The primary influence [sic] for lenders are the signals received from secondary mortgage market investors. A lender originating a large number of mortgages with an unacceptable level of risk will find itself facing significant price disadvantages in the market. These signals prompt lenders to alter product features, introduce new features and remove features that do not work. These product changes are immediate. In this manner, the private market can and does correct for excess risk more quickly than can a regulator who necessarily must move at a more deliberate pace. MBA believes that market signals have already addressed many of the concerns expressed by the Agencies in the Proposed Guidance.
The MBA's claims can be most charitably described as fictions drummed into the authors' heads by neoclassical economists. The secondary market funded the fraudulent lenders. It did not discipline them. Home lending became ever more fraud-friendly through mid-2007. The MBA asserted that the following standard should govern any guidance:
Where guidance or regulation imposes a standard that is not aligned with mortgage markets, the net effect is to limit the ability of mortgage lenders to create viable products that respond to consumer demand.
Yes, you read the MBA correctly -- no regulatory guideline should be issued it if conflicts with "mortgage market" practices. Of course, if it simply reiterated current mortgage market practices there is no point to issuing a guideline or rule, so the MBA position was that the regulators should issue no rules or even unenforceable guidance. After all, the mortgages that the markets offer are by definition "viable products" "that respond to consumer demand."
The MBA assured the regulators that the lenders had decades of successful experience with exotic nonprime loans and that they were not risky.
First, the Proposed Guidance should explicitly recognize that Federally-regulated institutions have successfully offered these nontraditional products for decades and should not be disadvantaged in the marketplace from continuing to do so. Secondly, interest-only and payment-option loans are different products that require different underwriting standards and risk management practices. Finally, though defined as products, interest-only and payment-option are actually loan features that, in and of themselves, do not inherently pose significant risks.
There is no charitable way to characterize these claims. The MBA would have destroyed its credibility with any competent financial regulator (and the FBI if it had the benefit of the regulators' expertise) by this point in its comment letter (and we have only reached the top of page three of an 18 page comment letter). Even casual readers are likely to recall that the standard industry line now is that the industry had only brief experience with such lending and only in benign economic times. In 2006, the industry assured the Nation that the opposite was true.
The MBA reserved its "strong[est]" wrath for the (pathetically weak -- and deliberately unenforceable) proposed guideline provision designed to reduce the endemic fraud by originators of "liar's" loans.
MBA strongly disagrees with the apparent bias in the Proposed Guidance's caution that lenders "should avoid over-reliance on credit scores as a substitute for income verification in the underwriting process.
A credit score, of course, cannot establish the mortgage borrower's capacity to repay the loan. Income verification is the only effective means of verifying the borrower's capacity and it has a phenomenal track record of success in preventing fraud and reducing default rates to the point that they are exceptionally uncommon. Liar's loans, by contrast, have a horrific track record in mortgage lending because they inherently produce severe adverse selection and produce a negative expected value to the lender. The MBA reserved its strongest effort to try to continue the most endemically fraudulent lending practice.
In today's dynamic primary mortgage market, to regress to prescriptive and rigid underwriting standards would be to stunt innovation and limit borrower's access to credit. Mortgage lending today does not need to solely rely on rigid debt to income (DTI) ratios because automated tools and advanced risk modeling have allowed lenders to go beyond simple thresholds for borrowers that exhibit risk mitigating characteristics, such as a high credit score or sufficient cash reserves.
MBA believes the Proposed Guidance's language in the Qualification Standards should be rewritten to remove any prescriptions to specific credit policies that a Federally-regulated institution should adopt."
The MBA was writing in the midst of an epidemic of mortgage fraud through inflated appraisals generated by its hundreds of fraudulent members -- six years after the honest appraisers began their petition asking the government to intervene to prevent the fraud. The MBA comments, however, implicitly assume the epidemic out of existence.
Certainly, a so-called "collateral-dependent loan" with a low LTV and to a borrower with a high credit score would not create undo [sic] financial risk to the Federally-regulated institution.
Well, no, not "certainly" and not even "likely." It is time for a reality check. First, the lengthier MBA discussion that precedes the sentence quoted above makes clear that the MBA's real concern is that lenders would be advised to verify the borrower's income on "collateral-dependent loans." These loans were largely liar's loans, which are endemically fraudulent. Borrowers on liar's loans have to pay roughly 100 additional basis points in interest so liar's loans are always a terrible deal for honest borrowers. Loan brokers pushed borrowers into liar's loans because fraudulent lenders structured their compensation to insure that they received additional fees for originating loans at higher interest rates and because they were incented to inflate the borrower's income to increase the chances that the loan would be approved and they would get their very generous fee for fleecing the client.
Second, "LTV" stands for the "loan-to-value" ratio. "Value" refers to the appraised value. The fraudulent lenders created compensation systems that created an incentive for loan brokers engage in liar's loan fraud and appraisal fraud. By inflating the appraisal the broker (fraudulently) made the reported LTV far lower than the actual LTV. This helped the fraudulent loan originator to sell the loan to the secondary market at a larger profit, which meant that it also increased the likelihood that the lender would approve the broker's proposed loan and pay the fraudulent broker a generous fee for aiding the loan origination fraud. The MBA, however, implicitly and conveniently assumed the epidemic of appraisal fraud out of existence and assured the regulators that loans with low reported LTVs were "certainly" not an "undo" [sic] risk.