Metas
What’s Happening to the Mortgage Market
There is turmoil in the Alt A market brought on by the crisis in the Subprime market.
Why it is happening and what is needed to calm the markets. In order to accomplish this, I will be presenting a number of commentaries written by local mortgage professional within the Naples area.
Many lenders are moving away from this market but there are still good lenders who understand the fundamentals of these loans and they are still available, albeit at higher rates.
This type of loan is absolutely vital to the Naples real estate housing market and the recovery.
Today’s commentary was written by John Calabria from BancMortgage Corporation, in Naples.
Unfortunately, Congress and the public are being led to believe that the current volatility threatening to worsen the housing market is being caused solely by poor underwriting, poor mortgage loan instruments, bad borrowers and in general fraud perpetrated by borrowers and all individuals associated with the lending function. While one can site evidence of this in the Sub-Prime market, this cannot be said about the Alt-A and Prime Markets.
Much to our surprise even some less informed mortgage brokers have even expressed happiness with the demise of American Home Mortgage, the 10th. Largest provider of Alt-A mortgage loans in the country. They appear to blame adjustable rate loans for all that ails the housing market and proclaim the benefits of the standard 80%, fixed rate,conventional loan. They mistakenly believe that the demise of companies offering these types of loans will only strengthen the housing market. They are by their comments hopelessly uninformed for the housing market, the engine of our economy, relies on these types of loans to serve a needy and deserving borrowing public. It would be impossible to have a healthy housing market without these types of loans for in 2006, they accounted for 40% of the mortgage market.
American Home Mortgage did not go out of business because of poor loans. They went out of business because they did not have deep enough pockets to cover the margin calls required by their warehouse banks, when investors turned away from investments considered riskier due to the defaults associated with Sub-Prime loans.
American Home’s experience was the same as that of an investor who buys stocks on margin. The bank expects not only to receive his interest on the loan but also that the borrower will maintain the same margin of collateral in the stock, no matter what happens to the price of the stock. If the value of the stock goes down, a call for more collateral is requested to maintain that margin. If the borrower is unable to provide the additional collateral or pay down the loan immediately, the bank sells the stock and satisfies the loan.
Well, the same thing happens with a lender’s warehouse line of credit. A mortgage lender pledges loans as collateral to a bank. The bank receives good loans issued at a certain rate of interest. In turn, the bank agrees to give the lender a line of credit equal to say hypothetically 80% of the value of the collateral. This 20% remainder is a margin that must always be maintained to insure that the line of credit loan is paid off. The line of credit is usually paid off by the sale of the loans in a security to a Wall Street investor. The bank monitors the value of the loans based on what similar loans/securities are selling for. If the value of the pledged loans decline due to a decrease in the price of securities in related markets such as the sub-prime market, a margin call goes out to the mortgage lender to bring in more cash or loans to restore the 20% collateral margin the lender must maintain.
This collateral requirement has nothing to do with the quality of the loans that are acting as collateral. If the bank’s margin is not maintained by the mortgage lender, the loan is considered in default and the bank must sell the loans to satisfy the warehouse line of credit. This most often is a fatal blow to the lender. This essentially is what happened to American Home Mortgage.
For example: Loan amounts that exceed $417,000.00 cannot be purchased by the agencies and therefore are classified as jumbo loans and fall into the category of Alt A loans. These borrowers are just as credit worthy as those borrowers whose loan amounts do qualify for purchase by the agencies. In fact they are often more credit worthy than many borrowers whose loans do qualify for purchase by the agencies. Another example is a loan on a condominium unit in a project that has not met the minimum presale requirements of the agencies. While Alt-A loans included some form of stated income programs, higher minimum credit scores and higher proven assets are generally required.
Mortgage lenders pool the agency loans together and issue guaranteed securities through Fannie Mae and Freddie Mac and then sell the securities to Wall St. investors. Because of these guarantees by the agencies, they are given the highest rating that mortgage backed securities can get.
The loans that American Home Mortgage made to borrowers and used as collateral were not in default and were not of lesser quality, except for the fact that there were no guarantees by the agencies. However, because of the turmoil in the Sub-Prime market and the resulting flight to quality by investors of mortgage backed securities, a perception developed that the value of anything but agency guaranteed securities was too risky to purchase. Thus, the reason for the margin calls and the resulting closure of American Home Mortgage.
SO WHAT’S THE FUTURE OF THE MORTGAGE MARKET?
