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Tuesday, November 24, 2009

FHA - The Last Man Standing

As we get set to give thanks for what we still have, those of us in the mortgage business are also giving thanks for FHA. After all, the population of home buyers these days consists mainly of investors buying at the bottom (or the perceived bottom) and first time home buyers utilizing an FHA insured mortgage.

FHA mortgages are loans that are 100% insured by the Federal Housing Administration in case the borrower defaults. Most of the mortgage loans used to purchase homes over the past couple of years are FHA loans. The reason for this is that a borrower only needs a down payment of 3.5% and a credit score around 640. Other conventional mortgage guidelines require higher down payments and have stricter credit score requirements.

For several years, FHA was much less relevant in the mortgage marketplace. There was discussion of dissolving FHA during the 1996 election campaign. I even referred to FHA as obsolete a number of times as the private sector had plenty of 3% down payment, and even zero down payment loans available for people with marginal or no credit history. Those private sector organizations I referred to were Fannie Mae & Freddie Mac which ironically have been rescued by the federal government and are therefore no longer private. In addition the private mortgage insurers who made those low down payment programs possible have reeled back after heavy losses from a tidal wave of claims.

Therefore FHA is now the mortgage program of choice. It meets the needs for many first time home buyers who, due to falling home prices, can finally afford to buy their first home. Also armed with the incentive of a tax credit, first time home buyers are the big winners in today's market. FHA = Sunshine & Rainbows.

Before you skip away singing Zip-a-dee-do-dah, there is a black cloud on the horizon for FHA. Just as the private mortgage insurers had their losses, now FHA is suffering from similar losses due to a massive rise in claims from lenders who are seeing their customers default. All of the FHA loans are fully document, in other words no stated income (liar's loans). And the vast majority are have fixed rates. So why are FHA borrowers defaulting?

Defaults in the FHA universe are occurring for the same reason they occur with other mortgages: a reduction in the borrower's income; and/or the property is now worth less than the balance on the loan. Certainly the ongoing recession contributes to the defaults, but when someone owes more than the property can be sold for, it makes the decision to walk away much easier. With only a 3.5% down payment, there is little "skin in the game," and in many cases there was no down payment due to a down payment assistance program. Also, since FHA is an insurance program, the borrower pays a premium (at closing, and monthly). The upfront portion is financed into the loan amount therefore eating into the already paltry 3.5% equity. Therefore it takes only minimal price declines to put a home owner upside-down when the down payment is small.

A Wall Street Journal report this morning indicated that one in every four home owners is upside down. That number is one in every two here in Arizona according to the graphic that accompanied the report. Another number that was a bit more startling is that one out of every ten homes purchased this year is already upside down. This year! If you are wondering how that has happened, remember the popularity of FHA loans and re-read the previous paragraph.

When the only bright light for aspiring homeowners is taking a financial hit, what is to be done? There is a bill in the House to increase the minimum down payment to 5%. That's not a terrible idea. While it will make it a bit tougher for home buyer's to come up with a down payment, it is not so big to make FHA loans out of reach for a significant number of first time home buyers. There has also been some discussion about raising the minimum down payment to 10%. Now that is a terrible idea, and would make buying a home near impossible for a large portion of the population.

The most palatable solution is to raise mortgage insurance premiums. The most equitable way to do that is to raise premiums for the highest risk borrowers (those with the lowest credit scores). By keeping premiums the same for borrowers with higher creidt scores, they can be rewarded for maintaining excellent credit.

We need FHA because it is the best solution for most home buyers to purchase a home. Our legislators need to find a way to keep it solvent. If that means raising premiums, then that is what needs to be done, let's just do it in a way that benefits those borrower's with the strongest credit history.

Friday, November 6, 2009

Tax Credit Extended (with some enhancements)

The first time home buyer tax credit that was set to expire at the end of this month has been extended through April 30, 2010. Both the House & Senate have passed the legislation which is expected to be signed by President Obama very soon. Let's discuss what the extension does, then we can talk about whether or not it is a good thing.

Like the previous tax credit, this extension offers up to $8000 in the form of a tax credit to first time home buyers. It extends the credit through April 30 of next year. In order to be eligible, buyers must have an executed contract by April 30, and then close on the transaction within 60 days of the April 30 deadline. Here are some enhancements to the new plan:
  • Income limits raised to $125,000 for single buyers and $225,000 for married couples
  • Up to $6500 tax credit for "move-up" buyers that are not first time homeowners
  • Extends tax credit through April 30, 2010
For those that will take advantage of the program and those that work in the housing market (like me) this is a great program. It will provide stimulus to the housing market as first time home buyers have greater financial incentive to purchase their first home. Despite the housing meltdown, I believe getting families into their first home is still a good and noble deed.

Move-up buyers may have a more difficult time taking advantage of the program since they will typically have to sell another home in order to qualify. The $6500 tax credit will provide some financial incentive for them, but it hardly seems to be enough in markets that have seen steep devaluation like Arizona, Nevada, California, & Florida.

Some will argue that the tax credits are just another "Cash for Clunkers" type program that will provide only temporary relief, then cause another decline in sales when the program is ended. That's probably true. Any government rebate or incentive has some affect in affronting the free market process.

