Part of the problem lies in changes in mortgage processing over the past few decades. Fannie and Freddie rolled out automated-underwriting systems in the mid-1990s that allowed lenders to punch borrower data into computer systems in order to receive faster approvals or denials.The mortgage bust highlighted weaknesses. Fannie and Freddie did few upfront reviews of loans that they purchased; instead, they screened some of those that went bad, forcing banks to buy back any with obvious signs of negligence or fraud.After the meltdown, the mortgage giants began hiring armies of auditors—called "bounty hunters" by bank executives—to conduct detailed reviews of loan files to spot errors that could justify a put-back.deja vu
I commented on an interesting article published September 14, 2012 in the Wall Street Journal, How Greenspan Misread the Risks at Fannie and Freddie. It’s an article based upon an excerpt (written by James Hagerty) from his new book The Fateful History of Fannie Mae: New Deal Birth to Mortgage Crisis Fall By James R. Hagerty.
In December of 2011 the SEC filed lawsuits against several former executives of Fannie Mae and Freddie Mac. One of the allegations in both of the two lawsuits is that former executives of Fannie and Freddie mis-categorized mortgage loans that were being bought by Fannie and Freddie and that they failed to inform investors and Fannie and Freddie’s regulator [The Office of Federal Housing Enterprise Oversight] of the true number (percentage and value) of Sub-Prime and Alt-A loans they purchased.
So, it’s not that shocking that most people who believed what Fannie and Freddie were telling them didn’t know of the significant default risk.
Only people like Michael Burry(2) Laurence Fink(3) John Paulson(4) and perhaps Stanford Kurland(5) who actually studied (or were aware of) the progressively diminishing mortgage qualification standards as the bubble formed, and who studied (or were aware of) the actual mortgage borrower income statistics, were prescient enough to become alarmed about Fannie and Freddie’s exposure to default risk.
Based upon what Fannie and Freddie were claiming as their mortgage loan quality, It should be no surprise that Alan Greenspan, John McCain, George W. Bush, Treasury Secretary, John Snow and the Office of Federal Housing Enterprise Oversight [OFEO] were more concerned about the impact of credit rate risk and accounting fraud at Fannie Mae and Freddie Mac than they seem to have been about default risk.(6)
(1) Reference SEC Website SEC CHARGES FORMER FANNIE MAE AND FREDDIE MAC EXECUTIVES WITH SECURITIES FRAUD.
(2) Reference, Betting on the Blind Side By Michael Lewis – pub. Vanity Fair Magazine | April 2010.
(3) Reference, Inside the Trillionaires Club at BlackRock pub. Forbes Magazine August 17, 2009. From the article:
LESSON 2: When investments get complex, do your homework:
. . . In late 2006 the company developed a model that put a lower, more realistic number on the incomes subprime borrowers were claiming on their "no doc" loans. The projections were shocking: BlackRock figured that when the loans reset to their new, higher rates in a couple of years, most borrowers would be spending more than half their real incomes on mortgage payments. Foreseeing an avalanche of defaults, BlackRock dumped subprime bonds in early 2007 when the prices were still lofty.
(4) See, John Paulson, Trader Made Billions on Sub-Prime By Gregory Zuckerman pub. Wall Street Journal January 15, 2008.
(5) See, Stanford Kurland - Former Countrywide No.2 Sees Opportunity in Troubled Mortgages By Matthew Padilla Orange County Register - June 10, 2008. From the article:
Q. How did this venture come about?
A. I was somewhat in a state of retirement. I left Countrywide in 2006 after 27 years. From the sidelines, I was watching the mortgage market meltdown and was in communication with associates of mine over what it was going to take to improve or revitalize the mortgage market. Wall Street firms were reaching out to me on whether I had an interest in participating with them. I got a call from the chairman of BlackRock, Laurence Fink, who asked if I would meet a group of executives who were talking about how to address issues in the mortgage market, and they were working with another company (Highfields Capital Management).
I was very receptive to talking to Larry Fink. We had grown up together and have been friends since grade school days.
