“Fannie and Freddie did not fully disclose their exposure to NTM (nontraditional mortgages) until after they had been taken over by a government conservator in 2008. Before the crisis, analysts, regulators, academic commentators, rating agencies and the Federal Reserve (did not understand) the scope of the NTM problem, believing it was much smaller, and that the number of traditional prime mortgages outstanding was much larger, than in fact they were…

…markets were shocked by the number of mortgage defaults when they eventually began to appear in 2007 and 2008….With approximately 55 million mortgages in the United States on June 30, 2008, NTMs made up 57 percent (or 31.35 million) of all U.S. mortgages outstanding.…..(as of that date) all government agencies as a group were exposed to 24 million NTMs (see Table 1.1), or 76 percent of all the NTMs outstanding…..Fannie and Freddie had the greatest (government agency) exposure…16.5 million or 69 percent……These numbers are likely to be much higher than most observers of the mortgage markets had assumed, even six years after the financial crisis. (The reasons for this discrepancy were noted in the previous chapter, and the consequences are covered extensively in chapter 10.)”, Peter J. Wallison, Hidden in Plain Sight: Chapter 2, The Difference Between Prime and Nontraditional Mortgages”

Other Key Excerpts of Chapter 2:

“The difference in the performance between a traditional prime mortgage, or NTM, is crucial to the argument presented in this book. Traditional prime mortgages have historically had low rates of default. NTMs, on the other hand, usually have rates of default that are multiples of the prime loan default rate. In periods of economic stress, such as the one that occurred in the period between 2007 and 2009, even prime mortgages defaults might substantially exceed 1 percent, but the performance of NTMs became disproportionately worse. That difference was crucial between 2007 and 2009, when large numbers of NTMs in the financial system began to default.”

“Pinto’s data and analysis are available on the American Enterprise Institute website…..Pinto’s analysis establishes the total number of NTMs outstanding at June 30, 2008, by adding together two separate categories of subprime loans….those identified by lenders as subprime (6.7 million), which Pinto called “self-denominated subprime,” and those made to borrowers with FICO credit scores of 660 or less (9.2 million), which Pinto….following the definition used by the U.S. bank regulators….called “subprime by characteristics.” (The support for counting loans with FICO scores of 660 or less as subprime is covered later in this chapter.) These totaled 15.9 million. Pinto then added the total number of Alt-A loans outstanding on June 30, 2008 (15.3 million), which consisted of 10.4 million to which Fannie and Freddie were exposed on June 30, 2008, 1.4 million insured or held by the FHA or the Veterans Administration, and 3.4 million self-denominated or other conventional Alt-a loans, for a total of 15.2 million. The total came to 31 million. This should be compared with Table 1.1, which combined subprime and Alt-A loans by entity exposed.”

“Table 2.1(“Results of a 1996 Federal Reserve study of FICO scores”) sets an index of 1 for the likelihood of default for a loan that has a FICO score greater than 660, an LTV ratio lower than 81 percent (a down payment of 20 percent), and a borrower’s income of any size.”

“Then varying these parameters, the table shows the likelihood of default is 3.3 times greater…no matter the borrower’s income….if the LTV ratio is 81 percent or more (that is, the down payment is less than 20 percent) and the FICO score is more than 660. This is a substantial difference, attributable (ONLY) to the lower down payment.”

“However, if the same loan (income of any size and LTV ratio greater than 81 percent) were made to a borrower with a FICO score of 621-660, the chances of a default are more than 15 times greater, and if the borrower’s FICO score is less than 621, the chances of default are 47 times greater.”

“This study, then, demonstrates the extraordinary sensitivity of the FICO score and the fact that there is a substantial difference between a FICO score greater than 660 and one 660 or below. Five years later, perhaps relying on this data, U.S. bank regulators defined a subprime loan with reference to a FICO score of less than 660.”

“If we consider all of the purchase loans in the data set (Freddie Mac data set from 1999 to 2007), the number of NTM’s are these: 626,724 (15 percent) were subprime because they had FICO scores less than 660; 1,631,386 (39 percent) had DTI ratios greater than 38 percent; and 1,066,485 (26 percent) had LTV ratios higher than 90 percent. And these, recall, were Freddie’s best loans (the data set excluded many acquired for compliance with affordable housing goals). At the very least, these deficiencies indicate that degraded mortgage underwriting standards that the GSEs were compelled to adopt by the affordable-housing goals had not been confined to low-income borrowers.”

(Table 2.2, “Prime vs. non-prime default rates through 2007 on fully documented loan, Freddie Mac 30-year fixed-rate home purchase loans acquired in  1999”, shows the following: Prime (>660 FICO, < or =90% LTV, < or = 38% DTI equals “1” default rate. DTI’s greater than 38%, but prime FICO’s and down payments, have a 1.8 times, or 80% higher default rate than prime. LTV’s above 90%, but prime FICOs and DTIs have a 4.1 times or 310% higher default rate. FICO <660 with non-prime down payments and/or DTI ratios have a 12.7 times or 1,170% higher default rate than prime.)

“It is worth noting that the Dodd-Frank Act tasked several agencies (the Federal Reserve, the Comptroller of the Currency, the Federal Deposit Insurance Corporation (FDIC), the SEC, the Federal Housing Finance Agency (FHFA), and the Department of Housing and Urban Development (HUD), with the responsibility to develop a “qualified residential mortgage” (QRM) that is, a mortgage of such quality that it would present a very low risk of default.”

“To meet this standard, the agencies originally developed a mortgage with the same three underwriting constituents that had characterized the traditional prime mortgage: a substantial down payment on purchase money loans (20 percent), a DTI ratio after the mortgage of 36 percent, and strong credit history (the agencies did not use FICO scores per se).”

“However, succeeding events show that the lessons of the financial crisis had not been learned.”

“The proposed rule met with a substantial outcry from what might be called the “government mortgage complex”….Realtors, banks, and community activists….who contended the down payment and other provisions would deprive low-income borrowers and others of a chance to buy homes. Lawmakers who had voted for the QRM quickly reversed themselves in the face of this opposition and called on the agencies to repropose a more lenient rule.”

“In August 2013, accordingly, the agencies succumbed to this pressure and published a new proposal for QRM. This one abandoned any reference to traditional underwriting standards for a prime or low-risk loan and adopted as the standard a minimum mortgage standard proposed in January 2013 by the Consumer Financial Protection Bureau.”

“The standard did not require any particular down payment or credit record, and the agencies admitted in their reproposal that, by 2012, mortgages meeting this standard between 2005 and 2008 had experienced serious delinquency or default at a 23 percent rate.”

“The agencies also made their motivations clear when they noted that they were “concerned about the prospect of imposing further constraints on mortgage credit availability at this time, especially as such constraints might disproportionately affect groups that have been historically disadvantaged in the mortgage market, such as lower-income, minority, or first-time homebuyers.”

“The rule was finalized in October 2014.”

“In other words, the underlying ideas of affordable-housing goals were going to be incorporated into the rules of Dodd-Frank, despite the language in the act that had attempted to create higher mortgage underwriting standards for at least some limited number of loans. Chapter 14 discusses how the failure to understand the lessons of the 2008 financial crisis will eventually bring about another.”

Posted on April 10, 2015, in Postings. Bookmark the permalink. Leave a comment.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: