May 02, 2008
Fast and Easy Fannie
The Wall Street Journal had a very disturbing story on Wednesday about the "Fast and Easy" loan program of Countrywide Financial Corporation, many of whose mortgages were bought up by Fannie Mae.
Some of the problems are surfacing in a mortgage program called "Fast and Easy," in which borrowers were asked to provide little or no documentation of their finances, according to [people with knowledge of a Federal probe] and to former Countrywide employees.... Fast and Easy borrowers aren't required to produce pay stubs or tax forms to substantiate their claimed earnings. In many cases, Countrywide didn't even require loan officers to verify employment, according to an October 2006 presentation by Countrywide's consumer-lending division. That left the program vulnerable to abuse by Countrywide loan officers and outside mortgage brokers seeking loans for customers who might have been turned away if their finances had been more closely scrutinized, according to three current and former Countrywide senior executives and to several mortgage brokers who arranged loans through the program.
But here's the part that really scared me:
Both Countrywide and Fannie Mae, the government-sponsored company that bought many of the loans, classify the loans as "prime," meaning low-risk.... A Fannie spokesman agreed that the verification of employment wasn't required on all loans, but added that Countrywide was expected to verify employment details on a "sampling" of loans. The Countrywide spokesman said his company fulfilled that obligation.
It's news to me that Fannie was buying no-doc loans and calling them prime. I presume that if the WSJ article is correct as to the magnitude of fraud, Fannie would have a case in trying to recover any losses by suing Countrywide. But if Countrywide goes bankrupt, that plus a few dollars will get you a cup of coffee. Or perhaps we hope our Fannie is covered by credit default swaps that are supposed to pay if these loans default. Unfortunately, it doesn't require much imagination to conjecture a scenario in which the counterparty to those CDS also lacks the resources to make good on their promises. So who's holding the bag here?
From page 102 of Fannie's 2007 Annual Report, as of the end of 2007, the enterprise had leveraged $44 B in stockholders' equity with $796 B in short- and long-term debt to acquire $761 B in mortgages either held outright or intended for resale or trading. I read that as an equity cushion against a 5.8% loss on the mortgages held directly (44/761 = 0.058). But in addition (page 1), Fannie has guaranteed $2.1 trillion in separate mortgage-backed securities it has sold to outside investors, for a ratio of core capital to total book of business of 1.6%.
From the beginning, my conception of a really big financial meltdown would be one that pulls one of the GSEs into insolvency. Please tell me why it can't happen.
Posted by James Hamilton at May 2, 2008 06:20 AMdigg this | reddit
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» May 2, 2008 from PrefBlog
Finally, there is a good crop of links today! James Hamilton of Econbrowser remarks on a WSJ article about prime no-doc loans, which arose through a Countrywide “Fast and Easy” programme which generated no-doc / low-doc loans which were the... [Read More]
Tracked on May 2, 2008 05:44 PM
Hmmm, so you were not aware that all FNMA approved lenders have access to FNMA/FHLMC automated programs that allow reduced documentation for certain loan profiles that have high credit scores, good assets and good employment histories?
These are customers who meet the profiles that show low delinquencies across the board and there would be nothing gained by making customers prove income or assets.
Perhaps you should do a little more research before painting Countrywide with such a wide brush for doing what many lenders have done thru FNMA/FHLMC. The question is whether the loan originators loaded correct info into the computer or did they commit fraud. If fraudulent info was loaded, then the automated results would, of course, be scewed
Posted by: TEHelms at May 2, 2008 07:39 AM
JDH says, "It's news to me that Fannie was buying no-doc loans and calling them prime."
James, as a faculty member you should know that not even a rattlesnake is more dangerous than a precedent.
The whole point of the exercise from the beginning has been to socialize losses while privatizing profits. This was obvious when the Fed first started taking uninsured paper back in mid '07. It was a horrific precedent, one that has been followed up with the even more horrific precedents.
Given the magnitude of the re-pricing of mortgages, there were only two ways to prevent an earthquake in the financial sector: pay off mortgage holders or pay off financial institutions. The former would have been relatively cheap, but required Congress to act promptly. The latter is expensive and could be done by abusing the charters of the Fed and the other quangos, damaging trust in the financial system for decades.
So, of course, we did the latter.
Posted by: Charles at May 2, 2008 07:40 AM
"So who's holding the bag here?"
Answer: The same sucker who's always holding it.
Posted by: esb at May 2, 2008 08:34 AM
Isn't Fast and Easy is just another term for Accept Plus? Countrywide just marketed it their own way? Any borrower with a low loan to value and a high credit score (at least 680 or better) can get an accept plus from both FNMA and FHLMC. Every lender out there has access to this product. The only thing that makes Countrywide different is that they were smart enough to market to product.
