Saturday, December 31, 2011

Radio Interview: Subprime CDOs Played a Starring Role in the Financial Crisis

The Norris Group's Real Estate Radio Show
Riverside, California
December 31, 2011
Bruce Norris Interviews Robert Stowe England
Topic: Black Box Casino

Listen to the broadcast at this mp3 link:

Summary of the Interview:

This week Bruce is joined once again by Robert England. Robert is a journalist and author who has written extensively on mortgage finance, banking, retirement policy, and the financial and economic impact of aging population. His most current work is Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance. Previous works include Aging China: The Demographic Challenge to China’s Economic Prospects. Robert is also a senior writer for Mortgage Banking Magazine.

In our minds, we used to think that we would go to the bank, get a loan, make a payment to them until we paid it all off, then they hold the loan the whole time. This was called a portfolio loan. It was not until late 2007 when Bruce heard the term mortgage-backed security and CDO.

Bruce wondered if, therefore, at the time this was commonly understood by people who were even in the loan business. Did they understand the path the paper took and how it was disseminated?

Robert believes the people involved with mortgage originations understood it, although other people involved in the housing sector probably did not understand it as much. They did not understand that the loans were being put into portfolios while securities were being issued against the portfolio so that investors were the ultimate funders of the mortgage loans and not banks. The money was funded temporarily by the mortgage originator. They would obtain a warehouse line of credit from a bank if they were an actual mortgage banker as opposed to a broker. They would have money just to the point that the loan closed, and then the loan was sold to an investor. For the mortgage originator, the investor was either Fannie or Freddie or a bank that was acquiring the loan. They did not really know what happened to the loan after that. They did not have to know this; they only knew that they were creating loans, and the demand for them kept increasing even though the quality was decreasing.

Out of the mortgage-backed security world came a product called a CDO. This is a collateralized debt obligation, which began to be used as early as the 1980s. It was used to take existing corporate debt and roll it into a pool of loans to issue securities against a pool of corporate bonds. This never became a huge amount of business and was tried later for bonds from developing nations and other kinds of debt instruments. The market would rise and fall and vanish away, so someone was always trying to come up with another way to use a CDO, which is just another form of securitization. The 1999 credential came up with the idea of having a CDO that put together mortgage-backed securities into a pool and issued securities against those securities, so you were securitizing securities.

There was also the concept of a tranch, which Bruce thought was brilliant and a good vehicle if done correctly. In the private-label mortgage-backed securities world, they all had tranches even before the CDO, and every deal had as much of the deal as possible set up as AAA rated. These were credit-rating tranches. About 94% of most MBS deals were AAA rated by the credit rating agencies, such as Moodys and Fitch. They were paid fees to buy the Wall Street firms, and they also rated the CDOs. The huge volume of private mortgage-backed securities and CDOs did not really take off until after 1999.

The reason for this was when the Basel Committee for Banking Supervision came up with a concept for having the idea risk-waited capital standards apply to these kinds of financial instruments and to give the credit-rating agencies a job of determining their credit rating, only then did it determine the amount of capital banks would hold against the tranches of the deals. The central bankers never really thought this through and were actually creating a monster here because by giving this role to the credit rating agencies, they had made a big mistake. Ironically, when the idea was first proposed, Moodys Investor Service wrote a letter in response to the proposal and suggested that it not be done and that it would corrupt the credit rating standards and created a moral hazard. Yet, this was ignored, and the various countries, including the United States, adopted the standards in 2001 that gave the credit rating agencies this role.

The same year there was a Gramm–Leach–Bliley Act that also did away with the last of the Glass-Steagall Act and barred the SEC from regulating the investment banking holding companies. The investment banking companies, which were already independent, did not have a prudential regulatory regime since Gramm–Leach–Bliley cast this in stone. There was a battle subsequently with the Europeans over this, and Congress first passed a law allowing a voluntary regulatory regime to be established for the bank holding companies and investment banking firms. All of the banking regulation was based on the idea that banks have deposits, taxpayers are exposed to deposits, and banks hold assets for a long time and therefore we are protecting the taxpayers from losses. However, investment banks do not hold deposits and by the nature of their business should not be holding assets for a very long time but rather should create markets. By adopting a regulatory regime in 2004, the bank holding companies and investment companies were given the incentive to buy and hold assets and the use of tremendous leverage, especially mortgage-backed securities. Risk-weighted capital standards are supposed to discourage banks from picking on assets with high risk, but what they really did was create incentives for banks to take on assets with low capital ratings. The investment banking firms did the same things that banks were doing, which were loading up on the assets.

