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Lower Standards Save the Day

This week, Bill Gross has been pounding the folks in Washington, saying 20% to 25% down payment for a house is too much in this economic environment. I agree as there is too much inventory, too much unemployment, and too much fear to get houses moving via old school parameters. Here's the rub. I said all along that the war on banks and prosperity in general would see the pendulum swing so far that many people would be shut out of the housing market. As it turns out, millions are also being shut out of traditional banking, too. The market needs traction that only comes from an increase in home sales. The ugly truth is we need subprime lending more than ever, or to be ready to settle into current home values for many more years.

The thing is we the people don't need to facilitate such loans through government-owned enterprises. Few words illicit the kind of anger that subprime does, and adjustable rate mortgages are seen as the devil. These things have been demagogue so much that many people don't want them. Many big banks have gotten out of the business or are looking to if they can find buyers or the right time to spin them off. But, the industry is going to be around, and despite the role played in our current mess, will be a pivotal component to putting a bottom into housing. Without Fannie Mae and Freddie Mac buying the crap, the self-regulation Greenspan thought was a natural part of capitalism will return.

I desperately want the private sector in the housing market. Just as I want the government to move out. But, they've beat so many lenders up in an effort to be the only game in town the transition back to private capital taking risk without intimidation and name-calling isn't going to be easy. Moreover, the desire by government to make sure everyone gets a bite at the housing apple is still embedded. As much as President Obama wants to somehow erase past discrimination through absurdly cheap loans backed by taxpayers, he would be better off letting the entire economy heal as to lift the economic boats of all Americans. Right now, it's not unreasonable to say it will ultimately cost $1.0 trillion to clean up Fannie Mae and Freddie Mac, and yet we keep piling it on.

According to the Federal Reserve, lenders have already begun to relax standards in response mostly to competition. If they can avoid being called "reckless" and singling out for mistakes everyone made during the good times banks would lower the amount needed to buy a home. As for the subprime market, it could be gearing up for more demand. Lord knows they have a larger pool of potential customers. Of course, there is the new financial regulatory reform law, as a continued work in progress it will be a continued dark cloud adding to anxieties. I think the White House is going to drop a massive program on us soon as a last hour effort to win midterm elections...oops, I a last hour effort to save the housing market.

Betty White and Subprime Lending

Just as Betty White has found ways to revive her career, for decades there has been a constant evolution of lending to high risk, low income consumers.

After banks were saddled with a ton of houses they couldn't sell the government created FHA, ostensibly to improve standards and conditions in which to provide financing of houses through insurance of mortgage loans. There was a time when mortgage loans were only three to five years long. In 1938, Congress created FNM in an effort to expand homeownership. The 1940s and 1950s were a great time for housing and Betty White, whose career blossomed on radio, while the baby boom drove housing demand. Sometime around 1959 Wisconsin assemblyman, William Double, won approval for a new type of mortgage loan. The variable rate loan was designed to help banks stuck with large portfolios of low interest rate mortgages in an environment of rapidly rising interest rates.

From the start, variable rates were tinkered with, and took off in California in the 1970s just as Betty White's television career was zooming on the Mary Tyler Moore show. In 1977, the Community Reinvestment Act went into effect, designed to combat lending discrimination in certain neighborhoods. From 1992 to 2008, $6.0 trillion in CRA loan announcements were made with 94% concentrated at four banks- WFC, C, BAC, and JPM. Of those loans, more than $2.0 trillion were for single family homes. In 1981, Great Western Financial of Beverly Hills pioneered the modern version of the ARM. James Montgomery, under the tutelage of his mentor Stuart Davis, tinkered with variable rate mortgages to find a product attractive to borrower and lender. The rate was tied to the average cost of money for thrifts n Nevada, California, and Arizona.

According to American Banker, there will be at least three big players in the subprime space.

CitiFinancial, which has 1,300 branches, is going to be spun-off from Citigroup (NYSE:C) soon. CitiFinancial closed 300 branches and turned another 181 into service centers, and is focusing on refinancing and auto loans.

General Motors just bought Americredit, which specializes in subprime auto loans.

Fortress Investments bought 80% of the subprime consumer finance unit at AIG.

It should be noted Wells Fargo closed its subprime unit, and there isn't a groundswell of smaller names popping up. But, the industry isn't going away. In fact, its rebound would correlate with a rebound in housing. I don't think people should be allowed to put less than 10% down unless the lender has capital to take the hit. There needs to be securitization, we just need to take the taxpayer out of the loop.

In 1994, there was $35.0 billion in subprime mortgages in existence, of which 31.6% was securitized.


All eyes are on Ben Bernanke, who got this period of angst going with his comments about "unusual uncertainty." I'm not sure what the Street wants to hear but it better sound like it came from our dad when we made it home an hour past curfew. Conviction and leadership are needed, along with a game plan. To be sure, I think the solution resides at the White House, but I think Wall Street would like to hear a concrete plan, and even hard numbers. Maybe buying $1.0 trillion in Treasuries and MBS would be the right combination, and take the heat off the Federal Reserve. But, I'm not sure. I'm not a fan of quantitative easing, and low rates are the problem. At least Ben Bernanke is working, he gets kudos for that. However, Jackson Hole is beautiful, and not the toughest place to put in some elbow grease.

They're working at the SEC, too, and that's scaring the hell out of the Street. Everyone wants the bad guys to get caught, but the marching orders from Dodd-Frank are worrisome. It feels like we're watching a phalanx of soldiers marching down Red Square on their way to knock heads...any heads. According to FT, the SEC has hammered out 12 of the new laws mandated by financial regulatory reform. In the course of the year since the law was enacted, the SEC has to create 100 new regulations and complete 20 studies. Someone pull those numbers out of a hat? Talking about asinine, were those numbers picked because they were nice and round? Anyway, enforcement is up, which is good if it's legitimate. The agency is hiring 800 more troops and the budget is swelling to $1.3 billion from $960.0 million in 2009.


The revision was better than expected, but at 1.6% it's down from 3.7% in the first quarter and the initial reading of 2.4%. The Street is relieved, but I wonder if this "moral victory" will be enough to carry the entire day after yesterday's fizzled early into the session. We have a confidence reading coming, and Bernanke's comments, too. The market, oversold as it is, can break either way. There are so many oversold names out there, but we are not going to force it this morning…maybe on the afternoon update.

Disclosure: none