I should make that more clear. I'm not talking about the underwriters but the underwriting rules themselves. The underwriters were just following them. FHA underwriters today get all the same pressures, and had all the same time constraints yet FHA default rates have actually gotten lower. The reason is that HUD holds the lenders accountable and will cut them off from the FHA program if their default levels are too high. So if a lot of business comes in the door, underwriting times just get longer. They don't relax the rules because they know they're selling the loan to someone else and won't have to worry about it. HUD will cut the lender off no matter who holds the loan when it defaults.

So on FHA loans you don't just approve a loan automatically as long as it has the right credit score and the right number of late payments in the last 12 months the way subprime loans have.  Or allow a debt ratio to go too high without some evidence that a person that a person can handle it or allow stated income loans as all. An underwriter on an FHA deal looks at the whole credit picture and analyzes the patterns. They don't just check off the boxes on a matrix and send it on down the line.

Challenging appraisals has more behind it than just too much time on the hands of underwriters. For the last several years as foreclosures have gone up, lenders are finding that values on the homes aren't anywhere near what they thought they were. There are a lot of different reasons for that that often have nothing to do with the quality of the original appraisal, but the result is that they had to set up some review systems and rules that make sure the quality of the appraisals is maintained. As usually happens when a process like this is made bureaucratic, people who don't really even understand the concepts behind and reasons why an appraisal is done the way it is. They just have a checklist and an AVM that determines what they do. Not to mention many lenders have now set up whole departments that every appraisal is sent to automatically. Human nature seems to be that if someone's job title includes the term "review" that they think they are supposed to find something wrong. ;)

Jerry,

Thanks for your comment. :)

Your post is an excellent exposition on why the underwriting rules ended up so lax.

Yet I've read it through 3 times now and don't find anything which differs from my original point that lax underwriting rules and not subprime ARM adjustments were the cause of the foreclosures and resulting fall in property values. Yet even now we still hear on the news every day that the problem is a "subprime" mortgage mess caused by 2/28 ARMs adjusting.  The problem is much deeper than that.

People who are not speculators will fight tooth and nail to keep their home if they ever really had a legitimate chance of affording it in the first place. A large percentage of the foreclosures we've been having occurred before any rate adjustment at all because those people should have bought a less expensive home.

I was comparing all the problems we're having due to this lax underwriting with the FHA program which never got quite so free and thus is not having as bad a foreclosure problem in terms of percentage increase. Even FHA has had some underwriting issues, but never to the extent of using stated income or no doc programs or not ever requiring explanations for bad credit.

Thanks!

Carl Pruitt

Juan,

You're right. It sure didn't take a genius to figure out that the thousands of loans done with underwriting guidelines like those had no chance to weather even the slightest market turbulence, much less the rapidly falling values in some areas today. Values, by the way, which never would have been that high without loose credit. 

And that loose credit would never have existed in the secondary market without both actual and implied guarantees from the government and from the Federal Reserve that they wouldn't let banks and large secondary market firms fail no matter what. Now they are in the catch-22 situation of having to guarantee deals like the Bear Stearns deal just to make sure the financial system doesn't collapse, when doing so actually makes the problem worse in the long term! Quite a mess. A big vicious circle.

On the other side, although the problem began with the underwriting rules, and better underwriting rules would have prevented the problem completely, I still don't care to hear the typical mortgage broker/loan officer excuse that they were just following the rules. Rules which we've already noted any idiot could see would send their customer into bankruptcy. Not a good long term business plan to bankrupt your customers.

But the best solution is at the source. Shut down the Federal Reserve from using loose credit to "manage" the economy. Nobel Prize winning economist F.A. Hayek showed them more than a half century ago that no one is smart enough or has enough information to do that.