April 30, 2024

“Financial Catastrophe” – Part II

February 5, 2009 by 2 Comments

President Predicting Catastrophe

President Obama declared today that “A failure to act and to act now will turn crisis into catastrophe and guarantee a longer recession.”

Alan Blinder, a former vice chairman of the Federal Reserve, echoed the President by proclaiming “It would be an act of extreme stupidity not to enact a big stimulus”.  Mr Blinder did not expound on the logic of his remark.  Presumably, if you were too stupid not to vote for spending one trillion dollars, then you would be too stupid to understand his rationale.

A short 6 months ago President Bush, Chairman Bernanke and Treasury’s Paulson were predicting a financial meltdown if the $700 billion TARP bill did not pass.   The $700 billion was approved and the money passed out to banks and other assorted supplicants.  How wisely was the $700 billion spent?   All we do know is that the bankers managed to pay themselves huge bonuses, the money is gone and we now face financial Armageddon (again) if we do no spend another massive amount of borrowed money.   All we really know about the new, almost $1 trillion dollar “stimulus package”, is that it must be passed immediately, no questions asked.   Maybe more questions should have been asked the first time, when $700 billion was supposed to have solved the financial crisis.

Bernanke Proclaims Financial Crisis Resolved: October 2008

In October 2008, after passage of the $700 billion TARP bill, Chairman Bernanke spoke at the Economic Club of New York.

“The problems now evident in the markets and in the economy are large and complex, but, in my judgment, our government now has the tools it needs to confront and solve them.

Generally, during past crises, broad-based government engagement came late, usually at a point at which most financial institutions were insolvent or nearly so. Waiting too long to respond has usually led to much greater direct costs of the intervention itself and, more importantly, magnified the painful effects of financial turmoil on households and businesses. That is not the situation we face today. Fortunately, the Congress and the Administration have acted at a time when the great majority of financial institutions, though stressed by highly volatile and difficult market conditions, remain strong and capable of fulfilling their critical function of providing new credit for our economy. This prompt and decisive action by our political leaders will allow us to restore more normal market functioning much more quickly and at lower ultimate cost than would otherwise have been the case.

Reading the Chairman’s comments today, we know that his assessment of the situation was wrong. TARP 2008 did not resolve anything nor will the stimulus package of 2009.

Did the original $700 billion “save” our country from a “catastrophe”?.  In hindsight, much of the money spent was wasted on zombie banks that should have been shut down.  The executives running Bank of America, Citibank, JP Morgan and Wells Fargo, etc. still have their high paying jobs, while many others are unemployed.

What Does The Stimulus Spending Accomplish?

If we are facing a financial catastrophe, why is so little of the spending being directed  towards solving the root of the problem –  insolvent banks and the decline in home values?  Some of the spending goes towards minimalistic tax breaks – up to $500 per individual or $1,000 per couple.  Is an extra $10 or $20 a week going to make a real difference to most people?  The vast majority of the spending goes for expanded funding of various social programs and special interest groups.  The money will be disbursed through Government agencies that will need a much larger bureaucratic staff to administer spending and regulation.  This will accomplish nothing for the real economy and we are still left with insolvent banks and foreclosed homeowners.   Maybe after passing the bill, someone should say “mission accomplished”.

End Result

The one certainty is that this will not be the last trillion asked for.  The banking industry will need many more trillions of dollars to become solvent.  Fortune Magazine estimates the ultimate banking bailout cost at $4 trillion, maybe more.  Yet there is still no overall coherent plan for resolving this crisis.  Watching the elite ruling class operate in Washington reminds me of Groundhog Day.   Washington keeps doing the same thing over and over again, expecting a different result – isn’t that the definition of insanity?

