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How Wells Fargo’s CEO John Stumpf would reform the mortgage market

Posted: 05 Apr 2011 03:30 AM PDT

The Wells Fargo CEO is getting involved in the political posturing around mortgage market reform being considered in Washington. Today we will examine his recent statements on reform.

Irvine Home Address ... 15 CANDLEWOOD Irvine, CA 92620
Resale Home Price ...... $999,999

When you try your best, but you don't succeed
When you get what you want, but not what you need
When you feel so tired, but you can't sleep
Stuck in reverse

Coldplay -- Fix you

The CEO of Wells Fargo, John Stumpf (I like saying that last name), has put forth some good ideas concerning mortgage reform. I recently reported that he wanted to see a 30% down payment requirement on the new qualified residential mortgage. His proposal is self-serving as his bank is better able to carry loans than small banks, but it also makes for good policy, so I'll embrace him when he's right.

Wells Fargo's John Stumpf: How to fix the mortgage mess

By John Stumpf, chairman, president, and CEO, Wells Fargo

FORTUNE -- For most Americans, their home is the largest and most important investment they will ever make. Ensuring that they have the right kind of mortgage is critical to their financial well-being and -- as we've seen recently -- critical to our entire economy.

That means we have to solve the Fannie Mae and Freddie Mac problem and eventually figure out the proper role of the federal government in supporting a secondary market for home mortgages. Doing that right is one of the most important issues facing Congress and the Obama administration.

This issue is very important. As i wrote recently in Defining qualified residential mortgages: a battle over minimum down payments, "We have witnessed many tempest-in-a-teapot issues like robo-signer that flare up and go away without long-term impact on the housing market. This issue is different. The minimum qualifying standard on this loan is going to become the bedrock of mortgage finance. If we get this wrong, we will rebuild the mortgage market on a weak foundation."

Some people ask, Why do we even need a secondary market for home mortgages? Why don't we just go back to the good old days before those markets existed and require banks to hang on to all the mortgages they create?

Let me tell you why. When I went to buy my first house in 1976, mortgage money was hard to find. In fact, it was rationed. Banks simply didn't have the deposits on hand to meet the demand. That was 35 years ago, and we don't want to go back to those "good old days." Mortgage rationing is not the future we want for our customers, their children, or their grandchildren.

I would have no problem at all going back to the mortgage market of 1976. Mortgages were almost exclusively 30-year fixed rates, debt-to-income ratios were manageable, and house prices were affordable. The debt we created since then has only served to inflate real estate values, destabilize pricing, and increase the overall level of indebtedness among the populace. From a banker's point of view, the last 35 years made great progress -- at enslaving the population.

Consider these facts: There are 76 million homes in the U.S., of which 51 million have mortgages. Taken together, those mortgages represent a debt of $11 trillion. That's a level of debt that banks can't afford to hold on their balance sheets alone. As a nation, if we want to make home ownership broadly available and affordable, we need a secondary mortgage market that operates fairly and efficiently for all parties.

Freddie Mac and Fannie Mae were created in part to help achieve those goals, but they've run into big trouble along the way. They now own or guarantee nearly 31 million home loans, worth more than $5 trillion. Their role is so critical in mortgage finance that the federal government bailed them out in 2008 to the tune of what might end up to be more than $250 billion.

This is how your tax dollars are paying the debts of Ponzis everywhere. The stupid loans both insured and purchased by the GSEs at the top of the housing bubble paid for many things I would rather not see my tax dollars go toward.

So as Fannie and Freddie unwind, as they certainly will, what principles should shape the future of home financing? I believe the answer comes in three parts. First, all parties involved in making and investing in mortgage loans need to share a financial interest in the quality of those loans. That includes the customer taking out the loan, the financial institution or broker originating the loan, and the investor who ultimately owns the loan. All parties need to have skin in the game. If originators don't have a financial interest in the loan, they will have less concern for its quality, and poor lending decisions will happen and be passed along to investors. That creates a house of cards.

I believe his analysis is accurate. Without financial accountability throughout the supply chain, the incentives are wrong, and bad behavior will ultimately ensue.

A healthy debate is already taking place about how much a homeowner should put down and how much a bank should keep on its balance sheet when it bundles and sells mortgage loans. There is no magic number out there, but I can tell you one thing: The more the risks and rewards of a mortgage loan are shared by all parties -- and the better those risks and rewards are understood -- the better the quality of the loan will be.

Will this mean higher down payments for homeowners and more financial skin in the game for banks? Probably so, but the long-term costs for homeowners, bankers, and the economy will be dramatically lower. Just look at what past mortgage lending practices have cost all of us.

Mr. Stumpf bears some responsibility for the past mortgage lending practices that caused our woes, doesn't he? 

Second, whatever role the federal government assumes in mortgage finance going forward, its role needs to be explicit, not implicit. Currently federal backing for Fannie and Freddie is implied because they are "government-sponsored enterprises." It needs to be crystal clear for investors around the world whether GSE loans are backed by the full faith and credit of the United States. If they are, consumers would benefit from worldwide liquidity for mortgage products.