The government cannot continue to extend the program in perpetuity. It must end sometime as they will eventually need to collect tax revenue to pay for dramatic increases in spending. Can the government continue these tax credits until the housing market has rebounded? How will we know when the market has rebounded? What is our definition of rebound? Sorry for all the questions, but there should be some definition if the plan is to continue these incentives until there is a rebound. Prices going back to 2005 levels should definitely NOT be the definition. If the definition is to be based on the number of sales taking place, then we have already rebounded. But that shouldn't be the definition either since a large portion of current sales are investors (another issue I will write about soon). Perhaps owner occupied sales should be the definition of the rebound.

At some point we have to stop the tax credit. I am glad that it has been extended for several more months, but we need to be ready to move on when it eventually ends.

Wednesday, September 30, 2009

Licensed to Originate

You need a license to do a lot of things. A license to drive; a license to sell insurance; a license to cut hair; a license to kill (007 reference); and a license to ill (Beastie Boys reference). In most states, my state of Arizona included, today one does not need a license to originate a mortgage loan. Now before you panic and wonder who the idiot was that did your last mortgage loan for you, a law was passed last year that requires all 50 states to license loan originators.

Whew! That is good news. You might be wondering why the loan officer you worked with that handled all of your financial information, your credit report, copies of your bank statements and tax returns, and helped you make decisions about the largest debt you will ever have in your life wasn't required to have a minimum amount of education, training, or even a criminal background check. This is probably why we had so many loan originators that did not have the borrowers' best interests at heart during the height of the housing boom.

In Arizona, starting in July of next year all loan originators must be licensed with the Department of Financial Institutions. What do originators need to do to get this license? Take 20 hours of education about various mortgage and regulatory topics, pass a test to demonstrate their knowledge, and pass a criminal background check. While this process won't guaranty a loan originator is smart, ethical, and always has their client's best interests at heart, it does help to eliminate the riff-raff. It will also eliminate loan originators who really don't know what the heck they are doing.

It is also interesting to note that only loan originators that work for a mortgage broker or mortgage banker will be getting licensed. Loan originators that work for a federally regulated bank or a credit union won't be licensed. So originators that work for Wells Fargo, Chase, Bank of America, MetLife, and others will not be licensed. Those institutions lobbied very hard to make sure they didn't have to license their employees, many of which sit in cubicles in large corporate buildings and take calls from customers all over the country. Does that mean those originators won't be as qualified as loan originators that work for mortgage brokers and mortgage bankers? No, but you can be confident that the loan originate that works locally for a mortgage banker or broker had to meet minimum education requirements, pass a test, and a background check to make sure they are qualified to help you with your mortgage loan.

I am teaching classes in Arizona for loan originators to get their education hours. I took and passed the test last night. While I don't think the test was that hard, it does take some studying, and I predict that a lot of current loan originators will either fail the test (75% needed to pass) or make a decision to find another line of work. The other option for them is to take a job with a bank.

Friday, July 24, 2009

Throw the Baby Out with the Bath Water

Those of you in the mortgage business are surely familiar with the term "Yield Spread Premium" (or YSP). It has been a hot issue for several years, and if the Federal Reserve has its way it will soon be illegal. Yesterday, the Federal Reserve issued a proposed rule that would make YSP illegal. Why are these three little initials such a lightning rod? First I will provide a simple explanation of YSP for those that are not familiar with it.

Mortgage brokers are company's that originate mortgage loans, but rely on a bank (known as a wholesale lender) to fund the loans they originate for their customers. The mortgage broker may earn fees for their work, but they may also be paid by the wholesale lender for delivering the loan. This fee paid by the wholesale lender to the broker is the YSP.

Why does the wholesale lender pay the broker? Because the wholesale lender wants the loan. These wholesale lenders (aka the banks) earn money from the interest on the loans they service. Therefore it is worth it to the wholesale lender to get brokers to send them as many loans as possible. For most of my career I was one of these wholesale lenders. Working for Countrywide's wholesale lending division, we funded loans for mortgage brokers and often paid them yield spread premiums when they delivered the loans to us.

How is the amount of the YSP determined? The amount the broker is paid in YSP is typically determined by the interest rate. A higher interest rate will pay more YSP, a lower rate may pay zero YSP (also called par). An even lower rate would actually cost money in the form a discount points to the bank.

Below is an example of how a rate sheet might appear for a 30 year fixed mortgage. The rate sheet would come from the wholesale lender, and the broker would use it to price their loans. It is important to note that wholesale rates are lower than retail rates. Even if a bank has both a wholesale division and a retail division, the wholesale rates will look more attractive. This allows the broker to earn their fees and still offer competive rates and fees to their customers. Having a wholesale division also offers lenders a lower cost of doing business.

On the table below, the interest rate is on the left and the amount of YSP (negative numbers) or discount points (positive numbers) are on the right.

4.750 1.375
4.875 0.625
5.000 0.000
5.125 -0.250
5.250 -0.875

In the table above, 5% is par. The wholesale lender would not pay any YSP, and the borrower would not have to pay any discount points. At 5.25%, the broker receives .875% of the loan amount in the form of YSP from the wholesale lender. On a $100,000 loan that would be $875.

