Reason In the Air

If you're paying too much for your optional ARM or interest-only loan, tune in to Airtalk with Larry Mantle (actually guest host Jon Beaupre), a gabfest on NPR Los Angeles affiliate KPCC 89.3 FM, which was kind enough to have me on a panel about the U.S. Comptroller's new guidelines on "predatory lending." Listen here.

Reason has chiseled interest in the expansion of financing in the past: James Twitchell took a look at how the longterm debt revolution put more money in everybody's pockets, while Mike Lynch said a prayer for the legal loan sharks of "payday lending."

Comments

[smerkin]

the issue is full disclosure — perfect information makes for perfect markets, natch! and you’ve gotta lemon ;P

[Sandy]

Pity you didn’t bend this guy‘s ear before he lied on loan applications and ended up with $2 million in unpayable debt and houses worth less than the loan amount. And he’s 24. And married.

[highnumber]

If you think the fed’s predatory lending laws are inane, draconian, misguided, or whatever other derogatory adjective you can think of, don’t move to Illinois. IL House Speaker Michael Madigan sponsored HB 4050. His spokesman sums up politicians’ view of the mortgage industry:

“Certain elements fought this bill tooth and nail,” said Steve Brown, a spokesman for Madigan, whose district is in the targeted area. “It’s not surprising that these elements and their allies have found new things to complain about.”

and

“There are lists being circulated, but I don’t know if people seeking financing are actually being turned away,” Brown told Inman News. “This whole thing was fought tooth and nail by the predatory lenders and their allies. My guess is once the program gets going, it will be expanded into other areas of Illinois until these people (predatory lenders) are run out of town, and it will be a model for other states.”

Wherever you live look out.

[highnumber]

Sandy,

I just emailed the link to that kid’s blog to everyone at my office (we’re a mortgage banker) and my wife (she’s an underwriter). That is one of the scariest things I have ever read about our industry. It is kind of funny, too. Like the Motley Fool writer, I too wonder if it isn’t a hoax. Can someone really be that c-a-t dumb and proud?

[shylock]

If you’re paying too much for your optional ARM or interest-only loan, tune in to Airtalk with Larry Mantle

..and when you’re done with that, email me. (C’mon, it’s not spam if I’m a regular and it’s topical, right?)

Wherever you live look out.

Looking!

[anon]

Great job, Tim.

[Speedwell]

Are the groups who are coming out against payday loans really serious about saying that the payday loan customer would be economically better off just bouncing a check?

Uh, that’s a crime. How much money do you lose if you have to miss work, go to court, pay a fine, possibly go to jail?

And I have nothing but contempt for people who can say with a straight face that “people in need of short term cash” should start savings accounts. Oy.

[highnumber]

I’m trying to listen to the radio program right now, but I think the Reason server squirrels are moonlighting. Streams for 5 minutes then I have to restart, jump ahead to where it cut out, then do it all again. Grrr!

[Ammonium]

When I bought my house using an ARM, I had to sign like five different pieces of paper acknowledging that my interest rate may go up. These were actually the most easy to read things I signed during my house buying.

I suppose that if you didn’t bother doing any research, and you come to the closing and are presented with a piece of paper telling you how your monthly payment could double, you might not know what to do. But I found information to be readily available from the loan company. If you’re taking out a gigantic loan for a house, it is prudent to do just a little bit of research before committing.

[Larry A]

If you’re taking out a gigantic loan for a house, it is prudent to do just a little bit of research before committing.

But if you do your own research, you might not come up with the Government Approved Answers.

[highnumber]

At about 15 minutes after the program began, someone finally called out the host on his use of the term “predatory lending.” This has become the boogeyman phrase for regulators. The prof who defined it did a great job. It has nothing to do with ARM vs fixed, neg am vs full am. Predatory lenders charge rates, fees, and points way above what the rest of the market would charge any borrower of a certain risk. Whether the gov’t has a duty to protect the consumer by interfering in the market is of course a dumb question to ask at a libertarian website, but if you are the sort who believes that it is gov’t’s role, at least understand the damn term.

[highnumber]

Tim,

It’s a shame you weren’t able to contribute more on the show. Prof Gabriel was pretty righteous. He knew what he was talking about. The host, on the other hand, seemed to be entirely ignorant of the mortgage industry. He must be a renter. The woman in DC or one of the Carolinas had some wild figures that I think were pretty far off. 70-80% of mortgages are ARMs? Maybe in certain markets, but overall, I am fairly certain this is wrong. The yield curve has been flat or inverted for a while. Conventional mortgages are all strictly fixed. I checked Tuesday’s pricing while listening to the show, and 30 year fixed, 3/1 ARMs, 5/1 ARMs are all at exactly the same price for a rate @6.500%.

