What is the Federal Reserve?  Its the central bank of the United States of America.  What does the Federal Reserve do?  It provides the United States of America with a safe, flexible, monetary and financial system.  How does the Federal Reserve provide the nation . . . → Read More: US Federal Reserve Wins The New Nobel Prize For Comedy]]>

Snapshot of Federal Reserve Website on April 19, 2011

What is the Federal Reserve?  Its the central bank of the United States of America.  What does the Federal Reserve do?  It provides the United States of America with a safe, flexible, monetary and financial system.  How does the Federal Reserve provide the nation with a safe, flexible, monetary and financial system?  In a press release dated April 2011, the Federal Reserve proposed a rule under Regulation Z of the Dodd Frank Act that would require creditors to determine a consumer’s ability to repay a mortgage before making the loan and would establish minimum mortgage underwriting standards

To paraphrase Patrick McEnroe, the Federal Reserve cannot be serious.  I don’t know if President Obama deserved the Nobel Prize for Peace but the Federal Reserve definitely deserves a new Nobel Prize for Comedy.  Can the Federal Reserve get more comical than this?  It is insulting to the people of the United States that public comments are invited over this proposed rule.

Winston Churchill supposedly said about us that, “Americans always do the right thing – after they’ve tried everything else”.  One can hope that Churchill is right.

National Debt Versus Federal Budget Deficit

The national debt is the total accumulated indebtedness of the U.S. government and this stands at 14 trillion.  The federal budget deficit, the difference between what the government spends in a given year and what it takes in stands at 1.5 trillion.  At that level, for every $1 the government spends, it must borrow 43 cents.

US National Debt

Only individuals who itemize deductions can benefit from the Mortgage Interest Deduction (MID), and the value of the deduction increases with the marginal tax rate. If the government wishes to promote home ownership, . . . → Read More: Reduced Mortgage Interest Deduction (MID) coming?]]> Urban Institute’s publication titled, Reforming the Mortgage Interest Deduction by Eric Toder, Margery Austin Turner, Katherine Lim, Liza Getsinger suggests that

Only individuals who itemize deductions can benefit from the Mortgage Interest Deduction (MID), and the value of the deduction increases with the marginal tax rate. If the government wishes to promote home ownership, a refundable tax credit available to all taxpayers would be more effective.

Henry Paulson, former US Treasury Secretary, recommends that

We should go further and reduce the subsidy for home ownership that helped create the crisis.  The central place of home ownership as part of the American dream reflects a bias of our society that is unlikely to simply end.  Policymakers may well decide that we should continue to facilitate lower-cost mortgages through a subsidy to mortgage credit guarantors.  Even so, the scope of the subsidy should be reduced by rationalizing and reducing the missions of the FHA and the successor(s) to Fannie and Freddie.  I would recommend limiting the availability of the subsidy to smaller mortgages or lower-income buyers or both.  And the price the government charges this new private-sector entity for its credit guarantee must be high enough to leave room for a robust private-sector mortgage market that serves taxpayers and homeowners equally. The benefits of a reduced subsidy for home ownership are clear.  But we cannot move toward this model until the housing market is stabilized and housing prices are likely to rise.

Mortgage Interest Deduction

Signature of Solon Golf Community Subdivision

A Signature of Solon resident approached City of Solon Planning Commission and stated that she believes there have been builders in the Signature . . . → Read More: Signature of Solon rental properties cause concern]]> The City of Solon Planning Commission is discussing an ordinance proposal which will require that owners or agents obtain Occupancy Permit for rental units.

Signature of Solon Golf Community Subdivision

A Signature of Solon resident approached City of Solon Planning Commission and stated that she believes there have been builders in the Signature of Solon neighborhood who have built homes and rented them prior to obtaining an occupancy permit.  Additionally, many Signature of Solon model homes were built but not sold and have become rental properties.  Many of these Signature of Solon rental homes are neglected and improperly maintained which is damaging to the Signature of Solon community. This resident was concerned that the appearance of some of the homes will affect overall resale in the Signature of Solon neighborhood.

It appears that due to  the economic downturn, builders and homeowners associated with some  Signature of Solon properties are renting homes out of necessity rather than facing foreclosure.  There have been some foreclosure filings on properties located on Royal Portrush Drive, Capilano Drive, Vahalla Drive, Bellerive Drive, Merion Court, Prairie Dunes Court, Sotograde Court in Signature of Solon.

