Monthly Archives: May 2016
“Mortgage Credit Risk #2: Mortgage underwriting (the activity of underwriting a mortgage loan to ensure it meets an investor’s loan program guidelines) defect rates and mortgage fraud DID NOT cause the U.S. mortgage crisis, so what did?…
…1) Macroeconomic events (e.g. asset bubbles/busts, including housing, trade deficits, monetary policies, and reduced economic activity and increased unemployment, etc.) beyond the control of any bank or mortgage lender, which I have discussed at length on my blog and others have written about. and 2) A gradual deterioration of mortgage lending program guidelines over many years. Government and private mortgage lenders, investors, guarantors, and insurers all established riskier mortgage loan programs over time. This posting is all about #2. Don’t believe me, that it’s the primary cause of the U.S. mortgage crisis (within our control)? You don’t have to believe me. See the excerpt just below from Elizabeth Warren’s Consumer Financial Protection Bureau (CFPB). They agree with me. There is no mention of mortgage defect rates or mortgage fraud is there (and there isn’t in the full document either)? (And by the way, for my final blog posting on mortgage credit risk, I will prove the government and others claims of high pre-crisis mortgage underwriting defect rates are bogus, a Red Herring.) The CFPB only mentions “ability to repay” (a mortgage loan program guideline) and “the gradual deterioration of underwriting standards” (again, that’s not the activity of mortgage underwriting, “mortgage underwriting standards” is another term for “mortgage lending guidelines”). Also, I have attached an excerpt from former FCIC Commissioner and AEI Scholar Peter Wallison’s 2016 writings, where he shows a table from Fannie Mae’s 2nd Quarter 2009, 10-Q, that discloses credit losses by product feature (another term for loan program guidelines). The increased losses are directly related to the riskiness of the lending guidelines and not to mortgage underwriting defects or fraud (which while present were minor and non-systemic and so weren’t disclosed anywhere by Fannie or anyone else). Could it be any clearer? So, how did this happen and who is responsible? First, I want to dispose of another related falsehood. In particular as it relates to private MBS issued pre-crisis, many have made roughly the following claim: “mortgage lenders and/or mortgages securities issuers and underwriters (Wall Street) misled investors into buying MBS backed by shoddy mortgages”. That is a LIE. Every single one of these transactions disclosed upfront all key lending guidelines for each mortgage loan (Fannie Mae’s “product features” below), underlying each MBS. These disclosures, on an electronic “tape”, were available to everyone involved in the transaction, and included borrower name, property address, loan amount, whether it was a 1st lien or 2nd lien/HELOC, appraised value of the home, loan-to-value ratio, FICO score, whether income was documented or not and how much, debt-to-income ratios if applicable, whether other assets were verified and how much, etc…and this data was audited, in our case by a major U.S. auditing firm, who issued a “comfort letter” in each securitization that the data on the “tape” matched the data in the loan files. So the securities issuer, the underwriter, the insurer, the rating agencies, and most importantly the investor, understood clearly the key risk parameters of the underlying mortgage loans in every single transaction. (This is why I said in an earlier blog posting re. the movie The Big Short, “They used the securities’ prospectuses and the individual loan data on the tapes to make their decision to short, the disclosures worked!”) So back to, “Who is responsible for deteriorating mortgage lending guidelines/standards over many years?” I think Peter Wallison makes a strong case that well-intended government policies/mandates to expand home ownership in America, was a key cause (and I have documented his work in this area extensively on this blog). I have also mentioned less prominently numerous times on this blog two other key issues both related to The Federal Reserve: Our Central Bank: 1) As a result of the Fed’s dual-mandate (stable prices and low unemployment), I and others believe their monetary policies led to a smoothing-out of economic cycles. Greenspan and Bernanke even bragged about this, calling it “The Great Moderation” period. However, there was an important, negative unintended consequence of this that is not discussed much. During times of stable and growing economic activity, it is well-known that credit expands, both as a result of more economic activity and lending standards loosen/deteriorate, because the good economy masks lending risks. In other words, if as a result of the Fed’s distortions, you don’t have the ups and downs of normal economic/business cycles, you won’t have a normal credit cycle either, with a normal correction in credit standards, when the economic downturn hits. Some have used the analogy of the U.S. Forest Service not allowing smaller natural fires to burn and so putting us at risk for much larger, highly destructive ones. And 2) Because the Federal Reserve, pre-crisis and now again post-crisis, in its mis-guided attempt to fulfill its dual mandate, distorted interest rates far lower than normal for long periods of time, they forced investors, both pre-crisis and again now, to seek out riskier assets (like riskier private MBS pre-crisis) resulting in massive mal-investment. In other words, The Fed’s monetary policies created more demand, than the free market would otherwise, for risky mortgage securities and other risky investments. Many now believe that The Fed is a key cause of asset bubbles and busts and our financial instability. Bankers and mortgage lenders, as financial intermediaries between borrowers and investors, were just responding to the economic incentives created by these well-intended government distortions of the marketplace. Who is the real control point? Isn’t it the investors? As soon as investors stopped buying private MBS, riskier mortgage loans stopped being made, except those risky mortgages that are still being insured and/or guaranteed by the government: FHA, VA, Fannie Mae, and Freddie Mac!”, Mike Perry, former Chairman and CEO, IndyMac Bank
Excerpt from The Consumer Financial Protection Bureau’s 2016: Policy priorities over the next two years:
“With a market size of approximately $10 trillion, the mortgage market is far and away the largest consumer credit market. For most consumers, a mortgage is a necessary step in the path to home ownership….The CFPB envisions a mortgage market where lenders serve the entire array of credit-worthy borrowers fairly and in a non-discriminatory manner, servicers’ processes result in fair and efficient outcomes for consumers, and new mortgage rules are implemented in a manner that supports a sustainable mortgage market…Why is this a near-term policy goal? Leading up to the mortgage crisis, certain lenders originated mortgages to consumers without considering their ability to repay the loans. The gradual deterioration in underwriting standards led to dramatic increases in mortgage delinquencies and foreclosure rates….As required by the Dodd-Frank Act, the CFPB issued several rules to address the issues that helped cause the crisis. The Bureau is now responsible for implement those rules. This includes requiring that lenders assess a borrowers ability to repay a mortgage before making the loan.”,
From former FCIC Commissioner and AEI Scholar Peter Wallison’s 2016 writings about the mortgage crisis:
“Perhaps the most telling exclusion from the report were data published with Fannie’s 10-Q report for the second quarter of 2009 – after the firm was taken over by the government but almost two years before the FCIC issued its report. Table 2 includes an excerpt from the 10-Q that shows all the NTMs they held at that time. These amounted to $838 billion, less than a third of Fannie’s $2.8 trillion book of business, but they were responsible for 81 percent of its 2008 credit losses.
