Seeking Reader Questions on Fixing Mortgage Securitization for the House Financial Services Committee Hearings « naked capitalism

Tuesday, May 10, 2011

Seeking Reader Questions on Fixing Mortgage Securitization for the House Financial Services Committee Hearings

I participate in various e-mail threads where people chat among themselves (my hedgie bunch can be wickedly funny on slow market days) and one of the groups is focused on the mortgage mess.

I thought readers might be able to help with a query from one of the participants:

On May 23 the House Financial Services Committee will be having a briefing session on Securitization and risk retention proposals under Dodd-Frank. The following parties will be presenting and available for questions:

· David Moffitt, Global Head of Structured Solutions and Securitization, Morgan Stanley
· Tom Deutsch, Executive Director, American Securitization Forum
· Evan Siegert, Managing Director, Senior Counsel, American Securitization Forum
· Jim Johnson, Managing Director, Public Policy, American Securitization Forum

He is skeptical of the Dodd Frank risk retention rules and asked:

Does anybody who thinks differently have any questions regarding risk retention that should be asked of a person listed above? How about questions for any of these participants regarding securitization generally?

I find it impressive that the American Securitization Forum, which to date has been consistently in the wrong on foreclosure fraud and chain of title issues, is still treated with such deference, particularly since the sell side of the securitization industry, which is what the ASF represents (despite its pious claims otherwise) has fought meaningful securitization reform tooth and nail, with the result that the industry is almost entirely on government life support. Therefore I hope readers can come up with some suitable questions.

One participant in the thread gave me permission to post his questions to provide a point of departure:

The ASF seems very well staffed for a trade group representing a blown up industry!

Presumably tomorrow, the ASF will be requesting an exemption to the risk retention proposals for MBS – they have stated that they prefer that sellers retain a vertical rather than horizontal slice of risk in a deal. They suggest that requiring a horizontal slice would be too onerous and might damage the fragile recovery underway in MBS market (their words).

1. Since mortgages are the securitized asset class that exhibited the worst lending and issuance performance and have demonstrated repeatedly that such failure was because the incentives lenders and issuers were not aligned with investors, why should this asset class get any exemption from risk retention rules? In contrast sub-prime auto loans have performed comparatively well, yet no exemption is requested for this asset class, why is that?

2. The problems with mortgage securitizations continue to unfold years later, including billion dollar disputes regarding the quality of the mortgage loans. Have lenders and issuers demonstrated any understanding of why so many bad things happened to their mortgage lending standards and their mortgage loans? Rather than retaining risk, wouldn’t it make more sense to require lenders and issuers to pass a test demonstrating that they now understand underwriting and credit and they have analyzed their performance history and identified the sources of the high failure rate of their loans and instituted policies to protect against such failures in the future?

3. European regulators have not permitted an exemption for MBS in their jurisdictions, yet, by most accounts, their MBS performed better than similar vintage US MBS – why should US MBS be permitted a lower standard?

4. The ASF proposes that mortgages with 5% down payments are sufficient to be “qualified residential mortgages”, provided they have mortgage insurance – yet most mortgage insurers are substantially undercapitalized and have been downgraded to barely investment grade levels and their defaults would have a catastrophic impact on investors Fannie and Freddie and, ultimately, taxpayers. In addition, they are rescinding insurance coverage on a widespread basis, exposing investors to significant potential losses. Why should such loans be given an exemption under any circumstances?

5. Have lenders demonstrated any ability to originate mortgages with 5% down payments in an appropriate manner since the crisis? Have lenders demonstrated any scenarios under which such loans represent reasonable risk for investors on a non-government guaranteed basis? If not, why should such loans be subject of an exemption?

6. The ASF repeatedly asserts that various more stringent requirements for mortgages would make the affected loans more expensive for consumers. However, the ASF fails to articulate why this should be seen as a negative consequence. Shouldn’t loan types that have demonstrated a propensity to default at significantly higher levels be assessed with a comparatively higher interest rate? Shouldn’t borrowers who have historically demonstrated weaker performance be assessed with a higher interest rate? For borrowers who put down only 5% on a home, or have higher debt to income ratios, adjustable rate loans, or limited ability to verify their income or assets, wouldn’t a higher interest rate discourage or limit such borrowing and, thus reduce risk in the market place?

