Michael's Blog

When A Tax Credit Becomes A Pain To Get, It's No Longer A Credit - A Few Word On HR 3221

Sat, 12 Jul 2008 15:34:21 -0500

This post was inspired by discussion on John Farris's blog yesterday on whether or not the government's first-time buyer tax credit is an appraisal consideration. It's a good read with good commentary, so check it out.

It drove me however to drill-down a little further in to the bill, exposing what I believe are a few short comings in the tax credit provision. If you're not familiar with the House or Senate versions of HR 3221, follow the links below courtesy of the THOMAS/Library of Congress website:

1. Foreclosure Prevention Act of 2008 (Engrossed Amendment as Agreed to by Senate)

2. American Housing Rescue and Foreclosure Prevention Act of 2008 (Engrossed Amendment as Agreed to by House)

---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Let's parse through a couple of not so obvious caveats and qualifiers built-in to the tax credit.

With regard to early disposition of a property originally purchased with the benefit of this tax credit - but sold in the first 2 years - here is some text.

`SEC. 25E. CREDIT FOR CERTAIN HOME PURCHASES.

`(e) Recapture in the Case of Certain Dispositions- In the event that a taxpayer--

`(1) disposes of the qualified principal residence with respect to which a credit is allowed under subsection (a), or

`(2) fails to occupy such residence as the taxpayer's principal residence,

at any time within 24 months after the date on which the taxpayer purchased such residence, then the remaining portion of the credit allowed under subsection (a) shall be disallowed in the taxable year during which such disposition occurred or in which the taxpayer failed to occupy the residence as a principal residence, and in any subsequent taxable year in which the remaining portion of the credit would, but for this subsection, have been allowed.

In plain English, if you sell the home in the first two years or fail to use it as your primary residence, you forfeit the balance of the credit for the period that it would have applied. Whether this is prorated monthly or in yearly lump sums, check with an accountant. But here's a catch.

Under limitations part`(3) ONE-TIME ONLY clause:

`(A) IN GENERAL- If a credit is allowed under this section in the case of any individual (and such individual's spouse, if married) with respect to the purchase of any qualified principal residence, no credit shall be allowed under this section in any taxable year with respect to the purchase of any other qualified principal residence by such individual or a spouse of such individual.

So if this credit means anything to you - choose your home wisely. You will be married married to it for at least two years. And if you sell, it will be three years before you qualify again for the tax-credit based on the definition of "first-time home buyer" in the House version. (a widely accepted definition mind you).

What I found a bit amusing was their definition of eligible property:

`(c) Qualified Principal Residence- For purposes of this section--

`(1) IN GENERAL- The term `qualified principal residence' means an eligible single-family residence that is purchased to be the principal residence of the purchaser.

`(2) ELIGIBLE SINGLE-FAMILY RESIDENCE-

`(A) IN GENERAL- The term `eligible single-family residence' means a single-family structure that is a residence--

`(i) upon which foreclosure has been filed pursuant to the laws of the State in which the residence is located, and

`(ii) which--

`(I) is a new previously unoccupied residence for which a building permit was issued and construction began on or before September 1, 2007, or

`(II) was occupied as a principal residence by the mortgagor for at least 1 year prior to the foreclosure filing.

`(B) CERTIFICATION- In the case of an eligible single-family residence described in subparagraph (A)(ii)(I), no credit shall be allowed under this section unless the purchaser submits a certification by the seller of such residence that such residence meets the requirements of such subparagraph.

`(3) PRINCIPAL RESIDENCE- The term `principal residence' has the same meaning as when used in section 121.

Here is where it get's sticky, so stay with me.

Part 1 clearly delineates a house, but not condos. Part 2 says a foreclosure filing must have been filed, so this should include short-sales, right? Maybe not. It says the home must have been previously owner-occupied in subsection (ii) which potentially eliminate a good pool of speculated property that are in short-sale (pre-foreclosures). It hammers this point home when it delineates that previously unoccupied homes are eligible only if it is new construction.

So if you are a speculator and you are defaulting on an investment property, this tax incentive won't apply to your case. And if you are a builder that can't sell off units but broke ground after September 2007, you're out of luck, too.

Subsection (B) is most troubling. It puts the burden of proof on the buyer to provide the lender a seller certification verifying occupancy status. And if vacant, the buyer must provide the lender a certification from the builder that (a) it is new construction, (b) it was never inhabited, and (c) it was not built after 10/01/2007.

This is dumb.

The point of the credit is to incent buyers to buy and absorb our housing glut. Yet, while Congress needs more customers it conditions their participation, only to limit it. When hurdles become onerous buyers will simply pull back and the value of this credit will be lost in the market.

I get the moral hazard implication of allowing speculated property any benefit from this credit, but it's simply way too late to cry foul. In the big scheme of things, the notional benefit of this credit is a pittance. So why the hurdles?

Would a buyer who found their dream home abandon it because it was previously investor owned and no longer eligible? Should they have to make that decision?

The way I see it this should be all or nothing. Either this applies categorically across the board or not at all. Moral hazard can not play into this because when a tax credit becomes a pain in the a$$ to get, it's no longer a credit.

A CBO Chuckle

Sat, 12 Jul 2008 04:30:42 -0500

I don't really expect anyone to find this funny. But...

On yet on another "hair-raising" Friday night, I was thumbing through the CBO Director's Blog and got a chuckle from his closing paragraph on a post about Infrastructure spending:

"In addition, attentive readers will note that in what I believe to be a first for CBO, the testimony includes a few lines of poetry (see footnote 47). These lines appear in response to a comment from David Brooks of the New York Times at a public forum that CBO reports don't have enough "romance" in them; when I asked him what he possibly meant by that comment, he suggested that CBO documents could include some poetry. Footnote 47 was the best we could do for now."

