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The Great Mortgage The Great Mortgage Market Implosion of 2007Market Implosion of 2007
The Evolution of Risk Based Real Estate LendingThe Evolution of Risk Based Real Estate Lending
George W. LawrenceGeorge W. LawrenceMember, Master Instructor FacultyMember, Master Instructor Faculty
California Association of REALTORSCalifornia Association of REALTORS®®
September 2008September 2008
22
1994: The Beginning of the Boom1994: The Beginning of the Boom FOUR EVENTS AIDED BIRTH OF NEW LOAN FOUR EVENTS AIDED BIRTH OF NEW LOAN
PLANS AND SOURCES OF FUNDS TO PLANS AND SOURCES OF FUNDS TO STIMULATE LENDINGSTIMULATE LENDING CREDIT SCORING & RISK BASED CREDIT SCORING & RISK BASED
UNDERWRITINGUNDERWRITING AUTOMATED UNDERWRITING AUTOMATED UNDERWRITING CREATIVE SECURITIZATIONCREATIVE SECURITIZATION COMMUNITY REINVESTMENT ACT COMMUNITY REINVESTMENT ACT
AMENDMENTS OF 1995.AMENDMENTS OF 1995.
33
Birth of Creative Loan ProgramsBirth of Creative Loan Programs
SUBPRIME LOANSSUBPRIME LOANS
NEGATIVE AMORTIZATION LOANSNEGATIVE AMORTIZATION LOANS
INTEREST ONLY LOANSINTEREST ONLY LOANS
REDUCED DOCUMENTATION LOANSREDUCED DOCUMENTATION LOANS
44
Securitization: Key to ExplosionSecuritization: Key to Explosion $50 B IN SUBPRIMES ORIGINATED IN 1994$50 B IN SUBPRIMES ORIGINATED IN 1994 $665 B ORIGINATED IN 2005$665 B ORIGINATED IN 2005 SECONDARY MARKET INVESTORS SECONDARY MARKET INVESTORS
PACKAGED MORTGAGE BACKED PACKAGED MORTGAGE BACKED SECURITIES AS CDO’SSECURITIES AS CDO’S
FINANCIAL ENGINEERING ALLOWED THE FINANCIAL ENGINEERING ALLOWED THE CDO TO BE RISK RATEDCDO TO BE RISK RATED
RATING GAVE APPEARANCE OF LOW RISK RATING GAVE APPEARANCE OF LOW RISK INVESTMENT TO GLOBAL INVESTORS.INVESTMENT TO GLOBAL INVESTORS.
5
Subprime Explosion
• 1994: START OF SUBPRIME “EXPLOSION”• PRE 1994: ONLY 70 SUBPRIME LENDERS• 1994-97: NUMBER GREW TO 210• PRE 1994: 32% OF SUBPRIMES WERE
“PACKAGED” AS MORTGAGE BACKED SECURITIES (MBS’)
• SINCE 1994: 81% OF SUBPRIMES WERE PACKAGED AS MBS
• PRE 1994: 64% HOMEOWNERSHIP RATE• SINCE 1994 RATE ROSE TO OVER 69%.
6
Subprime Loans Originated1994-2007
$0
$100
$200
$300
$400
$500
$600
$700
Bill
ions
Subprime defaults begin Wall Street Subprime funds collapse.
Housing Market cools
Recession 2000-2001
Fed Raises Fed Funds Rate
7
California Median Home Prices 1973 to 2008
0
100000
200000
300000
400000
500000
600000
Subprime Era
1994 to 2007
8
Prime Mortgage Securitization
AAA
AA
MEZZANINE B
JUNIOR/EQUITYUNRATED-UNINSURED
Borrowers Lender/ServicerSecondary Market
Investor
SPE
NOTES
$MBS
$
$
Collateralized Debt Obligation Bond
AAA
Rated
Subprime Securitization
MBS
9
Collateralized Debt Obligation Bond - Example
AAA
AA
MEZZANINE “B”
JUNIOR/EQUITY UNRATED, UNINSURED
ABSORBS ALL LOSSES UNTIL TRANCHE IS DEPLETED
ABSORBS NEXT LOSSES UNTIL TRANCHE IS DEPLETED
ABSORBS NEXT LOSSES UNTIL TRANCHE IS DEPLETED
ABSORBS FINAL LOSSES
IS PAID FIRST,LOWEST YIELD
IS PAID NEXTWITH HIGHER YIELD
IS PAID THIRD,EVEN HIGHER YIELD
IS PAID LAST,GETS HIGHEST YIELD
10
AAA
AA
MEZZANINE B
JUNIOR/EQUITYUNRATED-UNINSURED
Borrowers Lender/ServicerSecondary Market
Investor
SPE
Global Investors
SPE
NOTES
$MBS
$
$
Collateralized Debt Obligation Bond
Subprime Securitization
MBS
$
1111
Negative Amortization LoansNegative Amortization Loans ALLOWS PAYMENT LESS THAN THE ALLOWS PAYMENT LESS THAN THE
ACTUAL INTEREST AMOUNT DUEACTUAL INTEREST AMOUNT DUE START RATE PAYMENT AS LOW AS 1%START RATE PAYMENT AS LOW AS 1% INTEREST ONLY PAYMENT ALLOWEDINTEREST ONLY PAYMENT ALLOWED NOTE RATE 5 – 6% HIGHER OR MORENOTE RATE 5 – 6% HIGHER OR MORE PAYMENT RESETS AFTER 5 YEARSPAYMENT RESETS AFTER 5 YEARS
AT CURRENT NOTE RATEAT CURRENT NOTE RATE FOR 25 YEAR TERMFOR 25 YEAR TERM
A GAMBLE!A GAMBLE!
