You would think that mortgage lenders would be chastened by the financial crisis and prolonged economic slump. After all, mortgage loans played a central role in the calamity from which we are still struggling to recover.
But you’d be wrong.
Based on my conversations and emails with people involved in the mortgage sector, they are still extremely confident.
They believe that they understand a whole array of things that the mortgage meltdown suggests they did not. Most importantly, they believe that they understand why borrowers default on their mortgages and how to predict defaults.
Don’t take my word for it, though. Here’s an email I recently got from the CEO of a Midwest mortgage company. As a courtesy to him, I’m not going to use his real name.
I was just wondering if you actually know anything about the mortgage market?
Your article Banks Push to Weaken Dodd-Frank Risk Rules is terrible.
Please speak with the actual originators before writing an article that is so senseless. Listen, there is very little correlation between down payments and defaults.
People don't stop paying their mortgages because of small down payments. This is my 11th year in the business and it simply doesn't happen that way. The two guys on 60 Minutes doing strategic defaults are the exception. Moving from a house with your wife, kids and belongings is a tough deal and they don't do it because they had less than 20% as a down payment.
The FDIC and FRB are certainly not experts in the mortgage market. Take a look at their track record of regulation. Congress is clueless. As long as Fannie and Freddie are around, the new reg won't be a big deal. Bt (sic) as soon as they are gone it will hurt. FHA will be obtaining the majority of new loans with less than 20% down and the Gov't will once again be on the hook since those will continue to be exempt.
Why don't you call some people who actually do mortgages?
In response, I wrote to tell him that it’s just not true. Down-payments do matter.
I’d love to talk to you about this. I’m afraid, however, that you are just incorrect. There is a strong and well documented correlation between down payments and defaults when home prices fall.
While I agree that the regulators are not experts in the mortgage market, I also don’t accept that “people who actually do mortgages” can be taken to be experts on sources of mortgage defaults. The past errors of this class of people disqualify them as sources of authoritative expertise on the subject.
Harry, however, wouldn’t budge. Here’s how he responded.
Sorry my friend, you are wrong.
I don't know where your data is coming from? Job loss/reduction of income is the number one indicator of default, followed by death of a family member/illness.
In addition, I never said you had to be in the mortgage business to analysis it, all I said was you need to speak to people in the industry in order to understand what has to be done rather than those in Washington who as far as I can see are clueless.
I invite you to my office anytime you are in Chicago so you can hear the phone calls coming in from borrowers who will do ANYTHING to keep their homes. The slime that do strategic defaults without even trying to short sale or work something out with their lenders are a very small percentage of people. And the fact that you put down 3.5% with an FHA loan generally has nothing to do with whether you get foreclosed on.
I assume your issue is you are looking at a 2 or 3 year period (or even the last 5 or 6 years) of foreclosures. As a former analyst at ABN AMRO I could make an argument on just about anything using a small amount of data. Look at the last 20 or 30 years of data what does that say?
People don't purchase houses to leave. Yes, they did from late 2004 to 2007 but that was just a blip on the screen. Those 3 or 4 years are aberrations. So your data better not be from those 3 or 4 years otherwise its wrong.
Why am I an expert? Because I sell loans and I see foreclosures everyday, that is why I am an expert. Data, its an interesting term as is the term "analysis." I live in the real world and that world says that moving your family, pet, furniture, etc, sucks and no one likes to move, especially if you have children that go to school and have friends in the area. You do everything possible to not get foreclosed on and you don't sit at the dinning room table and say, I put 20% down or I put 3.5% percent down, let's see should we get foreclosed on?
The first thing to notice is is that "Harry" regards himself as an expert in mortgage defaults because he is in the business of selling loans. His confidence in his expertise is completely unshaken by recent events.
Notice too how "Harry" insists that the last few years are a “blip” or an “aberration.” He feels that any findings based on these years can be safely ignored. It’s only the pre-crisis data that matters.
I find this terrifying. If "Harry" is representative of the mortgage banker mindset—and my encounters over the past few years suggest that he is—the mortgage bankers not only do not understand their own ignorance, they are immune to evidence of their ignorance.
This means that any attempt to impose financial regulations that depend on mortgage bankers responding to incentives to reduce the risks they are taking are likely to fail—because the bankers don’t understand that they’re taking the risks in the first place.
On a purely factual matter, "Harry" is just plain wrong. A study out of the Boston Fed established that homeowners are highly sensitive to the direction prices and to the initial combined loan-to-value ratio at origination, while these out-comes are somewhat less sensitive to employment conditions. Since low down payments often result in high loan-to-value ratios at origination, the down payment size matters.
What’s more, Harry is wrong to claim this is just a “blip” or and “aberration.” The Boston Fed’s study was not based on recent data. It looked at defaults from 1989 to 2007.
"Harry", my friend, this study was first published in December of 2007. You’ve been ignoring the evidence for over four years!
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