[James]

Sandy: I have heard that in some overheated real estate markets up to fifteen percent of the housing is owned by speculators. But it never occured to me to link that statistic to the “get rich quick/no money down” investment seminar industry. Frankly, I think those snake-oil salesmen have done a lot more damage than “predatory lenders.”

Oddly enough, some lefties defend the payday lenders and pawn shops on the very grounds libertarians would: they are lenders of last resort for people who have no other resource, ie the poor who would otherwise bounce checks, get eviction notices, or be arrested for failing to pay child support. Life sucks down there at the bottom, but there’s no situation so bad the government can’t make it worse.

[Herrick and His Balls]

I’ve wondered if there are people who decide against checking out a house if its profile says its in a “gay friendly” neighborhood.

[ChrisO]

Actually, from what I’ve read, the urban coastal markets are running around 50% ‘non-traditional’ mortgages like I/Os and option ARMs, and much higher than that in places like San Diego and Orange County. How else do you think Mr. and Ms. America are ‘buying’ $800,000 houses on household incomes under $100k? Not to mention all of the speculators.

As long as no fraud is involved, then I don’t see a proper government role. Just know that this sucker is starting to crash, and it’s going to crash hard. Add to the overextended homebuyers all of those idiots who maxed out their ARM home equity lines of credit to pay for Hummers and big-screen TVs, and you’ve got the makings of a disaster. We are in debt up to our eyeballs in this country, with very little in savings to fall back on.

[downstater]

our office has been tracking foreclosures in our county and some of the data is amazing.

in a given year, our county has about 1500 foreclosures. in the past year, there have been about 2500. further, when coupled with the data of homebuyer income and home price increases, we see a great deal of areas where people with 50%-75% less income than the existing median are buying houses which have risen in price 50% over the last few years.

in short (for the sake of using round numbers), homebuyers making 50K-75K are buying 300K homes where a few years ago, people making 100K were buying the same homes for 200K and foreclosures are going up.

now i don’t know if providing these loans is “predatory” or not. i’m not sure if that’s really relevant. the scary thing i see is that banks seem to be willing to make riskier loans and they don’t seem to be paying off so well. wasn’t there a time when it was supposed to be somewhat difficult to get a loan? you had to dress nice to go to the bank to convince them you’re a good risk, etc.? while i agree that that it is a good thing to provide lending services to riskier people who need it, however it seems to me (admittedly a non-expert) that the loans given are out of proportion to the risk.

my basic question is: how does someone who never would have qualified for a loan for X dollars before be seen as a good risk now? perhaps some people here who know more about lending than i do could educate me, cause it seems a bit scary to me.

[downstater]

our office has been tracking foreclosures in our county and some of the data is amazing.

in a given year, our county has about 1500 foreclosures. in the past year, there have been about 2500. further, when coupled with the data of homebuyer income and home price increases, we see a great deal of areas where people with 50%-75% less income than the existing median are buying houses which have risen in price 50% over the last few years.

in short (for the sake of using round numbers), homebuyers making 50K-75K are buying 300K homes where a few years ago, people making 100K were buying the same homes for 200K and foreclosures are going up.

now i don’t know if providing these loans is “predatory” or not. i’m not sure if that’s really relevant. the scary thing i see is that banks seem to be willing to make riskier loans and they don’t seem to be paying off so well. wasn’t there a time when it was supposed to be somewhat difficult to get a loan? you had to dress nice to go to the bank to convince them you’re a good risk, etc.? while i agree that that it is a good thing to provide lending services to riskier people who need it, however it seems to me (admittedly a non-expert) that the loans given are out of proportion to the risk.

my basic question is: how does someone who never would have qualified for a loan for X dollars before be seen as a good risk now? perhaps some people here who know more about lending than i do could educate me, cause it seems a bit scary to me.

