton said.

“The political climate has changed,” Miller said in the statement. “The foreclosure crisis has wreaked havoc on middle- class families and our economy as a whole.”

cringely Government News, News banks, legislation, mortgage crisis, mortgages, News

January 16, 2009 — Fourth quarter mortgage production was down by almost 50 percent from a year earlier at CitiGroup, according to the company. Last year's residential originations were $104.3 billion, down from $163.3 billion in 2007.

Fourth-quarter 2008 production was $16.6 billion, down from $22.0 billion in Q3 and from $32.0 billion a year earlier.

The third-party mortgage servicing portfolio ended the year at $646.6 billion, up slightly from $646.5 billion at the end of September and $599.6 billion at the end of 2007.

CitiBank said it held $197.4 billion in home loans as of Dec. 31, lower than $202.0 billion on Sept. 30 and $218.6 billion a year earlier.

Including loans it owns, Citi serviced $844.0 billion in mortgages at the end of last year, higher than $818.2 billion at the end of 2007.

The 90-day delinquency rate on residential loans was 4.73 percent at the end of December, climbing from 3.85 percent in the third quarter and 2.22 percent 12 months prior.

Citi reported an $18.7 billion loss for 2008 — deteriorating substantially from a $3.6 billion profit in 2007. During just the fourth quarter, the company had an $8.3 billion loss — worse than the $2.8 billion third-quarter loss but better than the $9.8 billion loss in the fourth-quarter 2007. Included in the results were $4.6 billion in subprime net write-downs, $1.3 billion in net Alt-A write-downs and $1.0 billion in commercial real estate write-downs.

The company said it will split into two divisions: Citicorp and Citi Holdings. It expects to close on a joint venture with Morgan Stanley in the second half of this year where it will get a 49 percent stake in the new entity, Morgan Stanley Smith Barney, in exchange for contributing subsidiary Smith Barney.

cringely Lender Updates 2008, CitiBank, CitiCorp, CitiGroup, earnings, Lender Updates, mortgages, newsp, pnews, Q4

We’re a month into the Obama Administration and still looking for a way out of both the banking and housing crises.  TARP didn’t seem to work.  The new housing plan hasn’t been well received, though frankly we don’t have all the details yet.  The good news is that Washington has been asking for suggestions, though without giving out any clear method for submitting them.  So as a blogger I’ll just hold up my hand and say, “Call on me, Mr. Obama, me, me!  I have an answer!”

And I do, or at least I think I do.

You’ll note this is my third try at such an answer since Washington didn’t pick up and run with ideas one or two.  But I’ve got a million of them, folks, so here’s Plan Number Three, called the Not-So-Bad Bank.

It might be good to start with some analysis of why what we've done so far hasn't yet been broadly perceived as working or even enough.  

You could get Rush Limbaugh and his two cousins in a room and even they would say things have not yet started to get better and are probably getting worse.  One reason for this might be that we simply haven't allowed enough time.  That's probably true for results, but not for perception.  Nobody's saying, “Well we've taken care of that one, now what about health care or Social Security?”  Nope, we're still stuck on banking and housing.  It could be we simply haven't done enough — not allocated enough money.  It could be that what we've done so far were the wrong things to do.  All of these possibilities are discussed in the press every day.  What isn't discussed, I think, is that we may have the wrong attitude.

The financial world, especially, has ways of doing things, and the number of approaches they'll generally consider to ending a recession is deliberately limited — limited by what are perceived to be the available tools and limited, too, by how the financial establishment sees itself.  These are proud people who think of themselves as smart and on top of most any situation.  Tom Wolfe called them Masters of the Universe and they like that image.  The problem is that now we're in a situation none of them (or us) have been in before and we (they) are limited by both lack of experience and by the way we see ourselves.  This is why, for example, banks accept Federal bailout money then don't lend it.  It's also why our government gives Federal bailout money then doesn't attach conditions.  That's not what they do.

