"Emancipate yourself from mental slavery, none but ourselves can free our mind.” - Bob Marley

Sunday, June 7, 2009

Mortgage Disaster: Who Did It, and When

Who Did It

This presentation has been making the rounds. It has some amazing graphics: An Overview Of The Housing/Credit Crisis And Why There Is More Pain To Come

(NOTE: In the following, clicking on any image will casue a larger version to open in a new window.)

As to who did it, this chart is the most concise and specific thing I've seen yet:

The GSEs may have been active during the bubble, but the failed mortgages driving our crisis com mostly from the private sector. The driven by Wall-Street securitization are 51% of all failed mortgages, more than 2.5 times that of FNM and FRE combined.

"The GSEs Hold a Disproportionately Small Percentage of the Nation’s Seriously Delinquent Loans

While the government-sponsored enterprises (GSEs) own 56% of the nation’s single-family mortgages, the mortgages they own represent 20% of all serious delinquencies. In contrast, private label securities own 15% of the nation’s mortgages but 51% of the serious delinquencies."

The source of this given in the T2 presentation is Freddie Mac. This might seem a dubious source, but so far, it is the only breakdown of this type I have found.

At Freddie Mac is a document containing this figure:

The numbers are the same, though we get more information as to the sources used to compile this: "Sources: Federal Reserve Board, FDIC, Freddie Mac, Fannie Mae, Mortgage Bankers Association, First American CoreLogic (LoanPerformance); data as of December 31, 2008. Seriously Delinquent loans are at least 90 days delinquent or in foreclosure. Components may not sum to total because of rounding".

We may wish for another source, but I have yet to find one, after searching, and certainly I have found nothing to contradict this, and a lot of information that would explain or confirm this.

When Did It Happen:

Many have previously noted that the Big 5 Investment Banks received permission in 2004 to raise their leverage from around 12:1 to as high as 40:1. In addition, they were in large part left to be "self-regulating" at the same point. I believe that this was a turning, as shown below.

Wall Street Leverage became (briefly) Main Street leverage.

Again from T2:

"From 2000-2006, the Borrowing Power of a Typical Home Purchaser Nearly Tripled"

Look at the jump in 2004!

And more from T2:

"The Decline in Lending Standards Led to a Surge in Subprime Mortgage Origination"

"Source: Reprinted with permission; Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009."

About Option ARMs, the most toxic of all loans, which Bernanke can only partially defang with low rates:

Below, note the text box and especialy the green line showing "when nearly all Option ARMs were written":

When these come home to roost, they will even more disproportoinately impact the Wall-Street driven loans - because the GSEs were kept out of the worst of them by the conforming loan limit:

And in case anybody thinks it's a coincidence, see here: Pressure from Wall Street Caused Spike in Predatory Lending:

Because investment banks provide subprime lenders with necessary funding, they wield a great deal of power in determining what sorts of loans are offered to subprime borrowers.

Kurt Eggert, Professor of Law at Chapman University, in testimony to Congress, April 2007: “I think we've had a presentation of the secondary market as mere passive, you know, purchasers of loans and oh, they may select a loan, but it's really the lenders who decide loans. But if you talk to people on the origination side they'll tell you the complete opposite. They'll say, you know, our underwriting criteria are set by the secondary market. They tell us what kinds of loans they want to buy. They tell us what underwriting criteria they want us to use. And that's what we do because we're selling to them.”


Fremont General: “The Company sought to maximize the premiums on whole loan sales and securitizations by closely monitoring the requirements of the various institutional purchasers, investors and rating agencies, and focusing on originating the types of loans that met their criteria and for which higher premiums were more likely to be realized. The Company also sought to maximize access to the secondary mortgage market by maintaining a number of relationships with the various institutions who purchase loans in this market.”
The "premium" noted above was greater payment for more toxic loans was called YSP or YLSP - Yield (Loan) Spread Premium:

A yield spread premium (YSP) is the money paid to a mortgage broker based on an interest rate above the lowest rate the borrower qualifies for (called the par rate). Banks and mortgage brokers make money by setting interest rates above wholesale prices. However, the term "yield spread premium" only refers to mortgage brokers' rebates. Consumers are unaware of the premium a direct lender such as a bank earns when it sets rates to its borrowers above the par rate.
So there we have it. Who, When, and How.


suek said...

"...the Big 5 Investment Banks received permission in 2004 to raise their leverage..."

From whom did they receive the permission? Was this Fed regulated? What was the justification for the request?

If the answer is contained in the material, please point it out...I'm still working on it.

suek said...

"The Decline in Lending Standards Led to a Surge..."

Who sets the lending standards? Reading further, it seems to say "purchasers of secondary loans" and then it says loan originators.

I'm sorry to be so ignorant, but who's who? Purchasers are those who buy bundled loans? Loan originators are the banks?

Two other things which puzzle me...

You say that the CRA isn't to blame because Fanny Mae and Freddy Mac had such a low % of defaulting loans...but the CRA affected the banks who originated the loans - not the FMs. Were the standards for the loans different?

bobn said...


"...the Big 5 Investment Banks received permission in 2004 to raise their leverage..."

From whom did they receive the permission?

The SEC permitted the Investments Banks increased leverage and decreased regulation, see here and here.

Who sets the lending standards? Reading further, it seems to say "purchasers of secondary loans" and then it says loan originators. ...who's who?

The loan is made to the borrower by the originator. Thhis can be a bank, or it can be non-banks such as mortgage brokers or the subprime loenders. In almost all cases they turn around as sell the loans to the secondary market, which could be Fannie, Freddie or an investment bank, which securitizes the loans.

So the secondary market makes the rules, which they enforce by buying or not buying, and by how much they will pay. The YSP, a payment from the secondary buyers to the originators, would typically increase for more toxic loans, see here:

The big money for unscrupulous brokers, however, lies in steering borrowers into higher cost loans. A prime, fixed-rate loan at par may earn a broker a fee of one percent or less, but a hybrid adjustable rate mortgage (ARM) can pay four percent or more.

The Center for Responsible Lending (CRL) has said that inflated YSPs are included in 85 to 90 percent of all subprime mortgage loans.

Borrowers of hybrid ARMs, nicknamed "exploding" or "toxic" ARMs, often get stuck with prepayment penalties that penalize a borrower for paying off a loan early

Fannie and Freddie did not, to the best of my knowledge, ever pay YSP. They also had, during the bubble, a "conforming loan limit" of $417,000, which helped keep them out of the bubbliest parts of the market. I believe they also had other standards that would limit the silliness of the loans they would buy, but this turns out to be surprisingly hard to get at.

The CRA is not the issue here. Here are links to previous things I've written, whcih have external links to show this. here, here and here.

And Carl even concedes "It wasn't CRA. Period." (Don't tell OBH, though. He lives to tell how the CRA caused the whole thing.) Carl disagrees with me on everything else related to regulation, however.

OBloodyHell said...
This comment has been removed by a blog administrator.
OBloodyHell said...
This comment has been removed by a blog administrator.
OBloodyHell said...
This comment has been removed by a blog administrator.

About Me

I'm a 57 year old geek. I voted Democratic for 20 years, because I disliked the Republicans more. But now, nobody really speaks for me. I'm for Guns, for more correct government regulation of the financial world, against illegal immigration and amnesty. (in 2008 I ended up voting Republican - too many questions about Obama, and voting against anybody who voted for TARP 1.) In 2010 I voted a stright republican ticket because the Democrats have completely lost their minds.