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Thread: Essence of the subprime problem in pictures

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    Default Essence of the subprime problem in pictures

    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
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    Default Re: Essence of the subprime problem in pictures

    would have been nice if they published that before the crash...
    Oh Canada, we stand on cars and freeze...

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    Default Re: Essence of the subprime problem in pictures

    I wasn't paying attention before the crash, but to the best of my knowledge the central theme was that people were undervaluing risk. Was this reported before the crash, maybe in the form of "The housing boom can't go on forever" or "People are really borrowing heaps now, aren't they?".

    That is, bankers/traders were paying too much for these mortgage backed bonds either because they believed that the risk of the homeowner defaulting was lower than it was, or they thought they could sell the home for a profit anyway if the person defaulted, or they were happy to write down the paper profit using the same valuation everyone else was and then sell the bond to someone else.
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    Default Re: Essence of the subprime problem in pictures

    true in regard to carry trade loans being used for highly leveraged speculation in subprime mortgage backed securities.

    However, this is only the 'middle' of the story. For the 'beginning' of the subprime crisis, you need to look here ...



    (snip)"THE NATIONAL HOMEOWNERSHIP STRATEGY
    Out of this logic arose the National Homeownership Strategy, prepared by
    the U.S. Department of Housing and Urban Development (HUD), under the
    direction of Secretary Henry G. Cisneros, in response to a request from President
    Clinton.

    According to the website devoted to the Strategy initiative at HUD1, “In the
    spring and summer of 1994, Secretary Henry Cisneros met with leaders of major
    national organizations from the housing industry to solicit their views about
    establishing a national homeownership partnership. In August 1994 these
    planning sessions culminated in a historic meeting at which industry
    representatives agreed to the formation of working groups to help develop the
    National Homeownership Strategy,” (The National Homeownership Strategyartners in the American Dream, Chapter 1: The National Homeownership
    Strategy).

    The Strategy brought together a diverse set of public and private housing
    market participants in coordinating an approach to, “…achieve an all-time high
    level of homeownership in America within the next 6 years.” The Strategy
    included input from, “…private and public sector resources and commitments to
    implement three broad approaches designed to make homeownership more
    affordable, accessible, and available.” Specifically, strategies advocated under
    the initiative include:

    …streamlining transaction costs, expanding creative financing and public gap
    financing, and making technological improvements in loan underwriting [that] will
    reduce the costs of homeownership…. Regulatory reforms will allow developers and builders to reduce the costs of land assembly, housing construction, and home rehabilitation, making homeownership more affordable for willing homebuyers who are now priced out of the housing market (The National Homeownership Strategy: Partners in the American Dream, Chapter 1: The National Homeownership Strategy).

    Chapter 4 of the Strategy deals with innovative approaches to mortgage
    financing that can help borrowers live in homes (I say “live in” homes because
    non- or negative-amortizing instruments do not help individuals buy homes). In
    what now appears to be rather startling language, the Strategy advocates,
    “…financing strategies, fueled by the creativity and resources of the private and
    public sectors,” to help homebuyers that lack cash to buy a home or income to
    make the payments,” (The National Homeownership Strategy: Partners in the
    American Dream, Chapter 4: Financing). It strikes me as reckless to promote
    home sales to individuals in such constrained financial predicaments.
    With respect to down payments, the Strategy lauded the, “…great strides
    [which] have been made by the lending community in recent years to reduce
    down payment requirements, particularly for low- and moderate income
    homebuyers.” The Strategy even went so far as to advocate using, “…existing
    household assets that may be converted to down payment assistance, subject to
    income tax and other considerations. For example, many households now
    participate in tax-advantaged savings vehicles (such as 401(k) plans), which
    historically have not been available for down payment on a home.” (Let’s be glad
    that piece never became reality.) (The National Homeownership Strategy:
    Partners in the American Dream, Chapter 4: Financing)
    With respect to mortgage payments, the Strategy sought to, “…reform the
    basic contract between borrowers and lenders to reduce interest costs.”