Well maybe it is time to start doing things a little differently.  It is time to start looking at the fundamental processes of this financial engine in a new way.  That is done all the time for profit, of course.  Every time a new derivative security is announced it is some company's way of grabbing a little errant profit they sense in the market — it is a new way of doing business.  New stuff in that context is considered good.  I just think we need new stuff in EVERY context to track down the causes of our problems and fix them.  Alas, when it comes to that sort of behavior the financial establishment gets a lot less creative.

To this point we as a nation have come up with three ideas about how to help the banks: 1) buy their bad mortgage securities; 2) invest lots of money in them to build their capital bases, and; 3) preserve them at any cost as being too big to fail.  These are perfectly fine ideas, but I think we're limiting ourselves far too much when it comes to exploring how they might work.  We can be smarter and will have to be smarter before the day is over.

My idea involves only the first of those three parts, buying the bad mortgage securities, the so-called “toxic assets.”  I think this is a valid thing to do but by limiting our view of it to how it helps the banks is keeping us from reaping the benefits this process could afford to all of us.

The way most pundits expect the toxic assets to be bought up is through the creation of what’s called a “bad bank.”  The Resolution Trust Corporation (RTC) was our band bank the last time we went through something like this during the 1980s Savings & Loan crisis.  The RTC bought bad assets of those many S&Ls and slowly resold them into the marketplace as houses were sold and mortgages were refinanced.  Though it took 15 years to do so, the RTC eventually got rid of all those toxic assets and even made a small profit, too, by holding those assets effectively to maturity. It was a low-risk process but low reward, too, because it took so long.

That’s the archetype for this next Bad Bank; buy up the toxic assets and dribble them back into the market over time.  The one big issue that’s keeping such a bad bank from being created is deciding what price to put on those toxic assets.  The banks want the government to take all the risk and bear all the cost so they’d like to sell their toxic assets for 100 cents on the dollar, please, which is lunacy since such securities are selling now on the open market (when a buyer can be found) for 15-20 CENTS on the dollar.

If the Obama Administration follows recent tradition, they’ll give the banks a good deal.  This is bad in that the cost will be higher but good in that the Credit Default Swap market will be helped and those costs, at least, will be lower.  So I can see reasons to do it both ways, though frankly I’d like to see these bankers and insurance companies pay a bit for their folly.

The problem with the bad bank scenario is that it does nothing – nothing at all – to help homeowners.  Bad banks just help banks, not people who own houses, which is why I think we need a Not-So-Bad Bank  (a term I just invented) that will help the banks AND homeowners.

Here’s how it works.  The so-called toxic assets bought by the bad bank are, for the most part, bonds called Collateralized Mortgage Obligations or CMOs.  These were created originally by pulling together a huge pile of mortgages about $100 million high and chopping that amount of debt into various classes of principle and interest and risk amounting typically to 4-5 different types of bonds that were sold to institutional investors.  CMOs are types of derivative securities, many of which are protected by Credit Default Swaps (CDS’s), another class of derivative securities sold usually by insurance companies like AIG.  That $135 billion given to AIG to keep it afloat was to cover bad bets of CDS’s, remember, because the CMOs were going down in price, homeowners were defaulting in high numbers, The banks were being forced to mark the asset value of their CMO's to that depressed market value (mark to market)  triggering claims against the CDS's, which turned out to be a VERY bad bet for the insurance companies.

One thing important to remember about CMOs is that, as the banks continually explain, they are so complex and so dispersed that there is no way to put them back together again prior to maturity.  Can’t be done.  And since politicians are particularly stupid when it comes to math (being only able to understand deficits, it seems), they buy this argument, which is supported to some extent by experts at the Treasury and the Federal Reserve who I think, frankly, identify maybe a little too closely with the bankers.

The fact is that Wall Street has all the time had the ability to put those CMOs back together again, just like Dorothy was all along able to return to Kansas by simply clicking her heels.  Computers are very good at keeping track of deals like CMOs and they have to because – contrary to what the bankers and brokers tell us — CMO's are put back together again all the time. This happens every time a mortgage is retired either through the sale of a house or a refinancing.

