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General News    H2'ed 2/26/13

The Big Lie Annotated: An AEI History Of The Financial Crisis

By       (Page 2 of 3 pages) Become a premium member to see this article and all articles as one long page.   1 comment, In Series: Fannie Mae & Freddie Mac
Message David Fiderer
Note 1:   Here we get to the heart of Wallison's deceptive technique, wherein he claims that HUD's efforts to prod the GSEs into extending credit to certain underserved sectors translated into, "the agency's intention was to reduce the underwriting standards that were then prevailing in the market." 
That's not how it works in the real world.  When large lending institutions devise their underwriting guidelines, they set up internal portfolio limits, and sub-limits, for different types of loans with different types of risk exposures.  So, for example, if a bank has a $1 billion balance sheet, it may cap the limit of its exposure to high-risk loans to no more than $50 million.  For instance, GSE originations, when segmented according to FICO score, were remarkably stable. About 65% had FICO scores higher than 700, about 18% had scores between 699 and 660, and about 17% were below 660.

by FHFA

  As we'll see, HUD prodded the GSEs to set up small sub-limits for riskier types of loans. But these efforts never reshaped "the prevailing market."

Whopper 2: It was difficult for Fannie and Freddie to find prime mortgages among borrowers who are at or below the median income, especially when the quota had been raised to 50%.  So in the mid-1990s they began to reduce their underwriting standards, accepting 3% down payments by 1995, And zero down payments by the year 2000.  Acceptable FICO scores were also reduced.
Note 2:  Lots to unpack here:

A. Wallison's claim, about the GSEs loading up on low income borrowers in the mid-1990s, is false. 

As HUD Secretary Mel Martinez, a Bush appointee, testified i 2003:  

[N]umerous HUD studies and independent analyses have shown that the GSEs have historically lagged the primary market, instead of led it, with respect to funding mortgages loans for low-income and minority households. The GSEs have also accounted for a relatively small share of first-time minority homebuyers.
Joe Nocera and Bethany McLean  confirm this point: 

Here's the great irony of the mortgage market in the 1990s: to the extent that lower- and moderate-income Americans were being swept along in the rising tide of home ownership in the 1990s, it was happening not because of Fannie and Freddie, but despite them... Fannie and Freddie may have been given a federal mandate to help lower- and moderate-income Americans buy homes, but that GSEs were cautious about the credit risk they took... They wanted nothing to do with subprime. Subprime loans didn't conform. And anyway, there was so much money to be made elsewhere.... Repeated studies by HUD showed that GSEs purchases of loans made to lower income borrowers lagged the market.
B. There is zero evidence that the GSE's underwriting standards deteriorated in the 1990s. As reflected in the GSEs' stellar loan performance: 

by FHFA Report to Congress
C. Wallison's claim, about the GSEs' acceptance of low down payments, is misleading because its presented outside the context of risk limits.  
Every bank extends loans that are somewhat riskier than their overall portfolios. But unless the amounts are quantified and put in context, they are meaningless. It's like focusing on the player who struck out in the third inning, while ignoring the final score.

D. Private insurance companies, not the GSEs, set market demand for low-downpayment mortgages.

Fannie and Freddie could not, by law, assume the primary credit risk on any mortgage loan in excess of 80% of the home's appraised value. If a loan had an LTV higher than 80%, then the first loss was covered by private mortgage insurance.  In other words, the amount of low-down payment loans available in the marketplace was never decided by the GSEs. It was the private market, private mortgage insurers, which  were not regulated by the federal government. In addition, the GSEs' policies prevented them from assuming 80% credit exposure on high LTV loans. So, for example, if a loan had an LTV of 85%, the minimum insurance coverage was 12%, so that Fannie's net risk exposure would be no more than 73% of the total.

E. FICO were not "reduced' because they were not used in the underwriting process prior to 1996. Thereafter, they were used as an initial screening device, not as a proxy for creditworthiness.

