For whatever reason, stock market-themed flicks have been among Hollywood’s most popular movies. In 1987, who didn’t dig Charlie Sheen and Michael Douglas in “Wall Street”? In 2013, we fell in love with Leonardo DiCaprio in “The Wolf of Wall Street.” More recently, the “Big Short” was the big deal. It’s hard to pinpoint why we love these movies so much. Maybe it’s the excess – or it’s as close as it gets to real life without any of us actually having to go to jail. What we can take from these movies is that life can be stranger than fiction. Who’s to say that in today’s “fake news” world, life won’t repeat itself?
To understand these story lines, we need to go beyond the headlines, sound bites and movie titles such as “Too Big to Fail.” A good movie has a sexy story line. In this tale, it’s the economic meltdown. It has plot twists, heroes and villains.
The start of the meltdown involves understanding the importance of money in America. Greenbacks have always been part of our national obsession. Many of the things we hear on the news or around the water cooler are related to the economy in one way or another. Stories about cash, or the lack thereof, go as far back as the days of our founding fathers. The ability to get credit has literally won our independence and built our industry.
The challenge in the game of life has always been getting a fair shake when it comes to credit. Believe it or not, there was once a time when lenders could consider an applicant’s race, sex and ethnicity when evaluating a loan application. Luckily, consumer protection laws were put in place since then. Today, we look to the Fair Housing Act. It was established to protect buyers and renters from sellers’ or landlords’ discrimination. There’s also the 1974 Equal Credit Opportunity Act, which prohibits discrimination based on race, color, religion, national origin, sex, marital status or age. Another noteworthy law is the 1968 Truth-In-Lending Act (TILA). For the most part, the acts collectively ended old-school discriminatory lending practices.
In this money-themed story, rules were needed to protect consumers from higher-priced mortgages. Laws such as the Home Owners Equity Protection Act (Section 32) were created to fill that need. Section 32 became law in 1994 under “42.” That’s how we identify presidents these days – by their numbers – and “42” is Bill Clinton. Under Section 32, lenders are required to provide certain disclosures. The law also imposed restrictions on high-cost loans.
In addition to Section 32, state regulators instituted their own state-specific, high-cost laws. Those laws regulate the annual percentage rate and costs an applicant can be charged. The rule of thumb is to use whichever law provides the most protection to the consumer.
To diagnose how the Wall Street implosion was even possible, we need to go back to “42.” President Clinton was no different from any other U.S. president; he ran on economy-based campaign promises. Upon election, his administration changed consumer and banking laws. The intent was to make financing for housing more available and affordable. This wasn’t an original idea, but wouldn’t you know it, the plan worked! The Clinton years are best described as a return to economic prosperity, which in many ways set the stage for “43,” or President George W. Bush, who had a governing philosophy of deregulation, which is eerily familiar in today’s news cycle. The further easing of regulatory requirements under “43” has been said to have opened the doors for risky loan programs.
The view from the proverbial time machine tells us that conventional loans were the only game in town back then. Lenders eventually developed alternative financing programs to assist in qualifying the self-employed borrower. If you were self-employed with tons of write-offs on your tax return, it was nearly impossible to get a loan. That need gave birth to the “stated income” and “no-income, no-asset” (NINA) programs of the past.
To better understand these loans, we need to understand the lingo. Loan to value (LTV) is the loan amount compared against the value of the property, reflected as a percentage. The basic formula is to take the loan amount and divide it by the appraised value. For example, a $50,000 loan being made against a property valued at $100,000 is 50% LTV. Second mortgages (junior liens) have the same equation to consider. This is called combined loan to value (CLTV). Back then, the riskier the loan, the lower the LTV/CLTV someone would get. The higher the LTV/CLTV, the less equity in the property, which translates to a lesser chance for a lender to recoup its monies in the event of foreclosure.
In later years, something called a “credit score” came along. Once these triggers got configured, a loan approval was based on the credit score, LTV/CLTV and income verification type (full doc/NINA or stated). As lending got more aggressive after Y2K, higher LTVs on stated loans with lower-scored borrowers became the norm. Eventually, stated and NINA loans were for everyone, not just the self-employed. Anyone who took out a loan could refinance fairly quickly back then. Refis masked defaults that were likely to happen, if they played out. As time went on, high-cost tests for mortgages related to rate and charges, including ensuring a consumer’s ability to repay (ATR), were at the forefront of consumer protection laws. This was a great time to be a consumer and a banker – it meant cheap money.
Like in the movies, borrowing money became fast and furious. Mortgage brokers were popping up everywhere. Consumers were buying and refinancing at an insane and unsustainable pace. To feed the beast that had become the mortgage machine, bankers looked to Wall Street to sell their mortgage-backed securities and collateralized debt obligations. This was the time when securities went from Main Street to Wall Street. This process was known as vertical integration.