The money to fund the CDOs came from investors, and it had to rated AAA to attract a lot of money. Two things were going on in the early days of the CDO. There were institutional investors who invested in the CDOs that contained mortgage-backed securities and subprime. Banks were also creating CDOs to get the lower-rated tranches of mortgage-backed securities off their books. They could not sell them, but they were trying to get rid of them, so they would put them into CDOs so it would become AAA rated. The institutional investors had lost interest in the lower-rated tranches of the private-labeled mortgage-backed securities subprime, particularly around 2003. The CDO was a way to recycle those assets that institutions would not buy by turning them into AAAs. You would basically take the worst from one pile, and it magically turned into the new pile of the best. By making it very opaque, some investors who did not understand it could be enticed into investing. These were actually black boxes.

Most of the investors aforementioned were foreign investors. After 2003, the U.S institutional investors were not buying, and the investors who were willing to buy had incentive to buy dollar assets and were looking for bond assets. They had trade surpluses or recycled petro dollars. They had lots of dollar denominated funds, and they needed to invest them in dollar assets in order to avoid currency risks. Therefore, the Asian and European banks and other institutional investors were buying these CDOs without much regard for what was in it, and you could not really know what was in it. They did not quite get the level of risk that was there because they were rated AAA.

Bruce wondered what role the Credit Default Swap played in the world of CDOs. Robert said the Credit Default Swap is a form of insurance in which one side sells credit protection against the bonds or mortgage backed securities that the payments would be made, and the other side buys the insurance. The availability of credit default swap made it possible to create synthetic CDOs on a massive scale beginning around 2005. They had existed before, and people were buying credit default swaps to protect their risks for owning certain tranches of the mortgage-backed securities. They then applied this concept to the CDO, but the synthetic CDO was created entirely with credit default swap. The actual assets were a pool of credit default swaps, and the entity issuing the synthetic CDO was insuring their performance. They would turn around and try to get insurance that would cover their losses if the bonds or notes failed. The provider of that was AIG’s financial products division, which sold all the protection for many years.

There were other companies that did it as well, but not nearly the size. The mono-line bond insurance companies that were looked over by state regulators became involved to their own detriment. When they went out of business, whoever was supposed to obtain the insurance coverage just lost.

What happened was the issuers such as Merrill Lynch, Goldman Sachs, and Citigroup were putting together synthetic CDOs and were providing the insurance. In turn, they often could not buy the insurance. Goldman Sachs was able to, but Merrill Lynch and Citigroup increasingly were not able to buy the protection and continued to put together synthetic CDOs without it. They were the designated back holder at that point. They ended up owning all the super senior tranches, which is part of the deal that is made up of the credit default swaps.

Citigroup tried to hide these assets on their balance sheet as well as their trading accounts. When the investment banking regulation was adopted, the Wall Street firms obtained a provision that allowed them to model anything held in their trading account on their book if it had not traded recently. However, Citigroup was also putting these assets into structured investment vehicles, which are more black boxes off its balance sheet. These were funded with asset-backed commercial paper, which was then backed in some cases by subprime mortgages. The Citigroup had over $50 billion worth of toxic assets at the time of the crisis. They were telling the public they had practically no subprime exposure.

Usually the person holding the credit default swap had the other side of the transaction, but this was not even necessary to get a credit default swap. One person was buying protection, and the other was selling. Merril Lynch was putting together a deal where they were providing credit protection to the other party that was in the deal. Then, someone such as Kyle Bass comes in and says he can buy, Bruce wondered if he could invest in a credit default swap and not have the other side.