12
Negative Amortization ARMs
NOTE RATE VS. START RATE
0.000%
1.000%
2.000%
3.000%
4.000%
5.000%
6.000%
7.000%
11TH COFI 2.829% 3.050% 5.880% 1.250%
INDEX MARGIN FULL RATE START RATE
FULL PAYMENT:
$3,107.25 Mo
START RATE PAYMENT
$1,749.57 Mo
1313
Negative Amortization ARMsNegative Amortization ARMs
THE “SHOCK” THE “SHOCK” AFTER 5 YEARS PAYINGAFTER 5 YEARS PAYING
START RATE PAYMENTSTART RATE PAYMENT IF ACTUAL RATE REMAINS STABLE, NEW IF ACTUAL RATE REMAINS STABLE, NEW
PAYMENT COULD BEPAYMENT COULD BE
AT LEASTAT LEAST
$3,875.54$3,875.54AN INCREASE OF $2,125.97 MONTHLYAN INCREASE OF $2,125.97 MONTHLY
1414
Negative Amortization LoansNegative Amortization Loans
THE REAL SHOCK:THE REAL SHOCK: AT THE “LIFE TIME CAP RATE” THE PAYMENT AT THE “LIFE TIME CAP RATE” THE PAYMENT
COULD JUMP FROM $1749 TO:COULD JUMP FROM $1749 TO:
$5,346.44$5,346.44 Monthly… an Monthly… an
INCREASE OF INCREASE OF
$3,596.87!$3,596.87!
1515
Negative Amortization LoansNegative Amortization Loans
75% OF BORROWERS MADE ONLY MINIMUM 75% OF BORROWERS MADE ONLY MINIMUM PAYMENT PAYMENT
GREATEST NUMBER ORIGINATED BETWEEN GREATEST NUMBER ORIGINATED BETWEEN 2003 AND 20052003 AND 2005
PAYMENT RESETS BEGAN IN AUG 2008PAYMENT RESETS BEGAN IN AUG 2008 RESETS WILL PEAK JUNE 2010RESETS WILL PEAK JUNE 2010 RESETS SHOULD END BY DEC. 2010RESETS SHOULD END BY DEC. 2010 AVERAGE LOAN BALANCE AT RESET IS 115% AVERAGE LOAN BALANCE AT RESET IS 115%
TO 125% OF ORIGINAL LOAN AMOUNTTO 125% OF ORIGINAL LOAN AMOUNT MOST LOANS EXCEED PROPERTY’S VALUE.MOST LOANS EXCEED PROPERTY’S VALUE.
16
Adjustable Rate Loans Reset Calendar June 2008 to Dec. 2011
ARMS Forecast to Reset
0
5
10
15
20
25
30
35
40
45
50
Jun-
08
Sep
-08
Dec
-08
Mar
-09
Jun-
09
Sep
-09
Dec
-09
Mar
-10
Jun-
10
Sep
-10
Dec
-10
Mar
-11
Jun-
11
Sep
-11
Dec
-11
$ Billion
Subprime Pay Option
1717
Interest Only & Reduced Interest Only & Reduced Documentation LoansDocumentation Loans
STATED INCOME: INCOME IS STATED NOT STATED INCOME: INCOME IS STATED NOT VERIFIEDVERIFIED
FICO AND LTV DETERMINE RATEFICO AND LTV DETERMINE RATE
SOME PLANS ALLOWED “INTEREST ONLY”SOME PLANS ALLOWED “INTEREST ONLY”
IRS FORM 4506IRS FORM 4506--T NOW USUALLY REQUIREDT NOW USUALLY REQUIRED..
