October 1, 2008

The Fire Inside the Smoking Gun at Fan and Fred That Ruined Mortgage Lending

Filed under: Business Moves,Economy,Taxes & Government — Tom @ 9:03 am

Here’s the smoke (HT my guardian angel), from the September 30, 1999 New York Times (click on “more” if you’re on the home page to see the smoke), AND, in the rest of this post, the fire:

Fannie Mae Eases Credit To Aid Mortgage Lending

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers.

….. Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980′s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

….. In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae’s and Freddie Mac’s portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.

The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants.

The “pilot program” went nationwide a few years later.

Here’s the fire: “The automated underwriting systems” were modified as indicated in the graphic that follows. The last bolded sentence above makes you wonder if it was done to get rid of a conveniently-timed lawsuit.

You can see the huge, unwarranted risk Freddie Mac and wicked sister Fannie Mae took on:

FICOdelinquencyChances2008

The chart shows, based on experience, the chances of serious delinquency (90 days or more late) for various credit score ranges.

A reminder, from this BizzyBlog post, and this Pajamas Media column, a few weeks ago:

Fredron and Fanron

Fan and Fred ….. significantly lowered the standards built into the loan-approval programs lenders used to ensure that their mortgages would be bought by the two government-sponsored enterprises. Specifically:

  • The credit-score threshold for conventional mortgages, which had generally been 670 or more, dropped to about 630. In the real world, a score of 630 indicates that you’re having trouble with your debt load, paying your bills on time, or a little of both.
  • More ominously, the credit-score threshold for subprime mortgages, which had generally been 630 or more, fell to about 590. A score of 590 is the credit-scoring equivalent of barely having a pulse.

A quick primer on credit scores is here.

You can seen the huge impact of those moves by looking at the graphic at this myfico.com page:

  • About 10% – 12% of the population, people who formerly would have only qualified for subprime mortgage consideration, suddenly became eligible for conventional treatment.
  • Far worse, another roughly 7% – 9% of the population with awful credit records, most of whom had no business taking on a mortgage, now received subprime treatment

The items I superimposed on the graphic above demonstrate the following:

  • How much additional risk Fannie Mae and Freddie Mac took on, and gave others tacit permission to take on, by lowering the credit score needed to get a conventional mortgage to 630 from 670.
  • On top of took on by that, the even worse risk they took on by lowering the credit score needed to get a conventional mortgage to 590 from 630.

To be clear, the graph above shows the historical chances of going seriously delinquent in general, including secured and unsecured loans. You would expect the delinquency rate on mortgages to be somewhat lower, but not low enough to affect the lesson behind the chart. It’s clear that Fan and Fred decided to lend money to people who had a too-high percentage of not being able, or in some cases willing, to pay it back.

We cannot afford to reward behavior this egregiously bad — by Fan, Fred, the current and previous presidential administrations, Congress, or the banking system.

Dave Ramsey’s “Common Sense Fix,” or something very close to it, would be an acceptable solution. A blank-check bailout with a made-up number of $700 billion isn’t.

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4 Comments

  1. Call me a racist or refuse to post this if you want. Freddie and Fannie were designed to help the lower paid working class (all races) own a home. It worked until the democrats (using racism) demanded they finance homes for blacks who have never worked and will never work, they then added the Mexicans who came here solely to bleed the American taxpayers and not to work. I remember when the democrats promised in 2006 to change the direction of the country (market over 15,000, gas $2.20 a gallon and unemployment the lowest in history (the only unemployment was those above who never work), so in it’s flash of stupidity they elected enough democrats to take over congress. The democrats sure changed the direction of the country, from the best economy in the world in history to worse than the crash in the 20′s. This mess was created by democrats and they blocked every attempt to stop it and now they deny it’s their fault. Just like it’s the republicans fault that the rip off bail out failed when Peeeloshi let (most say directed) 95 democrats (scared of losing their seats) vote no on the bill. Give me a break.

    The American public is smarter than the elected officials except when they enter the voting booth and send the same rip offs, criminals and con democrats back to the white house, congress and the governors office’s. This crisis is small compared to the shooting war that is coming to this country. I gave the war until 2025 to start, I now see it, shooting war, coming between 2012 and 2015.

    Comment by Scrapiron — October 1, 2008 @ 11:10 am

  2. To keep up with Wall Street expectations, Fannie Mae held onto more mortgages and mortgage-backed securities for investment purposes. The same practice nearly drove the company into bankruptcy in the early 1980s. Once again it was spared in 2008.
    nomedals.blogspot.com

    Comment by Jason — October 1, 2008 @ 9:36 pm

  3. Who’s responsible for the credit/housing crisis?…

    Here’s your answer. Guess who took $105,849 from Fannie Mae? Look who’s at #3 on the list of pigs at Fannie’s trough: Barack Obama. Obama took hush money from the……

    Trackback by Brain Shavings — October 3, 2008 @ 4:22 pm

  4. [...] with low FICO scores are normally the first people who experience layoffs during a slowing economy. People with FICO scores from 590 to 630 are 51% to 31%, respectively, likely to default on their ob… Being at the bottom of the economic ladder they tend to work in areas that are highly subject to [...]

    Pingback by Collateralized Debt Obligations, The CDO Menace &laquo Publius’ Forum — October 4, 2008 @ 10:32 am

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