July 22: Letters on Basel problems, eSignatures & eNotes, GSE reform, the credit crisis

Forget Day 1 Certainty, re-imagining the mortgage process, FHA reform, housing reform, GSE reform, electronic mortgages, lack of inventory, declining refis… everyone’s excited about the eclipse that will snake its way through the U.S. on August 21. (The Mortgage Collaborative, for example, which is holding its Summer Conference in Nashville at that time, has a “Solar Eclipse Break” on the agenda.)

“Rob, do you know about any associations for mortgage bankers in their 20s or 30s?” I imagine there are several, but the one that jumped to mind is the Young Mortgage Professionals Association. Write to them to be added to their distribution list if you’re interested: info@youngmortgageprofessionals.com.

GSE reform

“Rob, I know that you’ve written extensively about reforming Fannie Mae and Freddie Mac. Is there a basic list of what they’re trying to do?” Sure. There seem to be four key components of GSE reform, while at the same time minimizing housing finance disruption and allows the GSEs to build capital. The devil is in the details, of course, and any moves will take years and years to implement. Here’s an easy list of what they’re trying to accomplish: transferring credit risk, leveling the playing field, maintaining a cash window (providing plenty of avenues of execution and options in selling loans), and the GSEs partnering on the common securitization platform.

Credit crisis

Shifting to opinions about the credit crisis, and there are plenty of them, Brent Nyitray, CFA and Director of Capital Markets with iServe Residential Lending, writes, “The cause of the mortgage crisis was a residential real estate bubble. The idea that government policy had nothing to do with the mortgage crisis is ridiculous. There is nothing, absolutely nothing, “free market” about the US residential real estate market. It is subsidized six ways to Sunday, the US taxpayer bears the credit risk of 90% of all new origination, it is used as a tool for do-gooder social engineering, and the most basic input into the market – interest rates – are set by a bunch of academics sitting in a room. The 30-year fixed rate mortgage is a distinctly American product, where the taxpayer bears the credit risk and the lender bears the interest rate risk. In the rest of the world, lenders bear the credit risk, and borrowers bear the interest rate risk.

“In my opinion, the dual mandate was probably the biggest cause. Enacted during the Carter Administration, it sounds good in theory, directing the Fed to minimize unemployment while controlling inflation. That unfortunately translated into a directive that says the Fed must keep the pedal to the metal if we are below full employment and inflation (solely measured by PCE) is in check. This means ‘too much money chasing too few goods’ (aka, inflation) is a problem but not ‘too much money chasing too few assets’ (bubbles) is not. 20 years after the law was put in place, we officially had the ‘Greenspan put,’ and 10 years after that we had a raging housing bubble.

“Yes, the private sector screwed up during the bubble, but the whole mortgage ecosystem is a function of government directives and incentives.’ Thank you, Brent.

On this topic of attributing the credit crisis to government vs. private actions, an underwriter in the Southeast writes, “Ask yourself why CRA pay-ups are over a point. When you have quotas, and can’t find enough high-quality loans, you must do the lousy ones or buy them in the open market at a premium as a cost of doing business. Your readers should look at the severities of CRA loans: Lots and lots of houses in places like Detroit, Harrisburg, and Toledo that are worth $10,000 and have a $100,000 mortgage on them.”


Paul Anselmo, CEO of Texas’ MRN3 Companies, writes, Rob – great info on the eMortgage ‘land grab.’ I call it that because we are seeing more interest in the last 7 months than in the last 7 years. But I somewhat disagree about the statement ‘many are lenders grappling with LOS platforms that cannot integrate with today’s technologies.’ While I agree that the technology is decades old, and no one seems to like theirs, the eMortgage concept has been around for more than a decade. For perspective, MISMO released the eMortgage Closing Guide in 2006.

“In my opinion, the real issue is not the LOS, it’s the document providers. LOSs today transmit the data to content providers to produce the packages. As you know, the eNote is the only ‘required’ SMART Doc because that historically was all the agencies (who were driving) wanted. The rest of the package, pre-meltdown was not their concern as they relied on the old faithful ‘Rep and Warrants’ with counterparties.

“eSignatures work better on SMART Doc(s) than on forms where the points are mapped with x-y coordinates. With a SMART Doc, the signature lines move as necessary with the document content. Many providers still struggle somewhat just to produce the eNote alone as a SMART Doc, and are pushing flat PDF adoption which I liken to scanning a cocktail napkin (drink ring optional) with an X ______________.

“In our diligence work, we often see eSignatures that are over the signor’s name or in the middle of the line itself, as opposed to on the line, making it often difficult to see the actual date/time stamp that is so critical in helping to determine TRID compliance for example. We have also seen missing signatures; my guess is the ‘dumb’ package was tagged for eSign in the ‘hair on fire’ last minutes before closing and something wasn’t tagged. Build a document rather than fill out a form.

“The solution is the entire loan package as SMART Doc, a stream of XML data with the view for the consumer to eSign. This provides many upstream and certainly downstream benefits (delivery/servicing boarding). The actual legally binding documents can be machine read to replace ‘stare and compare’ or the many attempts of extraction and recognition that are utilized today. If the data doesn’t match the tape (maybe that is eliminated one day too) you know unequivocally that it’s the tape that is wrong. The note rate maybe was intended to be something else, but it is what it (legally) is.