TABLE 2: FANNIE MAE CREDIT PROFILE BY KEY PRODUCT FEATURES (AS OF JUNE 30, 2009)
|Product feature||Unpaid principle ($B)||Percent of credit losses (%)|
|Loans with FICO < 620||109.3||11.8|
|Loans with FICO ≥ 620 and <660||230.4||17.4|
|Loans with original LTV ration > 90%||262.6||21.3|
|Loans with FICO < 620 and original LTV > 90%||24||5.4|
|Subtotal of key product features||837.8||81.3|
SOURCE: Fannie Mae
The FCIC majority thus seemed to have made up its analysis for why Fannie and Freddie bought all these risky NTMs in order to fit the conclusion it wanted to reach: that insufficient regulation and Wall Street greed — and not government housing policy — caused the financial crisis.”
“Mortgage Credit Risk #1: Mortgage Underwriting Did Not Cause the Crisis: Some important thoughts on why claims by the government (and others) that mortgage underwriting deficiencies by banks and private mortgage lenders, were a material cause of losses to mortgage securities investors and insurers (including FHA, VA, Fannie, and Freddie) is largely bogus, a Red Herring…
…First, credit losses on pools (securities) of mortgage loans come from four sources: 1) The program parameters of the loan (also called product or loan/lending guidelines). For example, a mortgage with little or no down payment/equity. (The lower the down payment/equity, the higher the loan-to-home value ratio, and generally the higher the credit risk/risk of borrower default.) Or a borrower with a low credit score. (A borrower with lower or poor credit, is generally a higher credit risk.) 2) An error by the mortgage underwriter in determining whether the borrower and the property/collateral meet the program parameters. 3) Fraud on the part of the buyer/borrower, seller/builder, lender, appraiser, Realtor, or other party to the transaction. and 4) Macroeconomic events beyond the control of the borrower, mortgage lender, or investor. Examples would include significant changes in home prices and/or employment.
In preparing this blog posting, I sent a note out to several industry veterans asking the following question: “How does a mortgage underwriter know that a mortgage application is prudent and responsible and therefore they should approve it? Seems like a pretty simple question, but is it?” Everyone in the industry agrees that a loan with 20% down payment, where the borrower has good credit, a good job that pays enough to easily afford the mortgage, and solid cash reserves (for a “rainy day”) in the bank is a prudent and responsible mortgage. Everyone knows intuitively that’s a good loan, but the reality is they don’t really know. And it’s even harder to determine what’s a “prudent and responsible” mortgage, when you deal with the reality that most mortgages today (especially first-time homebuyers) involve very little down payment, to borrowers who are stretching to afford the home and mortgage. Why don’t mortgage underwriters and other mortgage industry vets know what’s a “prudent and responsible” mortgage? Because, believe it or not, nearly everyone in the mortgage banking industry is not involved in assessing mortgage credit risk. They may think they are (even seasoned veterans), but they aren’t. Why is that? Any mortgage loan can go bad, even one that appears very safe upfront, because a percentage of mortgage borrowers, suffer a personal tragedy…death, divorce, job loss, serious health issue, etc….each year (I have heard it’s 5% a year) that causes them to struggle with their mortgage. So think about it, what would an underwriter do knowing that one mortgage they approved defaulted and the lender/investor suffered a loss, as result? Chances are they would draw the wrong conclusions and make the wrong underwriting decisions going forward. To properly assess mortgage credit risk, you have to look at mortgage credit losses in large, statistically-valid pools (by product-type, by geography, and by many other characteristics) and by vintage (year) over many years and over various economic cycles. Almost no one in the mortgage industry does that. The ones who did that, were the rating agencies, Fannie and Freddie, FHA, and a handful of other large institutions and they set the lending guidelines, for the entire industry, from what’s called today “Big Data.” To restate, the bulk of the mortgage industry is mainly just data collectors and fact/data verifiers, with a hunch (that could just as easily be wrong, as right) about mortgage credit risk.
I know I am repeating myself, but this is important to understand. Underwriters in the mortgage lending industry, even ones with years of experience, have little-to-no ability to know whether a particular mortgage loan is a “prudent and responsible” mortgage/acceptable credit risk or not. Why is this? Mortgage underwriters are only responsible for making sure that a borrower and the home (value, as collateral) meet the loan program’s parameters/lending guidelines. For various reasons to extensive for me to discuss here, while they might hear about a loan they underwrote and approved that defaulted or had to be repurchased from an investor or indemnified against loss, they never get to see the overall results of their underwriting decisions. They never see the actual performance of all the loans they underwrite and in most instances it wouldn’t be helpful anyway, because most mortgage underwriters and even most mortgage lenders, don’t underwrite a large enough population of loans, over diverse economic cycles, to be able to draw any statistically-valid conclusions. In other words, mortgage underwriters are mainly fact-checkers. Their role is to ensure that the mortgage loan file (some now over 1,000 pages of numerous documents) meets the mortgage loan program guidelines and if it does not (and cannot), to generally decline or reject the borrower’s mortgage application. Mortgage loan programs have guidelines, rather than absolute rules, so borrowers with a minor weakness in one area, may still appropriately be approved for a mortgage, if they have strengths in one or more other areas. In industry jargon, these strengths are called “compensating factors”, that compensate for a weakness in another area. For example, let’s say a loan program’s guidelines requires a borrower to have a minimum FICO score of 680 and the borrower has an actual score of say 670 (a minor difference), but has cash in the bank that far exceeds the minimum and a better job and income than normally required. The underwriter, in their judgment, may approve the loan based on these positive “compensating factors.” My belief is that some, and possibly most, of the mortgage defects cited in government and other claims against the industry, are minor guideline discrepancies, where other compensating factors, resulted in the mortgage’s approval. In future blog postings on mortgage credit risk, I will show how initial mortgage defect rates cited by the government and others, fall dramatically (are reduced by 80% to 90%) as mortgage lenders and investors like FHA engage in a proper review (back-and-forth) of these initial mortgage defect claims. Much like the back and forth you have when you are audited by the I.R.S.. I believe the government deliberately stopped this “back-and-forth” process for crisis era (bubble/bust period) mortgages (2006-2011), because they knew it would dramatically reduce their Red Herring allegations of high mortgage defect rates and therefore their claims and moral authority.
Bottom line, the activity of mortgage underwriting plays a relatively small role in credit risk management and any errors that they might make would generally be fairly small and not systemic. As result, despite all the hype to the contrary, mortgage underwriting had little-or-nothing to do with the U.S. mortgage and housing market collapse in 2008 and resulting financial crisis. And while mortgage fraud might have been elevated during the bubble, again it’s a smaller, non-systemic issue. (No one, as far as I am aware, has provided any statistically-valid facts to support mortgage fraud being a material cause of the mortgage crisis.) So what caused the U.S. mortgage crisis? I believe its #1 above, expanded/riskier loan program guidelines over time, and #4 above, macroeconomic events. I have discussed/documented the macroeconomic issues at length on this blog and so I will focus my next blog posting on #1, expanded/riskier loan program guidelines.”, Mike Perry, former Chairman and CEO, IndyMac Bank
This May 17, 2016 email from me to Mark Calabria of The Cato Institute (responding to his article advocating portfolio lending for mortgages over securitization), further explains my points above:
Dear Mark (Calabria of The Cato Institute),
My name is Mike Perry. I am the 53-year old former Chairman and CEO of IndyMac Bank, which failed during the 2008 financial crisis (and was a major mortgage lender and issuer of private MBS, pre-crisis). I have a blog at www.nottoobigtofail.org that is all about IndyMac, mortgage lending and the financial crisis, that you might be interested in. I am also a small donor and follower of The Cato Institute.
