Big New Housing Problem: Mortgage Insurers Back Off

This is REALLY BIG folks:

NEW YORK, July 16 (Reuters) - Mortgage insurer MGIC Investment Corp reported a wider quarterly loss and said it will stop writing new business as losses mount in the battered housing sector, sending its shares down 14 percent in premarket trade.

You basically cannot finance a home purchase with more than 80% LTV (loan to value) without private mortgage insurance - that is, insurance that covers the lender if you default and they take a loss.

MGIC (NYSE: MTG) is the largest issuer in this area. They said they will be "trying" to capitalize a new company to write this business, but their continuing losses - which, by the way, they said they thought they had under control last year after repeated flirtations with going under outright - has apparently forced this decision.

There is absolutely no way to read this as anything but an outright disaster for the housing industry.

We need to force lending back to 80% maximum LTV (20% down payments in CASH) and 36% DTI (debt-to-income) ratios maximum, but the housing industry has continued to rely on and demand access to money on looser (that is, more leveraged) terms.

The problem is that there's no way to do that and turn a profit, as MGIC continues to show. Between them and PMI (PMII), the other "big" player in this space (due to report in August), they provide the backing for these high-LTV loans - backing that is now disappearing.

Let me be clear: this sort of lending needs to go away, but essentially the entire thesis behind those who claim that we're "bottoming" in the recession and the housing market depends on the availability of private mortgage insurance so these loans can be funded, securitized and financed, including but not limited to funding by Fannie (FNM) and Freddie (FRE).

Put a fork in the calls for a bottom to housing folks - we're going back to sustainable lending, whether the Realtors Guild and Housing Crooners like it or not.

With the death of the "housing has bottomed" call will come an end to those who claim that the economy has turned. It may take an hour, a day, a week or a few months before these folks realize they were wrong, but there's no way around the conclusion given this set of facts.

Comments

[Mike Sanborn:]

I thought the free market could determine risk and reward and an investor who wants to lend 100% of a collateral's value to you would have every right. If another investor wants to offset the risk by insuring a portion of the loss for a fee, he/she has every right. (You do have life insurance, car insurance, health insurance, long-term disability insurance, homeowner's insurance, etc., right?) They risk their own money and therefore they make their own rules, which are to minimize loss. (Try working for a portfolio lender and then you'll understand how this works) The problem with the mortgage industry is not the loose lending guidelines, it is the free money that the government provides to banks and large investment firms that has eliminated the accurate assessment of risk. All of these 'greedy' investors and lenders are simply generating fees lending the governments money. There needs to be real loss at risk for these investors so they will revert to proper assessment of risk. If that balance is found at 95% LTV or 80% LTV, then so be it. The monetary policy of the government is the sole cause of the mortgage debacle. Whoever gets to the money first, wins. You cannot tell me that the solution to the problem is 80% max financing as that only reveals your complete ignorance of the big picture.

Jul 16 01:42 PM

[Gtarras:]

Karl
I dont even know where to start to critique your thesis. First of all, MGIC IS NOT EXITING the business. Quite to the contrary. They are restricted by the regulator to write new business if their risk-to-capital ratio exceeds 25:1 and anticipate that that will happen at the end of this year. So they decided to set-up a new entity called MIC, with fresh capital, through which they will continue writing. of course, the funding will come from the old entity, which will make the RTC to jump there, and might at the end hurt the clients, but thats different subject (see MBIA, for example).

As for your point that LTV > 80 loans need to go away, this model has been around for as long as mortgage market existed. you want to kill it NOW? Just because cars have accidents sometimes, does it mean we have to stop using them?

Jul 16 01:45 PM

[vvvvviking:]

Unfortunately in the MI business the free market was not at work.

MI is required for any loan over 80LTV that Fannie and Freddie buys.

The mortgage originator determines which MI company is used on each loan.

So the MI companies were squeezed by the lenders on one side and the GSEs on the other, and forced to take risks they shouldn't have taken.

I do agree with your argument that the market should determine the risk taken, but any free marketer needs to acknowledge that we can have market failures. The Lender/MI/GSE setup was one of them.

The only sustainable solution is to require the lenders to keep some "skin in the game".

The GSE charters allow lender participation as an alternative to mortgage insurance on loans over 80LTV. the mortgage insurance industry should be shut down, and lenders forced to retain the risk on loans over 80LTV. This would result in "the market" making more intelligent decisions on what loans to advance.


On Jul 16 01:42 PM Mike Sanborn wrote:

> I thought the free market could determine risk and reward and an
> investor who wants to lend 100% of a collateral's value to you would
> have every right. If another investor wants to offset the risk by
> insuring a portion of the loss for a fee, he/she has every right.
> (You do have life insurance, car insurance, health insurance, long-term
> disability insurance, homeowner's insurance, etc., right?) They risk
> their own money and therefore they make their own rules, which are
> to minimize loss. (Try working for a portfolio lender and then you'll
> understand how this works) The problem with the mortgage industry
> is not the loose lending guidelines, it is the free money that the
> government provides to banks and large investment firms that has
> eliminated the accurate assessment of risk. All of these 'greedy'
> investors and lenders are simply generating fees lending the governments
> money. There needs to be real loss at risk for these investors so
> they will revert to proper assessment of risk. If that balance is
> found at 95% LTV or 80% LTV, then so be it. The monetary policy of
> the government is the sole cause of the mortgage debacle. Whoever
> gets to the money first, wins. You cannot tell me that the solution
> to the problem is 80% max financing as that only reveals your complete
> ignorance of the big picture.

Jul 16 02:02 PM

[vvvvviking:]

To paraphrase your description (which is correct), MGIC, through a very kind decision by their regulator (who by the way allowed Ambac to do exactly the same thing), will shuffle what little capital they have around different companies and be allowed to lever up beyond what the law currently allows. Great solution - allow more leverage, at a time when unemployment is still rising, and many of their current borrowers are severely underwater. This regulation deserves to lose his job.

As for your analogy, quite simply, it sucks. Just because something has been around for a long time, doesn't mean we should continue to allow it.

Though I don't have a problem with >80LTV lending, or even 200LTV lending, as long as the fool lending the money is on the hook for the credit risk.

the current MI/GSE/Lender menage a trois is broken, and it needs to be ended, now. the MI industry needs to be abolished.


On Jul 16 01:45 PM Gtarras wrote:

> Karl
> I dont even know where to start to critique your thesis. First of
> all, MGIC IS NOT EXITING the business. Quite to the contrary. They
> are restricted by the regulator to write new business if their risk-to-capital
> ratio exceeds 25:1 and anticipate that that will happen at the end
> of this year. So they decided to set-up a new entity called MIC,
> with fresh capital, through which they will continue writing. of
> course, the funding will come from the old entity, which will make
> the RTC to jump there, and might at the end hurt the clients, but
> thats different subject (see MBIA, for example).
>
> As for your point that LTV > 80 loans need to go away, this model
> has been around for as long as mortgage market existed. you want
> to kill it NOW? Just because cars have accidents sometimes, does
> it mean we have to stop using them?

Jul 16 02:07 PM

[markfl:]

The ultra-low Fed Funds poured the gasoline and high LTV lit the match on this housing bubble. Continuing this practice in a high unemployment era only perpetuates further defaults and foreclosures.

"We need to force lending back to 80% maximum LTV (20% down payments in CASH) and 36% DTI (debt-to-income) ratios maximum, but the housing industry has continued to rely on and demand access to money on looser (that is, more leveraged) terms."

The tried and true lending worked fine for decades in this country. We've had severe recessions, but they didn't turn into housing collapse because people had equity. Let me add to that no more pick a pay or Alt-A with unverified income. If you have non-W-2 income, show 3 years of tax returns. To do otherwise is fraud.

Jul 16 02:16 PM

[Carlos Lam:]

On Jul 16 02:16 PM markfl wrote:

> The tried and true lending worked fine for decades in this country.
> We've had severe recessions, but they didn't turn into housing collapse
> because people had equity. Let me add to that no more pick a pay
> or Alt-A with unverified income. If you have non-W-2 income, show
> 3 years of tax returns. To do otherwise is fraud.

Well said, markfl. When one has to put down 20%, one has "skin in the game" and is more willing to ensure that one's home is preserved. With no money down, one essentially has a cost-free put option to "put" the home back to the lender.

