IS REDLINING BACK? Recent Moves by Countrywide, Other Lenders have Critics Wondering!

The GSEs (Government Sponsored Entities, Fannie Mae and Freddie Mac) and MI companies released soft market policies to protect themselves from high LTV/CLTV lending in areas that have declining values and/or have values projected to decline.  It's proof that investors have lost some confidence in real estate in general. Consider the investor's logic, if a loan is done at 95% LTV today, with the valuation declines we're seeing right now, it could be > 100% LTV within the year.

Don't be so quick to blame the lenders for issues like this. Countrywide, and other lenders, are only following the directives of investors.  And policies like "soft market" only prove the lack of confidence investors have in real estate right now. Needless to say, it will change over time and policies like these will be revised back to the way they were. In the meantime, look to FHA for your low downpayment buyers.

THE REAL SCANDAL

HOW FEDS INVITED THE MORTGAGE MESS

By STAN LIEBOWITZ

February 5, 2008 — PERHAPS the greatest scandal of the mortgage crisis is that it is a direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults.

At the crisis’ core are loans that were made with virtually nonexistent underwriting standards - no verification of income or assets; little consideration of the applicant’s ability to make payments; no down payment.

Most people instinctively understand that such loans are likely to be unsound. But how did the heavily-regulated banking industry end up able to engage in such foolishness?

From the current hand-wringing, you’d think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and “progressive” political forces.

In the 1980s, groups such as the activists at ACORN began pushing charges of “redlining” - claims that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.

In fact, minority mortgage applications were rejected more frequently than other applications - but the overwhelming reason wasn’t racial discrimination, but simply that minorities tend to have weaker finances.

Yet a “landmark” 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.

That study was tremendously flawed - a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination.

Yet the political agenda triumphed - with the president of the Boston Fed saying no new studies were needed, and the US comptroller of the currency seconding the motion.

No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: “discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.”

Some of these “outdated” criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant’s ability to manage debt.

Sound crazy? You bet. Those “outdated” standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.

Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with “100 percent financing . . . no credit scores . . . undocumented income . . . even if you don’t report it on your tax returns.” Credit counseling is required, of course.

Ironically, an enthusiastic Fannie Mae Foundation report singled out one paragon of nondiscriminatory lending, which worked with community activists and followed “the most flexible underwriting criteria permitted.” That lender’s $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003.

Who was that virtuous lender? Why - Countrywide, the nation’s largest mortgage lender, recently in the headlines as it hurtled toward bankruptcy.

In an earlier newspaper story extolling the virtues of relaxed underwriting standards, Countrywide’s chief executive bragged that, to approve minority applications that would otherwise be rejected “lenders have had to stretch the rules a bit.” He’s not bragging now.

For years, rising house prices hid the default problems since quick refinances were possible. But now that house prices have stopped rising, we can clearly see the damage caused by relaxed lending standards.

This damage was quite predictable: “After the warm and fuzzy glow of ‘flexible underwriting standards’ has worn off, we may discover that they are nothing more than standards that lead to bad loans . . . these policies will have done a disservice to their putative beneficiaries if . . . they are dispossessed from their homes.” I wrote that, with Ted Day, in a 1998 academic article.

Sadly, we were spitting into the wind.

These days, everyone claims to favor strong lending standards. What about all those self-righteous newspapers, politicians and regulators who were intent on loosening lending standards?

As you might expect, they are now self-righteously blaming those, such as Countrywide, who did what they were told.

Stan Liebowitz is the Ashbel Smith professor of Economics in the Business School at the University of Texas at Dallas.

This needs to be shouted from the (foreclosed) rooftops.

But of course it will not be.

(And of course not only is Mrs. Clinton a big ACORN supporter, but Mr. Obama worked for them both before and after attending law school.)

Ntsike WIllis -- don't chalk everything up to cartoonish evil motives. It would be extraordinarily stupid for a business to lend money *without* calculating the risk.  That is simply the technical term for "how likely is it that we will get paid back".  That is a good thing for a business to estimate.  There is nothing immoral about this -- the employees are not lending their own money, they are lending other people's money.

Second, redlining is merely an easy to follow (for the employees) rule to avoid mistakes.  If an area is in decline, there could still be some reasonable loan terms, but loans there are riskier -- they are more likely to lose that someone else's money.  Redlining is a simple control that allows the company to say "we've looked at this area and don't want to risk it".  Businesses don't need to make every possible sale/loan/contract possible -- they make those that can be made without too much hassle and risk.  Also, making reasonable loans in the redlined areas would require doing so with higher rates, causing some people who don't understand the situation to howl with rage. It's not worth that risk either oftentimes.

More importantly, why is it morally better to lend people money to buy houses that professionals believe are going to lose value?

I notice you use the word "deserve", but I find that hard to defend.  Do people "deserve" to use other's money to buy themselves things?  Hardly -- people only lend money to be paid back, along with some interest for the risk and trouble.  They don't lend because someone deserves something.  Do people "deserve" to borrow money to buy something that is going to lose value?  Do they "deserve" to borrow money they can't pay back.  I think the answer to all of these is "no".  Not because I'm some mean person who tries to take advantage of others.  Don't paint your world in such bleak colors.

People watching out for themselves is not a bad thing.  Do you get in your car with the intent to drive into a tree?  No?  Are you some kind of greedy person who is watching out for themselves?  Do you buy a new TV with the intention of throwing it out the window?  No?  Of course not and you should't.  These things not beneficial to you.

I'm not saying that you shouldn't do things for other people.  I'm sure you do.  I do also.  But you shouldn't be forced to lend your money to people you don't think will pay it back.