I read your April 21 Commentary this morning and I found much to like and agree with you on.
In regards to securitization vs. the originate-and-hold model of mortgage finance, you miss two HUGE benefits of securitization.
Let me step back for a minute. I recently asked a number of senior mortgage industry folks, “how do you know when you have underwritten a prudent/responsible mortgage loan?” Pretty simple question, right? No one could answer this simple question, in my view.
Why? First, because mortgage underwriting is mis-named/mis-understood. Unlike underwriters in say insurance, mortgage underwriters do not have any skills or experience in determine the credit risk of a particular mortgage (borrower and collateral). Mortgage underwriters are just fact checkers. Making sure the borrower and the collateral (property), meet the program guidelines (whether those are established by the government mortgage firms like Fannie, FHA, whether those are established by private securitization or secondary whole loan markets, or whether they are established by the underwriters own bank, in an originate-and-hold environment). In fact, I checked recently, and mortgage underwriters still rarely see the actual performance of the mortgage they underwrite and even if they did, how would they evaluate that, when its not a big enough or representative enough sample to determine with any statistical relevance, whether the loan should have been made or not.
Clearly, I think we all can guess that loans with 20% or more in down payment/equity, where the borrower has excellent credit, and a solid and stable job where the income clearly allows them to afford the mortgage is a prudent risk. But, we live in the real world and the real world is that most purchase mortgage loans (and most of these are provided through a government guarantee) these days, involve very little in the form of down payment and often to borrower with less-than-excellent credit, who are stretching to pay the mortgage, and have little in cash reserves or other assets.
In that situation, the only way to know that a mortgage is prudent/responsible….is if you have lot’s and lot’s of loans and can evaluate their performance over time via statistical models. That, to me, was the biggest benefit of securitization.
Also, I see a lot of originate and hold mortgage lenders putting 30-year fixed rate mortgages in portfolio these days, at these historically low rates. In fact, because a portfolio lender does not have to mark to market their loans held for investment, they can hide a loss on their balance sheet and bleed it out (through lower spread income) over the life of a mortgage. In the originate-to-sell mortgage finance model, if you make an underwriting or pricing error, you immediately are penalized for it, when you try to sell it into the secondary market.
You are right about investors needing to take on risk and understand risk. You are right about government mortgage and deposit insurance distorting the marketplace. You are right about Basel 3 and risk-based capital resulting in too much leverage.
Those all need to be addressed. Take the National Statistical Rating Agencies out of the process and force investors to evaluate the underlying collateral (mortgages) in the bonds…..they would then determine how much subordination the originator needed to retain, before they would buy a senior tranche.
Something like that. Happy to discuss anytime. Best, mike
“…“recap and release” is rubbish. In an election cycle when private enterprise is often accused of crony capitalism and participating in a “rigged” system, it is forgotten that Fannie and Freddie were the very embodiment of crony capitalism. Granted charters by the federal government, they benefited from presidential appointments to their boards, lines of credit at the Treasury, exemptions from taxation and securities registration, and minimal capital requirements, even as they accumulated enormous, undiversified portfolios of mortgage assets…
…These special provisions permitted Fannie and Freddie to borrow cheaply while asserting (wink, nod) that they were absolutely independent of the federal government. Investors benefited from highly leveraged returns on fees collected to guarantee often risky mortgages. Housing advocates took advantage of off-budget slush funds that Fannie and Freddie were happy to dole out in pursuit of political influence. And the system was rigged to ensure that taxpayers picked up the tab when it all came tumbling down. Recap and release does nothing to change the fundamental flaws in this business model. More important, Fannie and Freddie cannot compete as genuinely private enterprises. The FHFA is currently winding down their portfolios of mortgage assets. If it was a ripe profit opportunity to have a monoline-housing hedge fund, the private sector has been readily able to get into that business at any time. There is nothing special about Fannie and Freddie in that regard. That leaves the business of collecting fees in exchange for mortgage guarantees. It may be that there is a private business model, with competitive rates of return on capital, for providing guarantees on new mortgages. But Fannie and Freddie together carry an existing stock of roughly $5 trillion in mortgages, so they would have to charge much higher fees to accumulate capital to back those guarantees successfully. Those fees would be easily undercut by, and the business lost to, any new competitor entering the guarantee business. The only way Fannie and Freddie’s investors make money is to maintain the existing crony business model. But not even that gets the GSEs out of the woods if they are required to hold adequate capital. As the Journal’s John Carney explained in an April 4 column, at current rates of profit, Fannie and Freddie wouldn’t have enough capital to depart conservatorship for decades. In the end, it isn’t about the details of the law or the policy objectives in low-income housing. The issue is a business model that is dangerous to taxpayers, cannot survive on its own capital, and should not be permitted to continue. Now is not the time for “recap and release.” It’s time to put Fannie and Freddie out of their—and taxpayers’—misery.”, Douglas Holtz-Eakin, “Fannie, Freddie and an Outbreak of Amnesia”, The Wall Street Journal, May 25, 2016
“Well said! I completely agree.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Fannie, Freddie and an Outbreak of Amnesia
The growing ‘recap and release’ movement is a bad idea that could lead to another financial disaster.
Fannie Mae headquarters in Washington, D.C. PHOTO: BLOOMBERG NEWS
By Douglas Holtz-Eakin
A dangerous amnesia pervades the current discussion about the future of mortgage giants Fannie Mae and Freddie Mac. Recall that during the 2008 financial crisis these “government-sponsored enterprises,” hit hard by the subprime meltdown, were put into full-blown government conservatorship, with taxpayers footing the bill for a $188 billion bailout. Many, myself included, thought reforming Fannie and Freddie would be an immediate postcrisis priority. Sadly, it never happened.
Now there’s a growing movement afoot to recapitalize Fannie and Freddie and release them from conservatorship. Even conservative groups such as the National Taxpayers Union and Americans for Prosperity are pushing for passage of the Housing Finance Restructuring Act of 2016, introduced in April by Sen. Mick Mulvaney (R., S.C.), which includes a recap-and-release scheme.
This is a bad idea that fails to address the fundamental flaws in Fannie and Freddie’s business model and could lead to another financial collapse and taxpayer rescue.