CMO's were invented in 1973.  That date stems from the arrival of several market conditions, one of which was having the available technology to both create CMO's — to tear apart and securitize the mortgage pools — AND TO KEEP TRACK OF ALL THE DISPERSED BITS FOR REPAYMENT.  If we could do it in 1973 we can do it EASILY today and the fact that we are continually told that it is difficult or impossible probably represents either ignorance, institutional inertia, or someone not really wanting to try. 

Think about it: you've sold your house, the mortgage is gone (repaid), so the CMO, which is where the mortgage debt obligation actually lies, has to have been repaid, too — every little bitty piece of it, held in different proportions by at least four different bondholders. And as long as there have been CMOs it has been thus.

The funny part is that what is supposed to be impossible happens so easily and so often.  A typical CMO deal involves about 10,000 mortgages, the bank knows the shelf life of those loans is three years, which means they get paid off or adjusted after the first year at about 5,000 loans-per-year or around 15 loans-per-day.

So the CMO that was so dense as to be indecipherable is actually deciphered 15 times per day after the first year.

It takes time and effort on the part of mortgage servicers to figure out CMO's and it costs them money.  That’s one reason why they want a pre-payment penalty if you pay off your mortgage in the first year. 

Understanding all this, let’s now go ahead and fix the system by first figuring out how to price the government purchase of those CMO's.

If President Obama wants to be a good guy, which he will if he’s planning on having a second term, he’ll come up with some plan that doesn’t hurt the banks too much, doesn’t hurt the insurance companies too much, oh and by the way maybe even helps homeowners.  That smooth move would be to create a Not-So-Bad Bank (NSBB).

This has to be done by Congress passing a law creating the bank and giving the bank certain privileges and responsibilities, one of which is the ability to buy-up CMOs, not one bond coupon at a time, but as entire offerings, which would be recaptured and redeemed en masse.  Congress can require this by passing a law, but of course the issue is still what price to offer for those typical $100 million (at issuance) CMO deals.  The banks want the price to be $100 million.  The free market says the CMOs are worth maybe $20 million.  Let’s split the difference and have the NSBB pay $60 million.

This price accomplishes three important things.  First, it finally sets a price so the secondary CMO market can get moving again.  The price is set is high enough that though CMO investors lose something they don’t lose everything.  It’s high enough, too, that insurance companies don’t have to pay so much to cover those CDS’s.  Everyone hurts a bit but nobody dies.

Now we have an entire CMO offering held by the NSBB at a value of $60 million.  This type of transaction would be done over and over again, buying-up deal after deal, though it wouldn’t have to be done for all CMOs because the secondary market would have been unfrozen through this government action and private trading of CMOs resumed with a noticeable firming of house prices as a result. 

Let’s assume that the NSBB uses $50 billion or more tax dollars to buy-up CMOs at 60 cents on the dollar, which reflects less the market value of the securities and more the market value of the underlying assets or collateral, the homes.

With a normal bad bank now would begin the painfully slow process of waiting for people to sell their houses or refinance so the government can get paid back and eventually even make a profit on its $50 billion investment.  Remember this process took the RTC about 15 years to complete.

But we don’t have a bad bank, we have the Not-So-Bad-Bank, which operates differently.  Relying on another clause in the law passed to establish the NSBB, the bank has the right to call all the mortgage loans connected to its CMO portfolio, to force them to be refinanced all at the same time.  No waiting for people to sell their homes or refinance on their schedule, in this case the government says to do it NOW.

Using as an example this one CMO deal for 10,000 mortgages, that would mean 10,000 refinancings all at the same time.  Is that bad or good?

Well it turns out to be very good for at least a couple reasons.  There’s an opportunity here for economies of scale and for mortgage arbitrage. Doing the numbers we can see that the NSBB owns the CMO deal for $60 million or 60 cents on the dollar.  So the NSBB turns around and forces all the homeowners to refinance at 70 cents on the dollar, the difference between those two numbers being the NSBB’s gross profit or about 13 percent.