Filed Under: Bailout, Banking Industry, Economy, Federal Reserve, Stimulus Plan Tagged With: ,

Fannie and Freddie – The New Subprime Lenders

February 2, 2009 by Leave a Comment

Fannie and Freddie Impose Huge Fees On Borrowers

Freddie Mac last week announced additional fees for condo owners who refinance, effective April 1, 2009.  The fee mirrors a similar charge imposed by Fannie Mae last year.  Both Fannie and Freddie now assess a wide variety of fees to borrowers based on loan to value, credit and type of loan.  The fees are euphemistically referred to as “Postsettlement Delivery Fees for Mortgages with Special Attributes”. Translation – we need the money and are now charging huge fees to reflect lending risks that we never recognized prior to the housing crash.

Many borrowers are finding out that the Fannie and Freddie fees are resulting in mortgage rates far higher than the rates they see advertised.  See All Time Low Rates For A++ Borrowers Only.   The fees imposed are too large to be absorbed by the lending institutions that sell their loans to Fannie and Freddie.  Therefore the fees must be passed on to the customer in the form of closing costs and/or a much higher interest rate. The total fees imposed by the agency lenders are cumulative for each special attribute. The end result is that the fees and rates are so high that most borrowers are unable to refinance.

Here is an example of the fees that Fannie and Freddie would charge on a routine mortgage refinance with the following “special attributes”.   The borrower is attempting to refinance at 80% loan to value, has a 675 FICO score and needs to take cash out.    This is a routine type of refinance and the credit score of 675 is considered good.  The borrower is applying for the prevailing rate of 5.5%. Three years ago, this borrower would easily have qualified under a conforming Fannie or Freddie loan with a minimum of agency fees.  The same borrower today, if approved, would be facing very steep fees as follows in a $250,000 loan example.

Delivery Fees Effective April 1, 2009 Based on 80% Loan to Value

1. 675 FICO score fee 2.50%
2. Cash out fee 1.50%
3. If the property is a  Condo add additional fee .75%

The total fees imposed by Fannie or Freddie on this example loan would total 4.75% of the $250,000 loan or $11,875. In addition, there are various lender and legal fees involved in a refinance that could easily total another $2,000.   These Fannie and Freddie fees make the defunct sub prime lenders look like good guys.

Rates Are Low – Don’t Bother Applying

In real life, here’s what would happen. The borrower refuses to pay $11,875 in fees to get 5.5%.  The lender could not provide that rate in any event since the total of fees involved are so high that they would violate predatory lending rules. The rate cannot be raised enough to absorb all of these fees based on current pricing structures.  The best this customer could get would be a rate of around 7.25 and agency fees of $7,000, plus regular closing costs.  Several years ago, this customer could have gotten a lower fixed rate with much lower fees from a sub prime lender.

For a borrower to get the “low rates available” today, you usually need to show up with a credit score of 740 and a loan to value of 70% or less. Most borrowers who need to refinance today do not possess this loan profile.  While the Fed strives to lower mortgage rates, Fannie and Freddie are effectively telling all but the highest quality borrower to get lost by pricing them out of the market.  Compounding this ridiculous situation is that the Federal Housing Administration (FHA)  does not charge many of these fees, even at higher loan to values and lower credit scores.

By the way, did I mention that the Government has effectively nationalized the mortgage industry?

Filed Under: Banking Industry, Federal Reserve, Mortgages, refinance Tagged With: , , ,

New Federal Standards For Mortgage Industry Largely Irrelevant

January 26, 2009 by Leave a Comment

Obama Plans Fast Action to Tighten Financial Rules

WASHINGTON — The Obama administration plans to move quickly to tighten the nation’s financial regulatory system.

Officials say they will make wide-ranging changes, including stricter federal rules for hedge funds, credit rating agencies and mortgage brokers, and greater oversight of the complex financial instruments that contributed to the economic crisis.

Broad new outlines of the administration’s agenda have begun to emerge in recent interviews with officials, in confirmation proceedings of senior appointees and in a recent report by an international committee led by Paul A. Volcker, a senior member of President Obama’s economic team.

Timothy F. Geithner, the nominee for Treasury secretary, made similar comments in written and oral testimony before the Senate Finance Committee.