Those who favor recap and release are buttressed by a lawsuit filed by investors in Fannie and Freddie equity. Initially, taxpayers were compensated for the bailout with a 10% annual dividend on their investment. In 2012, however, the Treasury Department began sweeping all quarterly profits from Fannie and Freddie into the general fund, nearly $250 billion to date. Investors in the GSEs have sued the government, labeling the Treasury action an illegal “taking” that has prevented Fannie and Freddie from accumulating capital and meriting release from conservatorship.
Affordable-housing advocates, the mortgage industry, home builders and realtors are also in favor of recap and release. They argue that the Federal Housing Finance Agency, the GSEs’ regulator, should reverse course. In other words, stop eliminating Fannie and Freddie’s portfolios of mortgage securities, stop transferring credit risk to the private sector, and—most important—stop the scheduled elimination of Fannie and Freddie capital by 2018.
Regardless of any group’s rationale, “recap and release” is rubbish. In an election cycle when private enterprise is often accused of crony capitalism and participating in a “rigged” system, it is forgotten that Fannie and Freddie were the very embodiment of crony capitalism. Granted charters by the federal government, they benefited from presidential appointments to their boards, lines of credit at the Treasury, exemptions from taxation and securities registration, and minimal capital requirements, even as they accumulated enormous, undiversified portfolios of mortgage assets. These special provisions permitted Fannie and Freddie to borrow cheaply while asserting (wink, nod) that they were absolutely independent of the federal government.
Investors benefited from highly leveraged returns on fees collected to guarantee often risky mortgages. Housing advocates took advantage of off-budget slush funds that Fannie and Freddie were happy to dole out in pursuit of political influence. And the system was rigged to ensure that taxpayers picked up the tab when it all came tumbling down.
Recap and release does nothing to change the fundamental flaws in this business model. More important, Fannie and Freddie cannot compete as genuinely private enterprises. The FHFA is currently winding down their portfolios of mortgage assets. If it was a ripe profit opportunity to have a monoline-housing hedge fund, the private sector has been readily able to get into that business at any time. There is nothing special about Fannie and Freddie in that regard.
That leaves the business of collecting fees in exchange for mortgage guarantees. It may be that there is a private business model, with competitive rates of return on capital, for providing guarantees on new mortgages. But Fannie and Freddie together carry an existing stock of roughly $5 trillion in mortgages, so they would have to charge much higher fees to accumulate capital to back those guarantees successfully. Those fees would be easily undercut by, and the business lost to, any new competitor entering the guarantee business.
The only way Fannie and Freddie’s investors make money is to maintain the existing crony business model. But not even that gets the GSEs out of the woods if they are required to hold adequate capital. As the Journal’s John Carney explained in an April 4 column, at current rates of profit, Fannie and Freddie wouldn’t have enough capital to depart conservatorship for decades.
In the end, it isn’t about the details of the law or the policy objectives in low-income housing. The issue is a business model that is dangerous to taxpayers, cannot survive on its own capital, and should not be permitted to continue. Now is not the time for “recap and release.” It’s time to put Fannie and Freddie out of their—and taxpayers’—misery.
Mr. Holtz-Eakin is president of the American Action Forum and former director of the Congressional Budget Office.
“To me, this new mortgage program is further proof that Wells Fargo’s management and board admitted to acts in its recent DOJ/FHA mortgage settlement that they did not and do not believe are true. How so? If they believed their admissions, they would repair their ways, rebuild their relationship with FHA, and continue to do business with FHA and not initiate the loan program below, which undercuts FHA and the need for its mortgages…
…Right? Some might rightly view Wells Fargo’s DOJ/FHA settlement as selling the bank’s long-term reputation and shareholders down the road, so the current management could “get this behind them.” The BofA/Countrywide Second Circuit Court of Appeals ruling this week, makes Wells’ settlement look like a bad decision. In fact, The Wall Street Journal Editorial Board, commenting this week on the BofA/Countrywide ruling said the following: “The bank’s victory makes us wish other banks had been willing to fight the federal extortion in court rather than roll over to appease political demands for headlines.” Quicken Loans has courageously and rightly decided to fight the DOJ’s bogus FHA claims against them and I think the odds are in their favor to win their case.”, Mike Perry, former Chairman and CEO, IndyMac Bank
May 26, 2016, Joe Light and AnnaMaria Andriotis, The Wall Street Journal
Wells Fargo to Offer Low-Down-Payment Mortgages Without FHA Backing
Wells Fargo & Co. is rolling out a new mortgage for borrowers making minimal down payments, an offering that could allow the bank to step back significantly from a controversial Federal Housing Administration program
Wells Fargo made $6.3 billion in FHA-backed loans last year. PHOTO: RICHARD B. LEVINE/ZUMA PRESS
By Joe Light and AnnaMaria Andriotis
Wells Fargo & Co. is rolling out a new mortgage for borrowers making minimal down payments, an offering that could allow the bank to step back significantly from a controversial Federal Housing Administration program.
The move comes as most of the country’s main banks exit from any substantial role making loans guaranteed by the FHA. The agency insures mortgages made to buyers who would otherwise have a hard time getting loans, but it has been shunned by banks following a wave of lawsuits by the Justice Department that alleged poor underwriting.
Wells Fargo, which made $6.3 billion in FHA-backed loans last year, is the only mainstream bank in the FHA’s top 20 originators, according to trade publication Inside Mortgage Finance.
The bank’s new mortgage allows borrowerswith credit scoresas low as 620 on a scale of 300 to 850to make down payments of as little as 3%, while also allowing them to use income from family members or renters to qualify. The requirements don’t represent a significant expansion of mortgage access, but will allow Wells Fargo to make more loans to low- and middle-income borrowers without going through theFHA.
The bank’s new program, which was launched through a partnership with mortgage-finance giant Fannie Mae, could replace about of half the bank’s current FHA volume and increase its market share, a person familiar with the matter said.
In April, Wells Fargo and the government wrapped up a $1.2 billion settlement in which the lender admitted it submitted ineligibleloans for FHA backing and failed to notify the government when it became aware of the problems. With the settlement, Wells Fargo joined J.P. Morgan Chase & Co., Bank of America Corp., SunTrust Banks Inc. and many other lenders that have been penalized or threatened with penalties for FHA-related problems.
Some executives have said the penalties are too harsh for what they describe as minor errors, while government lawyers have said they have been appropriately high and that some lenders’ actions amounted to fraud.
Wells Fargo, like other banks, has scaled back on FHA-backed mortgage lending in recent years. The bank’s loans accounted for just 2.5% of total FHA mortgage dollars originated in 2015, down from 9% in 2013 and 13% in 2010, according to Inside Mortgage Finance.
Banks including J.P. Morgan and Bank of America were in the top 20 lenders under the program as recently as 2014, before they curtailed their participation. Nonbank lenders have rushed in to fill the void.
