Monday, February 28, 2011
Last week I looked at various aspects of the new Federal Reserve Rule regulating loan officer compensation and I wrote about two of reasons that I believe that the independent mortgage broker will not survive the rule, which is being implemented April 1, 2011. Today, I am concluding my three part series on this issue with the final reason that I believe that the new Federal Reserve Rule on loan originator compensation will be the death of the independent loan originator.
Reason # 3--the new Federal Reserve rule governing loan origination is unrealistic and does not consider real world market realities. For instance, to be in compliance with the Safe Harbor provisions of the rule, a loan originator must provide a consumer with loan options from which to choose--these options should include the loan with the lowest interest rate and the loan with the lowest costs and fees. A loan originator working for a depository bank might meet this requirement by showing the consumer the comparative costs of a 15 year loan, and a 30 year loan, as well as a loan with or without discount points. Since the originator works for the institution making the loan, his administrative costs are always the same. Only an originator who is salaried by his employer can receive any compensation from the consumer, so his estimate might show a 1% origination fee, and $700 in administrative and underwriting costs. He could also show an estimate with a 1% discount which raises the upfront fees but lowers the interest rate. And he could show the consumer what the payment will be on a 15 year loan which would bear a lower interest rate
The independent originator (mortgage broker) must also meet the safe harbor provisions by allowing the consumer to "shop" for the lowest interest rates and fees, but because he offers more than one lender he must allow the consumer choices from among the lenders he represents. And under the Federal Reserve's recently clarified rules, the consumer cannot pay any part of the originator's fees unless the originator is salaried or is a sole proprietorship. Since all of the originator's fee is paid by the lender and the fee is not negotiable from transaction to transaction, the lender will price the originator's compensation directly into the interest rate. But, of course, interest rates will continue to vary a little among lenders daily, so Lender A may offer an interest rate that is slightly less than the rate offered by Lender B, but Lender B might have lower administrative fees. The originator will also want to quote a rate with and without discount points.
Once the consumer chooses the particular combination of interest rate and fees that he wants, the originator and the consumer both sign a statement affirming that the consumer has received the loan product that he wants, and then the loan is sent to underwriting.
While this type of a system might sound good to somebody who has never originated a loan, in real life it is ridiculous. What if the consumer chooses the costs and fees from Lender B because they are the cheapest and the originator sends the file in? The originator has underwritten the income (which includes recurring income such as interest and capital gains) and is certain that her figures are accurate. However, the Lender B underwriter disagrees. The underwriter will not allow the capital gains to be used as income because although there is a two year history of receiving them, the amounts vary widely from year to year so even when taking the most conservative figure, the underwriter does not believe that they should be counted as income, so she denies the loan. (This actually happened to me last summer.)
Like any good originator, our loan officer knows that one man's junk is another man's treasure and although the underwriter at Lender B will not do this loan, the underwriter at Lender A is more open-minded. The problem is that she sold the borrower on the lower costs and fees of Lender B, and the borrower signed a statement that this was the loan they wanted. Since the 2010 Good Faith Estimate does not allow redisclosure for changing lenders, and since origination fees can never increase once the original estimate is issued, the loan officer cannot resubmit the loan. She has to decline the loan and the consumer has to go elsewhere in search of financing.
And this is the basic problem with the new rule: In real life borrowers usually don't get the financing they really want; they get the financing they can qualify for. If we all got the mortgage loans we want, we would all have low interest rate, low fee loans and many of us would be in 15 year mortgages, but we know from experience that real life usually does not present us with an ideal situation. Very few of us actually have our dream job, or our dream house, or our dream car, or even our dream mortgage.
Mortgage brokers had a competitive advantage in the market place because when a loan was denied with one lender they could change directions and send the loan out elsewhere to a lender who would actually close it. Even with the new GFE last year, as long as we quoted our estimates so that we always reflected the fees of the most expensive lender we used, we could shop our loans around within the perimeters we had set. The new compensation rule is going make it impossible to make any corrections, and that is going to cause a lot of loan fallout.
Of course, the originator at the bank will also have fallout, but the bank originator has a steady stream of new applications coming in, while the small independent broker does not. That is another reason that a high close ratio is so important, both reputationally and financially to the independent broker. Independent originators do not have big budgets for marketing--their primary source of business is word of mouth referrrals from satisfied customers. And though they may not see a lot of traffic through their doors, as long as they close a high percentage of the business that they do write up, they can have a steady stream of income.
I want to finish this segment up with an illustration that I used last year when the Fed Rule was first published. I have updated it to reflect the information we have today.
Originator A works for Mega Bank. Mega Bank gives him a salary, a desk, a telephone, a receptionist, office equipment and coffee. Mega Bank does millions of dollars of advertising every year, so Originator A's job is to write the loan applications driven in by the advertising. Mega Bank provides Originator A with a rate sheet every morning showing the interest rates and the factors that cause those rates to adjust including credit score and credit worthiness. Mega Bank has one set of fees totalling $850.00 and their computers are preprogrammed to show this combination of fees on their good faith estimates. Under the Fed Rule clarification, because Originator A receives a salary, he can charge an origination fee on his good faith estimate.
Now, Originator B works for himself. He has been an independent mortgage broker for 15 years. Each day he receives multiple rates from multiple lenders. He does not consolidate these into one sheet. He knows that Lender X will close certain borrowers more easily than Lender Y. Lender Y is offering him a pricing special of additional yield spread premium to earn his business, and even though he now has to credit that to the consumer, he can use that pricing incentive to offer a lower interest rate to consumers who qualify which helps him to woo business when he competes against Mega Bank.
Originator B does not get a salary from anyone. He has to pay for his office space, his computers, his phone lines, his Fed Ex bill. Unlike Originator A, he does not have potential borrowers coming in and out all day long, so he has to pay for whatever advertising he does to bring business in. He has to pay for memberships to organizations that might allow him to network and make contacts. He has to pay any employees who work for him. And unlike Originator A, he has to pay self-employment taxes.
Under the new rule, Originator B cannot receive compensation from the lender if he receives it from the borrower also. Since Originator B is a sole proprietor, he can choose to have the borrower pay him or he can be paid according to his contract with the lender. But he cannot negotiate his compensation contract with the lender on a per transaction basis, so if he chooses to offer the lower upfront costs which are result of being paid by the lender, he may lose the deal to Mega Bank because his interest rate is now too high to be competitive. If he chooses to be paid by the consumer, he is basically going to be limited to a 1% origination fee, since that is probably the most his borrower is going to be willing to pay.
Originator B used to be able to compete effectively because the lenders he sold to did not have to pay the cost of office space, or phone lines, or Fed Ex bills, for the areas where they had mortgage brokers, so they could offer him a better rate than Mega Bank and he could pass that rate on to his customers. And, he made a nice living off of the spread on the money, which the consumer did not have to write a check for at closing. The consumer got a low rate, and Originator B got a good payday. But now, with the new rules in place, Originator B will have to be able to prove that for every customer who walked in the door, he offered the best rate and the lowest cost loan based on all of the lenders he works with at any given time. That is virtually impossible to do, because it involves checking every lender for rates and costs without regard to other factors such as timeliness in underwriting or ability to underwrite a particular loan product.
But even if Originator B could pass this litmus test, which he cannot, he is going to realistically be getting paid 1% of the loan amount whenever he chooses to be paid by the consumer. And from that sum, he is going to have to pay the office rent bill, the phone bill, the utilities, the Fed Ex, the employee and the taxes. With whatever is left he might be able to buy some food and pay his own mortgage--maybe. So Originator B is out of the game. If his lenders turns down the loan, he cannot turn around and send it to a lender who will pay him directly because he cannot change his good faith estimate. If he is being paid by the lender directly, he cannot contribute any funds to correct any fee mistakes at closing. He cannot pay for a lock extension, or cover the cost of a survey. A correction that might have cost him $50.00 or $100.00 in fee reductions previously will now cost him his entire commission because his loans will not close. The loans that he cannot save will come to represent missed payments on the rent and utilities and maybe even his own home and car until he has finally drowned in an ocean of regulation so vast that he simply cannot comply with all of it.
