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September 06, 2006

How Toxic Is Your Mortgage?

Peter Coy

Banking Editor Mara Der Hovanesian wrote the powerful cover story in the current (Sept. 11) issue of BusinessWeek, "How Toxic Is Your Mortgage? Deceptive loans. Phantom profits. And coming soon: A wave of defaults." Several people have mentioned her story in comments on this blog. I invited Mara to write a guest blog entry. Here it is. Feel free to write to Mara by posting your comments below.

I’ve spent the last couple of months talking to a slew of homeowners, real estate attorneys, Realtors, fair-housing pundits, Wall Street bank analysts, mortgage brokers, economists, and bankers. Many are quite sanguine about the health of the American consumer, the long-term outlook for the housing market, and the business of banking.

Not me. I’m worried that while massive job losses have been the prime culprit in former real estate busts, the rising costs of homeownership, along with unprecedented household debt, are enough to tip many Americans and therefore the U.S. economy into the danger zone.

One source of mine, Robert Lacoursiere, who is a specialty finance analyst with Banc of America Securities, tells me that overburdened consumers and overstated real estate prices may be “the tinder for the credit fires that we fear. Never has the U.S. consumer promised so much to support his debts.” Homeowners are expected to extract $170 billion in cash out of the home equity they’ve built up this year. That’s down from last year's record of $244 billion, but it’s still 10 times higher than it was a decade ago. The worst-case scenario is that people are using that money to pay their monthly mortgage bill and stay afloat. States with serious early defaults (eliminating those impacted by Katrina) are not the frothy coastal markets, but include Michigan, Colorado, Alabama, Minnesota and Indiana. People on the front lines dealing with tapped-out consumers are worried. Andy Miofsky, a bankruptcy attorney in Granite, Ill., tells me that more and more of his clients are delinquent in their mortgage payments. “Quite frankly, these people are surviving paycheck to paycheck, credit card to credit card,” he says.

I’m also worried that the Federal Reserve is uncharted waters here. Demand from risk-hungry investors for securities backed by mortgage loans shows no signs of letting up and that means that there’s plenty of cash around to get people into houses they probably can’t afford. The way I see it, the path to equilibrium will require a great deal more pain.

There are those who, like me, believe that an out-of-whack mortgage lending system has contributed to our current ills. Some mortgage bankers have abused standard mortgage products to extend inappropriate levels of debt to tens of thousands of borrowers--from those with pristine credit to those barely scraping by--without regard to their ability to pay. My take on the current housing situation is that we’re dealing with a new style of predatory lending and that it’s impacting middle-class America. (Read our cover story in the Sept. 11 issue to find out who agrees with me, and who doesn’t.)

On some level, the solution is easy: Get back to basics. In the old days, banks held mortgages to maturity. That instilled natural discipline for prudent underwriting, and that made banks beholden to borrowers. Clark Abrahams, strategist of fair banking compliance at SAS, a business intelligence and analytics firm in Cary, N.C., told me recently that “the same old rules of thumb about meeting consumer needs need to be revisited. Banks have to stop thinking short-term profits and think about long-term relationships instead.” Now might be a good time to start.

02:51 PM

Mortgages

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if mortgage lenders went old school and only loaned people what they could afford to pay back, and 'gasp' started requiring downpayments of at least 10% (not a 10% heloc before you even own the property or piggy-back loans) then you would easily see prices collapse by 50% or more in a lot of the bubble markets. there are simply not the incomes out there to support current prices.

so much money has been lent out that will not be able to be paid back (barring massive income inflation or the highly unlikely further rise of home prices to bail people out) that i really don't see how this thing can end in any way that's not ugly.