Bank of America in February unveiled a new low-down-payment mortgage of its own without FHA backing. The Self-Help Ventures Fund, a Durham, N.C.-based nonprofit, agreed to absorb some losses in the event a borrower defaults, to reduce the cost of that product. Self-Help said the Bank of America product is on pace to make between $300 million and $500 million in mortgages within the first year.
Self-Help, which comprises a state and a federally chartered credit union as well as the ventures loan fund and has a total of $1.6 billion in assets, also teamed up with Wells Fargo to take on the risk of a borrower defaulting on some mortgages in its program.
The new Wells Fargo product might save money for some borrowers who would have otherwise taken out an FHA-backed loan. For example, a borrower who buys a $200,000 home and has a credit score of 715 would pay about $1,040 a month with an FHA loan from Wells Fargo, assuming the borrower includes the FHA program’s upfront costs in the loan amount and makes a 3.5% down payment, the minimum the agency requires. The same borrower under the new program would pay about $994 a month with a 3% down payment.
By taking a housing-education course, the borrower could reduce the mortgage rate by an additional one-eighth of a percentage point, making the payment about $979 a month.
The FHA in recent months has attempted to clarify lenders’ responsibilities in making FHA-backed loans to keep them from withdrawing from the program, but many lenders believe the program’s legal risk is still too high.
“There’s clearly a disincentive to use the FHA for first-time home buyers in the way it’s been done in the past,” said David Stevens, CEO of the Mortgage Bankers Association, a lender trade group.
An FHA spokesman in an email said, “We believe our efforts to clarify policies and streamline processes are helpful for lenders looking to do business with FHA and serve a critical part of the home buying population.”
Fannie Mae and competitor Freddie Mac have backed loans with down payments of as little as 3% for more than a year, though the programs’ volume is still small. In the past five quarters, Fannie has backed about 30,000 mortgages with down payments of less than 5%, which is about 1% of its business.
Fannie Mae Vice President of Product Development Jonathan Lawless said programs similar to Wells Fargo’s could be developed by other lenders and that he expects the volume of low-down-payment mortgages that Fannie backs to grow.
“Like Bernie, officials in the Obama Justice Department love to throw around the word “fraud” when a case involves a bank. In 2013 they even convinced a jury that fraud had occurred when Countrywide sold some mortgages to Fan and Fred that didn’t meet the quality standards required under its contracts with the two mortgage giants…
…But facts matter under the law even if they don’t in politics. The mortgages at issue were prime loans, and there’s a difference between failing to meet the terms of a contract and perpetrating a fraud. As the appeals court panel noted, “It is emphatically the case—and has been for more than a century—that a representation is fraudulent only if made with the contemporaneous intent to defraud—i.e., the statement was knowingly or recklessly false and made with the intent to induce harmful reliance.” The judges added that the government “did not prove—in fact, did not attempt to prove—that at the time the contracts were executed Countrywide never intended to perform its promise of investment quality. Nor did it prove that Countrywide made any later misrepresentations—i.e., ones not contained in the contracts—as to which fraudulent intent could be found.” Continuing to educate government attorneys, the appeals court noted Justice Oliver Wendell Holmes’s “articulation of the common law’s view of contracts as ‘simply a set of alternative promises either to perform or to pay damages for nonperformance.’” Justice officials must have known they didn’t have evidence of civil—never mind criminal—fraud. But they also knew that you can’t get the political left fired up by promising to punish banks merely for breach of contract. Occupy Wall Street until they fulfill previously agreed-upon covenants!
The case is thus another reminder that the financial crisis had more to do with bad policy incentives, loose monetary policy and the resulting mania for residential housing investment than with some spontaneous surge in greed and criminality.
Bank of America shareholders have every right to be outraged at the government’s conduct, which did more than simply tarnish their brand among financial consumers. The government’s initial win at trial gave the feds leverage, which they used to force the bank to pay more than $16 billion in a larger and even more dubious mortgage settlement. The bank’s victory makes us wish other banks had been willing to fight the federal extortion in court rather than roll over to appease the political demand for headlines. They might have won too. Oh, and where does Rebecca Mairone go to get her reputation back? An apology from U.S. Attorney Preet Bharara and other Justice officials would be a start.”, “The Bank Fraud That Wasn’t”, The Wall Street Journal Editorial Board, May 25, 2016
The Bank Fraud That Wasn’t
A federal appeals court overturns a politicized mortgage case.
Bernie Sanders claims that fraud is the business model of Wall Street, and most of the Democratic Party has complained for years that prosecutors went too easy on bankers after the financial panic. But this week three federal appellate judges unanimously ruled that the Justice Department didn’t go too easy on bankers; it went way too far.
A panel of the Second Circuit Court of Appeals overturned a $1.27 billion penalty against Bank of America and tossed out a $1 million penalty against Rebecca Mairone, a former executive at Countrywide Financial, which Bank of America bought during the panic. The government had claimed in its civil case that Countrywide ripped off Fannie Mae and Freddie Mac by selling shoddy mortgages to the two government-created firms.
Like Bernie, officials in the Obama Justice Department love to throw around the word “fraud” when a case involves a bank. In 2013 they even convinced a jury that fraud had occurred when Countrywide sold some mortgages to Fan and Fred that didn’t meet the quality standards required under its contracts with the two mortgage giants.
Regular readers of these columns know we were critics of all three parties in these transactions— Angelo Mozilo’s Countrywide subprime factory, as well as the two government-sponsored enterprises that were eager to buy his mortgage paper.
But facts matter under the law even if they don’t in politics. The mortgages at issue were prime loans, and there’s a difference between failing to meet the terms of a contract and perpetrating a fraud. As the appeals court panel noted, “It is emphatically the case—and has been for more than a century—that a representation is fraudulent only if made with the contemporaneous intent to defraud—i.e., the statement was knowingly or recklessly false and made with the intent to induce harmful reliance.”
The judges added that the government “did not prove—in fact, did not attempt to prove—that at the time the contracts were executed Countrywide never intended to perform its promise of investment quality. Nor did it prove that Countrywide made any later misrepresentations—i.e., ones not contained in the contracts—as to which fraudulent intent could be found.”
Continuing to educate government attorneys, the appeals court noted Justice Oliver Wendell Holmes’s “articulation of the common law’s view of contracts as ‘simply a set of alternative promises either to perform or to pay damages for nonperformance.’” Justice officials must have known they didn’t have evidence of civil—never mind criminal—fraud. But they also knew that you can’t get the political left fired up by promising to punish banks merely for breach of contract. Occupy Wall Street until they fulfill previously agreed-upon covenants!
Countrywide did rush loans through its mortgage pipeline that turned out to be bad credit risks. But it did so in part because Fannie and Freddie were in a rush to buy them. They were hardly innocent victims.
The case is thus another reminder that the financial crisis had more to do with bad policy incentives, loose monetary policy and the resulting mania for residential housing investment than with some spontaneous surge in greed and criminality.