    The Strategy notes further that:
    The most significant monthly housing cost for most new homeowners is the monthly mortgage cost…. When mortgage rates are high, many households are precluded, at least for a while, from the opportunity to own a home. Low mortgage interest rates sustained over an extended period of time can have a compelling, beneficial impact on mortgage affordability and the rate of homeownership in America. (The National Homeownership Strategy: Partners in the American Dream, Chapter 4: Financing )

    THE PRESENT SITUATION
    The strategy worked. It worked really well. Some might say too well. The
    strategy indeed had both the intended “…beneficial impact on mortgage
    affordability and the rate of homeownership in America,” as homeownership rose
    to record highs by 2007. But in doing so the partnership of public and private
    institutions that originate, service, and sell mortgages ignored many important
    prerequisite warnings included in the one-hundred action items in the
    Homeownership Strategy.
    For instance, the Strategy acknowledged that, “In many instances,…
    prospective first-time homebuyers find that developing the proper savings
    patterns to accumulate sufficient cash for the down payment is difficult.” The
    Strategy also admitted that, “…although the variety in loan products available to
    the borrower is commendable, it can prove confusing to a first-time homebuyer,”
    (The National Homeownership Strategy: Partners in the American Dream,
    Chapter 4: Financing). A great many of the present ills could have been avoided
    had some of those warnings been heeded before politicians were lured by the
    siren song of homeownership and the votes it brings."(snip)


    this it is very arguable that the entire concept of widespread subprime mortgage lending, as well as the risk situations entered into by subprime mortgage lenders, were in fact based on official government policy (at the time) as well as gov't sponsored lending rule changes specifically designed to make subprime lending more widespread, plus an implied guarantee of GSE / gov't backing if things should turn sour in a big way.

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    Default Re: Essence of the subprime problem in pictures

    Oh dear... so exactly what innovations were made to encourage home "ownership"? (I know the ultimate effect was lending money to people who wouldn't have got it under the old methods of estimating whether they could repay the loan)

    If there was a mandate to lend money to heaps of people to buy homes, then maybe that's part of the mispricing of the mortgage backed securities (housing demand is guaranteed to go up, along with housing prices, government is backing it - Buy?).
    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
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    Default Re: Essence of the subprime problem in pictures

    By most measures, prices are still above the levels implied by the fundamentals. Using a model that ties house prices to disposable incomes and long-term interest rates, analysts at Goldman Sachs reckon that the correction in national house prices is only halfway through. They expect an 18-20% correction overall, or another 11-13% decline from now. But their models suggest that six states—Arizona, Florida, Virginia, Maryland, California and New Jersey, could see further price declines of 25% or more.
    http://www.economist.com/daily/news/...ry_id=11325709
    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
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    Default Re: Essence of the subprime problem in pictures

    ^^^ well, Clinton's HUD directives to Fannie and Freddie certainly promoted the concept of lenders accepting more risk against an implied gov't backing ...



    (snip)"Special Affordable Housing goals
    The proposed rule establishes the "Special Affordable Housing" goal at 11 percent for 1995, and at 12 percent for 1996. This goal has two parts. The first is homeownership for either low-income families living in low-income areas or homeownership for very low-income families. The second is rental housing for very-low-income families. Each subgoal is to receive 5.5 and 6 percent of the GSEs' units financed during 1995 and 1996, respectively.
    In this case as in the others, the GSEs are only following the market. According to HUD, "the market is originating many more loans for lower income homebuyers than the GSEs are purchasing." The GSEs purchased a much smaller proportion of conforming mortgages originated for very-low income homebuyers than of mortgages originated for high income homebuyers (41 percent versus 55 percent), HUD's research shows. In 1993, low- and moderate-income individuals received 16 percent of all mortgages made, yet of all loans purchased by Fannie Mae and Freddie Mac, only 14.4 percent were from low- and moderate-income borrowers.

    The central question posed by HUD is: what is the appropriate extent to which Fannie Mae and Freddie Mac should be leading the housing finance industry to increase its lending to underserved segments of our population and disinvested communities? The GSEs contend they are already doing this, but research suggests they can do much, much better. The 1992 GSE Act is premised upon the belief that, while the GSEs cannot force mortgage originators to increase their lending in underserved markets, they can and should provide the necessary leadership to spur this outcome. Although the performance of the GSEs appears to have improved somewhat over the past two years, the bar still needs to be lifted further to ensure that they fulfill their public mandate. "(snip)


    .... which by the end of Clinton's term had arrived at this result ...


    (snip)"Even though the African-American homeownership rate is already at a record high and other minority homeownership rates are near a record (40 percent of net new homeowners since 1994 were minorities, even though minorities account for 23 percent of the population), the gap in the white and minority homeownership rates is still far too large, Cuomo said. The number of African-American and Hispanic homeowners has increased by nearly 3.5 million over the past seven years.

    Today, an estimated 423,000 additional African-American families and about 420,000 additional Hispanic families would need to become homeowners to achieve the goal of homeownership for a majority of these minorities.

    To help achieve this goal, Cuomo committed the Federal Housing Administration, which is part of HUD, to insure mortgages for more than 765,000 African-American and Hispanic families over the next three years.

    HUD is expected to ask a broad range of groups-including the National Association of Realtors, the National Association of Mortgage Brokers, the Mortgage Bankers Association of America, Fannie Mae and Freddie Mac-to help finance the remaining new minority homeowners.