42 Comments:

Kiffmeister says:

May 10, 2011 at 7:35 am

Where can I find more information about this May 23 session? I just visited the House Financial Services Committee website and there was nothing like this on their schedule.

Mark K says:

May 10, 2011 at 7:47 am

How about this:

How many trillions are there currently are in defaulted, foreclosed, or underwater mortgages in the US? How is this amount distributed among the different exemption categories you propose?

ambrit says:

May 10, 2011 at 7:55 am

Madam;
Would it be feasable to impose a top limit to total interest and fees generated by a mortgage as a percentage of the principal? That would tend to reduce incentives for cosmetic transactions. Either that or a financial transaction tax? Tied to the mortgage as it winds its way through this vale of tears, thus presentable as a virtue inducing measure. Total transparency, “bundled” as a mortgage followingtail would be the least we could ask for.
As Mr Kiffmeisters post suggests above, the Feds look to be trying to bury this one deep.

justa70'scaveman says:

May 10, 2011 at 8:00 am

I’m don’t necessarily believe that inflation is just around the corner, and I’m not sure what the “normal” interest range should be for housing finance, but the daily stories headlined “Housing prices still haven’t turned around” NEVER address the fact that interest rates are still at the low end of the spectrum of the last 30-40 years. If there is a lot more room for rates to fluctuate up than down, then how is this a good business to invest in (as opposed to “being” in)? Credit risk aside, I can see why you don’t want to be required to hold a stake.

So, Mr. TBTF, aren’t you really saying “this is such a good business that we don’t want to reduce what is avaialble to investors because we have to retain part of it?”

Cedric Regula says:

May 10, 2011 at 8:08 am

I really can’t think of any intelligent questions on the subject, so rather than just stew about it, I’ll post these.

If Willie Sutton were alive today and someone asked him “Why do you rob the Federal Reserve?”, would he answer “Because that’s where the money is.”

If the securitization industry already went supernova why would anyone outside the industry want the opinion of the industry?

Does it worry you that underwriters and originators are holding risky paper with poor underwriting standards, and that’s why they need to sell off 100%?

If mortgage backed security investors want to take delivery on lumber, shouldn’t they buy a lumber futures contract instead of a piece of a mortgage pool?

If undercapitalized mortgage insurance, and for that matter CDS as pseudo insurance, makes the industry “less frail”, would it be a good idea to expand the concept to all insurance companies and reduce their capital requirement to nothing? How about casinos? Like have slot machines that don’t pay out at all?

Does “operating in a vertical slice of the industry, instead of horizontal slice” mean that a bank holding company can monopolize all transaction fee based aspects of the loan life cycle and pass all risk bearing aspects to either the investor or homebuyer. They can then hump anyone, in any way, as they please. Can you present any evidence to the contrary?

What was it again that was wrong with the Savings and Loan model of home lending?

What is securitization? Can you provide a real world example? (that one should get ‘em)

F. Beard says:

May 10, 2011 at 8:13 am

Eliminate all government privilege for fractional reserves such as the Fed and FDIC and we shall soon see cautious bankers.

Eliminate all government privilege for usury such as legal tender laws for private debt and the capital gains tax and we would soon see far fewer bankers.

Question? If high prices are the cure for high prices then why aren’t high interest rates the cure for high interest rates? Ans: Because the US has a government enforced money monopoly? So I would bet.

VM says:

May 10, 2011 at 8:19 am

To me all this sounds like a Three Card Monte.
I believe the issue really is that there is way too much emotional baggage involved in the entire housing industry.
Think about it – When something is bought and sold as “______a dream” (feel free to prefix Spanish, Irish, American or whatever as appropriate) you are essentially in lala land.
The buyers -of houses, mortgages, securitized loans need to beware.