Foreclosure decreases the property value by 28% (Campbell, John Y., Stefano Giglio, and Parag Pathak. 2009. “Forced Sales and House Prices.” NBER Working Paper 14866).  Some builders are facing property foreclosures because lenders have become conservative by cutting their line of credit.  Common sense lending standards mean that lenders expect builders to have their own skin in the game.

Home-equity loans and lines of credit are second mortgages.  Second mortgages are made after a primary mortgage is in place.  If a homeowner defaults, the proceeds of the home’s sale go first to the lender that holds the primary mortgage.  The second-mortgage holder gets whatever is left after the primary mortgage is satisfied.  Lenders are rightly shying away from secondary mortgages and rental occupancy permits will not loosen the line of credit leash.

Signature of Solon does allow home rentals, however,  a deed restriction stipulates that home must be owner-occupied for the first year to ensure that landscape work and proper maintenance is completed.  However, Signature of Solon does not request the tenant’s name.  Chagrin Highlands subdivision in northeast Solon also has a deed restriction similar to Signature of Solon.

A deed is the legal document that transfers ownership of real estate.  It contains the names of the old and new owners and a legal description of the property etc.  The deed is signed by the property owner.  Deed restrictions place limitations on the use of the property by the property developer.  It is my belief that some property owners may use a bypass  to get around a deed restriction.

The following is the testimony of Patricia Lindsay for the Financial Crisis Inquiry Commission Hearing on April 7, 2010:

Thank you for inviting me to speak this afternoon. My hope for today’s session is that I give you a unique perspective into . . . → Read More: The nature of subprime mortgage lending]]>

Mammon, the God of Subprime Lending

The following is the testimony of Patricia Lindsay for the Financial Crisis Inquiry Commission Hearing on April 7, 2010:

Credit, Collateral, Capacity and Character

Thank you for inviting me to speak this afternoon. My hope for today’s session is that I give you a unique perspective into Subprime lending. I know I was not alone in not understanding the steadily increasing risks taken in the years before my employer New Century Financial Corp. stopped making loans in March of 2007. I grew up in the real estate business where my father was a Broker and a hard money lender. A hard money loan is a short term loan to a borrower who has a significant amount of equity in the property and cannot qualify for a traditional bank loan. I became an Account Executive at Beneficial Mortgage the end of 1996. Beneficial was one of the original subprime lenders who held their loans in their portfolio rather than selling them. There were a lot of similarities between Beneficial and my experience with hard money lending, Beneficial and the various hard money lenders with whom I worked were very aligned in their thought process on how to evaluate a loan. We had three things that we used to evaluate a loan; Credit, Collateral and Capacity. We would look at these three C’s and if any were lacking, like credit, a borrower better have some compensating factors, like great collateral. There was a fourth C, character, that went missing when the loan process became more impersonal and the prospective borrower never met face to face with the lender.

The disapperance of Credit, Collateral and Capacity

I joined New Century Mortgage as a Wholesale underwriter in June of 1997 and left New Century in December of 2007. I was part of a skeleton crew kept on to help unwind the corporation after they filed bankruptcy. I found the lending standards at New Century were much different than the hard money standards I had learned. I really didn’t understand what it meant to securitize a loan, but thought they must have found the secret sauce, so to speak, on how to take already risky borrowers and give them more money than the traditional hard money or portfolio lenders could. I loved my job at New Century, and found my niche growing and developing fraud detection and prevention measures across all of the business channels in the company. New Century provided me with all of the training and tools I wanted and needed in order to be the best asset to the company. I attended numerous seminars, became proficient at my job then began speaking at the seminars and teaching. We talked about the three C’s when I came to New Century and common sense lending. These were terms I stopped hearing in the last few years. There was no longer any common sense, the three C’s had disappeared and the risk was layered rather than offset . The business became volume driven and automated. A broker could get a loan pre-approval in 12 seconds or less with our proprietary system. If we couldn’t close a loan quickly, one of our many competitors would. With this increased speed, I was tasked with finding a way to automate fraud detection. With the support and backing of Executive management, in 2005 I brought in a company who used our known fraud loans to build a predictive analytics tool that ran in tandem with our loan origination system. High risk loans were identified and reviewed by a local risk manager who either cleared them or recommended further action.

The growth and evolution of the subprime mortgage industry

The niche market of subprime lending grew and evolved into huge business when unlimited funding became available through Wall Street via securitizations. Before Wall Street came on to the scene, there were specialty finance lenders, like Beneficial Finance and Beneficial Mortgage, who filled this niche market. They catered to borrowers who could not qualify for a conventional loan because of poor credit, a high debt to income ratio (“DTI”) or other mitigating factors. They would offset their risk by commanding a higher interest rate and providing a lower loan to value (“LTV”) financing. The riskier the borrower (i.e.; unsteady income, poor payment history), the higher the probability of a default, thus the need to offset the risk by reducing the LTV.

