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Assigning blame needs to take a back seat to restoring confidence
By ROBERT M. PARDES

It is times of crisis that define those who can help and are part of the solution and those who can hurt and are part of the problem.

As the nation wrestles with dysfunctional housing credit markets and the attendant implications to the economy, those with the capacity to restore order ­ namely our politicians and regulators ­ need to understand where they can be most effective in meeting the near-term challenges and establish priorities on that basis. Up to now, the response has largely been centered on the cause of the crisis and the placement of blame. However, for now, the sins of the past have been dealt with swiftly and violently in the form of trading losses, bankrupt lenders and hedge funds, job losses and, of course, defaulting homeowners.

When the lending environment is dominated by fear and uncertainty, lower interest rates and greater access to liquidity in the banking system are of limited utility. The tourniquet that is needed to stop the proverbial bleeding is threefold:

• Restore confidence in the acceptability of underwriting standards that go beyond the rules applicable to loans eligible for purchase by Fannie Mae and Freddie Mac or FHA guarantee.

• Bring to a halt any discussion of the possibility of imposing liability on assignees (purchasers) of mortgage debt.

• Be surgical rather than general in terms of guidance that encourages leniency to defaulting borrowers.

Loans with limited documentation as to income, assets or employment were around years before the recent housing boom and have proven to be sound in terms of risk-adjusted returns. The problem was never the widespread availability of these features, but the layering of risks that occurred when these features were combined with little or no equity contribution by the borrower. Nevertheless, the perception that the regulators in general now frown upon these features even with equity contributions by the borrower of 20 percent or more of the property’s value has severely cut back on the availability of products that have comprised core demand and that serve to bridge the socioeconomic diversity that has been the hallmark of our nation’s homeownership goals.

Regulators are urged to lift the chill by providing affirmative guidance that encourages, if not trumpets the availability of nonconforming or reduced documentation under the standards that prevailed prior to the height of the housing boom in 2003. Calling on the collective expertise of lenders, rating agencies and investment bankers may be an expedient path to bringing certainty in the form of an endorsed menu of products likely to support improved access and demand for homes while curbing the excesses that were the culprits in the first place.

As to assignee liability -- the concept that buyers of mortgage collateral should be accountable for the wrongdoings of lenders, mortgage brokers and other participants in the mortgage originations process -- our legislators need to step back and understand the “circle of life.” Loans are originated, many are sold to institutions that aggregate the loans, structure liquid securities, arrange for a rating of the securities and distribute the securities to banks and pension funds all over the nation and the world. That’s right, the ultimate “assignee” is our own savings and retirement funds. Moreover, given the complexity of the chain of ownership and the fact that any additional exposure will be incorporated into rating assumptions and increase the cost to homeowners, the imposition of assignee liability is little more than a fool’s errand and the primary beneficiary is not the homeowner but the hordes of litigators drooling over the prospect of replacing defendant service providers --

typically sole proprietors or small businesses - with institutional deep pockets. In the meantime, heightened discussion of assignee liability only contributes to the hesitancy on the part of investors to re-enter the market.

Finally, we are all concerned about the prospect of projected annual foreclosures in the range of 2 million. No one wants to see homeowners who have been misled into unsuitable products suffer the humiliation of foreclosure. However, the instinct to do good should be tempered with the practical understanding that there are many defaults where the homeowner never had equity in the property and has only played with the house’s money. Moreover, to the extent that all constituencies are in agreement that a vibrant secondary market benefits all, then there is a need to provide investors with reasonable predictability as to the cash flows generated by mortgages. Guidance that is too general in nature will quickly become the tool of attorneys and dubious credit counselors to encourage defaults as a means to obtain more favorable terms than originally bargained for. The cost of less predictable cash flows will be borne by those most deserving affordable homeownership.

Amidst all this uncertainty, the one certain thing is that liquidity will return to the capital markets, a vibrant mortgage-backed securities market will re-emerge and homeownership will generate the modest long-term returns that we have grown accustomed to. Money funds and managers simply cannot earn their keep by directing the flow of funds into short-term treasuries and agency securities. The question is how long and how much pain will be endured to get there.

Robert M. Pardes is a lawyer who specializes in residential and commercial mortgage financing and banking.

 

 

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