Quite a few of our clients ask “Where have all the easy to get mortgage products gone?” so I’ve republished the following article from Economonitor which is one of the clearest analyses I’ve seen on the origin of the changes in the mortgage market.
Though it focusses on the US experience the underlying mechanics are pretty much the same for Europe.
MORTGAGE FRAUD REVISITED: Why Did the Fed Pump and Dump US Real Estate Markets?
My colleague, Bill Black, has been entertaining himself by reading through the transcripts of the Fed’s meetings to find discussions of mortgage fraud. As you probably know, Congressman Henry Gonzalez forced the Fed to release these transcripts after he caught Chairman Greenspan in a white lie. Well, maybe it was not so white—just an outright lie trying to claim that transcripts of Fed meetings did not exist. We now know they did. Greenspan then agreed to release them, with a five-year lag. So, joy of joys, you can now read the transcripts from FOMC meetings for 2006, right at the end of the biggest real estate boom in human history. And Bill Black is just the sort of guy who would find this fun.
I did the same thing for the period surrounding 1993-94 (back when Greenspan was caught in making those untruthful statements to Congress—never a good idea since Congress can throw the liar in prison). It is actually more fun than you might think. Go read the transcripts from the secret conference phone call when the Maestro informed his fellow FOMC members not only that he had misled Congress, but also that every word they had ever uttered at his FOMC meetings had been taped, as in Watergate secret taping. The gasps are still audible after all these years. But forget all that, let us turn to mortgage fraud in the 2000s.
Many of those involved in promoting the fraud have claimed that “no one could have seen it coming”—meaning the collapse. This is, of course, implausible. The FBI had warned of “an epidemic of fraud” back in 2004—long before the worst abuses became normal bank practice. And from the Fed’s transcripts, there is no doubt at all that the Fed “saw it coming”. Let’s look at a particular report from December 12, 2006. Don’t take my word for it. Read this: http://www.federalreserve.gov/monetarypolicy/files/FOMC20061212meeting.pdf
Here is a relevant portion of the transcript, with a bit of added bold:
MS. BIES. As many of you have noticed, some of us are optimistic that we may be approaching a bottom in the housing market…. The growth in mortgage credit has slowed significantly from where it was in the past two years, dropping to only 10 percent growth this past quarter, a growth rate that is significantly above the growth of personal income and that most of us in the past would have considered to be alarming. Part of what’s amazing in all of this is that in 2004 and 2006, particularly toward the end of that period, purchase money seconds, by which people borrowed the down-payment for homes, were a big part of mortgage financing… The one sector that has had a jump in delinquencies is subprime ARMs, and clearly the jump is related to rates that have already reset. We’ve got more to come. One thing I’m hearing more from some folks who have been investing in mortgage-backed securities and maybe in some CDOs (collateralized debt obligations), where they’ve been tranched into riskier positions through economic leverage, is the realization that a lot of the private mortgages that have been securitized during the past few years really do have much more risk than the investors have been focusing on… We’re seeing that some of the private-label mortgage-backed securities are having very high early default rates or delinquencies in the mortgages, which usually means that the originator has to buy them back out of the pools. There isn’t a whole lot of transparency in the disclosures around some of these bonds, and some of the brokers are underwriting products that have very high early default rates, which is something that investors are starting to focus on. As more products are generated outside the banking sector, they get funneled to pools through broker-dealers as opposed to the banks. I think that we’re missing a level of due diligence regarding brokers, who may not be doing a good job. As you all know, the fraud rate on mortgages has tripled in the past two years. So I think we could see noise in some of the mortgage-backed private deals and some of the riskier CDO economic leverage positions…. Loan-loss provision continues to be the best in many, many years.
Let’s translate some of this. Governor Bies recognized that:
a) Homebuyers were borrowing their down payments. Geez, do you think it might be a wee bit risky if a home buyer puts in none of her own money?
b) The Fed’s position is that 2006 will be the bottom of the real estate market. The bottom? The biggest real estate boom in human history, and that is the bottom? Hey, folks, the bottom might be reached in 2015, after real estate prices have fallen by at least 50% and perhaps $10 trillion of real estate wealth has been wiped out! (Already they’ve fallen by 33%, $7 trillion of household wealth was lost, and 12 million homeowners are underwater in their mortgages.)
c) Subprime adjustable rate mortgage delinquencies are up in 2006. Who wuddav thought? You mean that making NINJA loans might be a tiny bit risky? Oh, come on—why would anyone need income, a job, or assets in order to service mortgage debt. And since the Fed began raising interest rates back in 2004, who wuddav thought this might actually hurt owners who had floating rate mortgages that would adjust upward by 10 percentage points or more? Well, the Fed certainly understood this, as Bies helpfully said “we’ve got more (delinquencies) to come”! Yes, dear, lots of them.
d) Early defaults are spiking already in 2006. Let me explain: by late 2006 and early 2007 we got the news that increasing numbers of homebuyers were defaulting on their very first mortgage payment! Indeed, that is what led me to start warning in spring of 2007 that the whole kit and caboodle was going to blow. And now we know the Fed knew that too. Look, if a buyer defaults on the first payment there is no doubt whatsoever that the loan was fraudulent. Either the lender had duped the borrower, or (less commonly) the borrower had duped the lender.
e) She warned there isn’t any underwriting or transparency in the whole damned mortgage finance food chain. That, of course, is a recipe for fraud. Lender’s fraud. Securities fraud. Appraisal fraud. Accounting fraud. The Fed knew all this in 2006.
f) And, well, yes, mortgage fraud has tripled, “as you all know”. Yes, all members of the FOMC knew fraud had tripled. It’s an incredible understatement, but still a significant acknowledgment.
g) And yet, isn’t it great news that banks have reduced their loan loss reserves? Their protection against losses due to declining underwriting standards, elimination of down payments as borrowers simply borrowed them, and outright documented fraud? Oh yes, banks don’t need no loan loss reserves now. We’ve got the Great Moderation. What could possibly go wrong?
There is no doubt at all that the Fed knew fraud was rampant and rising. There is no doubt at all that the Fed knew underwriting standards had collapsed. The Fed knew delinquencies had risen and would continue to rise. And they knew banks were reducing loan loss reserves—in order to book fake profits and to pay bonuses to top management.
And what did the Fed do about all this? The Fed sent representatives all around the country to argue that fundamentals were sound, that real estate markets had bottomed, and that the future looked bright ahead.
Did the Fed at any time ever tighten up mortgage lending standards? No. Did it ever publicly warn of a real estate bubble? No—only privately. Did it ever worry in public that we were set for the biggest real estate crash the US had ever seen? Of course not. That would have been counter-agenda.
At the time we could not get the transcripts—since they are released with a five-year lag. So all we got was cheerleading for fraud by Fed officials.
Why? Because the Fed had become the government’s main tool for pumping bubbles. There was nothing else up the sleeve; it was all there was so far as a government strategy for growth. It was the tried and true method developed under President Clinton. And it worked. Until it didn’t. And won’t any more.
Unfortunately, neither President Obama nor the likely Republican candidate, ex-governor Romney have anything up their sleeves, either.
And the US economy will not recover until housing recovers. And housing will not recover until the Banksters are shut down. Because they’ve got all the dogs in the hunt—they cannot recognize the real estate losses because their exposure is too big.
It’s the biggest Catch 22 the world has ever seen. The big banks must be resolved—shut down—to relieve the pressure on homeowners, but that cannot happen because the big banks are too big to be shut down.
Dodd-Frank changed none of that. Indeed, it strives to keep the frauds running.
This was reposted from the excellent Economonitor Blog which I wholeheartedly recommend here