Posted by: Accept Plus at May 2, 2008 08:40 AM
One cousin alone is holding $1.1M of IO loans, on a family income
We're gonna have a problem when the accountants find out their aren't as many beans in the warehouse as there are on the books. But the Fed is guarding the warehouse and won't let anyone in to count beans, so all is well.
Posted by: KnotRP at May 2, 2008 09:01 AM
...curse you, html brackets.
on a family income under $100K.
They sellers walked off with the real asset (the money) a long time ago.
What's left is something under $600K worth of homes, if one thinks income and house price have a causal relationship under normal conditions.
Posted by: KnotRp at May 2, 2008 09:04 AM
I have worked for both BOA and Countrywide and Fannie knew about these loans and approved them. At the boom they had a lower default rate then full doc loans. Rember the main underwriting critera was credit and a decent loan to value. Countrywide of course push the envelope more that most lenders by easing standards and now is paying for it.
Posted by: TOM at May 2, 2008 09:29 AM
What a bogus article about a lender who followed the guidelines established by Fannie and then when the loans go bad they want to blame everybody else but the people who set up the program.
My guess would be that they allowed higher LTV's than they should have...over 80%....and probably had rates lower than they should have have...and probably allowed these loans for all transactions when it should have been for refi's only.
Fannie is no different than the wall street firms (gangs) who leveraged everything on production and threw quality out the door with the bath water.
Posted by: Mugsy101 at May 2, 2008 10:16 AM
"GSEs into insolvency. Please tell me why it can't happen."
Cause FED will throw money and avoid it. If they can bail out Bear Stearns, they will pretty coolly save GSEs.
anybody disagree ?
Posted by: Dr.Dan at May 2, 2008 11:12 AM
Pricing was the problem--FNM became dependant on CFC for market share and CFC bullied FNM to accept Fast & Easy (nickname: Fast & Sleazy) loans at guaranty fees that were way too low because they were the same as or close to fully documented prime loans even though they were riskier Alt-A loans. As the bubble inflated, defaults were remarkably low on all sorts of risky products, including F&E. F&E loans are really "stated income" (aka: liar loans). Originally called "internet loans," the assumption was that early internet users were sophisticated borrowers who had excellent risk characteristics. It got twisted/expanded from there. And btw, CFC often used its own automated underwriting system (CLUES), which the GSEs were never allowed to examine.
Posted by: 76s at May 2, 2008 11:23 AM
dan, i am a reporter for a major publication. can we talk re F/E???? pls email me.
Posted by: reporter at May 2, 2008 03:17 PM
Reporter, I'm guessing your query is for 76s, not Dan.
Posted by: JDH at May 2, 2008 03:36 PM
The answer to why it cannot happen is, I think, because the US government won't let it happen (see comment above). Not when the US government is looking to the agencies to offset the fall in lending from folks who used to repackage mortgages into "private" MBS. No GSEs, no mortgages at current rates ...
And then there is the probability that the Agencies are now, in some sense, too Chinese to fail. China's reserve manager -- SAFE -- has about half of its (visible) US assets in Agency bonds, a sum that is now close to $500b. Real money. I strongly suspect that China would view the collapse of one of the Agencies and associated losses rather negatively. And I suspect that would influence US government decision making in a crisis.
Please tell me why I am wrong!
Posted by: bsetser at May 2, 2008 03:58 PM
* * *
At the height of the mortgage boom, however, especially in pricey markets, the liar's loan became a routine way of doing business; for some lenders—both smaller ones like IndyMac and WMC as well as big ones like Countrywide and Washington Mutual—it was the main way. In 2006 in some parts of the country, these loans made up as much as half of new mortgages, for both subprime borrowers and for homebuyers with high credit scores.
* * *
In 2006, a man named Steven Krystofiak gave a statement in a Federal Reserve hearing on mortgage regulation, representing an organization called the Mortgage Brokers Association for Responsible Lending. The organization had compared a sample of 100 stated income mortgage applications to IRS records.
More than 90 of the applications overstated the borrower's income at least a little. More strikingly, more than three out of five overstated it by at least 50 percent. ...
A blogger named Michael Shedlock ... analyzed one particular bundle of loans from Washington Mutual consisting of 1,765 mortgages from around May 2007, a total of $519 million in loans. These were not "subprime" loans. The borrowers' average credit score was 705, well within prime territory. This is a fairly typical package of loans for a mortgage-backed security, but one thing that does make it stand out is the proportion of these loans that didn't ask for income documents: 88 percent.