Yield spread premium is also a tool for brokers to offer flexible options for their customers. Like I said in the beginning, brokers can earn their income from the customer in the form of fees, as well as from the wholesale lender in the form of YSP. So in the table above, the broker may offer a customer the option of getting a loan at 5% with a .875% origination fee, or 5.25% with no origination fee. Either way the broker earns the same amount of income, but the borrower can choose whether they want to pay a fee for 5%, or pay no fee for 5.25%.

Now why does that sound like something that the Federal Reserve wants to make illegal?

Unfortunately YSP was abused by a lot of mortgage brokers, and wholesale lenders allowed the abuse to take place. For many years, mortgage brokers would rarely earn more than 1% in YSP. The only exception would be if the broker was paying other closing costs for the customer. But then some unscrupulous brokers were taking advantage of unsuspecting borrowers and getting 2% or more in YSP as well as charging up front fees like an origination fee.

The wholesale lenders capped what brokers could earn, but that cap was typically 5%. That seems high, unless the broker is trying to close a $40,000 loan. On a $200,000 loan that 5% is $10,000, an outrageous amount for closing a $200,000 loan. Why a borrower would choose to work with a mortgage company that charged those fees is puzzling, but they did.

The most egregious abuse of yield spread premium took place with a particular loan product called an option ARM. This was an adjustable rate mortgage that was appealing to borrowers because it offered a low minimum payment, sometimes at a rate as low as 1%. But the loan would accrue interest at a higher rate. How higher of a rate was determined by the margin that was added to the rate index. With this program it was the margin (the add on to the rate), not the rate itself that dictated the YSP the broker would earn. The higher the margin, the more YSP.

This product was not a bad loan product (I use past tense because you can't find a bank that will lend an option ARM loan any more). It had been around for decades. I even seriously considered getting an option ARM myself (although I chose not to). It was a unique product that was appropriate for a small population of sophisticated borrowers. Unfortunately, it was sold to main stream America. Actually it was mostly main stream California, Nevada, Arizona, and Florida.

Why did brokers as well as mortgage bankers want to sell so many option ARMs? The obvious answer is because they were profitable. And they were very profitable. A broker could earn at much as 3% YSP with the wholesale lender that I worked for. Add another 1% origination fee and they could easily earn $10,000 on a $250,000 loan. Some of our competitors offered as much as 4% YSP on option ARM loans.

Why did wholesale lenders offer so much YSP on option ARM loans? Because they were so profitable. They could sell them to Wall Street where the appetite for mortgage products was insatiable. Some banks like World Savings kept them in their portfolio where they were earning high rates of interest. Even if the borrower only paid the minimum 1% payment, the bank could show the higher interest as earned income on their financial statements. Wholesale lenders were in competition with each other to get option ARM loans originated by brokers, so they paid the brokers handsomely.

At one point while I was a sales manager at Countrywide, we received a memo that we were raising our maximum YSP from 3% to 3.5%. In the memo the senior manager implied that brokers shouldn't really be choosing that high of a margin which would result in a 3.5% YSP. In addition we (my sales team, and all of the company's account executives) should encourage our brokers to select a lower margin that earns them only 1% or so in YSP. I was so stunned by the duplicity of the memo that I called my boss and let him know my thoughts. Why were we talking out of both sides of our mouths? The senior manager was clearly acknowledging there was something wrong with paying too much YSP, but at the same time we were increasing the amount we were willing to pay the brokers in order to compete with other wholesale lenders that were offering as much as 4%.

This illustrates the blind race for market share in which banks were competing. The loans were profitable and otherwise obvious flaws were ignored.

But I digress...

So this is how YSP turned from a useful tool that offered options for borrowers into the lightning rod that it is today. Instead of banning YSP altogether, it should be regulated not to exceed a certain amount, say 1.5%. Why would the Federal Reserve want to throw the baby out with the bath water? Eliminating mortgage brokers makes the Fed's role as a regulator much easier. It also creates greater market share for the big banks that the Fed is closest to. That's my guess anyway.

In the end, if the Fed's proposed rule goes into effect, it will mean less competition and choice for borrowers. It will also shut down thousands of brokers and harm other small businesses that service brokers. Borrowers will still be able to get loans from mortgage bankers that fund their loans on lines of credit, then sell them to banks. Those mortgage bankers don't earn YSP. Instead they get something called SRP from the bank they sell the loan to. Yes, it's pretty much the same thing as YSP, except that it won't be illegal. Frankly neither one of them should be.

Thursday, July 9, 2009

Upside Down Refinances

Head over heels, but not in a good way, is how to describe the mortgage debt with which many homeowners are strapped. The government's Home Affordable Refinance Program attempted to address this back in March when they began allowing some homeowners to refinance their current mortgages for up to 105% of the value of their homes. In other words, if the home is worth $100,000, then the homeowner can get a refinance up to $105,000.

This limit of 105% reflected the disconnect in Washington with the real world. Unfortunately, the homeowners that are truly at risk of foreclosure owe significantly more that 105% of the value of their home in mortgage debt. Five months later the government has tried to address the issue by raising the limit to 125%. While this will certainly help some folks, it will not help the great number of homeowners in Arizona, California, Nevada, and Florida that are considerably upside down with their mortgage debt (by more than 25%).