Aggravating the problem -perhaps a bunch of folks also cynically put zero down and took advantage of non-recourse debt floating around to in essence buy call options on the mania that was “housing”. But this too happens largely because the hoopla of RE industry allows for emotional baggage to obfuscate the understanding of the transactions and perverts the mechanics.

In the end a mortgage loan is and should be no different as an asset (for the lender) and as an obligation than any other loan/product. The issue we are dealing with is just one mass imprudence (both by lenders and borrowers) – not sure why this needs or could have a different or special fix.

I mean no matter you call it a “________ dream” even if you believe it reality does not easily alter. If you jump off a tall building no matter you believe you are a bird I think there are chances you will fall. And when when you do there is no special fix.

Bravo says:

May 10, 2011 at 8:21 am

In the minds of even the general public now, the securitization industry is now widely recognized as the single party most responsible for creation of the economic calamity that will take Main Street Americans years to recover from. Just how could it be that an industry with such an awful track record of looking out for anyone other than Wall Street’s own selfish economic interests, have the arrogance to even suggest that they be allowed to do it all over again with a second business model that can be barely differentiated from the first? Has Wall Street still not learned the lessons of excessive leverage and lack of meaningful skin in the game?

Capo Regime says:

May 10, 2011 at 8:28 am

Hmmmm.

1.) If we were in a normally functioning democracy how many years do you think you guys would serve in prison?

2.) If we were in pre Meji japan would you have already evicerated yourself?

3.) With what thoughts do you start your day gentlemen?

4.) What ideas and principles animate your professional life?

5.) Can you explain and provide empirical proof of you and your firms ethics?

debi P says:

May 10, 2011 at 8:29 am

What’s the point when the interests are going to be covered up any way. I don’t trust any of them. Period. Debi

VM says:

May 10, 2011 at 8:41 am

I propose let the Nevada Gaming Commission have oversight responsibility for housing and mortgage industry. They have more appropriate domain knowledge.

Ladies and Gentlemen please place your bets.

Doug says:

May 10, 2011 at 8:42 am

The purpose of retention of risk is to put skin in the game. The purpose of skin in the game is a belief that it leads to more careful attention to risks of loss.

Therefore, some questions:

What are the specific kinds of risks that, if not carefully attended to, lead to losses? In particular, please describe what we’ve learned from our securitization experience with respect to (i) quality of underwriting; (ii) how incentives drive sales efforts that, in turn, drive consumer choices in types of mortgages; (iii) risk of legal noncompliance regarding mortgage and/or note transfers; and, (iv) the capacity of investors and their representatives to assess the quality of assets being securitized?

If retention of risk levels are too low, it means that there will not be enough skin in the game to pay attention to efforts needed to offset risks like the above. And, that will lead to losses. Please describe the level of risk retention needed to avoid this trap — and support your contention with specific reference to the players/capabilites/operational controls that you can guarantee us will be in place to protect against risks.

Tell us what assets, insurance, escrow amounts, etc, that ASF will put up as a guarantee in this regard.

Securitization demands volume. Describe the capacity of volume driven, technology dependent institutions to make quality underwriting decisions?

Last a question for Congress: Why are there no non-profit housing groups in the list of speakers? And how does Congress square their absence with the fact that they dramatically outperformed private sector players in quality of underwriting?

F. Beard says:

May 10, 2011 at 8:49 am

You guys who talk about “risk” don’t get it. Our entire money system is unstable besides being dishonest.

Banks lend money they don’t have for interest that does not exist. How does one manage that “risk”?

Sociopaths of BOA says:

May 10, 2011 at 9:17 am

You aren’t allowed to “securitize” mortgages. The original “contracts” were illegal. The DC show is another example of “illegitimate authority”.

No One Who Matters says:

May 10, 2011 at 10:04 am

I have a more fundamental question.

“How can I explain to my child why he should obey the black letter law when the banks and other financial institutions do not, especially considering that when their nominally illegal actions are discovered they are either not punished or the punishment is such as to make their illegal activity profitable?”

F. Beard says:

May 10, 2011 at 10:13 am

Here’s another fundamental question: Why should enforcing the law be a threat to the entire national economy?