Who is the real loser in all of this? All of us. We hear new statistics daily that we are in the middle of a "jobless recovery" and that housing remains "flat." But no one seems to consider that the recovery remains jobless because small entrepreneurs can no longer make a living in industries where they have spent their professional lives--much less employ others. And real estate remains "flat" because borrowers cannot qualify for loans.
The ultimate extinction of the mortgage broker does not come without a cost. The reason that 65% of mortgage loans were done by brokers in 2006 was that we offered personal service and flexibility which are largely missing in an on line or institutional experience. The fact that the broker was a self-employed commissioned person who had bills to pay and got paid only if the loan closed gave him or her an incentive to really go the extra mile for the borrower. A salaried employee of a huge bank is not going to have that same incentive. Nor are they going to offer the option of moving a problem loan to a different lender while keeping it in house--something which can save a borrower hours of time and legwork. "Leveling the playing field" by making it impossible for all originators to shop loans from lender to lender is not the solution to the deadness of the housing market.
People may not think so today, but they're going to miss us when we're gone.
For related posts, go to http://www.frontier2000.net/
Wednesday, February 23, 2011
Yesterday I started the first of a three part series about the top three reasons that the new Fed Rule on loan originator compensation, being implemented for all applications received by lenders after April 1, 2011, will ultimately kill the independent mortgage brokers. I talked about the first reason--the anti-competitive nature of the rule which favors banks heavily against small origination companies.
Today I want to talk about the second reason that that rule will kill brokers. Reason # 2 that the mortgage broker will not survive the rule is that the rule is incomprehensible. Although there have been multiple requests for clarification about the Federal Reserve's new rule, those requests have been largely ignored. So as a result, in about five weeks the mortgage industry will be attempting to implement a sweeping new rule that it does not fully understand.
The areas of confusion were very apparent yesterday in a conference call hosted by one of my investors. For example, nearly everyone seems to agree that consumer-paid compensation offers the most flexibility for the originator and the most options for creating flexible pricing. In a sale, the seller can contribute to the buyer's closing costs--sometimes up to 6% of the costs, which can include paying the originator's fee in a consumer-paid transaction. However, in the case of lender-paid compensation, the seller cannot pay the originator's fee, because it is being paid by the lender. But, since the Federal Reserve announced last week that brokers must salary their loan officers--or as some companies interpret the rule be a sole proprietor--consumer-paid compensation will not be an option for many small broker shops.
A second area of confusion is going to occur in how to quote interest rates. The originator can still quote above par pricing for the interest rate, but in the case of consumer-based compensation he cannot be paid on it. In the case of lender-paid compensation, the originator can be paid only the percentage that has been agreed upon between the mortgage company and the lender. So in a real life pricing scenario, if the lender and the broker have agreed that the broker will be paid 2% on each transaction, the above par pricing is 2.5% after all adjustments, the extra .5% goes to pay for the borrower's closing costs. Right now, all of the premium is credited toward the closing costs, but the origination fee can vary based on the terms of the loan. In the new world of compliance with the Fed Rule the loan officer's compensation cannot vary from transaction to transaction. So what happens to the extra money? Normally it would go to the consumer, but what if the seller is paying all third party closing costs? (In a case like this the seller contribution would have to be reduced so that the premium could cover the balance of the closing costs.)
Additionally, the lender-paid compensation packages will include dollar amount caps with lenders. So even though the originator has an agreement with the lender to receive 2% on each transaction, if his contract has a $6000.00 cap, on a $417,000 loan he would receive only $6000.00. The difference between the 2% and the $6000.00 will be credited to the borrower or else the originator will need to select a lower interest rate.
With interest rates on the rise and fees that affect the interest rate also rising, I do not see pricing the loans with additional premium pricing to be credited toward the borrower becoming a big issue. As I discussed yesterday, I believe that the likelier outcome is that broker interest rates are going to be higher than bank interest rates on the same transaction. This will create a very different dynamic in the lending world, since traditionally brokers offer lower interest rates than banks which has historically made them a more attractive option for the consumer.
One major change in the new truth in lending rule is that all compensation will become part of the APR, so the lender's compensation to the broker will be included in APR charges. As a broker community, we have argued consistently that the spread on the interest which paid to us by the lender is calculated as part of the interest rate so it is included in the APR now. However, up until last year, the compensation that we received from the lender did not show up on the good faith estimate. Beginning in 2010, RESPA required that we show the total amount of the compensation we plan to receive on the transaction on the good faith estimate and then we credit the amount paid by the lender back to the borrower. So the bank's estimate with one percent origination fee is going to offer a lower APR than the lender paid transaction with a 1.5% or 2% fee paid by the lender. Both the interest rate and the APR will be higher on the brokered deal.
Under the Federal Reserve's new rule, however, the originator cannot be paid by both the borrower and the lender, but even if he is being paid solely by the lender, he must show the amount of the compensation on the good faith estimate. The dollar amount of the compensation is not shown as an origination fee or a processing fee, because in a lender-paid compensation environment, the broker cannot receive origination or processing fees. But the fee is shown on page 2 of the good faith estimate. This is going to cause a lot of confusion for the borrower.
Last year, when HUD changed the good faith estimate from a one page form which included the borrower's funds to close and total estimated monthly payment to a three page form which does not show total funds to close or the total monthly payment, borrowers became very confused. I used to be able to prepare a good faith estimate in 15 minutes while my borrower waited at application. Now, I email them an estimate after loan application to give myself time to double check all numbers. But even with my notes clarifying their monthly payment and funds to close and explaining that the owner's title policy is going to be paid by the seller as spelled out in their contract, borrowers are still confused.
Imagine the level of confusion two months from now when the interest rate is a lot higher than the rate would normally be, and the percentage of compensation that we are receiving from the lender is on the good faith estimate, but the fee is not negotiable. Isn't the purpose of showing the borrower how much the originator is getting paid on the transaction so that the borrower can negotiate for better terms? But in the case of the broker who is receiving lender-paid compensation, the borrower on a $250,000 loan whose originator is receiving 2% in lender-paid compensation will come to understand that the originator is making $5000.00 on a transaction and cannot even pay the lock extension fees--even if the delays are the perceived fault of the originator. Talk about an exercise in frustration!
Some lenders are offering to allow brokers the flexibility to select consumer-paid or lender-paid compensation at the time that the transaction is registered. I do not believe that this practice will stand up to scrutiny since my own understanding of the new rule is that originators are supposed to have written agreements regarding their particular manner of compensation which stay in place for a period of time--probably quarterly. But suppose the lenders do continue to allow originators to choose between borrower- paid and lender-paid compensation at the time of the loan registration. A broker will have to present choices to the borrower for consumer- or lender-paid compensation at the time of loan application as part of presenting loan options. (I will discuss the hazards of this for the broker tomorrow.) Then the broker issues a good faith estimate to the borrower which is a binding contract on the broker's part. Remember that under the current RESPA reform rules, a new good faith estimate can be issued only in the case of a valid changed circumstance, and changing lenders does not qualify as a changed circumstance. Further, the loan originator's compensation cannot increase from the original amount quoted, unless the loan amount increases. So if the originator sells the borrower on lender-paid compensation, but then that investor turns down the loan, what is the originator to do? He cannot go back and redisclose a new good faith estimate with a different compensation plan, so all he can do is deny the application, unless he has a second lender with an identical or lower compensation plan that he can send the loan to. Later this year, the good faith estimate and the truth in lending are supposed to be combined into one new form as part of the Dodd Frank bill, so when this new form emerges some of these problems may be corrected in the rule making, but as the rules stand today, I do not see many avenues for resubmitting problem loans.
The Federal Reserve Rule is being implemented subject to interpretation by a lot of different parties, and this is going to lead to regulatory problems and enforcement issues. Broker shops tend to be small and to have limited budgets to pay attorneys for help and guidance. In the past, we in the broker community have relied largely on guidance from our lenders about how to implement new rules. But now that the SAFE Act is in place, we have a national loan originator registry, and we will be subject to the Consumer Financial Protection Bureau, we can be held responsible for compliance individually. Our conference call yesterday started with a disclaimer that the lender was not giving us legal advice and that we should consult with an attorney to make sure that we are individually in compliance. But most brokers are not going to do that, nor can they afford to. So brokers with multiple relationships with multiple lenders who are allowing various types of compensation agreements may be held individually responsible for being out of compliance with the Federal Reserve's rule regardless of whether they met the guidelines of their individual lenders. That's the problem with a vague, incomprehensible new rule--now matter how well intentioned the broker-owner is, it almost impossible to know whether he is really complying with it until it is too late.
