Search This Blog

Monday, February 4, 2013

S & P - The Horses are Already Out of the Ban

My, my, my the federal government, as well as various state governments, plan to sue S & P (Standard and Poors) alleging wrong doing related to the rating of mortgage bonds (see this).

This wrong doing would relate to the fact that though banks and the US Government were creating insane loan products like the "no doc" loans that allowed virtually anyone with some cash to buy a house via a mortgage.

Because of the 2008 financial crisis the government is now looking for a scape goat on which to blame this crisis.

In response to the lawsuit presented by the US Government S & P said: "It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market—including U.S. government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained—and that every (collateralized debt obligation) that DOJ has cited to us also independently received the same rating from another rating agency.

"S&P deeply regrets that our CDO ratings failed to fully anticipate the rapidly deteriorating conditions in the U.S. mortgage market during that tumultuous time. However, we did take extensive rating actions in 2007—ahead of other ratings agencies—on the residential mortgage-backed securities, which were included in these CDOs. As a result of these actions, more collateral or other protection was required to support AAA ratings on CDOs.

S&P apparently, see the underlined text above, relied in part on the US Government's assessment of the housing market.


But where did this "subprime" market come from (that was or was not "contained")?

It started in 1977 with the "Community Reinvestment Act" - an act designed to help people purchase houses - houses they could afford.  Traditionally it was difficult to get a loan, particularly if you lived in a distressed area because there was a greater risk of the value of your home diminishing.  (You can think about it this way - buy a $20,000 house in one neighborhood that had property values going up and another where the values were going down.  Which is a good investment?)

While this worked to some degree it didn't make enough people happy.

So in 1994 this appeared in the Federal Register: "... Evidence of ``disparate impact,'' when a lender applies a practice uniformly to all applicants but the practice has a discriminatory effect on a prohibited basis and is not justified by business necessity. ..."

So even if we treat everyone trying to buy a house equally - exactly the same in all regards - and there is evidence of 'disparate impact' there is a problem.  The core of "disparate impact" is this: "It [ disparate impact] does not require any showing that the treatment was motivated by prejudice or a conscious intention to discriminate against a person beyond the difference in treatment itself. It is considered by courts to be intentional discrimination because no credible, nondiscriminatory reason explains the difference in treatment on a prohibited basis."

Well this is a problem: you can be found guilty of "discriminating in housing" even if you actively don't discriminate if the government just so happens to "discover" some consequential discrimination and can find no other explanation for it.  Kind of like the tax man discovering you're a millionaire by adding up all the deposits your business made in a year (completely ignoring, for example, any expenses or inter-account transfers), calling it all your "income" during an audit,  and sending you a tax bill.

The new model of the 1995 Clinton version (see link above) of the Community Reinvestment Act as this: "The only thing that ought to matter on a loan application is whether or not you can pay it back, not where you live."

So if you buy a house in a neighborhood that had a decreasing property value you should get the loan as as easily as if you bought a house in a neighborhood with an increasing property value.

Hmmm...  Great investment advice that.

So what happened is that everyone, the government, the banks, the rating agencies, the lenders, the loan officers, etc. etc. simply stopped worrying about what you were buying and worried only about if you had the income to make the payment.

Here's a good summary of the results:

With banks having to issue loans to virtually anyone the price of housing rocketed up because there was enormous pressure for houses.

As the government and banks moved "down the income ladder" looking for customers there was a shortage of houses.  Fannie Mae and Freddy told the banks to just keep loaning because it was guaranteeing the loans.

Moving down the income ladder involved things like ARM (Adjustable Rate Mortgages) which became huge (see 2004 in the image at the top of the article).

Then interest rates rose, prices rose, and making payments on your "cheap and easy" mortgage became a problem.

Which left us with the housing crisis of 2008.

Sadly while S & P is right that that Fannie and Freddy said they would guarantee these loans when push came to shove - but without it in writing they are probably screwed.

And don't blame Bush - in 2002 the Bush administration tried to "regulate" Fannie and Freddy because they were out of control:

Here Barney Frank tells us that Fannie and Freddie are "financially sound" and that, if we regulate them, there will be less "affordable housing."

Poor S & P - it went to the party with its big brothers Fannie, Freddy and its good Uncle Sam.

But sadly, when the lights came on with the cops standing in the room S & P was with its pants down, as it were...

So now the government will sue S & P.

In fact it should be suing itself because its practices and regulations created the problem.

Banks, auditors and the S & P's of the world had no choice but to go along.

And now they're standing with their pants down.

I wish them luck but I don't see them getting out of this alive.

No comments:

Post a Comment