A Government Bailout

In attempting to address the current foreclosure crisis, many are looking back in American history to see how this problem had been addressed previously. When reasonable people are faced with a problem, a good first step is to look around. See if someone has faced the same issue, examine what actions were taken, qualify how successful the actions were and then decide if that solution will adequately solve the problem at hand.

A possible solution to today’s foreclosure crisis is a program mirrored to what Franklin D. Roosevelt created in 1933, The Home Owners’ Loan Corporation (HOLC). The mission of the HOLC was to purchase non-performing mortgages from banks and write new mortgages that homeowners could afford. I’m not going to go into the details of the program but during the period the HOLC was conducting business, it acquired nearly 20% of the outstanding mortgages in the country. It couldn’t help every homeowner and ended up foreclosing on approximately 200,000 homes. It was however, successful in rewriting over 80% of the mortgages.

The corporation was closed in 1951 showing a small profit for their efforts and had sold off the entire inventory of foreclosed properties. The HOLC proved to be an example of a successful federal program that not only accomplished its goals but also did it at no cost to the taxpayer.

A growing group of influential people, ranging from Senator Christopher Dodd of Connecticut to Alan S. Blinder, former vice chairman of the Federal Reserve as well as Nicholas Retsinas, former Federal Housing Commissioner, are pushing for the creation of a similar corporation.

I agree that this is a solution that deserves to be discussed and is a viable solution to the problem at hand. We do need to keep in mind that we will not be as fortunate this time around. The fact that the HOLC successfully completed their mission with no cost to the taxpayer should not lead us to think that a similar program today could be effective at the same cost. Today’s borrower's live by a different set of standards then those of the thirties.

The attitude that our parents and grandparents had, of paying your rent (or mortgage) first, is no longer prevalent. The fear of being thrown out of your home and having no place to live is no longer first and foremost in our minds. In addition, today’s homeowner has little or no money of his own invested in the property.

The February 29th, 2008 issue of The New York Times contains an article, “Facing default, some walk out on new homes”. This article confirms what I’m saying.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, [and former Federal Housing Commissioner] said in an e-mail message.
For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.
“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania is quoted in the same article:

“Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

The National Association of Realtors tracks ongoing trends in homeownership. This is what they’ve found:

“Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989 Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.”

The mortgage industry has been meeting the needs of the first time homebuyer by developing programs that enable people to purchase homes with little or no money down. This was done to encourage home ownership. History has proven that a higher percentage of homeowners in a community creates a more stable community. Over time, as mortgages are paid down and property values increase, each family’s wealth increases.

Over 60% of the US economy is based on consumer spending. In order to keep the economic engine of our economy running, the government encourages consumers to spend. Consumers are expected, if not encouraged, to spend above their means. Homeowners have been using their homes as an ATM machine, drawing down the equity in their homes to feed their spending addiction.

The majority of the mortgages today that are in default are not purchase money mortgages; they are cash-out refinances. Recently, homeowners bought their homes with very little or none of their own money. They have little motivation to make their mortgage payments when they see the value of their homes falling. Those who took the equity out of their homes by refinancing, have even less motivation. They converted the paper profits of the housing bubble into cash. Cash they could spend anyway they wanted. It’s hard to find any motivation for these individuals to pay what they owe to the bank.

The homeowner from the thirties that got into financial trouble appreciated whatever the government or any one else did to help them out. They were determined to do whatever they could to live up to their financial obligations and hold on to their home. Today’s homeowner feels that he is entitled to be bailed out and feels no obligation to live up to his responsibility to the lender. In fact, they believe that the lender is the cause of the problem!

Communities can’t survive with a high level of foreclosures. Some form of intervention needs to be implemented and a modern day HOLC is an excellent approach to address the problem. We all need to realize though, that there will be a hefty cost to the taxpayer this time around.

Understanding Yield Spread Premiums

The New York State's Governor's office requested that the New York Association of Mortgage Brokers (NYAMB) provide an explanation of the use of the Yield Spread Premium and what suggestions they have to curtail the abuse of it. Don Romano drafted their response and it is presented here.

Yield Spread Premium (YSP) is an important tool available to brokers in servicing the applicant. As is the case with any tool, its improper use results in damage. The goal is to implement a mechanism that will eliminate the ability for abuse of YSPs yet maintain the consumer’s options in determining the most advantageous way to pay for his or her mortgage.

The real cost to a consumer for a mortgage is paid through a combination of interest rate and points. We are defining a “point” as any upfront fee that is priced as a percentage of the mortgage amount. A discount, broker or origination fees are all the same. Each one is priced as a percentage of the mortgage amount and higher upfront fees on the same mortgage will yield a lower interest rate on the mortgage.

