(artlessly copied and pasted from the FDIC website)
Read the whole thing.
Remarks by FDIC
Chairman Sheila C. Bair to the Wharton School, University of Pennsylvania
International Housing Finance Program; Philadelphia, Pa.
June 18, 2010
For many decades U.S.
government policies have promoted housing in general and homeownership in
particular. These policies have been very successful in raising the quality of
our housing stock while extending the benefits of homeownership to more than
two-thirds of American households.
But now that our housing
bubble has burst, a critical task lies before us: rebuilding U.S. mortgage
finance on a sounder footing, not only to restore the confidence of homeowners,
investors and lenders, but more fundamentally to restore balance to our broader
economy.
There is no single fix that
will restore confidence or immediately repair the dislocations that have taken
place in housing and mortgage markets. But if we are willing to take bold
steps, and return to the fundamentals of mortgage lending and securitization,
we can get back to a more rational world where consumers are protected, risks
are contained, and our scarce resources are allocated to their highest and best
use.
Underwriting: Back to Basics
First, we must recognize
that the financial crisis was triggered by a reckless departure from tried and
true, common-sense loan underwriting practices.
Traditional mortgage
lending worked so well in the past because lenders required sizeable down
payments, solid borrower credit histories, proper income documentation, and
sufficient income to make regular payments at the fully-indexed rate of the
loan. Not only were these bedrock principles relaxed in the run-up to the
crisis, but they were frequently relaxed all at once in the same loans in a
practice regulators refer to as "risk layering."
As all of you know, the
long-term credit performance of a portfolio of mortgage loans can only be as
sound as the underwriting practices used to originate those loans.
Macro Implications of Faulty Underwriting
The FDIC is in the midst
of cleaning up the damage wrecked by the bursting of the greatest real estate
bubble in U.S. history. A key lesson of this crisis is that weak underwriting
practices have macro implications for home prices, economic performance, and
the stability of our financial system.
Let's look back for a
moment to how the housing crisis unfolded. At the end of 2003, we were already
well into a historic housing boom. Over the previous decade, nominal home
prices had risen by 81 percent, while per capita disposable incomes were up by
just over half. You might have expected a cooling off in home prices after this
remarkable run. Instead, during the next three years we saw an acceleration of
home price increases.
Between 2003 and 2006,
average prices rose by another 38 percent, almost two and a half times faster
than incomes. It was this surge in home prices, preceded by a decade of steady
increases, that took prices far above any reasonable measure of the
fundamentals.
More than any other
factor, what explains the post-2003 acceleration of home prices is an extreme
deterioration in mortgage lending practices. For example, subprime mortgages
rose to more than 20 percent of all originations between 2004 and 2006,
compared with less than 10 percent in 2003. And so-called Alt-A mortgages rose four-fold
between 2003 and 2006. Many did not require amortization of principal during
the first five years, and many required little or no documentation. By early
this year, almost 40 percent of 2006 Alt-A vintage loans were in default.
The Role of the Capital Markets
So, why it is that these
changes took place so suddenly? One reason was the decline in prime mortgage
originations after the refinancing boom of 2003. Almost $4 trillion in
mortgages were originated in 2003 as prime mortgage rates fell to their lowest
level in more than 40 years. That was a tough act to follow. Lenders who wanted
to try to keep up the pace turned to subprime and nontraditional mortgages,
most of which were securitized by private issuers of mortgage backed
securities.
From 2003 through 2006,
the share of total U.S. mortgage debt held by these private issuers more than
doubled, from 9 percent to just over 20 percent. All told, over $2.1 trillion
in private securities backed by risky subprime and Alt-A mortgages were issued
between 2004 and 2006.
How was it that
investors were so willing to invest so much in securities with such poorly
underwritten loans? For one thing, the big run-up in home prices postponed the
realization of the downside risks in these loans. In addition, as private
securities were taking off, the capital markets were also dramatically
increasing issues of collateralized debt obligations -- CDOs -- which included
the risky subordinate tranches of the private mortgage securities. CDO issuance
related to structured finance increased almost nine-fold between 2003 and 2006
to over $300 billion a year.
These complex, opaque
CDO deals obscured and spread the risks associated with subprime and Alt-A
securities, but they certainly did not make the risk go away. By the summer of
2007, the capital markets began to realize the extent of these risks and the
flaws in the securitization structures that had spawned them.