The best suggestion to resolve this came from John Courson at the Mortgage Bankers Association when the program was first announced back in March. He recommended that there be no limits on the loan to value. These refinances are only for loans that are currently owned by Fannie Mae and Freddie Mac. And Fannie and Freddie will own the new loans that are created by the refinances. Since the federal government owns Fannie and Freddie, we the tax payers own these mortgages.

These homeowners that are upside down are potential foreclosures which will cost the government (aka we the taxpayers) mucho dinero. Why not let these homeowners refinance to a lower payment and avoid the foreclosure and the cost that goes with it regardless of the loan to value ratio. There is already a precendent for this with FHA and VA refinances. Since the government already guarantees those loans they just want to put the homeowner in a better financial position. How is Fannie & Freddie any different today from FHA & VA? The answer is, they are not any different from an ownership and accountability standpoint.

Lift the loan to value restriction and more homeowners will be helped. If not, then more loan modifications will need to be done. For homeowners that need a loan modification and don't want to pay thousands of dollars to an attorney or loan modification company, visit www.eModifyMyLoan.com. The site helps struggling homeowners in need of a modification create a complete and well-organized package to deliver to their lender and will help expedite the modification process.

Saturday, June 27, 2009

Deflated Expectations

A traveler wandering through the desert spots a watery oasis. He moves toward it in hopes of quenching his thirst and taking a dip in the cool clear water. It's only a mirage of course, but in the traveler's mind it clearly exists. His belief in the mirage is strengthened by the only thing he has to hang on to. Hope.

Financial markets have recently been influenced by hope. Hope that the recession will end soon. Hope that the worst is behind us.

After an apocalyptic fourth quarter, the first half of 2009 resulted in a rather beefy improvement in equities with speculation (aka hope) that the recession had bottomed out and that there is light at the end of the tunnel. Interest rates rose in May and June as government debt soared and a new fear took hold, inflation. But is that fear real yet? Isn't our immediate fear deflation?

In the long term, the massive government spending that is taking place no doubt will have negative effects, but in the near term, deflation is the enemy. Starting with real estate, the value of assets has declined the past couple of years. Bank lending continues to decline because it is foolish to lend on a declining asset. This is evident in the Fed's weekly H.8 report which shows that bank credit actually fell $59 billion last week, and fell $83 billion over the past two weeks. Without credit, markets for these assets are stifled. And the negative loop continues.

Until credit loosens, inflation cannot appear. So in the near-term, deflation and low interest rates abound. The benefactors in the second half of the year will continue to be first time home buyers who can now afford homes (which values have deflated) and qualify for loans at low interest rates. Also, the handful of homeowners who still have equity in their homes and can take advantage of refinancing.

So with every bit of bad news, there is a silver lining. Low interest rates are what we have to look forward to for the second half of the year.

Tuesday, May 5, 2009

Mortgage Lending and the Search for the Bottom

Housing statistics are like a good news - bad news thing now. The good news is that there are more sales taking place in markets that have been hammered like Phoenix. The bad news is that prices are falling and don't seem to want to stop. What does this mean for the housing market and real estate lending?

The obvious conclusion is that the number of sales is increasing because the prices are coming down to a reasonable level. We are actually seeing multiple bids taking place for homes at the lower end of the market. First time home buyers can finally afford to buy a home which is a wonderful silver lining that doesn't get much attention in the media. Real estate investors are also able to buy some of these low end homes, often at trustee sales or from banks. These investors make repairs and rent the homes for a profit.

These two players in the market (first time home buyers & real estate investors) are able to win because of the funding available to them. For first time home buyers, they are primarily utilizing FHA loans with a low down payment (3.5%) to secure their financing. Government guaranteed loans are about all that is left and first time home buyers are often the biggest users of these loans.

Real estate investors don't have many financing options available. With excellent credit, income they can document, and a significant down payment, they can secure a Fannie Mae or Freddie Mac loan. More often than not, they pay cash or get a private money loan with an even larger down payment (40% or more) and high interest rate. But because the sales prices are so low (I have seen many sales between $20,000 and $50,000) they have enough cash to purchase the property without financing or put down such a large down payment that their debt service is low enough to generate positive cash flow.

What about everyone else? The player that is absent from this market is the move-up buyer. There are a couple of factors keeping this player from participating. First, they already have a house that they are unable to sell. In the past, move-up buyers could sell their existing home for a profit and use that profit as the down payment for a newer, nicer home. That's not the case today. In fact, if they bought their home after 2003, it is likely that they owe more on their mortgage than what the home is worth today. Even if a move-up buyer can overcome their first challenge, their second challenge is the lack of jumbo mortgages available (loans over $417,000).

Outside of the activity in the lower end homes with first time home buyers and investors, the rest of the market continues to be sluggish. Where is the bottom? If you were looking for an answer to that question in this article, you will be disappointed. I don't know. However, homes are finally priced at affordable levels. So it is reasonable to infer that prices may stabilize soon. The wild card is employment and income. If unemployment continues to be an issue, and it likely will, and incomes continue to decline, and they likely will, then housing still has further to fall. Once it does stabilize it will be a very long time before they rise again.

Unfortunately this is what banks and lenders are thinking when they analyze their lending guidelines. They are afraid to give loans secured by a declining asset. So they don't lend, and people can't buy, and the negative loop continues.

I'll try and finish on something more positive next time.