Robert responded you can in that you would only take one side, in this case the protection side. You can also bet against some of the various parts of the deal, which is what the hedge funds did. The smart people were buying the protection, and the less smart people were not. The general public did not realize how many bad loans were out there, including investors. They assumed that the deals would function and people would pay their mortgages. They did not see the dangers. However, those with the hedge funds did see the dangers and began to sponsor CDOs in order to create tranches they could bet against. They were selling a product they knew was going to fail, and then they bet against its failure. This was at least what was alleged with Goldman Sachs and the deal that got so much attention in Congress.

What the hedge funds did was slightly different, and it is not clear the extent to which the investment banking firms knew about it or whether the people at the top knew about it. Hedge funds would sponsor CDOs, and they would buy the equity tranch. The banks would then have to sell the AAA and BBB to someone else. There were CDO managers, and the catch funds were not supposed to influence the choice of assets that went into the CDO. That was how investors were assured that this was done with integrity. However, certain hedge funds appeared to influence, but it cannot entirely be proved because it was done in ways where it was difficult to trade. Very often with certain hedge funds, such as Magna Tar based in Chicago, the deals they sponsored and the $50 billion worth of CDOs all failed spectacularly.

The CDO managers picked the worst assets out there. The question is whether Merrill Lynch in this case knew what was going on, and this is still going through litigation. Logically, you would think that they had to know something. The people at the top were probably the ones who did understand what was going on at the time. Interestingly, it seems to happen where they may not even understand completely the concepts that are emerging constantly.

You wonder about someone like Stanley O’Neal, who was supercharging at Merrill Lynch the CDO business at the worst possible moment because they thought it was very lucrative. You have to wonder if they were really that foolish and unaware. It is hard to know.

In Robert’s book, it talks about one trader who actually earned more doing one trade than for what Bear Stearns was sold. Bruce wondered if he used a naked short sale to achieve this. Robert said he did and that naked short selling was almost impossible to do with the uptick rule. You could still do naked short selling, but it was difficult to execute. An uptick means that stock has to rise and move up before it goes back down again. The naked short selling is selling shares of stock that you do not own or borrow. This is illegal and is done to manipulate markets to achieve outcomes that the manipulator desires to do.

In March 2008, somebody bought an option for $1.7 million that would not pay off unless the chair price at Bear Stearns collapsed within ten days. Immediately after this happened, rumors were circulated throughout the industry that Bear Stearns did not have enough cash even though it had $18 billion in cash. Brokerage firms started pulling their money out of Bear Stearns. Within days, they only had $2 billion in cash and were on the verge of collapse. Over the Bear Stearns weekend in March 2008, the sale of Bear Stearns was negotiated by the Fed. In the initial deal, which was only $2 a share, the person who made the $1.7 million bet made $270 million off the bet. The company was sold for $236 million, which was worth less than the corporate headquarters of Bear Stearns.

Bruce read a quote that stated, “Bear Stearns was vulnerable to runs because, like most of Wall Street, it had been funding its operation from short-term secured and unsecured cash. When these short-term arrangements did not roll over, new arrangements could not be secured. Cash was drained out of the firm.” We now have sovereign debt. In his book Boomerang, Kyle Bass has done his job of doing credit default swaps on Greece. He would pay $1100 for $1 million coverage. Bruce wondered if Robert saw the same setup that really damaged the world’s economic mortgages done and if round 2 might be sovereign.

Robert believes this derives from the same problem with giving assets too low a risk waiting, especially in Europe where soverance requires no euro capital. Originally this was supposed to apply to AAAs and AAs, and in fact it does still apply to lower rated tranches. You could own a lot of these assets and fund them through overnight lending, and confidence in the system would vanish and people would want their cash back. They would demand more and more assets. Effectively, the price of the asset was declining, but it was being affected by cash being drained out of the system.

For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.

Wednesday, December 28, 2011

The Fannie and Freddie Hate Storm

Holman H. Jenkins, Jr. writes in a column in the Wall Street Journal December 28:

Like amoebas feuding in a drop of water, pundits have been savaging each other all year over whether Fannie Mae and Freddie Mac "caused" the financial crisis. Lately the argument has become apoplectic.

But the question is phrased badly. Three things happened: a housing bubble, a collapse in lending standards, and a global liquidity panic when markets lost trust in the solvency of financial institutions.