Aides said they would propose new federal standards for mortgage brokers who issued many unsuitable loans and are largely regulated by state officials. They are considering proposals to have the S.E.C. become more involved in supervising the underwriting standards of securities that are backed by mortgages.

More Effective Regulation Was Necessary Years Ago

Anyone familiar with the type of mortgage lending that occurred during the housing boom and lending mania should applaud the actions of the Obama administration.   Mortgage loans werer granted to all takers, no questions asked.  Every party involved in the lending lunacy bears responsibility –  this includes the Fed, Congress, Wall Street, major banks, sub prime lenders, and the multitude of mortgage brokers who fed the food chain above them.

The unanswered question is why weren’t these regulations passed and enforced 5 years ago?  Apparently, Alan Greenspan’s encouragement to borrow by keeping credit easy and rates low lulled all of us into complacency.

Too Little, Too Late

Enacting legislation now to control the excesses of the mortgage industry is largely for public relations consumption.

Stricter regulations won’t help much now –  the disaster has already occurred.  The sub prime lenders are out of business, most of the major banks are insolvent, the Wall Street firms are largely bankrupt, borrowers no longer qualify, buyers are too afraid to buy a home and most of the mortgage brokers are out of business.  Who is left to be regulated??

The mortgage industry has effectively been nationalized.  The only lenders that remain are government owned or sponsored – Fannie Mae, Freddie Mac and the FHA.  It’s great to have these new financial regulations but it is largely irrelevant at this point.

Filed Under: Banking Industry, Federal Reserve, Mortgages Tagged With: ,

Insolvent Banking System Eludes Government Containment

January 20, 2009 by 2 Comments

Denial Of Reality Becoming Impossible

The game of pretending that the world banking system and national governments are solvent becomes more difficult by the hour.

The true magnitude of the write downs that the banking industry needs to take to reflect the reality of asset impairment was highlighted by the Royal Bank of Scotland.   Pretending that the losses do not exist is no longer worth the effort since no one is fooled anymore.  There can be no recovery in bank lending unless impaired assets are written down and sufficient amounts of new capital are raised.  This is the point at which things get interesting since the capital markets are not open to the banks; the lender of only resort to the banking industry are the world’s central governments.  The really scary question now is whether the central governments have the financial capacity to recapitalize the banking industry (along with everyone else) without resorting to printing money on a grand scale.

Far from being contained, as some have proclaimed, the banking crisis continues to expand.  The debate is no longer focused on whether the banking industry is solvent.  The real question is whether central governments can contain the economic meltdown.

Consider the size of losses reported by Royal Bank of Scotland and the excuses and comments by RBS Chief Executive Stephen Hester.

RBS Expects Huge 2008 Losses

LONDON — Royal Bank of Scotland Group PLC said Monday that tough market conditions in the fourth quarter and mounting impairment charges could push it to a 2008 full-year loss of as much as £28 billion ($41.29 billion), the U.K.’s biggest ever corporate loss.

The government currently owns just under 58% of RBS after last year underwriting a £15 billion rights issue that saw little take-up by existing shareholders.

The move means RBS will now have to pay back less to the government, but it has also to agree to boost lending to consumers and businesses. The Monday update comes ahead of the announcement of its 2008 results on Feb. 26.

RBS Group Chief Executive Stephen Hester said: “The dislocation of credit markets and the global economic downturn continue to hit RBS hard, as with many other banks.

“We are making progress in recognizing excess risk and dealing with it. Significant uncertainties and risks inevitably remain.

“In this context, the support we are receiving from the government benefits all our stakeholders and enables us to provide more customer support in return.”

“With enhanced core capital, removal of the preference share dividend and the prospect of further asset and liquidity measures, RBS is able to continue its strategic restructuring purposefully,” he added.

