The originators/warehouse lenders knew *exactly* what they were doing. That’s why they were immediately assigned!
And look at the bonuses the instigators received as *rewards* for their actions.
And then they lied about AAA ratings to sucker in US and foreign investors, including municipalities and state governments that are now in critical economic positions, as well.
BY: CARRIE BAY DsNEWS.com
It’s hard to pinpoint just what brought the nation’s thriving residential real estate market to its knees. Everyone’s got an opinion, but trying to nail down the exact trigger in order to prevent a sequel is a difficult task. The Mortgage Bankers Association (MBA) is attempting to do just that.
According to a study released Wednesday by the trade group, poor risk management habits, including insufficient data and incomplete performance metrics, coupled with a short-term focus and unrealistic optimism among senior business managers were all factors that contributed to the collapse of the U.S. housing and mortgage markets.
The study entitled, Anatomy of Risk Management Practices in the Mortgage Industry was conducted by Professor Cliff Rossi of the University of Maryland and sponsored by MBA’s Research Institute for Housing America (RIHA). It analyzes the risk management processes employed by mortgage lenders leading up to the housing crisis and discusses lessons learned for future risk managers.
Professor Rossi, who has more than 20 years’ experience within the mortgage industry and at regulatory agencies, says that as home prices increased, lenders were pressured to offer innovative products that could help borrowers afford a home. He found that the increase and expansion of risk layering that resulted, along with changes in borrower behaviors, left risk managers unable to offer reliable risk estimates.
“According to some empirical analysis, when market conditions changed, mortgage performance models proved unstable, with loans originated in 2006 defaulting at four times the rate of what a model prior to 2004 would have predicted,” Rossi explained. “Moving forward, it will be essential for the industry to develop early warning measures of the level of risk in new originations and less reliance on imprecise historical performance of new loan products.”
Rossi says that in addition to limited information available for proper risk assessment, corporate culture and cognitive biases also strongly influenced decision-making during the boom. He argues that one of the biggest black eyes to come out of the prosperous years leading up to the bust was the decline in senior management’s loss aversion, thanks to a lengthy period of strong home prices and low defaults, which in turn led to relaxed underwriting and again, higher levels of risk layering.
“The combination of informational limitations on risk managers and a governance structure and culture that may have tipped decisions in favor of business-driven strategies is central to explaining the increase in risk-taking that took place throughout the industry,” Rossi said. “As the industry is now compensating for the resulting losses through tighter underwriting standards and a lower appetite for risk, it will be vital for executive management to instill a culture where all employees are on guard for risks that exceed the risk appetite of the company.”
Key findings from the study include:
- Subprime loan underwriting criteria along several risk attributes expanded between 1999 and 2006. In particular, combined loan-to-value ratios (LTVs) increased over time as the percentage of loans with silent second liens attached to the property also increased. At the same time, the percentage of loans with full documentation declined.
- The relative lack of geographic and product diversification by a number of the largest mortgage lenders was rationalized by investment opportunity costs and relative value.
- A false sense of security with new products originated prior to 2007 occurred as a result of better than average economic conditions coupled with a lack of information regarding subtle but real changes in borrower and counterparty behavior.
- Cognitive bias toward risk management may have combined with management views on loss-taking to view risk managers as overly conservative and inefficient, which would explain senior management’s actions that ultimately placed their firms at risk.
Michael Fratantoni, MBA’s VP of research and economics, commented, “Today’s mortgage industry is operating under vastly different guidelines than just a few years ago and the survivors in the industry today are clearly the companies that did things right. There is room for debate on how best to proceed, but certainly building a stronger risk management framework around the mortgage industry will be critical.”
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