Can somebody familiar with sub-prime mortgages explain something to me?

[XMan]

All right, so these were loans to people with less than perfect credit, possibility no down payment, etc. Got all that.

But given that in most cases they were at 100% or greater LTV, why in the world weren't they paying PMI?

If so, where'd that money go? Isn't it supposed to protect the bank if the mortgage goes south?

 

[IronWing]

Welcome to the world of 80/20 loans. First mortgage at 80% of "appraised" value, therefore no requirement for PMI. Second mortgage for the remaining 20%. The banks wanted the business so bad they screwed themselves out of PMI coverage.



Edit: In the bigger picture, I think PMI is basically a shell game anyway, designed to make advertised interest rates look lower. The interest rate is supposed to reflect the risk inherent in the loan. Splitting the risk premium into interest plus PMI is just marketing as far as I can see.

 

[XMan]

That's . . . ridiculous, to say the least.

I think I was going to wrong banks when I was trying to buy a house . . . I should have dressed in rags like that one episode of the Cosby Show . . .

 

[daniel49]

Basic how we got here from 1999 NYT article.

Text

 

[IronWing]

Originally posted by: daniel49
Basic how we got here from 1999 NYT article.

Text

That is one piece of the puzzle but certainly not the whole story. More informative to the current crisis is what folks in the securities markets did with all those mortgage backed securities. Via the magic of insurance schemes of various types the banks were able to count money out on loan as meeting capitalization requirements for making even more stupid loans. They were building an inverted pyramid of credit based on bad mortgages. It worked until housing prices, having exceeded any reasonable level, stopped growing. Then the bottom of the pyramid collapsed and now the whole spun glass structure is shattering. The bailout is basically shooting glue into the structure to try to keep it from crumbling.


Edit: I forgot to mention the reason the insurance schemes didn't pan out is that the banks were selling each other insurance on the same class of stuff. When Lehman bit the dust, the banks realized that their insurance contracts were pretty much worthless, forcing them to admit the mortgage backed securities really weren't capital reserves which in turn hosed the bank's ability to make loans, being already grossly over-stretched.

 

[daniel49]

Originally posted by: ironwing

Originally posted by: daniel49
Basic how we got here from 1999 NYT article.

Text

That is one piece of the puzzle but certainly not the whole story. More informative to the current crisis is what folks in the securities markets did with all those mortgage backed securities. Via the magic of insurance schemes of various types the banks were able to count money out on loan as meeting capitalization requirements for making even more stupid loans. They were building an inverted pyramid of credit based on bad mortgages. It worked until housing prices, having exceeded any reasonable level, stopped growing. Then the bottom of the pyramid collapsed and now the whole spun glass structure is shattering. The bailout is basically shooting glue into the structure to try to keep it from crumbling.


Edit: I forgot to mention the reason the insurance schemes didn't pan out is that the banks were selling each other insurance on the same class of stuff. When Lehman bit the dust, the banks realized that their insurance contracts were pretty much worthless, forcing them to admit the mortgage backed securities really weren't capital reserves which in turn hosed the bank's ability to make loans, being already grossly over-stretched.

Wonder how much glue 700 billion buys nowdays?

 

[IronWing]

Originally posted by: daniel49

Originally posted by: ironwing

Originally posted by: daniel49
Basic how we got here from 1999 NYT article.

Text

That is one piece of the puzzle but certainly not the whole story. More informative to the current crisis is what folks in the securities markets did with all those mortgage backed securities. Via the magic of insurance schemes of various types the banks were able to count money out on loan as meeting capitalization requirements for making even more stupid loans. They were building an inverted pyramid of credit based on bad mortgages. It worked until housing prices, having exceeded any reasonable level, stopped growing. Then the bottom of the pyramid collapsed and now the whole spun glass structure is shattering. The bailout is basically shooting glue into the structure to try to keep it from crumbling.


Edit: I forgot to mention the reason the insurance schemes didn't pan out is that the banks were selling each other insurance on the same class of stuff. When Lehman bit the dust, the banks realized that their insurance contracts were pretty much worthless, forcing them to admit the mortgage backed securities really weren't capital reserves which in turn hosed the bank's ability to make loans, being already grossly over-stretched.

Wonder how much glue 700 billion buys nowdays?

That is the 700 billion dollar question. Might work, might just disappear into the rat hole.

