Presentation on theme: "Ira G. PEPPERCORN The Continuing Tragedy of the Mortgage Commons"— Presentation transcript:
1 Ira G. PEPPERCORN The Continuing Tragedy of the Mortgage Commons PresidentIra Peppercorn International, LLCNATIONAL HOUSING BANK OF INDIA - IFCSOUTH ASIAN CONFERENCE ON AFFORDABLE HOUSING & HOUSING FINANCENEW DELHI, INDIA january 28, 2010
2 U.S. Mortgage System Formerly mortgage market leader Homeownership rates over two-thirdsMortgage system collapsedCredit standards and access tightensBurden shifting to U.S. Government insuranceU.S. economy in recessionWorld-wide impactSouth Asian nations: growing economies can learn from U.S. mistakes
3 “Sub-Prime” Crisis Misleading Language unfairly blames the borrowerSub-prime mortgage for a borrower with less than A creditNegative implications for low income and minority borrowers33% Sub-prime borrowers in New York could have qualified for prime mortgageCrisis not just about “who,” but “what” and “how”Mortgages with multi-layered risks
4 True Causes Competitive “gold rush” environment New, risky financial productsIrrational exuberance and capital flowLack of responsibility and accountabilityLack of information and documentationFederal Reserve: Prevent deflationFragmented regulatory systemProducts outside of regulated sectorGovernment unprepared
5 Comparative Understandings Adam Smith: “Individuals acting in their own rational self-interest in a free-market economy leads to economic well-being.”Garret Hardin: “An unmanaged commons in a world of limited material wealth and unlimited desires inevitably ends in ruin.”
6 Prudent Mortgage Lending Employment and salary historyMonthly debt to income ratio (mortgage and total)Credit worthinessDown payment source and availabilityDocumentation and verificationProperty valuation
7 U.S. Institutional History Response to Great Depression & banking crisisCreation of FHA: mortgage insurance (1934)Establishment of FNMA: liquidity (1938)Fannie partially privatized (1954)Institutional change (1960s)HUD, Ginnie Mae, Freddie Mac createdFannie privatized: enters conventional marketGrowth 1970s-1990s)Conventional purchases more than government (1976)Financial safety and soundness oversight (1992)Fannie & Freddie 40% of U.S. mortgage market (1990s)
8 System Benefits Tremendous growth of mortgage market: 68% homeowners Development of mortgage standards and disciplineDown-payment requirements reducedSecondary market partnering with governmentsLiquidity for financial institutionsNot perfect: minority and low income lending
9 Breakdown of System “Innovative” financial products Competitive environmentInvestment bankers and others: market opportunityRating agencies performanceGovernment regulatory system that was fragmented and ineffectiveCentral bank prevent recessionCapital flowing into systemGovernment encouragement
10 2000’s: Growth of “Innovative” Mortgages Non-traditional mortgages and risk layeringPiggy-back loans (80/20)Stated income loansInterest only loansAdjustable rate mortgages with no or high adjustmentsNegative amortization mortgagesLack of prudent underwritingHigh debt service coverage ratiosQualification based on initial “teaser” ratesLow or no down payments—sometimes cash backCash out refinancings
11 The Market Overheats Intense competition: Compete or die Borrowers sold mortgages easier and less upfront, but with long term consequencesLack of responsibility; lack of accountability throughout the processIn a rush, due diligence not thoroughly performedRisked passed to next player in the chainCompensation not tied to medium or long term performanceWhat have we seen overall?
12 Money TalksAmericans owed $8 trillion in mortgages, more than Treasury debt,Non-traditional debt higher yield, higher feesInvestment banks aggressively pursuing lendersSecurities issued in tranches with risky portions backing stronger onesAsset backed securities in 2007 greater than top 5 banksLenders & investment bankers differences blur
13 Capital Floods InTreasury rates low, stock market low, housing sector strong and growingInternational & domestic investors see opportunityMove from Treasuries to Fannie & Freddie paper; believe implicit federal guaranteeStep to non-governmental or GSE securities; AAA, higher yields and market blessing of Fed ChairmanCapital pushes investment banks, REITs, pushes lendersCompetitive process becomes circular
14 Rating the Rating Agencies Rating agencies should perform thorough due diligenceGave senior tranches top ratingsAgencies not required to check information from originators or servicersFinancial models built on older mortgage modelsDisconnect between value of securities and value of underlying assetsWho investigated the mortgage portfolios?