Tomorrow, I will examine the third reason that the Fed Rule will kill the mortgage brokers.
For related posts, go to http://www.frontier2000.net/.
Tuesday, February 22, 2011
If the new Federal Reserve Compensation Rule were ever the subject of a Hollywood movie--which it won't be--the most appropriate title I can think of would be "10 Things I Hate About You." Now that our industry is only about 5 weeks away from implementation of the new rule, we are starting to receive some training on how loans will be done in the new world of lending as defined by the Federal Reserve. I sat through my first conference call this morning on the how to comply with the new rules, and I now have more questions than I did before I started.
When the Federal Reserve Compensation Rule was finalized last August, many of us predicted that the rule spelled the end of the mortgage broker industry. Since that time, a number of industry participants have assured us that such predictions are alarmist--mortgage brokers will continue to be a vital part of loan origination and we can emerge from the wreckage of the last three years stronger than ever. The reassurances of these "experts" are so comforting that they are easy to believe. But having completed this preliminary training, I can give you three reasons that the Fed Rule will be the end of the mortgage broker industry.
1. The Rule is tilted completely in favor of banks and larger correspondent lenders, so much so that it destroys any concept of competition. Remember that the rule states that no loan originator can be compensated by both the lender and the the borrower. That original wording led brokers like me to believe that our compensation would be coming from the consumer. However, last week the Federal Reserve issued a clarification on this point. Under the new clarified version of the rule, the borrower can compensate the loan originator only if he is salaried (or as some companies interpret the rule if he is a sole proprietor with no loan officers working for him.) Small broker shops cannot afford to salary their loan officers. In fact, the mortgage broker industry has been successful because it revolved around commissioned sales people. But in this new world, the loan officers must be salaried in order for the consumer to pay the fees.
It turns out that there are several benefits to the consumer being able to pay the fees. For one thing, if the borrower is charged an origination fee, the originator can reduce the fee in order to correct problems with the good faith estimate, or to pay fees that were not quoted properly. None of that is possible if the lender pays the loan originator.
According to the Fed Rule, the loan originator cannot be paid on the terms of the loan. However, if the bank or lender is selling a closed loan, the bank or origination company can be paid on the service release premium (which is the same as the yield spread premium). They can keep that money--they just can't pay it to the loan originator. The loan originator has to receive a set amount of compensation from each borrower; if the borrower is paying the loan origination fee, the percentage of fee must be exactly the same for all borrowers. So a salaried originator working for a bank can charge a 1% origination fee to the consumer and the bank can keep the spread on the sale of the money. Isn't that basically the way it works now?
But for the independent mortgage broker the change is huge. A mortgage broker who cannot salary his loan officers or who is not set up as a sole proprietor cannot receive any compensation from the consumer. He must set up a payment agreement with each of his lenders. That agreement cannot be renegotiated for a set period of time, such as quarterly. And since all compensation must come from the lender, it must be charged to the consumer in the form of a higher interest rate, but since the percentage of compensation is the same on all loans, the interest rate is increased proportionately the same for all loans.
Lender-paid compensation cannot be reduced for any reason. The originator cannot use it to lower the consumer's costs or to correct any discrepancies on the good faith estimate. The good faith estimate allows only a 10% tolerance for third party fees. For example, I recently did a good faith estimate for a long-time borrower of mine who recently moved to Dallas, Texas. The contract says that she has to pay for her survey. Since I do the majority of my work in El Paso, Texas, where surveys cost $216.50, I looked on line for a surveyor in Dallas. I found a company that looked professional and appeared to service the Arlington area where she is moving, and I used that company for my written provider list. Since the costs for home inspections were quite a lot more than they are in El Paso, I surmised that a survey might also be more, and since I know that the house she is buying has a comparatively large lot, I estimated her survey fee at $400.00. After I sent the estimate to the borrower, I asked her about ordering the survey, and she said that her agent had recommended that the title company order it. Interestingly, when the survey arrived from the title company a few days later, the company was the same one that I had quoted on my provider list and the actual survey cost was $390.00.
But what if I had quoted the El Paso fee of $216.50? In that case I would have been responsible for paying any amount over a 10% increase against what I quoted. In a world of lender-paid compensation, which is the only type of compensation that I can legally receive under the new guidelines, I am not allowed to pay for these kinds of corrections. And legally, my borrower is not allowed to pay for them either. So the lender has to pay for the corrections, and to do that they have to set up a special fund to pay for items such as lock extensions, missed tolerances, etc. Whether or not they use that fund to pay for one of my specific missed tolerances will be determined by my overall performance with them, including number of closed loans, quality of loans, etc.
Most of the time corrections to the good faith estimate can be avoided simply by double checking all of the fees carefully ahead of time, but what about lock extensions? Missed closing dates can be unavoidable even when the originator does all of the components of his job properly. Take my borrower in Arlington again. At the end of January, she requested that I do her loan for her in Arlington. I sent her a loan package to sign, which she sent back around February 3rd. Since her husband is salaried and they have excellent credit, I was able to complete all of my due diligence and get her underwriting approval back before February 11--she told me when she asked me to do the loan that she wanted to close February 24. However, her closing on her home in Arlington is conditional upon her selling her home in El Paso, and her buyer has not closed yet. Originally, her buyer was supposed on February 14; that closing has now been delayed until February 25. I can extend her lock, which expires March 3, for three days free but then the lender starts charging. Under normal circumstances, a broker will lower his fees to cover a lock extension for a long time customer so that everyone walks away happy. But what if we were in the new world of lender-paid compensation and she refused to pay for the lock extension since the circumstances that will cause it are beyond her control? I would not have the option of paying for it, and if the lender determined that they were not going to pay for it, the deal would be dead. The only way to prevent this type of situation is to require longer lock periods to start with. And that is what we will have to see--lock periods that are 45 days or longer will probably become standard for brokered deals.
Now the problem with that is that in a competitive situation, the brokered loan now has a much higher interest rate. Remember that the salaried originator working for a bank can charge a 1% origination fee and he can still pay for items like lock extensions. Since he can charge the borrower directly, all of his fee is not priced into the interest rate, so he can afford to offer a shorter lock at a lower interest rate which is going to help him capture that deal in the first place. The independent broker has to figure out how set his initial compensation that he is getting from the lender at a percentage that will allow him to keep the doors open while still allowing him to compete. And since the compensation cannot be changed for a set period of time--we all assume that the period will be quarterly--he has to try to predict the future interest rates to figure out where to price himself. Then, when we add in factors such as longer lock periods in a rising interest rate environment where we are today combined with rising fees imposed by Fannie and Freddie, the broker has probably priced himself out of the market.
Tomorrow, I will examine the second reason that the Fed Rule will kill the mortgage brokers.
Friday, February 18, 2011
All the posts this week have focused on the Obama Administration's Housing Plan presented last Friday. Today, I will explore the final major piece of the housing plan--a commitment to rental housing. The plan stresses the importance of a renewed commitment to rental housing from the introduction--"Our plan champions the belief that Americans should have choices in housing that make sense for them and for their families. This means rental options near good schools and good jobs." And while the plan proclaims that mortgage loans will still be available for middle class families who want to own their own homes, in reality in a world of tightened FHA guidelines which will exclude many middle class families, and 20% down payments with increasingly stringent guidelines regarding credit scores and debt for those who do not qualify for an FHA loan, home ownership is going to slip further out of reach of many working and middle class families. This may be one reason that the paper dedicates several pages to the importance of the rental market.
"As we move forward to address the challenges of affordability and access, we must address how those issues impact renters. Today, renters often face significant affordability challenges...Promoting a housing finance market that provides liquidity and capital to support affordable rental options can alleviate the high rental burdens that many low-income households face. It can also expand rental options for low-income households in urban, suburban and rural communities of opportunity, with good jobs for parents and quality schools for children."