Jul 16 02:46 PM

[joker:]

The entire mortgage industry, especially mortgage insurance industry is a bust without government's backing/subsidizing. Think about it: with default rate as high as above 10%, the basic logic for insurance is that, an insurer has to charge 10% and above of insured amount to at least break even, not to mention to make a profit - mortgage lenders could a little lower since there is residual values.

However, MI rates are set by statement governments, and currently their charged rates are no way near the required break-even points. Therefore all MIs are in losing / bankruptcy positions.

Charging 10% and above - no home buyers could afford that, even if they want. Therefore it only leaves one way for the keeping housing markets alive: government and GSEs step in to take all the lending and insuring responsibilities, even if it is obviously by doing so, they're going to lose tons of money.

Jul 16 04:50 PM

[Philip Gvinter:]

Don't worry guys FHA loans are still available and are filling in the hole that MI pricing created by making it very expensive to buy a house without 20% down!

Please pardon my sarcasm but I agree with Karl and the above comments in principle but not entirely on the details. ALT-A and option ARMs are fortunately already gone and should never come be allowed to come back. Lending standards are still too lose with 50DTIs and 3.5% down payments being allowed. We need to tighten some more but not all the way back to 20% down and 36DTI. The old standard on DTI used to be 33housing 38 total debt. That is perfectly reasonable and I can even accept up to 40 total DTI regardless of the housing ratio. Really since at least a part of the mortgage payment is tax deductible it is better for the housing payment to make up a part of the DTI than for other debt. As to 20% down, that is just unrealistic. 2nd mortgages and MI have existed within reasonable limits for decades and should not be taken off the table. I think that FHA guidelines should be 5% down and reasonable access should be made for private MI with 10% down. We do want to let the housing prices correct themselves but want some level of orderliness to the process. By tightening standards from where they are today we would take out one of the remaining props to the market and let it reach true equilibrium. Tightening the standards too much will lead to even lower prices more rapidly and can bring about undesirable levels of instability. As to having to produce three years of tax returns as the only viable alternative to W2s, I think that allowing 2 years of bank statements should do just as well since tax tricks are legal and are not outright fraud. Many business owners simply find ways to write down their taxable income below its true level. The consequences of this should not include an inability to secure credit.

Jul 16 06:01 PM

[mortgagemin...:]

I can't believe no one has mentioned the 97.5% LTV FHA loan that requires a 1.5% up front mortgage insurance premium to HUD as well as MI on the back end to protect the lender. Another housing bubble in the making. Since the crisis FHA loans account for, don't quote me on this 43% or more of all purchase transactions and increasing on a daily basis in a DECLINING market. Almost all of the FHA loans made at the beginning of last year, (I'm in CA) are underwater now. Does this mean that FHA loans will eventually become uninsurable should all MI companies vanish or I guess they will make exceptions for FHA loans because an FHA loan is essentially a Gov loan.

Jul 16 06:39 PM

[Philip Gvinter:]

The FHA loans are 96.5LTV and the 1.5% "funding fee" is indeed upfront MI with 55bip annual premiums. To the best of my knowledge the FHA MI program is run by the FHA itself not by an outside vendor. The FHA is going to take some bad losses on the mortgages it is currently insuring.


On Jul 16 06:39 PM mortgageminister wrote:

> I can't believe no one has mentioned the 97.5% LTV FHA loan that
> requires a 1.5% up front mortgage insurance premium to HUD as well
> as MI on the back end to protect the lender. Another housing bubble
> in the making. Since the crisis FHA loans account for, don't quote
> me on this 43% or more of all purchase transactions and increasing
> on a daily basis in a DECLINING market. Almost all of the FHA loans
> made at the beginning of last year, (I'm in CA) are underwater now.
> Does this mean that FHA loans will eventually become uninsurable
> should all MI companies vanish or I guess they will make exceptions
> for FHA loans because an FHA loan is essentially a Gov loan.

Jul 16 09:05 PM

[Gtarras:]

when people realize the extent to which FHA screwed up with their lending practices as of late, they will be happy private MIs are still around. private business is always better managed.


