When home prices begin to fall, a natural level of weak support may develop around a loan-to-value ratio of one. That is, when equity in a home approaches zero, the homeowner ought to become reluctant to sell. History suggests any such strategy should prove foolhardy. Trends in housing tend to be long and headstrong, and hence not easily resisted…The development of significantly negative home equity among the same homeowners that also comprise the world’s most voracious consumers would likely trigger several economic problems…banks would become reluctant to lend to home buyers. The effect would be to contract the credit available to would-be homeowners and therefore severely undercut the main late-cycle driver of demand…These problems would compound the worsening domestic employment situation, further reducing demand for residential housing and thereby producing the requisite positive feedback loop that historically has allowed burgeoning asset deflation to accelerate. As the real estate deflation wears on, it would not be unreasonable to expect that unemployment-induced income shocks mix in toxic fashion with the comparatively high mobility tolerance of the United States citizenry, motivating homeowners to start sending their keys to the bank in ever-increasing numbers. Many banks taking possession of increasing amounts of real estate will ultimately fail themselves. A catharsis could then take shape, and home prices would leg down yet again. After much pain both despair and disgust will settle in, and a bottom would begin to form.-Scion 2Q 2003 Letter to Investors
BUSINESS DAY | February 05, 2012
A Mortgage Tornado Warning, Unheeded
By GRETCHEN MORGENSON
Inspired by a personal experience, a businessman began delving into the practices of the mortgage industry, including Fannie Mae. His findings have been prescient.
Ms. Morgenson:Regarding MERS, a few months ago I read that MERS was actually conceived by Fannie Mae and the concept was described in a presentation given at a Mortgage Bankers Association convention in 1993 or 1994. The article claimed Fannie got positive feedback on the MERS concept from the mortgage bankers. The article claimed that Fannie Mae and Freddie Mac then funded the development of MERS with contributions of 2 million dollars each. After MERS was 'brought live' Fannie and Freddie invited large mortgage industry members to join MERS on a subscription basis.I've searched again for the article(s) recently, but I haven't been able to find the articles that described the actual creation of MERS. Perhaps the articles have been "scrubbed".What I read seems to confirm the leadership role that Fannie and Freddie had, and the ways these two GSE's influenced and led the industry, and how they shaped practices in the industry. You might find the two articles referenced below interesting:Is FM Watch a Crusader With an Agenda? By Louis Sichelman – RealtyTimes, pub. 7/5/1999 at: http://realtytimes.com/rtpages/19990705_fmwatch.htmNew Alliance Confronts FM Watch, Champions Existing Housing Finance System By Broderick Perkins RealtyTimes, pub. 10/5/2000> http://realtytimes.com/rtpages/20001005_fmwatch.htm
During a December 15, 2010 U.S. House of Representatives Judiciary Committee hearing witnesses gave testimony on issues relating to "Mortgage Servicing and Foreclosure Practices".1
A critical focus of the testimony and discussion was apparent problems with the recordation of land title and note ownership. Witnesses claimed that the Mortgage Electronic Registration System (MERS)2 has failed to reliably record changes in title and note ownership (chain-of-title). The accompanying video-clip is a segment from the C-SPAN video of the hearing:
If you are not familiar with MERS do a key-word-search for more information.
1. see, C-SPAN Video Library, Mortgage Servicing and Foreclosure Practices House of Representatives Judiciary Committee December 15, 2010 at: http://www.c-spanvideo.org/program/297095-1
2. see, Washington Post - October 8, 2010 article titled, Reston Based Company MERS in Middle of Foreclosure Chaos By Brady Dennis and Ariana Eunjun Cha at: http://www.washingtonpost.com/wp-dyn/content/article/2010/10/07/AR2010100702742.html
Congressman Ron Paul U.S. House of Representatives July 16, 2002*
Mr. Speaker, I rise to introduce the Free Housing Market Enhancement Act. This legislation restores a free market in housing by repealing special privileges for housing-related government sponsored enterprises (GSEs). These entities are the Federal National Mortgage Association (Fannie), the Federal Home Loan Mortgage Corporation (Freddie), and the National Home Loan Bank Board (HLBB). According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone.