 

[Jhhnn]

Originally posted by: ironwing
Welcome to the world of 80/20 loans. First mortgage at 80% of "appraised" value, therefore no requirement for PMI. Second mortgage for the remaining 20%. The banks wanted the business so bad they screwed themselves out of PMI coverage.



Edit: In the bigger picture, I think PMI is basically a shell game anyway, designed to make advertised interest rates look lower. The interest rate is supposed to reflect the risk inherent in the loan. Splitting the risk premium into interest plus PMI is just marketing as far as I can see.

PMI is just one way of offloading risk onto somebody else, a different business entity. Banks developed other ways of theoretically doing the same thing with bundled mortgages and CDS, for example. They also had no intention of actually holding those mortgages, per se, but rather of selling off the risk to investors packaged into MBS of various flavors that they'd administrate. When investors got wise, they shut off the cashflow very quickly, leaving banks holding the bag of risk, unsold MBS. Banks were and are very heavily leveraged, so they don't have the assets to absorb losses well, at all. It didn't help that many were drinking their own Koolaid, holding a lot of high risk paper as theoretical "assets", or that abuse of the CDS market hadn't really reduced risk, at all, but had rather made it systemic.

At the other end of the business, mortgage brokers collected higher fees for selling the more creative mortgage products, so they steered unwary consumers right into them... Lots of people going under when their ARM resets actually qualified for fixed rate 30 year mortgages, even if they were subprime borrowers, but their lenders weren't ethical enough to steer them in that direction...

 

[Balt]

Originally posted by: ironwing

Originally posted by: daniel49
Basic how we got here from 1999 NYT article.

Text

That is one piece of the puzzle but certainly not the whole story. More informative to the current crisis is what folks in the securities markets did with all those mortgage backed securities. Via the magic of insurance schemes of various types the banks were able to count money out on loan as meeting capitalization requirements for making even more stupid loans. They were building an inverted pyramid of credit based on bad mortgages. It worked until housing prices, having exceeded any reasonable level, stopped growing. Then the bottom of the pyramid collapsed and now the whole spun glass structure is shattering. The bailout is basically shooting glue into the structure to try to keep it from crumbling.


Edit: I forgot to mention the reason the insurance schemes didn't pan out is that the banks were selling each other insurance on the same class of stuff. When Lehman bit the dust, the banks realized that their insurance contracts were pretty much worthless, forcing them to admit the mortgage backed securities really weren't capital reserves which in turn hosed the bank's ability to make loans, being already grossly over-stretched.

So if the prices in the housing market were over-inflated and were basically just being corrected by the recent crash did we just flush money down the toilet hoping to artificially re-inflate them again?

 

[IronWing]

Originally posted by: Balt

So if the prices in the housing market were over-inflated and were basically just being corrected by the recent crash did we just flush money down the toilet hoping to artificially re-inflate them again?

IMHO, no. I think we are done with housing bubbles for a decade or two. The bailout is supposed to reduce the banks' leverage so they can lend again. By taking the worst crap off the banks' hands, the government is trying to free up the banks so they can get back to being banks. The question is really one of scale. Does the value of all the loans made on top of the inflated value of the mortgage backed securities so greatly exceed the value of the junk mortgages themselves that the system collapses even if those securities are replaced with good money (at lower valuations)? Beats me.

 

[Moonbeam]

Originally posted by: Balt

Originally posted by: ironwing

Originally posted by: daniel49
Basic how we got here from 1999 NYT article.

Text

That is one piece of the puzzle but certainly not the whole story. More informative to the current crisis is what folks in the securities markets did with all those mortgage backed securities. Via the magic of insurance schemes of various types the banks were able to count money out on loan as meeting capitalization requirements for making even more stupid loans. They were building an inverted pyramid of credit based on bad mortgages. It worked until housing prices, having exceeded any reasonable level, stopped growing. Then the bottom of the pyramid collapsed and now the whole spun glass structure is shattering. The bailout is basically shooting glue into the structure to try to keep it from crumbling.


Edit: I forgot to mention the reason the insurance schemes didn't pan out is that the banks were selling each other insurance on the same class of stuff. When Lehman bit the dust, the banks realized that their insurance contracts were pretty much worthless, forcing them to admit the mortgage backed securities really weren't capital reserves which in turn hosed the bank's ability to make loans, being already grossly over-stretched.