"Private credit markets have generally underserved multifamily rental properties that offer affordable rents, preferring to invest in high end developments. By contrast, Fannie Mae and Freddie Mac developed expertise in profitably providing financing to the middle of the rental market, where housing is generally affordable to moderate income families. As we wind down Fannie Mae and Freddie Mac, it will be critical to find ways to maintain funding to this segment of the market."
Everywhere we turn now, we see a greater emphasis on rental housing, and that has actually been true for several years. And some of the initiatives we are seeing today sound a lot like Chris Dodd's "Livable Communites" Act which he tried to get voted through last year. The Livable Communities Act called for voluntary participation with heavy incentives from the federal government to locate housing, schools and businesses within walking distance of each other and to make sure that they were conveniently located to public transit. In fact, here in El Paso, Texas, a consulting firm hired by the city of El Paso is holding a series of meetings in various parts of town about how to implement the "livable communities" concept here. The idea is to create "walking neighborhoods" where buildings are mixed use--maybe apartments on the upper levels and grocery stores and shops on the ground level. Residents would be able to walk to and from most areas to shop and would be able to access public transportation conveniently, but the communities are not designed for individual cars. In livable communities, parking is on the street because the lots are exceedingly small, but the streets are also very narrow to discourage driving.
In my travels, I have been in a number of major metropolitan areas with good public transit, and rental units on top of grocery stores and drycleaners. My brother lived in Chicago, Illinois, for several years and he walked from his apartment on the 32nd floor of a high rise in downtown Chicago to his job at CNN which was housed in the Chicago Tribune building. He told me that he could take the "L" to be anywhere else in the city he wanted to go. He was within walking distance of excellent dining and shopping and lived in the center of an exciting cosmopolitan city. I enjoyed visiting him there thoroughly, but I could not help but think whether I would want to live in such a city, or whether I would want to try to raise a family there. He lived in a studio apartment with an amazing view, but surprisingly few comforts and he paid almost $1000 a month in rent to do so. I could not help but compare that lifestyle to the one we enjoy in Texas where $1000 a month payment allowed people to own their own homes with more room, greater amenities and places to park their own cars.
Yesterday I had lunch with a friend I had not seen for a while. She lived in Europe for many years and she was explaining to me what housing is like in Italy. She said that young couples in Italy rent an apartment and live there for many years saving as much money as they can. When they have saved up enough money, they ask their parents to help them with the rest of the downpayment and then they buy their own apartment, which costs them "a small fortune." They have an expectation of living in that apartment for the rest of their lives, knowing that when their own children are grown they will be helping with the downpayment for their children's apartment. My friend loved Italy and the Italian way of life, but she said that the expectations are very different there from our own expectations in the U.S.
More than anything else, what I am seeing from the federal government today is a push to adjust our expectations and to get us accustomed to a standard of living that is more European and less what we have always known as Americans.
Thursday, February 17, 2011
As I read through the Obama Administration's Housing Plan released last week, I am amazed by how completely the plan revolutionizes every aspect of mortgage lending. The stated goal of the proposal is to "dramatically transform the role of government in the housing market." Government initiatives and government backed mortgages are meant to be replaced with private market solutions from a "robust" private market. But in fact, the new housing rules greatly restrict and constrict many of the private market solutions to housing that already exist.
One example--second liens. Second liens are a true private market solution that lower down payments for homeowners and provide access to the equity in the borrower's home via cash loans. The implementation of the Safe Act and required licensure for all loan originators eliminated seller financing and seller seconds on residential mortgages. This was truly the most "private" of all private market transactions. A seller wanting to sell his house could offer to carry a seller second, with the approval of the lender making the first lien mortgage. If the seller's terms and conditions were accepted by the first lien lender, the seller could "carry" the second at no risk to anyone but himself. But when the National Mortgage Licensing System was implemented, the Safe Act required that any person originating a mortgage loan be licensed. Since a seller carrying a second lien on his own property is originating a mortgage loan, the new rule basically abolished seller financing and seller seconds.
Still, institutional second liens have remained a strong tool for financing. And institutional second liens always represent private market options. Most second liens are portfolioed by the lenders who offer them, so they are not sold but remain on the lender's books until the lien is refinanced or paid off. On purchase liens, the first lien mortgage holder must be informed of the presence of a second and the terms of repayment. But what about a homeowner who has been making his mortgage payments and wants to get a second lien equity loan or line to consolidate some debt or cover additional expenses. Who does he ask permission from?
Until the Administration rolled out its new Housing Plan, the answer was "no one." But that is all about to change as part of the Obama Administration's plan to phase out Fannie Mae and Freddie Mac. "We should reduce conflicts of interests between holders of first and second mortgages and improve transparency for lenders and borrower regarding the total debt secured by a given piece of property. Mortgage documents should require disclosure of second liens. In addition, mortgage documents should define the process for modifying a second lien in the event that the first lien becomes delinquent. This will prevent a second lien from standing in the way of a first lien modification and help prevent avoidable foreclosures. Finally, we should consider options for allowing primary mortgage holders to restrict, in certain circumstances, additional debt secured by the same property."
Suppose that you own a home worth $400,000.00 which you have owned for 5 years, and because you made a large down payment when you sold your original home, you owe $300,000 on that home now. Due to a family illness and some unexpected emergencies, you have acquired $50,000.00 in credit card debt, which you would like to pay off. Because you have good income and an excellent credit score, your credit union will loan you the $50,000. to consolidate all of your bills at a lower interest rate with one new monthly payment that you can easily afford. The credit union is glad to get the loan, and you are glad that you are consolidating your debt. The only problem is that your primary mortgage holder now has to approve the transaction, and they say "no" because you will reduce the equity in the house by applying the second lien.
This represents a major shift in thinking from what we have experienced the past few years. Up until now, the equity in a homeowner's home has been considered the owner's money. Even in Texas, where strict home equity laws enacted in 1998 prevent a homeowner from borrowing more than 80% of the total value of the home for purposes of getting cash or consolidating bills, we recognize that the accumulated equity is really the homeowner's money.
I understand that it is a major irritation for mortgage lenders to learn of the existence of a second lien they did not know existed. Last summer I refinanced a nurse whose home I have financed a number of times. She wanted to take advantage of the 15 year interest rates at 3.875%. I financed her home when she bought it and I have handled each of several refinances. I pulled a title commitment which was clear, and a credit report which was also clear. Just before the loan was ready to close, I was doing final due diligence and I asked her about an inquiry from USAA on her credit report. "Oh, that's my second lien," she said confidently. "USAA gave me a loan to pay off all of my credit cards." I stared at her in horror trying to figure out how to rework her first mortgage. I knew that she had not deliberately withheld this information in an attempt to deceive me--she just didn't think it was worth mentioning or that it was really any of my business whether she had gotten a second lien. Fortunately, we qualified her with the terms of her new loan and got USAA to subordinate the existing second behind the new first lien and the story had a happy ending.
But while my borrower's choice to get a second lien--and mainly her choice not to tell me about it at loan application--created a lot of extra stress for me, I never questioned whether she had a right to take out a second on her home. She has spent tens of thousands of dollars renovating her home over the past four years, including a new kitchen, new bathrooms, new landscaping, etc. Through her hardwork and determination she has increased the property's value greatly. As a single mother who works as a specialized nurse she works long hours and earns an extremely good living for herself and her children. Why should she have to ask permission to get a loan that she clearly qualifies for that will make her life easier?
A large part of what is being lost in the Housing Plan is the opportunity for people like my borrower to make their own decisions about their own property and their own money. And while denying homeowners the right to access the credit in their home by restricting access to second liens may make life a little easier for mortgage servicers, it certainly makes life more difficult for working families who have built up equity in their homes.