We’ve already given the banks and insurance companies a survivable level of pain by redeeming the CMOs at 60 cents.  Now we give the homeowners a break, too, by forcing them to refinance at 70 cents.  If they owed $100,000 on their old mortgage, on the new one they’ll only owe $70,000.  Most loans that were under water will be dragged to dry ground by this action because it affects only the loan balance, NOT the value of the house.  People will owe less, their houses will be worth the same or more, so their equity — which may have been negative — will now suddenly be positive, making it easier to qualify for Fannie, Fredd, Gennie, VA, or FHA refinance loans.  And because those loan balances are all 30 percent lower the payments will be 30 percent lower, too, making the homes more affordable to own. That's homeowner relief.

Lower payments and higher equity will lead to lower default rates, avoiding the current mortgage restructuring problems that appear not to improve default rates at all.

The best part about this process from the standpoint of the NSBB is that those mortgages can be then resold in the secondary market or aggregated by outfits like Fannie Mae or Freddie Mac, freeing up the NSBB capital to be reused immediately to buy and retire more CMOs and refinance more mortgages.

Running on a 90 day buy-call-refinance cycle, the NSBB could reuse its capital four times per year and within a couple years (not 15) be out of business, having shown a substantial profit that would go back into the Treasury.    

The Not-So-Bad-Bank would work better than a Bad Bank.  It costs less money, helps firm house prices, gives relief to homeowners, and tempers the distress of banks and insurance companies.

Why not give it a try, Mr. Obama?

cringely Blog banking crisis, Blog, cds, cms, Cringely, economic policy, financial crisis, mortgages, Obama Administration

This is the first of a zillion-part thread on how the heck we got into this financial mess in the first place.  With reader feedback and a lot more reading I'm sure I'll get close to the real reason, but you have to start somewhere, why not here?

My young and lovely wife, showing what might be overoptimism or maybe artful timing given the economy but more likely just general disappointment with me, has decided to embark on a career in real estate sales. She has taken classes and passed tests, joined one of the very best local firms, and hurled herself into the business of selling historic Charleston homes while they still have some value and the termites haven't finished their work. And along the way, while mastering the Multiple Listing Service, she learned an important fact that was news to us both: people no longer find houses for sale by looking in the local newspaper. They use the Internet, instead.

The irony here is that — at least in these parts — the local paper seems chock-full of real estate ads. But according to her teachers down at the MLS university, those listings are simply vestigial, like little toes we all have but probably don't need for balance or, indeed, for anything at all. Real estate brokers put ads in local newspapers because their customers expect them to do so, not because they actually help sell houses.

I'm sure there are exceptions to this rule, but if 80 percent of all houses for sale in the U.S. are eventually sold NOT because of any newspaper listing, tradition or professional pride aside, at some point we can expect real estate newspaper advertising to eventually disappear. Chock up more bad karma for the newspaper industry, where this fact has to have been long known, and which is apparently in even worse trouble than we thought.

But this post isn't about the newspaper industry or even about the real estate industry. It is about the lack of friction in our commercial lives brought about by the Internet and an emerging thought in my mind that maybe it is time we as a people took action to change some things.

Let me explain.

It's not that newspaper ads work so poorly for selling real estate, it's that Internet advertising works so well. You can put more words on a web ad than you could ever put in the newspaper for the same money. You can put more and bigger pictures, virtual tours, Google maps. You can put Zillow virtual appraisals and links to lenders, home inspectors, and the local Chamber of Commerce. Internet house listings can be searched in a zillion ways that newspaper listings cannot. In the time it takes to find a house — any house, maybe even the wrong house — in the newspaper and then go see it, well in that amount of time using the Internet you can find the house, order an inspection, get a loan, and make an offer on the darned thing. It's like crossing house-hunting with air hockey.

But is it all good?

Don't tell George W. Bush, but we are in a recession, which is making me look more critically at the Internet as a marketplace. There's a lot of good about the Internet market, of course. Auction sites like eBay help us get rid of our junk and then help us replace it with new junk. The web has made comparison-shopping for houses and cars and disposable diapers almost a contact sport. And we're sure as heck better equipped than we were before to claim all that money that's been waiting for us with some bank manager in Nigeria.

Just as an aside, I know a guy from Japan who actually went to Nigeria once to pick up some of that unclaimed money. It didn't exist and he felt lucky to get home at all.