What Chief Executive Hester is really saying is that he managed RBS poorly and took ridiculous lending risks; no one will buy our shares or debt securities and we need a government bailout to prevent closing the bank.  Nonetheless, we now recognize “excess risk” and are ready to start lending again once we receive government funding.

Hester should be fired for incompetence –  he dissipated investor money and bank capital and now wants to try his hand with government supplied funding.

The question of how the British Government will raise the funds to bail out RBS is answered by The Telegraph.

Bank of England Edges Closer to Printing Money

Under the scheme’s terms, the Bank will be able to buy assets including corporate bonds and commercial paper, a move which Mervyn King, the Bank’s Governor, called “an important additional tool to improve financing conditions in the economy”.

The asset purchase facility does not in itself amount to quantitative easing or “printing money”, because the scheme initially will be financed by Treasury Bills and does not involve an increase in the money supply.

However, the Treasury has given the Bank’s Monetary Policy Committee the option to go down that road by extending the scheme at a later date and paying for assets with what amounts to newly created money and not Treasury bills.  Quantitative easing is a more unconventional tool available to the Bank beyond interest rates as it attempts to halt the pace of economic decline in the UK.

“This does not mean that quantitative easing will definitely happen, but does allow the MPC to move fairly quickly if they want to,” he said.

Ross Walker, economist at Royal Bank of Scotland, said: “This framework could readily evolve into full-blown quantitative easing – we would expect it to do so given the proximity of Bank Rate [to zero] and deteriorating economic conditions, perhaps as soon as March/April.”

I agree with Ross Walker – full blown money printing will occur as demands on the British treasury continue to explode in size.   The British Government, approaching the limits of their borrowing capacity, will come to the rescue of RBS and others by printing money.  At this point, no one is even trying to pretend that RBS is solvent or that the British government can bailout every failing enterprise.  The end result will be a catastrophic destruction of confidence world wide.  When governments’ last resort is to print money, one can sense that the end of the old order is near.

Half of Europe Trapped in Depression

Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.

Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state.

A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece’s social fabric is unravelling before the pain begins, which bodes ill.

This week, Riga’s cobbled streets became a war zone. Protesters armed with blocks of ice smashed up Latvia’s finance ministry. Hundreds tried to force their way into the legislature, enraged by austerity cuts.

“Trust in the state’s authority and officials has fallen catastrophically,” said President Valdis Zatlers,
who called for the dissolution of parliament.

Spain lost a million jobs in 2008. Madrid is bracing for 16pc unemployment by year’s end.

Private economists fear 25pc before it is over. Spain’s wage inflation has priced the workforce out of Europe’s markets. EMU logic is wage deflation for year after year. With Spain’s high debt levels, this is impossible.

Italy’s treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 last week. The debt compound noose is tightening around Rome’s throat. Italian journalists have begun to talk of Europe’s “Tequila Crisis” – a new twist.

Greece no longer dares sell long bonds to fund its debt. It sold €2.5bn last week at short rates, mostly 3-months and 6-months. This is a dangerous game. It stores up “roll-over risk” for later in the year. Hedge funds are circling.

Printing money, a self destructive tactic is the last option left to the governments mentioned above.  Expect major social unrest in these countries as their governments collapse the national wealth through the printing press.

Depression Ahead, Prepare for Stock Rout

LONDON (Reuters) – Societe Generale said on Thursday that the United States’ economy looks likely to enter a depression and China’s could implode.

In a highly bearish note, veteran cross asset strategist Albert Edwards said investors should now cut equity exposure after a turn-of-the-year rally and prepare for a rout.

He predicted that the S&P 500 index of U.S. stocks could be set for a fall of around 40 percent from recent levels.

“While economic data in developed economies increasingly reflects depression rather than a deep recession, the real surprise in 2009 may lie elsewhere,” Edwards wrote.

“It is becoming clear that the Chinese economy is imploding and this raises the possibility of regime change. To prevent this, the authorities would likely devalue the yuan. A subsequent trade war could see a re-run of the Great Depression.”