Susan Truxes says:

May 10, 2011 at 10:11 am

I would like to have some information from this panel of “securitizers” which breaks down the definition of securities vs. commodities. Hard for me to get specific here because I don’t understand either process, but could someone formulate a question that asks them to define the difference? And another question: Why did the SEC avoid responsibility for overseeing all these RMBSs by passing the buck and saying that they really aren’t “securities;” they are actually commodities. So if this is true and the RMBSs have morphed into some kind of commodity, what implication does this have for “securitizers?” Aren’t they really “commodifiers?” Is that even legal? I mean, how do you meet your fiduciary responsibility to securitiize a commoditized thing? Sorry to be so off the wall here.

Susan Truxes says:

May 10, 2011 at 11:24 am

Lemme try to restate that a little: If an investor buys commodities, he or she is doing so because they expect the price to go up basically. They are speculating. But an investor who buys a MBS is not speculating on a future price. They might be speculating that interest rates will come down, but since when are interest rates commodities? Nevermind..

VM says:

May 10, 2011 at 10:26 am

I would like the participants to wear powdered wigs and purple colored plastic trousers.

Ladies and Gentlemen this is all a circus. I believe in Roman times someone said give circus & give them (people)bread & they will remain distracted or something to that effect.
This is the current era equivalent.

So I would like the Gladiators to wear wigs & plastic pants – why not?

dejauvuagain says:

May 10, 2011 at 10:55 am

1. Prohibit covenants limiting ability of small groups of investors to sue.
2. Impose liability for benefit of investors upon all in the chain of the mortgage process against all providing any certifications or opinions – bare opinions without reasonable due diligence prohibited. Extent of due diligence to be described.
3. Place liability on the trustees and issuers that complying mortgages are in trust.
4. Prohibit mortgage default insurance except by all issuers and trustees guaranteed by the parent owners present and future
5. Require MBS’S to be pure pass-thrus. Only payments actually received by servicers to be passed through.
6. Allow beneficiaries of pension plans to sue issuers and trustees.
7. Impose triple damages.

etc.

meli says:

May 10, 2011 at 4:15 pm

dejavuagain, i like your list with one exception: number 5. The biggest contribution of the agencies for the last 30 years wasn’t the guarantee of payment and principal. After all, until recently, housing prices only went up, so you would get your money. It was the TIMELY payment of principal and interest that got all the wheels turning. The big players, pension and insurance companies want predictable cash flows.
- dejauvuagain says:
  
  May 11, 2011 at 9:39 am
  
  Meli
  
  Then one is not selling an MBS, but a bond of the issuer somehow loosely couple to a pool of hypothetical mortgages.
  
  Many of the abuse which created this train wreck arise out of the effort to turn MBS’s into corporate bonds – when cash flow is loosey goosey, then there is decoupling from a specific pool of mortgages.
  
  Going down the road of guaranteed cash flows removes a major check and balance to assure quality servicing and a defined set of mortgages in the pool. And, it incentives servicers to engage in abuse of borrowers — the practice encourages smoke and mirrors and further attracts to the business those who thrive in smoke and mirrors.
  
  The MBS purchasers have to get real and understand the nature of their investment.

Paul Tioxon says:

May 10, 2011 at 11:57 am

I would ask about the securitization of residential home mortgages. I would propose an Investment Grade MBS Class I. This class this class would have the defining criteria as follows:

1.

Paul Tioxon says:

May 10, 2011 at 12:17 pm

I would ask about the securitization of residential home mortgages. I would propose an Investment Grade MBS Class I. This class this class would have the defining criteria as follows:

1. Only primary residences.
2. LTVs not to exceed 80%.
3. Front and Back Debt Ratio not to exceed 35% of borrowers
verified income, averaged for 3 years.
4. Credit Bureau Scores, commensurate with successful probability of homeownership, based on credit history, job history.