Q. Where did you and Mr. Fink grow up?
A. We grew up in Van Nuys. That’s the valley.
(6) See, YouTube video-clip, Timeline: George Bush, John McCain Warn Democrats of Housing Crisis, at:
In this PBS NewsHour video-clip aired January 21, 1998 President Bill Clinton points to his accomplishment of having his 'regulators' force banks to grant loans to applicants to whom the banks would not have otherwise granted loans.
In this video-clip President Clinton, claims that 85% of the loans issued under the guidelines of the (then 20 plus year old) Community Reinvestment Act were issued during his first five years in office.
Is it any wonder that the GSE's, Fannie Mae and Freddie Mac, under direction from Clinton and his two administration's HUD Chairmen, Henry Cisneros, and later Andrew Cuomo, continued lowering the standards for loans they would purchase from mortgage originators?
And, is it any wonder that investment banking interests devised ways to 'package' large numbers of mortgage loans into "tranches" of different risk level in order to diversify the risk they were being pressured through regulatory mandate, and political persuasion, to accept?
Notice that Clinton mentions this activity was not necessarily an affirmative action or civil rights oriented activity, but rather that it had significant impact on the economy. . . .
See, The Community Reinvestment Act, at: http://en.wikipedia.org/wiki/Community_Reinvestment_Act
Bill Clinton's Drive to Increase Homeownership Went Way Too Far By Peter Coy -pub. in Bloomberg BusinessWeek 2/28/2008, at: http://www.businessweek.com/the_thread/hotproperty/archives/2008/02/clintons_...
Bill Clinton, Wanted For Crimes Against Our Economy By Jim Newman pub. 2/27/2012, at: http://kayleighmcenany.com/2012/02/27/jim-newman-bill-clinton-wanted-for-crimes-against-our-economy/
Key words search for: Janet Reno threatens banks
Many people and much of the media are pointing to recent improvements in home prices as a sign that the single family home market is bottoming and starting to recover. It seems to me that an alternative way to look at recent changes in the housing market might be to look at things a bit differently.
How about reading the tea leaves this way:
Several institutional asset managers have convinced investors that buying single family homes ‘in-bulk’ and then renting the houses or flipping them is a good business that will provide better yields than most other investments currently available (in The Bernanke Economy). However, it seems the institutional asset managers that are doing this have ignored that single family home property management and single family home ‘flipping’ are generally not ‘scaleable’ activities. That is, the operational costs of single family property management and single family home 'flipping' are very high, and the activities involved usually cannot reach economies of scale.
Meanwhile, the media is reporting a recovering market in housing. And, some homeowners who have discretion about the timing of selling their homes make a discretionary decision not to list their home and to wait for a better price – because all indications and the media say home prices are rising. This reluctance to list reduces the LISTED inventory, which further creates the appearance of a recovering housing market.
Then, in a few months, the investors in the institutional funds that have purchased homes 'in-bulk' begin to realize the institutional managers are not reaping the expected returns and they begin to cash-out of the institutional home buying funds. This cashing-out forces the institutional funds to sell the homes they bought ‘in bulk’ at the best price they can get.
Many very smart institutional investors have mentioned the operational difficulty and lack of ‘scaleability’ as reasons bulk home buyers may not succeed at single family home property management and / or single family home ‘flipping’.
Private Equity Has Too Much Money to Spend on Homes By John Gittelsohn | pub. Bloomberg News - Jun 12, 2012: http://www.bloomberg.com/news/2012-06-13/private-equity-has-too-much-money-to-spend-on-homes-mortgages.html
Institutional Investors Are Turning to Residential Foreclosures Investing in single-family rental market in its infancy By Arleen Jacobius | Pensions & Investments April 2, 2012: http://www.pionline.com/article/20120402/PRINTSUB/304029978
Insight: The Wall Street Gold Rush in Foreclosed Homes By Matthew Goldstein & Jenneifer Ablan - Forbes Magazine 3/20/2012, at: http://www.reuters.com/article/2012/03/20/us-usa-foreclosures-investors-idUSB...