The footnote:

47. The longer a capital asset is assumed to last, the lower the depreciation cost that would be included in the budget in any given year. Besides the assumed lifetimes, the depreciation schedules for such assets would also reflect assumptions about how quickly or gradually the assets' performance declined over time. The extreme case would be what economists have sometimes called "one-hoss shay" performance. The phrase derives from Oliver Wendell Holmes's poem "The Deacon's Masterpiece or, the Wonderful ‘One-hoss Shay,'" which depicts a vehicle that worked perfectly throughout its lifetime but then "went to pieces all at once,/ All at once, and nothing first,/ Just as bubbles do when they burst."

* Emphasis added.

You would think I was tossin' back a few cold ones right about now...but no. I just found this funny. :)

Wiki: "One-Hoss Shay"

Bear Stearns Revisited, GSE Style

Fri, 11 Jul 2008 08:29:11 -0500

In the week leading up to the Fed coordinated buy-out of Bear Stearns, a massive stock sell-off stoked by insolvency rumors brought the 85-year old investment institution to it's knees.

This week, history repeated itself only this time, the obituaries bear the names of Fannie Mae and Freddie Mac.

The twin pillars of the US mortgage finance system found themselves caught in a vicious rumor mill ignited Tuesday when a Lehman Brothers analyst advanced the notion that under a proposed accounting change, namely FAS 140, the pair would have to raise a whopping $75 billion of combined capital - an impossible task in any market.

The report ricocheted media outlets sparking grave concerns intensified yesterday after Bill Poole, former president of St. Louise Federal Reserve said "Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer..."

Déjà vu

Both the GSE's have had their stock price buzz-sawed at the torso in the last 72-hours in full "Al la Bear Stearns" fashion and according to Bloomberg this morning, shares of both companies tanked another 45% at the time this post was published due to government takeover talks.

UPDATE 1: Fannie, Freddie Slide as Speculation Mounts U.S. May Be Forced Into Rescue

UPDATE 2: Paulson Says Regulators Support Fannie Mae, Freddie Mac in `Current Form'

UPDATE 3: Reuters: Fed's Bernanke tells GSEs discount window open: source

Resources:

Bloomberg: Fannie Mae, Freddie Mac Tumble on Takeover Option (Update1)

Financial Accounting Standards Board: Summary of Statement No. 140

Financial Times: Freddie and Fannie in turmoil (Graph: Financial Times)

HousingWire: Are Investors Overreacting on Fannie, Freddie?

HousingWire: Fannie, Freddie Shares Battered By Credit Concerns

News: OTS Director Approves Basel II Proposal

Thu, 03 Jul 2008 06:39:43 -0500

Well, Treasury's not wasting any time. This from yesterday's OTS press release:

OTS Director Approves Basel Proposal for Alternative Approach

Washington, D.C. - The Director of the Office of Thrift Supervision approved today an interagency proposal for public comment that would offer savings institutions the option of adopting a less complex alternative for calculating risk-based capital requirements under the international Basel II capital accord.

The option of adopting this standardized framework would be available to all thrift institutions except the largest and most complex ones, which are required to follow the advanced approaches that were issued in a final rule on December 7, 2007.

Although the standardized approach is a less complex alternative to the advanced internal-ratings-based approach, institutions of varying asset complexity may make use of the standardized framework. Thus, the proposal addresses the needs of a broad range of institutions. The proposal makes clear that institutions may also choose to remain under the current general risk-based capital system.

The federal bank regulatory agencies are seeking comment on the proposed framework, including possible enhancements and alternatives to using external credit ratings, especially for structured finance exposures. Comments will be accepted for 90 days from the date of publication in the Federal Register.

A copy of the proposal is attached:
Preamble
Regulatory Text

Reference materials:

Technical Overview of Final Rule [pdf]

Hat-tip, Paige Rausch. Links added...

Discussing The Meltdown With Mark Zandi, Angelo Mozillo, And Friends

Wed, 02 Jul 2008 11:03:04 -0500

On December 3rd, 2007, Maria Bartiromo moderated a roundtable at the OTS's National Housing Forum titled, "Outlook for the U.S. Housing Market and Potential Impact on Financial Institutions"; which served to answer the follow questions:

- How deep and long-lasting will the current slow-down in the housing sector be?
- Are some areas of the country faring better than others?
- What will be the effect(s) on the economy as a whole?
- How well have banks and thrifts weathered the downturn?"

The discussion was paneled by Frederick Cannon (Managing Director of Keefe, Bruyette & Woods), Angelo Mozilo (Chairman/CEO of the now famously defunct Countrywide Financial Corp.), Robert Toll (Toll Brothers Home Builders), and Dr. Mark Zandi (Co-Founder/Chief Economist of Moody’s Economy.com).

Given the candor of the panelists, it's a worthy 50 minute trip down memory lane. Each segment averages roughly 8 to 9 minutes in length. Enjoy...

Part - I

Part - II

Part - III

Part - IV

Part - V

Part - VI

Pay-Option ARM's No Longer an Option At Wachovia, Prepay's Waived To Boot

Mon, 30 Jun 2008 14:52:43 -0500

And so it seems the era of the Pick-A-Pay loans maybe be winding down afterall.

From Housing Wire:

Wachovia Ditches Pick-A-Pay, Will Waive Prepayment Fees on Option ARMs
By PAUL JACKSON
Published: June 30, 2008

In a nod to increasing investor and credit rating agency concern over mushrooming exposure to its now-infamous Pick-A-Pay mortgages, Wachovia Corp. (WB: 15.62, -3.70%) said on Monday afternoon that it would no longer offer negatively amortizing mortgages to customers. So-called option ARMs were originated in force during the recent housing boom, and have recently led to large losses for the banks involved in making them.

The move is a stark change of direction for the Charlotte, North Carolina-based bank, and a tacit admission that option ARMs are a big problem for the bank, which paid $25 billion to purchase Golden West Financial in 2006. Golden West owned World Savings Bank, one of the nation's largest originators of option ARM mortgages, and was at the time the nation's second largest thrift; that ill-fated deal ended up costing CEO Ken Thompson his job roughly one month ago, and the bank has yet to find a successor. Continue Reading

Related stories:

Interesting Read on Behavioral Economic Trends

Sun, 29 Jun 2008 21:39:11 -0500

While perusing the CBO Director's blog this evening, I stumbled upon this post that talks about advances in behavioral economics in UK policy making. He links to two interesting Times articles on the topic of Behavioral Economics and politics below. It's cool stuff, enjoy.

