A mortgage broker responds

Our post last week quoting Lou Barnes' assessment of the mortgage crisis drew a number of angry comments along the lines of: how dare we use Barnes -- a mortgage broker! -- as an objective source! Lou, who writes at Inman.com, read your comments and sent me this email:

"I read all of the posts, and the range of replies is an accurate indication of breadth and depth of concern in the nation, and the equally deep confusion about what's going on.

"For those suspicious of the messenger... you are wise. I'm an old guy, 58, and a lack of discipline has led to a checkered career: five years as proprietor of a 45-broker real estate firm (difficult years for mortgage supply, '78-'83); five years as a bond and mortgage-market investment banker, including two years of regulatory work in the S&L disaster; and the last 20 years a co-owner of a modest mortgage bank. As far as I know, no client of our firm has ever gone into foreclosure, and my life-total closings of sub-prime loans: one.

"I think it's very hard for anyone without experience in all three fields -- real estate, investment banking, and mortgage lending -- to understand the current problem and how we got into it.

(Read more Barnes below)

"Too many people want to find villains in the play. They are always with us, but luck is a far bigger actor. Circa 2000, four elements combined to produce this hazardous moment: the invention of 'credit derivatives' on the Street; the overwhelming demand for financial investments by the 'global savings glut' (the Asian Trade Dollar Recycling Machine later joined by Petro recyclers); the Fed's deflation-fighting cut in the cost of money to 1% (yes, it was necessary); and a natural home-price boom in land-scarce coastal markets, at first fueled by the immense gain in household financial wealth in the 1990s.

"All four elements then reinforced each other, the most important spiral the rapid home-price rise camouflaging credit risk. Those who want to blame fraud, or greed may if they wish, but be careful about magnifying the effects of the few, and envious gloating at the misfortune of others. Those who want to blame the re-sale of loans need to study banking.

"Your return commentators are right that booms like this one should come to their own painful ends, 'moral hazard' lessons learned. Nobody should be bailed out, with taxpayer money or otherwise. However, those who think that solution lies in a deep-enough cut in sellers' prices should reconsider: 15% of American households have less than 10% equity, and cannot cut their prices. If prices fall farther, more sellers will be upside down versus their loans, and we run the risk of a negative spiral. Historically, the solution to prior housing escapades has been a long, long, long flat-price interval, as markets wait for incomes and scarcity to support over-shot prices.

"The exception, of course, was that unpleasantness 1929-1939. Extreme fans of market discipline should always consider that time -- the Fed sitting on its hands; early on, the government trying to balance the budget; and the great stabilizing benefit of the FHA and Fannie Mae, government credit guarantees for good loans that restored faith in credit.

"The problem today is a loss of confidence in the credit-derivative structures in which sit the $4 trillion mortgages that I wrote about, and probably a like amount of corporate devices. Investors bought vast quantities of these in reliance on ratings by the three private agencies, and elegant models of future behavior. These structures -- 'tranches' -- are completely opaque as to the underlying credit, and today no one knows what they're worth. The market loss at the moment, confidence destroyed, is vastly greater than the actual credit loss!

"Until confidence in actual credit quality is restored, the owners of these things are not buying any more. And, because they are leveraged, they and their lenders are at bankruptcy risk as well. That means further: an extreme contraction in credit available for new borrowers.

"The classic moment for government to intervene: when markets appear to enter a self-reinforcing downward spiral. This is it. To figure out what really stands behind those tranches, and certify the finding -- that's the job of government. Right now."

Thanks, Lou.
Thoughts? Comments?

Comments

[Toby]

I guess the question here is Do we want a slow bleed or a quick break? I think trying to bail out the industry will only cause deflation, to drag it out propping up microeconimies here and there as house prices slowly drops here and there, leaving more and more houses vacant. Because no matter what kind of "bail out" anyone suggests, the vast majority of Sub-primes simply can't afford the loans, at any rate. Not when they are paying principle on top.

Or we can let it snap back. Yes, a lot of people will lose their investments. That's unfortunate but it is the risk of investing. Yes a lot of people will be upside on their loan, but that has ALWAYS been a risk on home ownership.