Posted by: mike at September 6, 2006 03:53 PM

Everyone sees that lending is broke (well everyone thinks its broke but homebuilders and realtors), But the political pressure to keep the status quo is enormous, the NAR is pushing for "affordability" programs (subsidies for homebuyers) instead of fixing the EZ credit problem. The lenders are pushing "affordabilty" loans (Neg arm) as paths to home ownership. And Congress is trying to allow the GSEs to buy those "affordable" loans on the secondary markets so that when the other investors get smart and back away the party wont stop. Heck, Centex is even pushing "Affordability Days" (http://www.affordabilitydays.com) to try to push home sales.

The guise of regular people being able to afford a home is far too great of a political pressure to be stopped I fear. A politician can cater to big business and at the same time say he is helping the voter (doing nothing of the sort ni reality) in one fell swoop. What are the chances they would choose to instead look like they are making homes LESS affordable and go against big business? Zero.

I dont hold out a lot of hope for this situation, I think we will be here in a decade still watching a slow steady death of housing and the American economy.

Posted by: Cal at September 6, 2006 11:16 PM

here's the housing panic manifesto posted last night at http://housingpanic.blogspot.com which speaks to this debt-mortgage-consumer issue:

This may disturb some of you. This may surprise some of you. This may disappoint some of you. But it has to be said.

After denying it for sometime, to you dear reader and even to myself, the truth is now clear. And you should now read this blog in the context of what I am about to say.

I am rooting for an epic housing collapse, a disastrous recession, the collapse of the stock market, a complete replacement of our current partisian leadership, a questioning of our country's current economic model, and a severe and historic financial meltdown.

Period.

Before, I thought just a correction would do the trick. A cleansing of the debt-and-greed-fueled housing balloon we as a society created.

But I've come to the conclusion that will not be enough to right the wrongs and fix the problem, so that future generations will not be burdened with the current generation's misguided and self-centered ways.

Pure and simple, I want Change (with a Capital C), and I now feel that only an historic financial meltdown will create the environment where Americans wake up from their current slumber, and call for new leadership, new thinking, and above all, change.

Something went awry in the US over the past decade. Something changed, with our government, our system, and our collective conscious. And this change was not for the better.

Greed overcame and infected so many of us - the idea of getting rich without working, and an overwhelming need to consume, consume, consume. We no longer worked for the benefit of our common man - we worked only for ourselves. We said "screw the next generation - I want mine, and I want it now!". And we went on a debt-fueled orgy of spending, never stopping to look at the bills coming due, and never stopping to think about the repercussions.

Now, dear reader, it's time to stop. It's time to pause, and consider where we went wrong, and above all, how we can fix it.

So, in conclusion, the fate that awaits us, this cleansing of our ways and of our system, in the form of an epic real estate market and financial collapse, in my simple opinion is a fate of necessity, and will serve as a catalyst for needed Change.

And away we go. Good luck to all of you, and know that I believe that we will come out of this stronger, wiser and determined to Change.

Posted by: jason at September 7, 2006 07:22 AM

Mara,

I agree that our "out of whack" mortgage system has contributed greatly to this problem.

I have been preaching against the "stated income" mortgage for years. I kind of feel like a lone soldier, in the wilderness, speaking to myself.

Let's take California for example. If you use traditional measures of qualification, only 18% of the population can afford the median home.

My industries solution? Stop making people prove their income and let them "state" their income. They know what they are doing...right??? WRONG!

One of the things that controls the price of real estate is the public's ability to afford to buy it! If no one can afford to buy it then the price is certainly not going to go up.

However, when you remove the restriction of having to prove your income and allow people to use "liars loans (state income loans), then you have effectively removed that barrier and up, up and away go prices of real estate.

I have visited Hawaii, California, Florida, and Arizona. I was utterly aghast at the feeding frenzy I was witnessing!

The problem is plain ole' ordinary greed. Some lenders were more interested in short term profits then the long term health of their clients. AND.....as you pointed out, because they were able to sell these loans on Wall Street..they were able to put the liability for these ridiculous loans on to unsuspecting and greedy investors.

I fully expect that portfolio's containing billions of dollars of "stated income" mortgage loans to have very high delinquency problems.