Right now, it is crystal clear: GSE mortgage-backed securities are insured by Uncle Sam. There is little difference in risk between a 10-year T-bill and a GSE MBS. There is usually a spread between the two that represents the risk premium the market demands for risk of loss. With direct government backing, the spread is very small, so mortgage interest rates are relatively close to 10-year yields.

Keeping interest rates low allows lenders to roll over their toxic debt into amortizing loans insured by the US government. Eventually the mortgage market will be cleansed, or at least the losses will be transferred to Uncle Sam who can borrow money to pay for it. If lenders absorb all the losses, significant capital would exit the banking system, and our economy would be seriously impaired.

The private market at the government fringe -- the jumbo market -- is a complete mess. Spreads are high because jumbo loans carry risk, and the underwriting standards are high which means very few borrowers qualify. Hence, the high end has low transaction volume, and a lot of shadow inventory.

If we fully convert to a private market, mortgage interest rates will almost certainly rise because the private market will price the risk back in to mortgage-backed securities. If rates rise too soon, affordability will become a problem, and the supply liquidation will push prices lower.

To protect taxpayers, adequate levels of private capital should be required to take the risk of loss. In this way, the federal government would only act as a "catastrophe risk" backstop much like the role the FDIC plays in protecting bank deposits up to a certain limit. Banks would pay a fee, just as they do for FDIC insurance, and the homeowner's mortgage would be guaranteed up to a certain amount by the federal agency providing the insurance.

This is the traditional role of the FHA. The government through the FHA makes sure loans will always be made available to people who meet their underwriting guidelines. These guidelines are strict in order to protect the government from loss. And despite some weakening after the bubble, FHA guidelines still serve to limit the taxpayer's risk.

The private market is free to underwrite FHA loans, or it can create competing products to entice customers. Since the FHA is a government agency, it doesn't mind losing market share to the private sector. It has no pressure to change its guidelines to adapt to the market. If its market share goes down, the bureaucrats process less paper. They get paid the same either way.

The FHA is a worthy government bureaucracy as far as they go, but the rigid guidelines they adhere to make for a poor business model. Private sector lenders must be responsive to changes in the marketplace or they will lose customers and go out of business. Therefore private lenders must have more flexible guidelines than the FHA if they are to survive.

The GSEs are a poor synthesis of a government program and a private sector endeavor. The mandate of a government program is to provide financing and limit taxpayer risk. This is incompatible with the survival needs of a business entity. The GSEs were asked to provide financial innovation. Financial innovation is an oxymoron. It usually results in a financial bubble or Ponzi scheme.

The GSEs in their current form must die.

And third, as we move forward in a post-GSE marketplace, we need to make sure we have uniform underwriting and servicing standards for mortgage loans, and more common products for what are called conforming mortgage loans. An efficient secondary market depends on relatively standard products and processes. Otherwise every batch of loans has to be examined in detail for its unique qualities, an examination that results in higher transaction costs and ultimately less attractive investments. The lack of standardization drains the lifeblood out of secondary market operations.

Mortgage financing is a big deal for millions of Americans and for our economy overall. All sides should be looking for solutions that will help all Americans. The path forward will not be easy, but I truly believe the solutions can be found. It will require hard work, courage, and cooperation across the board.

The real question we must face with the GSEs is to what degree society wants to subsidize the mortgages of middle- and upper-middle class Americans. We could convert the shell of the GSEs back into a government program, sell off the portfolio of securities, and collect insurance fees to reserve for future losses. We could layer them on top of the FHA to provide price support to places like Orange County.

There will be many in Republican rural America that will resist the idea of their tax dollars going to subsidize the shenanigans they see on the Real Orange County housewives. Republican Orange County won't resist quite so much.

CNN Money on mortgage issues

A little Ponzi 

Not all Irvine loan owners are big-time Ponzis. Some are merely frequent credit card consolidators who slowly but consistently grow their mortgage balances albeit at a rate less than appreciation. Is that wise?

In the HELOC Abuse Grading System, I described people like this:

HELOC Abuse Grade C 

I hate to give borrowers in this category a "passing" grade, but this is the reality for most Americans. Growing credit card or mortgage debt slowly generally can be compensated for through home price appreciation, and although I consider this a bad idea, I can't really call it HELOC abuse, just foolish HELOC use. Is there a distinction there? I will let you decide.

Financial planners will tell you that most people fail to budget properly for unexpected expenses (they don't save), so when they fall behind a little each month, they put the balance on a credit card and hope they can pay it back with a tax return -- or during the bubble with a visit to the housing ATM.

People are still going to manage their bills this way going forward, and there will be pressures to "liberate" this equity to pay for these expenses. The money changers will continue to peddle this nonsense as sophisticated financial management. It is a stupid way to manage debt, and I give it a C.

This property was purchased at the bottom of the last real estate crash.

