Lower mortgage rates are about to happen. We are going to continue the bullish cycle which started last last year and was interrupted. Subprime will never be the same but with appropriate adjustments for stated income Jumbo rates should soon (within a month) return to some more appropriate levels.
The bad news is that we will likely see GDP stagnation and lower corporate profits and equity prices and well as perhaps 5 years of flat housing prices. The good news is that we will see lower mortgage rates.
Lower Rates in 4th Quarter
Mortgage liquidity is starting to return. I would think that well before the end of this month we will see changes to subprime and jumbo stated guidelines and/or prices which will, for practical purposes, restore liquidity to the market.
We have a most interesting picture with the technicals in as much as the long-term (monthly) tech has re-upcrossed (Spell-Check be darned). Couple that with the bearish macro trend (lower GDP growth) which will result from a slowdown of home building and home buying and we have the makings of a serious bull market and low rates in the fourth quarter.
That said I want to attempt to close out the ongoing story about subprime and illiquidity. The great story from the subprime thing is the resilience of the U.S. economy and the ability of the Fed to provide liquidity in a quiet, orderly manner.
From my point of view the story in the media about the subprime mess has been one of utter cluelessness. Let me try to give some history.
After World War II home ownership spiked dramatically going for about 45 to 65% in one decade. But that was a more traditional sort of lending usually requiring 20% down payment.
In about 1980 two things happened which enabled the subprime industry. First the Depository Institutions Deregulatory and Monetary Control Act of 1980 was passed. That, in essence, abolished usury laws on first mortgages. It made it legal to make relatively high interest rate mortgages to borrowers who could not qualify for what we now call "A paper."
Second, the Mortgage Backed Securitization was invented. This was enabled by computer power and modeling and had the value of spreading the risk. I wrote about this last week: "The securitization of mortgages into mortgage backed securities is attributed to what Salomon Brothers did for Bank of America starting in the late 1970's and coming to fruition in 1981. The folks who hold mortgage backed securities get others to take the risks associated with default."
Until the past 5 or so years subprime had made sense (at least it had made sense to me). Subprime was for folks with bad credit histories but always required full documentation. It made sense to see if someone with a history of not always paying their bills on time as least had the ability to make their mortgage payments.
In the last few years many absurd loans have been made. It did not, does not and never will make sense to make a subprime loan with "stated income." This is what the subprime mess is all about. Period.
Is someone to blame? I suppose. Blame everyone: the Wall Street folks who enabled securitization, the mortgage banks who made these loans, the brokers and loan officers who pitched them and the borrowers who lied about their income. In short no one is innocent.
There is one very important distinction here. Subprime lending is that made to people who's income, credit history and equity translate into risk. This risk can be measured objectively by models such as FNMA's Desktop Originator. Predatory lending is less well-defined but for I would describe it an making a loan which the borrower has little real chance of being able to make the payments on.
The Mortgage Bankers Association defined predatory lending as "intentionally placing consumers in loan products with significantly worse terms and/or higher costs than loans offered to similarly qualified consumers in the region for the primary purpose of enriching the originator and with little or no regard for the costs to the consumer."
The problem that I have is that I find this difficult to define objectively but the difficulty of any law or regulation is getting the details right. Am I guilty of predatory lending if I make 0.5 point more on one loan that an average of "similarly qualified consumers in the region." Or is it 1 point, 2 points?
In the mortgage business it has long been the case that, on the average, loan officers made more on a subprime loan than a prime loan. It has also be the case that Jumbo loans are more profitable to mortgage banks than agency (FHLMC & FNMA) loans. I am not talking about size related rewards but "points." The ultimate fact is that it is the responsibility of the borrower to search for the best deal. No amount of regulation will substitute for that.
For me the solution is painfully obvious. All subprime loans should be full doc and the lender must underwrite the ability of the borrower to make the payments.
Dick Lepre
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