The theme of disintermediation — of eliminating middlemen — has been a driving force in the Internet for as long as commerce has been allowed on the web. But what happens when the middleman you just eliminated had as one of his or her jobs the task of keeping us from being ripped off?

Tasks that are harder to accomplish are also less likely to be foolishly accomplished, which is why so few of us make trips to Nigeria.

That's not the way we are supposed to view things, of course. Ideally the Internet as a research tool is supposed to give us all the information we need in order to resist any allure the Internet has as a tool of fraud or misadventure. But this attitude ignores many of the fundamental forces at work in most sales situations where the simple fact is that we want to buy, the seller wants to sell, and so any countervailing forces are purely voluntary, which is to say often nonexistent.

Take our current national economic mess, the so-called sub-prime mortgage crisis. I like to think that I'm not a subprime kind of guy, but pretending to work as I do (my kids think I TYPE for a living) the world may not always see me the way I would like to be seen. So last year, in what we didn't know were the waning and idyllic pre-subprime days, I tried to get a new mortgage. Of course I used the Internet to get the loan because, as we all know, when banks compete I win. And within a few days, without having to actually meet with or even speak to another human, I found myself offered a $336,000 mortgage.

It was SO easy. Fill out a few online forms, make some choices, and there I was, about to close that loan. But then I did an odd thing. I carefully read the papers I was about to sign (I'm one of THOSE people). And in that residential loan application, right on line something or other, was a number that didn't make any sense to me at all. It was labeled “total household income” and was almost twice the pitiful amount I actually earn.

From where did that number come? It certainly never came from me. Since my signature would be at the bottom of this application I wanted to make sure everything was correct, so I called the mortgage broker. For the first time we spoke. She was a very nice lady, too, and explained that number was the variable required for all the ratios to be correct so I could qualify for the loan.

“But it isn't true,” I said.

“Do you want the loan or not?” she asked.

Not.

I wasn't so principled as cowardly, but maybe that doesn't matter: I did what I knew was the right thing for me, which was to walk away from the loan. But evidently a lot of other people took the other course and today are having trouble paying for their houses, which is a big part of the reason why we are in this current economic mess.

This little drama of mine explains the credit crunch better than Federal Reserve chairman Ben Bernanke ever would. Securitization of mortgages works just fine unless the mortgages are based on lies. Lenders turned a blind eye to bad loans and bad loan candidates because another company assumed the risk by bundling these loans and reselling them on a global market.

What has caused the credit problems to extend beyond subprime borrowers to just about everyone is the simple fact that lenders can't act so sloppily now, but having turned that blind eye for so many years they have no idea who is telling the truth anymore. So they don't trust anyone.

And that brings me back to transparency and disintermediation and why the heck the Internet, which was very involved in enabling a lot of this bad behavior, didn't do even the smallest thing to help save us from ourselves?

I suppose it was because there is no money in virtue, no easily measurable value in NOT having those banks compete so I could win only to eventually lose.

Do these loan referral outfits like LendingTree and LowerMyBills and the many, many others EVER say, “Wait a minute, pardner, there's no way you can qualify for any loan, much less that no-doc super-jumbo you have your eye on?”

No.

In their defense, these companies are never actually faced with that question, which is ultimately asked not of them but of their customers, the lenders, and we know how much self-restraint those people have: almost none.

Here's why I bring this up. It is clear to me that government (ANY government, not just the U.S. federal government) and Wall Street have no idea whatsoever how to handle the current crisis. They are just trying to look busy while protecting their own interests and allowing those affected to muddle our way through this mess to some kind of solution. It's not that they don't want to be helpful (if the cost of being helpful is low enough) but that they simply don't know HOW to be helpful. They can't be educated and they can't be changed. Certainly they wouldn't consider any course that would curtail government authority or commercial opportunity.

So I figure we're on our own. And if we are really, truly on our own, we shouldn't pretend that we're not, that some agency that doesn't know its IP address from a hole in the ground will take care of us and make this all better. If we're on our own we should solve our own problems using the tools at our disposal. Which brings me back to the Internet, where it ought to be possible for a change to use all that transparency and economic friction reduction to actually do something FOR us, rather than something TO us.

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