Read more at this link.

Tuesday, December 27, 2011

Why the Left is Losing the Argument over the Financial Crisis

By Peter Wallison and Ed Pinto

American Enterprise Institute
December 27, 2011

The day before Christmas, Joe Nocera did it again—wasted a perfectly good column with another attack on us, Peter Wallison and Ed Pinto.

It’s worth reading for what it says about the Left’s current situation. According to Nocera, we “almost single-handedly” have created a “myth that Fannie Mae and Freddie Mac caused the financial crisis.” Those who have fallen for this myth, according to Nocera, include the congressional Republicans and the Wall Street Journal’s editorial page.

It’s somewhat implausible that two guys at a Washington think-tank, arguing that the financial crisis was caused by government housing policy, could create a widely accepted alternative to the conventional liberal narrative that the financial crisis was caused by the greed and lack of regulation of Wall Street. After all, the conventional narrative was created by the government, propagated by the New York Times, and accepted without question by just about every other major newspaper and electronic mass media outlet, foreign and domestic. Apparently, however, in Noceraworld, threats to the accepted narrative can never be fully suppressed.

Read more at this link.

Saturday, December 24, 2011

Radio Interview: Congress Set Fannie, Freddie on the Road to Ruin

The Norris Group's Real Estate Radio Show
Riverside, California
December 24, 2011
Bruce Norris Interviews Robert Stowe England
Topic: Black Box Casino

Listen to the broadcast at this mp3 link:

Summary of the Interview:

257-TNGRadio – Robert England 12-24-11
Friday, December 23rd, 2011

This week Bruce is joined by Robert England. Robert is a journalist and author who has written extensively on mortgage finance, banking, retirement policy, and the financial and economic impact of aging population. His most recent work is Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance. Previous works include Aging China: The Demographic Challenge to China’s Economic Prospects. Robert is also a senior writer for Mortgage Banker Magazine.

Bruce said he really appreciated his Black Box Casino book and was familiar with the overall story. There are a lot of insider terms where when you are in Wall Street and you watch Squawk Box, they use the terms as if the world knows what they mean when they don’t. One thing his book really did that was very helpful was every time he had one of these words to use, he took time to explain what it means. Robert said he did this after a copy editor was reviewing his work that had a general but no financial background, so she kept saying she did not know what something meant. Since she did not understand what words meant, then Robert decided that he needed to define the term. Bruce said it was really helpful because there are some things you hear and you just pretend you know, but then you realize when you have to explain it to somebody that you really don’t know what it means.

The book talks about events as they unfolded in 2007 and 2008, yet Robert had just written the book in 2011. The reason for the long gap of time was it took a while for him to find a publisher who was interested and also to obtain a book contract. This was part of the reason. Another reason was information came out later on that was more helpful than what was available immediately after the crisis. This included a lot of research that was dug up by the financial crisis. Bruce wondered if as time passed people were more apt to say what really went on because there was a safety of distance between the events. Robert said this was probably true for some sources in the book; but for other sources they clammed up because whatever they had been involved with was being embroiled in lawsuits, so they did not really want to talk.

The name Black Box Casino is a concept that describes the change that was occurring in the global financial system. First, there was the increasing prevalence of black boxes within the system, which are financial instruments and institutions that have no transparency; you can’t see what is going on inside and therefore they are black boxes. The casino part of the title comes from learning that much of the activity that went on in a number of the black boxes was in fact speculation, even wild speculation.

Bruce said when we used to think of Fannie and Freddie; we used to think of the safest possible loan pool with a mandate to keep safety as first priority. Bruce wondered how wrong this perception is, to which Robert said this is completely 180 degrees from the reality that was going on at Fannie and Freddie. The way the regulation was set up to govern Fannie and Freddie did not guarantee that they would be operated in a safe and sound manner, and it may in fact have encouraged them to do the opposite.

Bruce wondered if the title of GSE (Government Sponsored Enterprises) came with benefits. Robert said it does because the government is sponsoring what you do, yet you are a private corporation that has shares that are publicly traded and that benefit the executives of the company if they can use the public mission of the corporation to increase revenues and profits for themselves. It is a hybrid form of a business that comes with a lot of problems and can reap a lot of damage if things get out of hand.

