April 20, 2016
Wednesday’s Academic Roundup
- How Does Bank Capital Affect the Supply of Mortgages? Evidence from a Randomized Experiment, Valentina Michelangeli & Enrico Sette, BIS Working Paper No. 557.
- Housing Schemes, Price Fixation of Houses and Other Related Issues: A Study, Mukund Sarda.
- The Dynamics of Mortgage Debt in Default, Helu Jiang & Juan M. Sanchez, Economic Synopses, Issue 3, 2016.
- Green Home Standards: Information and Incentives, James Charles Smith, Houston Law Review, Forthcoming; UGA Legal Studies Research Paper No. 2015-15.
- Explaining the U.S. Housing Bubble: Are CDOs to Blame?, Thomas Bernardin.
- Valuing Real Options in Real Estate: A Spatial Study of the Option to Redevelop, Henry J. Munneke & Kiplan S. Womack.
- The Impact of Capital Expenditures on Property Performance in Commercial Real Estate, Chinmoy Ghosh & Milena T. Petrova.
- Class Differences in Real Estate Private Equity Fund Performance, Lynn M. Fisher & David J. Hartzell, Journal of Real Estate Finance and Economics, Vol. 52, No. 4, 2016.
- Real Estate Fund Flows and the Flow-Performance Relationship, David H. Downs, Steffen P. Sebastian, Christian Weistroffer & Rene-Ojas Woltering, Journal of Real Estate Finance and Economics, Vol. 52, No. 4, 2016.
- Systemic Banks, Mortgage Supply and Housing Rents, Pedro Gete & Michael Reher.
- Stirring Up a Hornets’ Nest: Geographic Distribution of Crime, Sebastian Galiani, Ivan G. Lopez Cruz & Gustavo Torrens.
April 20, 2016 | Permalink | No Comments
April 19, 2016
Principal-ed Forgiveness
The Federal Housing Finance Agency announced a new program to implement principal reduction for seriously delinquent, underwater homeowners who meet the following criteria:
- Are owner-occupants.
- Are at least 90 days delinquent as of March 1, 2016.
- Have an unpaid principal balance of $250,000 or less.
- Have a mark-to-market loan-to-value ratio of more than 115% after capitalization. (1)
The program’s “modification terms include capitalization of outstanding arrearages, an interest rate reduction down to the current market rate, an extension of the loan term to 40 years, and forbearance of principal and/or arrearages up to a certain amount to be converted later to forgiveness.” (1) Once the borrower completes three timely payments, the principal forbearance amount can be forgiven.
This program can help just a small proportion of homeowners who have been underwater on their mortgages. Most importantly, it is being implemented years after the foreclosure crisis swamped the nation’s housing markets. But as can be seen from the criteria above, it is targeted just to homeowners with below-average principal balances on their mortgages and who are severely underwater. There are all sorts of political reasons that principal reduction was not a key component of the post-crisis housing finance reform agenda. But it is worth asking now — should we deploy it more quickly in the next crisis? What would be the principled reasons for doing that?
Many argued that principal forgiveness would reward homeowners for making bad, even immoral, decisions. With the benefit of hindsight, it would have been better to put that questions aside and ask what the best policy option for the country would have been. If outstanding principal balances could have been aligned more closely to the new normal of the post-financial crisis economy, the recovery could have proceeded more quickly.
Now would be the time for the FHFA to implement regulations to deal with the next great recession. If principal forgiveness makes sense under certain conditions, let’s identify them now and then have an easier time of it down the road.
April 19, 2016 | Permalink | No Comments
Tuesday’s Regulatory & Legislative Roundup
- New York City has announced a new comprehensive plan with a focus on efficiently assisting the homeless population.
- The House Agriculture Appropriations Subcommittee marked up its Fiscal Year 2017 spending bill, proposing $31 million in increases to the US Department of Agriculture Rural Housing programs.
- The Federal Housing Finance Agency will allow a limited, onetime mortgage principal reduction for borrowers that have fallen behind on monthly payments. This temporarily reverses the policy for Fannie Mae and Freddie Mac.
April 19, 2016 | Permalink | No Comments
April 18, 2016
Goldman’s $5B Mortgage Settlement: If They Only Knew
The news reports about Goldman’s $5 billion settlement over its boom-time securitization practices have focused on whether Goldman would really have to pay all $5 billion at the end of the day. It is important to focus on the size of the deal: does it do justice? I am not sure whether I have an answer to that question though. With these billion dollar settlements, it is hard to tell whether the punishment fits. Should it have been a billion more? A billion less? What is the right metric?