Politicians are devouring the work of academics who explain why the carrot beats the stick

The five sexiest ideas in politics

(Hat tip, Dr. Orszag)

Look-Out Petrol, Hydrogen's Made It's Way To SoCal!

Fri, 27 Jun 2008 18:44:27 -0500

Weeks ago a friend and I were mulling over which "eco-friendly" fuel would eventually emerge as the primary source of propulsion for next generation autos. He was pretty sold on ethanol, I banked on Hydrogen.

Well, today's momentous unveiling of the first commercially available Hydrogen fueling station in Southern California maybe pointing to the future of "clean-air" automobiles.

"Out of the way, Petrol. Hydrogen's in the house!"

(Click image for the full story and video)

Snippet:

By Amy Powell

WEST L.A. (KABC) -- The state's first hydrogen station opened Thursday morning in West L.A., built to handle the growing demands of
hydrogen-powered cars.

The Shell gas station on Santa Monica Boulevard is only the second station in the country to have a hydrogen fuel pump in a retail setting.

With gasoline prices continuing to soar, there's a lot of attention on the need to find alternative energy sources, and authorities hope
this will help the public learn more about hydrogen, which they say is good for cars and emits nothing harmful to the environment.

In the future, when Californians pull into a service station to fill up, they may be buying hydrogen instead of gasoline.

(Continue)

The Antithesis of a Bubble?

Wed, 25 Jun 2008 14:28:20 -0500

Columnist John Kay at the Financial Times put up a real thinker yesterday titled Strange financial physics of the inverse bubble. It's a clever piece with a simple question; what term best labels the opposite of a bubble? (Hint: It's not anti-bubble).

This is a kōan, of sorts. When a car crashes into another we call it a collision. So what then is the word for a car not crashing? Hmmm.

He writes, "Some literary journals invite their readers to compete in the invention of new words to describe activities or concepts that have not yet acquired a label. In current markets, what we need is a term for the opposite of a bubble."

John describes a bubble as follows:

"In a bubble, prices become disconnected from values because purchasers believe that, whatever the fundamentals, they will soon be able to sell what they have bought at a higher price. The bubble must burst eventually because the supply of new people willing to buy at ever higher prices will be exhausted, and generally bursts sooner than that because people come to realise this."

...and it's opposite:

"In the opposite of a bubble, prices become disconnected from values because sellers believe that, whatever the fundamentals, they will soon be able to buy what they have sold at a lower price. The anti-bubble must also eventually collapse because the supply of new people willing to sell at ever lower prices will be exhausted."

If exuberance causes a bubble, then fear of loss causes the anti-bubble. But the question is not about cause and effect. Nor is it about buying low to sell high, although in the context of a bubble, there is a market pathology that slingshots the price of things such as homes, past their fundamental value.

If the result of manic buying is termed "bubble" on the upswing, what is the name of it's opposite?

Calendar: Predictive Methods Conference 2008 (June 9 – 11)

Fri, 06 Jun 2008 07:01:47 -0500

I'm headed to San Diego this weekend to attend the 8^th Annual Predictive Methods Conference. I'll be joined by Bill Nazur of Nazur Enterprises and Bank of America Mortgage, and Vlad Bien-Aime of G-DMS who'll be speaking at the conference.

Unlike most conferences, PMC isn't your garden variety powwow. Among the A-listers' paneling the event will be executives from Fannie Mae, Freddie Mac, Standard and Poor's, Goldman Sachs, and OFHEO to name a few. A wide spectrum of industries will be represented including valuation, credit bureau's, rating agencies, origination/banking, monoline insurers and a litany of technology folks.

From their website:

"PMC 2008 will explore the application and evaluation of collateral risk analytics and associated enterprise decision management systems throughout the life of the mortgage loan. The panel sessions will focus on how AVMs, fraud scores, collateral scoring methodologies, HPI and valuation forecasting solutions and other mortgage risk analytics will be most effectively developed, implemented and applied in the lending process - with a goal of maximizing loan performance and profitability while meeting regulatory expectations."

The conference will open with the hotly contested Home Valuation Code of Conduct. The Office of Federal Housing Enterprise Oversight (OFHEO) who signed into the agreement spawning the "Code" will discuss the topic in great detail. (This should be interesting)

Here's the 3-day agenda:

2:00 PM - 2:15 PM		Opening Remarks
2:15 PM - 3:15 PM		OFHEO Code of Conduct - Understanding the Code
3:15 PM - 4:30 PM		Session One: Loan Product Development
4:30 PM - 4:45 PM		Refreshment break
4:45 PM - 6:00 PM		Session Two: Loan Origination
7:00 PM - 9:30 PM		PMC Welcome Party on the beach

7:00 AM - 9:00 AM		Alliance Partner Demos
7:00 AM - 9:00 AM		California Continental Breakfast
9:00 AM - 9:50 AM		Keynote Address J. Dann Adams President, U.S. Consumer Information Solutions Equifax
10:00 AM - 11:30 AM		Session Three: Quality Control & Valuation Review
11:30 AM - 1:00 PM		Beach side lunch speaker: Ben Mezrich, author of Bringing Down the House
1:00 PM - 1:30 PM		Dessert & cappuccino
1:30 PM - 2:40 PM		Session Four: Loan Servicing
2:50 PM - 4:00 PM		Session Five: Foreclosure and REO
4:00 PM - 4:15 PM		Refreshment break
4:15 PM - 5:30 PM		Session Six: Secondary Marketing/Servicer Sales
5:30 PM - 7:00 PM		Cocktail Reception & Drop your card Give-a-way
8:00 PM - 10:00 PM		Annual Poker Tournament

7:30 AM - 8:30 AM		California Continental Breakfast: How would you like your Data Breakfast
9:00 AM - 10:15 AM		Track One: Fraud, Global & Data "Liar Liar Pants on Fire" Track Two: Small & Medium Lenders AVM Validation & Use
10:15 AM - 10:30 PM		Refreshment break
10:30 PM - 11:45 PM		Track One: It's a small world after all ... Track Two: Best practices in policy development and the systems available for their effective implementation.
11:45 AM - 1:00 PM		Beachside Luncheon Speaker
1:00 PM - 2:30 PM		OFHEO Code of Conduct - Breaking the Code
2:30 PM		Conference ends

The conference starts Monday but we'll be arriving this Saturday evening to "unwind" beforehand. Afterall, by the looks of this agenda we may end up walking away from this event with long white beards and two tablets of stone. If you happen to be in San Diego this weekend, shoot me an email.

