NEWSFLASH...The Fat Lady Has Sung

Brian Hicks

Updated October 19, 2006

Baltimore, Md.It may have taken a while and may have been long overdue, but it has finally happened-the fat lady has sung at last. And in singing as she did, she unleashed a monumental downpour on the dreams of housing bulls everywhere.

Earlier this month it finally happened: the nation's lenders were called into the principal's office for their part in helping to create the epic housing bubble.

And not only was he not happy, but he was clearly in no mood for any further funny business.

In fact, he was feeling downright regulatory.

All of which was bad news for the nation's housing market, because the truth is nobody, but nobody, can pop an overheated bubble like a set of regulators on a mission.

And these regulators were the heavyweights-the Federal Reserve, the Department of the Treasury, the Federal Deposit Insurance Corporation, and the National Credit Union Administration.

Together, these agencies set out on a simple mission-to rein in the types of "non-traditional" mortgage products (option ARMS and interest-only loans) that have been described everywhere lately as being either "toxic," "exotic," or both.

The results of this mission were released in a report entitled "Interagency Guidance on Nontraditional Mortgage Product Risks."

And while its title is one that only a bureaucrat could love, the details within its 27 pages are juicy, to say the least.

As a matter of fact they are huge. That's because the guidelines they contain promise to rein in the very types of risky and fraudlent loans that sent waves of unqualified buyers into the marketplace at a time when the bubble was at its frothiest.

In reading these pages one thing is perfectly clear: there will be substantially fewer qualified buyers now and in the years to come because of these guidelines.

That's because these guidelines establish much higher underwriting standards for these loans, making them that much harder to qualify for.


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In fact, the final guidance stated-in language that only a former mortgage broker could love-that to manage the risks associated with nontraditonal mortgage loans, management should:

  • Ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower's repayment capacity.
  • Recognize that many nontraditional mortgage loans, particularly when they have risk-layering features, are untested in a stressed environment. These products warrant strong risk management standards, capital levels commensurate with the risk, and an allowance for loan and lease losses that reflects the collectibility of the portfolio.
  • Ensure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.

While all of that may sound like so much mortgage legalese, the reality is that these guidelines and others within the report will effectively put an end to "creative financing."

This, in short, means that the toolboxes of loan officers everywhere have substantially fewer tools in them, because these "loans of last resort" have now been effectively reined in.

Underwriters are now actually going to have go to much greater lengths to make sure that borrowers can actually qualify for and afford these loans-even to the extent of verifying incomes. (What a concept!)

This is particularly going to be true for the subprime market, the fastest growing and shadiest segment of the marketplace.

In fact, the report went to great lengths to single out that market, saying: "Institutions designing nontraditional mortgage loans for subprime borrowers should pay particulary attention to this guidance."

Given these new guidelines and the threat of "remedial action," lenders have recently begun to fall in line.

Just last week, a mere 12 days after the new guidelines were released, New Century Mortgage Financial Corporation (NEW:NYSE), one of the biggest subprime lenders in the country, announced that it was making significant changes in the ways that it sold and underwrote these loans.

Company CEO Brad Morrice said, "In light of the recent regulatory guidance and the changing interest rate environment, we have reevaluated our programs and practices and developed enhanced policies and techniques to reinforce our goal of providing fair and informed access to credit."

The translation, naturally, was much simpler: pain.

At least that's how the analysts at Stifel Nicolaus & Company interpreted it. They downgraded the mortgage giant to "sell" while reducing their estimates for the company.

Their underlying logic was simple-"that the company's plans to constrict its underwriting standards are likely to have a significant negative impact on its origination volumes, disqualifying 20%-50% of the loans."

All of which means more bad news for an already reeling housing market, since not only will the new guidelines mean significantly fewer buyers, but those buyers who do qualify will do so at much smaller loan amounts.

This means that the so called "soft landing" in real estate is going to be much harder than hoped for.

In fact, it means that not only will the freefall in housing continue, it will accelerate.

So welcome to the house of pain.

Grab yourself a seat . . . there's still plenty of them.

Sure, the fat lady may have finished her tune, but the show is just beginning.

The regulators are just warming up. Their aria promises to be the longest and hardest of them all.

And believe me, when they get done you won't even recognize the place.

BTW-For those of you who already have one of these "exotic mortgages," you had better get used to it-because now you are trapped in it. You see, when your loan officer told you not to worry about those "exotic" parts of the deal because you could refinance out of it later, he was wrong. After all, they just changed the rules that allowed you to qualify for it in the first place. Regulators are like that . . . it's what they do.

It sure is a good thing that the lenders got all of those new bankruptcy laws that they wanted . . . boy are they smart!

It's almost like they knew what was going to happen.

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