I was recently at a National Mortgage Brokers Leadership Conference in Monterey, California. While there I was speaking to a Mortgage Broker from San Francisco. He said, "If people had to tell the truth about their income, we wouldn't be able to sell any homes in California".

That about sums it all up in my opinion!

Posted by: David Porter at September 7, 2006 10:30 AM

It would be nice if the author had actual statistics to back up her crash scenario. From what I gather from her post, she talked to a bankruptcy lawyer, and one analyst who thought banks needed to focus on relationships. Hardly, what I would consider a representative sample.

Let's address each contention:

Why are foreclosures rising in Michigan and places like Ohio? Lets look at the stats, Detroit is losing jobs according to CES, and Ohio is basically flat. Colorado, has lagged the country in job growth, up until recently. Likewise for Indiana, and I am not sure why they are up in Minnesota, it would be nice to have numbers for that one. I would expect foreclosures to flatten out in Minnesota and Colorado because they are both starting grow. The picture is a lot more complicated than the author and her fellow travellers would like to make it out to be. So, yes jobs are essential to the foreclosure issue, so far the predicted bust isn't happening in the "bubble" markets.

Credit and the Banking System:

And let me ask you another question, what is wrong with deepening credit markets? I think you need to look at things from a different perspective. The author seems to believe it is wrong for people in the lower income strata to be able to afford a home. (that is explicit effect of tightening down payments and various other credit conditions). I tend to believe that the extension of credit, and the diversifying of risk (via MBS) isn't scary, but a good thing for several reasons.

1. It eliminates systemic risk in the banking system, thereby negating the possibility of Japanese style deflationary cycle.

2. It allows the deepening of the credit markets, thereby driving down interest rates, which increaeses affordability. The expansion of available credit has allowed the creation of so-called "exotic" mortgages, which has raised the ability of entry-level and lower income strata people to afford a home.

How is this not a good thing? That would be why, people who actually study the housing market are more sanguine than the author and the housing bubble enthusiasts. The facts simply don't add up.

I would also question the theory of the over-burdened consumer, because the implicit contention is that the American consumer is an idiot. He/she is stupid enough to take on all this debt that he/she can't afford to make payments on. That can be your belief, but one that I and I believe a vast majority of our fellow citizens do not share. This is much more complicated topic, so I will cut my comments there.

Thirdly, and I apologize for the long post, what does the MEW have to do with anything? I am familiar with the storyline that it supports consumer spending, and without we wouldn't be able to purchase anything. Simply put, the facts do not back that contention. The worst-case estimate is that about 11% of spending is predicated on a wealth effect from housing. It is likely to be much smaller. Income, by far and away is the biggest contributor to consumer spending.

Posted by: Nathan at September 7, 2006 02:29 PM

I have a radio program out here in San Diego CA, AM 1700 "Cash1700"

The Program is deisgend to give the listener a real world sense of where the real eatate market is and where it's headed. While no one (including the precious blogger) has a corner on the market as to where we are headed, we do have some clear problems. Responsible lending industry guidelines and yes, government oversight is necessary. We (the lending commnunity) have an obligation to bring more professionalism and integrity to the market.

Short term expectaitons on profits have motivated the lending commmunity to create a barrage of new programs which allow the average borrower to buy more house than they can afford. Short term ARM's and Neg Am loans account for some 70% of all the laons written in California during the last 3 years or so. This will be a problem for many.

Here is the good news: We are at or very near full employment by most economists assesment. People who go to work and own a home are inclined to keep paying the mortgage. I don't agree that we are lazy as a country. While there will be an increse in the number of people on the margin who get into deep trouble, the core of this country are hard working people with character and they will find a way to make it work. While jobs are strong, housing will continue to be a solid investment for many Americans.

Posted by: Radio Rob at September 8, 2006 08:33 AM

Mara,

Great article. If more people read my book, "What Mortgage Brokers Don't want YOU to Know", (available on www.Ripoffreport.com) they would have avoided a lot of these issues you brought up. Your article was GREAT! I got sick and tired of people getting ripped off by mortgage brokers, that is why I wrote the book.