I say to bail out to sustain the current house prices to help a fairly small minority of Americans (we're talking about what? 15-20 million people, maybe?) at great cost to the vast majority of Americans (high cost of living causing inflation and other bad things) just so investors don't lose their investment doesn't make a whole lot of sense to me.

I say, let them sit upside down until the market catches up with them. Not the other way around. Why should other people suffer so they don't?

[brettdl]

"Those who want to blame fraud, or greed may if they wish, but be careful about magnifying the effects of the few, and envious gloating at the misfortune of others."

"Envious gloating at the misfortune of others?" Please, I lived in the Inland Empire in a tiny, next-to-the-freeway house because the "effects of the few" pushed the prices of homes beyond all reason.

Fresh-out-of-high school kids were buying homes twice the size of mine with half the income. My neighbors refinanced themselves into negative positions to buy fancy cars and boats. And to remodel and then sneer at our run-down exterior.

These people threw their "success" in our face at every given opportunity. We are not gloating. We're saying: Please let prices come down so those who have worked hard for 20 years, not 20 months of their lives buy modest homes we can raise our kids in.

[Brian Flanagan]

Mr. Barnes seems to want us to believe that the crash of the real estate market and mortgage security problems were unforeseeable. "Luck is a far bigger actor", he says. There was no luck about it. These problems have been building and in plain view for years. The fact is, the price rises, especially in Southern California, were unsustainable. When the median house price rises to 8, 10, 12 times the median income, it cannot last. There were no lack of commentators pointing out these problems, and predicting a crash. The extent of the credit contraction might not have been anticipated, but falling house prices, defaulting loans and foreclosures certainly were.

Mr. Barnes also faults people for looking for "villains". The mortgage broker who falsified the loan documents about income and assets -- he was only helping me poor struggling buyer achieve the American dream of homeownership. Coincidently, and fortunately, the fees he got for the option ARM were much higher than for a fixed-rate, conforming 30 year loan. Just "luck", I guess.

Countrywide and the other mortgage lenders who provided the loans -- well, they made more money off of the "innovative" mortgage products than they did off of the conforming loans. The fact that those were the loans given to Wall Street to be turned into securities -- just "luck". And Angelo selling $526 million worth of stock in the last few years -- boy was he lucky.

And how lucky that the Wall Street firms that turned the mortgages into securities got their fees up front, and the hedge fund managers who bought the securities for their clients get paid 2% of assets and 20% of profits-- just lucky guys. And even when the fund closes, as former Harvard endowment manager Jeffrey Larson's Sowood Capital did, they don't give the money back.

No, there's no lack of villains here. No George Bailey's helping people into a safe, secure home for their family. Just a bunch of Mr. Potter's, getting their money up front and saying "Hasta la vista, baby".

By the way, I'm not giving a free pass to the people who took out these mortgages. Time after time, the LA Times, the New York Times and the Washington Post have published front-page articles about the poor, besotted rubes who were bamboozled into signing mortgage terms they didn't understand. Usually, when the facts are examined closely, we find people who gambled, and took a chance that house prices would keep rising, that they could remodel the kitchen, buy the truck and the motorcycle, put it on the credit card, and pile that debt into the next refinance. It was only when it all came crashing down that they looked around and said "J'accuse".

Mr. Barnes also comments on the dangers of further price falls -- pointing out that 15% of Americans have less than 10% of equity in their home, and that if prices fall further, they would be upside down. He seems to assume that everybody is looking to sell their house. Most of the people that I know that purchased their house intend to stay in it. Price rises and falls don't have any affect on their current mortgage terms, and since they're not planning on selling until retirement, market moves are theoretical. Only a small minority of people are trying to sell their houses at any one time.

