Financial Katrina
The subprime debacle may start being characterized as a Financial Katrina.
The anecdotal articles of black, Latino and other minorities who will be losing their homes are now being published on a daily basis all over America - they are hard hitting and scary. The sins of "predatory lending" - saddling lower income homeowners with loans they can't afford - and "discriminatory" lending - just charging higher rates based on their resident location or even race - becomes the warcry. However, we as real estate professionals remember two years ago when such subprime loans were offered as an entry level way for anyone to become a homeowner or investor. They weren't called predatory then as they facilitated the American Dream.
At best, the selling of the American Dream to low income homeowners might now be called "illusory". Now, the rug is really being pulled on them. With the bankruptcy and closing of subprime shops like New Century, the subprime homeowner is lost... no lender (almost all of them have suddenly instituted credit tightening guidelines) will work with them, and foreclosure becomes inevitable.
This debacle goes beyond the desperate individuals and families. The Woodstock Institute of Chicago, a nonprofit community economic development research center, has shown that houses within an eighth of a mile of a foreclosure lose 1 percent of their value. If true to form, the values of subprime financed homes will fall faster, aggravating whole communities... and these are the marginal communities that need the most support to maintain the livability of any city. Riots happen when whole communities fall apart.
I don't think the Bush administration or the Republican party can afford to ignore this Financial Katrina after what happened in the real Katrina two years ago. This will become a political issue - the Democrats will certainly grasp how callous the situation is for minorities. And by the way, this is one reason why I think Bernanke can't raise interest rates - it would increase foreclosures, accelerate politicization and be perceived as uncaring, to put it mildly.
Technorati Tags: financial katrina, katrina, foreclosures, subprime, subprime loans, American Dream, home ownership, New Century
Pat
Good pick up on the detrimental effect of a single foreclosure on an entire community. I agree strongly about the politicization of the subprime debacle by one party or both. The situation is to enormous to ignore.
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Hi Patrick,
Thanks for your comments on this serious issue. If I recall correctly, in the same press release that announced the upcoming closing of the Fannie Mae Foundation, Fannie was going to refocus its charitable work specifically at the politically sensitive areas of New Orleans and Washington DC. In view of your analysis, doing nothing would risk future riots in the US capital, so Fannie for one seems to be trying to act. Its bad enough contemplating the future of the Buffalos, Clevelands, and Detroits.
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Good post, Pat.
Interesting to see one of your articles is from the Houston Chronicle. Here in Houston we’re still feeling the fall out from Katrina the hurricane, and I’m sure that this “financial Katrina” will add to the problems that a lot of low income communities are facing.
In the long run you can’t make money by issuing a $360k loan to a 57 year old maintenance worker with poor credit who makes $35k a year – the case sited in the Woodstock article. This isn’t a sustainable business model.
A broker who bags a commission doing a deal like this is both deceiving the unsuspecting borrower and, effectively, stealing from the company that he’s sticking the loan to.
There are a number of ways of dealing with this. First, companies that are starting to take on water will be forced to clean up their policies, alter their practices, and fire unscrupulous employees. Second, bad actors need to be punished under existing laws – especially senior managers who encouraged illegal predatory lending practices.
That said I’d hate to see a cure that’s worse than the problem it’s trying to solve. (Australia was dealing with an infestation of bettles in the 1930s and someone came up with the bright idea of importing toads from South America. And to this day they’re dealing with an infestation of toads - http://snsimages.tribune.com/media/thumbnails/photo/2007-03/28643781.jpg).
I don’t know whether or not a tactic to obfuscate and confuse potential borrowers is illegal, if it isn’t then it should be. But I’d hate to see legislation which drives companies to close the doors of their sub-prime lending practices altogether.
Fair, transparent loans (no resets, fees openly disclosed) at higher rates to borrowers with poor credit history is a good thing for communities.
I think your assertion that this may become a political football is correct. I just hope that fact helps the situation, instead of further confusing it.
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The problems of the subprime borrowers are isolated to the communities and individuals involved. Our capitalist system doesn't have the socialist capability of bailing out the poor... it would be unfair to offer sweetened deals to subprime borrowers to keep them afloat. I think attention to community development, as FNMA seems to be doing (as mentioned in a previous comment) will become the political means for assisting communities hurting from the instability of foreclosures.
