Sunday, March 06, 2011

Housing Thoughts

You know, I'm not terribly upset at the idea of winding down Fannie Mae and Freddie Mac. That's a reasonable proposition if, once every couple decades they're going to cost taxpayers a sudden $135 billion. They did help provide home buyers of the past 30 years with slightly lower rates and made it way easier for them to get fixed-rate mortgages (and thus, stability in cost). So there was definitely a benefit, but at this point we've become acutely aware of the costs. We're probably over-emphasizing them, since they're fresh in our minds, but that's alright, we weren't too aware of them ahead of time. In short, winding down these entities isn't really a bad thing, and doesn't scare me too much.

But what does scare me is the idea that I sense floating around that somehow getting rid of Fannie and Freddie is going to prevent this kind of economic disaster in the future. Or that Fannie and Freddie were singlehandedly responsible for this particular disaster. Or that the private market will get it right without any checks.

See, Fannie and Freddie weren't the only ones backing subprime mortgages and bad debts. They weren't even the first ones doing it. Heck, after you figure in the bailouts, they weren't even the only ones who had their bad loans guaranteed by the taxpayers! Much of what went wrong in the housing market happened in the unregulated private market, and much of what went wrong with Fannie and Freddie went wrong because of the lack of regulatory guidance on mortgage terms.

It wasn't just making loans to people who couldn't pay them that caused the financial meltdown. A lot of happened because these companies created loan products that were designed to not-be-paid-back. And a lot happened because there were rewards for total transactions, regardless of quality, because of the brokerage situation. And a lot happened because there were rewards for misleading borrowers into loans with higher rates than the borrowers actually qualified for.

These things all happened in the private market, and will continue to happen unless we have some rules protecting borrowers from unconscionable loan terms. Because mortgages are such complex documents, just putting borrowers on notice of the terms isn't sufficient to protect them; borrowers aren't sophisticated enough to know that a "yield spread premium" means "kickback to your broker for conning you into taking a higher interest rate than you should have." That means we should probably have some laws that make certain types of abusive mortgages illegal. We should also have law that make sure the language used in mortgages is clear and readable. We should probably have some laws that regulate brokers to make sure they aren't playing the people they're supposed to be helping. And we should make sure these laws have some teeth.

And we should probably know full well that these laws are going to cost homeowners a little bit more money in their respective rates. But we should also know that if we're going to leave it all up to the private market, well, that's not cheap either.

Mary Anne, do you remember
The tree by the river
When we were 17?


Durham said...

So, are saying we should pay a higher rate on our mortgage (that goes to funding a mortgage policing agency) to ensure that we don't pay a higher rate on our mortgage (that goes to broker kick backs)?

Matthew B. Novak said...

Well I'm not calling for a policing agency here, more just consumer protection statutes that can be enforced via private citizen suits. But in a way, yes. Because the former is better at creating a stable economy.

aaron said...
This comment has been removed by the author.
aaron said...

Although Fannie and Freddie do hold a lot of the blame here I will repeat my past thoughts. The government and banks are at fault yes, but the real problem lays with the individual. Who better should know your financial status, history, and ability to pay off debt than yourself? Are you really trusting someone that you just met ten minutes ago and who only knows your finances at the current state to know what you can and cannot afford?

Nope, it falls back onto individual responsibility. I have past up many, many good deals, and low low monthly payments, because I know my history. I know that although it looks like a good deal, I would probably be buying something that I did not need in the first place.

Live within your means.

mariatrueblood said...

@Aaron: I think the problem with putting the responsibility entirely on the individual is that not everyone is as knowledgeable. There are a lot of people who don't understand their financial situation and can only see in the short term. This is for several reasons: 1) finance classes are not a standard part of high school curriculum 2.) generally, if someone's parents are financially illiterate, their children will be too and 3.) even if they try to educate themselves, the initial costs of that education may be too steep (which is why these low monthly payments seem so great and people think it is a great way to access their dreams).

I think if we want to put responsibility on the individual, which is not a bad thing, we need to really change the mentality in the United States toward standards of living. There is such a great pressure to have a house and everything that goes with it (a family, cars, newest phones). It is hard to withstand that pressure especially when it is just the attitude you are born into. Willpower and the ability to say "no" are not two strong aspects of our culture (ergo the obesity crisis in our nation).

Still, I definitely understand what you are saying, and there can definitely be an increase in responsibility on the individual. However, it is harder for us, as a nation, to hold individuals accountable: we cannot really control what another person chooses to do.

