Risky mortgages imperil market; financial threat a challenge to Fed
The risk of a financial crisis is growing as home prices continue to fall and questionable mortgages made in the past two years go into default, finance officials warned on Dec. 11.
Banks and mortgage brokers have been passing along to unwary investors as much as $600 billion a year in risky mortgages they made through untested channels in the junk-bond market. That raises the threat of a financial crisis beyond the ability of the Federal Reserve to remedy, said Lewis Ranieri, the Wall Street guru who is widely credited with creating the multitrillion-dollar market for mortgage-backed securities in the 1980s and 1990s.
Bank regulators told the National HousingForuminWashington,D.C. that they have found major banks punting to investors questionable mortgages they could not legally keep in their own loan portfolios. Mr. Ranieri said brokers on Wall Street have raised the risks by repackaging the mortgages in deceptive and opaque ways so that the small investors and foreigners who buy them are unable to understand the risks.
“No securities market can stand if we do not have true disclosure, and we do not have true disclosure” of the growing risks of exotic mortgages whose payments can double overnight and force buyers into default, said Mr. Ranieri. “This stuff doesn’t just get sold to [professional] money managers. It gets sold to the public and to foreign investors who don’t have a clue what to look for.”
Allen Sinai, chief global economist at Decision Economics; Richard A. Brown, chief economist at the Federal Deposit Insurance Corp.; and several other economists and regulators attending the forum also emphasized the substantial risks to the economy and financial markets from the deepening recession in the housing market and possible mortgage-finance crisis.
Despite the growing dangers, Rep.BarneyFrank,incomingchairman of the House Financial Services Committee, indicated he saw no reason for federal legislation to better regulate the mortgage markets to prevent a possible financial meltdown.
Hesaidhewelcomesrecentlarge drops in home prices because it makes housing more affordable for young people and minority buyers.
“Housingsufferedfromirrational exuberance” during the first part of the decade, though it fell short of beingafull-blownbubble,theMassachusetts Democrat said. “The end result of a 10 percent drop in many parts of the country will be a more rational housing market. [. . . ] If a few speculators get burned, that’s just icing on the cake.”
Mr. Frank noted that a few years ago, consumers were expected to devote about 25 percent of their income to house payments. Today, however, consumers expect their homes to contribute 25 percent to theirincome—throughcash-outrefinancingsandothertechniquesthat havecomeintovogue,hesaid.“Let’s get back to the normal situation.”
A top national bank regulator said many banks are continuing to offer consumers loans they cannot afford when their teaser interest rates expire and payments rise to reflect market conditions. Some banks are selling the questionable loans to investors to avoid keeping them in their portfolios, where they would be unacceptable to regulators, said Kathryn Dick, deputy comptroller at the Office of the Comptroller of the Currency.
Consumersalsomaybeunaware of the risks inherent in these adjustable-payment loans, she said, because they are not getting full disclosure or are getting information too late to prevent them from closing on the loans.
Mr. Ranieri said the riskiest loans were made in the past two years as banks and brokers strived to help consumers qualify for high-priced homes that were beyond their reach. Loan innovations and loose lending standards have continued despite efforts by a group of five federal banking regulators to limit such loans, he said.
“We have a tremendously powerful mortgage-backed securities market. This market is unfettered in its enthusiasm and unchecked by regulation,” Mr. Ranieri said. “The interagency task force can’t touch it. The capital is coming from international markets.”
Mr. Ranieri said that brokers are even bypassing the traditional market for mortgage-backed securities that he helped create. Instead, they are bundling the riskiest mortgages together and offering them as “collateralized debt obligations” on the corporate bond market. The offering documents often do not explain the serious risks involved with the mortgages in a declining housing market, he said.
One recent offering failed to disclose to investors that the homeowners not only were faced with high adjustable payments that they might have difficulty paying, but they had financed 100 percent of their purchase and had no equity in their houses — something that greatly increases their likelihood of default.
Mr. Ranieri said the quality of loans has fallen so much recently that his firm has stopped buying whole mortgages for repackaging into mortgage-backed securities. He recently rejected some mortgagesofferedtothefirm.Hesaidhe asked what the broker would do with the loans, and was told they would be sold to investors in the junk-bond market.
The only federal regulator with jurisdiction over the burgeoning market for such securities is the SecuritiesandExchangeCommission, Mr.Ranierisaid.ButtheSECseems to be largely unaware of what’s goingoninthemortgagemarket,he said.