Who is to blame? What is to be done? Both of these questions have been circulating among industry participants and observers alike for some time, and while we likely will never find answers everyone can agree on, some fresh perspective is always enlightening.
This week, MortgageOrb discussed the state of the industry with David Hamermesh, a senior analyst in the consumer lending practice at TowerGroup, a research and consulting firm focused on the global financial services industry.
Q: Do you think predatory lending was a major cause of the current mortgage situation? Has its role been exaggerated? What should be done now to control it (through both legislation, if any, and other measures)?
Hamermesh: Using the term ‘predatory lending’ instantly points blame at the lender. This is a popular approach among some consumer advocates, but we feel that it unfairly demonizes large segments of the lending industry.
A more appropriate question is whether consumers were hurt by taking out mortgages that were inappropriate for them. This is clearly the case, but the blame needs to be split between lenders (including mortgage brokers and bankers), Realtors and consumers.
Lenders certainly made available to consumers products that allowed them to make large profits, and some lenders made these profits without paying any regard to consumers' best interests. Realtors benefited from the availability of credit that allowed borrowers to buy houses with minimal (if any) down payments. Some consumers failed to take appropriate steps to understand the complicated financial transaction they were entering.
This last point emphasizes that the single most effective fix to much of the mortgage situation (at least as it affects new originations) would be improvements to the disclosure process.
Standardized and simplified documents and terms would be a huge help. Several regulators, states and lenders have seen this and proposed new alternatives to the traditional labyrinthine documents. Until there is consensus and standardization, the situation remains a mess.
Q: How, specifically, would Home Ownership and Equity Protection Act (HOEPA) amendments affect lending if stricter measures are passed? Why should mortgage brokers/bankers be concerned? On the other hand, which portions of the act (either existing or proposed) are necessary and worthy?
Hamermesh: There are two key points to the proposed changes to HOEPA: the expansion of the definition of high-cost loans, and the addition of restrictions on loans that qualify as high-cost loans. The intent of the expansion of the definition is to include subprime loans and exclude prime loans from the HOEPA restrictions on high-cost loans.
We expect that the change will make most subprime loans subject to the HOEPA provisions. One interesting question is what lenders will have to do to make sure that their prime loans avoid being considered high-cost loans. This is likely to be a problem for some lenders on lower loan amounts, as their fees (some of which are defined in dollar amounts, rather than basis points) may bump up the APR significantly.
Additionally, the existing trigger for high-cost is so high that lenders have not been able to keep their compliance costs relatively low since the vast majority of all loans (even subprime) have not triggered HOEPA.
With the new definition – and even with the severe reduction in subprime loans – many more loans will require compliance checks to validate that the lender is adhering to the HOEPA requirements for high-cost loans.
Q: One TowerGroup observation was that the mortgage industry must ‘admit failure.’ What steps would doing so involve? What were the specific failures? What should the role of groups like the Mortgage Bankers Association be at a time like this to improve the industry's image, particularly as negative news coverage continues to grow?
Hamermesh: The failure of the industry to self-regulate effectively is one of the underlying causes of the current mortgage situation. Two specific examples are the proliferation of new mortgage products and the breakneck pace of creation of collateralized debt obligations (CDOs).
Mortgage lenders made large profits on the origination of new no-documentation loan programs (aka ‘liar's loans’) and payment option adjustable-rate mortgages (ARMs). The industry collectively failed to accurately assess and price the risk associated with these product features.
Many parties knew that something was wrong, but too many failed to take appropriate steps to scale back their originations or otherwise protect themselves and their investors.
Similarly, investment banks aimed to satisfy an ever-growing thirst for American mortgage debt by re-tranching mortgage-backed securities into new and ever more exotic CDOs. The risk in these derivatives was difficult to measure.
The mispricing of risk on CDOs has had a much bigger impact on the global debt markets than subprime or predatory lending. The industry collectively must recognize that these problems could have been prevented with more prudence and long-term thinking and change its ways going forward.
This is not an easy challenge, but steps such as truly partnering with consumer advocates will go a long way toward helping the industry act for its own long-term benefit (and not just to try maximizing profits in the short term).
Q: Are groups like the HOPE NOW Alliance doing enough to prevent foreclosures? Is borrower counseling the best method right now? What else should be done by mortgage servicers in particular?
Hamermesh: The statistics being published by the HOPE NOW Alliance are certainly impressive.
What is unclear is whether this is part of a concerted effort or simply the natural course of business. In other words, we don't know whether those servicers have really changed their behavior at all. There is no one right method.
What servicers need to do is look at their portfolios, put in an effort to treat each customer as an individual, use appropriate analytical technology to determine optimal response strategies, and then employ a mixture of counseling, collection, modifications and foreclosures to make good choices for the consumer, the lender and the investor.
Q: Do you agree with a recent assessment by Fannie Mae's chief that the housing recovery is likely to occur in 2010? What sort of time line do you foresee?
Hamermesh: The right question isn't ‘when will the recovery occur,’ but rather ‘when will the recovery begin.’ The recovery itself is a process, not a point in time; looking at it like this helps to focus the industry on two related issues – how to encourage the turnaround to start, and how to make sure the turnaround lasts and works.
As to some specifics, TowerGroup agrees with the Mortgage Bankers Association's forecasts that housing prices will hit bottom in the middle of 2009. Even if that is the start of the turnaround, it will still be quite some time before prices rebound to 2006 levels. We also expect total mortgage lending volume to continue to decrease through 2010.
So by some measures, the turnaround may start in 2009, but we expect that it will not have fully taken hold until the second half of 2010.