5. ONLY seasoned notes, held by lenders for 12 months before they can be securitized.

6. Borrowers must escrow for RE taxes and insurance.

7. Title companies, must not only record deed and lien on the county or local level in compliance with state laws, but must be notified by the note holder, in order to record assignment of note to buyer, or transfer to a trust in the case of securitization.

8. Note holders or trusts must in addition to recording their lien assignments, must notify local recorder of deeds of Mortgage Servicers or transfer or name changes of new Mortgage Servicers of the notes. A current and accurate physical address, working phone number and web site with email address must be include for communication purposes and to verify who is servicing the mortgage notes.

9. This would be a good start.

Doug Terpstra says:

May 10, 2011 at 12:27 pm

Were you unable to devise any surer, faster way to bankrupt the US government and destroy any vestige of faith in the free market myth than the exemption from any risk that the ASF is proposing, while imposing instead all risk on explicit, unlimited taxpayer subsidies and guarantees?

Have all members of Congress’ Financial Services Committee been bought off or marginalized to ensure continued immunity for looters?

Is the Criminal Reserve Bank adequately collusive in this cartel strategy? Has it made proper assurances that it will continue to give ASF members free money, while allowing all the toxic waste created in the process to continue to be dumped, no questions asked, into its already reeking landfills for taxpayer consumption?

Is there consensus within the creative genius of the ASF that this is truly the fastest way to cause disaster and impose shock doctrine austerity for the huddled unwashed?

Has Grover Norquist been consulted about a more efficient method of drowning babies in bathtubs?

Has FEMA been apprised to prepare adequate space in its concentration camps for the restive masses?

Why don’t you wear clothes in public? No one should have to see your junk.

steelhead23 says:

May 10, 2011 at 12:35 pm

You have suggested that upon sale of a MBS, the originator should be free to dispose of all VAR onto investors. Originators would then be free to short those products if market conditions suggest it would be prudent, without the courtesy of letting investors (clients?) know your position. If Fannie and Freddie were to tighten their requirements for conforming loans, securitize its MBS independently and sell such products on the open market, carrying an explicit government guarantee, while your products are known to carry risk, how would your industry survive? Would you prefer government regulation, or government competition?

dejauvuagain says:

May 11, 2011 at 9:48 am

Originators and issuers of MBS’s should be prohibited from shorting the same MBS’s. Ever. Disregard Chinese Wall fictions. Prohibition applies to all affiliated companies. Consider off-balance sheet companies as affiliated.

rOn cOn cOMa says:

May 10, 2011 at 1:29 pm

Since there has been widespread problems with mortgage assignments, what percentage of securitized mortgages in this decade, are actually owned by the investors (trusts)?

Purposeless Banks says:

May 10, 2011 at 3:09 pm

Wouldn’t lowering the price of housing be a better solution then some overwrought bullshit where other people can make money out of a deal that they should have nothing to do with in the first place? (air goes out of the room)

ambrit says:

May 10, 2011 at 4:24 pm

Friends;
Someone is going to have to have a haitcut sooner or later.
Who will decide whom and how much?

F. Beard says:

May 10, 2011 at 4:28 pm

Someone is going to have to have a haitcut sooner or later. ambrit

I disagree. The debt could be inflated away without serious price inflation if the banks were simultaneously put out of the counterfeiting business via a 100% reserve requirement.

Bailout and reform could be combined in a neat little package.

ambrit says:

May 10, 2011 at 4:26 pm

Dear Friends;
Sorry about the “Freudian Slip” in the previous post.
Flagellantly tyours

Dean Sayers says:

May 10, 2011 at 5:01 pm

Mortgages are one of the worst-performing security backings. To what extent can a stagnant real wage (coupled with a huge increase in worker productivity), an artificially deflated CPI, and an increased ratio of consumer credit:wages be cited as causes for the failure of MBSs?

