If the report on the financial crisis published by the Senate Permanent Subcommittee on investigations were a photograph, it would require a wide-angle lens to encompass all the villains it identifies.
Lenders, regulators, securitizers and credit agencies, some more than others, but all in some part, share the blame in this report for the mortgage market implosion that nearly brought down the nation’s financial infrastructure.
The report, issued with bi-partisan support, describes a financial marketplace riddled with conflicts of interest and perverse incentives that led lenders, investment banks, and credit rating agencies to understate or ignore the risks in the loans they were originating, rating, securitizing and selling to investors.
“Blame for this mess lies everywhere from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild and members of Congress, who failed to provide oversight,” said Sen. Tom Coburn (R-OK), who co-chaired the panel with Sen. Carl Levin (D-MI).
The committee paints with a broad and scathing brush, but singles out two of the credit rating agencies (Standard & Poor’s and Moody’s) and the Office of Thrift Supervision for conflicts of interest at the former (classifying as investment grade securities that were anything but) and overly “deferential” regulation at the latter, resulting in the failure of Washington Mutual, the largest bank failure in U.S. history.
The report cites the “sudden mass downgrades” of mortgage-backed securities and collateralized debt obligations the rating agencies issued as “the immediate trigger” for the financial crisis. The conflict of interest inherent in their fee structure (the agencies are paid by the issuers of the securities they rate) led them to ignore warnings sounded by their own analysts more than a year before they finally began issuing the belated downgrades, the researchers found.
“The problem was that neither company has a financial incentive to assign tougher credit ratings to the very securities that for a short while increased their revenues, boosted their stock prices, and expanded their executive compensation,” the report concluded.
The report faults all the banking industry regulators, but it heaps particular scorn on the OTS for essentially allowing Washington Mutual “to police itself” despite overwhelming evidence of problems with the bank’s underwriting standards and securitization practices. “OTS did not once, from 2004 to 2008, take a public enforcement action against Washington Mutual to correct its lending practices, nor did it lower the bank’s rating for safety and soundness,” the report notes.
The criticism of the investment banks, Goldman Sachs and Deutsche Bank in particular, is equally white hot. Both are blasted for selling securities to investors that they knew to be flawed (“crap” and “pigs” is how one internal Deutsche Bank memo described them), but Levin has accused Goldman Sachs of actually misleading some clients by betting against the securities the company sold them and misleading Congress in testimony about the company’s practices.
“In my judgment, Goldman clearly misled their clients and they misled the Congress,” Levin said at a press briefing. He indicated that the committee plans to turn its information over to the Justice Department to investigate possible perjury charges against Goldman executives who testified before Congressional committees.
BRIGHTENING VIEW
Economists are still finding housing market indicators worrisome, at best, but potential buyers and sellers appear to be feeling better about the outlook. Nearly 70 percent of respondents to a recent survey said they think home sales and prices will begin to recover within the next year or two – a marked improvement over the 47 percent who expressed similar optimism in this survey (by Prudential Real Estate and Relocation Services) last year. And despite the market’s continuing struggle with foreclosures, falling prices and anemic sales, 86 percent of the respondents said they still consider real estate to be a good investment.
Reflecting the opposite view, the Wall Street Journal reported recently that the housing downturn has soured the dream of home ownership for many prospective buyers. The article cited the results of Fannie Mae’s annual housing survey, in which the number of respondents viewing a home as a “safe” investment declined to 64 percent from 70 percent a year earlier, producing the lowest reading since the survey began in 1993.
“The magnitude of the housing crash caused permanent changes in the way some people view home ownership,” Michael Lea, a finance professor at San Diego State University, told the Journal. “Even as the economy improves, there are some who will never buy a home because their confidence in real estate is gone,” he observed.
The nation’s home builders apparently share that less than optimistic view. Confidence levels, as measured by the National Association of Home Builders/Wells Fargo Housing Market Index (HMI), slipped again in April, falling back to 16 after inching a little above that in March. While the component gauging current sales conditions fell only one point, the component gauging sales expectations for the next six months declined three points to 23, its lowest mark since October of 2010. On the other hand, the gauge of prospective buyer traffic rose to its highest point (13) since last June. The index has been below 50 (indicating a negative view of the market) since May of 2006.
David Crowe, the NAHB’s chief economist, acknowledged that the spring buying season “is getting off to a slow start,” impeded by foreclosure sales, tight credit standards, and concerns about the economy generally. Most current activity is concentrated “in the lower price ranges,” Crowe said, dominated by “first-time buyers [who] have greater flexibility than repeat buyers who must sell their current home. Consumers who can take advantage of today’s low mortgage rates and very attractive pricing are finding bargains and are buying,” he noted.
PUSHING BACK
Pushback is intensifying against a proposal that would make 20 percent down payments the qualifying standard for the best mortgage rates. And the criticism is coming from consumer advocates and legislators as well as from financial industry executives. All are warning that the so-called “skin-in-the-game” rule requiring lenders to retain a portion of the risk on mortgages they originate, could permanently bar the door to home ownership for millions of potential buyers.
The proposed regulations would exempt from the risk retention requirement “qualified residential mortgages,” which the regulatory agencies have defined as loans to borrowers with pristine credit histories who make down payments of at least 20 percent. Critics say the exemption is too narrow and focuses unreasonably on down payments to the exclusion of other factors that also help to determine a borrower’s ability to manage a mortgage.