Edwards has long been one of the most bearish analysts in London, first with Dresdner Kleinwort and then with SocGen.

The world Central Governments are resorting to the nuclear option – printing money – in a last attempt to hold the financial system intact.   Had they allowed selected major bankrupt institutions to fail, severe financial pain would have been inflicted on many.   The strategy of attempting to save all bankrupt industries with printed money will result in worthless currencies worldwide,  thereby guaranteeing financial ruin for all.

Filed Under: Bailout, Banking Industry, Confidence Tagged With: , , ,

Congress Proposes Cram-Downs As New Mortgage Solution

January 7, 2009 by 2 Comments

The plight of homeowners delinquent on their mortgages has been the focus of much debate lately.  There have generally been two major lines of thinking:

-The best course is to let free market principles apply.  If homeowners cannot afford the mortgage payment, the old fashioned remedy of foreclose should take place, turning an overburdened homeowner into a renter.

-Those more inclined to assess the loss of a home in terms of human suffering rather than as an economic equation have sought to provide relief to struggling homeowners by modifying the terms of the original mortgage.

As the number of mortgages in default grew, the situation attracted the attention of politicians.  Their viewpoint seemed to focus on helping the homeowner stay in the home, regardless of cost.

The governments’ efforts to encourage the banking industry to cure the foreclosure problem through voluntary participation in loan modifications was a failure.   For a variety of reasons the loan mods were not working.   Data from the Comptroller of the Currency shows that over 50% of modified loans re-defaulted within 6 months.  With many loan mods, payments went up for the borrowers and principal was hardly ever reduced.  The loan mods actually left many borrowers in a worse position than when they started.  In addition, most of them had negative equity before and after the loan mod.  The negative equity position locked them into the house, unable to sell or refinance.

Today, from Washington, a new solution – giving bankruptcy courts the power to alter the terms of the original mortgage.

Lawmakers Set New Mortgage Bankruptcy Bill

WASHINGTON (Reuters) – Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.

“Economic conditions have only worsened since we last debated this plan,” said Rep. Brad Miller, a member of the House Financial Services Committee who plans to introduce a bankruptcy reform bill on Tuesday. “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”

The legislation would change allow bankruptcy judges to modify home loans in the same way that they currently may modify other unsettled obligations, such as credit card debt.

The lending industry has said that allowing bankruptcy judges to modify mortgage obligations would change how they weigh risk. Currently a lender knows that it has recourse to foreclosure if a borrower fails to meet mortgage payments, but the lender does not have to factor in the possibility that the payments it receives could be decreased by a judge.

What will be the impact of allowing bankruptcy judges to discharge (cram-down) mortgage debts?  Some of the issues and questions to be considered include the following.

1.  Interest rates are correlated to risk – that’s the way things work in a free market.   If a mortgage loan is made with the risk of principal impairment by bankruptcy, this risk has to be priced into the loan rate.  Reducing mortgage principal by legislative fiat may bring unintended adverse consequences.

According to The Mortgage Bankers Association “It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.”

2.  Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy,  cram downs might help less than 5% of mortgaged homeowners.   If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

3.  According to The Housing Wire, 50% of Americans oppose bailing out troubled homeowners. “These findings indicate that there are significant political barriers to proposals now being drafted in Congress”

The bankruptcy discharge of a mortgage balance will be viewed by many as the ultimate bailout.  The final compromised bill may result in contorted regulations that ultimately benefit few homeowners.

4.  The free market has a solution for “troubled homeowners” which is known as foreclosure.  Does the free market solution lose all merit merely because the number of foreclosures increased dramatically due to imprudent borrowing and lending?

5.  According to Rep. Brad Miller, “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”   Rep. Miller is confusing a symptom of the disease as the cause.  Falling home prices did not cause our economy to weaken.    The housing asset bubble that burst was due to reckless lending, fueled by a government providing easy credit and obsessed with making everyone a homeowner. Political interference in economic matters usually delays a solution by impeding the free market forces that will ultimately prevail anyways.