The case also casts doubt on the use in these cases of the Financial Institutions Reform, Recovery, and Enforcement Act. Prosecutors like the law because in various ways it stacks the deck in their favor. The catch is that they have to claim the alleged fraud affected a federally insured financial institution.
In a novel interpretation developed after the financial crisis, prosecutors decided that if they couldn’t find a bank to serve as the victim, they could consider the banks to be victimizing themselves. The lawyers call it a “self-affecting” fraud. In this case since there wasn’t any fraud we won’t have the chance to learn whether it’s an actual offense or merely a case of prosecutors self-affecting themselves.
Bank of America shareholders have every right to be outraged at the government’s conduct, which did more than simply tarnish their brand among financial consumers. The government’s initial win at trial gave the feds leverage, which they used to force the bank to pay more than $16 billion in a larger and even more dubious mortgage settlement.
The bank’s victory makes us wish other banks had been willing to fight the federal extortion in court rather than roll over to appease the political demand for headlines. They might have won too.
Oh, and where does Rebecca Mairone go to get her reputation back? An apology from U.S. Attorney Preet Bharara and other Justice officials would be a start.
“Three U.S. Federal Appeals Court judges unanimously ruled that BofA/Countrywide (and an individual manager) DID NOT commit mortgage fraud, overturning a jury’s erroneous decision in the government’s civil case alleging that Countrywide ripped off Fannie and Freddie by selling shoddy mortgages to them and this reporter devotes an entire article to refuting this ruling and bad-mouthing it as a “legal technicality.” Since when did the LA Times Business Section become a liberal OpEd page…
…that doesn’t care about the facts or the law? Again, as I have said many times on this blog, the truth is emerging and destroying the false liberal narrative that greedy and reckless bankers caused the financial crisis.”, Mike Perry, former Chairman and CEO, IndyMac Bank
May 24, 2016, Michael Hiltzik, The Los Angeles Times
The legal technicality that let BofA skate on an alleged billion-dollar mortgage fraud
Bank of America gets a break on alleged mortgage fraud. (AFP/Getty Images)
Michael Hiltzik, Columnist
If I’m ever dragged into court for a financial fraud, I want to throw myself on the mercy of Judge Richard C. Wesley.
Wesley is the U.S. appeals court judge in New York who, with his colleagues Reena Raggi and Christopher F. Droney, found a loophole in federal fraud law big enough for the nation’s second-largest bank to fit through without even scratching a fender. In a ruling written by Wesley and issuedMonday, the three judges tossed out a $1.3-billion judgment against Bank of America for stuffing thousands of lousy mortgages into the portfolios of Fannie Mae and Freddie Mac in 2007 and 2008 by pretending they were high-quality loans. Their ruling turned on the curious question: “When is a fraud not a fraud, but just, sort of, a lie?”
(Countrywide’s ‘Hustle’ program) was…the vehicle for a brazen fraud…driven by a hunger for profits and oblivious to the harms.— U.S. District Judge Jed S. Rakoff
Anyone concerned about white-collar crime should be find the appellate court’s logic appalling. One who does is Dennis Kelleher, a former corporate lawyer who is now CEO of the financial watchdog group Better Markets. “You wonder why the American people are so cynical,” he told me after the decision came down. “It’s because there’s an endless reservoir of ways to figure out how to hold no one accountable for illegal conduct.”
In Monday’s decision, the appellate judges didn’t actually question that the mortgages sold to Fannie and Freddie by BofA (originally via Countrywide Financial, the subprime lender BofA acquired in 2007) weren’t the quality they were claimed to be. Indeed, they didn’t really address at all that question, which was analyzed in great detail by the trial court judge who imposed the $1.3-billion penalty, New York Federal Judge Jed S. Rakoff.
Rakoff found that Countrywide/BofA set up a mortgage program known as the “High Speed Swim Lane” (HSSL), or “Hustle,” to crank out low-quality mortgages at great speed. Under the leadership of BofA executive Rebecca Mairone, Rakoff concluded after trial, the conventional quality-control measures for mortgages were thrown out the window. (Rakoff hit Mairone with a $1-million penalty, which was also overturned by the appeals judges.)
The program transferred responsibility for vetting the loans “from quality-focused underwriters to volume-focused loan specialists” using automated credit software, eliminated rules that effectively reduced commissions for low-quality loans, and cut the turnaround time for processing mortgages to 15 days from six weeks or more.
With speed and volume taking precedence over quality, a huge percentage of these loans was destined to be lousy. Sure enough, more than 42% of the loans were “materially defective,” Rakoff found. As far as Fannie and Freddie knew, however, they all still met Countrywide’s contractual representation that all the loans were “investment quality.”
Instead, Rakoff wrote, HSSL “was from start to finish the vehicle for a brazen fraud…driven by a hunger for profits and oblivious to the harms thereby visited, not just on the immediate victims but also on the financial system as a whole.” Fannie and Freddie, he concluded, “would never have purchased any loans from the Bank Defendants if they known that Countrywide had intentionally lied to them.”
So how, you might ask, could Bank of America wriggle out of that one?
The answer is through what Kelleher calls a “hyper-technical decision.” The judges based their ruling on the contracts that Countrywide had reached with Fannie and Freddie, pledging to provide those government-sponsored firms with “investment quality” mortgages. There was no evidence, the appellate judges found, that the executives who signed those contracts intended at the time to stuff the pipeline with toxic junk. It just turned out that way.
Because there was no intent to defraud when the contracts were signed, the judges ruled, this whole affair is merely a case of breach of contract, not fraud. The penalties for a breach are much lower than those for fraud–often, the guilty party has to give back the money it got from breaking the contract. According to the judges’ analysis, a mere breach of contract can’t be elevated into a case for fraud.
There are a few problems with this analysis. One was pointed out presciently by Judge Rakoff. In a 2013 ruling in the case, he observed that under the federal mail fraud statute, that limitation doesn’t apply. In any event, the bank’s misrepresentations were continuous and ongoing: every time it sold Fannie or Freddie a substandard loan, it was arguably lying.
The biggest danger with the court’s exoneration of the bank, however, is that it provides a road map for white-collar wrongdoers to evade responsibility. Breach-of-contract damages, as Kelleher says, have “zero deterrent effect — there’s no downside for committing the fraud.” You either get away with it and pocket the gains, or you get caught, and have to give back the money. The way to stamp out fraud, however, is to make punishment greater than the potential gains.
That course was closed off by the appeals judges. Wrongdoing executive now know they only have to dredge up a preexisting contract “breached” by their behavior–since few businesses enter into contract plotting in advance to make it the vehicle for fraud, this becomes an all-purpose get-out-of-jail-free card.
It’s quite possible that the appeals court happened upon a loophole that had been lying around for years. If that’s the case, Congress should close it, quick. On the other hand, Judge Rakoff anticipated and rejected that argument, and even pointed out that Congress closed the loophole by amending the mail fraud statute — in 1909. It’s also likely that the government will appeal the latest ruling to the full 2nd circuit court, and thence, if necessary, to the Supreme Court.
