Study: Freddie, Fannie to blame, not Subprime.

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SirNitram
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Study: Freddie, Fannie to blame, not Subprime.

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It’s almost taken as common knowledge at this point that out-of-control subprime mortgage lending — the funding of home loans to borrowers with less-than-perfect credit — was the chief culprit behind the unsustainable boom in U.S. home prices that eventually derailed the real estate and mortgage markets.

But new research, published Wednesday by UC Irvine’s Paul Merage School of Business Center for Real Estate, suggests that subprime loan products themselves may not have been the primary cause of U.S. home prices’ rise and fall.

Instead, the study argues that the considerable 2003 pullback of government-sponsored financial service corporations Fannie Mae and Freddie Mac from the mortgage credit market and their subsequent replacement by aggressive, private mortgage securities issuers in late 2003 had a significant impact on home prices and was more responsible than subprime lending for the drastic price runup that peaked in early 2006.

“We were quite surprised to find the intensity of subprime lending was insignificant after controlling for all the other factors influencing the market, but we were really blown away when Fannie’s and Freddie’s continuing presence in the market was shown to be so important,” said Kerry Vandell, UCI finance professor and Center for Real Estate director.

Vandell, along with Major Coleman IV, a finance doctoral student, and Michael LaCour-Little, a Cal State Fullerton finance professor, used 1998-2006 housing and mortgage data from a variety of sources — including First American LoanPerformance, the S&P/Case-Shiller Home Price Indices and the Federal Housing Finance Board — to analyze 20 U.S. metropolitan areas as part of their study.

The researchers found that rising home prices up to 2003 could be explained by economic fundamentals, such as low unemployment rates, expanding household incomes and population growth. These factors fueled housing demand and, in turn, increased U.S. home prices. During this time, Fannie Mae and Freddie Mac actively issued and purchased conventional, conforming mortgage-backed securities.

But in 2003, political, regulatory and economic factors–including accounting irregularities that led to their senior officers’ resignations and the capping of their retained loan portfolios–forced the two entities to significantly slow their lending volume. Private funding in the form of asset-backed securities and residential mortgage-backed securities replaced conventional, conforming mortgage-backed securities as the prevalent source of mortgage capital.

The new credit environment allowed looser underwriting standards and increased tolerance for riskier, high-yield loan products, the study’s authors said. It also birthed a borrowing climate that sought to provide previously marginal borrowers with additional access to credit — a movement that was heartily endorsed by the Bush Adminstration, who actively pushed its vision of “the Ownership Society” at that time, as well.

This fundamental credit market shift led to a record increase in total mortgage volume, and pushed up home prices with momentum characteristic of a bubble.

The researchers also determined that interest rates did not significantly affect house prices. The finding defies conventional wisdom that ties interest rates directly to the monthly cost of housing and assumes an effect on purchase prices.

“These findings help us understand that the government can have a major role in affecting the mortgage and housing markets,” Vandell said. “It’s important policymakers consider this influence when they attempt to shape the markets in the future.”

And, in other words, Fannie Mae and Freddie Mac may yet matter more to our mortgage markets than some in the industry might otherwise want to admit.
Clipped the disclosure bit, it's through the link if you want it.

Accounting irregularities. Again. It seems that the more one looks, the more one finds the numbers played with since Bush took office. And the fallout continues.
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Post by J »

Huh? So subprime isn't to blame for the mess we're in, Fannie & Freddie are because they were restricted from the mortgage market which allowed private companies to flood the market with questionable loans and mortgage backed investment products. Which would mean subprime IS the problem, but they're saying it's not to blame. I don't get that.
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Post by SirNitram »

J wrote:Huh? So subprime isn't to blame for the mess we're in, Fannie & Freddie are because they were restricted from the mortgage market which allowed private companies to flood the market with questionable loans and mortgage backed investment products. Which would mean subprime IS the problem, but they're saying it's not to blame. I don't get that.
You're knee-jerking back to 'Subprime, subprime, subprime', the mantra of the banks to isolate this into one category of people. The problems weren't 'subprime', as we see when the problems spread like fire into Prime and Superprime borrows, and then spiralled out of control and started killing banks.

The problem was they basically created a system where the appraisal was rigged(Generating a fee), the loan was always approved(Nothing, whatsoever, to do with subprime. The Liar Loans often had Prime credit, but no assets. Also, a fee.), moving the loan into a big pie and slicing that up(Another fee), dressing up the slices and further slicing them, and giving them fancy names and buzzword descriptions to hide they were crap(For another fee), and finally, for a fee, sold to all and sundry so the lenders could get profit coming and going, making more bad loans, fraudulent loans, bribing appraisers, hiring those convicted of money laundering, identity theft, and loan fraud...