Matthew B. Novak said...

Aaron -

Maria sums up some of the problems pretty well; a lot of people just aren't financially literate. But even more than that, a lot of financially literate people are bamboozled and sold to. That is, people can be convinced to enter into bad economic transactions because people don't just operate as rational consumers. This is especially true when you're dealing with a situation as complex as a mortgage; people just don't have the sophistication they need to make a 100% pure rational decision, which opens the door for abuses. See the "Yield Spread Premium" example I gave in the original post. No amount of sophistication is going to help you figure that one out - you need to have somewhere along the line been told specifically what that means.

I'm not talking about the house that flat out costs too much here - I'm talking about hidden fees and charges and adjustments that aren't known about.

I'm not opposed to holding individuals responsible and letting them get foreclosed on when they make bad economic decisions; heck, we're letting them get foreclosed on now. What I have a problem with is allowing banks/brokers to entice people into signing bad deals when there's no way for the individual to know that it's a bad deal.

Durham said...

It's a pretty simple formula to determine whether a mortgage is within the realm of possibility, probability, and good sense. You determine whether the projected monthly payment is affordable, and you keep the term as short as possible. If the term of the loan is longer than 30 years then it is definitely not good sense, and if the monthly payment is more than 4/9th of your monthly income then it does not make good sense.

It isn't that hard. And within those conditions the possibility of getting "screwed" by the mortgage company, or broker, is pretty limited. It doesn't take an entire class to understand that, it takes a very short conversation with someone you know to have good finances (whether rich or poor), and they aren't that hard to find.

@mariatrueblood, it saddens me to hear you have such little faith in people's abilities. As if the minority, lowest common denominator, is the benchmark to measure. The fact of the matter is most people make good decisions, and it is still a very minority who are having housing/mortgage problems. And if you think you will be able to "really change the mentality in the United States toward standards of living", I will enjoy watching you do it. But the only thing you will really be able to affect is your own actions, and serve as a model for others to follows, if they wish.

Matthew B. Novak said...

Durham -

See my previous point. I'm not talking about the house that flat out costs too much here - I'm talking about hidden fees and charges and adjustments that aren't known about.

When you don't know about the fees/costs/charges, when those amounts change throughout the term of the loan, when there are sudden balloon payments, etc., it becomes very complex. Good luck figuring out what percentage of your income you'd be paying on your mortgage when you don't know what your monthly payment will be a year or 3 out.

And what about things like the Yield Spread Premium? Those are fees that are "disclosed" into the total, such that the buyer knows they are paying for them, but has no way of knowing what exactly they're paying for. Even if you have the ability to pay the higher amount, does that mean it's ok for your broker to get a kickback for conning you into paying a higher amount? You'd be getting screwed in that situation, even if you met your other conditions.

I'm not saying people should be able to buy houses that are too expensive for them. You're right, given a normal contract relationship it's not that hard. And I'm not saying people shouldn't get foreclosed on if they don't pay - they should. What I'm saying is that there needs to be some upfront protections against abusive contracts.

Durham said...

And I'm saying if you stay within the terms I indicted it is pretty hard to get abused by the mortgage company and/or the broker.

Sudden balloon payments? You would have to be a complete idiot to not know about a "sudden" balloon payment. It only takes a calculator, and basic arithmetic skills. The only that's sudden is their inability to pay it, not the scheduled payment.

Now the adjustable rate is a concern, and is easily addressed: don't accept an adjustable rate mortgage, or accept an adjustable rate mortgage with a defined rate spread that is within you ability. If they don't exist now, they will be, or can be, when people don't accept mortgage terms with an undefined adjustable rate spread.

What about Yield Spread Premiums? Are you suggesting the broker shouldn't get a fee for fronting the mortgage? Or are you just suggesting they shouldn't get to set their own terms? Or are you suggesting they shouldn't be able to have an adjustable yield spread?

Matthew B. Novak said...

And I'm saying if you stay within the terms I indicted it is pretty hard to get abused by the mortgage company and/or the broker.

If you are unable to figure out the terms of the mortgage, it is very tough to accomplish this task. Abuse by the bank/broker takes exactly this form; the borrower doesn't sufficiently know what the terms of their loan are/what they're paying for. When that is the abuse itself then you can't successfully meet the targets you laid out. The abuse is precisely that the borrower thinks they're taking out a loan on terms that fit your targets but have been misled about the real terms.