For related posts go to http://www.frontier2000.net/
Wednesday, February 16, 2011
Last May, I wrote a post for this blog entitled, "Every Loan a Government Loan" in which I talked about the proposed bill by Maxine Waters to statutorily raise the FHA annual premium from .55% to 1.55% and the annual to a maximum of 3%. At the time, HUD was looking for assistance from the Realtor community to lobby Congress on behalf of the change. One of the Realtors I know who was reading the blog sent a copy to David Stevens, FHA commissioner, to ask him whether the information contained in it was true. Stevens promptly responded with a personal email to me and to the real estate agent that the information was in fact not true. Stevens wrote, "The current premium is 2.25% up front and .55% annually. Under the legislation, FHA will have the authority to raise the annual higher but as stated the fees will be changed as follows: the upfront will drop from 2.25% to 1% and the annual will go from .55% to .90%. the trade off is easier for the market by lowering the upfront it impacts initial equity less and the trade off is the increase to the annual." When in a response email I pressed him on the fact that the verbiage of the bill allows FHA to increase their premium to 1.55%, Stevens replied that the increased premium gives FHA room for years to come without going back to Congress for authorization.
Fast forward nine months later to the Obama Administration 2012 budget which includes raising the FHA premium again. The new increases, announced by FHA on February 14, 2011, go into effect April 18, 2011, and raise the annual premium for loans at less than 95% loan to value from .90% to 1.10. Loans at greater than 95% will see an annual premium jump from .90% to 1.15%. Loans under 90% loan to value that previously did not have annual MI will see .25% annual MI for case numbers assigned after April 18, 2011 and those between 90-95% will now have annual MI of .50%. The upfront MI remains at 1%.
Why, you may ask, would the government want to increase FHA premiums right now just at the time that they have announced that Fannie Mae and Freddie Mac are going to be phased out? Simply put, part of the Administration's Housing Plan is to reduce the role of FHA while closing down Fannie and Freddie. Remember that the Administration's goal is to find solutions through "robust" private market initiatives--a lofty goal considering that the same Administration is heaping on more regulations to the lending world than ever before.
"In addition to winding down Fannie Mae and Freddie Mac, FHA should return to its pre-crisis role as a targeted provider of mortgage credit access for low- and moderate-income Americans and first time homebuyers. (Today, FHA's market share is nearly 30%, compared to its historic role of between 10-15% percent.) As Fannie Mae and Freddie Mac's presence in the market shrinks, the Administration will coordinate program changes at FHA to ensure that the private market--not FHA--picks up that new market share."
Although the Housing Finance Plan gives FHA currently a nearly 30% market share, Housing Wire estimates that 40% of all purchase loans originated in 2010 were FHA loans. What is very interesting is that the Housing Plan wants to return FHA to their historic levels of 10-15%. And over the course of their existence--since the 1930's--that may be an accurate average. However, by 2006, just before the housing collapse, FHA had between 2-4% of total market share. The product had become obsolete as it had been crowded out by "robust" private market solutions. FHA's 3% down payment (which is now 3.5%) could not compete with private market solutions of 100% financing and sometimes greater. Also, because FHA had guidelines that prevented most small brokers from qualifying to sell the product, they had limited access to the consumer in a mortgage market driven by mortgage brokers and independent originators. Those factors, coupled with the fact that FHA had comparatively low loan limits, meant that their market share had dried up so much that many believed that the program had outlived its usefulness.
Today, however, FHA is responsible for 40% of purchase loans--up from no more than 4% five years ago! So who pulled FHA off life supports, resuscitated the program, and transformed it into a primary provider of mortgage money? The government, of course. As part of the Economic Stimulus Act of 2008, FHA's loan limits were raised to up to $729,750 for high costs areas, with a floor of $271,050. for all areas. In Alaska, Hawaii, the Virgin Islands and Guam FHA loan limits are $1,094,625.00. By changing the requirements for qualifying income and raising the loan limits, a product that could not compete with private market products became the financing vehicle of choice for nearly everyone who could qualify for it.
Now, however, the Administration wants to scale FHA usage back. One way to accomplish this is to raise the fees to make it less competitive. "As we begin to pursue increased pricing for guarantees at Fannie Mae and Freddie Mac, we will also increase the price of FHA mortgage insurance. We have already acted on this front, raising premiums two times since the beginning of this Administration. And we will put in place another 25 basis point increase in the annual mortgage insurance premium that is detailed in the President's 2012 Budget. This will continue the ongoing effort to strengthen the capital reserve account of FHA, and put it in a better position to gradually shrink its market share."
Other goals to reduce FHA market share include decreasing the FHA loan limits. The Administration is going to let the present limits expire on October 1 and then will review whether to further decrease the loan limits. Historically, the FHA loan limits have been 115% of the median housing prices of the markets they serve. Going forward, "the Administration will make sure that creditworthy borrowers that have incomes up to the median level for their area will have access to these mortgages [FHA], but we will do so in a way that does not allow FHA to expand during normal economic times to a share of the market that is unhealthy and unsustainable."
To put this in perspective, I did a little research. According to Census.gov, in 2008 the median household income in El Paso, Texas was $36,519.00; the median income for the state of Texas was $50,049. The median home price in El Paso, Texas in 2009 was $115,300, and the median home price for the state of Texas was $125,800. So to qualify to use FHA, under the Administration's proposed guidelines, a young couple purchasing a home in El Paso needs to have a combined income of no more than $36,519.00 and be purchasing a home costing no more than $132,595.00. The Housing Plan also proposes raising the required down payment for FHA loans so that borrowers have a greater investment in their home.
We are not supposed to be concerned about this credit tightening, because the private market is supposed to make up the difference with new mortgage products. But in the new world of Dodd Frank, where products that the government considers higher risk require that the originator retain 5% of the loan in their portfolio, aggressive new products may be very hard to find. And since the Dodd Frank bill automatically exempts FHA mortgages from the 5% risk retention rule and treats them as qualified residential mortgages, lenders will continue to try to put as many borrowers into these loans as possible, no matter how difficult qualifying becomes.
For related posts go to http://www.frontier2000.net/
Tuesday, February 15, 2011
On Friday February 11, the Obama Administration unveiled its plan to reform housing and wind down Fannie Mae and Freddie Mac. The timing was interesting since over the weekend the President released the 2011 budget which includes budgetary items regarding housing and the cost of loans. Although the passage of the budget is currently a matter of debate, there is no question that we are about to see the greatest remaking of the U.S. mortgage system in 70 years.
The stated goal of the Obama Administration's Housing Plan is to:
"1. Pave the way for a robust private mortgage market by reducing government support for housing finance and winding down Fannie Mae and Freddie Mac on a responsible timeline.
2. Address fundamental flaws in the mortgage market to protect borrowers, help ensure transparency for investors, and increase the role of the private capital.
3. Target the government's vital support for affordable housing in a more effective and transparent manner."
This is a common, recurring theme throughout the document--Fannie and Freddie must be "wound down" in an orderly, responsible manner and we must have "robust private" capital supervised carefully through government oversight. At the end of the paper, the Administration details three possible scenarios for how to effectively accomplish this goal with the pros and cons for the implementation of each, and then invites discussion and in put from Congress and industry participants.
First, however, there is the matter of killing the mortgage giants, which the administration acknowledges must happen gradually over a period of several years to avoid a complete disruption of the housing market. Remember that Fannie and Freddie are providing about 70% of mortgages in the U.S. right now. And the Administration acknowledges that as underwriting has tightened over the last two years, the quality of loans being originated by Fannie and Freddie have improved considerably, so the losses on their books mainly stem from riskier loans taken on between 2006 and 2008.
So let's look at the plan to phase out Fannie and Freddie:
1. Increase the guarantee fees to make conforming mortgages less competitive and reduce the market advantage that Fannie and Freddie have. In other words, conforming mortgages need to become more expensive so that they are not the most attractive option for homebuyers. Remember that one of the suggestions from the think tanks last week was to add a 1% fee to all mortgages originated by Fannie and Freddie to pay into a reserve fund. Typically, these fees are priced into the interest rates and show up as a higher rate to the borrower. With interest rates on the rise anyway, we can expect to see rates for mortgages secured by Fannie and Freddie increase a lot. The Administration's plan states that although the "pace of these price changes will depend significantly on market conditions, such changes should be phased in over the next several years." However, Fannie and Freddie announced a fee increase in January ahead of the Obama Administration's plan, which can lead us to believe that this increase is the first of many.
2. Increase private capital ahead of Fannie Mae and Freddie Mac guarantees. This will come from insurance from private investors, and higher down payments from homeowners. Although the housing plan states that they want loans secured by Fannie and Freddie to have at least a 10% down payment, we know that in reality the FDIC chairwoman Sheila Bair has already given us a strong indication that the new "qualified residential mortgages" which are exempt from risk retention rules will require at least a 20% down payment.
3. Reducing conforming loan limits. Under the Obama Administration's Housing Plan, the higher loan limits established by Congress in 2008 (super conforming mortgages) which allowed borrowers to refinance and purchase homes with mortgages up to $729,000 in high cost areas should be allowed to expire in October of 2011 and the previous loan limits should be reinstated. The previous loan limit was $417,000, and in areas that were not designated "high cost areas" that loan limit remains in place. However, the Administration says that, "We will work with Congress to determine appropriate conforming loan limits in the future, taking into account cost of living differences across the country." That indicates to me that we can expect to see the conforming loan limit drop below $417,000 back to $330,000 or possibly lower as Fannie and Freddie wind down. The purpose of this is to force the larger loans for the more expensive homes to be funded through private markets.
4. Wind down the investment portfolio. The Administration's goal is to wind down the portfolio at a pace of 10% a year. To accomplish this, they need to impose tougher underwriting standards and higher fees. "As the market begins to heal and private investors return, we will seek opportunities, wherever possible, to accelerate Fannie Mae and Freddie Mac's withdrawal." One suggestion from the think tanks was to limit Fannie and Freddie loans to those for primary residences only, leaving second homes and investment properties outside of the portfolio. I think we expect to see new guidelines limiting conforming loans to primary residences in the near future.
What is most interesting to me about this is that the Administration insists that private capital should be able to fill the void left by Fannie and Freddie, while at the same time touting the need for all the restrictions that the Dodd Frank Act puts in place and blaming the entire mortgage community, from originators to servicers, for the problems with the housing market. But the Administration and the authors of the housing plan seem totally unaware of the relationship between risk and reward as part of the free enterprise system. For example, as part of the preamble, entitled "Housing Finance from the Great Depression to the Great Recession" the Housing Plan gives the short history of Fannie Mae, which started in the 1930s and Freddie Mac, which started in the 1970s to compete with Fannie Mae. "Initially, Fannie Mae and Freddie Mac were largely on the sidelines while private markets generated increasingly risky mortgages. Between 2001 and 2005, private label securitizations of Alt-A and subprime mortgages grew fivefold, yet Fannie Mae and Freddie Mac continued to guarantee fully documented, high-quality mortgages. But as their combined market share declined--from nearly 70 percent of new originations in 2003 to 40 percent in 2006--Fannie Mae and Freddie Mac pursued riskier business to raise their market share and increase profits. Not only did they expand their guarantees to new and riskier products, but they also increased their holdings of some of these riskier mortgages on their own balance sheets."
In other words, Fannie and Freddie were becoming irrelevant in a mortgage climate with freedom and private capital and so to compete they took on more risk. But the reason that the private markets produced a lot of products was that they could expect a high rate of return for those products. This was capitalism at work. No rules were in place that originators had to retain 5% of the risk of most kinds of mortgages. The government did not dictate what kinds of loans individual homebuyers could get--rather, the lending institutions decided how much risk they felt comfortable assuming. Loan officers and mortgage brokers got out and sold mortgage loans because they could earn a good living, lenders made those loans because they could earn a good living, and Wall Street packaged and sold the loans because they could earn a good living. And the American homeowner purchased the houses (and with them the mortgage loans) because they believed that housing was a good investment.
When the loans got too risky and the housing prices began to adjust, of course, the companies with the most exposure were going to go bankrupt. That is also capitalism at work. But by allowing those in trouble to fail, the government could have let the system correct itself. Rather than greatly expanding the loan offerings of Fannie and Freddie until we are again in a situation where they back about 70% of the loans in the U.S., both the Bush and Obama administrations should have said, "Freedom cuts both ways. You are free to succeed and free to fail. Right now you are failing. Deal with it." That is the way to find private market solutions to private market problems. But by taking Fannie and Freddie into conservatorship and making them the primary providers for loans, the government has set the entire housing system up for a collapse when they are gone.
Today, the federal government is writing the suitability standards for mortgage lending, setting the compensation packages for the originators, and setting the rules for the servicers of those mortgages. To tell the private markets in this climate that they need to step up and provide the capital to back the mortgages in the U.S. under these rules is a little like Pharaoh ordering the children of Israel to produce their normal quota of bricks without government-issued straw. The Adminstration's incessant chiding of businesses to get back in the game is both extremely unreasonable and unlikely to be heard. And at the end of the day, when private markets do not respond to this new formula of risk with little reward, we will hear that this is just another failure of capitalism.
Friday, February 11, 2011
Yesterday, I wrote about the recommendations coming from think tanks for how to deal with the problems of Fannie Mae and Freddie Mac. Mid day today, the Obama administration revealed its plans to fix Fannie and Freddie and create a new system for mortgage lending in the United States. Although previous remarks by Congressman Barney Frank had led to speculation that the administration would push for a mostly government-run mortgage lending system, the 32 page report released today appears to debunk that prospect in favor of government micromanagement of a private system.
The first paragraph of the introduction lays the ground work for what we can expect. "This paper lays out the Administration's plan to reform America's housing finance market to better serve families and function more safely in a world that has changed dramatically since its original pillars were put in place nearly eighty years ago.
"Our plan champions the belief that Americans should have choices in housing that make sense for them and for their families. This means rental options near good schools and good jobs. It means access to credit for those Americans who want to own their own home, which has helped millions of middle class families build wealth and achieve the American Dream. And it means a helping hand for lower income Americans, who are burdened by the strain of high housing costs. But our plan also dramatically transforms the role of government in the housing market. In the past, the government's financial and tax policies encouraged housing purchases and real estate investment over other sectors of our economy, and ultimately left taxpayers responsible for much of the risk incurred by a poorly supervised housing finance market. Going forward, the government's primary role should be limited to robust oversight and consumer protection, targeted assistance for low- and moderate-income homeowners and renters and carefully designed support for market stability and crisis response....Under our plan, private markets--subject to strong oversight and standards for consumer and investor protection--will be the primary source of mortgage credit and bear the burden for the losses...Our plan is also designed to eliminate unfair capital, oversight, and accounting advantages and promote a level playing field for all participants in the housing market."
The Administration's plan does include reducing Fannie and Freddie's role in housing with the ultimate goal of "winding down" the two entities. "Successful reform will require more than just winding down Fannie Mae and Freddie Mac and reducing other government support to the housing market....The government must also help ensure that all Americans have access to quality housing that they can afford. This does not mean our goal is for all Americans to be homeowners. We should continue to provide targeted and effective support to families with the financial capacity and desire to own a home, but who are underserved by the private market, as well as a range of options for Americans who rent their homes."
Next week we will look at the specific points of the Obama administration's plan to reform housing.
For related posts, go to http://www.frontier2000.net/
Thursday, February 10, 2011
Yesterday the House Capital Markets Subcommittee held a hearing on the steps that need to be taken to "fix" Fannie Mae and Freddie Mac. As you may recall, as part of the Dodd Frank Bill, Secretary of the Treasury Tim Geithner was supposed to present Congress with a report for the administration's plans to deal with Fannie and Freddie in January. Based on comments made by Congressman Barney Frank last summer, many of us who have watched the soap opera that is financial reform believed that the administration's solution to Fannie and Freddie was to replace both entities with an entirely new, entirely government-run agency which will set the rules for housing. However, presumably the political upset in November put a damper on some of the administration's plans, which may be one reason that we did not see the new policies from Geithner in January.
Now, as we approach the middle of February, we are getting glimpses of what the proposed solutions are to the problems of Fannie and Freddie. Remember that these two entities were mostly privately owned up until 2008 when the federal government took them into conservatorship. Since 2008, both entities have cost tax payers approximately $150 billion in what may ultimately amount to the single largest bailout in the financial collapse. A January 2011 article by the New York Times states that taxpayers have spent $160 million alone defending Fannie and Freddie from lawsuits accusing them of fraud.