Whopper 3: Because Fannie and Freddie were the dominant players and largely set the standards for the housing mortgage market, these lower underwriting requirements spread throughout the market, not just of those mortgages the qualified For the affordable housing goals.
Note 3:  Nobody in the mortgage business would be dumb enough to believe, "Fannie and Freddie are taking on greater risk, so I can take on greater risk as well." First of all, what businessperson would want to repeat someone else's mistake? Secondly, the GSEs had an entirely different level of risk capacity:

A. The GSEs, unlike the banks, had enormous balance sheets of super-safe mortgages to balance out any higher risk mortgages they financed. 

B. Private label mortgage securitizations cannot diversify market timing risk. Since time immemorial, real estate lending has been governed by two immutable rules: (1) Location, location, location; and (2) Timing is everything. The most important risk factor is that level of property price appreciation, positive or negative, after the loan closes. With securitizations, the investor risks taking on loans that were booked at the peak of the cycle. Whereas the GSEs book loans continually, before, during and after the peak, and so their capacity for taking on risk exceeds that of the private label securities market.

Yet is was private label deals that continually lowered their credit standards, as illustrated Subprime Mortgage Derivatives: 


by Subprime Mortgage Derivatives

Whopper 4: The availability of government support for low quality mortgages and the easy availability of mortgage credit substantially increased demand for housing and built an enormous bubble, nine times larger than any previous bubble, between 1997 and 2007.
Note 4:  You could easily write 2,000 words debunking that singular whopper.

A. Most mortgage originations were not for new homes or home purchases; they were for refinancings. 


by HUD Report

The subprime sector was dominated by cash outs, larger home mortgages based on inflated appraisals. And a huge percentage of subprime mortgages were extended as part of fraudulent home flipping scheme, not because of government policy. 


B. The GSEs and FHA were constrained by predatory lending rules, not private lenders or Wall Street. Consequently, Affordable Housing Goals did not include loans for which the lender did not adequately consider the borrower's ability to make payments.(65 FR 65069, Oct. 31, 2000)

C. The GSEs' affordable housing goals excluded the "B&C mortgage" segment, aka subprime mortgages.(65 FR 65090)

D. Ever hear of FRAUD? Check out the lawsuits filed by the Federal Housing Finance Agency alleging securities violations by 18 major banks. The word "fraud" appears 67 times in the Federal Housing Finance Authority's complaint against JPMorgan, 53 times in its complaint against Countrywide, and 41 times in its complaint against Merrill Lynch. It's impossible to read those filings and not be struck by all the damning evidence of the banks' complicity, as underwriters subprime and Alt-A mortgage securities, in promoting systemic fraud throughout the loan distribution chain. Not the FHFA was the first to the courthouse.    AllstateAIGMBIAMassMutual , and a multitude  other investors    had all filed suits alleging substantially identical allegations of fraud in the sale of the same types of securities.  

Wallison is famous for denying the existence of Wall Street fraud. As he wrote in his FCIC dissent:

The Commission's report also blames predatory lending for the large build-up of subprime and other high risk mortgages in the financial system. This might be a plausible explanation if there were evidence that predatory lending was so widespread as to have produced the volume of high risk loans that were actually originated.
As it happened, Wallison along with all but one of the GOP members, boycotted the FCIC hearings in Miami, Bakersfield, Las Vegas, and Sacramento, where the evidence of widespread fraud was laid out in detail. 
 
Whopper 5: By 2008, half of all mortgages In this bubble, that was 28 million mortgages, were subprime or otherwise low-quality. Of these, three quarters were on the books of government agencies, such as FHA, or other entities controlled by the government such as Fannie  and Freddie.
Note 5:  One can write many words about why Pinto's tally of 28 million" subprime or otherwise low-quality" mortgages is a complete crock.

But why bother? The world of free market capitalism does not revolve around the labeling schemes of Peter Wallison and Edward Pinto. It revolves around performance.

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For over 20 years, David has been a banker covering the energy industry for several global banks in New York. Currently, he is working on several journalism projects dealing with corporate and political corruption that, so far, have escaped serious (more...)
 
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