[Concerned Citizen]

While Lou explains his position well, the crux of the matter is that the financial services industry and its regualtors have failed the interests of financialy responsible citizens and exposed all of us to rampant inflation in housing prices. What is the point of having all these industry insights if an expert is unable to identify the issues preemptively before the disaster strikes? Sadly, the financial services industry (and its regulators) are addicted to unnaturally high commissions, bonuses & huge stock option gains from the top to the bottom of the hierarchy and are unable to take the long view on any issues that impact the average American. The industry just serves the richest segment of society and every player seems to be motivated only to get his/her share of the loot before the pyramid collapses. The industry desparately needs some good leaders (and regulators) who will look beyond their excessive compensation and quarterly earnings to focus on national economic goals along with their corporate goals. A debased currency and rampant credit is the first step to economic collapse of the American markets - why is this industry playing such a lose-lose game?

[Pat]

I don't think Lou Barnes wants a bailout for anyone. I think what he wants is government intervention that would allow the market to re-evaluate the true price of CDOs (the bonds based upon mortgages). Once a market value is re-established, normal trading will resume. To some extent, this is exactly what the government has been trying to do (injecting liquidity, reducing the discount rate). Another step would be to set a floor to the valuations through some sort of modification to Fannie Mae, Freddie Mac standards. I think that such a move could be done with little risk of large taxpayer cost by setting the floor artificially low (say 50 cents on the dollar). As long as the market settles on a cost that is greater than this (I think the likelihood is somewhere around 60 cents on the dollar), the government will owe nothing (it might even make a little money).

[lefty]

Seems to me the agencies that rate the securities as "AAA" grade or whatever, are the most responsible for investor losses.

[sunsetbeachguy]

Lou Barnes Real Estate centric business and outlook has fully internalized the assumption that high housing prices are a social good.

But nowhere in his various posts does he established that high housing prices that lost any relationship to fundamentals is a social good.

It may have been a social good for his benefactor sector but that is it.

On the other hand homes that can be afforded with sustainable financing is a social good.

[Monkey In Chief]

"Historically, the solution to prior housing escapades has been a long, long, long flat-price interval, as markets wait for incomes and scarcity to support over-shot prices."

This is a false statement. Housing prices had big (> 20%) declines in California in the early 90s and the world didn't end.

"The exception, of course, was that unpleasantness 1929-1939. Extreme fans of market discipline should always consider that time -- the Fed sitting on its hands; early on, the government trying to balance the budget; and the great stabilizing benefit of the FHA and Fannie Mae, government credit guarantees for good loans that restored faith in credit."

I have to take extreme exception this pro bailout distortion. The Fed sat on its hands in regard to the money supply allowing deflation to happen as people pulled money out of banks and stuff in under their mattress. If the money supply starts to contract again due to a similar falling deposit ratio, the fed should and will start the printing presses and print enough money to prevent a falling money supply. Intelligently managing the money supply has nothing to do with trying maintain price levels on residential housing and everything to do with sound monetary policy.

Bailouts and monetary policy aimed at asset prices risk a severe economic downturn as eventually asset prices will come back in with their fundamentals. Government intervention to prolong the adjustment risks making it the eventual adjustment a lot worse.

[sunsetbeachguy]

The blog got my nice comment already.

Now the snarky one.

Why is it that authors/analysts on the RE market utilize an appeal to authority preface to their self-serving comments?

http://en.wikipedia.org/wiki/Appeal_to_authority

Granted Lou's appeal to authority premise is much more subtle than the other local RE analysts at the OCR blog.

But nonetheless it is filled with the same condescension.

This attitude of I am an expert you must follow my advice, probably serves him well at the closing table when "asking" sheeple to sign mortgages at 8-10 times their annual income but is a real problem when attempting to influence public policy in a self-serving manner.

While dwelling on rhetorical styles, I agree with Monkey in Chief on Lou's amazing ability to decimate a straw man argument of his own making.

http://en.wikipedia.org/wiki/Straw_man

I look forward to seeing the Real Estate Industrial Complex's (REIC) justification for stable, high (unrelated to fundamentals) housing prices as a social good.

[AnnS]

""I think it's very hard for anyone without experience in all three fields -- real estate, investment banking, and mortgage lending -- to understand the current problem and how we got into it."

