February 08, 2008
Just an anecdote, but an interesting one.
One Oakland woman, who asked not to be identified, explained how she exaggerated her income-- with encouragement from her mortgage broker-- when she refinanced her home.
"He didn't say anything illegal out loud," she said. "He didn't say 'lie,' he just made a strong suggestion. He said, 'If you made $60,000, we could get you into the lowest interest level of this loan; did you make that much?' I said, 'Um, yes, about that much.' He went clickety clack on his computer and said, 'Are you sure you don't remember any more income, like alimony or consultancies, because if you made $80,000, we could get you into a better loan with a lower interest rate and no prepayment penalty.' It was such a big differential that I felt like I had to lie, I'm lying already so what the heck. I said, 'Come to think of it, you're right, I did have another job that I forgot about.' "
The transaction between the broker and customer was just the first link in the mortgage securitization chain. To the extent that the originator washed his hands of the whole thing by immediately selling off the loan to the next sucker in the chain, you can understand the incentives for the originator to cheerfully go clickety clack on his computer. But as I've said many times, the big question (and fundamental problem) arises from the incentives for investors further up the chain who willingly poured in the cash necessary to fund these deals.
One key problem with that chain of incentives seems to be the off-balance-sheet status of the bankruptcy-remote trusts that ultimately held the loans. Tanta interprets a recent statement from Financial Accounting Standards Board director Russell Golden as signaling the intention of the FASB to end the off-balance-sheet status of such entities. If so, I would view that as an unambiguously favorable development.
The brighter the light we can shine on this whole process, the better. And the accountants would serve us well by leading the charge.
Posted by James Hamilton at February 8, 2008 06:52 AMdigg this | reddit
There was a good scene in 3rd Rock from the Sun several years ago. A life insurance salesman was at the house getting details on Harry's lifestyle.
Harry kept insisting that he smoked, and the salesman kept insisting that he didn't.
Posted by: tachyonshuggy at February 8, 2008 07:35 AM
When I was in college – graduated in 2004 – I wanted departmental honors in to accompany my general honors. I wrote an extensive paper on Ethical and Responsible Sub-prime lending in inner-city St Paul. The paper focused on the lack of responsible lending, what it was doing to neighborhoods, even during that time, and how the situation could be helped.
Because these were the salad days of sub-prime lending data was easy to come by and many of the things I found were striking. It still blows my mind that a 20-something college student can see what was happening but professionals couldn’t/wouldn’t acknowledge it.
I spent an eternity on the paper and thought it was thorough. Unfortunately it was before its time. I did not get departmental honors and my work went hardly unnoticed. Ultimately graduating Magna CL was satisfying enough for me. I do wish the paper would have had more impact however. Because times were so good my paper amounted to shouting in the dark.
Posted by: JS at February 8, 2008 08:11 AM
Can you post the paper?
Posted by: Buzzcut at February 8, 2008 08:32 AM
My opinion is that there is considerable pressure on securities and accounting regulators to clean up the securities industry. The reasons are manifold: Loss of confidence among international and domestic investors in US securities; Excessive debt burden on the US economy depressing real GDP growth; Serious structural damage to the US banking system and monetary stability.
Eliminating QSPEs will have the immediate effect of reducing corporate liquidity while at the same time improving the accuracy and transparency of financial statements. The credit bubble will shrink somewhat, and investor confidence will be improved. I suppose that FASBs QSPE intentions can be added to the list of recent regulatory innovations (Sarbanes-Oxley, etc.). However, I do expect that all the players who have been exploiting SPEs will squeal loudly.
Posted by: MarkS at February 8, 2008 09:06 AM
Contrary to politicians blathering, the subprime problem is not Ma and Pa Joad being turned out of the family homestead by Snidely Whiplash.
"Speculators May Have Accelerated Housing Downturn: Rising Number of Defaults Also Could Complicate Effort to Help Homeowners" by Ruth Simon and Michael Corkery in the Wall Street Journal on February 6, 2008 at Page B8[$ Link]:
"As lenders ... are learning that the number of people who bought homes as investments is much greater than previously believed. ... Roughly 20% of mortgage fraud involved "occupancy fraud," or borrowers falsely claiming they intended to live in a property, according to an analysis by BasePoint Analytics, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in."