The loophole Judges Wesley, Raggi, and Droney identified should hearten anyone motivated by pure greed in financial dealings. For the rest of us, it’s a ticking time bomb, until Congress or the courts extinguish the fuse.
“Speaking of legal matters, Guild Mortgage grabbed the headlines yesterday as the Department of Justice filed a lawsuit against Guild under the catch-all False Claims Act. The action is captioned United States ex rel. Dougherty v. Guild Mortgage Company (D.D.C.). It continues to be interesting why smaller lenders seem to continue to originate this product wholeheartedly whereas the big banks, such as Chase, have moved away from the program given the potential liability…
…Do smaller companies think that they are too small to be noticed, or are immune from prosecution? Or because they were originating perfect FHA loans ten years ago? Yes, this suit covers originations starting in 2006. Settling with the DOJ is certainly an option – just ask Wells Fargo, Franklin American Mortgage, Walter Investment, First Tennessee Bank, Freedom Mortgage or M&T Bank how to do it. Guild acted as a “direct endorsement lender” in the FHA insurance program, which grants the lender the authority to originate, underwrite and endorse mortgages for FHA insurance without prior review or approval from the FHA. The news prompted one industry vet to write to me saying, “I wonder if the DOJ understands how these enforcement actions cause FHA versus conventional primary market price spreads to widen and is costing every low and middle income FHA borrower about 200 bps in price compared to where levels would be without lenders building in the cost of the uncertainty into their daily price sheets? And ‘enforcement actions?’ ‘Extortion’ now numbering into the billions of dollars in actual fines levied upon lenders with deep pockets and the additional safeguards to avoid such extortion that has caused huge inefficiencies in producing the product. In the end the government wins and the consumer loses. This is the exact opposite effect that these programs were designed to avoid.” Taking the high road, Guild released a public statement. Mary Ann McGarry, president and CEO of Guild Mortgage Co., issued the following statement regarding an action initiated against Guild by the Department of Justice: “We are extremely disappointed that the Department of Justice has elected to pursue this action. Guild has a proud record of making FHA loans since 1961 and we welcome the opportunity to set the record straight and correct the numerous misstatements in the government’s complaint. The government’s action is unwarranted and without merit. The implication that any default on an FHA loan by a borrower represents wrongdoing by the lender is not justified. For more than five decades Guild has responsibly underwritten fixed rate and fully documented loans in accordance with FHA requirements. This enforcement environment that lenders face today threatens to limit opportunities for home ownership and hurts the housing market. It is contrary to the mission of HUD and the FHA program to help the underserved – a Guild tradition since its founding in 1960. It is unfortunate that lenders such as Guild have been placed in this untenable position where any minor error could result in substantial financial penalties. To help families with low and moderate incomes, we need to expand home buying opportunities, not shrink them. Sadly, if this punitive environment continues, the cost of lending will continue to increase for FHA borrowers and only the wealthy will be able to buy homes. Although we disagree with the allegations and intend to defend ourselves vigorously, we will continue to serve the FHA and first-time homebuyers, which we have served for more than 50 years.””, Excerpt from May 2016 Mortgage Industry Newsletter
“These policies (The Fed’s ultralow interest rates) are toxic for financial stability. They force retired people to curtail spending and discourage the young from saving for retirement. They force people into making risky investments and don’t stimulate economic growth. Worse, they gradually undermine personal responsibility and ensure that future generations are more dependent on government programs…
…The Fed has kept interest rates near zero for more than seven years…. Those who do save for retirement face enormous pressure to invest in risky assets to stretch for higher returns. Their demand bids up the price of stocks, high-yield bonds and real estate, creating a price bubble that may deflate once interest rates return to normal levels…..The anemic economic growth of the past seven years has revealed the ineffectiveness of ultralow interest rates. A return to more-normal interest rates is essential if Americans are going to maintain the strong household balance sheets that are vital for weathering financial storms and saving for retirement.”, Paul H. Kupiec, “The High Cost of Ultralow Interest Rates”, The Wall Street Journal, May 23, 2016
“Post-crisis, The Fed has made clear that increasing the nominal value of assets is a key part of their monetary/economic strategy and they have taken credit for re-inflating the monetary values of stocks, bonds, and real estate, but they swear they have nothing to do with the pre-crisis housing bubble or other asset bubbles/busts!!! Does that make any sense to you? It doesn’t to me and lots of other financial and economic experts.”, Mike Perry, former Chairman and CEO, IndyMac Bank
The High Cost of Ultralow Interest Rates
They discourage saving and undermine personal responsibility, making government dependency more tempting.
By Paul H. Kupiec
At last, the Federal Reserve is sending signals that an interest-rate increase might come next month. That’s good, but a modest bump up, following the one in December, won’t be enough. The sooner the Fed moves from near-zero interest rates—and negative interest rates, the latest central-banker fad—the better.
These policies are toxic for financial stability. They force retired people to curtail spending and discourage the young from saving for retirement. They force people into making risky investments and don’t stimulate economic growth. Worse, they gradually undermine personal responsibility and ensure that future generations are more dependent on government programs.
The Fed has kept interest rates near zero for more than seven years. Experts generally recommend that U.S. households accumulate savings sufficient for 25 years of spending at 80% of earnings the year before retirement. Some savings will be in the form of Social Security benefits. But unconventional monetary policies are making it nearly impossible for most households to achieve the rest.
PHOTO: GETTY IMAGES
To understand why, consider an individual with a master’s degree who begins a career at age 25 with a starting salary of $50,000. Assume his expected income increases by $2,500 each year until age 45, when his annual income reaches $100,000 and remains at that level until retirement at age 65. (This mirrors the average for similarly educated people in the U.S.) Let’s also assume that Social Security provides $28,000 a year in retirement, and there is no inflation. How much he will need to save during his earning years to reach his retirement goals depends on interest rates.
If interest rates are zero, accumulated savings earn nothing, and the individual’s total savings must equal $2 million by age 65 to fund retirement. Future Social Security benefits provide $700,000, which means he must save nearly 38% of pretax earnings each year to accumulate the additional $1.3 million. When interest rates are negative, say minus-1%, he must save 49% of every pretax dollar earned. Oh, and the average U.S. college undergraduate starts a career with nearly $40,000 of student-loan debt that must also be repaid out of income over the first 10 years of employment.
Under these conditions, building private savings to fund retirement becomes infeasible for most people and households. Extended periods of ultralow rates also make it more difficult for families to build precautionary reserves—for example, life insurance and long-term care insurance become prohibitively expensive.
The 2013 Federal Reserve Board’s Survey of Consumer Finances, conducted after nearly five years of the Fed’s near-zero rates, found a significant decline in participation in retirement plans. Other studies find a similar trend. A recent report by GOBankingRates estimates that 33% of Americans have no retirement savings, including 24% of those over age 55.