Between my husband and myself, we'll see and raise you 6 degrees in public policy, economics, and law (including some from the University of Chicago, home of that disconnected-from-reality, greed-is-okay Friedman.)

It is perfectly easy to understand. Loans were given to anyone who was breathing without regard to ability to repay through the life of the loan.

This drove more buyers into the market which in turn drove up the price of housing.

In the meantime, those who had houses with a nice comfortable fixed mortgage and manageable payment, jumped on the bandwagon. They bought into the false mantra that by borrowing money which they had to repay, they were 'getting their equity out' - and ignored the 'repay' part of the deal. They went on a buying binge with borrowed money - using it instead of real income because their incomes were staying flat as the cost of living rose and employers balked at giving wage increases (and one can't cut into stockholder profits you know.)

Sooner or later the piper has to be paid; and those in risky mortgages where the payment is more than they can afford are defaulting.

"15% of American households have less than 10% equity, and cannot cut their prices. If prices fall farther, more sellers will be upside down versus their loans, and we run the risk of a negative spiral. "

Well yes, that is what happens when you mortgage Blackacre to buy $4000 motorcycles or take a vacation to Australi aor buy the new SUV or add a $40,000 kitchen to a $140,000 house while running up $100000 in credit card debt in 6 years even though household income is in the top 21%. Sooner or later, there is nothing left to borrow.

Those who end up "upside down" have only one option if they can afford the payments: Stay put in the house and don't borrow anymore.

If they can't afford the house, then sell it at a loss or file bankruptcy.

Those who want consumers to keep buying have a very simple option open to them: Increase Wages - even if it means the CEO of a Fortune 50 has to take a 75% pay cut and the stockholders only earn 3-5% a year.

The flat incomes are the direct reault of the economice gains going to the top 5% and particularly to the top 1%.

It is not a "negative" for society at large if housing prices fall. It may be a 'negative' for realtors, loan brokers, lenders, investors and other who live off inflating the market; but it is not a negative for Aunt Tilly and Uncle Jake who have to have somewhere to live and haven't seen their income go up in years. Shelter is a necessity - unlike plasma TVs and Ipods and fancy motorcycles. When it takes at minimum an income in the upper 15-18% of incomes to purchase the median-ish priced house in the US at current mortgage rates, that is completely out-of-whack. Where are the other 85% supposed to live - either renting or buying- when the costs are out of reach?

If bringing down the housing prices means a whole lot less McMansions from the current average 2400 or so sq ft homes of today to the more modest size of homes typical in 1900 -1940 of 1000 to 1500 sq feet, so be it. Developers will make less per house but will sell more of them. Granite countertops are not essential for survival.

An economy can not function when the method of fueling it is to have consumers keep buying on borrowed money and credit. Sooner or later the consumers will default - either now or when they die and are in debt beyond the ability of the estate to pay. They will not have accumulated "wealth" - only debts.

[vultur]

" However, those who think that solution lies in a deep-enough cut in sellers' prices should reconsider: 15% of American households have less than 10% equity, and cannot cut their prices. If prices fall farther, more sellers will be upside down versus their loans, and we run the risk of a negative spiral. Historically, the solution to prior housing escapades has been a long, long, long flat-price interval, as markets wait for incomes and scarcity to support over-shot prices."

You'd like that, wouldn't ya Lou? A US taxpayer-relief package aimed at refinancing existing debt at lower government subsidized rates. Might mean more business for you and your kind. Wouldn't that be grand!

The solution to this problem that has been building since the birth of neutron 'patriot loans'- neg amortization rockets ready to explode on a reset to market rates of interest- is very very simple. It's no longer an issue of seller's lowering their asking prices- sellers have no equity! It's up to the lender now to take their medicine.

1. FORECLOSURE
2. AUCTION SALES AT TRUE MARKET VALUE ($0.25-$0.30)
3. WRITE-DOWN DEBT
4. BIG LOSSES
5. LAYOFFS

Then, slowly new homeowners emerge (probably mostly old homeowners) and the cycle begins again.

No one wants to take their medicine anymore. Everyone wants a handout. Tough luck lenders!