Foreign money also
flooded in, helping keep mortgage rates low and deal-flow high. Between 2004
and 2007, foreign holdings of U.S. agency debt almost doubled to over $1.4
trillion, while foreign holdings of U.S. asset-backed securities more than
tripled to just over $900 billion.
Flaws in Private Securitization Structures
We come now to the crux
of the matter. Ordinarily you expect long-term investors to carefully
scrutinize the securities they buy. However, in this episode, market discipline
was tossed to the wind.
There were at least four
reasons for this. For starters, as I have mentioned, all these investments performed
marvelously as long as home prices continued rising. But prices stopped rising
in the spring of 2006, and then fell by one-third over the next three years.
Second, the senior
position of many investors led them to believe that they were shielded from all
risk of loss. Normally they might well have been right. But in this case, they
significantly underestimated the odds of big losses that could affect even
their senior securities.
Third, the substantial
risks associated with junior positions in subprime and Alt-A securitizations
were obscured because they were packaged in complex CDO structures.
And, finally, many of
these securities and CDOs were given overly optimistic agency ratings. Many
investors relied too heavily on these ratings and failed to do their own due
diligence.
This is where the story
reconnects with loan underwriting. Had those MBS and CDO investors not been so
passive, they would have pulled away and imposed the market discipline needed
to uphold best practices at the front end of these deals, when the loans were
made. The lack of market discipline also relates to a near-complete divergence
in financial incentives between the originators and deal underwriters, on the
one hand, and the investors on the other.
In contrast to the long-term
payoffs that are expected by investors, many other parties – from the mortgage
brokers, to the lenders, to the securities underwriters, to the ratings
agencies – got paid upfront. This divergence of financial interests, and the
lack of market discipline that it created, explains why loan originators failed
to apply appropriate underwriting standards in the first place.
It also explains why
trillions of dollars in faulty mortgage paper was issued before the home price
bubble finally collapsed.
Restoring Confidence in U.S. Mortgage Finance
This pervasive breakdown
in financial practices at the peak of the housing bubble points to the need for
fundamental reforms in mortgage finance. But it is simplistic to believe that
all of this can be legislated by fiat from Washington, D.C.
While regulation is
necessary to set the ground rules and protect consumers, excessively
proscriptive rules are likely to either stifle the initiative of the market or
be circumvented by new practices. Instead, we need a whole new set of basic
ground rules that go from origination, to securitization, to the servicing of
the loans. These rules should create the transparency and incentives needed for
this market to do what competitive markets do best – efficiently allocate
resources and price risks.
We need to have some
basic underwriting guidelines that apply to mortgages originated not just by
FDIC-insured depository institutions, which are already heavily regulated, but
also for the thousands of mortgage brokers who fall outside the rules for banks
and thrifts. Basic limits on loan-to-value and debt-to-income ratios, and
consistent documentation requirements should be set for any loans held by a
depository institution or sold to a securitization trust. Equally important
will be to have higher, more consistent standards for consumer disclosures and
for ensuring that the loan serves the long-term interests of the borrower.
We also need to strike a
balance. We want to prevent the most egregious abuses. But at the same time we
don't want to stifle useful innovation and prudent judgment by responsible
lenders. By reforming the securitization process, aligning financial
incentives, and making deals more transparent, investors can and will impose
the market discipline that's been sorely lacking.
The FDIC has taken a
lead role in establishing new baseline requirements for structuring
securitization deals by updating its rules governing the treatment of
securitized assets of failed banks that have been placed into FDIC
receivership. These "safe harbor" rules impose a number of
common-sense requirements in order for securitized assets to receive sale
treatment in a receivership, including: Simpler and more transparent
structures; loan-level disclosures, with an adequate due-diligence period and
data updates throughout the term of the deal; compensation tied to performance;
and origination standards and some retention of an interest in the deal by the
sponsor of the securitization.
We see our efforts as
complementary to similar efforts underway at the SEC and new rules under
consideration as part of the financial reform package being finalized in
Congress.
Reforming the GSEs
Since the 1930s, the
federal government has played a major role in facilitating the development of a
strong secondary market for mortgage loans. Through the Federal Housing
Administration and the government-sponsored enterprises, the government has
directly or indirectly provided credit guarantees that have promoted the
origination and securitization of mortgage loans that conform to certain
standards and size limits.