15 Fannie Mae, Freddie Mac Compete Accounting scandals hurt reputationOther financial organizations gain market shareInherent contradiction in government structureFannie Freddie restricted on types of mortgages purchased and guaranteedFannie Mae CEO: “We face two stark choices: one, stay the course; two, meet the market where the market is.”
16 In the Back Door Greater spread on investments than purchases Sub-prime senior tranch AAA; permitted investmentGovernment increases mission goals & relaxes sub-prime standards in 2004By 2008, 1/3 sub-prime; 2/3 stated income loansNow 68% “private label” securities purchases below investment grade
17 Where were the Regulators? Fragmented Regulatory System Federal Housing AdministrationFederal Housing Finance Authority (new)Office of Thrift SupervisionFederal Housing Finance BoardFederal ReserveFederal Deposit Insurance CorporationComptroller of the CurrencySecurities and Exchange CommissionState & local regulators
18 HUD Challenges: Fragmentation, Funding, Credibility Regulatory functions split between mission & financeMission: decrease gap minorities and majorityFinance: Safety and soundnessLack of funding and staffFHA destabilizing communities, not sub-prime loansFannie MaeCommunity contributionsTrillion dollar affordable housing commitmentStrong relationships with CongressHUD had the mission challenge, and was also given and oversight role. 17mm 62 mm regulate two most powerful and strong Mention your testimony; say mission you believe in. Talk about your experiences in communities Chicago, Syracuse
19 The Regulatory Paradox Consumer protection causes loss of market shareStronger appraisals cause negative reactionPrevention of predatory lending (2000) cause more loss of market.Anti-predatory lending reversed (2004); helps cause mortgage crisis.
20 Federal Reserve Bank Monetary Policy: Prevent a Recession September 11, 2001 caused national trauma & economic tensionHousing market Challenged by Fannie & Freddie accounting scandals & declining customer baseGreenspan feared deflation similar to Asia in 1990sLowered prime interest rate from 3.5% to 1%
21 Fed Chairman’s Views on Regulation Housing market driver of economic growthHousing growth supported by public & private; Democrats and RepublicansGreenspan’s : market discipline not bureaucratsSupports alternative and other financial productsInternational capital flows in
23 Analysis of FHA Market Share Loss Product restrictions and lack of process improvements relative to the conventional marketProduct innovations, expanded loan origination and funding channels in the conventional market, interest rate and house price changesLess bureaucracy and lower initial costsRisk: low initial interest rates could rise substantially in a short period of time
24 Changing Strategies 2008: Trillions spent to save large institutions Foreclosure prevention efforts fail2009: Keynesian approachStimulus package: Car companies, communities, construction2010 Mixed signalsStill a need for stimulusFew permanent mortgage modificationsNow freezing discretionary spendingThe crisis, while building, actually happened very fast. What did the government do?
25 Initial Response: Prevent Economic Collapse (2008) Lehman Brothers allowed to collapse—too concentrated in one industryAIG assisted more than $150 billion—too big to failFannie Mae, Freddie Mac federal conservatorshipPolicy from trouble assets to capital provisionPreferred stock in exchange to capital infusionNo other requirements placed on financial institutions
26 Government Commitments: $12.2 Trillion $9.0 trillion as an investor$1.7 trillion as an insurer$1.4 trillion as a lender.$2.5 trillion spent through April 30, 2009$10 billion recouped through dividends and fees.$1.25 Trillion of mortgage backed securitiesNY Times: much of this was purchasing securities. This is rarely talked about.