[Chris]

People like Lou Barnes can talk all the econometrical mumbo jumbo they chose. Nobody can explain away some of the dismal statistics in regards to housing affordability that prevail in residential real estate today (median income to median home price, percentage of homeowners that could actually afford to buy their own home with conventional financing, etc., etc.).

As far as Mr Barnes career is concerned - "...five years as proprietor of a 45-broker real estate firm (difficult years for mortgage supply, '78-'83); five years as a bond and mortgage-market investment banker, including two years of regulatory work in the S&L disaster; and the last 20 years a co-owner of a modest mortgage bank..." - he should know better.

My thoughts are based on the assumption that, in America today, there are wayyyyyy too many financial speculators, commission based paper pushers and the like bumping into each other with nowhere to go. Now they want the government to step in to keep the cash cow going. I realize many people have money at risk here (myself included), but was it every really there except for the commissions taken off the top?

[Cal]

I gotta admit I like my weekly (now thanks to Pete, twice this week!) Lou Barnes fix.

"To figure out what really stands behind those tranches, and certify the finding -- that's the job of government. "

This is the only sentence that I have an issue with, I wouldnt say its the job of this or any gov't to figure out what the risk is, what the gov't is doing is trying to give people time to figure out what the right risk pricing is for these securities.

The more data comes out the more it appears the ratings agencies were so absolutely trusted and unquestioned. Of course their models were completely off and now people are questioning everything in regards to ratings. Trust has been hurt and the onus is really on the ratings agencies to restore trust. There is a huge difference in a market where the price is 50 cents on the dollar versus "No bid", one may be extreme but functioning, the other is just not working.

Thanks for the extra Lou fix Pete.

[Problemwithcaring]

"But lending literally stopped this week."

This is the lie that folks like Barnes keep pushing on us. IT IS A LIE.

You can get a loan, you just have to be able to afford AND REPAY it on the banks terms. No money for speculation and "living above your means" for a couple of years in this country???

Just what the doctor ordered!

[Dean]

So, who is supposed to be silly enough to buy during this "long, long, long flat-price interval" until "incomes and scarcity" catch up, assuming they have the cash on hand? Gotta have a buyer, Lou. Ever hear of affordability, Lou? Ever hear of Case-Shiller, Lou?

[Problemwithcaring]

Peter, I think this guys isn’t as objective as he claims. Methinks he doth protest too loudly.

"For those suspicious of the messenger... you are wise. … the last 20 years [I’ve spent as] a co-owner of a modest mortgage bank.”

Absolutely NO interested in seeing the government bailout backers of these – not just risky – but falsified, loans – whether his bank made them or not.

"I think it's very hard for anyone without experience in all three fields -- real estate, investment banking, and mortgage lending -- to understand the current problem and how we got into it.

That is about as patently true as the need for a higher education degree for most jobs in the real estate industry, as AnnS, Cal and other have so eloquently demonstrated. How many bubble bloggers who’ve been passionately writing about this issue for the past 3 years have those credentials?

"Too many people want to find villains in the play. They are always with us, but luck is a far bigger actor. Those who want to blame fraud, or greed may if they wish, but be careful about magnifying the effects of the few, and envious gloating at the misfortune of others. “

This is just ridiculous and this is what makes me wonder what Peter Viles is trying to do here: Are you or aren’t you trying to illuminate the issue? If “fraud” is currently being “magnified”, what is causing the uptick in mortgages – increase almost 100% since this time last year? Our own inflated fears? Please. People DONT HAVE THE MONEY TO PAY. And at some point in almost all of those loan applications, bankers like Lou, as risk assessors – expected it to happen.

"Your return commentators are right that booms like this one should come to their own painful ends, "moral hazard" lessons learned. Nobody should be bailed out, with taxpayer money or otherwise. However..”
There is always a “but” with lenders….

“15% of American households have less than 10% equity, and cannot cut their prices.”

Can you tell this guy works for the mortgage industry. 15%, eh? So does that mean the other 85% needs to lower their asking prices?