    In the past seven years, FHA has increasingly focused on serving minority borrowers. The percentage of FHA-insured mortgages going to minority families has jumped from 22 percent in 1993 to 38 percent in 1999. This rate of funding minority home mortgages far exceeds the private conventional market, which provided 16 percent of its home mortgages to minorities in 1998. "(snip)

    from

    I would add that the latter article's use of the word 'minority', while serving the purpose of the news article, actually doesn't accurately describe the situation in financial terms. A much more accurate description would be 'low income' / 'no assets' first time mortgage applicants ... which includes people of all races, creeds and colors who did not have the income level or accumulated assets to meet conventional mortgage lending / equity standards prior to a loosening of mortgage lending regulations.


    The 'tin foil hat' crowd will tell you that, despite a near total lack of public discussion, the exuberance of the US Fed to bail out troubled subprime mortgage lenders is actually a partial fulfillment of the agreements made in the 1990's when gov't policy strongly promoted mortgage lenders to originate - and strongly promoted mortgage investors to accept risk from - 'subprime' mortgage loans.

    !
    Last edited by Melonie; 05-11-2008 at 04:47 AM.

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    Default Re: Essence of the subprime problem in pictures

    So from that article you just linked, it sounds like the GSEs have unlimited cheap capital available, which would help absorb P&L swings and let them increase liquidity and offer lower interest rates, but that doesn't explain mispricing the credit risk in these mortgages, does it? Unless there's some sort of underwriting by the government (they're bailing out people now, but was that part of the deal in 95?) then risky loans should have been treated the same over the last decade as they always have been treated.
    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
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    Default Re: Essence of the subprime problem in pictures

    ^^^ arguably, it boiled down to the 'carrot and the stick', since conservative mortgage lenders were also exposing themselves to charges of violating the 'anti-redlining' laws put in effect at the same time if they did not 'get with the (HUD) program'.

    Perhaps the best overview comes from this Business Week article.



    (snip)"A recently re-exposed document shows that his [Bill Clinton's - sic] administration went to ridiculous lengths to increase the national homeownership rate. It promoted paper-thin downpayments and pushed for ways to get lenders to give mortgage loans to first-time buyers with shaky financing and incomes. It’s clear now that the erosion of lending standards pushed prices up by increasing demand, and later led to waves of defaults by people who never should have bought a home in the first place.

    President Bush continued the practices because they dovetailed with his Ownership Society goals, and of course Congress was strongly behind the push. But Clinton and his administration must shoulder some of the blame.

    In writing this blog entry, I’m following the lead of Joseph R. Mason, who is a finance professor at Drexel University’s LeBow College of Business, a senior fellow at the University of Pennsylvania’s Wharton School, and a consultant at Criterion Economics. Here is a link to a piece that he wrote on Feb. 26. [same as my link to National Home Ownership Strategy document above - sic]

    The Clinton-era document that Mason cites—“The National Homeownership Strategy: Partners in the American Dream”—was hiding in plain sight on the website of the Department of Housing & Urban Development until last year, when according to Mason it was removed (probably because the housing bust made it seem embarrassing to the department). Mason credits Joshua Rosner of Graham Fisher & Co. with saving a copy of it before it was expunged.

    The National Homeownership Strategy began in 1994 when Clinton directed HUD Secretary Henry Cisneros to come up with a plan, and Cisneros convened what HUD called a "historic meeting" of private and public housing-industry organizations in August 1994. The group eventually produced a plan, of which Mason sent me a PDF of Chapter 4, the one that argues for creative measures to promote homeownership."(snip)


    Unless there's some sort of underwriting by the government (they're bailing out people now, but was that part of the deal in 95?) then risky loans should have been treated the same over the last decade as they always have been treated.
    one must assume such implied guarantees of gov't backing played a huge role in the rapid expansion of high risk 'creative' mortgage financing by mortgage originators and the secondary mortgage market ! By definition, and as thoroughly discussed in the Strategy document, conventional treatment of mortgages extended to people with low incomes and no equity is incompatible with 'affordability' - meaning that a 'mispricing of risk' was a basic and necessary tenet of the Strategy !!! This would only have been salable to mortgage lenders if implied gov't guarantees were extended to cover that risk. One must also also assume that a major reason the FED would now be 'buying back' subprime mortgage backed securities from investment banks to the tune of hundreds of billions of dollars is as fulfillment of implied guarantees given to those banks in the 90's as part of Clinton's National Home Ownership Strategy agreement.

    ~
    Last edited by Melonie; 05-11-2008 at 05:15 AM.

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