Investors Flock to Housing Looking to Buy Thousands of Homes in Bulk By Morgan Brennan - Forbes Magazine 4/3/2012, at: http://www.forbes.com/sites/morganbrennan/2012/04/03/investors-flock-to-housing-aspiring-to-own-thousands-of-homes/
Och-Ziff Calls Top Of "REO-To-Rental", And Distressed Housing Demand, With Exit Of Landlord Business Submitted by Tyler Durden on 10/17/2012 http://www.zerohedge.com/news/2012-10-17/och-ziff-calls-top-reo-rental-exit-landlord-business
The Housing Bet Warren Buffett Wishes He Could Make By Steve Shaefer pub. Forbes Markets 3/29/2012: http://www.forbes.com/sites/steveschaefer/2012/03/29/the-housing-bet-warren-buffett-wishes-he-could-make/#
Critics Question Investment Fund’s Sacramento Rental Venture By Hudson Sangree and Philip Reese Sacramento Bee – Monday April 8, 2013 http://www.sacbee.com/2013/04/08/5323832/critics-question-investment-funds.htm
Lower Rates Push Yield Seekers to Higher Risk By A. Gary Shilling – Bloomberg News - Jan 29, 2013, at: http://www.bloomberg.com/news/2013-01-29/lower-rates-push-yield-seekers-to-higher-risk.html
Warren Buffett Says, “Buy Real Estate Now!” at the same time he mentions the problem of “scaleability” see video from CNBC Squawk Box pub. February 27, 2012: https://youtu.be/XOGP6hd0B24
Don't forget the role of the rating agencies in the financial crisis. In the 1975 the U.S. Congress designated the Nationally Recognized Statistical Rating Organizations (NRSRO's). When Congress passed the legislation anointing the NRSRO’s it gave this limited number of organizations oligopoly status and unique competitive advantage. At the same time, Congress appointed the Securities and Exchange Commission as regulator of the NRSRO's.
Most investment advisors and portfolio managers use rating agency guidelines (ratings) to assist their evaluation of the quality and risk associated with the securities they purchase* and fiduciaries are restricted by law as to the minimum rating level from which they can select the investments they can purchase and manage. So, the rating agencies provide a seal of approval, so to speak, for the securities and companies they rate.
* In most cases, the ratings securities an investment advisor, or a portfolio manager will use are defined in a prospectus, offering circular, or by some other form of disclosure.
and Too Little, Too Late
Why is there a ‘shadow inventory’ of homes?
In last quarter of 2008, U.S. banks and their lobbyists pushed the U.S. Congress to force the Financial Accounting Standards Board (FASB) to postpone the implementation of mark-to-market accounting (FAS #157).* The FASB eventually acquiesced. So, after the acquiescence, banks and other collateralized mortgage obligation [CMO] investors can continue to carry these investments at origination value, rather than at the investment’s current market value.
But, if a bank or other mortgage investor forecloses, renegotiates the mortgage, or sells the home (the collateral) the new ‘book value’ of the investment is based upon the new selling price (or mortgage value) - as determined by the terms of the new deal (auction, renegotiation, or sale).
By not foreclosing, renegotiating, or formally taking back properties (REO) banks and other mortgage investors can, to some extent, manage what their losses appear to be, and hopefully offset the losses - they recognize - against other revenue, over time.
Key-words-search: “Congress Helped Banks Defang Key Rule” By Susan Pulliam & Tom McGinty WSJ 6/3/2009 | Professor Adam Levitin Congressional testimony “Federal Regulators Don’t Want to Know” YouTube | Zombie Banks | Japan Lost Decade (Please note that, at the beginning of Japan’s lost decade our current Treasury Secretary, Timothy Geithner was living and working in Japan as a Treasury Department attaché in the U.S. Embassy.)
* See, FAS #157 [mark-to-market accounting] and scroll down to the section heading: Effect on subprime crisis and Emergency Economic Stabilization Act of 2008 , at http://en.wikipedia.org/wiki/Mark-to-market_accounting
Federal Regulators Don't Want To Know