"Historically, the solution to prior housing escapades has been a long, long, long flat-price interval, as markets wait for incomes and scarcity to support over-shot prices. The exception, of course, was that unpleasantness 1929-1939.”

Again, other commenters have shown this is patently false, so I don't know what to make of all that experience Lou bragged about. Housing prices FELL at various points throughout American history. Everyone in Southern Cali remembers the most recent, most painful one in the 90’s.

“That means further: an extreme contraction in credit available for new borrowers.”

And this final lie really pisses me off about the aforementioned “Real Estate Industrial Complex.” Credit is not gone, or missing, or stopped or ended or any such thing. Credit is slowly going back to being tetthered to reality: meaning its going to those who can pay it back. That is inarguably a social good.

[Steve Reynolds]

"The median income for a Los Angeles household is $36,687" THEY CAN"T AFFORD THE HOUSE. Countrywide and its pals loaned 1/2 a million $$$$ to these people, they can't service the debt. I know lets offer everyone that has a mortgage 0% financing for 100 years that will work. Spin it left, spin it right THEY CAN'T AFFORD THE HOUSE.....

[Cal]

36k for household income? Its somewhere above 60k, still not enough, but where does 36k come from?

According to the NAHB 3% of the LAX MSA can afford a median priced house:

http://www.nahb.org/news_details.aspx?sectionID=135&newsID=5204

"Maintaining its spot at the bottom of the affordability scale for an eleventh consecutive quarter was Los Angeles-Long Beach-Glendale, Calif., where just 3 percent of homes sold in the second three months of this year were affordable to families earning the metro’s median household income of $61,700. "

[MyLessThanPrimeBeef]

Am I the only one here who agrees with Lou Barnes that without experience in all three fields of real estate, investment banking and mortgage lending, you can't understand the current problem and how we got into it?

But I will go a step further.

I assert that to create the current problem, the perpetrator needs experience in all those three fields - real estate, investment banking and mortgage lending.

Sadly, none of us here is qualified enough to make that mess.

[1]

"Maintaining its spot at the bottom of the affordability scale for an eleventh consecutive quarter was Los Angeles-Long Beach-Glendale, Calif., where just 3 percent of homes sold in the second three months of this year were affordable to families earning the metro’s median household income of $61,700. "

Three times this annually (two incomes) and still will not buy at these prices, or anything close. Just one layoff or other job loss away from financial disaster. Not to mention the ~$4000/month liability for 30 YEARS.

That's working to live, not living.

[jdd]

I have to disagree with the assumption that government can fix the problem. Government is the problem. But for the federal reserve existing and existing to a) create negative real rates for banks to borrow at and b) bail out said banks by making loans against worthless collateral there would be no credit bubble to begin with.

The best thing that could happen would be to let things unravel quickly, painfully and then move to a sound money standard in the future.

This sort of thing has happened throughout history. This guy should read about the Panic of 1818-1819. The same things happened. The same reaction - oh, government, save us. It doesn't work, it just drags things out.

People will be able to get credit in the future. People with saved money will want to loan it. They just will want to loan it to people or entities who will pay it back.

There simply is no entitlement to cheap credit, nor should there be. The longer this idiocy goes on, the more damages our economy suffers. Our money is worthless. Only the wall street financiers benefit from the massive and continual debasement of our money.

Printing a bunch of money to underwrite a bunch of bad loans or t o help people keep title to assets they can't afford is about as ridiculous as it comes.

[Steve Reynolds]

The $36000 figure came from the 2000 census it shows on Wikipedia when describing Los Angeles demographics. I'm sure you are correct the dollar figure is higher but $61000?

http://en.wikipedia.org/wiki/Los_Angeles,_California

[investorguy]

Steve: I read somewhere that LA bankruptcy courts use a figure in the $60s in their means test.

[Steve Ramirez]

A recent RealtyTrac survey reported that 115,292 properties went into foreclosure in the month of August 2007, up 53% from last year. In addition to those statistics, house prices have been stagnant or slightly decreasing all across U.S. I am hoping we can prevail and find a solution to this problem before it gets any worse so that we can look back on this situation in the future, and have learned a powerful lesson.