[highnumber]

downstater,

The lending business has changed dramatically in part due to automated underwriting systems. These are computer programs that take into account one’s ability to repay debt, one’s willingness to repay debt, and the ratio of the loan amount to the value of the property – really the same factors that came into play in the past. The difference now is that when a computer program is looking at current and historic income, amount of reserve funds, total indebtedness, history of debt repayment, and loan to value, the program looks at the total picture with an eye towards statistics of default far more effectively than a lowly human could. This accounts for borrwers who obtain a mortgage at 70% LTV, with 800 FICOs (credit scores), but a DTI (debt to income) or “back-end” ratio of 85%, when, typically, manual underwrites allow for a DTI of 45%, or slightly higher with compensating factors like a lot of reserve funds. Conventional financing with automated underwriting now also allows for some stated income and interest only loans.

The worlds of subprime, negative amortization, 100% financing (usually two loans, known as 80/20s), and no-doc loans are still based on manual underwriting for the most part, although these programs also use nominal automated underwriting, which mostly really a pre-qualification engine. The guidelines for these programs are also based on statistics, but much more emphasis is based on FICO scores, and the guidelines are much stricter – usually much less wriggle room.

High LTVs combined with no principal reduction or even negative amortization hit the market when housing prices were already rising. This was good in the sense that people could keep buying homes, but it also served to help keep driving prices up. Now we have all sorts of loans, the likes of which we have never seen, on the banks’ books while home prices are stagnating or even falling in certain areas. Combine this with lenders subtly and overtly pressuring appraisers to juice up values for refinances, and even purchases, and my common sense tells me the banks could be in a lot of trouble. We don’t have much history to look at for neg am loans or for so many loans on the books at such high LTVs. Lenders are already tightening up a lot of the standards for these non-conforming loans, which is a good thing, although it won’t do anything to increase home values.

In short, the answer to your question is that lenders use more complicated statistical models. Some of the these models, however, have a longer history behind them.

[ChrisO]

The other aspect to this is the rise of the secondary mortgage market–mortgages are packaged together and sold as securities. As a result, the issuing bank has less interest in what happens to the borrower five or ten years down the line–in other words, they aren’t going to scrutinize too hard whether a borrower can really afford to pay once the I/O or option loan resets to a higher rate or if they have a family difficulty and are stuck with a DTI ratio of over 50%, which is now increasingly common in the higher-priced markets.

These securities do have buy-back provisions under which banks are forced to buy back the loans if they default within a certain period, but I still believe that banks are mortgage brokers feel much less pressure to ensure that a borrower can truly afford the loan.

Housing prices in the bubble markets are so far above the fundamentals (rental value, median income) that almost everybody in those markets becomes, in effect, a ‘subprime’ borrower. Under traditional lending standards, a household needed about $200k income in order to buy a $600k house. Suburban crackerboxes in California now routinely sell for over $1 million. Very few people can legitimately afford those.

[highnumber]

ChrisO,

Have you read Liar’s Poker? That was a great book, wasn’t it?

I don’t think that banks don’t care what happens to their mortgage securities down the road. If that were the case, the value and saleability of the securities would be affected, which would wreak havoc on the markets that they rely on.
Most loans pay off much more quickly today than they did in the good old days, so lenders, or investors in the parlance of the industry, are right to not be very concerned about what happens 10 years down the road for most loans. Neg am loans are not a problem for the borrower or investor when they convert to full am usually, because the borrower will refi into either another neg am or a 30 year amortization both of which help to keep the payment lower for the borrower. The potential problem is that a market like ours went up really quickly and a lot of people borrowed far too much of their equity when the housing market was peaking. I don’t think these types of loans are inherently bad, but they hadn’t existed for very long when we saw a boom, and everyone jumped on the bandwagon to offer the hottest new loan product, without, it seems to me, fully understanding the possible consequences of a bust.

[highnumber]

Clarification:
are right to not be very concerned about what happens 10 years down the road for most loans.

They are concerned, but the fact that the loans will pay off within ten years is taken into consideration.

[ChrisO]

Actually, I haven’t read Liar’s Poker, but I should, as it sounds fascinating.

If the banks are counting recent homebuyers being able to refi their exotic loans, I believe they are in for a rude shock. These homeowners are sitting on an asset that is currently depreciating and is unlikely to being appreciating again for a number of years (look how long the last bubble took to unwind). Many of these borrowers are already underwater and it’s only going to get worse over the next several years.

Exotic loans certainly have their place, but they became a device to allow people to “get into a home” at prices they couldn’t afford. Not only did it make the current bubble possibly the worst in U.S. history, but it probably made the coming recession much worse than it had to be. Of course, nobody put a gun to anyone’s head and made them take out a neg-am. Borrowers saw dollar signs, didn’t do their research on the history of residential real estate crashes, and took the fatal plunge.