I leave these questions for others to wrestle with and turn to something a bit more prosaic: what exactly did Goldman do that was so wrong? The Settlement Agreement incorporates a Statement of Facts, attached as Annex 1 to the agreement. The answer, contained in the Statement of Facts, is that “Goldman received information indicating that, for certain loan pools, significant percentages of the loans reviewed did not conform to the representations made to investors about the pools of loans to be securitized, and Goldman also received certain negative information regarding the originators’ business practices.” (1) More specifically,
In various RMBS offerings, Goldman provided representations, or otherwise disclosed information, in certain offering documents, about the loans it securitized, telling investors that:
- Certain loan originators applied underwriting guidelines that were intended primarily to assess the borrower’s ability and, in some cases, willingness to repay the debt and the adequacy of the mortgage property as collateral for the loans;
- Loans in the securitized pools were originated generally in accordance with the loan originator’s underwriting guidelines;
- Exceptions to those underwriting guidelines had been made when the originator identified “compensating factors” at the time of origination; and
- The securitization sponsor or originator (which, in many instances, was Goldman) represented that the loans had been originated in compliance with federal, state, and local laws and regulations. (2, emphasis added)
This is what it told investors, but in fact, Goldman was accepting many, many mortgages that were rated EV3 — an unacceptable risk — into its mortgage-backed securities. In one proposed MBS transaction,
Although Goldman dropped 25 percent of the loans in the due diligence sample because they were graded as EV3s, including all the loans graded as EV3s for unreasonable stated income, which comprised at least 2.5 percent of the loans in the due diligence sample, Goldman did not review the portion of the pool not sampled for credit or compliance due diligence, which comprised approximately 70 percent of the total pool, to determine whether there were similar exceptions in the unsampled portion. (8)
In other words, Goldman knew that it had serious problems in the sample mortgage files it reviewed, but ignored the fact that those same problems were likely to be found in the files that were not sampled. That amounts to willful ignorance if the problem.
It seems that every big financial crisis lawsuit has that embarrassing note that management wishes had never seen the light of day. Here, “Goldman’s head of due diligence, who had just overseen Goldman’s due diligence on six Countrywide pools that closed during a two-day period at the end of March, responded to [a] research report by saying: “If they only knew . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .” (11) Turns out, they did find out — just much later than the Goldman folks.
April 18, 2016 | Permalink | No Comments
Monday’s Adjudication Roundup
- Goldman Sachs settled for $5.06 billion with federal and state authorities for its conduct leading up to the financial crisis in the residential mortgage-backed securities market.
- Credit Suisse will pay $50 million in mortgage-backed securities suit to settle allegations that it lied about the securities it had sold to two credit unions.
- RBS Securities files a reply brief arguing that Fannie Mae and Freddie Mac should have seen the bad loans coming and thus the federal district court erred in its judgment in levying $806 million penalty on another bank.
April 18, 2016 | Permalink | No Comments
April 15, 2016
Consumer Survey Surveillance
As I had noted previously, The Consumer Financial Protection Bureau had issued a notice and request for comment on the Financial Well-Being National Survey. My submitted comments on it are below:
The Consumer Financial Protection Bureau has solicited comment on whether this collection of information is necessary for the proper performance of the functions of the Bureau, including whether the information will have practical utility. While the Bureau has increased the rigor it has brought to its financial education mission over the last few years, it is unclear what the Financial Well-Being National Survey is meant to measure and it is unclear what it, in fact, will measure. Specifically, one of the goals of the Survey is to measure the level of financial well-being of American adults, but the survey relies too heavily on the subjective responses of participants to achieve that goal. We have reason to believe that subjective assessments of financial literacy are suspect.
Much of the academic literature around financial literacy and financial education is very depressing as it reveals that Americans are not very financially literate at all. Lusardi, Annamaria, Financial Literacy: Do People Know the ABCs of Finance? (November 30, 2014). Global Financial Literacy Excellence Center Working Paper No. 2014-9. Available at https://ssrn.com/abstract=2585246.