Cuomo On The Backs of Rating Agencies, Too

Thu, 05 Jun 2008 10:01:25 -0500

I said before that appraisers and ratings analysts have much in common by way of being disinterested parties and objective advisors to market participants. But who'd of guessed of all the possible similarities, the NY Attorney General Andrew Cuomo would be one of them?

In a move that utterly wreaks of the March GSE agreement that spawned the HVCC reform for the valuation industry, NY AG Cuomo has struck another accord with two of the three pillars of the ratings community.

In all fairness to the NY AG, the ratings community fell short in a couple of key areas. First, payments for ratings were tendered by the companies that stood to benefit or suffer from the outcome. There is no hard evidence of impropriety, mind you, but the air and plausible potential for impropriety was surely their.

Second, given the complexity of the instruments and lack of historic data to back their ratings beyond the shadow of doubt, perhaps some issuances should not have been made. In the valuation industry we must have both the competency to conduct a valuation and the sufficient information to do so. There comes a point when pages upon pages of hypotheticals, assumptions and disclaimers simply erode the validity of the results.

We may not be as smart these guys, but we surely know when to admit our limitations.

From Housing Wire:

New York AG Cuomo, Rating Agencies Reach Agreement: Reports
By PAUL JACKSON
Published: June 4, 2008

It's likely not quite the mea culpa some in the industry might have hoped for, but numerous published reports on Wednesday suggest that both Standard & Poor's Ratings Services and Moody's Investors Service have reached a deal with New York attorney general Andrew Cuomo on their core ratings businesses.

According to the New York Times, which first broke news of the expected deal early Wednesday morning, Cuomo would co-opt the rating agencies into his office's ongoing investigation into the role investment banks played within the formerly booming private-party mortgage securitization space; in particular, numerous reports have suggested that Cuomo is looking to see if i-banks withheld information from investors and due diligence providers alike, massaging the ratings of key MBS and CDO deals in order to obtain the best possible rating.

Earlier this year, Cuomo secured the cooperation of due diligence and loan surveillance specialist Clayton Holdings Inc. (CLAY: 5.90, +0.17%) as part of the same investigation.

In exchange for their help, Bloomberg News reported that the agencies would receive the equivalent of immunity - freedom from any sanctions that might otherwise be levied for prior ratings missteps, with Cuomo's office terminating its own inquiry into the rating agencies as a result.

Such an outcome, if confirmed, would seem sure to lead at least some investors to cry foul.

While a formal announcement has yet to be made, a number of media outlets obtained what appeared to be confirmation of the pending agreement from S&P president Deven Sharma, who said the agency was "pleased" to work with Cuomo's office on a new set of standards. Neither Moody's or Fitch have commented to the press on the alleged deal.

(Click to Continue)

Related [Housing Wire] stories:

A Big Fed Shoe Drops – Mishkin Exits

Thu, 29 May 2008 11:53:39 -0500

A great mind exited the FOMC yesterday.

Frederic Mishkin of Columbia University who joined the Federal Reserve in 2006, parted ways Wednesday for reasons seemingly rooted in the Board of Governors inability to adopt his view that communicating inflation targets with the public may provide the flexibility needed to steer (and over-steer) monetary policy towards stabilizing inflation.

It's hard to say for sure, so here's the article.

From the Financial Times:

Exit of Mishkin robs Bernanke of ally
By Krishna Guha in Washington
Published: May 29 2008 03:00 | Last updated: May 29 2008 03:00

The surprise decision by Federal Reserve governor Frederic Mishkin on Wednesday to quit the US central bank will rob Ben Bernanke, the chairman, of one of his closest intellectual allies at an exceptionally difficult moment for monetary policy.

The economy is either in or near recession and credit markets are still fragile, but the soaring price of oil is raising the risk of inflation, putting the Fed in a very difficult position.

In recent months Mr Mishkin was a strong advocate of aggressive preemptive interest rate cuts to mitigate the threat to growth from the credit crisis - a break from the more incremental approach to monetary policy practised by former Fed chairman Alan Greenspan.

But he also argued that the Fed should be equally pre-emptive in taking back some of the rate cuts as and when the "tail risk" of a deep and severe recession declines.

Mr Mishkin, a top academic economist, joined the Fed in 2006 in part to help Mr Bernanke push the US central bank towards a more formal inflation target, in keeping with the latest academic thinking and best practice at other central banks.

He pressed for the Fed to put a number on its inflation objective, though not a fixed time frame over which to achieve it. (Click to Continue)

I suggest reading his most recent speech at the Wharton Financial Institutions Center on asset price bubbles. It's a mouthful of insight.

* Photo courtesy of the Federal Reserve

Economic Heavyweights on The Mortgage Mess - Summing It All Up

Wed, 28 May 2008 01:31:52 -0500

If you're intrigued with economics, especially the wider impact of the mortgage fiasco; rare powwows that include economic heavyweights like Peter Orszag (Director of the Congressional Budget Office), Zanny Minton Beddoes ("The Economist" magazine and former International Monetary Fund ‘IMF' economist), and Alan Blinder of Princeton (former Vice Chair at The Federal Reserve), can prove insightful.

On April, 23, 2008, this power trio paneled a discussion at the Woodrow Wilson School titled, "How Did We Get Into This Mortgage Mess, and How Do We Get Out".