1818
Stated Income LoansStated Income Loans 80% OF NEGATIVE AMORTIZATION LOANS 80% OF NEGATIVE AMORTIZATION LOANS
WERE STATED INCOMEWERE STATED INCOME
90% OF BORROWERS OVERSTATED INCOME 90% OF BORROWERS OVERSTATED INCOME 5% OR MORE5% OR MORE
60% OVERSTATED INCOME OVER 50%60% OVERSTATED INCOME OVER 50%
NEARLY IMPOSSIBLE TO MAKE NEW RESET NEARLY IMPOSSIBLE TO MAKE NEW RESET PAYMENT BASED ON ACTUAL INCOME.PAYMENT BASED ON ACTUAL INCOME. Source: Mortgage Asset Research Institute Inc., Source: Mortgage Asset Research Institute Inc.,
Lender’s Tax Return Audit for IRSLender’s Tax Return Audit for IRS
1919
New Laws for Predatory New Laws for Predatory Lending PracticesLending Practices
Federal Agencies Take Steps to Federal Agencies Take Steps to Regulate Subprime Lending Regulate Subprime Lending
IndustryIndustry
2020
Amendments to Regulation “Z”, Amendments to Regulation “Z”, Truth in Lending ActTruth in Lending Act
RULES FOR “HIGHER PRICED” PRICED RULES FOR “HIGHER PRICED” PRICED LOANS EFFECTIVE OCTOBER 1, 2009LOANS EFFECTIVE OCTOBER 1, 2009 APPLY TO FIRST MORTGAGES HAVING APPLY TO FIRST MORTGAGES HAVING
INTEREST RATES GREATER THAN 1.5% INTEREST RATES GREATER THAN 1.5% OVER THE AVERAGE MARKET RATEOVER THE AVERAGE MARKET RATE
APPLY TO SECOND MORTGAGES HAVING APPLY TO SECOND MORTGAGES HAVING INTEREST RATES GREATER THAN 3.5% INTEREST RATES GREATER THAN 3.5% OVER THE AVERAGE MARKET RATE.OVER THE AVERAGE MARKET RATE.
2121
Amendments to Regulation “Z”, Amendments to Regulation “Z”, Truth in Lending ActTruth in Lending Act
NEW REGULATIONS FOR SUBPRIME LOANS:NEW REGULATIONS FOR SUBPRIME LOANS: LENDERS MUST VERIFY BORROWER’S LENDERS MUST VERIFY BORROWER’S
INCOME AND ASSETSINCOME AND ASSETS PREPAY PENALTIES PROHIBITED IF LOAN PREPAY PENALTIES PROHIBITED IF LOAN
PAYMENT ADJUSTS IN LESS THAN 4 PAYMENT ADJUSTS IN LESS THAN 4 YEARS, MAXIMUM 2 YEARS OTHERS.YEARS, MAXIMUM 2 YEARS OTHERS.
EFFECTIVE APRIL 2010, TAXES & EFFECTIVE APRIL 2010, TAXES & INSURANCE REQUIRED IN LOAN INSURANCE REQUIRED IN LOAN PAYMENT FOR THE FIRST YEAR PAYMENT FOR THE FIRST YEAR REGARDLESS OF DOWN PAYMENT.REGARDLESS OF DOWN PAYMENT.
2222
Regulating Predatory LendingRegulating Predatory Lending HINDSIGHT IS ALWAYS 20/20HINDSIGHT IS ALWAYS 20/20
IN 2004 FORMER FED CHAIRMAN ALAN IN 2004 FORMER FED CHAIRMAN ALAN GREENSPAN PRAISED SUBPRIME LENDINGGREENSPAN PRAISED SUBPRIME LENDING HOME OWNERSHIP MADE POSSIBLE FOR HOME OWNERSHIP MADE POSSIBLE FOR
MILLIONS PREVIOUSLY DISENFRANCHISEDMILLIONS PREVIOUSLY DISENFRANCHISED STATED IN 2007 “HE DIDN’T GET IT (THE DEGREE STATED IN 2007 “HE DIDN’T GET IT (THE DEGREE
OF DEFAULT RISK) UNTIL LATER”OF DEFAULT RISK) UNTIL LATER”
HOME OWNERSHIP FOR MOST SUBPRIME HOME OWNERSHIP FOR MOST SUBPRIME BORROWERS WAS TEMPORARY.BORROWERS WAS TEMPORARY.
2323
The OutlookThe Outlook
THE OUTLOOK:THE OUTLOOK: ECONOMISTS DIVIDED ON HOUSING MARKET ECONOMISTS DIVIDED ON HOUSING MARKET
RECOVERY, FROM LATE 2009 TO LATE 2010RECOVERY, FROM LATE 2009 TO LATE 2010 FANNIE MAE & FREDDIE MAC ARE LIKELY TO FANNIE MAE & FREDDIE MAC ARE LIKELY TO
SURVIVESURVIVE BARNEY FRANK AND CHRIS DODD LIKELY TO BARNEY FRANK AND CHRIS DODD LIKELY TO
GUARANTEE ITGUARANTEE IT GLOBAL INVESTORS WILL RETURN LIQUIDITY TO GLOBAL INVESTORS WILL RETURN LIQUIDITY TO
WALL STREET.WALL STREET.