“Well-underwritten low down payment home loans have been a significant and safe part of the mortgage finance system for decades,” a report produced by a coalition of housing and consumer groups, contends. Coalition members include the Center for Responsible Lending, the Mortgage Bankers Association, the National Association of Home Builders and the National Association of Realtors, among others.
The Dodd-Frank financial reform legislation established the risk retention requirement, but left it up to regulators to establish the standards for loans that would be exempt from it. Many lawmakers now say the proposed regulation is not at all what they had in mind.
In fact, several noted at a recent hearing that legislators intentionally avoided specifying a down payment minimum in the law, in order to avoid unnecessarily disqualifying many eligible borrowers. The legislation, they noted, directed regulators specifically to consider factors other than the down payment - -including the borrower’s debt burden and the characteristics of the loan – in establishing the exemption standards.
“I was definitely surprised and disappointed [by the proposal],” Sen. Kay Hagan (D-NC), one of the lawmakers who pushed successfully for an exemption from the risk retention requirement, said at the hearing.
Rep. Barney Frank (D-MA), who co-sponsored the financial reform legislation, said he found arguments against the 20 percent benchmark “persuasive. [It] does seem very high,” he agreed.
The hearing revealed that some of the regulators involved in writing the regulation disagree among themselves on the down payment requirement. Bob Ryan, acting commissioner of the Federal Housing Administration (a division of the Department of Housing and Urban Development, which is one of the agencies crafting the rule) said he is “definitely concerned” about the impact the requirement would have on potential buyers and the housing market recovery. (Last year, more than 50 percent of all U.S. homebuyers made down payments of less than 20 percent, according to LPS Applied Analytics.) Ryan said he supported the 10 percent threshold that regulators are reportedly considering as an alternative.
The Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, on the other hand, thinks 20 percent is a reasonable requirement, necessary to reduce risks to lenders. A 10 percent minimum would increase those risks without significantly increasing the number of eligible borrowers, Patrick Lawler, the FHFA’s chief economist, argued at the recent hearing.
Consumer advocates agree that lowering the down payment requirement to 10 percent would not significantly increase the number of qualified borrowers, but they think that’s an argument for making the underwriting standard even more flexible.
“Even a 10 percent down payment would put homeownership beyond the reach of many creditworthy families who would otherwise have succeeded in homeownership,” Ellen Harnick, senior policy counsel at the Center for Responsible Lending, told lawmakers at the hearing.
Regulators are accepting comments on the proposed regulation through June 10. It is supposed to take effect one year after it is adopted.
RETIRING MINDS
American workers are starting to feel a little better about the economic outlook, but they have never been more discouraged about their retirement prospects, a recent survey has found. More than one quarter (27 percent) of the respondents to the 2011 Retirement Confidence Survey said they were “not at all confident” about their ability to save enough for a comfortable retirement – the highest level of discouragement this survey has measured in the 21 years the Employee Benefits Research Institute has been conducting it. Only 13 percent of the respondents said they were “very confident” of saving enough to live comfortably after they retire.
Although the trend is negative, it reflects a positive change in attitudes, according to Jack VanDerhei, research director for EBRI, who co-authored the report with Matthew Greenwald of Greenwald & Associates. “People are increasingly recognizing the level of savings realistically needed for a comfortable retirement,” VanDerhei said in a press statement. “We know from previous surveys that far too many people had false confidence in the past,” he added. “People’s expectations need to come closer to reality so they will save more and delay retirement until it is financially feasible.”
The study indicates that more workers are recognizing that they may, in fact, have to work longer than they expected and continue working at least part time after they retire. Thirty six percent of respondents in the recent survey said they intend to work beyond the age of 65, up from 25 percent in 2006 and 20 percent in 2001. Two decades ago, only 11 percent expected to work past 65. Nearly three quarters (74 percent) now expect to work for pay after they retire, triple the number of retirees who reported working in the 2010 survey.
The survey identified a number of factors that are forcing workers to redefine retirement, including: high unemployment rates, rising health care costs, lower investment returns, longer life expectancies, and uncertainty about prospects for Social Security and Medicare benefits.
“Many people are planning to work longer and retire later because they know they simply can’t afford to leave the work place—both for the paycheck and for the benefits,” Greenwald noted. “Unfortunately, many retirees also tell us they left the work force earlier than they planned, either because of health problems or layoffs. So it may not necessarily be a bad thing that those who can work longer choose to do so.”
COMMERCIAL CONCERNS
You might not assume this from all the headlines about the housing market implosion and its devastating ripple effects, but it is commercial real estate loans, not residential mortgages, that have been responsible for many recent bank failures.
Analyzing the six banks the Federal Deposit Insurance Corporation (FDIC) closed in mid-April, a research report from Trepp, LLC found that of the aggregate total of $394 million in nonperforming assets at those institutions, 77 percent ($300 million) were in commercial real estate. An analysis of 12 banks that failed in February found troubled assets similarly concentrated (72 percent) in commercial real estate, according to Trepp, which provides commercial mortgage information to the securities and investment management industries.
In a year-end report, the company estimated that commercial real estate values have declined by 42 percent since they peaked in 2007, putting 50 percent of the commercial loans maturing between 201 and 2015 currently “under water.” Trepp analysts also tallied 1,300 banks with “significant” commercial real estate concentration.
Testifying at a recent Congressional hearing, Matt Anderson, managing director at Trepp, told lawmakers, “We remain concerned about the volume of underwater commercial mortgages that will mature over the next several years, despite gradual improvement in the economy.”