27 Second Response: Keynesian Spending but Little Housing Assistance Keynesian approach: spend to growAid for housingInitial response aided 25 of 400,000 familiesLater $75 billion for loan modifications759,000 loan modifications; only 31,000 permanent15%+ homes worth less than owed not eligibleCannot reduce principal balanceMany default even after modificationsGovernment mortgage insurance skyrockets
28 FHA Dollar Volume Market Share 10X Increase From 2005 Low Many actions individually make sense
29 FHA Market Share Increases Reserves Shrink Market Share New Endorsements 22.5%Peak Q1 2009: 26.3%Delinquencies growReserves Experience Sharp Decline2009: $3.6 billion of $685 billion72% Decline since 2009Reserves .53% of total insured loansLegislative requirement: 2% minimumRisk passed from private to public?Many actions individually make sense
30 FHA Quandary: Balance Mission with Finances FHA Programmatic changes:3.5% Down payment for higher credit scores only10% for lower credit scoresSeller concessions limit 3% from 6%Upfront premium 2.25% from 1.75%Cash out refinance maximum 95% LTV to 85% LTVWill this close out qualified but lower income borrowers?Many actions individually make sense
31 Mortgage Crisis 2009-2010: The Crisis Continues Home prices expected to fall 5-10% in 2010Pending home sales down 16% in Oct 2009Foreclosure filings: A record 2.8 million in 200921% Increase since 2008; 120% Increase since 20072.2% of all households foreclosure filing in 20091.8% 2008; 1% 2007; .6% 2006Mortgage applications down 25% in one year
32 Additional Economic Data Personal bankruptcy filings million, up 32% from 2008Unemployment rate 10%, up from 7.4% in one year39.8% of unemployed for more than a half yearFederal deficit highest since World War 2Only 3 States without deficitAlabama 42% Deficit compared to spendingWSJ Jan 7, 2010
33 Current Status (2010)Political criticism of bank bonuses as they pay backLimited attempts to preventsClaims of recession ending as many are hurtingBacklash against government spendingTo Keynes or not to KeynesLatest proposal freezes discretionary budgetDiscussion of coordinated regulatory authorityStill no effective housing solutionWSJ Jan 7, 2010
34 Lessons Learned Pushing loans not in borrowers best interest Higher rates, terms to minority borrowersProducts to avoid borrowers’ stake and insuranceSecond mortgages blocking restructuringsLack of due diligence on the part of all partiesPassing along risk without accountabilityCompensation not tied to long term performanceEncouraging “back door” channels from GSEsFailure to follow prudent lending practicesSome completely irresponsible
35 Innovations can be Positive if Handled Correctly Mortgages done correctly can aid people that could not get prime creditSecondary market can spur growth in marketPerformance based compensation can encourage meeting and exceeding goalsNew investors can create opportunitiesEmerging markets take lessons from mistakesSubsidies are sometimes necessaryNot everyone can or should have a mortgageMany actions individually make sense
36 Long Term Musts Accountability at all levels Proper underwriting and verificationFairness in lending and consumer disclosureMinimization of multiple risk factorsMortgage insurance unless significant down paymentCreate foreclosure prevention that worksEffective, coordinate regulatory systemReciprocity in government-corporate relationshipsSubsidies can fill gaps, but do appropriatelyDo not forget the importance of rental housing
37 Prevent the Next Tragedy Provide incentive to act like angelsDecisive disciplinary actions to prevent devilsEnsure foundation is strong and firmEstablish system for financial disaster preventionBe careful of donkeys on the runwayCarrot and stick
38 Angels and DevilsThe non-angel gains from his “competitive advantage” (pursuing his own interest at the expense of others) over the angels. Then, as the once noble angels realize that they are losing out, some of them renounce their angelic behavior.Garrett HardinUnderstand this through understanding of the tragedy of the commons. If the government could not stop it, why couldn’t individuals?
39 Thank You Shukriyah Dhanyavad For More Information:+1 (703)