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January 11, 2013

Debunking the Right Wing Case Against Fixed-Rate Mortgages

By David Fiderer

Right wing think tanks trash the 30-year fixed rate mortgage as part of their disinformation campaign about the causes of the mortgage crisis.

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(Article changed on January 12, 2013 at 12:08)

(Article changed on January 11, 2013 at 18:38)

Wall Street has a saying: Money talks, bullshit walks. Business is about money, not about empty words. The narrative is always framed around the numbers; never confuse words, or actions, with actual results. Or as Nate Silver said recently, "Peggy Noonan is very very talented at making bullshit look like a beautiful souffle."

To keep the vulgarity at a minimum I'll substitute the word "doublespeak" for "B.S." Doublespeak is used to obscure or distort the meaning of critical information in order to leave a false impression.

Take, for example, the case made by a consortium of right wing think tanks against the 30-year fixed-rate mortgage. It's complete and utter doublespeak. There is zero quantitative evidence, none whatsoever, to support their claim, which is that adjustable-rate mortgages are not significantly more risky than fixed rate loans. It's like saying your risk of heart disease stays the same whether or not you take up smoking.

Right Wing Conspiracy of Silence

Which is why the doublespeak artists who argue against fixed-rate mortgages--at the American Enterprise Institute, the Cato Institute, the Heritage Foundation, the Mercatus Institute, and the Heartland Foundation-- adamantly refuse to engage in any discussion that examines loan performance over time. Their right wing conspiracy of silence is part of a campaign to perpetuate The Big Lie that the financial crisis was caused by affordable housing policies.

Review any of the following pieces, and seek out any numbers comparing loan performance between ARMs and FRMs. You'll come back empty-handed:

The Risky Mortgage Business: The Problem with the 30-Year Fixed - Rate Mortgage

The Dark Side of the 30-Year Fixed-Rate Mortgage

The Dark Side of the 30-Year Fixed-Rate Mortgage, Part II

Housing Market Will Be Fine without 30-Year Fixed Loans

Do We Need The 30-Year Fixed-Rate Mortgage?

All of these authors engage in similar sleights of hand. They use words like "risky" and "safe" outside of any context, in order to create an impression of false equivalency.

None of them outdo Edward Pinto of the American Enterprise Institute, who perverts the history of the S&L crisis in the early 1990s, and the recent financial crisis, by claiming they were caused by fixed rate mortgages:

New Bubble May Be Building in 30-Year Mortgages

Government Must Jettison the 30-Year Mortgage

[The reason why Barry Ritholtz says Pinto is "batshit crazy" is because of the ludicrous way he cherry picks facts to conform to his own biases.)

Alex Pollock, Before He Hewed To the Party Line

It wasn't always so. Money talked in September 2007, when Alex Pollock, a resident fellow at the American Enterprise Institute, took note of what $10.5 trillion in residential mortgage deb had to say. Testifying before the Joint Committee of Congress, which convened a hearing on "The Subprime Lending Disaster and the Threat to the Broader Economy, " he focused on the numbers:

A systematic regularity of mortgage finance is that adjustable rate loans have higher defaults and losses than fixed rate loans within each quality class. Thus we may array the serious delinquency ratios as follows:

June 30, 2007

Prime fixed 0.67% Prime ARMs 2.02%

FHA fixed 4.76% FHA ARMs 6.95%

Subprime fixed 5.84% Subprime ARMs 12.40%

The particular problem of subprime ARMs leaps out of the numbers. Also notice that FHA and subprime serious delinquency ratios for fixed rate loans are not radically different. The FHA is predominately a fixed rate lender, whereas subprime is about 53% ARMs. The total range is remarkable: the subprime ARM serious delinquency ratio is over 18 times that of prime fixed rate loans.

(Image by Unknown Owner) Details DMCA

Source: Mortgage Bankers Association

In the years that followed and in the years that preceded Pollock's testimony, one metric in the mortgage has remained constant; Over time, ARMs always perform worse than fixed-rate loans by a lot.

Source: Federal Reserve

Lewis Ranieri's 35 Years Of Experience

Lewis Ranieri, whose career in mortgage finance predated the advent of ARMs, which were first used in 1980, explained the problem to the Financial Crisis Inquiry Commission. "Remember," he said, "we kept experimenting with adjustable rate mortgages unsuccessfully for almost 20 years. Every single one of them blew up." He emphasized that point directly to Alex Pollock at a working luncheon hosted by the U.S. Treasury on August 17, 2010:

Alex, I can give you a history of how many different types of floating rate loans we tried simply because the market wants more floating rate than it wants fixed. Every one of them blew up until Jim Montgomery created the California ARMs with caps and a floor. We never had a floating rate that didn't blow up on us. And that one is only a collar. All of these other structures that we have now never stood the test of time. You have nothing to prove to me that it's not going to blow up in your face.