From monetary policy to securitization, mortgage origination to bankruptcy legislation, there were no stones left unturned in this 83 minute video that summed it all up quite nicely.

The Q & A was especially insightful. Enjoy.

Click for Video

OCC’s Dugan Calls for Withdrawal of Appraisal Pact [HVCC]

Tue, 27 May 2008 16:10:21 -0500

I've got nothing to add to this. The title speaks for itself...

Check it out.

From HousingWire:

OCC's Dugan Calls for Withdrawal of Appraisal Pact
By PAUL JACKSON
Published: May 27, 2008

In the clearest challenge yet to a proposed appraisal management agreement reached in March by New York attorney general Andrew Cuomo and home finance giants Fannie Mae (FNM: 26.53, -3.84%) and Freddie Mac (FRE: 24.73, -3.89%), Comptroller of the Currency John Dugan has sent a letter calling on Office of Federal Housing Enterprise Oversight director James Lockhart withdraw the appraisal pact.

The letter, dated May 27, characterized the so-called Home Valuation Code of Conduct (or HVCC) as having "adverse consequences ... for the safe, sound, and efficient operation of national banks' residential mortgage lending activities, as well as for the cost of mortgage credit to consumers."

Republicans in the Senate have been mulling a Congressional challenge to the appraisal pact as well, on the grounds that the proposal violates or attempts to supsercede federal law. Dugan and other federal regulators have expressed their displeasure at what they see as a "power grab" by Cuomo's office, after the state AG didn't involve federal entities in crafting the original appraisal pact.

"The OCC endorses the principle that real estate appraisals must be conducted free from influence or coercion by any party," Dugan writes in the letter. "But this objective should be achieved directly ... not by dictating the corporate and internal organizational structures of lenders."

Full text Dugan's letter

Related [Housing Wire] stories:

Fannie Buckles to Consumer Groups, Tosses "Declining Market Policy" Out The Window

Fri, 16 May 2008 12:19:41 -0500

Effective June 1st, 2008, Traditional/Conforming O/O loans will cap at 97% via DU, and 95% if manually underwritten. I've got mixed feelings about this, but that's not important right now. See story for details.

From Housing Wire:

Fannie Nixes ‘Declining Market' LTV Restrictions
By PAUL JACKSON
Published: May 16, 2008

Under increasing pressure from consumer groups, Fannie Mae (FNM: 30.03, -0.66%) said Friday that it had eliminated its prior loan-to-value restrictions in so-called "declining markets," or those local housing markets most directly hit by the ongoing housing correction. New underwriting and downpayments standards will apply to all mortgages accepted by Fannie Mae, regardless of geographic location, eliminating the controversial policy.

In December 2007, Fannie Mae adopted a "Maximum Financing in Declining Markets Policy" that restricted the loan-to-value ratios on properties in markets where home prices are declining, essentially requiring higher down payments in these markets. That policy, as reported by Housing Wire, essentially added 5 percent to the LTV requirements of existing loan programs - so a 95 percent LTV program became a 90 percent LTV program in an identified declining market, for example.

Industry representatives had defended the move as prudent risk management, but consumer groups targeted the policy as so-called red-lining. Red-lining refers to decades ago, when banks once used red markers on maps to outline neighborhoods they would not lend in.

Starting June 1, Fannie Mae said it will accept up to 97 percent loan-to-value ratios for conventional, conforming mortgages processed through its automated underwriting system, and 95 percent loan-to-value ratios for loans manually underwritten, in all geographic locations in the United States. The LTV requirements will apply only to single-family, primary residences; other properties will face different underwriting restrictions.

Go to Full Story

US Banker: White Papers

Thu, 15 May 2008 15:01:22 -0500

If you're into real geeky banking stuff - like myself - a newsletter worthy of your in-box is one from US Banker. Their newsletter offers white papers by various organizations on a broad array of enterprise topics.

This morning, a paper titled CRO Survey: Risk, regulation and return caught my. Here's a snippet from the executive summary:

Banks the world over are reevaluating how they address risk. New regulations - from Basel II to the European Union's Capital Markets Directive* - are driving banks to take a more comprehensive approach to risk management. While compliance will remain the focus of risk management efforts in the near term, leading firms are transforming risk management into a full-fledged partner that provides value to the business. To better understand the perspectives and concerns of today's CROs, the IBM Institute for Business Value interviewed banking risk management executives in depth and cosponsored a wider, cross-industry survey conducted by the Economist Intelligence Unit. Our findings suggest that banks must address the need for change on several fronts: [...]

To read on (PDF only), go here (registration required): http://promo.sourcemedia.com/promoart/files/risk-regulation.pdf

* The Capital Markets Directive, or CMD, is essentially the EU's implemention order for Basel II capital rules.

Banker Groups Dissent "HARD" On The Home Valuation Code of Conduct

Tue, 13 May 2008 16:28:44 -0500

I just got wiff of a letter published by a group of eight major banking associations in "scathing denouncement" of the HVCC (Home Valuation Code of Conduct). The group is hyper-critical of the manner in which the agreement was reached and says to OFHEO and the GSE's to withdraw from the agreement.

I have to say, I particularly appreciate the distinguished guests they carbon-copied this doozy of a letter. (see below)

Hat tip, Valuation Review.

From the ICBA website, page 1 of the letter:

American Bankers Association
American Financial Services Association
Consumer Bankers Association
Consumer Mortgage Coalition
Housing Policy Council, The Financial Services Roundtable
Independent Community Bankers of America
Mortgage Bankers Association
Real Estate Services Providers Council, Inc. (RESPRO®)

April 30, 2008

The Honorable James B. Lockhart III
Director
Office of Federal Housing Enterprise Oversight
1700 G Street, N.W.
Fourth Floor
Washington, DC 20552

Dear Director Lockhart:

The undersigned are writing to register our concern with the serious legal and policy questions that are raised by the proposed Home Valuation Code ("Code"), which Fannie Mae and Freddie Mac (the "GSEs") have agreed to adopt, pursuant to a written agreement ("Agreement") with the Office of Federal Housing Enterprise Oversight ("OFHEO") and the New York Attorney General (NYAG). We agree that accurate appraisals are a critically important component of sound mortgage lending and that appraisal fraud is a factor in many cases of mortgage fraud.