On Jul 16 09:05 PM Philip Gvinter wrote:

> The FHA loans are 96.5LTV and the 1.5% "funding fee" is indeed upfront
> MI with 55bip annual premiums. To the best of my knowledge the FHA
> MI program is run by the FHA itself not by an outside vendor. The
> FHA is going to take some bad losses on the mortgages it is currently
> insuring.

Jul 16 11:17 PM

[derryl:]

If a banker makes too many high ratio mortgages and the bank goes belly up, his depositors' money is guaranteed by the FDIC. The FDIC is theoretically funded by the banks, so best case scenario is that our belly up banker has contributed to us paying higher bank fees so our bank can afford its FDIC coverage. But the FDIC has nowhere near enough money to cover a collapse like we have now, so taxpayers ultimately subsidize the high ratio banker.

This is not a "free market". This is a market that is explicitly backstopped by bank customer fees and implicitly backed by taxpayers. Because taxpayers and bank customers have skin in this game we have a right to insist that nobody gets a mortgage without some serious skin of their own in the game, namely 20% cash down. I agree completely with Karl.

Jul 16 11:18 PM

[Gtarras:]

Ehhh, do you have a bone to pick with the MIs or something like that? Go ahead write to your Congressman, etc do whatever it takes to abolish the MI business. I dont care. I was making a point about the LTV>80 loan business, which you seem to be fine with. Jesus.

On Jul 16 02:07 PM vvvvviking wrote:

> To paraphrase your description (which is correct), MGIC, through
> a very kind decision by their regulator (who by the way allowed Ambac
> to do exactly the same thing), will shuffle what little capital they
> have around different companies and be allowed to lever up beyond
> what the law currently allows. Great solution - allow more leverage,
> at a time when unemployment is still rising, and many of their current
> borrowers are severely underwater. This regulation deserves to lose
> his job.
>
> As for your analogy, quite simply, it sucks. Just because something
> has been around for a long time, doesn't mean we should continue
> to allow it.
>
> Though I don't have a problem with >80LTV lending, or even 200LTV
> lending, as long as the fool lending the money is on the hook for
> the credit risk.
>
> the current MI/GSE/Lender menage a trois is broken, and it needs
> to be ended, now. the MI industry needs to be abolished.

Jul 17 01:01 AM

[Karl Denninger:]

20% down limits your leverage to 5:1.

That's a reasonable leverage ratio. 100% LTV is of course an infinite leverage......


On Jul 16 02:46 PM Carlos Lam wrote:

> On Jul 16 02:16 PM markfl wrote:

Jul 17 08:00 AM

[Philip Gvinter:]

Karl,

I would agree with you when it comes to the purchase of rental properties and even 2nd homes. I have to disagree when talking about primary residences. the 4:1 leverage represented by a 20% downpayment is attractive but is just not a reasonable requirement in high cost markets. As much as I would personally like to see property prices spike down significantly which would increase their affordability I do not see a further 40% haircut as being healthy for the overall economy on a long term basis. This would be a bigger blow than the Fed could help absorb and would put not only the commercial banks but also the Federal Home Loan Bank system at serious risk with a very low likelihood of survival. Lending standards do need to be tightened a bit more but they are fairly close to sustainable at this point.

Jul 17 08:13 AM

[John Preston:]

Karl

Down payment has nothing to do with mortgage defaults. Historically, and I mean for ever, the prime cause for default is the 5 "D's": Death; Disability; Discharge; Downturn; and Divorce.

Down payment is not on the list. Home owners, and rents, pay for the space they occupy with earnings, and rely on liquidity when they hit a bump in the road.

What sort of economy do you want to see in the future. We have seen what a 2-4 percent drop in consumer spending can do the economy....basically, drive unemployment up over 100%. Can you imagine the economic landscape with increased cash hoarding. Someone with better math skills and too much time to invest will fighure this one out.

The real key is stability in the credit underwriting process. Thats were the leveraging needs to managed. The cycles I have experienced over 30 years in the treatment of income, the expansion and contraction of the income ratios (published ratios: 25/33; 28/36; 31/43. Actual ratios: 28/36; 31/39; 64.99/64.99!!!) is what really messes up the market and distorts asset prices.

At some point in the housing process, 20%, or more, down makes prudent sense: Jumbo; Alt, etc.