Ranieri expanded the benefits of fixed-rate loans to the FCIC:

You know, it was always a 30-year fixed rate loan with a powerfulness, you know, the great news of a 30-year loan is you know what the payment is for the rest of your life. Have you underwriting that payment, you know, it's pretty predictable that a borrower gets fired or something, you can make the payment, right, and it amortizes. So everybody forgets how powerful the amortization feature is in a 30-year loan and that's why we picked it.

When we did this all the way back in the early '70s, it wasn't an accident. That structure is immensely powerful to both parties. The first thing you keep counting more and more is home, and the lender becomes more and more secure. So it handles the vagaries of economic cycles and personal disruptions very well, right?

But by 2010, Pollock was no longer willing to engage in a discussion about loan performance. He was not about to violate the information lockdown, and instead penned The Dark Side of the 30-Year Fixed-Rate Mortgage.

Actual loan performance interferes with right wing political agenda, which is to pervert history and claim that the mortgage crisis was caused by government regulation and by affordable housing goals, and not by Wall Street and not by systemic fraud. Because there was only segment of the mortgage market that performed better than prime fixed-rate mortgages, the mortgages acquired by Fannie Mae and Freddie Mac.

Source: FHFA

If Necessary, Cherry Pick Numbers To Mislead

The exception that proves the rule is an an economist at the Boston Fed named Paul S. Willen. He used loan performance data to make an argument against the 30-year fixed rate mortgage, but he cherrypicked his information in order to present a very misleading picture. It's hard to believe that anyone at the Boston Fed, or the Atlanta Fed, which posted his argument on its blog, would buy in to his nonsense.

See if you can identify the doublespeak in Willen's testimony before the Senate Banking Committee on October 20, 2011:

So in Table 1 of my prepared testimony, I show some data that we put together, but everyone who has looked at the individual level data, who has looked at it, the mortgage level data or property level data, has come to the same conclusion. Our sample is a sample of 2.6 million foreclosures, so these are all borrowers who lost their home, and what we show is that 88 percent of them suffered no payment shock prior to defaulting on their mortgage. The mortgage payment they made when they defaulted on the loan was exactly the same as the payment they made when they got the loan, the initial payment on their mortgage. In fact, of that sample, 59 percent of them actually had fixed-rate mortgages. That is something like 1.6 million mortgages. That alone should disabuse us of any notion that a fixed-rate mortgage is an inherently safe product.

Everyone came to what conclusion? That a fixed-rate mortgage is an not inherently safe product? People in finance don't think that way. Some mortgage products are safer or less safe than others, but nothing is "inherently safe."

Anyone who follows the mortgage markets would pick up on Willen's fallacy. Suppose Willen had said "in fact, of the total electorate, 56% of the people who voted for Obama were white. That is something like 37 million people. That alone should disabuse us of any notion that minorities were inherently important to Obama's reelection."

If you understand what's wrong with with that statement, you understand proportionality and one of Willen's little tricks. It's certainly true that most of the votes for Obama came from white voters, because in the 2012 74% of the voters were white. But the key to his attaining a majority of votes was his vastly disproportionate support among among Latinos and African-Americans, who comprise a minority of the total electorate.

Willen excludes the fact that, of the universe of mortgages he considered, 80% of the originations were fixed-rate. So, according to his numbers, the foreclosure rate for ARMS was twice as high as that for fixed-rate.

As for ARMs defaulting before their reset date, but he ignores the salient data. The vast majority of prime loans were fixed-rate, and the vast majority of subprime and Alt-A loans were ARMs. These loan products were used in order to minimize a borrower's monthly payment, irrespective of the longterm risks. Plus, he ignores the fact that ARMs were most popular in the bubble states--California, Florida, Arizona, Nevada--where originators and borrowers tried to minimize monthly payments so that a mortgage would be "affordable." A huge percentage of securitized Alt-A and "prime" mortgages were interest-only or Option ARMs when these mortgages went underwater, homeowners, who saw bigger monthly payments down the road, decided that there was no point in continuing to pay good money after bad.

In his prepared testimony, Willens kind of gave himself away. He referred to data that refuted his theory, but he simply refused to believe it:

It does turn out that ï¬xed-rate mortgages default less often than adjustable-rate mortgages, but that fact reï¬‚ects the selection of borrowers into ï¬xed-rate products, not any characteristics of the mortgages themselves. In 2008, my colleagues and I showed that even accounting for observable characteristics of the loans--such as credit score, loan-to-value ratio, payment-to-income ratio, change in house prices, and change in payment--borrowers were more likely to default on adjustable-rate mortgages than on otherwise similar fixed-rate mortgages. The difference in default rates existed even for pools of loans where adjustable interest rates fell, further confirming that it was unobservable characteristics of borrowers, not of mortgages, that caused the difference.

The money was talking, but Willens refused to listen. Instead, he clung to his "unobservable characteristics." Beware of economists who can rationalize away anything.

Authors Bio:
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 scrutiny by mainstream media. He is trained as a lawyer.

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