  • On 9/22/1997 they paid $301,000 for today's featured property by using a $240,450 first mortgage, a $30,050 second mortgage, and a $30,600 down payment.
  • On 1/12/1999 they obtained a $55,000 stand-alone second and withdrew most of their down payment.
  • On 1/29/2002 they refinanced with a $282,000 first mortgage.
  • On 7/9/2003 they refinanced with a $322,700 first mortgage.
  • On 7/14/2006 they refinanced with a $322,000 first mortgage. I am impressed by that one. Three years after their last refinance, a period in which their property value went up 50% or more, they did not add to their mortgage.
  • On 5/23/2008 they refinanced with a $350,000 first mortgage.
  • On 8/3/2010 they refinanced one last time with a $360,000 first mortgage.

The will likely leave the closing table with a $500,000 check. It's not as big as it could be, but it is much more than most Ponzis take with them.

The problem with Ponzi borrowing isn't the high-profile flame outs I profile here frequently. The real problem is the pervasive use of Ponzi borrowing to sustain daily life. It's the little guy multiplied millions of times that destabilizes our economy. California has become so dependent upon borrowed money that the entire state economy crumbles when mortgage money fails to flow in.

The only real solution is a period of frugality and economic weakness while the Ponzis adjust to living within their means. We will see some of this natural economic purging take place as many Ponzis endure the unceremonious fall from entitlement. However, this cleansing will not go far enough because government policy and our federal reserve seem determined to keep the Ponzi scheme alive.

Irvine House Address ... 15 CANDLEWOOD Irvine, CA 92620   

Resale House Price ...... $999,999

House Purchase Price … $301,000
House Purchase Date .... 9/22/1997

Net Gain (Loss) .......... $638,999
Percent Change .......... 212.3%
Annual Appreciation … 8.8%

Cost of House Ownership
$999,999 .......... Asking Price
$200,000 .......... 20% Down Conventional
4.84% ............... Mortgage Interest Rate
$799,999 .......... 30-Year Mortgage
$203,304 .......... Income Requirement

$4,217 .......... Monthly Mortgage Payment

$867 .......... Property Tax (@1.04%)
$150 .......... Special Taxes and Levies (Mello Roos)
$208 .......... Homeowners Insurance (@ 0.25%)
$165 .......... Homeowners Association Fees
$5,607 .......... Monthly Cash Outlays

-$1023 .......... Tax Savings (% of Interest and Property Tax)
-$990 .......... Equity Hidden in Payment (Amortization)
$371 .......... Lost Income to Down Payment (net of taxes)
$125 .......... Maintenance and Replacement Reserves
$4,089 .......... Monthly Cost of Ownership

Cash Acquisition Demands
$10,000 .......... Furnishing and Move In @1%
$10,000 .......... Closing Costs @1%
$8,000 ............ Interest Points @1% of Loan
$200,000 .......... Down Payment
$228,000 .......... Total Cash Costs
$62,600 ............ Emergency Cash Reserves
$290,600 .......... Total Savings Needed

Property Details for 15 CANDLEWOOD Irvine, CA 92620
Beds: 4
Baths: 3
Sq. Ft.: 2350
Property Type: Residential, Single Family
Style: Two Level, Georgian
View: Canyon, Fields, Mountain, Orchard/Grove, Park/Green Belt, Trees/Woods
Year Built: 1998
Community: Northwood
County: Orange
MLS#: S653275
Source: SoCalMLS
Status: Active
* * * ONE OF ONLY 10 HOMES ON A SINGLE LOADED STREET FACING MEADOWOOD PARK AND CANYON VIEW ELEMENTARY SCHOOL * * * Cleaner than a Microsoft and Apple computer lab - COMBINED!!! MOST UNIQUE LOCATION ON THE IRVINE RANCH! Light and bright east facing with cathedral ceilings! Incredible privacy and location. Amazing floor plan with guest suite downstairs, 3 bedroom upstairs with option for bonus over garage or 5th bedroom with own bathroom. upgarded with cutom paint, large covered patio, granite kitchen counters, upagrded cabinets, plantation shutters. Hardly been lived in and immaculately clean!

MOST UNIQUE LOCATION? I don't think uniqueness can be modified. How is something less unique than something else? It's either unique or it's not, right?

* * * Cleaner than a Microsoft and Apple computer lab - COMBINED!!! He has a sense of humor.

upgarded? upagrded?

What were you doing at 10:50 last night?

Last night due to a technical problem at 10:50, I lost today's post. I last successfully saved the basic infrastructure of a post, but the analysis of the CEOs comments -- something I spent two hours writing -- was gone.

For a moment, I was in total shock. I could believe what happened. After a few unsuccessful attempts at recovery, I conceded defeat, and I was devastated. The sense of loss was powerful and jolting. Then the reality of staying up late to re-write the post set in, and I was just devastated (and pissed). I sought out my wife to calm down.

I didn't realize how important it was to me to put up a daily post (weekdays anyway). I felt like an injured Brett Favre who wanted to start if for no other reason than he always started. Some guys are just built that way. I calmed down, wrote this pep talk to myself, drank my coffee, and hunkered down to rewrite it all. Reliability trumps sleep.

And the tears come streaming down your face
When you lose something you can't replace
When you love someone, but it goes to waste
Could it be worse?

Lights will guide you home
And ignite your bones
And I will try to fix you

Coldplay -- Fix you

real estate home sales


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