Subprime was a distraction. It was a way to say 'The mean old government made us lend to poor people. We're NEVER doing that again. Now fund us so we can have more hundred million dollar bonuses'.
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Post by J »

I suppose a case could be made for Fannie & Freddie being the root cause of the current problems, but IMO it would be darn shaky to say the least.

The problem begins with the repeal of various banking & lending laws & practices born from the aftermath of the Great Depression combined with government, regulators, and industry turning a blind eye to all remaining rules & regulations. That's what's at the bottom of our problems, that's what allowed everything to go wrong. Greed & human nature took care of the rest.
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Post by White Haven »

If a law was repealed that had made it illegal to scoop your own eyeball out with a spoon, and you scoop your own eyeball out with a spoon, who's responsible? I'd argue that, illegal or not, you're still the one howling in pain whilst holding a spoon upon which rests a severed human eyeball.
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Post by White Haven »

Edit: And the market for severed human eyeballs doesn't look so hot anymore.
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Re: Study: Freddie, Fannie to blame, not Subprime.

Post by Darth Wong »

The new credit environment allowed looser underwriting standards and increased tolerance for riskier, high-yield loan products, the study’s authors said. It also birthed a borrowing climate that sought to provide previously marginal borrowers with additional access to credit — a movement that was heartily endorsed by the Bush Adminstration, who actively pushed its vision of “the Ownership Society” at that time, as well.

This fundamental credit market shift led to a record increase in total mortgage volume, and pushed up home prices with momentum characteristic of a bubble.
Uhhhh, that is subprime. What they're basically saying is that subprime lending was not the problem because the pullback of Fannie May and Freddie Mac allowed private lenders to get in ... where they started doing a lot of subprime lending. How does that make subprime lending not the problem?
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Post by Kanastrous »

Kind of like suggesting to someone who's just splashed on the sidewalk, that hitting the pavement was not their problem; no, stepping off the building was the problem.
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Post by Darth Wong »

White Haven wrote:If a law was repealed that had made it illegal to scoop your own eyeball out with a spoon, and you scoop your own eyeball out with a spoon, who's responsible? I'd argue that, illegal or not, you're still the one howling in pain whilst holding a spoon upon which rests a severed human eyeball.
This is like saying that if you're an ultra-libertarian and you fire the entire police department, then the resulting crime wave will be the fault of the criminals, not you. Yes, the criminals are responsible for their own actions. But you as the government are also responsible for stopping them.
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Post by SirNitram »

Oh, I don't agree it was Freddie and Fannie's fault; they were just punished for, oh, corruption, cooking the books, you know, what happens everywhere Bush touches, not to mention being the exact abomination to any market: One of socialized risk with privatized gain. Pretty much a walking moral hazard.

But the lenders lobbied to repeal the laws, got their way, and began 'improving' on processes that had existed for a decade or two. And by improving, I mean turning into a massive industry of processing money that didn't exist and charging fees each step.
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Post by Alan Bolte »

Subprime is a particular type of risky lending, not a catch-all term for risky lending. Low- or zero-down payment lending is often not subprime. Minimal or no documentation lending is often not subprime. Mortgages where payments balloon after a set time or event (there's a wide variety there), are generally not subprime. Financing a million dollar house for a guy who makes 90 grand a year is not subprime, so long as it is done at or below the prime interest rate.
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Post by SirNitram »

More on the Prime vs. Subprime part of this.

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Amidst the second quarter earnings season, yesterday brought about a quarterly report of a different kind — this one from industry coalition HOPE NOW, which said that mortgage servicers helped a record number of homeowners avoid foreclosure during the second quarter.

In June 2008, mortgage servicers completed more than 181,000 mortgage workouts for home loans, HOPE NOW reported; and in the second quarter of 2008, mortgage servicers completed more than 522,000 workouts. The industry coalition touted both numbers as exceeding estimates, and the largest number of workouts in any month and quarter since the group began compiling data in July of last year.

All of which is true, but looking underneath the hood at the data, it’s clear that many troubled prime borrowers are getting the short end of the stick relative to their subprime counterparts.

A prime problem
197,033 prime borrowers received some form of loan workout during the second quarter, compared to 324,961 subprime borrowers — a fact that, on its surface, may not surprise. After all, the number of troubled subprime borrowers is greater than the number of troubled prime credit borrowers, right?

Wrong.

The second quarter marked the first time in HOPE NOW’s quarterly data that the number of troubled prime borrowers — all 899,000 of them — exceeded the number of troubled subprime borrowers, which totaled 865,000. Which means that 37.6 percent of subprime borrowers 60+ days behind on their mortgage received some form of loan workout; only 21.9 percent of similarly positioned prime borrowers were so lucky.

