Felix Salmon

I’m a little bit confused about all the pessimism surrounding today’s housing starts figures. Yes, they’re low – but remember we’re talking about starts here: people and businesses brave or foolhardy enough to start building brand-new homes in an economic climate of steadily-falling property prices, in the face of the existence of a huge glut of already-built unsold homes on the market. Yet the number of homes getting started in December alone was over 1 million, on an annualized basis.

The Commerce Department doesn’t release raw numbers for this series, so it’s unclear how many actual homes got started in December. (Update: Er, yes it does. 68,800 new homes were started in December, down from 112,400 a year previously.) We are told that the final-year number for 2007 as a whole came in at 1.35 million – which means that December (seasonally adjusted) came in at about 75% of the average for the year as a whole.

Atop most minds right now is the risk – and possible severity – of a 2008 recession. Housing construction is a significant component of GDP, and scaling back will not help the broader economy. But continuing to build in the face of the present housing overhang would only serve to weaken house prices further, which would hardly help the economy in the longer term. It seems to me that builders are sensible and even bordering on the optimistic here. And anybody worried about plunging house prices should be relieved that the number of new homes coming onto the market is going to be relatively low in 2008.

I got some very interesting responses to my blog entry yesterday on mortgage brokers, in which I basically said that they were parasites on their way out who wouldn’t be missed.

Ken Houghton reckons that there must be some good mortgage brokers out there – and that Countrywide, for one, has enough data to be able to tell the good from the bad. Which is probably true – and I doubt that Bank of America is going to dismantle the entire mortgage channel overnight. They’re more likely to simply let it wither and die: cut off the bad brokers, allow the good brokers to keep on going, but not accept any new ones.

Then again, Ken doesn’t seem to have talked to Thomas, who found that every broker he talked to wanted to put him into a property he couldn’t afford. Which would align with the brokers’ incentives: the larger the mortgage, the larger the commission.

And PaulD made the point that what we’re seeing with mortgage brokers uncannily mirrors what we’ve already seen with the disintermediation and demise of travel agents. PaulD misses his travel agent; I don’t. I guess it’s a matter of taste, as well as a function of how good your travel agent was.

And then a mortgage broker, Susan Duffy, wrote to me saying she simply didn’t believe that JP Morgan’s default rate on brokered mortgages was three times higher than its default rate on mortgages originated in-house. How could it be, she said, when the same team was doing the underwriting for both channels?

I looked into it, and found this presentation from JP Morgan, dating from November 2007: it’s reasonably up-to-date. Check out these two graphs, showing what happened to broker-originated loans between the end of 2006 and the end of September 2007:

The difference, it’s fair to say, is pretty startling. But then again, it turns out that comparing broker-originated loans to loans originated through the Chase retail channel is not really comparing apples to apples. While the credit scores of the borrowers in each channel were pretty much identical, the loan characteristics most decidedly were not. The Chase bankers’ loans averaged 68% of the value of the house, and only 4% of them breached the 90% level; the brokers’ loans averaged 82% of the value of the house, and fully 31% of them had a loan-to-value ratio of more than 90%. What’s more, 44% of all broker-originated loans came from either California or Florida, compared to less than 1% of the in-house loans.

So maybe it wasn’t completely the brokers’ fault after all: maybe it just so happened that they were in California and Florida, financing speculative purchases with little or no money down, while the Chase bankers were dealing with much more conservative customers.

All the same, mortgage brokerage is a fast-dying industry, whether you like it or not. It makes sense: one of the reasons there were so many brokers in Florida and California is precisely that those states were where the brokers were in highest demand. Now that the demand for their services has fallen off a cliff, both from borrowers and lenders, the industry will naturally wither away.

Ruth Simon has a huge piece in today’s WSJ on second liens: home equity loans and lines of credit which are junior to primary mortgages. These things can cause a lot of trouble for homeowners:

"The people in the first position will say, ‘Until you get a deal with the second, why should I make a deal with you?’" says Iowa’s Mr. Thompson. Second-mortgage holders are often reluctant to approve a short sale or deed in lieu of foreclosure that could wipe out their claims, he adds.

At the same time, the second-mortgage holders often reject offers of as much as $2,000 for loans they’ve already written off, just because the costs involved in evaluating the offer and releasing the borrower from the lien. So while a second lien might be worthless to the person who owns it, it can make life very difficult indeed for everybody else.

One thing that’s interesting to me is that default rates on these second liens, which one might expect to be astronomical at this point, are in fact not all that high. Home equity loan default rates are at 4.65%, while default rates on home-equity lines of credit are only 2.01%. Economy.com estimates that total losses on $1.1 trillion of these loans might total $58 billion; reading the story, recovery values on these loans are negligible, which means that the economy.com estimate implies that eventually about 5.3% of the loans will have to be written off. Which is lower than I might have guessed.

In the mean time, it turns out that I was only half right when I said yesterday that "people have to max out their home equity lines before they default on them". Washington Mutual and Citigroup are already unilaterally reducing the credit lines of borrowers whose credit scores have fallen or whose houses have dropped in value. What’s more, Simon reports that "in some cases, servicers are telling borrowers they will take 10 cents on the dollar to settle their claim".

