I was happy to present on the History of Housing Finance as part of the Structured Finance Association’s SF Academy series, hosted by Elen Callahan, the SFA’s Head of Research & Education. You need to sign up to access the SF Academy content (although I have covered similar content in many other venues) for those who do not want to bother). The SFA website states that the
I, along with 73 other law profs, signed a letter of support drafted by Professor Pamela Foohey (Indiana). It reads in part,
Congress enacted our current Bankruptcy Code in 1978. Much has changed since then. Even after adjusting for population growth and inflation, Federal Reserve data show that credit card debt has tripled. In 1978, student-loan debt was such a small part of household finances that the Federal Reserve did not even separately track it. Today, student-loan debt is the largest component of household debt except for home mortgages. In 1978, asset securitization was in its infancy. Mortgages and auto loans are now routinely bundled and sold to investors, separating the servicing of the loan from the financial institutions that own the loan. Advances in technology have made it easier for debt collectors to hound consumers even for debts that are decades old. In 1978, what we now think of as the Internet was a little-known research tool for academics instead of a global information revolution that has affected how Americans interact, including with consumer lenders, attorneys, and the court system. Given all these changes, it is little surprise that a forty-year-old bankruptcy law no longer serves our needs today.
The central piece of the Consumer Bankruptcy Reform Act is to create a new chapter 10 for individual bankruptcy filers. The Act also eliminates chapter 7 as an option for individual filers and repeals chapter 13. Individuals will remain able to file under chapter 11 (those with debts over $7.5 million will be required to use that chapter), but for most people, the new chapter 10 will be a single point of entry into the bankruptcy system.
The single point will substantially improve the consumer bankruptcy system by replacing the current structure where consumer debtors must choose between a chapter 7 liquidation bankruptcy or a chapter 13 repayment plan bankruptcy. There are substantial differences around the country in the rates at which people use chapter 7 and chapter 13. In 2019, only 9.6% of the bankruptcy cases in the District of Idaho were chapter 13 cases as compared to 81.0% of the cases in the Southern District of Georgia. The gaping disparity itself is an indictment of a federal system that the Constitution directs to be “uniform.”
Robert Skidelsky
I just finished reading Money and Government by Robert Skidelsky (2018). It is a bit tough in parts for non-economists, but it is a great read for those trying to understand the appropriate relationship between economic theory and government policy. While that may sound dry indeed, it is of key importance to the design of a post-Financial Crisis world regulatory order.
The book delves into the the “Mysteries of Money,” providing a short history of a deceptively simple topic that I continue to find to be difficult to wrap my head around: what exactly is money and what can you do with it? The book then goes into some inside baseball analysis of the history of economic thought. I skimmed this section because it related some pretty technical debates among early economists to set up its more accessible discussion of Keynesian economics and its challenger, Milton Friedman-led Monetarism. The book then takes a look at how economic theory impacted governments’ responses to the Financial Crisis, for good and for ill.
I think readers of this blog would be most interested by Skidelsky’s insights in the final section, where he tries to sketch “A New Macroeconomics.” He asks and answers the question, “What Should Governments Do and Why?” He wants to make banking safe and address inequality.
Readers of this blog will be particularly interested in his analysis and recommendations for the mortgage market. He argues that the “main theoretical mistake behind securitization was the assumption that securities are always liquid: they can always be sold quickly and without (much) loss.” (328) The Financial Crisis demonstrated in spades that this was not true. He argues that “[c]ompelling banks to hold mortgages for a period of years” is the solution to this particular problem. (363) I do not think that I agree with this solution, but as he argues his point at a high level of generality, it probably is best to say that the devil will be in the details for any reform program in this sphere.
I found his analysis of populism compelling. He argues that the “political divide between right and left . . . is increasingly overshadowed by one between nationalism and globalism.” (372) I won’t go into the details here, but he has a very trenchant analysis of how the economist’s theoretical Homo economicus fails to account for important aspects of our humanity as individuals, as members of groups and as citizens of nation-states. He warns that we do that at our peril: citizens of democracies will punish their leaders for failing to take into account their complex need to flourish in all of those ways that economists can reduce down to one-dimensional units of measurement, such as “utility.”
Yale University Press says that the book is out of print, but Amazon has paperback copies available if you dig a bit on the book’s web page (and, of course, there are Kindle versions available for those so inclined). I recommend that you get yourself a copy.
Some readers may be interested in a free upcoming program on how to teach real estate securitization. The program is co-sponsored by the AALS Real Estate Transactions Section and the New York City Bar Association’s Structured Finance Committee.
You can attend by live stream webcast or in person. You can attend as much of the program as you have time to attend, and feel free to pop in and out of the webcast.
Law professors and leading practitioners will serve as panelist instructors. I will be moderating a panel on Servicing & Its Discontents. It should be a great program for those who teach in this area.
See https://law-u.net/ for the full program and to register or even better, view the PROMOTIONAL VIDEO here.
Craig Furfine has posted The Impact of Risk Retention Regulation on the Underwriting of Securitized Mortgages to SSRN. The abstract reads,
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 imposed requirements on securitization sponsors to retain not less than a 5% share of the aggregate credit risk of the assets they securitize. This paper examines whether loans securitized in deals sold after the implementation of risk-retention requirements look different from those sold before. Using a difference-in-difference empirical framework, I find that risk retention implementation is associated with mortgages being issued with markedly higher interest rates, yet notably lower loan-to-value ratios and higher income to debt-service ratios. Combined, these findings suggest that the implementation of risk retention rules has achieved a policy goal of making securitized loans safer, yet at a significant cost to borrowers.
