Tuesday, March 2, 2010

The Mortgage Trail: From Bottom to Top

It’s hard to imagine what investment banks and derivatives have to do with three-deckers in disrepair, but there are ways to connect the dots. Starting at street-level, there’s last December’s report by Jennifer McKim for The Boston Globe about a trail of bad loans connected in some ways with a single developer. More than two dozen of the loans were by a single mortgage banking company—by the way, not a bank that was directly pressed to satisfy mandates of the Community Reinvestment Act (CRA). As the Globe reporter took pains to discover, the owners of the properties may have been victimized, though they didn’t always fit the profile of the local buyers who only wanted a place to call home but got in over their heads.

At the other end of the financial trail, there’s Salon.com, with Andrew Leonard’s review of the new book by Michael Lewis, The Big Short. And that begs the question of regulation, with one possible answer yesterday by New York Times columnist Paul Krugman. In short, the answer is that you need oversight with a real firewall to keep the bubble-and-burst from happening all over again.

You don’t have to look beyond three-deckers to see the market extremes, or find that what looks like a bad loan waiting to happen becomes—usually on someone else’s books—a foreclosure petition. A year and a half ago, my curiosity was aroused by a three-decker unit at 310 Fuller Street in Dorchester that sold for $365,000 on February 29, 2008—at a time when it was quite clear three-decker condo prices were definitely going downhill (see Dorchester Reporter). The other two units in the building had sold less than a year earlier for only $355,000. After foreclosure action on the units sold earlier, a foreclosure petition was filed on the more expensive unit last September by CitiMortgage, Inc. The loan--$328,000—was originated by a company called Dreamhouse Mortgage Corporation. On its website, the company said, "Our team of experienced mortgage experts is committed to your success and will go above and beyond traditional means to insure your satisfaction." You can write a book about it, but you can’t make this up.

The CRA is still being blamed for the meltdown because many toxic loans were absorbed on the secondary market by Fannie Mae and Freddie Mac. To the extent they enabled bad primary lending, the secondary lenders should have been regulated more aggressively. It would be easier to blame their failings on the CRA if the toxic loans had lacked for other investors. According to Michael Lewis, this was not the case. As Leonard writes, the loans were originated due to sheer market forces--being readily scooped up by leading investment banks: “These banks were not creating complex derivatives tied to subprime mortgages because of government policy pushing homeownership or because individual homeowners were irresponsibly prone to lying about their income. Far from it; these banks had discovered that billions of dollars could be made transforming lousy mortgage loans into securities supposedly safe enough that they could be sold to pension funds or anyone else. So they had a huge financial incentive to encourage the creation of even more crappy loans.”