Sunday, March 15, 2009

Is it OK to Walk Away?

Is a home an investment or simply a dwelling where we reside? Should I give the lender the keys to the house the moment it is worth less than the balance of the mortgage? Is it okay to walk away?

Here's the dilemma. The Jones family lives in a beautiful home in a Phoenix suburb. They have children whose only memory of home is that house. They refinanced the home a few years ago when values were high and pulled some cash out. The cash was used for a variety of things. As home prices have fallen, and fallen, they find themselves with a loan balance that is two hundred thousand and fifty dollars more that what the home is actually worth today. Fortunately, both Mr. and Mrs. Jones fall into the 90% of people who are still employed and are capable of making the mortgage payment.

Mr. Jones looks at the situation and decides action must be taken. Men are problem solvers and this "upside down" issue needs to be addressed. It seems foolish to pay the lender a quarter of a million dollars more than what this home would fetch on the market today. If the lender won't write-down the principal balance, then let's mail them the keys and rent a house in the same neighborhood. A logical and practical solution.

Mrs. Jones views things differently. She doesn't want to move. This is her home. This is where she wants to continue to raise her children. This home is not an investment. The decision should not be based as if it is an investment. If the payment is affordable, then she wants her family to stay put.

This debate is likely taking place in thousands if not millions of households. I am aware of this particular debate, because I know the Jones's. That's not really their name. It has been changed to protect the delinquent. My own opinion is that people should keep their homes if they can still afford them. I will admit that I have not been placed in their situation, at least not yet. I don't envy their dilemma.

Monday, March 2, 2009

Stock Market Death Watch

As I write this, the Dow Jones Industrial average is at 6820 and falling. I have not witnessed a bear market like this in my lifetime. In fact, people twice my age haven't witnessed anything like this in their lifetimes either. I hear comparisons of this economy to 1982. I was only nine years old at the time, the same age as my oldest son is now. Back then I was more interested in Star Wars than the economy. I won't try to make comparisons with that recession, rather I tend to believe that this recession will represent a fundamental change in our economy.

As humans we tend to make assumptions and predictions based on our own experiences. Some people may look at the '82 recession and make predictions based on what happened then. Others may look at the Great Depression, and draw comparisons there. It appears the Obama administration is attempting to define their legacy as the New Deal Part 2. In the media I hear people cry to the government for help. Save UAW jobs in Detroit, save Citi, save me, save you. Instead of trying to preserve our economic fortunes of the past, perhaps we need to acknowledge the fundamental changes that are occuring. Like farmers moving from rural areas to cities to accept industrial jobs a century ago, this change will require a great number of people to get out of their comfort zones.

Changing jobs is difficult. Changing industries is more difficult, not because former mortgage loan officers are incapable for becoming nurses (just as an example, they certainly are), but because it requires one to try something that they don't know how to do yet. Individuals are not born to do a particular job. They can do any job as long as long as they have an open mind and the willingness to learn. A great example is Daniel Seddiqui. The 26 year old from Utah is 24 weeks into his journey to work 50 different jobs for one week each in all 50 states. In this journey, Daniel has worked as a corn farmer in Nebraska, a wedding coordinator in Las Vegas, a park ranger in Wyoming, and a cheesemaker in Wisconsin just to name a few. Every week he learns a new skill and is getting an education well beyond anything he could pay tuition for at a University. Perhaps government hand-outs need to instead be hand-ups to provide training and education for those individuals that are willing to adapt.

Adapting doesn't have to be as drastic changing industries. Perhaps it can be as easy as adjusting a product to fit the current environment. Hollandia International makes high-end beds. They made a custom bed for a client that contained a safe where he keeps a gun close by while he sleeps. Hollandia has adapted that concept to the recession and now markets a SAFE-T Bed so you can keep your cash in your mattress and feel secure about it. Brilliant! The Dow has dropped another 3 points since I started writing, so cash in the mattress sounds like a good investment in this deflationary environment.

Obama and Congress have a choice to make when they create bail-outs and programs to assist those that cry out for help. They can spend our money in an attempt to preserve the past, or they can accept the fundamental changes that are occuring and attack them head on with programs to help retrain individuals that are willing to adapt.

Wednesday, February 25, 2009

The Rescuers

I live in a nice house. It's not a mansion, but a nice house. I also live in a nice neighborhood. It's not millionaire row, but its nice. At the peak of the housing market, I was making good money, and I thought very seriously about moving to a larger, more expensive home in the subdivision adjacent to mine. As the market slowed I thought even more seriously about it, because I thought I could find a bargain. In the end, I decided that I was better off in my older, more modest home. What a great decision that was! Six months later I was laid off. Now I have started my own company. Those of you that are self employed understand what it is like to not get a regular paycheck even though you work. Any money I make goes back into my company, and it has been seven months since I have seen a paycheck. I should be the perfect candidate for a government bailout.

Alas, despite the lack of income I have paid all of my obligations on time. I had plenty of savings (and still have some) to get me through this. If I had only known that the federal government would be pushing loan modifications, I wouldn't have wasted my money on something as useless as savings. I would have bought that big beautiful house on millionaire row. I blame my parents for instilling me with financial sense and personal responsibility. Little did they know how useless those virtues would be in 2009.