The numbers get much worse when we narrow our focus just to loan modifications. For prime borrowers, modifications represented just 52 percent of foreclosure volume for the quarter — meaning that for every prime borrower getting a modification, two lost their home. For subprime borrowers? That ratio was at a record 119 percent of foreclosures, meaning that for every subprime borrower getting a modification, less than one lost their home.

And yet we continue to hear from consumer groups about the terrible plight of subprime borrowers. The data that’s emerging now makes it amply clear that, if anything, the legislative, regulatory and social focus on subprime mortgages has put those borrowers unlucky enough not to be in that category at a significant relative disadvantage.

More data to consider: The number of foreclosure sales among prime borrowers rose nearly 30 percent between the first and second quarters or 2008, while the number of workouts given to those same prime borrowers rose a total of zero percent. Meanwhile, subprime foreclosures rose 14.8 percent, and workouts for subprime borrowers rose 13 percent to meet it.

All of which underscores the politics of a housing rescue that, so far, has been geared mostly towards subprime borrowers under a misled perception that says we’re facing a classic haves-versus-have-nots struggle, a case of the rich abusing the poor. That sort of rhetoric sells magazines, and it gets the attention of Congress, after all.

But it’s not reality.

The data plainly and clearly suggests that the problems facing our housing and mortgage markets are less about class warfare than they are about a problem that affects all Americans. That realization is likely of little comfort to a growing number of prime borrowers that will soon face the loss of their home, given that Congressional efforts thus far have focused almost exclusively on helping the least credit-worthy among us.
The difference in 'troubled' borrowers is very slight, only 44,000 or so more Primes than Subprimes. What strikes me as interesting is the workout rate so drastically favors the Subprimes. While I agree a good chunk of that difference is politics.. Spurred on by the initial distraction that 'It's just subprime' from the banks, then excaberated by the have-vs.-have-not narrative.. I do wish they had more information on why the workouts were biased.

Subprime borrower just means shitty credit rating. If you have shit for credit but sufficient free income to make the loan, or make the loan once a few adjustments are made.. A workout.. Everything goes well. If you were Prime but had little or no income(And these people are everywhere), you twist in the wind no matter what.
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Post by J »

SirNitram wrote:What strikes me as interesting is the workout rate so drastically favors the Subprimes. While I agree a good chunk of that difference is politics.. Spurred on by the initial distraction that 'It's just subprime' from the banks, then excaberated by the have-vs.-have-not narrative.. I do wish they had more information on why the workouts were biased.
Subprime loans are more profitable for the originating lender, the margin on them is a fair bit higher than on a prime mortgage. Also, a subprime mortgage likely still has 100% of the principal plus interest to pay off while a prime mortgage is probably down to 90% or less of the principal. Thanks to the higher interest on subprime loans, the lender has more room to do a workout on the loan and more incentive to do so since there's more profit involved, or in this market, more losses to be taken if the home goes into foreclosure.
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Post by SirNitram »

Definitely agreed. Therefore, if these companies were run competently, they'd be throwing the bulk of their effort into working out Prime borrowers in trouble. But they wanted to make the punch bowl keep going around, so they blamed it on Subprime alone(Knowing the toxic Prime loans they had made), and now they reap their whirlwind.
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Post by J »

I'm hoping all those borrowers who put zero down on their homes and are now upside down on their mortgages decide to do what's best for themselves and deliberately default on their loans. Do the jingo mail, live for free for a few months or even up to a year in some places until their homes are foreclosed, then rent for a few years until home prices fall to something reasonable again. It would be nice to see all those shady lenders get stiffed, let the pigmen get shafted for once instead of regular taxpaying citizens.
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Post by SirNitram »

They're the only ones 'walking away', though the problem seems awfully exagerrated. They're also the ones defaulting and foreclosing, from the statistics I've seen.

And why not? They were functionally renters. What I'm glad is that there's no happy bailout for the construction companies. They were among the primary sources for Downpayment Assistance Programs(Or, as the kids with their new-fangled fist-bumping declare it, DAPs). They were eliminated for FHA loans in the Housing Bailout Bonanza.
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Post by irishmick79 »

The biggest problem as I see it is that the sub-prime lenders haven't faced a whole lot of regulation. The retreat of Freddie and Fannie might have opened the door for them, but the crux of the issue still lies with the inability or unwillingness of regulators to go after mortgage fraud cases and insider trading until the problems started to have reverberations in consumer confidence. It really shouldn't surprise anybody that the FBI sees a correlation between financial fraud cases and home loan defaults in areas where foreclosures have become a big part of the housing market.
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