Historically, a year into the life of a loan, well less than 1 percent of typical prime loans would be 30 days late or more. By the end of January, when Shedlock first looked at it, just eight months after the loans were made, almost one in five were at least 60 days overdue.
Shedlock looked at it again two months later, at the end of March. The results:
* Eighteen percent of the loans are already in foreclosure—or have already been seized by Washington Mutual.
* One in four of this bundle of liar loans is already 60 days past due.
* * *
But consider the position of borrowers in markets where close to half the people taking out mortgage loans were lying. Keep in mind that in some places (for instance, San Diego), half the people in the market were taking out stated income loans and so bidding up prices to points where almost any house became impossible to finance for someone who did not lie.
Posted by: Fat Man at May 2, 2008 05:21 PM
I agree that undocumented loans COULD be quite low risk if the lender has a high credit score and a very low loan-to-value (probably mostly lenders who are selling one house and putting the proceeds down on another one), and if there is little fraud.
What I'd like to know is if these PARTICULAR loans were like that. I'd hope yes, but my confidence in the mortgage rating systems has been badly shaken.
Posted by: ed at May 2, 2008 06:42 PM
FNMA is too big to save. They have $2.8 trillion in exposure between their liabilities and guarantees. With accelerating defaults in all mortgage classes, they will be called to make lots and lots of payments.
The Fed has a $900 billion asset base and the Federal government a $2.7 trillion annual budget. Between FNMA, MBIA, JPM, BOA, C, et al., there will be too many demands on the Federal Reserve and Federal government for them to save anyone except temporarily.
Financial armageddon is no more than one year away, and may arrive by year-end.
Posted by: jg at May 2, 2008 08:02 PM
What frightens me most are the figures from the Fannie Mae total book of business (the growth in 2007).
I'm also very much afraid Bsetser is right. It would be just like the Fed to stick the taxpayer with a bill to compensate China for all its help in exploding U.S. asset prices, which it did through currency manipulation to support its export growth. If it happens, I hope some politician comes along to make a real issue of it.
Posted by: don at May 2, 2008 08:23 PM
Is it plausable that there would have been no credit crunch without intervention by FNMA? As a creation of government intended to do just this kind of financing, why is anyone surprised?
Brad Setser is correct but to read his comments as a slam of China is wrong. China has to put its dollars somewhere and so it puts them in US instruments. The more the dollar falls the more China will invest. The only way you can stop this is to stop dollar inflation or stop trade with China.
More and more we are moving to a position where hyper-inflation is the only solution. We are currently in chronic inflation. Our monetary system has been crumbling from within for years because the inflationists have held the reins of power since FDR. A currency doesn't fail overnight, it just looks like it because most people don't understand the reasons. In 1928 the value of the dollar was the same as in 1800. In 2008 the dollar has dropped to $0.02.
But what is freightening is that with inflation as the government's only tool to solve the problems with Social Security, medicare and other social programs and the credit exposure created by the GSEs, a USdollar crash becomes more and more probable. The FED is simply running out of strings to pull.
Posted by: DickF at May 3, 2008 04:47 AM
Some clarification is needed here. There is a difference between "Prime" and "conforming" loans. Fannie issues guarantees on its securitizations of conforming loan pools.
The WSJ is describing an Alt-a non-conforming loan product, one which is typically also classified as "prime" because of the high FICO score. So its no surprise that a "liar loan" is "prime". What would be a surprise is if Fannie was issuing guarantees on these non-conforming loans, or including them in loan pools with other conforming loans.
As for "buying" Alt-a loans for their own portfolio, this should also not be a surprise. Fannie owns a chunk of non-conforming debt, including sub-prime.
Posted by: David Pearson at May 3, 2008 10:07 AM
BNP's Iley has been talking about "The Effective Nationalization of the U.S. Mortgage Market" for awhile now...
Posted by: archer at May 3, 2008 10:53 AM
FNM gives more detailed credit book performance in its quarterly conference call presentations. These are available on its website. For the most recent, see:
Esp. table on page 26.
Next Tuesday we will get the update on Q1 08.
Posted by: HZ at May 3, 2008 09:39 PM
It's a bit more subtle than this. See for example Calculated Risk's discussion here;
it makes a big difference if the lack of ddocumentation is because the borrower has gone looking for it or because the lender has said "hey you need to tell us your income and employment status, but actually we only verify 1 in X randomly". The later isn't foolproof, but has quite different implications from an underwriting point of view
Posted by: peterxyz at May 4, 2008 11:25 PM