6.  If the mortgage cram down bill is passed, it will drive many homeowners to bankruptcy, lured by the promise of wiping out mortgage debt.   The loan modification program allowed the banks to pretend that the amount they were owed would still be repaid over time.  When the loan gets reduced in bankruptcy, this illusion will be gone.  More write offs by the banks could lead to a self defeating cycle of tighter credit, stricter mortgage underwriting, weaker housing prices and further bailouts.

7.  How many homeowners that are incapable of handling the burden of home ownership will be allowed to remain in their homes, only to face foreclosure again at a later date?

8.  Continued massive government support of the mortgage market will be necessary since investor demand for mortgage securities is likely to remain low due to collapsing housing prices and the risk of mortgage debt being discharged by bankruptcy. How does an investor properly price a mortgage security where the asset value underlying the security is declining and also face the risk that the principal investment may be impaired by court decree?

9.  The Fed is now expected to absorb virtually all of the new mortgage backed securities this year.   With the Fed extending its purchases into virtually every asset class, a question comes to mind.  As the Fed assumes the losses of all failing economic entities in the country, at what point does the US Government begin to share the credit quality of those being bailed out?

Filed Under: Bailout, Banking Industry, Housing, Interest Rates, Mortgages Tagged With: , ,

Few May Benefit From Lower Mortgage Rates

December 31, 2008 by 2 Comments

Rates Increase

Mortgage rates increased today on a sell off in the Treasury market. The benchmark 10 year treasury note increased in yield by 16 basis points (bps) to 2.244%. The 2008 low on the 10 year treasury yield was 2.038%.

Courtesy Yahoo Finance

The increased yield on the treasury bond has resulted in a mortgage rate increase of 3/8% over the past few weeks.   A 30 year fixed rate mortgage at par today is 4.875%, historically a super low rate.  So what if rates moved up a little bit – 4.875% still sounds almost too good to believe.

Low Rate Does Not Apply To All Borrowers

Before rushing out to refinance, be aware that the advertised low rate of 4.875% is available only to the most perfect borrowers and the 4.875% rate will cost around 1 point (1% of the loan amount) plus other closing costs.

Unless a borrower has perfect credit (at least a 720 FICO score), adequate income (debt ratio of 32% or less) and substantial equity in the home (loan to value of 75% or less), the rate will be higher due to adders.  Adders are fees imposed by Fannie and Freddie if the applicant does not fit into the little box of a perfect borrower.  Adders are imposed for higher loan to value, lower credit scores and cash out refinances.  The adders can easily amount to 2% of the loan amount, or $2,000 on a $100,000 loan.   If a borrower is applying for cash out with a FICO score below 680 many lenders will turn the loan down.

Here’s an example of what used to be considered a prime borrower in the recent past.  Borrower has a 680 FICO score, adequate income and wants $20,000 cash out with an 80% loan to value and a loan amount of $160,000.   The chart below shows the cost of not being a perfect borrower as defined today.

Interest Rate

6.750%

Price Adjustments

-1 FICO 680-699, LTV 75.01-80

-0.8750 C/O Refi. LTV 75.01-80, FICO 680-699

The best rate this borrower would get quoted today would be 6.75% and the mortgage company would need to charge an additional 1 to 2 points on the loan (up to $3200 based on a $160,000 loan amount).

This is the reality of the mortgage market today.  Many borrowers applying for a refinance with visions of a 4.875% rate and a payment reduction are finding out that they do not qualify.   There is much in the news about the “mortgage refinance boom”.   Expect to see stories in a month or two about how few borrowers actually benefited from the lower rates.

Filed Under: Banking Industry, Interest Rates, Mortgages, refinance Tagged With: , ,

FHA Takes A Closer Look At Home Values On Refinances

December 30, 2008 by 3 Comments

HUD announced in Mortgagee Letter 2008-40 that effective January 1, 2009 that FHA will require a second appraisal for all cash-out refinances where the loan to value, exclusive of UFMIP,  exceeds 85% of the appraised value.  The new rule applies regardless of the loan amount or the location of the property.