You would have to be a complete idiot to not know about a "sudden" balloon payment.

1. There are plenty of people who aren't financially literate - or as you call them, "complete idiots" - who simply aren't able to wrap their head around such concepts. That's a big chunk of the population that I'm concerned about. And a big part of the population that bought bad mortgages in the housing bubble and helped throw off our entire economy. I'm concerned about "complete idiots" ruining the economy for the rest of us.

2. Given the extremely complex nature of mortgages, even moderately sophisticated people can make these kinds of mistakes.

3. Banks/Brokers can lie. One of the most common lies used to sell balloon payment loans was "oh that doesn't happen for 3 years, you can refinance before then and get rid of it. Don't worry, I'll take care of you." But then they wouldn't take care of the person, because it didn't make sense to refinance them, since the balloon payment was such a money maker. Or sometimes loans even had prohibitions against refinance w/in a timeframe that avoided balloon payments. There were all sorts of traps written into the mortgages. That's what I want us to avoid. So that people can operate like you suggest they should. On straight-forward contracts where people understand what they're getting into.

Don't accept an adjustable rate mortgage, or accept an adjustable rate mortgage with a defined rate spread that is within you ability.

Did you read the article I linked to? Adjustable rates are probably going to be about all there is.

And maybe you don't understand how abusive some of these adjustable rate mortgages were... I've spent literally hours trying to figure out just 1 mortgage document because of the way adjustable rate provisions were written. Seriously, it took me, a consumer law attorney, more than an hour to decipher some of these provisions. Adjustable rates need to be clear and straightforward in order for people to do what you propose. Thus, I suggest we make some laws guaranteeing clarity, so that your vision can come to fruition.

What about Yield Spread Premiums? Are you suggesting the broker shouldn't get a fee for fronting the mortgage?

A YSP is a fee that came in addition to the brokerage fees. Brokers got paid for doing their job. The YSP was a kickback that the mortgaging bank would pay to the broker for getting the borrower into a higher interest rate than the borrower qualified for. Thus, if you could actually get a 5% loan but your broker didn't tell you that, and instead said "here's the best loan I can find for you - 7%" the bank would give them a percentage of the difference. Because the bank was making an extra 2% off of you, they were willing to split some of that with the broker. That is, brokers were supposed to be getting borrowers the best rates but instead were getting them bad rates because brokers got paid extra as a result. I'm not suggesting that brokers don't get paid - I'm suggesting that they don't get paid extra for ripping you off. Check your mortgage. If it has a YSP that means you've been duped.

Matthew B. Novak said...

To maybe help clarify a bit... What people should do and what people are able to do are very different problems. I don't disagree with Durham's assertion of what people should do. I am just saying that the system as it currently stands often makes it difficult for people to have the ability to behave as they should.

aaron said...

Funny that I just reread the post and comments as I had a conversation today about peoples' ability to ask the right questions to get the answers they need.

As a teacher, I can see the ability to think of one's self dwindling, while the dependancy on others' advice is growing.

Matt, I agree that predatory lending is bad. However, I think the bigger problem our children are not learning to questions thinks, but take every word for gold.

When we bought our first house, we asked a ton of questions about this cost and that cost and why this or that. Not only at one bank, but we shopped around to find the best interest rate and payment. It was a very time intensive but we feel that we landed a good deal on the first mortgage.

When we built our next house, we did the exact same. In fact, i think our lender got annoyed by all of our questions and inquiries as though we did not trust her.....and why would we, she makes her living off people taking loans.

I agree with Durham, before buying a house, one should know what they can afford, and how long they want to pay that payment for.

So, yes, perhaps there needs to some reform, Perhaps there should be a finance class b4 purchasing,but the bigger problem here it that people are not being responsible for themselves. Again, I say that no one knows your finance history, ability, or education better than yourself.

Matthew B. Novak said...

I agree with Durham, before buying a house, one should know what they can afford, and how long they want to pay that payment for.

I agree. The problem is people's ability to actually do that. That's all I was saying. I think we're pretty much in agreement here.

You're right about finance classes being a good idea. I actually helped teach some when I was practicing in Virginia. But I do want to caution: it would pretty much take an advanced degree to figure out some of the stuff they came up with in these predatory loans.

In order to make personal responsibility a better reality, we need to make sure that the responsible aren't being duped along with the irresponsible.