The presence and impact of fraud in subprime origination

People who may not have committed fraud before did so by making material misrepresentations to buy a property. The 100% financing products on purchase money transactions provided a vehicle for people to enter into buying a property without putting forth any money. The stated income product eliminated the ability to prove fraud without supporting documentation. When previous products required some supporting documentation in order to get a higher LTV, it was easier to identify the fraud and stop it. Straw buyers were recruited for their credit scores specifically to avoid having to provide income documentation. And they would also claim that the property was to be owner occupied, as 100% financing was not offered on non-owner occupied properties. The numbers that we (at New Century) were seeing and identifying as true fraud loans were a minuscule number compared to the number of loans we were funding every month, so I think the products offered had a bigger impact on losses and defaults than fraud did, at least as far as New Century’s loans. .

The funding of subprime originators through the use of warehouse lines of credit

Many, if not all of New Century’s competitors were only able to operate with the use of warehouse lines of credit. These warehouse lines were provided by large financial institutions, many of which were the same Wall Street investors who would buy our loans. They very helpful in the sense that they made sure we had enough money to close the loans that they were waiting in the wings to buy. It was a very efficient model from a productivity standpoint. New Century had several warehouse lines of credit with many different banks which enabled the funding of 20k+ loans (approximately $5B) per month, at the peak. New Century did not have the liquidity to make these loans without the use of warehouse lines of credit. When New Century’s lines were shut down in March of 2007, business stopped. New Century’s repurchase requests increased significantly as well. There became a need for a new department to be developed  in 2006 to centralize these requests and help my department out. In early 2007, our repurchase process slowed, indicating there may have been a cash flow problem.

The impact of so-called “originate-to-distribute” model for mortgage origination and any concerns with that model

The Definition of a good loan changed from, “One that pays” to “One that can be sold”. The loans were no longer held by portfolio lenders, but sold to investors, most of whom placed them into securities. We had lost the ability to follow and monitor the performance of any loans that we did not hold either on our servicing platform or in a security we had an interest in. We did monitor the performance of the loans to which we had access, but this was not the whole picture. Virtually all of New Century’s loans were sold and or securitized and not held in a Portfolio. .

The quality of underwriting in the years leading up to the financial crisis, including the exceptions to underwriting policies and procedures that I observed

Loose guidelines allowed people to buy homes they couldn’t afford. Loan terms started in the early years, when I came on the New Century in 1997, with the 2/28 ARM (“2/28″), this is a 30 year adjustable rate loan that has a fixed interest rate for the first two years then would go to an adjustable rate, usually adjusting every 6 months until the loan became fully indexed. Later on, somewhere around 2004, the fixed portion of the loan was just interest only and a 40 year term was added into the products being offered, although the 30 year term was still the most widely used. These loose guidelines included 100% financing to borrowers with low credit scores and no supporting proof of income. .

Risk Management practices in subprime origination, including any changes in risk management leading up to the financial crisis

Risk managers at New Century were viewed as a roadblock rather than a resource in many instances. We had Risk Managers placed in production groups all across the country, and they had daily tasks that they were to perform. They would have targeted audits in addition to helping the group with researching any items of concern. Things like brokers on watch, multiple social security numbers for a borrower, or other discrepancies that needed to be clarified. If the risk manager could get to the bottom of the discrepancy and clear it, the file would be stronger because what started off looking like a problem was shown to be an error or whatever the case maybe. The real problems arose when the initial issue may have been cleared, but something else was discovered. One of the biggest changes we made in Risk management was eliminating a document we had called the Purchase Money check list (“PMC”). In the late 90′s we did a post mortem review of failed loans when New Century had taken a loss. An overwhelming number of those loans were purchase money transactions with certain  characteristics. To help mitigate any future losses, we required these transaction be reviewed by the local risk manager an fill out the PMC. During these reviews, many times the risk managers would find other issues that were not part of the PMC. The production groups were constantly complaining that the risk managers were finding other things when they were only suppose to be looking at the PMC. Around the middle to the end of 2005 at one of our Operations meetings it was announced that the PMC would no longer be used and we were “blowing it up”, which received cheers by sales personnel. There was a lot of tension in many of the groups between the risk managers and production. I was called upon to help bridge the gap with a couple of groups. The sales mangers would complain that the risk managers were “killing” their deals and making their account executives anxious. But there were also groups where there was synergy between risk and production, where the risk managers were respected and utilized.