Now that I have resigned myself to the fact that I won't benefit from any financial rescues, and will in fact be paying for the rescue of others for years to come, I can objectively review the President's announced Homeowner Affordability and Stability Plan. The plan covers three key areas: creating opportunities for homeowners to refinance; encouraging a larger number and more effective loan modifications; and strengthening of the governments commitment to Fannie Mae & Freddie Mac.

Refinancing
The first part of the plan is the affordability initiative. Loans that are currently owned by Fannie or Freddie or in mortgage back securities guaranteed by the government sponsored enterprises will be eligible for a refinance to current interest rates, which are very low by historical standards. A lack of equity is keeping many people from refinancing, so the President's proposal is to allow for loan amounts up to 105% of the current value. That will certainly open up the opportunity for some homeowners to refinance. It will leave out quite a few as well. For example, people who don't have a conforming loan (Fannie or Freddie) currently will not be eligible. Also, if they are so upside down (owe more than the house is worth) that 105% is not sufficient, they won't qualify either. There are a lot of homeowners here in Arizona that fall into that category. Jumbo loans are also not eligible (over $417,000). The Mortgage Bankers Association has argued that the 105% limit should be removed from the plan. Their argument is that Fannie Mae and Freddie Mac already have the liability for the existing loans no matter what the loan to value ratio is. Therefore it is in their best interest to refinance these loans to lower rates regardless of how much the value of the home has declined. That's a pretty valid argument, especially since there is already a precedent set in the form of FHA and their streamline refinance program.

Modifications
The second key to the plan is to increase the number of and the effectiveness of mortgage loan modifications. Many people have fallen behind on their mortgage payments and the only thing that will save them from foreclosure is a lender that is willing to change the terms of the loan and make the payment more affordable. Obama's plan calls for lenders to modify mortgage payments down to 38% of the borrower's gross income. In addition, the government will match dollar for dollar a reduction of the payment to 31% of the borrower's gross income. There are additional incentives that can be paid to the lender if the modification is successful (meaning the borrower makes the payments and stays in the house) as well as incentives for the borrower (beyond being able to keep their house) in the form of principal reductions for successfully paying their modified payment on time. It's a positive to get some guidelines on what has been a messy and confusing subindustry called "Loan Modifications." Lenders will continue to struggle with the problem of filtering true hardship cases versus those individuals that look to take unfair advantage of the lender and taxpayer. And the borrowers with the true hardship cases are not likely to comprehend how the plan works anyway. If they claim to have not understood their original mortgage that got them in trouble, how are they going to understand this?

Low Rates
The final part of the plan will likely be the most effective. That is because it is simple. The Treasury will continue to purchase Fannie & Freddie mortgage backed securities and increase their portfolios. The fact that the government is buying mortgage backed securities is keeping mortgage rates low. That is great for those that can refinance. It is really great for first time homebuyers that can now finally afford to by a home because of the devaluation that has occurred.

Meanwhile, I will continue to pay my mortgage on a timely basis. I even have one of those evil adjustable rate mortgages. My rate is lower than any fixed rate you can get now, and it is scheduled to go down again in a couple of months. An adjustable rate mortgage doesn't seem nearly as "evil" as the government taking my money to pay down someone else's mortgage.

Sunday, February 15, 2009

Light in a Dark Economy

On the weekends my wife, Jen, goes to WalMart to do the weekly grocery shopping. Meanwhile, I hang out with our two sons for a few hours. Today we played whiffleball. When Jen returned she commented that WalMart seems to be getting more and more congested with shoppers as of late. I wasn't surprised. The chain is just about the only retailer that actually performed well in the fourth quarter of '08. When times are tough, shoppers will be more price sensitive, and WalMart has the reputation for having the best prices. Of course, that's common sense. This got me wondering, what other "common sense" winners might there be in a tough economy? Let's put it this way, with unemployment rising, what are the growth areas for jobs?

1. WalMart Greeter - So I already established that WalMart has more customers, so they need a nice elderly person to greet them. If you are over 65, this job is for you.
2. Mortgage Loan Workout Specialist - Mortgage loan modifications are the service du jour. Since most homeowners no longer have equity, it's the new refinance.
3. TARP application reviewer - There is a backlog of 2,000 applications for bailout funds. Since the government is only getting through about 50 per week, that means that banks are waiting at least 9 months before they get a response on their TARP fund requests.
4. Keynesian Economist - The passage of the stimulus bill is based on the assumption that government spending will stimulate the economy. Well, that depends on what the money is spent on. Tax cuts help, as does some of the spending, at least temporarily. Regardless, if you know formulae for fiscal multipliers by heart, then you are sure to get a job as a White House economic advisor.
5. Liquor Store Owner - Cheap vices do well in recessions. Alcohol and cigarettes are sure to be good sellers with the light supply of discretionary income. Local governments won't mind since those items come with a hefty sales tax.
6. Security - More liquor stores are also likely to get robbed. So anything related to security should do well. Cameras, alarm systems, and rottweilers should all sell well.
7. Gun Sales - Also related to security, but the criminals will also be buyer them. But they will likely be buying on the black market.
8. Repo Man - duh!
9. Attorney - I'm not sure on the specifics here, but lawyers will always find a way to fleece the public.
10. Federal Bureaucrat - There are tons of examples, but here is just one. In the recent stimulus bill, there is an appropriation for $2 billion dollars described as "Extra money for the Office of the National Coordinator for Health Information Technology." Really? "Extra Money?" Well I'm sure some of that extra money will go to hiring some highly productive bureaucrats.