One of the major government privileges granted these GSEs is a line of credit to the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out these GSEs in times of economic difficulty helps them attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a massive unconstitutional and immoral income transfer from working Americans to holders of GSE debt.
The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase the debt of housing-related GSEs. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.
Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.
However, despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policies of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.
Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.
No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to the GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.
Mr. Speaker, it is time for Congress to act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors misled by foolish government interference in the market. I therefore hope my colleagues will stand up for American taxpayers and investors by cosponsoring the Free Housing Market Enhancement Act.
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.2Watch 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 ]Footnotes: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.pdf2. 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.htmand 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-2010043. see, FAS #157 at: http://en.wikipedia.org/wiki/Mark-to-market_accounting4. 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 ).
B of A Settles Lending Case By Ruth Simon and Brent Kendall
Wall Street Journal ~ December 22, 2011
Mr. Melton Commented: BofA just did not do due diligence and helped CW hide it's wrong doing and would have gotten away except for the housing mess.
Reply To: Mr. Melton, Please note that the allegations in the article claim that most of the overcharging took place "from 2004 through 2008, at the height of the housing bubble". During that time Bank of America was actually, in many ways, a competitor of Countrywide Financial. During that time Countrywide Financial had borrowed significant amounts of money from B of A, and Countrywide had a large authorized line-of-credit with B of A.
Toward the end of Countrywide's independent existence, executives at Countrywide, and most significantly Angelo Mozilo, claimed Countrywide had insignificant sub-prime exposure and that the company was in strong financial condition. Not long after the last time they made that claim Countrywide exercised the balance of the authorized B of A line of credit. I have always thought that when B of A bought Countrywide, B of A did it, in significant measure, to protect the B of A loans which B of A made to Countrywide without any knowledge (apparently) of what a snake-pit Countrywide actually was.
It's interesting that you claim that B of A participated in the alleged activities while in fact it was a competitor of, and a banker for, Countrywide, yet you don't question why Countrywide's Board-of-Directors and the CFO at Countrywide weren't more aware of the alleged abuses, and why they weren’t more actively engaged in monitoring and bridling-in the alleged abuses.
What kinds of people sat on Countrywide's Board-of-Directors almost up-to the very end? Were they unsophisticated rubes with no understanding of mortgage finance and no understanding of what was going on? If you think that might be the case, key-words-search: "The Tragedy of Countrywide Financial and Angelo Mozilo Muckety". Notice that Kathleen Brown, the very financially savvy and well credentialed sister of then California Attorney General - now Governor of California - Jerry Brown sat on the Countrywide Board of Directors, as did former (under President Bill Clinton) Director of the U.S. Department of Housing and Urban Affairs (HUD) Henry Cisneros [see, “The Reckoning: Building Flawed American Dreams” By David Streitfeld & Gretchen Morgensen, NYT 10/18/2008.]
Maybe the abrupt retirement of former President of Countrywide, Stanford Kurland, (who most considered the obvious 'heir apparent' to CEO Angelo Mozilo) about a year 'before the fall' should have been recognized as a sign that it was time to look more closely at what was going on inside Countrywide Financial. [see, "Former Countrywide No. 2 Sees Opportunities in Troubled Mortgages" By Mathew Padilla - Orange County Register, 6/10/2008].
