On A Clear Day . . .

 Many politicians, some federal regulators, and many vocal media commentators claim that the Community Reinvestment Act (CRA) and its regulatory evolution had nothing to do with the creation of the U.S. housing and mortgage bubble. It seems that, at some point in the near future, an objective review of the facts may require a revision of the claim that the CRA was not a significant factor in the creation of the U.S. housing and mortgage bubble.1


The Community Reinvestment Act: Its Evolution and New Challenges*

A speech by Chairman of the U.S. Federal Reserve, Ben S. Bernanke 

At the Community Affairs Research Conference, Washington, D.C.

March 30, 2007

From the third paragraph below the heading: The Evolution of The CRA

Even as these developments were occurring, extensive change was taking place in the financial services sector. During the 1980s and 1990s, technological progress significantly improved data collection and information processing, which led to the development and widespread use of credit-scoring models and the availability of generic credit history scores. Deregulation also contributed to the changes in the marketplace. Notably, the lifting of prohibitions against interstate banking was followed by an increased pace of industry consolidation. Also, the preemption of usury laws on home loans created more scope for risk-based pricing of mortgages. Securitization of affordable housing loans expanded, as did the secondary market for those loans, in part reflecting a 1992 law that required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a percentage of their activities to meeting affordable housing goals (HUD, 2006). A generally strong economy and lower interest rates also helped improved access to credit by lower-income households.

1. To see reasoning which strongly opposes the view that the CRA was not an influence in the creation of the bubble,see: The Financial Crisis on Trial By Peter J. Wallison - WSJ OPINION pub. December 21, 2011 at: http://online.wsj.com/article_email/SB10001424052970204791104577108183677635076-lMyQjAxMTAyMDAwNDEwNDQyWj.html?mod=wsj_share_email

Hedge Funds Build Case For Housing

By Gregory Zuckerman
Wall Street Journal – December 29, 2011
Many commenters here have used the term 'Shadow Foreclosures' the proper term is "Shadow Inventory'. Shadow inventory represents the excess supply of housing. Banks and other mortgage investors have been deferring foreclosures (for several reasons) but one primary reason is because they realize if all the inventory was to come to market in any short time period home prices in most markets would plummet (further). It's estimated, by S&P, that the current shadow inventory will take about 45 months 'to clear'.1

A subtlety, hedge funds invest other peoples' money (o.p.m.) and they collect an annual management fee while they wait for their strategy to pay-off. If the strategy pays-off they get a very large incentive bonus (portion of the profits). Hedge funds generally will not allow investors to 'cash-out' for a couple of years after the investor deposits his or her investment (the 'lock-up' period). So, the idea is to sell a very risky or a very volatile strategy, so you can get the management fee while you wait for - and hopefully eventually reap - the huge incentive fees.2 

What happens when a hedge fund strategy "blows-up"? The manager moves-on to a different strategy, and most likely, a different group of investors.

Picking the bottom of any market is a timing issue, by the time these hedge fund "lock-ups" have expired most of the investors will probably start to see signs of life in the housing market and will decide that after a couple years of pain, during the "lock-up", it's probably a good idea to hang-in-there and perhaps enjoy some profit. In my opinion the hedge fund managers in this article are following a contrarian strategy and may be quite early . . . but, it takes time to convince those hedge fund investors to invest.

Remember, home prices change at the margin, one-sale-at-a-time, the next sale is based upon comparable sales and an appraisal - and in most cases - the completion of the sale is dependent upon the availability of mortgage financing.

Watch unemployment and don't just look at the published numbers for mortgage interest rates, look at the number of new mortgages actually issued. If what used to be a qualified buyer can't buy, the excess inventory will not be absorbed by anybody but investors who want to be landlords. I believe Mr. Mark Hanson (in the article) has the proper current view of the housing market.