So there you go. When you thought there was only darkness in this economy, I have shown you the light.

Monday, February 2, 2009

Why Do People Think that the New Deal Worked?

It is with some sadness that I write this article. Irrelevant to this topic, I must acknowledge that I am an Arizona Cardinals fan and have been through many losing seasons. Our magical ride came to an end with 35 seconds left on the game clock on Super Bowl Sunday. It was the most exciting Super Bowl I have ever watched. It ended with me wanting to cry, and with my eight year old son Dominick actually crying as he sat on the couch in his Larry Fitzgerald jersey. It is cliche to say that we always have next year. But in Cardinal Nation, this is the first time we can hope for next year and actually believe it. After decades of being a loser, the Cardinals are now a force in the NFL.

As far as the economy goes, I am not convinced that there is hope for next year. I have heard so-called experts talk about a recovery in 2010, but they can never explain what will drive the economic growth. They just assume that what goes down will eventually go up. They fail to acknowledge that "what goes up" needs something to lift it.

Congress (at least the controlling party) and President Obama are selling a stimulus plan that uses a Keynesian philosophy of government spending to lift the economy. I have heard several politicians announce that this is their "best" opportunity to pass legislation since the Great Depression. What kind of legislation you ask? Legislation that spends money, and lots of it.

Certainly there are some worthy spending plans that the federal government can use to temporarily lift the economy and have long lasting benefits as well. Infrastructure spending that relates to energy independence and transportation are a good example as long we are smart about the choices of projects (e.g. don't just throw taxpayer money as something because it sounds green). When I read in the paper about the $900 billion stimulus package containing items that may be noble causes, but hardly qualify as "economic stimulus," I realize that very little has changed in our federal government. Does spending $335 million on programs to stop sexually transmitted diseases create jobs? Someone may argue that it does, and perhaps it does create a few, but tell me with a straight face that we'll get $335 million worth of jobs. How about an extra $50 million for that great economic engine, the National Endowment for the Arts? While there are some provisions that will actually create jobs, for example tax relief, much of it is simply a wish list by politicians for their pet projects or quid pro quo for their campaign supporters.

FDR is widely known as one of our greatest Presidents for leading the country through the Great Depression and World War II. The economic devastation of that era was much wider and deeper than what we are experiencing today (so far). He took drastic measures as soon as he took office in 1933 with colossal spending projects in the form of the New Deal to get Americans back to work. And it worked. Well, it worked temporarily. When he tried to pull back on some of the spending in 1937, the economy actually got worse than it was in 1932 before he started. New Deal spending relieved some of the symptoms of unemployment, but it did not solve the root of the problem. It took winning the largest war in world history to bring us out of the Depression.

It is worthwhile to note that the cost of this package well exceeds the entire cost of the Iraq war. Are we spending only to temporarily relieve symptoms as the New Deal did? What we need are businesses to invest in the economy. Business drives a market economy, so the government needs to give us a stimulus package that motivates people to invest in business, and business to invest in the market.

My recommendation to Congress and the President (it's kind of arrogant for me to think that they care about my recommendation) is to pare down this package dramatically to focus on projects that can have a true economic impact within the next 12 to 18 months. Energy independence and grid improvements, transportation infrastructure, and tax incentives are all subjects that will drive our rise from this economic funk. The consequences of wasting money on politician's pet projects are severe. Huge additions to an already out of control national debt limits what we can do in the future and will lead to inflation. Combined with a stagnate economy (stagflation), it will be an ugly situation for years to come. We need to care about what makes up $900 billion. Don't simply be satisfied that it is a big number and assume we need what they're giving us.

Tuesday, January 13, 2009

No Longer Too Big to Fail

"Too big to fail" has been the reason for bailout after bailout. As Americans we cannot live without some companies, so it is our responsibility as taxpayers to pay for their mistakes. Whether it's Bear Sterns' debt or saving automakers from bankruptcy, we the taxpayer are here to keep failing companies afloat. One of the companies that the government chose to spend our hard earned money to assist is Citigroup.

About a year ago I left a 16 year career with Countrywide to take a job as a Regional Manager for Citi's mortgage company. Four months later I was let go as the entire division was dismantled. I hold no hard feelings toward Citi. When I signed my severance agreement (which was generous considering I had only been there for four months) I agreed not to say anything negative about Citi in a public forum. So let me be clear, any negative comments concern the government, not Citi.

Now that I have that disclosure out of the way I can move on. Citigroup is the financial goliath created by Sandy Weil in 1998 when Citicorp and Travelers merged. The idea was to create a diversified financial supermarket that crontained various cross-sell and synergistic opportunities. Well, it didn't really perform like it was drawn up. There have now been five quarters of very large losses and questions about whether Citi would survive.

But Citi is the largest diversified financial organization in the universe. The federal government was fearful of what would happen if Citi filed for bankruptcy. I agree it would probably be very bad, and the stock market would tank like it did when Lehman went down. So far the feds have injected $45 billion in cash into Citi as well as guaranteed $260 billion in debt. That total exposure is 44% of the entire $700 billion TARP funds. Of course even in a worst case scenario you still wouldn't lose that amount, but it demonstrates how much support our federal government is providing to this private (albeit publicly traded) company.