Bruce also wondered if the political club had considerable political clout. Robert said they did because both Fannie Mae and Freddie Mac had a considerable amount of clout in the beginning before the regulations were set up to govern them. Once the regulations were put in place, there were a number of provisions in the regulations and the statutes that gave them a lot of power. For one thing, they were allowed to lobby and also got involved with making campaign contributions. Even though they were government-sponsored enterprises, logically they should not have been allowed to lobby the government. What happened was by giving them the authority to lobby, or more specifically not prohibiting it, it allowed them to make contributions, influence Congress, and give politicians a way to provide benefits to constituents without having to go through the budgeting process since everything going on at Fannie and Freddie was not involving the budget. Even their regulator was given minimal powers to regulate them, keep them in line; and this in turn gave them more clout. The regulator did not have a source of income from fees, which is usually what the banking regulators have. Instead, they had to go to Congress every year and get funding for their activities; so they were hamstrung by the ways that the law was set up.

This law was the 1992 Federal Housing Enterprise Financial Safety and Soundness Act, which was a very important law but that unfortunately did not live up to its billing. It was supposed to have been set up for safety and soundness, but once Congress got a hold of the original idea and began devising a bill, it was really put together in a way that would benefit politicians the most as it would give them a way to constantly provide a benefit to a constituency, and that benefit would constantly rise over time. There was no way to restrain the lowering of lending standards, which would be required to increase the level of lending to designated populations.

The law contained federal affordable housing provisions, which was a kind of coup for the politicians. Bruce was shocked that they had a mandate they had to loan to low-to-moderate income people a certain percentage of their loans. When the GSE Act was being put together, at that point both Fannie Mae and Freddie Mac had informal goals in place where approximately 30% of their business would be acquiring loans that went to borrowers who were low or moderate income borrowers. That reflected on natural market share or an entity in their position that would not distort the market. The crafters of the legislation wanted to give HUD the right to raise the affordable housing goals that were put into law and to do them on a periodic basis along with constantly raising them without any consideration to whether or not it would impair the safety and soundness of Fannie and Freddie.

What is interesting about all of this is the legislation really came on just after the SNL crisis, so you would think that everyone would be in the mood to create something that was safe and sound. Robert believes everyone was in the mood, but no one was paying attention to what was being done. First of all, the concept that you would now securitize loans would be a predominant way to finance mortgages was thought to be the way they would reduce the potential fallout from a bad period of lending that occurred with the savings and loans, which held their mortgages on their book. When interest rates rose very high, there was a huge mismatch between their assets and liabilities, which did them in. Securitization was supposed to take that risk off the book, but starting with that people thought they had a magic solution. However, they did not put together a regulatory regime that would be capable of assuring the safety and soundness of Fannie and Freddie, from setting up capital standards to allowing them to have investments in portfolio, to not allowing the safety and soundness regulator to raise their capital standards if they deemed that they were inadequate at any point. In addition to having to go to Congress every year for money, the regulator was also not an independent regulator. They were a part of HUD, and they did not have any control over the Affordable Lending Goal and could do nothing about them. HUD did not have to consider safety and soundness when they were considering the goal. There were actually three goals at the time, and the main goal was raised to over 55% by the time of the crisis, so there was a subsequent goal to low income households, which is more narrowly targeted. This had not existed before and began at about 11% and rose to nearly 27% at the time of the crisis.

Bruce wondered how people qualified for the loans, whether they were really subprime or if they were good credit but low income. Robert said over time the lending standards at Fannie and Freddie declined in order to meet the affordable lending goals. As the goals were put in place gradually, they weakened their lending standards. They first lowered the down payment then gradually lowered the FICO score for borrowers to qualify to be part of the Fannie and Freddie program. They then increased the segment of the business that was funding subprime without identifying that publicly. They drastically increased the amount of business funding Alternative A or low to no documentation loans even more without publicly acknowledging it. The legislation that set up Fannie and Freddie did not require them to file quarterly audited statements to the Securities and Exchange Commission, so they could get away with not telling investors the truth about their portfolio. By the time of 2000, they were doing 100% loan-to-value mortgages and were greatly expanding their subprime lending, but it was never identified as that. This was how we ended up this past week with the SEC filing charges against former Fannie and Freddie executives for lying about the amount of subprime and Alt-A in their portfolios and in their investment holdings. They had a black box, and they were wildly at odds with the actual amount they had.