 “The Tragedy of Countrywide Financial and Angelo Mozilo” at: http://news.muckety.com/2008/06/26/the-tragedy-of-countrywide-financial-and-angelo-mozilo/3712
 “The Reckoning: Building Flawed American Dreams” By David Streitfeld & Gretchen Morgensen, NYT 10/18/2008 at: http://www.nytimes.com/2008/10/19/business/19cisneros.html?pagewanted=all
 “Former Countrywide No. 2 Sees Opportunities in Troubled Mortgages” By Mathew Padilla – orange County Register - 6/10/2008, at: http://mortgage.ocregister.com/2008/06/10/former-countrywide-no-2-sees-opportunities-in-troubled-mortgages/
An excerpt from an article which appeared in The Wall Street Journal Opinion Section – December 8, 2011
Subsidizing Wall Street to Buy Chinese Solar Panels*
By T.J. RODGERS
At the end of the recently released film "Margin Call," the chairman of the fictional investment bank that triggered the mortgage-backed securities meltdown sits in his executive dining room, looking down on the Hudson River sunset while enjoying a steak and an expensive bottle of Bordeaux. Why not? He has just saved billions for his shareholders by dumping the firm's entire "toxic loan" portfolio in one hectic trading day. Just before giving a bonus to the brilliant analyst who foresaw the meltdown only hours in advance, the chairman predicts, "There's going to be a lot of money made coming out of this mess."
Wall Street understands how to make money, up-market or down. "Margin Call" may fuel Occupy movement ire, but in creating mortgage-backed securities, Wall Street did nothing other than facilitate home-financing access to the next tier of less-qualified home buyers, as demanded by every president since Bill Clinton. After that, the bankers did exactly what their shareholders wanted: bundle those risky loans into securities, sell them to lock in the profits, and dump the risk right back onto the federal government—where it belonged.
My purpose is not to debate the morality of mortgage-backed securities but to update the Law of Unintended Consequences with the corollary Law of Misguided Subsidies: Whenever Washington disrupts a market by dumping subsidies into it, Wall Street will find a way to pocket a majority of the money while the intended subsidy beneficiaries are harmed by the resulting market turmoil.
The recent crash in mortgage-backed securities was a near-repeat of the savings-and-loan crash of the 1980s, in which Washington insured the S&L industry but failed to set limits on high-risk loans. When the bubble burst, Washington paid Wall Street the insurance money while homeowners lost huge sums in real-estate hell. Wall Street understands how to manage risk; the federal government and consumers do not.
The complete article may be seen at:
See an article announcing the Massachusetts Attorney General’s lawsuit against firms in the mortgage industry.
The Mortgage Electronic Registration System (MERS) which is mentioned in the lead article is based upon a concept and operating model which was proposed to The Mortgage Bankers Association by the GSE’s, Fannie Mae and Freddie Mac, at a Mortgage Bankers Association meeting in the mid-1990’s. The Mortgage Bankers seemed to like the concept, so Fannie and Freddie financed the creation of MERS with a contribution of 2 million dollars each (from Fannie and Freddie). After MERS was created, Fannie and Freddie invited other major mortgage banking entities to join the MERS via an annual subscription arrangement.
The structure and the processes in the MERS system seem to have had some “destined to fail” characteristics which would make an interesting case study of ‘management control and audit procedures’. And, the system also raises some questions about the legality of the system’s processes in the context of common law of land title conveyance. See, “Two Faces: Demystifying the Mortgage Electronic Registration System’s Land Title Theory” by Professor Christopher L. Peterson at > http://search.earthlink.net/search?q=Two+Faces%3A+Demystifying+the+Mortgage&area=earthlink-ws&channel=sbt_sgin&abtcgid=219&abtli=1
In late 2010 in a hearing before a Congressional Banking Committee the acting U.S. Controller of The Currency, John Walsh, stated that results from a multi-agency investigation of MERS would be released in early January of 2011. (The investigation was led by The Office of the Controller of The Currency. I never could find the results of that investigation).