Still, Fannie and Freddie back nearly 70% of the mortgages in the United States even today. So getting rid of the agencies is not as simple as it sounds. Conservatives have long sought to completely privatize the two giants, but that poses a problem if the private markets cannot raise enough capital to effectively back the demand for mortgages. Liberals like Barney Frank have implied that they want a completely government-based public system which will be government backed and government run. Either way, we are going to see massive changes to how mortgages are originated in the United States. To paraphrase the old African proverb, when you take away the primary means of financing homes, you had better replace it with something of value.
We got our first taste of those changes yesterday when three conservative think tanks and one liberal one gave their recommendations of what needs to be done to stop the bleeding and change the system. The first three advocate for privatization and the fourth for continued government intervention.
Suggestions included lowering the maximum loan amount which can be sold to Fannie and Freddie from $729,000 to $500,000. I wonder if the experts making this suggestion understand that up until about three years ago, the maximum loan limits for Fannie and Freddie were $417,000. This whole idea of the super conforming mortgage, which is just a fancy way of saying that Fannie and Freddie would make jumbo loans in high cost areas, was a bailout of sorts in itself to allow people living in more expensive areas of the country to be able to purchase and refinance homes after the loan sources for jumbo loans dried up. I wonder if they are also aware that super conforming loans are available only to those people living in high cost areas--for example, a person living in El Paso, Texas, where there are quite a few homes that cost upwards of a half a million dollars, is not eligible for one of these super conforming mortgages and must get a jumbo loan or qualify for a first and second lien.
One way to immediately reduce risk would be to eliminate the super conforming mortgages by the end of 2011. And if $500,000 is to be the loan limit, why not make it the loan limit across the United States rather than just in high cost areas?
One problem that I believe that Fannie and Freddie have always had is that they did business differently in different regions of the country. For example, while El Paso is not eligible for the high cost mortgage relief, we are considered a low income city and so practically the entire city was eligible for aggressive affordable housing loans. That means that individual people, regardless of their own personal income, living in virtually every neighborhood in El Paso were eligible to take advantage of programs designed to help lower income families obtain cheap loans. So you could, and did, have families with six figure incomes getting loans with 100% financing and low cost mortgage insurance. And that brings me to the second recommendation--move all affordable housing initiatives from Fannie and Freddie to HUD. That would mean that any borrowers needing first time home buyer loans or loans with lower downpayments would have to get FHA loans.
Other suggestions include requiring that Fannie and Freddie's debt be shown on the government books (a sure fire way to dramatically raise the deficit in a matter of hours), requiring that Fannie and Freddie purchase only qualified residential mortgages conforming to the new guidelines being developed now, and requiring a new one page disclosure on all Fannie/Freddie backed loans (we already have page after page of disclosures, so what's one more!) The most disheartening proposals from a mortgage originator's standpoint are those to immediately restrict loans by Fannie and Freddie to those for primary residences with a projected delinquency rate of less than 5% and to impose a 1% fee on each loan which will help the government raise money to recoup costs and reduce "the competitive advantage of the GSEs [Fannie and Freddie]." That means loans that are a lot more expensive and much more difficult to obtain.
I realize that stopping the bleeding of taxpayer money from Fannie Mae and Freddie Mac is a major goal and concern, but maybe the House Capital Markets Subcommittee should hear from some housing professionals rather than people who work for think tanks, whether liberal or conservative. The housing market is stagnant and many Americans are choosing to rent rather than buy because getting a mortgage loan has become an out of reach goal for many Americans. Raising the costs of financing and making qualifying still more difficult is going to keep housing prices down and keep the market stagnant. We cannot expect a meaningful recovery unless the housing market begins to recover, and it cannot recover unless mortgage money is available again.
Tomorrow the White House is supposed to unveil its proposals to fix Fannie Mae and Freddie Mac.
Wednesday, February 9, 2011
Last night I watched an interview with Donald Rumsfeld, who is appearing on a number of talk shows to promote his new book. As part of the interview, the host showed a series of clips of Rumsfeld explaining the degrees of information that we have about situations at any given time. As Rumsfeld explains, there are the "known knowns"--information that we "know that we know", and then are the "known unknowns"--information that we know that we do not know. The final degree of knowledge is the "unknown unknowns"--information that we do not know that we do not know. This is the scariest place to be because we are not aware of dangers which might be lurking out there waiting for us.
Watching the old video clips of Rumsfeld's press conferences, I had to laugh until I really thought about how the principle of "unknown unknowns" applies to our industry. We now have the challenges of new truth in lending disclosures, new loan officer compensation rules, and federal licensure. These are our "known knowns." We also face the challenges that will come from the new Consumer Financial Protection Bureau, new disclosures replacing the good faith estimate and truth in lending, and new supervision. Because so many of these new areas of concern have not really been defined for our industry yet, these are our "known unknowns." But Dodd Frank also allows for hundreds of studies and many areas of new rule making by existing and new agencies. These are our "unknown unknowns" We have no idea what will these new rules could look like or how they can impact on our businesses, and we won't know until we start to see the proposed rules unfold.
For instance, the Federal Reserve has proposed new rules for determining companies which are "significant" to the financial system versus those which are "systemically important." The rules will be enforced by the newly created Financial Stability Oversight Council, which is a new panel of regulators who will assess the financial system for threats.
The Fed's proposal deems "significant" to the financial system bank and non-bank holding companies with more than $50 billion in total assets. Smaller entities can be deemed "systemically important" if at least 85% of revenues or assets are derived from financial activities, including originating, brokering or servicing loans or "extensions of credit", organizing and managing mutual funds, or acting as a "principal or agent" in insurance or annuities sales.
The significance of the proposed rules is huge. Designating a company "systemically important" means that the Financial Stability Oversight Council can close down a private company if they determine that the company is in financial jeopardy. A designated company which is in financial jeopardy can be deemed a "systemic threat" to the overall financial system and so to protect the financial system at large, the Secretary of the Treasury can recommend that the company be dissolved.
The Dodd Frank bill has given the government unprecedented authority to regulate, take over and dissolve private corporations. While a company may file a suit to protest an order of dissolution, no judge has the power to issue a stay to protect a company that has been ordered to dissolve or to prevent a take over. In other words, while the Financial Stability Oversight Council has life and death power over the businesses they regulate, they themselves do not have outside oversight through the judicial process.
This is pretty scary stuff for people working in financial services. Remember that non-bank financial entities usually take more risks than banking entities, and because of this higher threshold of risk they have been able to offer more aggressive products to consumers and higher returns to investors. To have an agency that has the power to determine that such a company is a potential threat to the financial system and that it needs to be closed down flies in the face of ingenuity and entrepreneurship.
It is impossible to know at this time how small the entities that come under increased supervision as part of the Fed's proposed rule will turn out to be. The Fed is accepting public comments on the proposed rule until March 30. After that date, the Fed will issue its final interim rule. Then we can watch as this latest government power grab takes shape over the next few years.
For related posts, go to http://www.frontier2000.net/
Monday, February 7, 2011
For the most part I write this post about the effect of financial reform on mortgage and real estate markets. But today I saw a topic that is just too good to pass up--the Federal Reserve's new proposed rule on credit cards which will require individual applicants to prove that they have sufficient income to repay the debt rather than qualifying against household income. The proposed new rules are supposed to protect college students and young adults from acquiring credit cards and incurring debt that they cannot afford to repay. The theory is that these young people run up huge debt and ruin their financial futures and credit history before they are even really ready to start their lives as independent adults. But the unintended consequence of the proposed rule is that it will make it impossible for stay at home mothers to obtain credit in their own names without their husbands as co-signers.
To me this is fascinating. My mother was a stay at home mother for over 25 years. She was joint on a couple of my dad's credit cards, but her use of credit was limited. Since my mother does not like debt and does not approve of much credit usage, I can never remember this working a particular hardship on her. Financially, she was more conservative than my father in her attitudes about debt and credit. After her children graduated from school, she went to work and she has her credit in her own name but she remains a fiscally very conservative person.