There are 2 features of YSP that open the door to abuse. One is the difficulty of the consumer to easily understand how YSP works and the other is a weakness in the current disclosure regulations. It is our opinion that the door for abuse can be closed through a revision to the current regulation.

Before we delve into the workings of YSP it is important to recognize that it is cost effective for Lenders to work through a network of Brokers. Due to the cost saving to the Lender, a lender offers a wholesale price structure to the broker. Through this pricing mechanism a Broker can offer pricing that is competitive with the pricing that Lenders offer directly to the public.

The mortgage application process is very labor intense, with the majority of the hours being dedicated to customer service. The volume of mortgage applications taken by a Lender varies greatly from year to year. This makes it difficult for Lenders to hire and keep good people since the number of employees that are required will be different from year to year.

Getting past the customer service component and looking at the actual underwriting process we find the next benefit. A Lender is forced to take an application from a consumer in any condition the consumer decides to present it. The application may not be filled out completely, it may not be signed, the supporting documentation may not be there or what’s there isn’t complete. This results with more man-hours being spent on the file.

When a Lender conducts business with a broker, it is a business-to-business relationship. The Lender can dictate to the broker what condition a package needs to be in before it gets to underwriting, require the broker to confirm the package meets certain guidelines before submission, demand a minimum closure rate on packages that are submitted, etc. The Lender can pick and choose which brokers it wants to work with and can stop dealing with a broker for any reason.

Now we can focus on how YSPs are utilized. As we have already said, the cost of a mortgage is a combination of points and interest rate. A consumer engages a Mortgage Broker’s service to arrange for the placement of a mortgage. For this example we will assume the consumer agrees to compensate the broker 1.0% of the mortgage amount for his services. We are also going to use an over simplified pricing model for the purposes of our example.

The mortgage is committed and the rate is set at 6.0% plus a 1-point broker fee. Straightforward enough, the consumer pays a 6.0% annual interest on his mortgage for as long as it’s outstanding and writes out a check to the Broker for 1.0%. The consumer also has the option to lower his monthly payment by increasing his upfront costs. He could decide to pay 2-points instead of 1 and lower his interest rate to 5.75% or he can decide to pay 3-points instead of 1 and lower his interest rate to 5.50%. These additional points are paid to the lender to make up for the reduction in the monthly mortgage payment.

The concept of paying more upfront in order to pay less over time is easy for the average person to understand. If paying more upfront lowers the payments over time then the opposite is also true. The less you pay upfront the more you pay over time. For a consumer that is either tight on cash or prefers to maintain a higher cash reserve after closing this is an important option to consider.

If 3-points buys an interest rate of 5.50, 2-points buys a rate of 5.75% and 1-point buys an interest rate of 6.0% is it surprising to find that if the consumer elects to pay a 6.25% interest rate, it entitles the consumer to pay 0 points upfront? It’s not a difficult concept for the consumer to understand. As long as the intention of the Broker, or the originator, is to bring clarity to the explanation then the consumer will have no problem in understanding.

Those in the business who are looking to abuse the use of YSP don’t want clarity. The poorer the understanding of YSP by the consumer, the better it is for the abusers. This brings us to feature number 2, the weakness in the current disclosure regulations.

The exact dollar value of a YSP isn’t determined until the mortgage rate is locked. A NYS Registered Mortgage Broker doesn’t have the authority to commit a lender to fund a mortgage application or commit a lender to a particular rate. The current regulation requires a Broker to disclose the exact fee that an applicant agrees to compensate the Broker for his services and a maximum amount the Broker can receive from the lender in the form of a YSP. There is nothing in the regulation that requires any connection between the upfront broker fee and any YSP. This situation creates the opportunity for abuse.

Going back to our example. The consumer starts off expecting a rate of 6.0% and a 1-point broker fee. Our consumer ends up closing at 6.50% with 1-point. He doesn’t really know why the rate changed. It could have been that the consumer didn’t qualify for that particular rate and the lender needed to charge more. Maybe there was a change for the worse in the market price for the mortgage between the rate quote and the rate lock. Or it could have been that the Broker just wanted to abuse the system by representing that he was making only 1-point on the mortgage but in reality was making 3, 1-point from the consumer and 2-points in the form of YSP.

Yes, we can definitely prevent this from happening by banning the use of YSP, but at what cost? When the power chain saw was initially sold to the public there were many injuries. Instead of banning the sale of this product, they modified the mechanism by adding an automatic brake making the tool substantially safer. We’re suggesting a similar modification to the existing regulation.

The residents of New York State are faced with the highest closing costs of any State in the nation. The biggest hurdle for the first time homebuyer is raising the cash needed to buy a home. One of the most important tools a Broker has at his disposal is YSP because it allows him to offer his clients the ability to offset out of pocket expenses with a higher interest rate.