The future of the mortgage market as we know it now will depend on how Alt A loans perform, how the economy performs and how Congress reacts to the crisis. We expect that as time passes, with the history of delinquencies and defaults being confined primarily to the sub-prime market, the market will return to more normalcy, albeit at higher rates but, only if Congress and Regulators do not over react.
On the matter of Congress and the Regulators, Lawrence B. Lindsey, a noted economist and former Director of the National Economic Counsel writes “the current troubles in the housing markets virtually guarantee that some restructuring of the home-finance industry will occur under the next president. Already there are a number of legislative proposals on the table with important implications for the ability of young men and women to purchase homes and existing homebuyers to sell.
One leading proposal is a bill offered by Sen. Chuck Schumer of NY. Without going into detail about the noble sentiments in the bill, Senator Schumer’s bill represents a regulatory and litigious approach to the mortgage-market reform.
Mr. Lindsey states that “the key to getting America out of its current housing and mortgage market mess is to do everything possible to maximize the availability of credit, not to reduce it.” The proposed legislation prescribes some regulatory tightening that will block access to mortgages for some key segments of the population, or at least make those mortgages more expensive and less appropriate. The bill would require that all borrowers qualify for a mortgage at the fully indexed long-term rate that would apply when a variable-rate mortgage converts to its long-term level.
Many borrowers choose to take out loans that have a lower rate for the first 2 to 10 years, which then rise to a higher rate for the duration of the loan’s 30-year life. Borrowers are then able to purchase a better home than they would normally qualify for if they had to qualify at a higher interest rate. If Sen. Schumer’s bill is approved as written, the abolition of these types of loans or unnecessary restriction of these loans will only cause many borrowers to be locked out of the
home buying process.
Now there should be no doubt by anyone that many excesses and even fraud occurred in the origination of sub-prime loans but, the answer to that is better underwriting by the lenders rather than doing away with the creative instruments that have successfully enabled many credit worthy homebuyers to benefit in the American Dream.
Arms are popular both to borrowers and lenders and even former Federal Reserve Chairman Alan Greenspan publicly recommended that people take out variable rate mortgages that may ultimately lead to higher rates. Why? Because they are cheaper. It is a little known fact that Chairman Greenspan bought 2 homes utilizing the financing of the popular Option Arm loan program through World Savings. This often criticized loan program, amongst others, is threatened by Sen. Schumer’s legislation.
Washington Mutual Bank and World Savings have been offering this popular Option Arm product almost exclusively and successfully for decades without the negative excesses the same product experienced in the Sub-Prime market. Obviously, these two banks attribute their success to good underwriting practices in granting these types of loans.
Additionally, locking in a long-term fixed rate loan is risky for the lender, and so he must charge more. Equally important, in a country where the average household moves every 7 years, it seems foolish for everyone to pay for “interest rate protection” they may not need. The Schumer bill requires that they do.
Mr. Lindsey further states that whatever the merits of the idea in the long run, this is precisely the wrong time to add this requirement. Three-quarters of the subprime mortgages issued in 2006 and other mortgages will reset in 2008. Borrowers who planned on refinancing them may be stopped by the requirements of Sen. Schumer’s bill.
Unable to pay the new reset rate and barred by law and regulation from easy access to refinancing, many or most of these borrowers will have little choice but to give up their homes. This in turn will put further downward pressure on all home prices.
As we mentioned previously 40% of all the loans issued last year were either subprime or Alt-A. If these two categories of loans reverted to their more traditional levels, one-third of the 2006 level of home demand would disappear. The Schumer bill would exacerbate this problem. The effect on home prices would be disastrous.
The key to getting America out of its current housing and mortgage market mess is to do everything possible to maximize the availability of credit. Credit is crucial to making sure there are buyers. Buyers maintain home prices. Sustainable home prices are key to minimizing foreclosures.
There are alternatives to regulation and trial lawyers. Fannie Mae and Freddie Mac, should be asked to step up to the plate. They can play a role in creating refinancing options for people who may be in distress. The private market place will come up with innovations designed to help keep people in their homes however, these ideas may be stopped in their tracks by the fear of litigation and excessive regulation.
Lindsey states that nearly 10 million more households own their own homes today than a decade ago. Most of this increase was due to financial-market innovation that made access to home mortgages more available. Excesses occurred—but a choice must be made about whether to sustain the progress of the last decade or revert to the pre-innovation days of the early 1990s. The value of every existing home in America is at stake.
Legislative proposals like the Schumer bill, which are well intended and have a credible chance of becoming law, will have their effect long before they are enacted. He says that all legislators and presidential candidates in both parties must make known if they support such legislation for the financial markets and America’s homeowners deserve to know the risks they face.
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