If the goal is a fluid economy with maiximum participation, then the thought process has be directed towards that goal. If the goal is an elitest, exclusionary, backward looking economy, well then, welcometo the past.

For a while now, there has been discussion of the "new normal"... I don't beleive that we can get back to our grandfathers normal...but, with your approach to housing, the new economic "normal" may be Yuma, AZ....unemployment rate, 24%.

Jul 17 09:10 AM

[Troyhector:]

The lenders and their representatives or not willing to either reduce the principal amount as well as the interest received from the borrowers as the amount they pay to the bank also reduces over time making it further difficult for them to tackle the vicious circle.

The unemployment rate in the nation, which stands at 9.4% currently, may even increase to alarming double digit number making the financial situation even worse for the borrowers to repay. The layoffs of many workers have been permanent and hence, their hopelessness in recovery of the jobs or helplessness to repay mortgage over time looks bleak and they resort to foreclosure than choosing to invest or borrow more money on something that they are not sure whether they would be able to afford in the long run.

Check out www.housingnewslive.co...

Jul 17 01:49 PM

[Russ Wetherill:]

Very interesting discussion on down payment requirements. I just have a couple of points to add:

The 20% down requirement is there to protect the lender against default, not necessarily to prevent speculation or to protect the system. When a borrower defaults on a loan, there are certain costs the lender may be liable for: 1) direct foreclosure costs, 2) carrying costs, 3) re-sale commissions, 4) fixing any damages to the property so that it can be re-sold, etc.

Clearly, 3% down won't cover even the 6% commission to re-sell the property, much less the foreclosure and carrying costs. A lender may choose to spread the risk over their entire portfolio and thereby reduce the 20% down to 10% based on the likelihood of a certain percentage of loans defaulting at any one time. If the lender sells the mortgages then their risk is reduced even further. But, the buyer of these loans should also assess risk and perhaps require greater than 20% given their lack of direct knowledge of the borrower's ability to repay.

Another problem we face currently is strategic defaults by underwater homeowners. Once an owner is more than 20% underwater they may decide that it is in their best interest to stop paying on their mortgage. Current housing data indicates that if a borrower is 30% underwater they are much more likely to walk away from the home even though they can comfortably make the payments. So, a zero down buyer is perhaps 5 or more times as likely to default as a 20% down buyer in a 30% down market.

If systemic risk is to be controlled with a down payment, then the down payment should be based on the historical trend line value of a house. As the bubble formed, the down payment requirements should have reflected the increase in lender risk in a steeply appreciating bubble market. In 2005, a down payment of 50% might have been appropriate in California, Nevada, Arizona and Florida. Instead, we had the opposite: down payments of 0% and debt to income levels of nearly 60% in the bubble areas.

This bubble we are experiencing is a "Katrina-like" 100 year storm. The question with bubbles and hurricanes is: How high do you build the wall? Before Katrina everyone knew that the sea wall was too low for the predicted 100 year storm surge. Nothing was done to raise the wall, however, because it was deemed to be too expensive to prevent, and too unlikely to happen.

The same can be said about the housing bubble. All we heard from the media during the housing boom was that housing prices always go up, that interest rates were cheap, and that it was a new paradigm. We effectively lowered the housing sea wall because we believed that by securitizing the mortgages we were lowering the risk, when in fact we were increasing the risk of a much steeper and more devastating fall in home prices.

Lowering down payment requirements, increasing DTI ratios, having teaser rates for ARMs, and not verifying borrower income is the same as removing the sea wall in New Orleans and no longer watching the sea for hurricanes because we believe that hurricanes no longer occur.

Sure, a 20% down payment requirement will slow down the housing market just like a sea wall will block the nice ocean view. But, a rational balancing of interests needs to be struck. Clearly, we didn't get it right in the last 10 years. Perhaps we should try again.

Jul 20 10:42 AM

[Rhabdamanth:]

test

Jul 21 01:17 AM

[Rhabdamanth:]

This a non-event. Anyone who didn't see this coming wasn't paying attention. But for the sake of argument, let's say it was unexpected. Who thinks that anyone was going to continue to underwrite loans at 95%+ LTV's in a declining market. Only the kamikaze bankers - and I'm pretty sure they've all gone to meet their ancestors.

Jul 21 01:20 AM