by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
Michael Cook did an excellent job explaining the two noteworthy debacles of last week. American Home Mortgage went belly up and Bear Stearns may be downgraded to a negative rating. Thursday afternoon, Angelo Mozilo of Countrywide Financial, did his best Nero impression by muttering two words to analysts; “Don’t Worry“.
Mr. Mozilo may be parroting Bobby Mc Ferrin but the rest of the lenders aren’t. Non-conforming lenders readjusted to what they now call “risk-adjustment” pricing. Basically, at Wall Street’s direction, the large lenders added about a 1% fee to the stated income and no income documentation loan programs. Loans that conform to FNMA or FHLMC guidelines, with verified income and assets, remain at their original pricing. There still are 100% financing programs available to those with good credit and the ability to make the payments.
Have borrowers who choose not to disclose income documentation become personae non gratae overnight? Not really. We have always known that light documentation borrowers, who can not demonstrate an ability to repay the loans, have been a higher risk. There has always been a price adjustment for that risk. Large down payments (20-30%) used to be the norm for those programs. It wasn’t until after our country was attacked, in September of 2001, that Wall Street started reaching for yield. The easy money policy and anemic stock market of that post-attack economy left the investment bankers STARVED for business; they found that business in high risk home borrowers.
This brings us to the Mortgage Tax Act of 2007. The way out of this mess is to originate more product. That sounds counterintuitive, doesn’t it? Well, if lenders can originate more loans, they can spread the risk across more assets. The risky loans (stated and no doc) now have a higher risk adjustment. That risk-classified pricing model is not unlike the insurance industry’s move to segregate tobacco users from non-tobacco users. Smokers are charged a higher insurance premium than non-smokers because their life expectancy is lower. That’s what the lenders did this week with their re-pricing; the stated income borrowers are the mortgage industry’s smokers.
The Mortgage Tax Act of 2007 is a way to recoup the losses from the poor loans made in 2003-6. This “premium” will fill the coffers of the lenders/securitizers and counter balance the losses taken from the poor loans. Will it work? Absolutely ! Debt, like tobacco, is addictive. To the irresponsible stated income borrower, debt is the fix, the hit, the high. It allows them to buy more toys, bigger cars, and over-remodel their home. The Mortgage Tax Act of 2007 will segregate those borrowers from the pack and exacerbate their addiction so that they will lose everything and eventually seek recovery.
The real loser is the “social stated income borrower”. She isn’t addicted to debt but is the exact borrower for whom this loan program was created. She may be newly self-employed, working on commission, or temporarily unable to prove the income which she makes. Her plan is to obtain one of these loans until her documentable income allows her to qualify for a conforming loan. She is getting taxed for the bad behavior lenders and securitizers exhibited by supplying the debt-addicts with the drug.
Don’t worry; lenders lend money. They may tighten up the purse strings every few years but some smart fella will see the opportunity, assemble a team to exploit that opportunity, and we’ll be back to normal once again. For now, we gotta pay the tax.
I kind of sound like Angelo, don’t I?
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Doug Trudeau says:
Brian – Great article. Lenders are tightening the belt all over. The greed and risk of 2004-2005 is coming back to haunt the high risk takers. In the long run I believe we will see controls and stability for the market that will be beneficial to everyone.
August 5, 2007 — 7:22 am
Dan Green says:
I’m a sucker for a fantastic metaphor. Thanks, Brian.
August 5, 2007 — 9:10 am
Consumer Mortgage Reports says:
This is about survival of the fittest. AHM is JUST a conduit – NOT a direct lender. A good friend of mine at Wells Fargo, a major buyer of AHM paper told me that this is NOT a spill over into the conventional market, but it is about mitigating risk and reward.
AHM underwrites the loans and sells them to 1 of 4 major buyers, At that point, they initially make the VAST majority of the revenue and then pass on the loan.
That is what they are a pass thru, just look at the dividends they paid out. Everyone saw how much they made and now its tightening AND now the big 4 better control their risks without sharing in the rewards
August 5, 2007 — 11:06 am
Consumer Mortgage Reports says:
StumbleUpon this article as well, great article. hope you get a lot of traffic.
August 5, 2007 — 11:08 am
Robert Kerr says:
Thank you for an interesting post and perspective, Brian.
I don’t (yet) agree with your all of your conclusions on this subject, but I did enjoy your presentation.
As usual, it was cogent, provoking and well-written.
August 5, 2007 — 1:24 pm
Brian Brady says:
Robert,
I know we both know that the problems at Countrywide are deeper than is currently being shown. Call my intuition a “sixth sense”. I watched Countrywide when it was still run like a family business: Mozilos running branches, costs under control, and prudent underwriting.
It seems that ego took over in 2003 and they went insane! They started paying people like NBA stars for originating product, crappy product. My only regret is that I didn’t “get me some” from them.
Having worked on The Street, I can spot double speak when I hear it. That’s what I hear from Countrywide. However, I believe that Countrywide will be the next Chrysler (my next blog post); government bailout in 2008.
August 5, 2007 — 3:08 pm
Robert Kerr says:
Brian, I completely agree with you regarding the magnitude of Countrywide’s problems but I’d be surprised to see any bailout, even in an election year.
There’s recently been rumor of FRE and FNM taking some of the subprime paper as a pseudo-bailout of sorts but Syron came out yesterday in the press and I think his statements have effectively killed any such move.
Of course, I may be wrong about any or all of this. I’ve been surprised quite a few times already by this economy.
As always, it’s a pleasure discussing these matters with you.
August 5, 2007 — 4:02 pm
Brian Brady says:
“Of course, I may be wrong about any or all of this. I’ve been surprised quite a few times already by this economy.”
Join the club.
“As always, it’s a pleasure discussing these matters with you.”
Ditto
August 5, 2007 — 4:06 pm
jim little says:
The whole idea of interest was supposed to be, the higher the risk, the higher the rate. In other words, all rates should have been “risk adjusted” all along.
I am not competant to discuss Countrywide, but I am concerned we are heading for a squeeze between higher interest rates and lower liquidity. History repeats, unbridled speculation and easy credit leads to problems.
August 5, 2007 — 4:45 pm
Rhonda Porter says:
Brian, considering the current market, do you think a consumer is better off working with a correspondent lender, mortgage broker or bank?
August 5, 2007 — 5:00 pm
Todd Carpenter says:
I was soooo ready to rip on you! Great article though.
August 5, 2007 — 11:35 pm
Jeff Belonger says:
Brian…. I think this was very well done. I also think that there is something more to the whole Countrywide thing and that it goes a lot deeper. And I think they don’t have as much room to play with as such lenders as WAMU, B of A, and Wells.
I think we see even more major changes in the next 30 to 45 days from Countrywide. Just my opinion. Again, great article with some good insight and opinion.
August 7, 2007 — 7:53 am