Recently the State of Massachusetts implemented regulations with the intention of eliminating a broker or banker’s ability to steer an applicant into a mortgage that generated a higher profit than the quality of the applicant deserved. The language of the regulation implied a banning of YSPs. Immediately, Lenders began to stop the origination of mortgages in the State. The regulation was put on hold, meetings were held with the industry groups and the language was modified.

We need to be careful when drafting new regulations in order to make sure that we don’t restrict the availability of mortgages to the public. It’s important that we don’t repeat the mistake that Massachusetts made.

Personal Fiscal Responsibility

The amount of money owed out by the average person is growing daily. This is proven by the government statistic that shows that America has a negative savings rate. This confirms what we all are afraid to admit; we are spending more than we make to support our lifestyles.

We can’t influence other people’s decisions but we owe it to ourselves to evaluate our own financial position. Are we making poor spending decisions? Are we prepared to deal with what the future has in store for us? Do we find ourselves moving from one crisis to another? What steps can be taken to bring order to our fiscal well-being?

These are the things I want to address today with the goal of giving you something to think about that can help you reach your long term needs.

Let’s start by looking at debt. There are 3 types of debt. We have Good, Bad and Emergency Debt.

Good Debt is money you borrow with the intent that you will get a greater return on your investment than the interest rate you are paying. An example of this would be a student loan. You take a student loan to pay for an education that will yield you a higher income in the future. Another example would be a mortgage. You want to buy a home today instead of paying rent because you believe that in the future, when the time comes to sell your home, you will sell it for substantially more than you paid for it.

There are no guarantees that you will finish your education and land a better paying job and there is no guarantee that when the time comes to sell your home you will make a profit. What makes Good Debt good is that you take it on with a reasonable expectation that the decision will be profitable in the future.

Bad Debt is money you borrow to feed your need for instant gratification. We purchase cloths today on a credit card. We don’t expect the cloths to have a higher value in the future but we’re willing to take on the debt, along with the interest charges, because we want the clothes now. We will at times justify doing this because what we’re purchasing is “on sale”. We conveniently forget to add the interest charges on the sales price, because if we did, it would become obvious that there is no bargain here.

Emergency Debt is debt we take on due to unforeseen circumstances. You lose your job and you are out of work for a month before taking a new position. You will be forced to take on addition debt during this time. You may be faced with an unforeseen car repair or home repair. These are examples than can require you to borrow money unexpectedly.

Money borrowed to bridge you through a rough period (Emergency Debt) tends to be paid off in as short a period of time as possible. This is probably due to psychological reasons. You want to get past the problem as quickly as possible and eliminate all references to the problem.

Good Debt generally is kept around for a long period. Student loans or mortgages are usually for large amounts and can’t be paid off quickly. In addition, this type of debt enables you to increase your net worth. These are two good reasons for you to pay off this debt only after all other debt is retired.

Credit card debt in this country has increased from 3.2 percent of the median family income in 1980 to 12.5 percent in 2004. Student loans, mortgages and any other Good Debt is typically not appearing on credit cards. This debt is held in long-term mortgages or loans. Emergency Debt by definition is not increasing regularly either s it is only bridge funding during unforeseen problems with cash flow.

Conclusively then, Bad Debt is the main source of this increase in credit card debt and the primary cause of this nation’s negative savings rate. Take a close look at your own debt position. Are you falling deeper and deeper into debt every month? Do you make only the minimum payment on your credit card bills? Are things getting so tight that you are afraid you may need to borrow from one credit card to pay the minimum payment on another? Are you afraid to even look at your total debt position?

Reaching out for help in personal financial matters is the last taboo. We are more likely to discuss health problems or sexual issues with others than we are to discuss our financial matters. By being afraid to analyse our own finances and at the same time, afraid to discuss solutions among our family, friends or professionals, we are boxing ourselves into a corner with no way out.

We need to begin to take responsibility for our fiscal well-being. We need to begin by reversing the trend of increasing our monthly debt and begin to reduce the amount of debt we are carrying. We need to change our attitude towards purchases. Instead of buying now and paying later we need to do what our parents did. Save up and make the purchase when we have the money. Changes like this are not going to be easy and will take time. Adjusting our spending habits is a part-time job and needs the same level of attention we give to our 9 to 5 jobs if we want to be successful.

The root of all the financial turmoil this economy is dealing with right now is our attitude of spending tomorrow’s money, today. This is the day of reckoning. The well of tomorrow’s money that every person, company and every level of government has been drawing from, is running dry. How is the leadership of this country addressing the problem? By borrowing even more money so every American receives a check. Then encourage everyone to go out and spend it. This is after forcing interest rates to drop in the hope of encouraging businesses to spend more!

We certainly are not finding long-term solutions from the government. The only thing we can do is to clean up our own financial house so as individuals we can better weather this financial storm.