Those who do save for retirement face enormous pressure to invest in risky assets to stretch for higher returns. Their demand bids up the price of stocks, high-yield bonds and real estate, creating a price bubble that may deflate once interest rates return to normal levels.
Over time, if a majority of voters lack retirement and precautionary savings or insurance, politicians will be only too happy to introduce new government programs to fill the void. Widespread expectations of government transfers subvert the responsibility to live more prudently and save.
The anemic economic growth of the past seven years has revealed the ineffectiveness of ultralow interest rates. A return to more-normal interest rates is essential if Americans are going to maintain the strong household balance sheets that are vital for weathering financial storms and saving for retirement.
Mr. Kupiec, a resident scholar at the American Enterprise Institute, is the former director of the Center for Financial Research at the Federal Deposit Insurance Corp.
“What the chart does accurately represent is the pullback of traditional banks from the mortgage lending business, primarily due to the federal government’s onerous and over-the-top enforcement regime that is extracting hundreds of millions of dollars in fines and settlements.”, David H. Stevens, President and CEO, Mortgage Bankers Association, May 19, 2016
May 18, 2016, Opinion Letters, The Wall Street Journal
Government Drives Banks From Mortgages
The chart accurately represents the pullback of traditional banks from the mortgage lending business.
I would like to clarify a point in a chart accompanying “Private Lending Fills Gap Left by Wary U.S. Banks” (page one, May 12). While the category of independent mortgage lenders does include some private lenders, it doesn’t include all of the private lenders mentioned in the article. It includes only those that have originated more than $10 million in mortgages or at least 100 mortgages in the preceding year.
By this definition, independent mortgage lenders have long been a staple of the mortgage market, working within their communities to offer sustainable mortgage credit to qualified borrowers. They are strictly regulated by state and federal agencies and must meet rigorous operating and capital standards from the counterparties they do business with—often other banks, investors, Fannie Mae, Freddie Mac and even government entities like the Federal Housing Administration.
What the chart does accurately represent is the pullback of traditional banks from the mortgage lending business, primarily due to the federal government’s onerous and over-the-top enforcement regime that is extracting hundreds of millions of dollars in fines and settlements. Borrowers are fortunate to have well-capitalized and well-regulated independent mortgage banks ready to plug the gap.
David H. Stevens
President and CEO
Mortgage Bankers Association
“How could a small business loan (or any loan) that regulated banks won’t approve, that new online marketplace lenders won’t approve, and that no other private lender will approve, on the same terms and conditions, without a government credit guarantee from the SBA, possibly be a responsible loan?…
…As many other economists and financial experts have noted, a big part of the financial crisis can be explained by well-intended government distortions (mortgage guarantees, government mandates for LMI borrowers, deposit insurance, Fed-distorted rates, tax free capital gains on homes, etc.) of free and fair private markets. P.S. And by the way, my vague understanding is that Ms. Contreras-Sweet’s career, involves little to no previous experience with any significant lending decisions, yet she is managing a government-guaranteed lending program that risks tens of billions of taxpayer dollars every year.”, Mike Perry, former Chairman and CEO, IndyMac Bank
May 18, 2016, Ruth Simon, The Wall Street Journal
Head of SBA Focuses on Access to Capital
Q&A with Maria Contreras-Sweet about challenges for small-business owners
By Ruth Simon
As the head of the U.S. Small Business Administration, Maria Contreras-Sweet has moved to modernize the agency and boost access to capital for underserved communities. The 62-year-old agency, which supports small businesses and entrepreneurs, provided backing for more than 69,000 loans to small businesses totaling nearly $28 billion in the last fiscal year.
Maria Contreras-Sweet, head of the Small Business Administration PHOTO: JORDAN STRAUSS/ASSOCIATED PRESS
Ms. Contreras-Sweet, who previously served as executive chairwoman of a Los Angeles-based community bank for seven years, sat down with The Wall Street Journal to discuss access to capital and other challenges for small-business owners. Edited excerpts:
WSJ: When you took office, you promised to modernize the SBA. What would you say are some of your major accomplishments?
Ms. Contreras-Sweet: We were able to create SBA One, a new process for making loans that will become mandatory on Oct. 1 for all loans where the SBA makes the credit decision. The system has the potential to be transformational. Everything is online. The goal is they should be able to process these loans in a matter of a couple of weeks. That’s a really big deal.
Last year, we launched SBA LINC, which is the Match.com version of SBA. You answer about 20 questions. Instead of going to bank after bank with a really slow “maybe,” you might now get five or six, or maybe one or no, bank that comes back and says we are interested in your loan or we are not interested.
We are now testing ways to take the SBA One concept to contracting. It can take six to eight months to get approved for SBA certification as a contractor. How do we streamline that process?
WSJ: M&T Bancorp Chairman Robert Wilmers recently said that too much of the SBA’s lending authority goes to support larger loans. Is the SBA reaching the kinds of customers you want to be serving?
Ms. Contreras-Sweet: I absolutely disagree. We wanted to make sure that people who had been disenfranchised and had not had access to the SBA now could. It is showing up. Community Advantage loans under $150,000 are up.
WSJ: Microloans backed by the SBA fell in the last fiscal year by 7%. Is getting a loan still a challenge for small businesses?
Ms. Contreras-Sweet: Access to capital is a challenge all around. It is equally important to make certain that small businesses are getting counseling because, even when we get them capital, sometimes they don’t deploy it correctly.
I ask for more money every year [for microloans] from Congress and it has not been easy to get that number up. Microloans are a priority for us.
WSJ: What about the high rates charged by some online small-business lenders?
Ms. Contreras-Sweet: Online lenders are creating dynamic activity that is causing the conventional lenders to be a little more creative and a little more aggressive. You see new partnerships taking place that we might not have seen heretofore, for example, On Deck Capital with J.P. Morgan Chase. I think that holds promise.
We are also seeing more entrants in the space. For me, the question is: What is the SBA’s proper role in that activity? We are not a direct regulator, but how do we protect consumers?
If you look at the way we operate with LINC, we don’t say that we think you should go to this bank, but instead here are your options. We might be able to do something like that with alternative lenders. We have also been working with [SEC Chairman] Mary Jo White because she is starting to put some boundaries around this space.
I believe in transparency and that by providing information to the consumer, you can drive behavior.
WSJ: What do you think will be the key challenges for your successor?
Ms. Contreras-Sweet: The future of financing will take hold in so many different shapes. It is a major responsibility of the SBA to make certain we are helping our nascent and mature businesses navigate through this development.
The second challenge is that entrepreneurs are going to be global in nature. We need to follow the trade agreements where they set the rules of engagement. Our loans on exports are 90% guaranteed. How do we help people partake of those?
We need to have a strong partnership with cities. When I was with Westinghouse and we wanted to locate a facility, municipalities would say that we can give you market credits, tax credits, accelerated permitting. You have got to do that for the small business community.