For the most part, there was not an equality between production (front end before the loans close) and the back end. It was clear that the front end ruled because they were bringing in the revenue. The only time the back end, specifically Risk Management had any teeth was when fraud was proven. If fraud was proven, the loan was locked and declined. If there was no physical proof of fraud, it became a business decision whereby the sale managers had the final say whether the loan would proceed or not. .

The compensation and incentive practices for persons involved in originating subprime mortgage

Account executives, who were New Century employees who brought loans in from brokers, were primarily compensated on commission of closed loans that they brought in. I was compensated with salary plus bonus based on company performance with part of that being discretionary based on personal performance. The compensation was significant for the top producing salespeople, some of whom were making several million dollars a year. Many of the sales managers and account executives lacked any real estate or mortgage experience. They were missing the depth of experience necessary to make an informed lending decision. These same sales mangers had the ability to make exceptions to guidelines on loans, which would result in loans closing with these exceptions, at times over the objections of seasoned appraisers, underwriters or risk personnel. Some of the best sales managers had underwriting backgrounds and were more closely aligned with risk management and better at understanding potential problems, but this was the exception and not the rule. . The growth, prevalence, and impact of so-called “exotic” mortgage products such as low documentation and stated income loans, and teaser rate mortgages: • The stated income, high loan to values (“LTV”), coupled with the 2/28, interest only (“IO”) loans impacted the market by making purchasing a home as easy as it has ever been. Property values were climbing due to the easy money and  excessively low interest rates. Any problems, including fraud or defaults were being masked by the rapid housing appreciation. .

The role and practices of appraisers in subprime mortgage origination

Properly valuing a property (one of our three C’s, collateral) is one of the most important components in a loan. In my experience at New Century, fee appraisers hired to go to the properties were often times pressured into coming in “at value”, fearing if they didn’t, they would lose future business and their livelihoods. They would charge the same fees as usual, but would find properties that would help support the needed value rather than finding the best comparables to come up with the most accurate value. Some appraisers would take boards off boarded up windows, to take the needed photos, then board the properties back up once the shots were taken. Or they would omit certain important elements of a property by angling the camera a certain way or zooming close in to make the property look the best possible. This level of appraiser activism compromises their objectivity.

At the end of the day, we had a system that went into a downward spiral because of layering risk rather than offsetting the risk because there was such a huge demand for the products. Our loans were sold before we even made them, which put more pressure on the production groups to get loans closed. Wall Street packaged and sold the Residential Mortgage Backed Securities to unsophisticated bond buyers/ investors. By unsophisticated, I mean they did not understand the true risk of the underlying loan product. The process was so convoluted it was nearly impossible to get a fraud loan pulled out of the entanglement to repurchase it. I actually had a Wall Street investment banker chastise me for trying to buy a fraud loan back. This particular loan was back in 2002 or 2003 when there were hardly any loans coming back from investors. His comment was, ” You want me to pull this one loan out of this security? Do you know what I have to do?” He proceeded to tell me that he had to find another loan to put in its place and asked if I really needed to pull it. To his credit, he did as I asked, pulled the loan and New Century repurchased it. It was at that point that I began to get a taste of the complexity of how securities worked.

The rating agencies improperly rated these securities, deeming them much safer than they actually were. It seems the lending process needs to return to the basics; true risk based pricing and transparency. We have to look at the kind of market we are in, do we have cheap money with increasing housing prices? If so, the loan to value ratios should be reduced to accommodate the increased risk. I just know if I am loaning my personal funds, which I have done on several occasions, I want to ensure I’m protecting my investment. By extension, the same common sense should apply in the marketplace. A return to our core guidance of the three C’s, and offsetting the risk rather than layering it.

It dates back to September 2007, when Cuyahoga County prosecutor, Bill Mason’s office did a press release about four morgage fraud cases in Solon.   These cases involved the following Solon properties:

A real estate player and a naive home buyer

They might tell you that “you don’t need a real estate attorney”.  They might tell you that “its a waste of money” to hire a real estate attorney because the home buying process uses standardized forms.   They might . . . → Read More: Be naive, don’t hire a real estate attorney]]>

A real estate player and a naive home buyer

They might tell you that “you don’t need a real estate attorney”.  They might tell you that “its a waste of money” to hire a real estate attorney because the home buying process uses standardized forms.   They might tell you that its not the practice to hire a real estate attorney in your town, city, area or state.  They might tell you that most people do not hire a real estate attorney.