We have very serious concerns with both the manner in which the Agreement and the Code have been mandated by OFHEO and the NYAG as well as the substance of the documents. (For simplicity purposes, reference herein to the "Agreement" shall include the Code.) We believe that OFHEO should withdraw its assent to the Agreement, should not permit the GSEs to implement the Agreement, and should take steps to assure that this type of rulemaking by settlement does not occur in the future. The Agreement is in violation of Title XI of FIRREA and permits the NYAG to unlawfully exercise authority that resides exclusively with the Federal Government. The method of imposition of the agreement is in violation of the Administrative Procedure Act and constitutes an unlawful delegation of authority by OFHEO to a third party. For a variety of reasons, the Agreement is not consistent with the best interests of the GSEs, the housing finance markets, and other aspects of public policy.

Continue 14-Page Letter In PDF

cc:

The Honorable Sheila Bair, Chairman, Federal Deposit Insurance Corporation

The Honorable Ben Bernanke, Chairman, Federal Reserve Board

The Honorable Roy Bernardi, Acting Secretary, U.S. Department of Housing and Urban Development

The Honorable Andrew M. Cuomo, Attorney General, State of New York

The Honorable John Dugan, Comptroller of the Currency

The Honorable JoAnn Johnson, Chairman, National Credit Union Administration

The Honorable Henry M. Paulson, Jr., Secretary, U.S. Department of the Treasury

The Honorable John Reich, Director, Office of Thrift Supervision

Federal Trade Commission Cautious Of The Home Valuation Code of Conduct

Thu, 08 May 2008 18:47:10 -0500

The FTC recently penned a letter to Freddie Mac (cc: Fannie Mae, OFHEO, NY AG "Cuomo") regarding the soon to be enacted "Home Valuation Code of Conduct" which bans the mortgage giants from buying loans with brokered-ordered appraisals.

The letter citied "competitive concerns" and potential regulatory redundancy with language that begs an impact study to fully consider the effects of the HVCC on the mortgage industry and the borrowing public before its' enactment.

(Boy does this sounds familiar)

The meats and bones are here in Section IV:

[...]
IV. Potential Concerns Raised by the Code of Conduct
The FTC staff is concerned about recent mortgage market turmoil and its effects on individuals, families, neighborhoods, and the overall economy. Some of the current problems in mortgage markets may be attributable to abuses in the appraisals of residential homes. In comments recently filed with the Federal Reserve Board ("Board"), the FTC staff supported the Board's proposed rule to protect appraiser independence, noting that pressuring an appraiser to misrepresent the value of a property distorts the lending process and harms consumers. Section I of the Code of Conduct would provide similar protections for appraiser independence.
Prohibiting specific conduct that may undermine the independence of the appraisal process - as Section I of the Code of Conduct would do - is the most direct means of protecting such independence. In contrast, limiting the way in which participants in the mortgage lending industry can contract with each other and thus imposing potentially significant changes in the structure and functioning of that industry - as Sections III and VI of the Code of Conduct apparently would do - is a much more indirect means of protecting appraiser independence.
The use of such indirect means also creates concerns that, notwithstanding the laudable goal of appraiser independence animating the requirements and prohibitions in the proposed Code of Conduct, such provisions may have unintended adverse consequences for competition and consumers in the mortgage lending area, including, for example, higher prices for consumers without sufficient protections or other benefits to offset such costs.
Based on its experience, the FTC staff recognizes the need to consider all of the implications - including both the benefits and costs to consumers - of imposing restrictions in the mortgage lending area because of the potential for such restrictions to impair consumers' access to mortgage credit.
[...]
Partial Footnotes:
FTC STAFF, 23 COMMENTS TO THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM ON PROPOSED RULE RESTRICTING CERTAIN MORTGAGE PRACTICES 9 (Apr. 8, 2008), available at http://www.ftc.gov/os/2008/04/V080008frb.pdf.
Given the significant roles that Freddie Mac and Fannie Mae serve in the secondary mortgage market, it seems likely that the Code of Conduct will have a significant impact on the structure and functioning of the primary mortgage lending industry.Code of Conduct § VI(5). Section VI(6) extends th 25 is prohibition to any entity owned in whole or in part by a settlement services provider. Id. § VI(6). 26 Id. § III. See also id. § V (requiring certain training for lender employees or, if the lender retains an AMC, employees of the AMC responsible for selecting appraisers).
Advisory Email Message to Seller/Servicers, Freddie Mac, Important Information about Home Valuation Code of Conduct (Mar. 3, 2008) (emphasis added), available at http://www.freddiemac.com/singlefamily/20080303_advisory.html. 28 It is unclear from the language of the email advisory whether prohibited appraisals include those "done" or "ordered" by "an entity that offers any other services other than appraisals" - or both.

Read Complete FTC Response to The Home Valuation Code of Conduct

Also See: An Industry's Fall From Grace...

British Subprime Humor (Video)

Mon, 05 May 2008 17:57:41 -0500

Ever wonder how the most complex structured investment vehicles work? Well here's a British satire featuring comedians John Bird and John Fortune in a mock bankers interview. (Kudos to Housing Wire)

California Taking Blows to the Head - Realtytrac Q1 2008 US Foreclosure Market Report Shows

Mon, 05 May 2008 00:02:46 -0500

Realtytrac released this week its Q1 2008 Foreclosure Market Report^TM citing a 23 percent quarter-to-quarter rise in nationwide filings, and a stunning 112 percent increase from Q1 2007.