Posted by: Fat Man at February 8, 2008 09:29 AM
Re fat man's comments:
I was recently playing with some MA RE data, looking at sales of condos and SFHs in the Boston area in 2006. A striking number of sales involved 100% financing 80/20 loans (some exceeding sale price - ?). SFHs less so, but still surprising. I would think that after at least 5 years of easy money that there would be no demand left (MA pop growth since dot com bust has been anemic), so I assume this demand is being met by speculators and people who in no way could actually afford a home without lying about income.
So, I would think that with some straightforward econometric analysis it would be very easy to show the incentives for the originator to go "clickety-clack."
Posted by: anon at February 8, 2008 10:39 AM
This really can't come as a shock to anyone, can it? I had students ask me the other day about the role of borrower "fraud" in the current crisis.
Fraud, I replied such an ugly word for a practice that was tacitly condoned. Thats like suddenly accusing someone who has been cutting through their neighbor's backyard for years of treaspassing.
Posted by: Karl Smith at February 8, 2008 12:36 PM
I believe this article addresses the fundamental problem of no-doc loans. Why lenders would lend money to a borrower without documentation defies the imagination until you realize the import of the article that shows that each actor can simply wash his hands of the matter by unloading it to somebody willling to purchase the loan. Those entities on up the foodchain who purchased investments containing subprime and Alt-A loans are now stuck with a financial product that nobody wants - even at a drastic discount. Unfortunately, this is an election year and the politicians are pandering to the investment/banking community with taxpayer funded bailouts. Since we elected these idiots, we have no one but ourselves to blame. In defense, however, this idiot submits that he did not really have much to choose from to start with?
Posted by: Boomer55 at February 8, 2008 06:25 PM
At the end of the day, there was a portfolio manager who decided to put these securitized no-doc mortgages in the portfolio.
Did he know that the mortgage pool consisted of no-doc loans? If not, why not?
Posted by: Norka West at February 8, 2008 08:00 PM
Posted by: zinc at February 8, 2008 11:23 PM
Finally you see the imbalance when you blocked my comments three years ago.
Welcome to reality.
Posted by: zinc at February 8, 2008 11:27 PM
"... the intention of ... FASB to end the off-balance-sheet status ... I would view that as an unambiguously favorable development."
The good doctor recommends strong medicine and we are inclined to admire him for it. The patient may become very sick before recovering, however. In fact the patient may look up wearily with a questioning look as if to say "unambiguously favorable? Really? You must have trained in Vienna..."
Posted by: STS at February 8, 2008 11:34 PM
Good that FASB has decided to act against a problem that has already manifested. The practice in question was explicitly allowed by FASB until now. Horse...barn. Ship...sailed. Since we know the history of bad lending practices in conjuction with easy monetary policy, of separating incentives from risks, all the stuff that goes into creating bubbles, hows come FASB (and the SEC, apparently) don't lean AGAINST the wind, rather than with it?
Oh, yeah. I forgot. Moneyed interests.
Posted by: kharris at February 11, 2008 07:07 AM
There we have it: SEC.
Lights on but nobody home...gone fishin.
I dunno JS. We will do all in our power to redistribute your "before it's time" (so unlike "premature") essay which may have just needed a proof reader:
I spent an eternity on the paper and thought it was thorough. Unfortunately it was before its time. I did not get departmental honors and my work went hardly unnoticed.
Did you thoroughly preview this comment before 'Post'? Would you B upset if some of us thought the Department might have a case? I will B upset if you don't see the humor of your ways.
Ok, here's to my continuing editorial support for your soon-to-be illustrious career.
Posted by: calmo at February 11, 2008 02:23 PM
In the late 1970's I was a very active Realtor. Most my customers had w2's with high income-- good income ratios and a bad credit history. They were prime candidates for lender's requirements then and also for today's new FHA guidelines. Most of them went into foreclosure in 2 years. Myself--I've used NO Doc loans and today have excellent credit- no late or missed payments. I'm not unusual. I'm a NO DOC candidate because I always have and always will make good on a loan.
Posted by: Ernie at June 2, 2008 05:40 PM