Bruce wondered if a lot of the fulfillment of the lower income goals happened because they were able to invest in mortgage-backed securities that had the loans in them. Robert said it was both through acquiring them and not calling them subprime, and also through buying private label mortgage-backed securities that had loans that met the qualifications and that would meet the goals. Jim Lockhart, the former head of the Federal Housing Finance Agency, told Robert in a recent interview that they could not have met their goals if they had not bought up a lot of the private label mortgage-backed securities. They bought large amounts of it and were the major purchaser of private MBS. Another reason may have been they were able to leverage it more. Their capital standards were very low, so they could leverage the acquisitions and increase their earnings as well as buy extensions, which was the compensation of the top executives. As a lot of people may know, the former heads of Fannie Mae and Freddie Mac were involved in accounting scandals in 2003 and 2004 where they were found to have manipulated the earnings targets to maximize their compensation. Both Franklin Raines and Leeland Brendsel had to leave the two GSEs at the time. You can jut up the amount of securities you purchase to increase your overall compensation and profitability that was at first profitable but later was not. By creating a compensation system that rewarded the executives by increasing volumes, it really drove the GSEs’ top executives to greatly expand their business in order to make more money.

The leverage for a mortgage-backed security that was stated in the books was 222 to 1, and this was for the guarantee. There were two capital rules. The first was the 222 to 1 guarantee, and the second was Fannie and Freddie had to only hold 0.45% of that capital against the guarantee of paying the principle interest to the investors in their securities. If they held any of the securities that they purchased, they only had to hold 2.5% capital against it. By early 2008, the GSEs were leveraged about 100 to 1 overall when you blend the two on standard accounting rules. The accounting rules were another way that Fannie and Freddie were able to get away with what they did. They did not have to meet what were normally considered bank accounting rules but could use generally accepted accounting principles, which allowed them to use some types of securities and assets to count as their capital when other people did not. This included losses that could be claimed against future taxes. When you are losing money constantly, there is no gain to apply the losses against.

The intended consequences of lowering lending standards was to increase homeownership rates among lower-income and moderate-income households. The homeownership rate was around 64-65% at the time that the GSE Act was passed, and they were hoping to raise it dramatically so that particularly minorities would have homeownership rates similar to those of whites. There was a disparity between both African-Americans and whites and Hispanics and whites in terms of the percentage of the population that owned a home. Although the homeownership rates were about 45%-50% range, they were better than a lot of people might have thought. However, they were not in the mid to high 60s. There was legislation in the 70s that tried to correct those things. This included the Home Mortgage Disclosure Act of 1975 that required the banks to collect data on which the person was that was the borrower as far as race. There was also the Community Reinvestment Act of 1977 against Red Lining.

When you are a lender, there are areas where you are not trying to be prejudice but you realize that an appraiser could literally get shot. Bruce is in the hard money business, and they get asked to go to certain areas to do loans; and all those things come into play that you are actually in danger. With Red Lining, the intent was not to have a prejudice outcome, which is just and fair; but you have to ask if it also takes away the ability to say no because you know it is not going to have a good outcome. The effect of all the various laws, provisions, and actions by regulators led banks and lenders to increasingly divorce the decision on whether or not to get the mortgage from hard realities of what lending is all about. At some point, in order to meet their Community Reinvestment Act targets, banks made loans they knew were going to be bad because they thought they had to do it to stay in business. The CRE Act originally required banks to make efforts to reach targeted populations but did not require that specific results be achieved. The Clinton Administration reinterpreted that law and rewrote the regulation regarding it in the mid-1990s and said that they actually had to show results. The Federal Reserve began to reject applications for mergers and opening branches to banks that did not have the Homeowner Disclosure Act data that was collected on lending by race, gender, and income. These steps taken by regulators had the effect of forcing banks to make bad loans. A common criticism against people who make claims that the CRE Act has an impact on lending is that it was passed in 1997 and the crisis was in the 2000s. The whole process was very gradual, and the idea of forcing banks to do lending against solid lending principles came into play in the mid 1990s. As each merger was made and came about in the years following 1995, the banks had to make a commitment to do a certain amount of CRE lending. By 2007, they had made commitments of over $4 trillion. If you go back to the mid 1990s, the CRE lending might be $50 billion inconsequential. In the end, it was trillions of dollars that the commitment had to be made.