Filings rose in 46 out of 50 states and 90 out of 100 of the nation's largest metros, per the report. The three states with the most filings per household were the usual suspects: Nevada (1:54), California (1:78) and Arizona (1:97). Filings reflect households linked to a default notice, auction sale notice or bank repossession. Click for Full Map

California's numbers were particularly troubling. Default filings topped the charts with a whopping 108,109 NODs (Notices of Default). That's 108,109 mortgages that are 90 days or more past due. Nevada placed a distant second with a meager 13,424. Adding salt to injury, California registered a whopping 40,023 REOs in the pipe.

NODs ("Pre-foreclosures") are critical because they reflect the number of REOs potentially in the wake. And as a greater number of NODs materialize in foreclosure, the more intense is the negative-feedback dynamic of price declines feeding foreclosures begetting more declines and so on.

But of course, not all NODs end in foreclosure. And I suspect (or hope) that a large number of the 100,000+ NODs are being worked-out in some way. Assuming a troubled borrower is willing and able, foreclosure can be avoided by paying arrearages, qualifying for loan modification, filing for bankruptcy (thereby "staying" default actions) or selling the property.

However, an issue facing most hot spots like California is the problem of mounting negative equity. The growing number of households faced with loans greater than the property's worth has servicers, lenders and analysts fearing the worst case scenario: a proliferation of ruthless defaults. This swanky term coined recently by Wachovia describes the choice by many underwater borrowers to voluntarily stop making payments on mortgages they could otherwise afford. Evidence of voluntary defaults lays with the fact that a large number of NODs are not on properties faced with a mortgage reset. Just Google mortgage rate resets aren't the problem to find plenty of coverage on this topic.

So what does all this mean? It means that so long as NOD cure-rates remain exceedingly low and auctions continue to poorly perform, expect really really elevated REO activity through the end of the year.

Stable Loan Limits Mean Stable Housing Markets

Sat, 03 May 2008 15:56:23 -0500

The Office of Federal Housing Enterprise Oversight (OFHEO) recently issued final guidance on how fluxing house prices would affect Conforming Loan Limits (CLLs) in the future. In a nutshell, the loan ceiling is no longer subject to reduction regardless of declines in price metrics - ever. The ceiling can go up but it will not come down. (Group hug?)

To appreciate the magnitude of this decision, background is in order. OFHEO, the safety and soundness regulator of Fannie Mae and Freddie Mac, govern loan limits to temper the GSEs exposure to the market. Since combined the enterprises fund about 70% of US mortgages, unsafe and unsound practices or policies can threaten the housing market and broader economy. Because of the massive buying power of the companies, their implied government guarantees, and "perceived" quality of their securities, lower rates are afforded to lower/middle class Americans as part of their core mission.

This said - every October the Federal Housing Finance Board (FHFB) issues its Monthly Interest Rate Survey (MIRS) which OFHEO relies on to set limits for the following year. When the MIRS report reveals house price increases, limits go up accordingly. When it reports declines however, OFHEO defers the reduction for 1-year following the results for the subsequent year. Somewhat of a wait and see thing. If indeed there is a persistent fall in prices, theoretically reductions would be in order the year after. This is why a reduction in loan limit was not seen in 2008 despite declines in 2006 and 2007.

As prices skyrocketed this decade, loan limits increased from $252,700 in 2000 to its present ceiling of $417,000 in 2006. That's nearly 40% growth in only 6 years. (See historic limits here). Inversely, imagine if years of decline occurred and this policy was not in place, indeed loan ceilings would have to recede sharply.

There have only been three instances when a reduction in CLL's occurred since established back in the seventies'. They were faint to say the least and rather disorderly (you should read the guidance for details). Given the enormity of the modern mortgage market and severity of declines in recent quarters - any open-ended question about limit drops next year was of high concern (at least to those who thought about this).

Here's an example of what it would mean to NOT have this policy.

Let's assume you bought a house this year and financed $400,000. Then next year the limit dropped to $370,000. Without clear grandfathering provisions, you'd be in a precarious situation if you wanted to refinance since your loan no longer qualified for favorable agency guides' and rates. Now imagine if you had to sell this house. The reduction in loan ceiling for access to GSE-insured financing would require your prospect buyers to; (a) put more money down, or (b) accept less-than-favorable non-conforming/jumbo financing. Either of these two options would materially affect its market value.

But OFHEO finally laid those uncertainties to rest.

In the guidance, it explains that it will defer percentage drops in the MIRS report until such time increases offset the net decreases. In other words, it will only raise the loan ceiling by the net percentage of growth based on the average of positive net-change in the MIRS report over many years. Once again, it will only raise the loan ceiling by the net percentage of growth based on the average of positive net-change in the MIRS report over many years.

For example: If the October MIRS report for 2007, 2008, and 2009 net a total of a 5% decline in prices (yeah right, probably more), and the subsequent 3 years yield an increase of 7% (yeah right, probably less); We could expect a net 2% raise in loan limits the year after the net increase was calculated. (Not too shabby, huh? At the very least it adds to long-term stability).

If you agree that Fannie/Freddie are the underlying force bolstering property values as we know them, then you appreciate significance of this policy. It is one thing for mortgage rates to change with the market's ebbs and flows, but it's entirely another to have volatility in the access threshold to prime financing.

Should we be breathing easier? I think so.

***

Conforming Loan Limits No Longer Subject to Decrease - OFHEO Examination Guidance EG-08-001

Fannie, Freddie and the Future of Property Values (Original Post 11/20/07)

Wachovia on "Ruthless Defaults" - Borrowers Gone Wild

Tue, 15 Apr 2008 23:27:11 -0500

On Monday, Wachovia's earnings call highlighted grave concerns of over "ruthless defaults", or "walk aways"; both terms describing voluntary defaults by upside-down borrowers.

In short, Wachovia's risk models (and that of all lenders) failed to take into consideration borrower behavior when faced with negative equity.

The question here is simple: What happens when borrowers reach LTV's greater than 100%? This previously unasked question is wreaking havoc on Wachovia's blance sheets, manifesting defaults in big numbers in of all places, The Golden State.

(Hmmm. A case of California borrowers gone wild? Who'd a guessed?)

