Lending Standards Plumb New Depths
The U.S. real estate bubble continues to swell like a lava dome, supporting full-blown manias on both coasts and in quite a few cities, suburbs and towns in between. You'd have to live in a place like Muncie, Indiana, or Vernon, Texas, to be unaffected by it all. In Vernon, a town of about 12,000 in the lower panhandle, a mere $50,000 still buys all the house a growing family could need. To put that in perspective, a beach dweller in the Hamptons could trade his or her property for 200 homes in Vernon, with enough left over to buy a few Wichita Falls mansions.
Not that anyone from the Hamptons is yearning to relocate to the Texas scrublands. Vernon is a quiet place, one where even big deals are still done on a handshake. But you'd be wrong to infer that it is a relative dearth of wheeler-dealers that has kept prices there from taking off. In fact, the town is where Charles Keating seeded his schemes. Yes, that Vernon Savings & Loan -- where my wife's grandmother kept her savings.
But I digress. For it is not Vernon's affordable housing that we wish to discuss, but rather the vast number of barely affordable homes on inventory just about everywhere else. In Southern California, to take a particularly notorious example, the concept of 'barely affordable' has been stretched to the threshold of the metaphysical. Los Angeles County's frothy market offers dwellings that only 17 percent of buyers can afford at the median price. And it's even worse in Orange County, where the figure is 11 percent.
But how, you ask, can real-estate mania be going full-bore in a region where home prices are so very high? Some would answer that it's simply a matter of all-but-insatiable demand meeting temporarily insufficient supply. No argument here. But even the most cravenous sort of demand cannot by itself cause a market to boom as Southern California real estate has. It is not the demand for housing per se that has pushed prices to extremes, however, but rather the relative ease with which home buyers can borrow money.
Most of us know, either through experience or anecdote, that home loans have never been easier to get. This is surely not because Americans have become better credit risks. In fact, the opposite is true. Personal bankruptcies have been setting new records almost monthly, the average worker has seen no real income growth in more than a decade, and household liquidity has dropped off the charts. But in response, and to an extent few could have imagined even ten years ago, mortgage lenders have compensated by becoming increasingly creative as Americans have gone deeper and deeper into hock. Thus has 'creative financing' become an ironic euphemism for a process that is inherently destructive. Indeed, the erosion of mortgage lending standards has progressed to such a degree that nearly anyone not living in a cardboard box or under a highway can qualify for a loan with ease.
Golden West Most-Admired
I recently had an e-mail conversation with someone in the mortgage business, and this is what he had to say about one lender in particular, Golden West Financial (NYSE: GDW), a firm that has always enjoyed a blue-chip reputation: "For the past ten years, Golden West has been the most admired financial firm in the U.S., according to Forbes and Fortune. It has been dominated by two of the wealthiest people in the world, Herb and Marion Sandler, husband and wife co-chairs, who have run it with an iron fist since the 1960's and with highly conservative and principled residential mortgage lending. They have by far the lowest foreclosure rate in the industry on their loan portfolio, which is primarily invested in California.
"Their primary lending unit, World Savings, is now offering on owner-occupied homes 90% loan-to-value, no-income-verification, cash-out refinances into negatively amortizing, adjustable-rate mortgage loans. There is no liquid-reserve minimum, nor is there a stated-minimum credit score. This type of loan was not available even through the sub-prime private lending market just five years ago. Today it is being made available by the company that has built a reputation for soundness, ethics and character that makes Warren Buffet[t] pale in comparison. Do ya think Herb and Marion know what is happening in their company? If the icons of business ethics are doing this what do you suppose the rest of the industry, comprised of mere mortals, is doing?
All Is Corrupt
"I do not offer this as a bashing of GDW, but merely as a heads-up concerning what has happened in the mortgage lending business. Survival in the industry has now mandated that all have become corrupt. This metamorphoses at GDW has been like watching your teetotaler buddy have his first drink at the age of 30, and then immediately start showing up at happy hour every evening. The story eventually ends badly. This is also the primary reason behind the drive to allow the members of the federal home loan banks, of which GDW is one, to sell their portfolios into the [mortgage-backed securities] market. They want to be able to unload the time bombs they know they are now sitting on."
My correspondent went on to describe some recent mortgage transactions he'd handled personally that reflect the dilemma of brokers who are committed to high ethical standards: "I don't know how various federal home loan bank members are calculating their portfolio risk, but I'm not an idiot. If you tell people that if they lie they can have a loan, then you can't hedge your portfolio risk because you don't know what it is. Further, because of the way the residential loan regulations are written, it is illegal for lenders to offer these loans and then not allow anyone who wants one to have it.
In Over His Head
"Recently, I took a loan application from a borrower wanting a particular kind of loan because his friend got one through me. The difference was that his friend legitimately qualified for the loan. This kid purchased his home for $350,000 two years ago with a 100% loan. He is now on his third mortgage with a balance of $500,000 and the property is worth $625,000. The $150,000 in increased equity he has taken out of the home has been spent. He is now asking me for a $562,500 loan; 90% LTV for another $62,500 in cash out.
"He didn't have the income to qualify for the first loan, let alone the subsequent mortgages. He has no reserves, suspect credit and a stay-at-home wife. It is illegal for me to deny him a loan. It is illegal for me to ask him to verify his income if he is applying for a no income verification loan. But his loan was approved, which made me sick to my stomach. Today I had a conversation with him. I told him that if he wanted the loan, I could not stop him from taking it and that I would give it to him. I also told him that I believed he was lying about his income. I violated the law when I did this. He is also a non-white, which means if he wanted to report me for discrimination I would likely be disallowed from offering residential loans from now on.
"He didn't tell me whether he was lying or not but he did ask me what the consequences for getting caught were. I explained the concept of bank fraud, felony conviction, possible jail time, etc. His response was to ask me what the probability of getting caught was. I explained that the possibility was nil unless he lost the house through foreclosure; in which case the probability was high. Mind you this kid just claimed three times his real income on a loan application, is living paycheck to paycheck and only has three years on the job.
"And still he needed to mull it over and speak with his wife before deciding. I, on the other hand had just violated many industry regulations even by having the conversation with him and my stomach was in a knot because I thought he might still actually take the loan. Luckily he called me back this afternoon and said he would decline the loan and follow my instructions on how to get liquid and secure his future. All of this just so I could absorb about $1,000 in expenses on his behalf in paying processors etc. to put his loan through to meet regulations while simultaneously hoping the kid doesn't take the loan I don't get paid on it.
"This is the world we live in now. And this is something I deal with daily. I used to help people by getting them into the best loan possible and got paid for it. Now, large portions of my time and money are spent trying to keep these kids from making a huge mistake."
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