I should mention there's no 1980's S&Ls to bail out here... the FDIC, a federal agency, had guaranteed loans made by S&Ls who acted fraudulently. All the subprime lenders had private backers.
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Hmmm, you know, it's something that most people ouldn't even think about, but I'm glad you got it out there. There should be more said and done about these problems.
Well said!
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http://www.inman.com/inmannews.aspx?ID=62741
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Great post. There are a number of issues here but the thing I think about is the incentives by financial institutions to create dubious loans because there is a large secondary market for them artifically supported by the GSA's like Fannie Mae. If I, as a lender can just originate a loan, pick up a fee, and then sell the risk to intermediaries like investment banks leaning on Fannie Mae, why not? Why not push the underwriting envelope because I like money. Don't you?
I strongly believe that the Governement has created perverse incentive by swallowing Fannie Mae's defaults. There was a time and place for Fannie when your race or gender meant no credit or when the country was in bad times. Perhaps now is the time to refashion them as a lender of last resort (the Federal Reserve for Mortgages) rather that a provider of liquidity. The world is awash with liquidity and there are real incentives to lend - at the right price. Do we really need Fannie Mae and Freddie Mac as they exist today?
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Interesting article, Matt. Last week at the AEI event on subprime, Des Lachman asserted (around 22:40 on the video) that the subprime meltdown, etc, would be the issue in the 2008 election. Your piece supports that view.
Karim, the government hasn't swallowed Fannie's losses yet, and remember it's only an implicit guarantee.
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John,
That is sort of true. They do receive compensation for defaults above specific levels. Question: do you think that this Federal default coverage, implying a guarantee, affects how the capital markets assesses the credit risk of default? I feel certain that their cost of capital would rise dramatically if the market thought they could fail.
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I researched the internet and could not find any conclusive evidence on Federal default coverage and its impact. Is it safe to assume that FNMA's exposure to subprime loans would be small in its huge portfolio and would easily be hedged?
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Karim, I didn't know about the compensation for defaults. Have you got more details? The short answer to your question is "yes". For an exhaustive discussion you can review the 03 Feb 2005 AEI event "Receivership">http://www.aei.org/events/eventID.996/event_detail.asp#">"Receivership Powers: What Are They and Should Fannie and Freddie's Regulator Have Them?" S&P's FNM analyst Michael DeStefano was grilled at length on agency debt's AAA rating and the implicit guarantee, and he gave surprisingly candid responses. We summarized this amazing performance last July 31st in a post titled "Debt">http://housingdoom.com/2006/07/31/gse-risks/">"Debt in the Afternoon".
Pat, I'd refer you to links in our Feb 21st post "Super">http://housingdoom.com/2007/02/21/super-freddie/">"Super Freddie! Can Syron Stabilize Subprime?" where we point to assertions in The GSE Report for Feb 19th and Jan-Martin Feddersen's Immobilienblasen for last Sept 18th that relate to F&F's involvement in subprime.
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There will be a huge revolt if the government even gets close to debating a bailout. Call it corporate welfare.
Sh*t runs downhill. The investors and shareholders will sue the subprime lenders, who will force the predatory mortgage brokers to buy back the loans. Predatory retail mortgage brokers forced to do this will go out of business.
What would be interesting reading right about now: A blank contract between a subprime lender, say, New Century, and it's investors, and then the other contract, the one between lender and mortgage broker.
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Patrick,
most of problems from these defaults, stem from loan officers who have no experience, who are only focused on the almighty buck, and the easy availability of stated income loans. These factors encourage these agents to encourage borrowers to knowingly and unknowingly commit mortgage fraud. And than you have it as Jefferson so kindly put it, the "masses are asses". Too many people don't want to read anything, even when they can, and end-up signing something later they regret, simply because by signing they get what they desire at the moment be it a new house or cash.
Just last week, I advised a client that there are always ways to get a loan, but they'd have to lie about their income on the loan application to do so, and that is considered mortgage fraud. And even if they get the loan, she would be struggling to keep up on the payments because her debt to income ratio would be over 70%. She didn't like the news. I just got feedback from my referral source she want to another broker who got her the loan to buy this vacation property. To top it all, she's a paralegal.
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