But now Citi is doing what they need to in order to survive. They are getting smaller. Does that mean they will no longer be too big to fail? They are shedding businesses including Smith Barney which will be a part of a joint venture with Morgan Stanley. It appears as though Citi will be more of a wholesale bank with large corporate clients and retail banking operations in only select markets around the globe. Would the fed actually bail out a firm that is what Citi will look like when the shedding is complete? I would hope not. But it's too late, the bailing out has been done.

Citi will shrink itself by roughly a third. Is that still too big to fail? I am not alone in my opinion that the government has done a lousy job so far with the TARP. It has been widely criticized. But the critisism must continue if things are going to change.

Monday, January 5, 2009

Mi Casa es Su Casa

I have a couple of housekeeping topics before I go into my article for this week.  First of all, I apologize to any Spanish-speaking readers for my title.  I don't know how to add the proper accents over the appropriate vowels when typing in Spanish on my keyboard.  My high school Spanish classes occurred when homework was still done with pen and paper.  Secondly, I removed my photo.  My father informed me I looked like a skinhead in that photo.  While I do have a shaved scalp, my views of the world and life in general would not come close to that of a neo-Nazi skinhead.  Even if I wanted to join one of their deranged groups, my marriage to a Jewish woman would probably preclude me from membership.  A new photo will be uploaded this week.

Now that we have that out of the way, I can address the topic at hand.  An article titled "Housing Push for Hispanics Spawns Wave of Foreclosures" by Susan Schmidt and Maurice Tamman captured my attention as I read the Wall Street Journal this morning.  Throughout my entire 17 year career, and especially in the past five years, I was very involved in promoting mortgage loan products that were designed to get more people into homes, especially new immigrants in the Hispanic community.  

The article discusses the great push by legislators, specifically the Congressional Hispanic Caucus, and mortgage lenders to ease lending standards and get more Hispanics to become homeowners.  It further discusses subprime lenders' involvement with policy-makers and industry associations such as the National Association of Hispanic Real Estate Professionals.  In 2005 at the height of the subprime boom, companies that were involved in subprime lending contributed $2.3 to the campaigns of  Congressional Hispanic Caucus members.  That wasn't even an election year.  The point is that all of the players were working together for what should have been a righteous cause, and it probably started out that way.

I started in the business in the early nineties when the movement to increase lending to minorities and low income Americans was gaining momentum.  Working for Countrywide, I recall us introducing our effort in the form of a program called House America.  This was not a subprime program.  It was a fixed rate loan with competitive market rates.  The key was the fact that it allowed the borrower to purchase the home with a minimal down payment (3% if I remember correctly) with minimal credit history.  We also took extra care to try to approve every possible loan in this program.  Many of these loans were for properties in California, where Countrywide had its strongest share of the market.  Unfortunately too many were approved that shouldn't have been, and when property values began to fall through the mid-nineties many of the loans went into foreclosure.  The company was able to remain profitable because these loans were a small share of overall production and because management handled the downturn well by cutting expenses.  It took several years for the memory of those events to fade.  

Fast-forward to 2003 and once again the entire industry is interested in capitalizing on the fasted growing segment of potential homeowners, Hispanic Americans.  At Countrywide we dusted off the old House America program with the best intentions.  Helping more Americans achieve the dream of homeownership was the right thing to do.  In Arizona and New Mexico I conducted countless seminars for mortgage brokers in English and Spanish.  We flew in a bilingual speaker from corporate to present.  The number of Spanish speaking mortgage brokers in the Phoenix area was growing.  I would visit offices of these mortgage brokers with one of my bilingual account executives and I would have no clue what anyone was saying.  Loan officers and processors were immigrants themselves and spoke no English at all.  But all of the loan documents were still only in English.  While these Spanish speaking mortgage brokers opened the door to a new segment of homeowners, I found many of them to be less than ethical.  Not all, but a significant portion charged exorbitant fees.  Loan files were often poorly packaged, and we terminated relationships with several after discovering fraudulent activity.  Before discovering the poor quality of one of these companies, I was astonished by the volume of loans they were originating.  I asked my account executive that managed that account why we were not getting more business.  His answer was that they were lazy.  This broker preferred to send their loans to a certain subprime lender because they asked for less documentation even though many of the borrowers would qualify for our more affordable House America or a Fannie Mae My Community loan.  All of the companies that I know conducted business in such a manner have since been shut down by the Arizona Department of Financial Institutions, but much of the damage was already done.  

Money was being made by the lenders (mainly subprime) and Wall Street, new homeowners were happy, and the policy-makers were receive fat campaign contributions.  This quote from the Chairman of the Federal Housing Finance Board Ronald Rosenfeld wraps it up nicely, "It's very hard to get in front of a train loaded with highly profitable activities and stop it."  In fact that pretty much sums up the inability to stop the entire financial meltdown.

I doubt that memories will fade as quickly this time around.  I support efforts to get more minorities and new immigrants to become homeowners.  I still believe that homeownership is a key component of Americana.  Let's just make sure we don't lose sight of sound underwriting principles as we strive to fulfill the American Dream.