From Housing Wire, "Wachovia: Borrowers in California are going AWOL":

Calculated Risk posted some highlights of the transcript from the Wachovia earnings call yesterday - and in it are some interesting details about how new modeling efforts at the bank led it to write down so much of the value of some of its loans.
Specifically, Wachovia has discovered the phenomena known as "ruthless defaults," where a troubled borrower faced with an insurmountable mountain of debt simply walks off into the night, never to be heard from again.
From the call, and Wachovia's chief risk officer Don Truslow:
I don't know where the tipping point is, but somewhere when a borrower crosses the 100% loan to value, somewhere north of that ... their propensity to just default and stop paying their mortgage rises dramatically and I mean really accelerates up and it's almost regardless of how they scored, say, on FICO or other kinds of character, credit characteristics.
It's difficult on the walk-away part of the question, that is going on, clearly and there's lots of evidence of that in the market ... And so we do our best to try to gauge but that portion of the defaults is just kind of hard to quantify. But that behavior is going on. We're seeing in our portfolio the most significant declines and defaults activity in California and of course it's the largest concentration for us in the pick a payment portfolio by far. What I don't know and I guess we're just learning over time is whether the same sort of behavioral trends and patterns will spread to other markets or be observed in other markets at the same pace that they have been in California.
In plain English, Wachovia is saying that prior models didn't account for what overextended, upside-down borrowers would do when faced with a mortgage on an asset worth less than they owe on it.
The above should make anyone in the industry take pause, and think about what an extended downturn and recession could mean for millions more borrowers who have either extracted their equity cushion or never had one to begin with.
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CBO Director's Blog

Sun, 13 Apr 2008 12:58:30 -0500

It's amazing what you can find on the internet these days. Would you guess that the Director of the Congressional Budget Office (CBO), blogs?

Well, he does.

Dr. Peter Orszag, the young director who strikingly resembles the kid you'd expect was bullied by the Varsity team, is a modern day "econo-pimp" (pardon the colloquial) that puts out tons of useful information direct from the CBO. I check in with his blog frequently for updates on economic issues. In particular, updates to past testimonies and analysis on housing. I've watched him testify before Congress, and he's quite the intellect you'd expect, with a bit of a humourous side, too.

Below is an April 11^th update on previous analysis of various policy options for the housing mess. Check out the graph below...

Housing policy options

This morning, CBO released a new study on policy options for the housing and mortgage markets. The paper discusses the potential for federal intervention to ameliorate the situation, by encouraging and removing impediments to private mortgage restructuring or by providing federal financial support. (It does not, however, address the question of what regulatory changes might be warranted over the longer term, either to address the problems that led to the current situation or to support any wider federal role in the financial markets.) CBO finds that:
The current economic situation is quite fragile, largely as a result of the difficulties in mortgage markets and other financial markets. Much of that fragility arises from falling house prices, which affect consumers through their housing wealth and lenders through their loss of collateral. It is exacerbated by the growing complexity of financial instruments and entities, which may make it difficult for participants to know what risks they are assuming, and by the leverage of both borrowers and financial market intermediaries, which means that it is difficult to prevent liquidity and solvency problems from spreading throughout the financial markets.

Foreclosures are an expensive way to resolve delinquencies. A large number of foreclosures is also likely to reduce the demand for houses, as potential purchasers conclude it would be better to wait until prices stop falling. Thus, excessive foreclosures could trigger a downward spiral of house prices that could take them below what would be justified on the basis of normal relationships to income and production costs. Such a downward spiral would exacerbate the problems in the financial markets, and...

(Click Chart to Continue)

President of Netherlands Bank on Basel II - FT.com

Thu, 10 Apr 2008 11:33:29 -0500

Basel II and Cornflakes® rarely mix. But while headed for some light reading on FT this morning, I caught an article written by Nout Wellink who is chairman of the Basel committee. Here he address's the core principles of BII and responds to critics of the framework who argue it is procyclical versus anticyclical - a key distinction worthy of address by the chairman himself.

From the Financial Times:

Basel II is sophisticated and sorely needed
By Nout Wellink
Published: April 9 2008 19:21 | Last updated: April 9 2008 19:21
The current financial market turmoil underscores the importance of strongly capitalised banking systems. It also highlights the shortcomings of the Basel I capital regime, which has been in place since 1988 and has contributed in the past few years to the concentration of risk in the banking sector.
There is a strong consensus that the implementation of Basel II will put capital regulation on a sounder footing. Among other things, Basel II will enhance capital regulation, supervision, risk management and market transparency. All exposures, whether on or off the balance sheet, will be subject to regulatory capital charges. There will be greater differentiation in the capital requirements for high and low-risk exposures. Basel II will create more neutral incentives between retaining exposures on the balance sheet and distributing them to investors through securitisations. It will introduce more robust capital requirements for banks' rapidly growing trading and derivatives activities. Supervisors will be given the tools to help strengthen banks' risk management and governance. Better disclosure of banks' risk profiles, including structured credit and securitisation activities, will be required.

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Here's the article he's rebuffing.

Turmoil reveals the inadequacy of Basel II
By Harald Benink and George Kaufman
Published: February 27 2008 19:23 | Last updated: February 27 2008 19:23
The turmoil in world financial markets, triggered by defaults on subprime mortgages in the US, raises questions about macroeconomic policy, financial stability and the design of financial regulation, including the new Basel II capital adequacy framework for banks.
The implementation of Basel II coincides with massive losses reported by some of the world's largest banks, requiring large-scale recapitalisations. The risk models that anchor Basel II are basically the same as the ones many of these banks have been using in recent years. Sheila Bair, chairman of the Federal Deposit Insurance Corporation in the US, recently noted that these models had important weaknesses which, in the light of today's market turmoil, were a flashing yellow light to drive carefully.
Basel II aims to address weaknesses in the Basel I capital adequacy framework for banks by incorporating more detailed calibration of credit risk and by requiring the pricing of other forms of risk. Under the Basel II framework, regulators allow large banks with sophisticated risk management systems to use risk assessment based on their own models in determining the minimum amount of capital they are required to hold by the regulators as a buffer against unexpected losses.
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