As readers may know, I sometimes find marked differences in how the Financial Times and the Wall Street Journal report the same story, with the FT typically doing a much better job. In this case, I was underwhelmed by both papers’ coverage, but together they conveyed some useful information.
Federal banking regulators (including credit union and thrift supervisors) released new guidelines on subprimes. The Journal and the FT focused on completely different aspects of the story. The Journal, in “Regulators Tighten Subprime-Lending Rules,” discussed tightened standards on new mortgages:
The guidelines require more than 8,000 federally regulated lenders to underwrite loans based on a borrower’s ability to make payments on a loan’s adjusted rate, not just its low introductory rate. Roughly 75% of the subprime adjustable-rate mortgages offered last year were loans with a low flat or “teaser” rate for the first two or three years and then a higher, floating rate for the life of the 30-year mortgage.
The guidelines are very similar to a March proposal, with two significant changes.
First, with limited exceptions, the guidelines expect lenders to collect much more information to prove that borrowers have the capacity to pay. Second, lenders are directed to give borrowers the option to refinance out of an adjustable-rate mortgage at least 60 days before the interest rate jumps to a higher level, without penalty.
There isn’t yet much consensus as to how the changes will affect the issuance of subprime mortgages. Indeed, some of the guidelines have already been implemented by the banking industry…..
Both Washington Mutual Inc. and HSBC Holdings PLC’s HSBC Finance Corp., two of the country’s largest federally regulated lenders offering subprime loans, said they would comply with the new policies.
The guidelines wouldn’t directly address Wall Street’s involvement in the subprime market, but they could indirectly reduce the supply of these loans available for securitization.
When crafting the guidelines, regulators walked a fine line between trying to curb lending practices without imposing prohibitions that could kill a market that has helped many purchase homes.
“There is no doubt in my mind that anytime you put in more stringent standards you are likely to reduce the supply of credit,” Comptroller of the Currency John Dugan said. “We don’t do that lightly.”
Steven Antonakes, Massachusetts’ commissioner of banks, said state bank supervisors were working on a parallel version of the guidelines. Independent state lenders, which aren’t supervised by the new federal guidance, originated more than half of all subprime loans last year.:
The industry should be cheering to have gotten off so lightly. Congress was pushing earlier to create liability for “mis-selling” (presumably that would be a lower threshold than fraud) and also have investors be included in liability for any originator fraud (“assignee liability). Although the latter idea would put a chill on the issuance of mortgage backed securities, it isn’t completely nuts. If investors benefit from a fraud, shouldn’t the damaged party be able to seek recourse from them? It would have the effect of making investors vastly more scrupulous about who they bought paper from (but not to worry, this proposal will never see the light of day).
Despite the banking industry’s good fortune, count on Mortgage Bankers Association to complain about anything that might reduce home sales, even if the buyer goes bust in short order:
Kurt Pfotenhauer, senior vice president of government affairs at the Mortgage Bankers Association, said the guidelines were too restrictive and predicted they would force lenders to deny more borrowers access to mortgages.
“All regulatory actions come at a cost,” Mr. Pfotenhauer said. “The people being stuck with the bill for this one are those who have been making successful use of [novel mortgage arrangements] and have paid their bills on time.”
The whole point of this exercise is to restrict the extension of credit to borrowers who can’t afford it. Guess the MBA doesn’t accept the premise that some people really can’t afford to buy a house. And anyone who can make sense of the second sentence in Pfotenhauer’s quote deserves a prize.
It’s simple: “The cost of not making loans to people who really can’t afford to buy a house will be passed on to those people who can afford to buy a house in the form of more junk fees and higher rates, because pigs will fly before subprime lenders actually allow their profit margins to shrink. Yes, dammit, we know perfectly well that this means that the people who can afford to buy a house will no longer be able to afford to buy a house and therefore will not be able to get a loan anymore, which will require us to find more people who can afford to buy a house to cover those costs without allowing RE prices to drop which would kinda farkle up the recoveries on the foreclosures of the loans we made to the people who really can’t afford to buy a house but did, but this business is a whole lot more complicated than you wankers at the OCC seem to think. The American public has a constitutional right to have its monthly payment subsidized by a practice of offering easy credit to the wrong people, and quite frankly I pity anyone who can’t see how that math works out. Look, over there–there’s a shiny object!”
Back to the original post:
If I were the MBA, I wouldn’t be seeking so much air time when the topic of subprimes arises. With Congress considering getting investors on the hook, I’m surprised no one has voiced the idea of going after brokers who knowingly put buyers in deals they can’t afford.
The FT story was surprisingly incomplete (it didn’t identify the regulators nor did it cover the new restrictions, although they were mentioned in a related video on its website). However, it mentioned something neglected by the Journal, namely, that the regulators are directing lenders to try to salvage subprime borrowers:
US regulators on Friday told banks to be more lenient with subprime mortgage borrowers in difficulties, potentially compounding uncertainties in the troubled mortgage securities market.
Such changes could affect the value of securities backed by subprime loans, which have already fallen sharply following a recent surge in defaults.
“Banks will have to work out how to reconcile the requirements of the regulators and the interests of holders of mortgage securities,” said one official.
American International Group has said implementing the guidelines will cost it at least $178m, while Washington Mutual has committed to cut rates on up to $2bn of subprime loans, some of which have been securitised.
The turmoil in the mortgage-backed securities market has brought two Bear Stearns hedge funds near to collapse, spreading wider concerns across credit markets. Richard Marin, Bear’s head of asset management, on Friday became the first high-profile casualty when he was replaced by Jeffrey Lane, a senior Lehman Brothers executive.
Several junk-rated deals coming to market were forced either to drop their most aggressively-structured elements or raise pricing.
The moves reflected investor jitters fuelled partly by subprime worries but also by rising global interest rates, expectations of heavy supply of debt for leveraged buy-outs and resistance to increasingly fashionable borrower-friendly debt structures.
Regulators have also expressed concern about rising levels of risk. A senior Bank of England official warned the vulnerability of the global financial system had increased as financial institutions have taken on greater risks in search of higher returns.
Meanwhile, investors are still struggling to evaluate the potential scale of subprime exposure in financial markets after the losses at Bear’s two funds and at others, including a listed fund run by London-based Cheyne Capital.
Much of the exposure to the subprime sector is through opaque and complex instruments known as collateralised debt obligations, which repackage tranches of debt of varying risk.
Morgan Stanley estimates the total volume of CDOs issued since the start of 2005 with some subprime mortgage exposure is about $550bn.
Strange as it may seem, this directive is also a boon to banks. It’s much easier for organizations to have clear decision rules. And you don’t mess with regulators. Banks can take the position that they are to work out loans up to the mod limits in their securitization agreements. Those vary, but my understand is that most permit either no loan modification or restrict it to 5% of the total (not clear whether this is based on number of loans or % of value). It’s likely, given the level of subprime defaults (some put the number at over 20%) that many banks will be restricted by their agreements as to how many they can modify, and thus will be able to select the ones most likely to make it.