“Think about a bond investor, or any other interested stakeholder being able to read data in a pool of loans long afterwards and know exactly what they have…

“This technology exists today and we have it. We are working on pilots with our aggregator clients to eliminate the manual diligence review of at least the disclosure/closing part of a loan file to be purchased. Think about the velocity this gives both parties in the transaction. If that correspondent is delegated, no review required. Purchase when the note is received minutes later.

“We are working on the credit side of the equation now. Appraisal down, many to go. Day 1 adoption will help, but TWN hit rates are still low. Besides, we know non-agency will someday be back.”

Regulation, and Basel’s deficiencies

Dick Lepre, with California retailer RPM and who hosts a blog, scribed, “Because of the mortgage mess/great recession we had Dodd-Frank which has created a great deal of additional banking regulation. I have no idea what the long-term consequences of these regulations will be on banking, the mortgage business and the economy. Regulations are made by people who usually do not have enough awareness of the consequences.

“On an international scale, we have the Basel accords which regulate international banking. The Basel accords are essentially an international standard for any bank which wants to do business outside the borders of its native country. They appear to be a system for making sure that everyone is playing by the same rules regarding, for example, how assets are risk-weighted. Before Basel each nation had its own definition of how to calculate bank capital and what constituted adequate capitalization. There is a Basel I, a Basel II and a soon to be in effect Basel III. In the rest of this piece I am referring to Basel II when I say ‘Basel.’ My criticism of Basel II also pertains to Basel III. The entity which manages the Basel accords is called the Bank for International Settlements more commonly known as BIS.

“Basel II requires all well-capitalized banks, which operate internationally, to hold capital greater than or equal to 8% of their risk weighted assets. Different assets classes have different risk weights: commercial loans are 100% risk, whole mortgages are 50% risk, GSE mortgage backed securities are 20% risk and government debt is zero risk.

“The country which was most affected by the original Basel accords was Japan. Japan was having a real estate bubble just before Basel took effect. The real estate bubble in Japan was much better disguised that it was here. Japanese banks simply made new loans to replace non-performing loans disguising the size of the non-performing portfolio. The fact that the Basel accords kicked in when they did may be part of why Japan has had a stagnant economy for 20 years.

“The issue really is this: are we better off with one set of banking regulations for all countries or would economies be better off if each nation decides its own standard for risk weighting of asset classes and capital requirements?

“Basel has some standards which make little sense to me. Commercial loans are, per Basel, 100% risk. I see a couple of things with that. Not all commercial loans have the same real risk.

To me, the problem with Basel is that it is static. It does not recognize that mortgage debt is riskier when there is a real estate bubble. It does not allow a change in risk weight for commercial lending when that lending might be expansionary and per se risk abating.

“Worse yet, Basel was partially responsible for the mortgage mess because it incorrectly assumed that MBS were less risky than whole mortgages. Banks sold whole loans which they had made according to their own standards because Basel allowed them to hold MBS with 60% less capital. In effect, Basel more than doubled their losses because it did not allow that those MBS were poor. Banks were making PLMBS (Private Label Mortgage Backed Securities) and selling them to FNMA because FNMA could not generate as many bad loans as HUD demanded. Basel made the enormously incorrect assumption that the risk of MBS was static. Instead of mitigating risk, Basel encouraged it.

“What happened with the mortgage mess was that despite the good intentions of Basel and the good intentions of HUD no one saw the possibility that the result of their well-intended regulation not only failed to prevent a problem but actually helped cause it.

“The notion that mortgage securitization minimizes risk makes perfect sense from a theoretical point of view. The failure was that Basel made no accommodation for the disasters created by government mandated downgrading of the quality of GSE debt or Wall Street and the debt rating firms downgrading the quality other MBS. Basel makes the incorrect assumptions that risk is static. It is not. Basel is, in a sense, a set of regulations for regulators and it failed to recognize that regulators can be just as wrong as bankers. Both bankers and regulators made cognitive errors. The story being constantly told is that the mortgage mess was due entirely to greedy bankers. While some bank losses were greed induced most of them were due to ignorance rather than greed. Some bank losses resulted from cognitive errors made as banks and regulators made incorrect assumptions about MBS. Failure to realize that the problem is not just greedy bankers or dishonest loan agents minimizes the complexity of the problem. It is imperative that if we want to prevent another such mess we understand what happened. Basel now has an additional incorrect assumption. Basel treats sovereign debt as zero risk.

“That may have been plausible before the Eurozone debt crisis. With Greece, Portugal, Italy and Spain all having debt issues requiring intervention, the zero-risk rate assigned to sovereign debt per Basel is not accurate. It sways banks to lend money to badly governed nations instead of lending it to companies and individuals who could use those loans to create economic activity. The fact that debt rating firms have already downgraded the rating of U.S. Treasury debt shows just how bad the overall sovereign debt situation is. It is, to me, indefensible at present to suggest that all sovereign debt has no risk. Nations are rather dissimilar. Greece (the first to fall) is a nation with a history of political corruption.

“In summary, Basel is built on a set of incorrect assumptions and we may be better off if we scrap the accords and have each nation let its central bank, the banks themselves and the legislated regulators work out what they believe is best for their nation. A competitive set of risks and rewards may be a lot better than the “one size fits none” mandate which results from Basel.”

English is a funny language, with all kinds of lists of things that don’t make sense. Like why do we say, “last night” or “last week” but not “last day?”

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Rob Chrisman