The actual letter ruling reads as follows:

· Second Appraisal Requirements/Loan-to-Value Limits for Cash-Out Refinances: The instructions in ML 2008-09 regarding when a second appraisal is needed, and the requirements for that second appraisal, as well as the 85 percent limitation on cash-out refinances when the loan balance will exceed $417,000, remain in effect.

In addition, FHA will now require a second appraisal for all cash-out refinances where the LTV, exclusive of the UFMIP, will exceed 85 percent of the appraiser’s estimate of value. This second appraisal requirement applies regardless of the loan amount or the location of the property, i.e., whether the property is in a “declining area” or is not. This second appraisal requirement for cash-out refinances is effective for all case number assignments on or after January 1, 2009 and is to adhere to the instructions set forth in ML 2008-09. Please also note that cash-out refinances with LTVs exceeding 85 percent will be over-selected for post-endorsement technical reviews (PETR) to assure the quality of the underwriting.

Additional underwriting and eligibility criteria

· The subject property must have been owned by the borrower as his or her principal residence for at least 12 months preceding the date of the loan application.

· If said property is encumbered by a mortgage, the borrower must have made all of his/her mortgage payments within the month due for the previous 12 months, i.e., no payment may have been more than 30 days late and is current for the month due.

· The property that is security for the refinanced mortgage must be a 1- or 2-unit dwelling.

· Subordinate financing may remain in place, but subordinate to the FHA insured first mortgage, regardless of the total indebtedness or combined loan-to-value ratio, provided the homeowner qualifies for making scheduled payments on all liens.

· Any co-borrower or co-signer being added to the note must be an occupant of the property. Non-occupant owners may not be added in order to meet FHA’s credit underwriting guidelines for the mortgage.

The FHA has been gradually tightening various underwriting guidelines for some time now, probably due to a default rate of over 12%.

The  new regulation requiring 2 appraisals on cash out refinances will probably reduce the number of refinances done on higher LTV properties.  The customer typically pays for the appraisal when doing a refinance and the FHA appraisal usually costs $350.  A potential borrower will now have to come up with $700 just to find out if they have enough equity in the property.

Actually the rules could have been constructed to further restrict cash out lending.  Many lenders who have doubts about the value of an appraised property routinely require a second appraisal to be conducted by an appraiser of their choice.  Often times, the second appraisal will come in lower under this method.

The FHA has seen a large increase in loan applications in 2008 due to underwriting restrictions imposed by other lenders.  It will be interesting to see if these new guidelines reduce the number of FHA refinances in 2009.

Filed Under: Banking Industry, Mortgages Tagged With: ,

When A Walmart Clerk Beats A $2 Million Trust Fund

December 17, 2008 by Leave a Comment

The Federal Reserve fired its last bullet today by formally cutting interest rates to zero percent.  A Fed statement noted that  “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability”.   In addition, the Fed will keep rates at this exceptionally low level for an extended period of time.

To date, the Federal Reserve has spent trillions and driven down rates on short term treasury paper to zero.  None the less, rates on loans for most individuals and corporations are much higher than when the credit crisis began.   One area that that has seen rates decline to all time lows is home mortgages, although it is debatable how many borrowers qualify for the best advertised rates.   Those most in need of funding are most often turned down at any rate due to issues with credit, income or collateral.

I have yet to hear of anyone who feels that the Fed really made a difference and saved them from financial ruin by cutting rates.  Whatever savings might have been accrued by the average consumer have been more than  outweighed by the losses suffered in their retirement portfolios and home equity declines.  The banking system was saved, the average worker was not.