There is a quote that states, “The GSE Act became the vehicle for putting forth the philosophical view that housing is the civil right,” which basically states that people are entitled to own a house. Major provisions of the act was written by a group of housing advocates and activists under an informal deputization by Henry Gonzales, who was the Chairman of the House Financial Services Committee in the early 1990s. These housing activists’ attorneys got together and crafted this language to achieve the goals and make housing more of a right and to impose that idea on lending. These are the same groups that are pointing out the loan programs and saying they were unfairly skewed to people of color and lesser income. They are now rewriting history and saying that lenders deliberately went out of the way to make bad loans, and therefore they are to blame instead of the rules, regulations, and laws. Because they were seemingly able to hide in the black box, not many people really understood the mandate underneath the covers that it was something Fannie and Freddie had to do. There was not much exposure to what was being proposed and put into law in the early 1990s. A lot of people thought it was just guaranteeing everyone equal access to credit and not steering it.

Tune in next week as Bruce and Robert England continue their discussion on the black box and real estate market

For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.

Tags: Affordable Lending Goal, Alternative A, Black Box Casino, bruce norris, fannie mae, federal affordable housing provisions, Federal Housing Enterprise Financial Safety and Soundness Act, Federal Housing Finance Agency, FICO score, financial crisis, freddie mac, gse, GSE Act, HUD, Jim Lockhart, mortgage-backed security, political clout, Robert England, The Norris Group Real Estate Radio Show

Friday, December 16, 2011

Fannie Mae and Freddie Mac Pushed Rapid Credit Rescoring To Briefly Turn Subprime to Prime To Get Risky Loans Approved, Mortgage Broker Says

By Robert Stowe England
December 16, 2011

According to a former mortgage broker, members of Congress, Fannie Mae, Freddie Mac, and federal officials orchestrated and imposed on mortgage brokers and credit rating bureaus a policy to rapidly rescore consumer credit ratings so that more borrowers without reported incomes could get mortgages.

This coordinated effort enabled many subprime and nearly subprime borrowers to temporarily appear to be have credit scores high enough to be prime borrowers and, in the process, greatly expand lending in a period that stretched from 1998 to 2004.

“I'll bet 95% of the mortgages that went out of our office were subprime even if they weren't rated that way,” the broker said.

Mortgage brokers are wholesale lenders who originate their mortgages for large banks and other financial institutions.

“What infuriates me about when [President] Obama speaks or Barney Frank or anyone else who talks about these mortgage-backed securities and everything that happened, is that nobody knows the real truth about what goes on in the mortgage business and why it failed,” the broker said.

The broker’s claims, if substantiated, could mean that the true level of subprime and risky lending at Fannie and Freddie ahead of the 2008 financial crisis, was dramatically higher than the already high $1.8 trillion previously estimated to be on their books in mid-2008 by Ed Pinto, former chief credit officer for Fannie Mae.

Rapid credit rescoring was designed to get low credit scores up to the 700 credit score level where borrowers could qualify for existing programs at Fannie and Freddie that did not require any reported or stated income.

The broker, who described how the scheme worked in a call in to the Rush Limbaugh Show on December 7, identified herself only as “Laurie,” who said she had worked both as a packager of loans and an advertising executive for a mortgage brokerage firm.

Laurie said she did not want to identify herself because the broker had become involved with lawsuits over some of these practices.

The script of the conversation between Laurie and Limbaugh can be found at this link:

The pressure on mortgage brokers to engage in rapid credit rescoring came from the credit rating agencies, according to the broker. “We used to get visits by our credit representatives from the three major credit bureaus,” she said. “They were under a lot of pressure to develop a program to allow people to, quote, unquote, fix their credits faster,” she explained.