In other words, if you’re going to need that money available in your home equity line of credit, you might think about tapping it now, before it disappears. In the worst-case scenario, you’ll only need to pay 10% of it back.

(Via Tanta)

"The broker model is broken," says Calculated Risk today, citing comments from Jamie Dimon of JP Morgan saying that delinquencies on broker-originated loans are three times higher than on loans originated in-house.

What’s more, says Peter Paul Jackson of Housing Wire in an email to me,

If you want to discuss what will largely be the single largest effect on Main Street of the BAC/CFC merger, it’s this: say goodbye to brokers.

Countrywide is (was?) one of the largest remaining mortgage operations with an active wholesale lending channel; while Countrywide has repeatedly said it is committed to brokers, BofA has a decidedly different view, having shuttered wholesale last year.

No one has talked yet about this, but you can bet that BofA will take steps to pull CFC out of the wholesale mortgage origination channel. And that will definitely be felt.

Jackson has dug up an old quote from BofA’s Ken Lewis:

While Charlotte-based Bank of America wants to sell more mortgages, Lewis said, the company isn’t attracted to the mortgage industry’s business model. "We like the product, but we don’t like the business," he said. He added that the bank is "not particularly interested" in wholesale lending through outside mortgage brokers and bankers – an area where Countrywide has a presence.

That doesn’t mean Lewis wasn’t interested in Countrywide, of course. Mortgages can and should be inherently profitable things, so long as they’re underwritten intelligently. And Countrywide’s servicing revenues are large and stable. But if Countrywide is now going to stop using outside brokers, as seems likely, the future for those brokers seems bleak indeed – after all, most other independent mortgage lenders have already closed their doors.

Frankly, in an era where people can get mortgage quotes online almost as easily as they can buy car insurance, I fail to see why mortgage brokers should exist. It would be an industry crying out for disintermediation even if it weren’t obvious that mortgage brokers are top of the list of people to blame for the current mortgage crisis. In the debate about "predatory lenders" and "predatory borrowers", the bigger truth is that the real problem was predatory brokers – people who abused the trust of both lenders and borrowers. If they do disappear, they shan’t be missed.

Barry Ritholtz, econoblogger extraordinaire, fired harshly at Tyler Cowen,

econoblogger extraordinaire, on Sunday, with a blog entry originally entitled "Tyler Cowen, Apologist for Fraud?".

Ritholtz has since toned down the headline, but the substance of his criticism stands, and it’s centered on one line of Cowen’s, from his NYT column:

There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem.

Ritholtz is convincing on the subject of mortgage originators’ complicity in borrower fraud. Yes, those stated incomes might well have been exaggerated, but much if not most of the time they were only exaggerated because the mortgage salesman encouraged the borrower to lie.

Still, I don’t agree with Ritholtz’s conclusion that Cowen’s statement is "utterly silly" and "misleading in extremis", and I certainly don’t think that it’s "utterly contemptible" to accuse the borrowers of fraud.

The last one’s the easiest to deal with: borrowers who lied on their mortgage applications were guilty of fraud. Simple as that. Were they egged on by sleazy mortgage brokers? I daresay they were. But frankly it’s silly for Ritholtz to delude himself that there was no fraud at all on the side of the borrowers.

As for the statement about "predatory borrowing", Cowen was basically just saying that there’s a hell of a lot of blame to be spread around in this housing mess that we’re in. And he specifically contrasted the actions of the borrowers with those of predatory lenders.

Now there was predatory lending going on in the subprime boom. Prime borrowers were talked into subprime loans, for instance – a clear case of lenders extracting much more money and value out of the borrowers than the borrowers needed to pay. Pensioners on fixed incomes were talked into refinancing their homes in order to reduce their mortgage payments, and the sleazy broker simply wouldn’t mention that the mortgage payments could and would adjust upwards. These kind of deals were bad for the borrowers, shouldn’t have been done, and constituted predatory behavior on the part of the originators.

But most subprime lending was not predatory. In many cases where a genuinely subprime borrower took out a mortgage on a house he couldn’t afford with little or no money down, it is the borrowerwho is coming out ahead: consuming much more in the way of housing services than he will end up paying for. The lender, meanwhile, gets left with an enormous loss – which is not what normally happens in cases of predatory lending.

So, was "predatory borrowing" – ie, fraud by borrowers – more widespread than "predatory lending", where borrowers were fleeced by dodgy mortgage originators? It’s entirely possible. Says Cowen:

I think the lenders are greatly at fault, as does anyone else with a fair mind. Pointing out additional faults elsewhere doesn’t (and should not be understand as) subtracting from those faults. More generally, the point of my column was… not to provide a comprehensive survey of who was at fault in the mortgage crisis. I didn’t even mention the regulators but clearly they are at fault too and of course you could lengthen the list of people at fault.

Southern California is full of borrowers who tried to get rich quick flipping property. It is they who helped fuel the speculative bubble, and they deserve their fair share of blame. I think that Cowen’s right, on this one, and Ritholtz, although he has a fair point, is a little too shrill.