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.
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:
I t 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.
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...)