While these programs
have long served to lower the cost of mortgage credit to broad classes of
homeowners, they have become an even more essential source of mortgage credit
during the recent crisis. In 2009, the FHA and the GSEs accounted for 95
percent of total U.S. mortgage originations.
To the extent that the
government wishes to promote homeownership and stability in the availability of
mortgage finance, some level of ongoing government involvement is certainly
justified. However, a lesson of the mortgage crisis is that any such program
must be much more definitive about where the financial obligation of taxpayers
begins and ends.
For decades, the
mortgage GSEs raised funds in global markets at preferred, near-government
rates on the basis of their quasi-governmental status. For many years, this
arrangement lowered the cost of mortgage credit to millions of homeowners
without adding to the federal debt. However, in the aftermath of the mortgage
credit crisis and the conservatorship of Freddie Mac and Fannie Mae, the
implicit backing of these entities is now an explicit cost. Federal subsidies
for the GSEs in 2009 and 2010 are estimated at over $300 billion.
In banking, the implicit
backing of large financial institutions under the doctrine of Too Big to Fail
led to moral hazard and excessive risk taking. This is a problem that Congress
is attempting to fix. In the wake of the financial crisis, the U.S. and other
governments around the world are feeling the brunt of a wide range of
"implicit liabilities" that are quickly becoming explicit obligations
in times of financial distress.
Our future financial
stability demands that we deal with these implicit liabilities head on, and
limit the ability of private companies to take risks at the expense of the
taxpayer. In the case of the mortgage GSEs, there are a variety of options for
making some of their functions governmental while putting others in private
hands. But what we cannot do is perpetuate their quasi-governmental status,
which privatizes gains and socializes losses.
After the financial
reform package becomes law, GSE reform should rise to the top of the agenda.
The goal must be to clarify once and for all which functions should be governmental,
and which are strictly subject to the discipline of the marketplace.
Restoring Balance to Our Economy and to Housing Policy
I've often spoken of the
need, in the wake of the financial crisis, to restore balance to our economy
and to our national economic policies. The mortgage crisis in many ways is the
culmination of a decades-long process by which our national policies have
distorted economic activity away from savings and toward consumption; away from
investment in our industrial base and public infrastructure and toward housing;
away from the real sectors of our economy and toward the financial sector.
No single policy is
responsible for these distortions, and no one reform can restore balance to our
economy. We need to look at national policies with a long-term view, and ask
whether they will create the incentives that will lead to improved and
sustainable standards of living for our citizens.
Homeownership is
certainly a worthy national goal. But does it make sense for the federal
government to subsidize homeownership in an amount three times greater than the
subsidy to rental housing? In the end, these subsidies have helped to promote
homeownership, but have failed to deliver long-term prosperity.
I am not advocating a
specific proposal. I'm only pointing out that where homeownership was once
regarded as a tool for building household wealth, in the crisis it has instead
consumed the wealth of many households. Foreclosures continue to take place at
a rate of about two-and-a-half million per year, and an estimated 11 million
households owe more on their mortgage than their home is worth.
Now, much concern has
been expressed in recent weeks that the financial reform legislation will hurt
our economy by limiting the earnings capacity of the financial services
industry. And if that means limiting the ability to expand private-sector
profits by imposing risks on the public balance sheet, they may well be right.
But let's put this in perspective.
Any potential harm to
the industry's future earnings potential must be weighed against both the
long-term increase we have seen in the financial sector's share of U.S.
corporate profits and the widely-shared and long-lasting costs of the financial
crisis. Whereas the financial sector claimed less than 15 percent of total U.S.
corporate profits in the 1950s and 1960s, its share grew to 25 percent in the
1990s and 34 percent in the most recent decade through 2008.
The financial crisis and
the Great Recession it spawned threw 8 million people out of work, reduced our
GDP by about 3 percent, caused a huge increase in federal debt, and virtually
wiped out the entire net income of FDIC-insured institutions for at least a
two-year period.
We need to get back to a
world where our financial sector supports the functioning of our economy, and
not the other way around. And we need to fix what caused the crisis by
reforming our mortgage lending and securitization practices. Only by getting
back to basics in these most fundamental areas of our financial system can we
begin to restore balance to our broader economy and confidence in our economic
future. Thank you.
And I respond.