1. see article, S&P: 45 Months to Clear Shadow Inventory By Kerry Panchuk pub. Housing Wire November 23, 2011 - at: http://www.housingwire.com/2011/11/23/sp-45-months-to-clear-shadow-inventory
2. see Introduction pages 1 and 2 to A Balancing Act: Privacy, Regulation, and Innovation in Hedge Funds By Thomas Van De Bogart and Justin Blincoe


The Fannie and Freddie Hate Storm

Wall Street Journal Online ~ DECEMBER 27, 2011 OPINION


The Fannie and Freddie Hate Storm*

A dubious prosecution but it helps set the record straight.

By Holman W. Jenkins, Jr.

As I read Mr. Jenkins’ article I was impressed by many of his points, but not his conclusion. Then, after some thought, I remembered the article is published in the OPINION section, not in the FACT section.

Q. What does CMO stand for? A. Collateralized Mortgage Obligation. What caused the COLLATERAL in CMO to become price inflated?

In my opinion, The Housing Bubble and the ensuing financial crisis were caused by several factors which played-out in concert. Political pressure for every person to receive a home loan was one principle cause. The Greenspan Federal Reserve's manipulation of interest rates, and the Fed’s long low interest rate policies, in order to avoid any-and-every anticipated economic slowdown was another. The irrational levels of leverage used by large financial institutions (including Fannie and Freddie) was another factor in the formation of the bubble. The unregulated and irrational use of mortgage derivatives was another contributor (adding another layer of leverage). Serial reductions in mortgage loan qualification standards, the move to low-down payment or no down payment mortgages, and exotic mortgages with deferred payment options, also contributed.1 These were just a few of the ‘moving parts’ which contributed to the home price bubble.

Then, when a few people began to look at the home price inflation - late in the bubble - those few people began to analyze the economics of home prices - it became clear to them that the 'house-of-cards' was dependent on infinitely increasing home prices and infinitely available financing for those infinitely higher home prices. That's when the music began to slow-down, and all the dancers began to head for that small exit.2

Watch this video-clip in which Warren Buffett tries to explain the dynamics of bubble formation and bubble bursting to the Financial Crisis Inquiry Committee (FCIC) at:

Note: Late in the bubble the impending implementation-date for the requirement that banks and other investors use mark-to-market3accounting for valuing ‘infrequently traded assets’ (way back in history mortgage backed securities were infrequently traded) might have also created a more sober attitude toward the volatility and risks involved in holding, leveraging and trading CMO’s 4

* On December 16, 2011 The SEC filed lawsuits - charging fraud- against former senior executives of Fannie Mae and Freddie Mac. The filings provide interesting information and evidence which might force retraction and republication of past financial disclosures made by Fannie and Freddie, and which might also force significant revisions to volumes of analysis and statements about the safety and soundness of the two Government Sponsored Enterprises. [See SEC Filings at:  http://www.sec.gov/news/press/2011/2011-267.htm ]

1. See, SEC filing against former executives of Fannie Mae: page 9 para. 32 “Desktop Underwriter” and page 10 para. 35 “Fast and Easy” and “Clues” at: http://www.sec.gov/litigation/complaints/2011/comp-pr2011-267-fanniemae.pdf
2. From, Inside Trillionaires’ Club of BlackRock By Shawn Tulley - Fortune Magazine - pub. August 18, 2009: 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.” see complete article at: http://money.cnn.com/2009/08/12/news/companies/blackrock_trillionaires_club.fortune/index.htm
and see, Former Countrywide #2 Sees Opportunities in Troubled Mortgages By Matthew Padilla - Orange County Register pub. June 10, 2008 at: http://mortgage.ocregister.com/2008/06/10/former-countrywide-no-2-sees-opportunities-in-troubled-mortgages/ and see, Betting on The Blind Side By Michael Lewis - Vanity Fair – pub. April 10, 2011 at: http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004
4. see, Congress Helped Banks Defang Key Rule By Susan Pulliam and Tom McGinty – WSJ, June 3, 2009 at: http://online.wsj.com/article/SB124396078596677535.html ).