It was about that time that the “villains” of our story appeared. Players including Lehman Brothers Bank, Merrill Lynch, Bear Stearns and Goldman Sachs were all vilified by the media. Oh, and let’s not forget Countrywide Mortgage, which was purchased by Bank of America (it, too, was front-page news). Oh, and don’t forget the scammers, such as Bernie Madoff. Collectively, they were the primary figures in the blame game – and deservedly so. All of this, coupled with the amount of mortgage fraud going on, was unreal. Aside from Madoff, the jury hasn’t completely condemned or indemnified the rest. One main reason is that laws back then made it all possible. We also need to consider that the ratings agencies kind of knew what was up, but they signed off on subprime loans.
Real estate professionals, from top to bottom, and consumers alike knew these loans weren’t right. Yet, consumers couldn’t sign on the dotted lines fast enough. As long as everyone got paid, everyone was happy. With this in mind, there’s another movie title that goes well with this story: “Reality Bites!”
As it turns out, Forrest Gump was a prophet – or was it his Mama? Either way, she, or Forrest, said, “Life is like a box of chocolates: You never know what you’re gonna get.” Back then, people really didn’t know what they were getting; they just knew they were getting “what they wanted.” Easily, this can be described as the unintended consequences of prosperity. What exactly was in that box of chocolates? Figuratively speaking, it was real estate. We should have checked for the expiration date on that box. What we didn’t know in 2006 was that home prices would be leveling off. It triggered a mess, as high LTV/CLTV loans became un-refinanceable. The risk spread into the mutual funds, pension funds and corporations that owned these derivatives.
For industry insiders, once stated loans with high LTVs and CLTVs up to 100% were available to first-time home buyers on non-owner-occupied properties, the writing was on the wall. First payment defaults and early payment defaults were suddenly on the rise, and it set off alarms. That is when default rates began to spike. Not only did they spike, but the values that were once on the upswing also reversed themselves. The market correction that analysts had feared had begun.
It was predicted that this market correction could take down industries and municipalities reliant on real estate sales, refinances and taxes collected from those transactions. Not only was this fear a domestic concern, but the dark economic forecast also took on a global feel. The long and short of it was that the subprime mortgage crisis happened because of banks selling off too many high-risk mortgages; then, investors bit into that box of chocolates, and it was not good. Reality does bite!
That box we once loved had a new name, and it was real estate owned, or “bank-owned.”
There is a good plot twist in this story of woe. To curb the hysteria surrounding the economic meltdown, measures were considered and eventually implemented by politicians from both parties. This was done to stay a potential run on banks. Under “44” (President Barack Obama), the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) was enacted. The intent of the DFA was to set up an agency that would restore consumer confidence in U.S. financial systems and better regulate lending practices.
Under the DFA, the Consumer Financial Protection Bureau (CFPB) was established. The CFPB is responsible for consumer protection in the financial sector. The CFPB’s jurisdiction includes banks, credit unions, securities firms, mortgage lenders, servicers, foreclosure relief services, payday lenders, debt collectors and other financial companies. Mandates were also put in place that required banks to meet liquidity thresholds (stress test). New standards of lending practices were also established.
As a result, stated and NINA loans became a thing of the past. A multitude of lending mandates were established to regulate and curb the declining markets and foreclosures that dominated the news. A provision was established that created certain mandates for lenders to utilize appraisal management companies. This was done to build consumer confidence and show consumers that lenders and originators were not colluding to create property values.
But wait – there’s more. On Nov. 20, 2013, the CFPB integrated the Real Estate Settlement Procedures Act (RESPA) and TILA. This is known as the TILA-RESPA Integrated Disclosures (TRID) rule. Under TRID, lenders are required to use integrated disclosure forms for consumers at the time of application and settlement. These forms are known as the loan estimate and the closing disclosure.
This was a lot to consider. In fact, TRID was the most comprehensive change in lending in years. Eventually, a sense of normalcy took hold in the markets.
Despite all of the controversy about the CFPB, markets have since rebounded, and credit is being extended.
Yogi Berra once said, “It’s like deja vu all over again!” As a result of the resurgence in lending activity, programs such as stated and high LTV/CLTV programs are resurfacing. Alternative-credit and lower-credit-score products are popping up, too. Those, coupled with a resurging housing market, have some fearing there is a sequel in the works.
With all due respect to Yogi, we can all breathe a little easier these days. Lenders have more prudent qualifying practices. Certain programs such as the home equity line of credit and reverse mortgage (a.k.a., home equity conversion mortgage) loans are now the new “in” loans. Adjustable-rate mortgages (ARMs) are also coming back.