While the paper primarily addressed the securitization of commercial mortgages, I was particularly interested in the paper’s conclusion that
the results suggest that risk retention rules will become an increasingly important factor for the underwriting of residential mortgages, too. Non-prime residential lending has continued to rapidly increase and if exemptions given to the GSEs expire in 2021 as currently scheduled, then a much greater fraction of residential lending will also be subject to these same rules. (not paginated)
As always, policymakers will need to evaluate whether we have the right balance between conservative underwriting and affordable credit. Let’s hope that they can address this issue with some objectivity given today’s polarized political climate.
photo by www.cafecredit.com
Researchers at the NY Fed have posted The Role of Technology in Mortgage Lending. There is no doubt that tech can disrupt the mortgage lending business much as it has done with others. The abstract reads,
Technology-based (“FinTech”) lenders increased their market share of U.S. mortgage lending from 2 percent to 8 percent from 2010 to 2016. Using market-wide, loan-level data on U.S. mortgage applications and originations, we show that FinTech lenders process mortgage applications about 20 percent faster than other lenders, even when controlling for detailed loan, borrower, and geographic observables. Faster processing does not come at the cost of higher defaults. FinTech lenders adjust supply more elastically than other lenders in response to exogenous mortgage demand shocks, thereby alleviating capacity constraints associated with traditional mortgage lending. In areas with more FinTech lending, borrowers refinance more, especially when it is in their interest to do so. We find no evidence that FinTech lenders target marginal borrowers. Our results suggest that technological innovation has improved the efficiency of financial intermediation in the U.S. mortgage market.
The report documents the significant extent to which FinTech firms have already disrupted the primary mortgage market. They also predict a whole lot more disruption coming down the pike:
Going forward, we expect that other lenders will seek to replicate the “FinTech model” characterized by electronic application processes with centralized, semi-automated underwriting operations. However, it is unclear whether traditional lenders or small institutions will all be able to adopt these practices as these innovations require significant reorganization and sizable investments. The end result could be a more concentrated mortgage market dominated by those firms that can afford to innovate. From a consumer perspective, we believe our results shed light on how mortgage credit supply is likely to evolve in the future. Specifically, technology will allow the origination process to be faster and to more easily accommodate changes in interest rates, leading to greater transmission of monetary policy to households via the mortgage market. Our findings also imply that technological diffusion may reduce inefficiencies in refinancing decisions, with significant benefits to U.S. households.
Our results have to be considered in the prevailing institutional context of the U.S. mortgage market. Specifically, at the time of our study FinTech lenders are non-banks that securitize their mortgages and do not take deposits. It remains to be seen whether we find the same benefits of FinTech lending as the model spreads to deposit-taking banks and their borrowers. Changes in banking regulation or the housing finance system may affect FinTech lenders going forward. Also, the benefits we document stem from innovations that rely on hard information; as these innovations spread, they may affect access to credit for those borrowers with applications that require soft information or borrowers that require direct communication with a loan officer. (37-38)
I think that the author’s predictions are right on target.
Researchers at the Fed and UC Berkeley have posted Liquidity Crises in the Mortgage Markets. The authors conclusions are particularly troubling:
The nonbank mortgage sector has boomed in recent years. The combination of low interest rates, well-functioning GSE and Ginnie Mae securitization markets, and streamlined FHA and VA programs have created ample opportunities for nonbanks to generate revenue by refinancing mortgages. Commercial banks have been happy to supply warehouse lines of credit to nonbanks at favorable rates. Delinquency rates have been low, and so nonbanks have not needed to finance servicing advances.
In this paper, we ask “What happens next?” What happens if interest rates rise and nonbank revenue drops? What happens if commercial banks or other financial institutions lose their taste for extending credit to nonbanks? What happens if delinquency rates rise and servicers have to advance payments to investors—advances that, in the case of Ginnie Mae pools, the servicer cannot finance, and on which they might take a sizable capital loss?
We cannot provide reassuring answers to any of these questions. The typical nonbank has few resources with which to weather these shocks. Nonbanks with servicing portfolios concentrated in Ginnie Mae pools are exposed to a higher risk of borrower default and higher potential losses in the event of such a default, and yet, as far as we can tell from our limited data, have even less liquidity on hand than other nonbanks. Failure of these nonbanks in particular would have a disproportionate effect on lower-income and minority borrowers.
In the event of the failure of a nonbank, the government (through Ginnie Mae and the GSEs) will probably bear the majority of the increased credit and operational losses that will follow. In the aftermath of the financial crisis, the government shared some mortgage credit losses with the banking system through putbacks and False Claims Act prosecutions. Now, however, the banks have largely retreated from lending to borrowers with lower credit scores and instead lend to nonbanks through warehouse lines of credit, which provide banks with numerous protections in the event of nonbank failure.
Although the monitoring of nonbanks on the part of the GSEs, Ginnie Mae, and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data, and staff resources still seem somewhat lacking relative to the risks. Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual nonbanks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business. We write this paper with the hope of elevating this question in the national mortgage debate. (52-53)
As with last week’s paper on Mortgage Insurers and The Next Housing Crisis, this paper is a wake-up call to mortgage-market policymakers to pay attention to where the seeds of the next mortgage crisis may be hibernating, awaiting just the right conditions to sprout up.