One group that has and will continue to suffer great stress due to diminished income is the never mentioned saver.  The saver group by definition spent less than they made due to thrift and hard work and put their savings in their local bank so that they money could be lent out to borrowers who bought homes and such, frequently at 100% financing.  Now that the borrowers are in trouble, the Fed needs to cut rates to help them.  Helping those in trouble is fine, but the consequences of the Fed’s rate cutting campaign is impoverishing those very same people who provided savings capital to lend in the first place.

Let’s take the case of a Walmart clerk who retires after 30 years of service and is awarded a pension of $25,000 per year.  The Walmart clerk’s retired neighbor lives off a $2,000,000 trust fund established by her father who directed that the monies be conservatively invested only in government debt securities.  The trust fund provides a life interest of income only to the beneficiary.   The original $2,000,000 principal goes to charity after the beneficiary’s death.

This $2,000,000 trust fund, laddered in 6 month and 2, 5 and 10 year government paper yields a total of $22,100 at today’s interest rates.   Should the Fed succeed in driving long term rates to the sub 1% level that we see in Japan today, the trust fund baby would be lucky to receive $10,000 per year.

Result of ultra low interest rates?

Walmart worker stays retired and lives poorly.  Trust fund baby lives poorly and goes back to work at Walmarts.

Filed Under: Banking Industry, Interest Rates Tagged With: , ,

Loan Modification Efforts Continue

December 16, 2008 by Leave a Comment

Despite the recent news that many of the mortgage loans modified have gone back into default, the loan modification effort continues.  Until a better solution is found loan modification efforts will continue, especially given the full backing by the FDIC and other government leaders.  It is likely, however, that the approach and methods will change to ensure that future loan mod efforts are more successful.

Bank United Announces New Loan Mod Efforts

Bank United announced today that it will intensify its efforts to save troubled homeowners  by outsourcing much of the work involved in a loan modification.   To anyone familiar with the delays and inconsistent procedures being employed by many banks in their loan mod efforts, this new approach is a welcomed fresh approach.  Many loss mitigation departments are overwhelmed with work, causing many months of delays before the homeowner receives any type of loan mod offer.   In many cases, the rules as to which loan is modified and under what terms also seems to be inconsistently applied.

Many of the $1 billion in delinquent loans at Bank United apparently are due to the large number of pay option arm loans that were originated.   Given the large drop in property values and the negative amortization features of the pay option arms, many borrowers in this category  have a large negative equity position.   The most probable course of action that Bank United will take for this category of borrower is to reduce the principal balance.   Without principal reduction, the borrower would still be in a negative equity position which frequently leads to default.  Unless the homeowner is wildly bullish about housing prices, very few people will continue to make payments on a $400,000 mortgage when the house is valued at $200,000.

With Bank United stock selling at 33 cents and almost 10% of their loans in default, they would apparently have little to lose by offering to put their borrowers in a stronger position through principal reduction.  As previously discussed, long term housing stability is based on strong borrowers.

Ocwen Shows High Success Rate With Loan Mods

Ocwen Financial reported that results with their loan modification efforts far exceed the industry results.   Ocwen is experiencing less than a 25% delinquency rate 60 days after the loan mod, compared to the industry average of over 50%.

CEO William Erbey stated that “The salient issue is not the efficacy of loan modification as a loss mitigation tool, but whether mods are being properly designed.   Our loan approach achieves the twin objectives of keeping homeowners in their homes and maximizing the net present value of the mortgages to the investors who own the loans.”

Mr Erbey further stated that “the re-default problem lies with how some servicers are doing modifications, not with concept of modification. It’s possible to do modifications right. It’s challenging, but we’re doing it — and doing it in a way that’s scalable.”

Ocwen’s good results seem to reflect it’s use of high technology applied on an individual basis.  Rather than having a loan mod decision made by an individual, the characteristics of the loan and the borrower are assessed using artificial intelligence technology.

To date, Ocwen appears to be an industry example of the right way to do loan modifications.  This year alone, Ocwen has kept over 60,000 borrowers in their homes with the mortgages now being paid on time.

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