Let’s give the mortgage industry a little credit. Despite higher rates and the more recent trend of lower loan applications, it could have given in to temptation. Thankfully, the industry hasn’t brought back the 2/28 Interest-Only loan. Instead, it has gone with a 7/1 ARM, which is much better for the consumer.
The need for existing laws was justified. However, as with all laws, their overall effectiveness should be reviewed from time to time. Even Thomas Jefferson suggested laws should be reviewed every 19 years to ensure they reflect the sign of the times. There’s always temptation for any new administration to simply repeal and eliminate laws that may not sync with its campaign promises.
In a perfect world, lawmakers would consider what’s best for the consumer over anything else. To simply change when a change may not be needed could have an opposite effect. Consumer groups suggest that if the DFA were to be repealed or gutted, and if the CFPB were dissolved altogether, it could have an overall negative effect. Other measures that could have adverse impacts include removing the high-cost lending laws and ATR mandates. These mandates insulate poorer and elderly consumers. Then again, there’s the argument that these laws, which are intended to protect consumers, are actually penalizing them.
If history has taught us anything, it is that we cannot rely on good intentions alone. We do need laws that compel us all to fly right. Admittedly, that may be a cynical view. There are countless honest and respectable industry professionals and consumers out there today. With all things being equal, there were plenty of those people back in 2008, too. As for mortgage compliance, there are many opinions on this topic. Some say that the financial investment, as well as upgrades in technical infrastructure to adhere to TRID requirements, has been substantial. Other industry professionals suggest it would be borderline criminal to simply go back to the Wild Wild West, the “anything goes” mentality in lending.
For bankers, liquidity mandates are a tough nut, but they are a big reason consumers have more confidence in the nation’s financial systems. Luckily, there hasn’t been a true measurement scenario to see if these requirements really matter. Some say this is limiting the positive impact that a more robust lending system could offer.
Recently, JPMorgan Chase Chairman and CEO Jamie Dimon called on regulators to overhaul many of the mortgage rules put in place after the financial crisis. He cited the difficulty for “the average American” to get a home loan. Consumer groups find irony with that statement. After all, JPMorgan Chase recently entered into a $13 billion civil settlement with the U.S. Department of Justice stemming from the bank’s mortgage-bundling practices that helped plunge the country into the Great Recession. Other players such as Goldman Sachs fared no better. It, too, will pay about $5 billion to resolve state/federal investigations.
Depending on what side of the fence you’re on, there are definitely different perspectives.
Going forward, there are things going on that will help consumers. As of July 1, judgments and most tax lien data will be scrubbed from consumers’ credit reports. This means credit scores will be higher. That leaves us with the million-dollar question: Will this new reporting artificially inflate scores? Will it also create riskier loans for lenders? Reporting agencies are collectively working with U.S. credit card issuers to use alternative data to identify creditworthy individuals. This can be concerning because S&P/Experian recently reported that first and second mortgage default rates increased slightly in February. Is this a trend? Maybe – maybe not.
Where to next? As the cycle repeats, the new administration under “45” (President Donald Trump) has lots of campaign promises to fulfill. Many revolve around repealing certain laws created under the previous administration, which has happened.
As it relates to this story, we have to ask ourselves, has confidence truly been completely restored? If so, is there still a need for some of these laws? There are other things to consider – there are other rumors floating in the air. Rumors include adjustments in the manner in which the U.S. Department of Housing and Urban Development/the Federal Housing Administration, Fannie Mae, and Freddie Mac operate, as well as easing banking regulatory mandates.
There are still many unknowns. But one thing is for certain: Greed and fraud have become a cultural phenomenon that was a vital cog leading to the crisis. Greed is hard to legislate. Regardless of what “45” does or doesn’t do, greed remains the “devil in the details” and the unknown variable. If we don’t eliminate it from our DNA, this story is destined to be a sequel.
The bottom line is that it’s challenging at best for any president to lead us to economic prosperity while maintaining integrity in our financial systems.
Whatever we do, hopefully we won’t inadvertently mortgage our future to correct our past. Only time will tell if “45” will have the dubious distinction of being a hero or a villain in this story.
Meanwhile, Jefferson’s words continue to inspire us. He said he likes the dreams of the future better than the history of the past. Hopefully we don’t end up having dreams of DiCaprio singing a Talking Heads song from the bow of the Titanic, bellowing out, “You may find yourself in a beautiful house, with a beautiful wife, and you may ask yourself, well, how did I get here?”
Jim Alvarez is director of risk management for Financial Asset Services Inc., a national asset management company specializing in providing asset management, property disposition and valuation services to mortgage companies and financial institutions. He can be reached at firstname.lastname@example.org.