Keep the TRUTH coming,

Sincerely,

Mortgage Advocate Dan

M.A.D.

mortgagefacts@yahoo.com

Posted by: Mortgage Advocate Dan at September 19, 2006 05:23 PM

Toxic Loans for Dummies! Check out this link.

http://www.youtube.com/watch?v=7RTqk1NbKJU

If link doesn't work, go to youtube.com and look for Odd Todd.

Posted by: lizziebeth at September 20, 2006 01:14 PM

In the early 90's we had the RTC bail out the S&L's and lending tightened. We will see a repeat of this in the next few years but on much larger scale.

Posted by: Dave at September 21, 2006 08:59 PM

I was stunned by the feedback you received to this article. I had no idea the gross negligence of my industry. An Option-ARM loan is a tool, and like any tool if used improperly can have negative consequences. However, when a consumer is given superior advise by a trained professional this loan has excellent benefits. The problem is consumers shopping for a lender based upon the best rate, not the best advise.

Posted by: Sean Buchanan at September 22, 2006 02:21 PM

Did anyone see this blog: http://iamfacingforeclosure.com/?

Basically, the boy borrowed 2.2M (of course using Liar Loans) to buy 6 properties in 4 states, can't make ends meet and are facing foreclosure now.

Posted by: smallbean at September 22, 2006 04:50 PM

I don't think the solution to this perceived problem is to increase lending standards. The banking and finance industry has done a good job in finding ways to extend more credit to borrowers while hedging losses through mortgage backed securities.

It's obvious many borrowers with option arms have been squeezed during the past 18 months and there have been unscrupulous mortgage brokers who have placed borrowers in bad loans. If there were more states that required licensing of mortgage brokers, fraud would go down.

The Fed has finally paused its' tightening cycle and many predict it will lower rates in the near term. This will be good for option arm and adjustable HELOC holders and I'm willing to bet we'll see pre-forclosure rates go down and the real estate prices will start to rebound in the spring.

Posted by: Nigel Swaby at September 23, 2006 05:32 PM

Yes, and this is justthe beginning as I see that the median home price statistics came out today and the median price dropped. the bubble has apparently officially burst!

Posted by: Scheryl at September 25, 2006 08:25 PM

As a personal mortgage advisor in the Michigan area, I see first hand many "Toxic" mortgage situations on a daily basis. Who's to blame? It's a combination of poor service from the lending institutions, a lack of due diligence on the part of the consumer (buyers need to ask questions and have a thorough understanding of want they are signing, and an over inflated housing market tied to a weekening economy. Some possible solutions (or improvements); all states need to enact licensing requirements and impose heavy fines/jail times for unethical loan originators, the secondary market which purchases loans need to rethink requirements for interest-only loans, piggy-back loans, no ratio loans, stated income loans, no-income/no-assest (NINA) loans, and the never ending amortization terms such as 40 year terms. Recommendation, if you are currenlty in a "Toxic" loan or are looking to find a new loan, be sure to ask your loan officer for references and make sure you are dealing with a reputable lender. Do your homework- Caveat Emptor!

Posted by: Chris Biernat at October 17, 2006 01:18 PM

Mara,

I have some good friends who have been defrauded by a mortgage broker and a local bank. The Broker is in prison for what he has done and now the bank is trying to foreclose on my friends. The bank thinks that they can just wash their hands of any responsibility for this situation but they had several appraisals done of my friend's properties that were greatly inflated and never conducted income verification or debt to income verification. We feel the bank is partially at fault as a lay person depends on the bank to let them know how much they can afford. Please do contact me and I will tell you more.

Thanks.

Posted by: Darcie at January 12, 2007 01:06 PM

It's time to stop the bad guys. Please visit Radical Title Talk and sign our petition. Make real estate transactions safe again for consumers.

Posted by: Diane Cipa at January 29, 2007 08:53 PM


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