So what is the issue with the income verification aspect of the new credit card rules? The rules are being issued in response to changes called for in the CARD act passed in 2009, but some proponents of the credit card reforms, including Representative Carolyn Maloney (D-NY) fear that the restrictive new rules will make it harder for women to get credit and that the rules will inadvertently trap women in abusive marriages since employers and landlords check credit histories.
Just to be clear, I am not a fan of any of the new financial regulation. I have watched access to credit become increasingly more restricted and more expensive. However, to argue that new credit card rules will trap women in abusive relationships is absurd. Honestly, how many women with no income of their own living in abusive relationships with violent controlling men are out running up debt their husbands/significant others don't know about? (If they are, they probably shouldn't be.) Not having a credit history at all does not necessarily mean that a woman will not be able to rent an apartment or get a job. And credit agencies are utilizing alternative credit more and more so someone trying to make a fresh start on her own may be able to use the fact that her name is on the utility bills and the current apartment lease to provide some credit history.
No credit history is always preferable to bad credit history. If only one person is a wage earner in the household, he or she probably needs to be consulted before the other spouse acquires new debt. Otherwise, the family as a unit is undoubtedly going to have a difficult time setting realistic budgets and sticking to the family's financial plan.
However, if advocacy groups really believe that the proposed rules are truly discriminatory against women and will return us to the 1950s when a married woman could not get credit without her husband's permission, this would be easy to solve. Since the rules are supposed to primarily protect those under 21, why not write a minimum age into the law? As a society, we do not allow people to drink under a certain age, to rent cars under a certain age, or to marry without permission of their parents under a certain age. What is wrong with saying that no person under the age of 25 can apply for credit without proving that they individually have enough income to cover the obligation? This would protect women who have successfully maintained a credit history for many years but do not have income at the moment because they are at home with their children, and it would also protect younger adults from incurring debts they can't pay.
Retailers are also unhappy about the new rules since businesses that cater primarily to women, such as bridal shops and department stores, will not be able to issue credit cards at the point of sale and many fewer women will apply for credit since they will not want to face the potential embarrassment of being denied or told that they need a co-signer. And that is probably the real issue. Consumers spend more on credit than they do in cash, so retailers really count on issuing credit to make large purchases even larger and more palatable for the consumer. A woman without her own income who is not living with an abusive, mean spirited man is probably not going to want to ask her even-tempered mate for permission to spend thousands on credit, but if she can just get the credit card without asking anybody, she will probably do so.
The irony of this whole debate is that the proponents and opponents of the proposed rules are focused on whether the rules give husbands too much control over their wives, but not whether the rules give the federal government too much control over everybody. Since when did it become the government's business to tell us what we can be allowed to buy and borrow? With no fault divorce, even the most brow beaten woman can eventually be free of a really controlling husband, but there is no divorce from Uncle Sam.
Retailers and credit card companies take a risk when they issue credit to any individual--whether that individual is working or not. Likewise, when any of us as a consumer completes an application for a credit card, we are also taking a risk. We are gambling that we will be able to pay that money back; the credit card company is gambling that we will be both able and willing to do so. At the end of the day, the decision to issue credit, and the decision to accept or reject the credit offers, should be between the individual and the credit issuer. The federal government should not be involved at all.
Friday, February 4, 2011
It seems hard to believe that it has been close to two years since the enactment of the Home Valuation Code of Conduct which essentially made it impossible for loan officers to hire or even communicate with appraisal companies. If you recall, the Home Valuation Code of Conduct came out of a deal made between Andrew Cuomo, then Attorney General of New York, and Fannie Mae and Freddie Mac. Cuomo promised to drop an investigation into the two agencies if they would sign the code and in the future essentially accept only appraisals ordered through appraisal management companies--at least in the world of mortgage brokers.
Protests immediately began as the rule was enacted. The summer of 2009 was truly awful as one deal after another imploded because of bad appraisals. (One title officer told me that she had a stack of files in her office that looked like the Leaning Tower of Pisa that were not going to close because the properties did not appraise.)
Now, close to two years later, HVCC is a thing of the past--sort of. The Dodd Frank bill abolished the Home Valuation Code of Conduct in favor of new strict appraisal independence guidelines. And what was the result? Basically the Home Valuation Code of Conduct has been codified into Federal law and expanded to include all real estate transactions, not just those secured by loans that are sold to Fannie Mae and Freddie Mac.
For example, during the months that HVCC was implemented, if I closed a loan through a portfolio lender who was not going to sell the loan to Fannie and Freddie, I could hire the appraiser. This was very useful, particularly in construction financing transactions that involved sets of plans, purchase contracts for land and construction contracts for the custom home. Custom homes can be very difficult to appraise, so it was comforting to be able to turn these projects over to seasoned appraisers I had worked with for many years.
The same principle was true for jumbo loans. Before the market meltdown, I did quite a bit of jumbo financing. Over the last two years, the lending sources for jumbos have largely dried up, but there is still a need for financing for these properties. Since El Paso, Texas is not eligible for conforming plus financing, any loan over $417,000 is a jumbo, and it was reassuring to be able to hire an appraiser who had experience with appraising larger properties in our market.
Under HVCC, exterior-only property inspections (Form 2075 appraisals) were not considered to be appraisals because they did not contain a value. Because of this, I could hire a local company to do these. By being able to send business to the local appraisers I knew on these types of transactions, I was able to support their businesses and also to provide better service to the borrower, since typically a telephone call to the appraisal company followed by a faxed request for the 2075 could result in same day service on this report rather than the 5 days that an order through an AMC can take.
Today, the new appraiser independence guidelines have done away with each of these opportunities. No loan originator or mortgage broker can have any contact with any appraiser regarding any report on any type of residential real estate transaction. This includes the 2075, which now must be ordered through the AMC. Our office is about to do the our first one time close construction loan under the new guidelines, and I will be holding my breath to see if the appraiser chosen at random is able to appraise this custom construction on the borrower's lot.
To be fair, the Dodd Frank bill did correct a couple of real problems with the Home Valuation Code of Conduct. For one thing, the bill mandates that appraisers be paid fair market value for their work. This is essential, because the Home Valuation Code of Conduct allowed the Appraisal Management Company to set the rates for the appraisers and pay seasoned men and women almost nothing for their services. But the down side for the consumer is that the costs of appraisals have risen. An appraisal that used to cost $350.00 now costs $400. A review typically costs as much as a full appraisal. And supplemental forms, such as rent comp schedules and operating income statements are now very expensive. Before HVCC, a full appraisal with a rent comp schedule and an operating income statement cost around $450.00. Today that same report costs around $600.00. That is a big difference for the consumer. Even the simple form 2075 costs more--when ordered directly through the appraiser it costs about $160.00 whereas through the appraisal management company it costs about $200.00.
The second problem corrected by the Dodd Frank rule is the problem of being able to transfer an existing appraisal. The appraisal independence rules allow for the transfer of appraisals on loans that have not closed between lenders. This is also huge since one of the key problems under HVCC was that appraisals could not be transferred so if a borrower needed to change lenders for any reason, he was stuck with the cost of a new appraisal.
Interestingly, the new appraisal independence rules specifically do not allow an appraisal for a closed loan to be used more than one time, even if it is unexpired. If the first transaction closed, a new appraisal must be ordered.
What galls me about the Dodd Frank bill with regard to appraiser independence is the same issue that galled me about HVCC. It bothers me that the government can go into an industry and legislate that various industry participants do not have a right to communicate with each other. While I understand that appraisers need to be able to arrive at values independently and free of coercion, to require that there be a "wall of protection" between appraisers and loan officers to me flies in the face of entrepreneurship and business relationships. The days of networking and building a business through contacts is over for the appraisal industry--the only contacts that matter are the ones at the Appraisal Management Companies that place the orders. That is anti-business and certainly against all principles of free enterprise.
There is a saying that if you put a frog in hot water it will immediately jump out, but if you put the frog in cold water and turn up the heat you can boil him to death. As an industry we are now used to the appraisal independence rules now, but that does not mean that ultimately those rules are good for businesses or good for the consumers. It only means that the water around us has been heated slowly and evenly for a long enough period of time that we are no longer aware of being cooked.