Not only is financial literacy in bad shape, but efforts to improve it have not proven to be very effective. Lauren Willis has provided a sobering, even depressing, overview of what we know about the efficacy of financial education. Willis, Lauren E., Financial Education: Lessons Not Learned & Lessons Learned (January 31, 2013). Life-Cycle Investing: Financial Education and Consumer Protection 125 (Zvi Bodie et al., eds. 2012); Loyola-LA Legal Studies Paper No. 2013-4. Available at SSRN: https://ssrn.com/abstract=1869313 or https://dx.doi.org/10.2139/ssrn.1869313.
Willis asks, “Does financial education work as hoped?” (125) She answers her own question: “Empirical evidence does not support the theory. Some (but not all) studies show a positive correlation between financial education and financial knowledge or between financial knowledge and financial outcomes. But no strong empirical evidence validates the theory that financial education leads to household well-being through the pathway of increasing literacy leading to improved behavior.” (125)
Even worse, Willis finds that some people who would have reason to think they are more financially literate because of their participation in financial education initiatives, do even worse than those who did not participate: “the only statistically significant effect of mandatory personal financial training on soldiers was that they adopted worse household budgeting behaviors after the training than before it.” (126) Some of Willis’ other important conclusions (based on a thorough review of the literature) include
- “Youth who took a personal finance course in high school do not report better financial behavior several years later than youth who did not take the course. Adults who attended public schools where they were required to take personal financial courses were found to have no better financial outcomes than adults who were not required to take such courses.” (126, citations omitted)
- One “reason financial education is unlikely to produce household financial well-being is that consumers’ knowledge, comprehension, skills, and willpower are far too low in comparison with what our society demands.” (128)
Willis’ conclusions about the efficacy of financial education initiatives are bolstered by a meta-analysis of the literature on financial education that was conducted by researchers at the World Bank. Their abstract reads,
This paper presents a systematic and comprehensive meta-analysis of the literature on financial education interventions. The analysis focuses on financial education studies designed to strengthen the financial knowledge and behaviors of consumers. The analysis identifies188 papers and articles that present impact results of interventions designed to increase consumers’ financial knowledge (financial literacy) or skills, attitudes, and behaviors (financial capability). These papers are diverse across a number of dimensions, including objectives of the program intervention, expected outcomes, intensity and duration of the intervention, delivery channel used, and type of population targeted. However, there are a few key outcome indicators where a subset of papers are comparable, including those that address savings behavior, defaults on loans, and financial skills, such as record keeping. The results from the meta analysis indicate that financial literacy and capability interventions can have a positive impact in some areas (increasing savings and promoting financial skills such a record keeping) but not in others (credit default).
Miller, Margaret and Reichelstein, Julia and Salas, Christian and Zia, Bilal, Can You Help Someone Become Financially Capable? A Meta-Analysis of the Literature (January 1, 2014). World Bank Policy Research Working Paper No. 6745. Available at https://ssrn.com/abstract=2380391
My first instinct is that there is no harm in conducting the Financial Well-Being National Survey. It asks reasonable questions, such as “How would you assess your overall financial knowledge?” and “How confident are you that the way you are managing money today is getting you to the results you want?” (5) There are also questions that ask concrete questions about the respondents’ financial situation, but they rely on self-reporting.
The key question that remains, then, is will the answers to such questions actually help shape consumer protection policy in a productive way? The Bureau should be sure that the answer to that question is yes before proceeding with the Survey.
I do not suggest that the Bureau jettison this survey, but I do suggest that the Bureau clarify what the Survey is meant to measure and that it ensures that it does measure those things. To do so, the Survey should be supplemented with studies that attempt to determine how accurate the subjective assessments contained in the Survey are. For instance, if respondents report that they are confident that they are managing their money effectively, targeted follow-up studies could determine whether that confidence is warranted. If the respondent reports that his or her home is valued at a certain level (and homeowners are wont to overestimate the value of their homes), follow-up studies can determine whether that valuation was accurate. Indeed, a well-designed follow-up study could determine the extent to which people overestimate their financial literacy and their financial situation.
It is of great importance that the Bureau gets its financial education initiatives right from the start. It is worth investing heavily at the outset to ensure that it does.
April 15, 2016 | Permalink | No Comments
Friday’s Government Reports Roundup
- The S. Department of Housing & Urban Development released new data on Housing Credit tenants, finding that nearly 60 percent earn less than $20,000 per year, as of the end of 2013.
April 15, 2016 | Permalink | No Comments
