October 17, 2008
by Dick Lepre
Now Make It Work
Most of what Congress, Treasury and the Federal Reserve have to do to cure the problems with the banking system have been set into motion. With Treasury buying pools of distressed mortgage to provide liquidity and making capital investments in banks to provide capital we will be getting to the point where it is up to banks to remember that their role is to take in money in the form of deposits and lend it out at a higher rate to make a profit.
That is easy for me to say. Banks have to be looking at uncertain real estate values and the chance of recession and make some decisions about whom to lend money to.
Let me give some advice:
- lend money to companies and people who can pay it back
- for an individual buying a home this is fairly straightforward. Make sure they have a stake in the home. We could call this something like a "down payment". It may be the case that people who have something to lose are more likely to prevent it from getting lost than people who have nothing to lose.
- actually calculate how much the house will cost each month. With the help of computers we might even be able to calculate the mortgage payment. Insurance companies and counties might even be willing to share ultra secret information about what the tax bill is and the insurance payments are.
- this is radical but let's consider asking people if they would be so kind as to show us what their income really is. Maybe they could make a copy of a couple of pay stubs and even those W-whatsis forms that get sent to IRS each January.
- by taking the two steps above we might actually assure ourselves that folks income exceeds their housing expense. We could even consider letting them have a little money left over to eat.
OK. It sounds as if I am merely being silly but my point is that we always knew what made a good mortgage loan and what did not. We got away from that for a few years.
How did this happen? No one single cause was responsible but I would offer that at least two different things happened. In 1999 HUD decided that FNMA and FHLMC were not making enough mortgage to low and moderate income borrowers and insisted that FNMA & FHLMC ease credit requirements. That may have been a less than good idea.
There are numerous references on the WWW to this NYT article of Sept. 30, 1999.
Once FNMA & FHLMC got into subprime HUD was less than satisfied with the amounts of subprime that went through FNMA & FHLMC and may have compounded the mistake by letting FNMA & FHLMC buy subprime mortgages originated by others. This peaked in 2004 when FNMA & FHLMC purchase 49% of subprime originations. See this graphic from the Washington Post.
In October 2004 SEC in effect gave Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley the ability to self-destruct by greatly increasing their ability to leverage. Read this NYT article.
I am not by any means making the case that FNMA & FHLMC created the subprime mess but they were complicit. Wall Street deserves the majority of the blame for the manner in which it conjured investment grade securities from this crap. Government oversight of all of this was cast aside by Congress in 1999 when it encouraged FHLMC & FNMA to do subprime and then by SEC. Watching people in Congress castigate Wall Street is, to me, a bit comical. Wall Street could not had achieved this disaster without Congress demanding subprime from the GSEs and magnification by the SEC decision of 2004. We folks in the retail mortgage business gave this our full support. This was a true team effort.
Dick Lepre
RPM - SF