Susan Truxes says:

May 10, 2011 at 5:07 pm

Maybe ask the securitizers how much more profit the trusts are able to realize as commodities as opposed to securities. Or is the depositor the only party to benefit by fees from fake securitization? Is this the reason the RMBSs have been handled like commodities? All those trading fees? How much profit will be forfeited if they must actually treat them as securities adhering to the PSAs. Do they think it is fraud to avoid the requirements of the PSAs. If covered bonds are the answer to bank and investor risk why do they oppose this? How do they propose to protect the housing market from another dead zone? Do they think it is fraud to trade MBSs like commodities? So can they define what a “commodities trust” is? If investors have lost faith in “securitization” by this housing betrayal, how will the securitizers survive – what else will they ruin next with fake securitizing? What makes securitizers necessary?

Susan Truxes says:

May 10, 2011 at 8:02 pm

Also don’t forget to ask the securitizers if they condone all the short selling of the RMBSs AND CDOs which they did in all out war with each other in an attempt to depress and control the housing market and what effect this had on their investors, not to mention the devastation to the homeowners which they so piously overlook. And if they were dealing with bonds which obligated them up to 20% would they have behaved in this “commodities market” manner.

FatCat says:

May 10, 2011 at 10:05 pm

Here’s what needs to be done:

1. Eliminate ALL business regulations.
2. Eliminate ALL corporate taxes.
3. Eliminate ALL inheritance taxes.
4. Eliminate ALL taxes on income over $250,000.
5. Eliminate ALL government.
6. Privatize EVERYTHING!

FatCat!

ajax says:

May 10, 2011 at 10:20 pm

What is the best way to value Residential Mortgage
Backed Securities in an illiquid market? Please justify
your answer.

VM says:

May 10, 2011 at 10:44 pm

If the market is illiquid I think your opportunity cost will be a good bench mark. The trade off between what you make else where and what you are willing to part with the security would be a good estimation for its value at that point in time given the characteristics. Most anything else seems mythical to me.

ajax says:

May 10, 2011 at 10:45 pm

On July 12 2004, Vernon H.C. Wright, at the time
Chairman of the American Securitization Forum, wrote
a letter to the Attention of Jonathan G. Katz, Secretary
of the Securities and Exchange Commission.

The forementioned letter stated, inter alia, that:

“Securitization has in many ways transformed the
American economy. Asset-backed securities (“ABS”)
provide safe and secure investments to mutual
funds, investment management companies,
pension plans, banks, insurance companies and
other businesses, as direct investors, as well
as to millions of Americans who invest in funds
that invest in ABS.”

This document is a file called:
ASF_Comment_Letter_on_SEC_ABS_Rule.pdf

Question:
Since that letter dated July 12 2004 by Vernon Wright,
has the view of the ASF on the safety and security of
ABS investments materially changed? If so, please
provide arguments that support your current view.
If not, please explain why you think Asset-backed securities
are secure and safe, as stated by Mr. Wright in his letter
to the SEC in 2004.

tnjen says:

May 11, 2011 at 12:03 am

How about asking how granting them an exemption benefits Americans or the US economy, especially given their record?

bryan says:

May 11, 2011 at 9:12 am

What about fiduciary duty of the end-user? If I am an investment bank and I take 100k ninja and multi-pledge that collateral into 5 different CDOs, which I then purchase 500k of CDS on each one of those CDOs a have created 2.5 million dollars of derivatives exposure on an underlying 100k loan that should never have come into existence (this of course magically transforms from a fake piece of paper into a real burden born by the taxpayer thanks to Timmy G and the Funkybunch). But, the key to this ever happening is the yield-chasing underfunded pension fund who is the ultimate lender that facilitates the fraudulent pyramiding to begin with. So my question is who represents the pensioner or mutual fund investor? The board of directors? The staff? In this era of postmortem finger pointing, there is no question that the investment banker who fraudulently multi-pledged the collateral should be held accountable, but at the very least I believe the only way capital markets reform can happen is if the managers of so-called “dumb money” (aka the hard earned life savings of the working class) are held accountable for the gross negligence of fiduciary duty. The high net-worth “sophisticated” investor solves this problem with immediate redemption of funds, but the pensioner or 401k has little recourse, and most likely little clue as to how his or her live savings is “efficiently diversified”.

JWP says:

May 11, 2011 at 9:24 am

Spot on…

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