A bit off-point, but still interesting, current California Governor, Jerry Brown, was the Attorney General of the State of California from 2007-2011. For much of that same period Jerry Brown’s sister, Kathleen Brown, was a member of the Board-of-Directors of Countrywide Financial [Henry Cisneros former Director of the Department of Housing and Urban Development (HUD), during President Bill Clinton’s first term in office, was also on the board at Countrywide during that time]. Kathleen Brown resigned from that board of directors shortly after information about the depth of Countrywide’s financial problems became public and only weeks before Bank of America acquired Countrywide. A few months later, when Jerry Brown was elected governor of California, Kathleen Brown almost immediately moved her Goldman Sachs municipal finance consulting office from Los Angeles, CA to Chicago, IL ‘to avoid any appearance of conflicts of interest’ with her brother’s gubernatorial administration. (See, “The Tragedy of Countrywide and Angelo Mozilo” at > http://news.muckety.com/2008/06/26/the-tragedy-of-countrywide-financial-and-angelo-mozilo/3712 and see Kathleen Brown's Wikipedia at > http://en.wikipedia.org/wiki/Kathleen_Brown
The other day I was reading an article which mentioned an organization called FM Watch.1 Out of curiosity, I did a key-words-search on: FM Watch. I discovered FM Watch was founded by private mortgage industry interests in the late 1990’s. Apparently, FM Watch was created with defined purpose of focusing attention on anti-competitive and risky mortgage lending practices employed by the Government Sponsored Enterprises, Fannie Mae and Freddie Mac.2 And, it seems FM Watch even anticipated that, if unchecked, the behavior of these Government Sponsored Enterprises would evolve even further into more risky and stronger anti-competitive behavior.3
While I was reading about FM Watch I saw a reference and a hyperlink to a video presentation called “A Crisis of Credit Visualized” it was claimed to be a very good video presentation describing the circumstances involved in the real estate bubble and the mortgage crises. Out of curiosity I went to the link and watched the video presentation. I thought you might also find the presentation interesting.4
I thought “A Crisis of Credit Visualized” was a good presentation of the basic processes in mortgage lending, mortgage securitization and mortgage financing. However, with the exception of the comment about the role of Greenspan era U.S. Federal Reserve interest rate policy, it lacks any discussion about the role of federal housing policy and the Government Sponsored Enterprises (Fannie Mae and Freddie Mac) in the creation and the extension of the housing bubble.
Furthermore, the presentation fails to specifically explain how government subsidized cheap money financing and government subsidized mortgage insurance increased demand and pushed home prices to levels that exceeded borrowers’ ability to repay what they borrowed (to finance their home purchases).
And, the presentation fails to emphasize that, after the bubble peaked, as riskier borrowers defaulted on their mortgages and those homes went on the market, the excess supply of houses and downward cascading home prices caused home values to drop to the point that well qualified borrowers, who could afford their mortgages, began to question the economic wisdom of continuing to pay down their mortgage. These qualified buyers’ decisions not to continue to pay their mortgage contributed further to the excess supply of homes which contributed to the further deterioration of home prices.5
In the viewer comments on “A Crisis of Credit Visualized” I found a comment mentioning the lack of information about how federal housing policy and the behavior of the Government Sponsored Enterprises contributed to the crises of credit. The commenter provided a link to another video titled, Burning Down the House: What Caused Our Economic Crisis?6 I believe that, by watching both “A Crisis of Credit Visualized” and “Burning Down The House: What Caused Our Economic Crisis” one can gain a very clear understanding of the major forces which caused the U.S. economic crisis.
1. Freddie’s Friend Newt By Holman w. Jenkins Jr. Wall Street Journal Opinion/Editorial page November 19, 2011.
2. Is FM Watch a Crusader With an Agenda? By Louis Sichelman – RealtyTimes, pub. 7/5/1999
3. New Alliance Confronts FM Watch, Champions Existing Housing Finance System By Broderick Perkins RealtyTimes, pub.10/5/2000
4. The Crisis of Credit Visualized A video presentation by Jonathon Jarvis published on Vimeo - 3 years ago
5. Many mortgage borrowers think of the home as an investment they will use in later years to fund children’s education, or their own retirement. If these home borrowers begin to believe the investment will end-up being a loss, or can’t be refinanced, their attitude toward continuing to make their mortgage payment changes - significantly. See, Underwater Home: What You Should Do if You Owe More Than Your Home Is Worth? By Professor Brent T. White - pub. 10/15/2010 and/or key-words-search “Strategic Default”.
6. Burning Down The House: What Caused Our Economic Crisis YouTube by TheMouthPeace pub. Sept. 30, 2008