A Common – Sense Piece of Dodd – Frank

In 2010, Obama signed the largest overhaul to financial regulation since the 1930’s.  The Dodd – Frank Act is a 2,000 plus page cluster that imposes over 400 new regulations on the finance year’s industry.  The various special interest groups and political parties have reacted over the past couple on speculated benefits and harm that this monster would unleash on society.  If any of the policy details, rules and regulations behind the bill has been written, they have not been publically socialized yet.  The one thing we do know is that all regulation has winners and losers.

The Consumer Financial Protection Bureau is the most public of the agencies created under Dodd – Frank and is responsible for consumer protection.  Its web site is surprisingly still soliciting the consumer for ideas on simplifying the mortgage disclosure statement, ways to make your credit card agreement more understandable and ways they can make the student loan process smoother.

Additionally, expect a crack down on predatory lenders, high interest rate short-term (payday loans), and aggressive debt collection practices.

A much-needed and common sense reform that unfortunately needs to be regulated because of past abuse is the no income-qualifying loan.  In the past so-called “liar loans” enabled a borrower to obtain financing to a home based on their credit alone.  As long as you paid your existing bills on time, you did not have to prove your income.  The greed factor made this provision by loan officers and prospective homebuyers alike.

During most of the 2000’s I was employed by a major bank in their auto lending division.  Much of that time was spent in the credit department, underwriting or overseeing the underwriting of auto loans.  Working in the direct lending department, I saw loan applications from all over the county.

Beginning in 2005 and becoming widespread in 2006, we began to see auto loan applications from borrowers who also had mortgages on their credit bureaus that made no sense.  Historically the mortgage industry held your mortgage payment to 31 percent of your gross income on the front end.  Including other debt such as an auto loan, and credit cards would bump your back-end debt to income ratio up to 43%.  Higher risk non-conforming loans would take a back-end debt to income ratio up to 55%.

The first sign of a terrible wrong appeared in the credit bureau reports of our auto loan applicants.  How were these consumers able to secure mortgage loan in the $200 – $250K while paying less than a $1,000 per month. This was not only a fully amortized loan payment; this was not even an interest only payment.

The second sign of financial funny business was an alarming number of auto loan applicants with mortgage loan payments that were between 60 – 85% of their gross income.  I cannot remember how many loan applications I saw where the applicant had verifiable gross income of $3500 per month and on the hook for a monthly mortgage payment of $2,000 per month plus.  We are not talking about joint mortgages either.

My Credit Team and I had numerous formal and informal discussions regarding the insane mortgage loans that were popping up and we resolved to start interviewing the applicants who fell into this profile.  Our thinking was, if they pay their credit on time there has to be more income.  We will get another signer on the loan to take care of the excessive debt to income ratio.

We interviewed nearly a hundred applicants over an eight-week period.  The borrowers fell into three broad categories.

Let us call the first set of borrowers the wishful thinkers.  What they do not know does not hurt them.  They bought into the line of the time.  The market is different time.  Values are going to keep going up.  When it comes time for your teaser rate to adjust, either refinance into another teaser rate loan or quickly flip the house for a tidy little profit.  This worked well for many borrowers until it did not. Some of these people owned two to five rental properties and envisioned themselves as high rollers playing the game.

The second set of borrowers were naïve or inexperienced homebuyers. They heard it was easy to get a home loan and had dreamed of getting their own home but never thought it possible.  The loan officer checked their credit and as long as they paid their bills on time, the loan officer would congratulate the customer on their good credit and assure them they will be able to buy a home.  In fact we thing you are so qualified for a home that we are not going to even check you income.

Sadly, this borrower was taken advantage of by some in the industry and was the face of the new legislation.  The primary breadwinner took all the risk.  I remember talking to one person who could not believe I would not give him a car loan.  He made $3,500 per month and had a mortgage payment of $2,200 per month.  After adding up all the debt on his credit bureau, he had responsibility for $4,000 month in debt.  He said, “I pay my credit on time, how come you won’t give me a car loan.”  There were other income earners in the household, but the customer refused to add them to his auto loan application.

Group three were the opportunists.  Hey, everybody else is getting some. I want some too.  Why not live in style for as long as I can?  Some if these borrowers never made a loan payment.  Others paid some money to show, but wanted to see how long they could get away with it.  The funny thing is that some of this group began to believe their own hype and became the angriest at eviction time.

This change will not fix the future of mortgage lending, but it will reduce some easiest and most tempting avenues for fraud at the retail level.

Foreclosure Gate’s Drag on the Market

The foreclosure freeze that began less than two weeks ago over improper signatures on foreclosure documents is already beginning to thaw.  A call to Bank of America’s home loan and insurance customer service line greets customers with an automated voice declaring that there is not a moratorium on foreclosures.  Bank of America, Ally Bank and JP Morgan Chase among other bank put a temporary freeze on foreclosures on revelations that the foreclosure documents were not reviewed before they were signed.

What initially seemed like a grinding halt to foreclosures has turned into a small bump in the road.  The foreclosure juggernaut will continue.  The toxic mortgages are working their way through the system and following in their footsteps are the homeowners who lost their jobs in 2008 and 2009 and have been unable to replace the income that enabled them to afford their mortgages.  Many of these individuals have been in their homes for 10 to 20 years in contrast to 2 to 5 years the homeowners who ended up with a subprime or Alt-A mortgage.

The banks are implementing follow-up procedures for reviewing foreclosure documents, making sure that sufficient oversight is in place.  While improper signatures have raised concerns, a much more problematic concern lurks below the surface.  You cannot foreclose on a property if you do not know who owns it.

Property ownership has traditionally been recorded by the county clerk and the records have been kept in a filing cabinet inside the county building.  Title insurance companies have had a reliable source from which property ownership can be established.  When a title insurance policy is written on a piece of property, the question of ownership rarely came up and if it did, fraud was usually involved.  This process has worked well for hundreds of years and no one questioned its authority. 

As the real estate boom took off in the 1990’s, many county clerks were unable to keep up with the sheer number of real estate transactions, not to mention the increase in home refinance and home equity lines of credit.  Closings were postponed and an anxious market looked for an escape valve to relieve the pressure.

The answer was to create an electronic clearinghouse that bypassed the cost and delays of recording the sale of a loan from one entity to another.  The Mortgage Electronic Registration System (MERS) was created in 1997 to expedite the transactions and enable ease in long distance transactions.  MERS helped the process move smoother, track ownership, and hold title as an agent of the owner.  It created efficiency in the system that paved the way for securitization and collateralized debt obligations, providing the capital necessary to fuel the real estate boom between 2004 and 2007.

The confusion in this system is that MERS is the mortgage holder regardless of the owner.  Let us say your mortgage loan was financed by Chase in October 2006. Chase, looking to raise capital for future mortgage lending, packaged the mortgages it originated in the fall of 2006 into multiple security issues.  These investment vehicles may have been sold through a hedge fund, Goldman Sachs, or Lehman Brothers to name a few, to pension funds, foreign governments and local municipalities looking to diversify their investment holdings. If a pension fund sells a portion of the issue purchased, ownership of specific piece of property can come into question, especially when there is not a paper document verifying ownership. 

Foreclosure gate’s signature problem has inadvertently brought to light the murky world of property ownership in the age of MERS and securitization.  The potential impact to the market is much greater than robo-signers.  How likely are you to make a bid on a foreclosed property if the property owner is a question mark? 

Capitalism is founded on transparency and trust.  If our trust in the market erodes, prosperity becomes more elusive.  Buyers in the foreclosure market go elsewhere reigniting the downward pressure on home values.  How does the market grow if you cannot trust the information?