Interest Rate Roundup

Wednesday, September 20, 2006

FDIC talks mortgage risk

Sandra Thompson of the FDIC is talking about the risk of non-traditional mortgage products ("Frankenstein Financing" in my nomenclature) before the Senate Subcommittee on Economic Policy and Subcommittee on Housing and Transportation of the Committee on Banking, Housing and Urban Affairs. Lots of scary stuff in here, if you're inclined to read the whole presentation. Among the juiciest nuggets:

On the prevelance of option-ARM and interest only lending:

"According to the publication Inside Mortgage Finance, an estimated $432 billion of interest-only loans and payment-option ARMs were originated during the first half of 2006. This represents approximately 29 percent of all mortgages originated during the same period. "

On how the bubble was fueled by risky lending, and how the bubble, in turn, fueled even more risky lending:

"The acceleration of the U.S. home price boom does appear to have been related to changes in the mortgage markets -- and causation probably runs both ways. The greater availability of flexible mortgage structures probably allowed price increases to outstrip growth in incomes to a greater extent than would otherwise have been the case. In addition, high-priced homes probably induced at least some borrowers to use interest-only or payment-option mortgages in order to afford their home."

On the results of a 2005 study by regulatory agencies (which reviewed what the nation's biggest lenders have been doing in the nontraditional mortgage arena):

"The review found indications of loosening in underwriting standards, some instances of borrowers not being qualified based on fully amortizing payments, and an increase in simultaneous second mortgages and other activities that added an additional layer of credit risk. The survey also found geographic concentrations of these products in areas experiencing rapid home price appreciation."

On the risky pratctices of today's lenders:

"Many nontraditional loan products require little or no documentation or have been accompanied by practices such as simultaneous second-lien mortgages that create additional layers of risk for lenders."

"In traditional mortgage lending, the borrower's repayment capacity, including debt-to-income ratios, has been a key underwriting consideration. However, there is growing evidence of interest-only and payment-option ARMs being made to borrowers with little or no documentation to verify income sources or financial assets."

"The combination of several liberalized underwriting terms, or "risk layering," also has become more prevalent. Lenders increasingly are providing simultaneous second-lien mortgages to cover a portion of the home purchase price. A simultaneous second-lien mortgage reduces borrowers' equity in their homes and increases borrowers' monthly debt service. When one loan combines several such features, the total risk is compounded."

I've been warning about this stuff for more than a year in our Safe Money Report newsletter, and more recently, in Money and Markets here and especially here. It's a shame the regulators didn't crack down sooner, before all this reckless lending really got out of control.


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