On point 1, yes. I agree that many black Americans do internalize White Supremacy. It's kinda how they know they are still 'black'. And the constant racism chasing done by various parties keeps them assured of their place in society - which they are perversely comfortable in. Money and light-skindedness are just two ways they offset that. Money is more real, but then it has to be real money.
2. Yes. That's absolutely right. The big problem is, of course, that people believe falsely about who 'white' people are, how they get and how they maintain their power. After enough time of looking at all power as a corrupt white hustle, these black people do themselves in. They doom themselves to powerlessness because they never learn the lessons of what real power is. It's like the man who only looks at women as objects because he's never known a truly good woman and all the ones who answer to 'bitch' are well.. just that. So that's all he knows. That's all he gets. He's doomed.
3. I think we, speaking for myself in this, have put too much faith in somebody special to explain it all to us. On the one hand it's true that we used to lack for enough righteous education and we needed our own leaders. But that's not really the case any longer. After all, it has been almost 50 years of public accommodations. And the fact of the matter is that if you really read Carter G Woodson or James Weldon Johnson, you'd realize that the answers are all out there and they're old answers. The problem is that people have been convinced that their freedom isn't real unless everyone in the race is free. That's foolishness and the Klan talking. See Point 1.
There doesn't need to be a brand new paradigm. The whole of revisionist history 'for' black poeple is wrong, which is what I hope Jelani Cobb was implying in his piece. People need to understand the whole of real history, not the self-esteem steroid version. Christianity is sufficient.
Let me take this tangent for a moment because it's kinda important and personal.
I'll tell my story about Nell Painter.
Nell Painter wrote the definitive biography/history of Sojourner Truth. I met her around 1991 when she joined the faculty at UCLA. So one day I'm on campus and she's being introduced to students and she talks about Tubman and being glad to be in Los Angeles. Then one of the students pipe up. What do you think is the solution to the problems in the black community? And of course, Painter, being an honest peson, can't asnwer. She's not from LA and she doesn't know what's going on in this black community. She's a little flustered but the answer that comes out is essentially, hell you live there, you should be telling me!
I'll tell you another story: of Derek Walcott.
I bought his epic poem Omeros when it came out. I was reading Moliere at the time and digging it, but thought I should perhaps pay attention to some blackness. So every once in a while, you could catch me with his book trying to rap it. And I would do so in cafes like the young pretentious aesthete that I was trying to be at the ripe old age of 29, just loud enough so people could ask me what I was doing. And I would explain that Derek Walcott was the darling of the intellectual set (and he was) and everybody acknowledges what a painstaking act of genius it was to take the story of the Illiad and translate it into a black Caribbean metaphor. Have you never heard of Derek Walcott? He won the Nobel Prize in Poetry. But he didn't solve the problem of the black community. And nobody in the black community reads anything by Derek Walcott.
The black community is its own problem. Black Intellectuals who try to solve its problems always fail. Black Intellectuals who don't try are not long considered Black Intellectuals. So it basically comes down to this point. Who's down with The Struggle and who's not.
Now the difficulty with The Struggle is that it has been hijacked by people who can't think their way out of a paper bag. And that's because the Real Struggle has already been won and the architects of that struggle have moved on. The laws of the most powerful nation in the history of the planet are now not against you based on the color of your skin. And in case you haven't noticed, thousands of people from halfway around the planet have come here in the past 20 years to work in an industry that didn't even exist until 20 years after those laws were changed. So why are there more Indians than black American in Silicon Valley? Was there ever an apartheid of computers? No, of course not. But the Black Intellectuals didn't go in that direction - they all wanted to rewrite history as academic department heads, not through private enterprise. The Struggle is a farce. It's about getting police officers fired. It's about getting comedians to apologize. It's about getting 20 year olds into undergraduate programs. That ain't power. That's middle class meddling.
So The Struggle is all about getting people out of ghetto depravity into middle class mediocrity, which is the essential component of Christian Missionary work in deepest darkest Africa. Teach 'em some hymns. Not that it's an entirely bad idea, lord know some of those pound cake thieves could use a lesson in Christian ethics. But it doesn't take an intellectual to effect such a program. Just a big bleeding heart and gobs of patience, which could easily be substituted with condescension - your mileage may vary.
Now might be a good time to go back and watch Sanford and Son. A father raised his son. Lamont Sanford didn't turn out so bad.