Q: What do you make of the current turmoil in the mortgage industry?
A: First point--and I'm sure you've heard this from everyone--is that the residential housing and mortgage industries are paying the price for the excesses of the past few years. Clearly, the housing and mortgage industries were in an overheated cycle. The resulting defaults and losses that are occurring are not just in the subprime segment of the mortgage market, but it's spreading across all credit segments. The magnitudes of the losses will vary by segment, but it's having a negative impact on all segments of the mortgage market.
Q: What is driving the losses in mortgages?
A: HPA--home-price appreciation--is driving the losses across all credit types, but it's being exacerbated by the aggressive lending that took place over the last few years. So, you've got the confluence of those two coming together. HPA, or the lack thereof, is unmasking the deterioration in credit standards that occurred over the last couple of years.
Q: What was new in this cycle that made things worse?
A: Importantly, the mortgage industry has been adversely impacted by parties with little or no financial stake in a mortgage transaction, such as mortgage brokers and Wall Street. The amount of fraud in some loan products is astounding. Not outstanding--it's astounding.
Q: What mortgage products are responsible for most of the fraud?
A: Third-party originated products in combination with a no-documentation or stated-income type of application has produced a recipe for fraud.
Q: Is this occurring in all the markets? Or are the problems concentrated in heated markets?
A: In terms of geography, it's everywhere. That's been our experience. Well, let me say it is everywhere, but it's more pronounced in the overheated markets where affordability became an issue and therefore the need to inflate someone's income to qualify for the loan.
Q: How did it come to be such a big part of the industry?
A: In some sectors of the country and some regions of the country, affordability became a big challenge. And this was a means by which to keep origination volumes going.
Let me say something I feel needs to be included: We believe clearly there is a need for stronger regulation of mortgage brokers and some form of regulatory authority allowing for the free exchange of information regarding brokers who commit fraud.
Q: How could that be done?
A: It needs to be implemented at the federal level, so we have consistency in the application of that regulation and everyone understands the rules of the game. So, as a result of all the points I have just stated, credit is tightening, and appropriately so. It's putting a governor on some of the frenzy that has taken place over the last few years. And it's bringing the residential housing and mortgage industry back to reality, and that's fine. It's bringing the industry back to more responsible lending.
Q: Some people seem to be overreacting, though, restricting loan availability and tightening underwriting criteria unnecessarily--partly, I think, because they want to curtail their exposure to subprime loans in volume, regardless of quality.
A: Yes, it's obvious that tightening in underwriting has taken place, with underwriting guidelines returning to more appropriate credit standards. And there has been an overreaction by the investor community, reducing availability of mortgage funds in all segments of the business, not just subprime. As an example, subprime was originally designed for a low LTV [loan-to-value ratio] mortgage. And it was a full-documentation loan. When the industry began to risk-stack no-documentation or stated-income [loans] with third-party origination channels and high-LTV levels, once again, that's when the industry became overly aggressive.
Q: And this was driven apparently by the desire to keep up volume, relying on third-party originators even if relaxing the underwriting standards? …