It was clear where the pressure on the bureaus originated. “According to the people from the credit managers bureaus, they were getting that pressure from Congress and [Federal Housing Administration or] FHA and Fannie and Freddie that they weren't doing enough to help people,” Laurie recalled.

Washington politicians and bureaucrats, in speaking to credit rating bureaus, belittled and ridiculed their rating practices. The credit bureaus were accused of “being unfair because they weren't doing enough to allow people who had had financial problems to fix their credit.”

Temporary Fix

The higher scores obtained through the rapid rescoring process usually proved to be fleeting.

The new higher credit score “wouldn't survive the next update from the credit bureau,” said Laurie. “The next time that update [from the credit bureau] came along, everything [that was detrimental to the borrower] was back on [the credit report], everything was like it was before,” she added.

Rapid credit rescoring was only available from mortgage brokers, Laurie said, and not for other consumer loans. In fact, sometimes people who knew about the availability of the rapid credit rescore would abuse that arrangement by going to a friendly mortgage broker to get a temporarily higher score to get a car loan, Laurie said.

The practice of rapid credit rescoring, in turn, made it possible for Fannie and Freddie to dramatically ramp up the volume of mortgage originations in the period from 1998 to 2004.

“When Fannie began this idea of packaging these things as securities and grouping them together, you'll find that the number of mortgage brokers for residential mortgages in the country skyrocketed,” Laurie said.

With Fannie and Freddie onboard the rapid credit rescoring process, new firms could quickly obtain lines of warehouse credit from banks to jump into the business of being mortgage originators.

The practice of rapid credit rescoring started out as a fairly benign. “It went from, yeah, maybe it took a long time to fix your credit to what we call the rapid rescore process,” Laurie said on the radio talk show.

Gradually, the practice turned toxic and fraudulent. “Our office could literally, in one day, take everybody's bad credit issues, write a one-line sentence about each one, fax it over to the credit bureau that . . . we paid to be members of, and, boom, within an hour, they were dropped off and the credit was rescored,” Laurie said on air.

The whole process became a sham. “It took literally less than 15 minutes at the end of the day,” said Laurie. “I mean we could fax it over and have it faxed back and rapid rescored.”

The growing band of mortgage brokers that joined the wholesale mortgage lending business would attend Fannie and Freddie seminars once or twice a year, according to Laurie.

“Fannie and Freddie were there, and they might as well have set up a carnival booth,” Laurie said. “I mean they were so excited about the fact that if you were a new mortgage business and you could get a wholesale line of credit, you could rapid rescore and qualify 500,000 people in a year, and they would back and buy everything you could send them.”

With the advent of rapid credit rescoring, the number of brokers employed by the business where Laurie was employed, was expanded from two to 20 brokers and the owner “sat in an office and did nothing but pull in wholesale lines of credit,” from such institutions as Washington Mutual, Laurie explained.


Tuesday, December 13, 2011

Could the 2008 Crash Have Been Prevented?

MortgageOrb Person of the Week: Robert Stowe England

Phil Hall of MortgageOrb writes December 13, 2011:

It has been more than three years since the September 2008 financial crisis, and many people are still trying to piece together what went so horribly wrong. Veteran financial journalist Robert Stowe England has offered his insight on what happened with his new book, "Black Box Casino: How Wall Street's Risky Shadow Banking Crashed Global Finance" (published by Praeger). MortgageOrb spoke with England about the circumstances that triggered the economic catastrophe.

Q: Was it possible that the 2008 financial crash could have been avoided? Or was this the financial services equivalent of a runaway train?

England: Both statements are true to some degree. There were so many vulnerabilities building up in the global financial system, it had, indeed, become a runaway train, while most did not yet realize that. Combine that with an ever-rising level of hidden bad credits and hidden bets and exposures, and a bad outcome was assured. In that sense, by 2005 or 2006, it was inevitable that we were headed for a train wreck. It was only a question of just how bad it was going to be.

There is a case to be made that certain actions could have prevented the coming crash from becoming the epic crisis it became. Admittedly, however, suggesting what might have been done to mitigate the expected outcome carries with it all the caveats one must make from hindsight bias.

Read more at this link