In previous articles, we’ve talked about creation of Yield Spread Premiums, the relaxation of underwriting standards, the dramatic expansion of the industry, and the egregious compensation being made by loan originators.
While loan originators made out like bandits, the Wall Street sources that packaged the loans also made a bundle, and the holders of the MBS were making that handsome yield of 8.5%. You can see why they were all so eager to keep the ball rolling.
Where were the regulators? Ahhhhhh! Good question. The answer is that they never are anywhere to be seen, that is until the stuff hits the fan. Everyone in the mortgage business -- hundreds of thousands of people -- knew what was happening. I have been writing about the abuses for over two years but no one cared. Even the Comptroller of the Currency, who ought to have SOME clout, gave a speech in late 2005 in which he warned of some danger. Resultant action? Zip! The FDIC got concerned about 9 months ago and didn’t do much more than write memos.
The Ameriquest debacle raised plenty of eyebrows after they were sued by Attorney Generals in almost every state. They settled, paying a $300 million fine. You’d think that someone at a regulatory agency would have said, “If all this bad stuff was going on at Ameriquest, why don’t we look for similar abuses at other lenders?” Because it was going on there too.
But it didn’t happen. Bottom line: They seem NEVER to be around when they ought to be REGULATING. They only come out after the damage has been done, pick over the wreckage, and say, “Tsk Tsk.” No one will get reprimanded and nothing will change.
Were there other early warning signs? You bet there were. New Century Financial, the latest high profile news target, had notices in their SEC filings that now look like warning flags. You can now read about them and all of the early-default loans they recently had to repurchase. Their actions caused their short-term credit providers to cut off funding which, in turn, caused New Century to abort funding operations themselves.
In their 330 page 10-Q, the quarterly filing to the SEC for the quarter ended Sept 20, 2006, almost 200 pages were devoted to things like AMENDEMENT TO RESTATED TRUST AGREEMENT and AMENDMENT NO.1 TO FOURTH AMENDED AND RESTATED MASTER REPURCHASE AGREEMENT. These were mostly agreements with their lenders and those purchasing the loans.
Get the whole report and other quarterly filings
Knowing what we do today, it would appear that all of those lenders and securities companies were CLEARLY seeing potential problems way back then and were moving to “perfect” their positions in the event of a meltdown, something that has now occurred. I guess Wall Street analysts missed interpreting those filings because one stock analyst was recommending New Century’s stock as recently as a month ago. Ooooops!
The justice in this is that some of the Wall Street sources that were buying loans and packaging mortgage-backed securities also had equity positions in these firms. There is some likelihood that these equity positions will be wiped out if the meltdown continues.
On the other hand, as usually happens, the final chapter in meltdowns is usually the appearance of vultures who come and pick through the ashes seeing if they can find something of value that someone in charge will sell them for 50 cents on the dollar. That is likely to happen here. In fact, one large lender, Accredited Home Mortgage, just announced the sale of some $2.7 billion of loans in their efforts to stay afloat. The company said, “The $2.7 billion of loans held for sale will be sold at a substantial discount in order to alleviate recent pressures from margin calls.” The company is also apparently in default under other credit agreements and is seeking “waivers” from those creditors.
It was also announced this week that many banks were grabbing loans out of New Century’s portfolio in exchange for some of the debt that they were owed. These lenders were apparently concerned about New Century’s ability to liquidate the loans and pay off their debts so they took the loans themselves and are auctioning them off. Morgan Stanley took 13,200 loans, canceling almost $2.5 billion in debt.
These loans are currently on the auction block and it will be VERY interesting to see what they go for. Auctioning them all off at one time will likely bring substantially less than if they sold them over time. Most of these loans are already in default, which is why New Century had to buy them back. How much money the buyer of those loans will make won’t ever be known, as the profits will be buried in the results of some huge company. But you can bet that it will be a lot more than you are making in your money market account.
So with all of this bad news, is there anything good that happened? I think there is. It appears that something like 45% of subprime loans done in the last year or two were purchase money loans. Assume that subprime loans were 20% of the total market. 45% of 20% equals 9% of all purchases. A good percentage of those people would not have had an opportunity to buy their homes without the availability of subprime loans.
Even if it turns out that 20% of these get foreclosed upon (unlikely, but possible), that still leaves 7% who kept their homes. That’s more than 1 million homeowners who got their shot at the American Dream of homeownership.
Those people will be better citizens with a greater stake in democracy and a far better shot at accumulating wealth in their lifetimes. I believe that is a good outcome, but if this was the only good part, it sure came at a great expense to society as a whole.
A lot of unsavory people made an unconscionable amount of money working for companies whose operating practices varied from unsupervised to unethical to illegal. Even those borrowers who survive this current mess will carry the scars for quite a long time to come.
It does not seem to have occurred to any regulator yet that they completely missed the boat. Had they jumped into this situation a lot sooner and instituted damage control, the carnage would have been substantially reduced. Will they learn from this? I’m not holding my breath.
I wrote my first book in 1997 and included a chapter that contained my thoughts on the need for reform in the mortgage business. That was ten years ago! I’m not sure I had all the answers. But I had SOME of the answers. If I could see this ten years ago, why couldn’t the regulators? I sent a copy to every secretary at HUD, but I’m pretty sure the books never got through the bureaucratic red tape to anyone in power.
When historians write their books, perhaps they will uncover more positive news from which to take comfort. I hope so. In the meantime, there will be a lot of unpleasantness and a lot of hurt families.
http://www.credit.com/credit_information/mortgages/Subprime-Mortgage-Madness.jsp