One or more of the following parties may have a vested interested (they eat from the same trough) in a home buyer, buying a home, any home:

1. The home builder
2. The seller’s real estate agent
3. The buyer’s real estate agent
4. The home seller
5. The buyer’s real estate agent
6. The real estate broker
7. The lender
8. The mortgage broker
9. The home inspector
10. The home insurance business
11. The title company
12. The local home maintenance businesses

A wolf is necessary to keep the fox on the straight and narrow.  A detail oriented real estate attorney is the best deterrence to gray area practices and to represent a home buyer’s best interests.  If the real estate attorney happens to be from the same city in which the home is located and is knowledgeable about the current real estate conditions, even better.  A real estate attorney may explain to the client:

1. Why a quitclaim deed is inferior to the warranty deed
2. If you live in a recourse or an anti-deficiency/non-recourse state
3. The differences between the two party mortgage and the three party deed of trust
4. Whether your state uses mortgage or deed of trust mechanism.
5. The differences between a judicial and non-judicial foreclosure
6. Anti-deficiency clauses, if any, for your state.
7. Why it is disadvantageous for home buyers to use a “standard” Home Purchase Agreement Form

The lender knows the answers to the above issues and the borrower should too.  What could happen if you don’t hire a real estate attorney to face the real estate cartel?    As an example, read about Bonita Bay Group and Bonita Bay Residents-An Issue.  What do you think?  Hiring a real estate attorney is worth the few hundred dollars or not?

A fool and his money are soon parted-Thomas Tusser

The glory of financial innovation

The fundamental lesson of this crisis is that, given the complexity of the division of labor required of modern global economies, we need highly innovative financial systems to assure the proper functioning of those economies.  But while, fortunately, much financial innovation is successful, much is not. . . . → Read More: Mortgage Loans-Home Mortgage Loans-Mortgage Innovation]]>

The glory of financial innovation

The fundamental lesson of this crisis is that, given the complexity of the division of labor required of modern global economies, we need highly innovative financial systems to assure the proper functioning of those economies.  But while, fortunately, much financial innovation is successful, much is not.  And it is not possible in advance to discern the degree of future success of each innovation.  Only adequate capital and collateral can resolve this dilemma.  If capital is adequate, no debt will default and serial contagion will be thwarted. We can legislate prohibitions on the kinds of securitized assets that aggravated the current crisis.  But investors have shown no inclination to continue investing in much of the past decade’s faulty financial innovations, and are unlikely to invest in them in the future. The next pending crisis will no doubt exhibit a plethora of new assets which have unintended toxic characteristics, which no one has heard of before, and which no one can forecast today.  But if capital and collateral are adequate, and enforcement against misrepresentation and fraud is enhanced, losses will be restricted to equity shareholders who seek abnormal returns, but in the process expose themselves to abnormal losses.  Tax payers will not be at risk. Financial institutions will no longer be capable of privatizing profit and socializing losses – Testimony of Alan Greenspan, Financial Inquiry Commission, April 7, 2010

In laws passed between 1996 and 1998, and in what officials believe is the first state law of its kind, Vermont declared that mortgage brokers’ fiduciary responsibility was . . . → Read More: Vermont’s Mortgage Law-Fiduciary Responsibility]]> Gary Fields writes about Vermont’s mortgage laws, in an article dated August 18, 2009 titled,  Vermont Mortgage Laws Shut the Door on Bust — and Boom

In laws passed between 1996 and 1998, and in what officials believe is the first state law of its kind, Vermont declared that mortgage brokers’ fiduciary responsibility was to borrowers, not lenders.  This left Vermont brokers partly on the hook for loans gone sour.

Vermont bankers also typically serviced their own loans, state officials say.  In other states, lenders often sold the loans they originated to investors, giving them little stake in their success or failure.

The concept of fiduciary responsibility does not make common sense.  Why would a mortgage broker have fiduciary responsibility towards the borrower, if source of the money is the lender?  The only party that can represent the borrower’s best interests is the borrower, irrespective of what the laws may state.

Economy and finance, as instruments, can be used badly when those at the helm are motivated by purely selfish ends.  Instruments that are good in themselves can thereby be transformed into harmful ones. But it is man’s darkened reason that produces these consequences, not the instrument per se.  Therefore it is not the instrument that must be called to account, but individuals, their moral conscience and their personal and social responsibility- Encyclical letter caritas in veritate of the supreme pontiff Benedict XVI.