So if the prices in the housing market were over-inflated and were basically just being corrected by the recent crash did we just flush money down the toilet hoping to artificially re-inflate them again?

I know nothing but I thought that what you call artificially re-inflating them was actually pulling them out of their black box of unknown value and giving them one. It's the unknown that freezes the market I thought, but again, I don't know anything.

 

[Balt]

Originally posted by: ironwing

Originally posted by: Balt

So if the prices in the housing market were over-inflated and were basically just being corrected by the recent crash did we just flush money down the toilet hoping to artificially re-inflate them again?

IMHO, no. I think we are done with housing bubbles for a decade or two. The bailout is supposed to reduce the banks' leverage so they can lend again. By taking the worst crap off the banks' hands, the government is trying to free up the banks so they can get back to being banks. The question is really one of scale. Does the value of all the loans made on top of the inflated value of the mortgage backed securities so greatly exceed the value of the junk mortgages themselves that the system collapses even if those securities are replaced with good money (at lower valuations)? Beats me.

I see.. I think.

 

[Vic]

Originally posted by: daniel49
Basic how we got here from 1999 NYT article.

Text

All those loans had PMI (paid by the borrower) if their LTVs exceeded 80%. If you think Fannie's Expanded Approvals and Timely Payment Rewards programs are 'how we got here,' then you don't know jack shit about the mortgage industry. Period.
I hate to be rude, but posting that old article with the comment "Basic how we got here" is about the stupidest spin I've seen on this issue yet. That's not how we got here. Those programs provided a in-between approval between prime and subprime. Before they came out, it used to be a joke that lenders really only had 2 programs, 7% fixed and 10% adjustable. Expanded approval programs allowed those who came just short of the 7% fixed to possibly get approved for an 8% or 9% fixed instead of the 10% ARM.
They were still never true subprime loans though. They didn't have prepayment penalties, stated income, jumbo loan amounts, negative amortization, or allow for any major credit derogs that Fannie wouldn't allow on their prime programs.

To the OP: all 1st mortgages with LTVs>80% had mortgage insurance in some form or another. The difference with true subprime mortgages is that the MI would be factored into the interest rate for each individual loan, as opposed to presented as a separate cost to the borrower. This allowed the lender to buy the MI in bulk on its own, and avoid the additional compliance.
Maybe I have an old rate sheet lying around somewhere, but unlike Fannie/Freddie and governments, interest rates for subprime mortgages were always both FICO and LTV dependent. Typically, the lender would present the rate matrix with FICO ranges running down the left and LTVs across the top, with the lowest rate for best score/lowest LTV in the top left and the highest rates for worst score/highest LTV in the bottom right. These rate differences would be profound too. Let's just say the highest rates for the least poorly qualified borrowers were usually close to the most the law would allow.

An additional note: even 80/20s from Fannie/Fannie had additional costs on their 1st mtgs, usually 1.5% hit to fee, and even in the heyday required full documentation and eligible credit.

edit:

Originally posted by: ironwing
In the bigger picture, I think PMI is basically a shell game anyway, designed to make advertised interest rates look lower. The interest rate is supposed to reflect the risk inherent in the loan. Splitting the risk premium into interest plus PMI is just marketing as far as I can see.

You are correct. Charging MI separately allows for the appearance of a lower interest rate than what is the actual cost of the financing. This is why the Truth in Lending requires that MI be disclosed inside the APR, and why subprime loans usually didn't bother with separating it out (because such borrowers were not as 'rate-sensitive' as prime borrowers).

 

[ericlp]

Interesting question but with 10% and rising walking away from their investments last month alone. Think about what % PMI can really cover? PMI would be lucky to cover 10% of a bad loans.

And I am sure PMI was managed very poorly. So, your probably only looking at 5% if your lucky that it could cover. Tho, I really wonder where the PMI money went to? I mean... Who's pocket?

 

[IronWing]

Originally posted by: ericlp
Interesting question but with 10% and rising walking away from their investments last month alone. Think about what % PMI can really cover? PMI would be lucky to cover 10% of a bad loans.

And I am sure PMI was managed very poorly. So, your probably only looking at 5% if your lucky that it could cover. Tho, I really wonder where the PMI money went to? I mean... Who's pocket?

In the case of my original mortgage part of the PMI went back to the lender in the form of kickbacks. One day a settlement check just showed up in the mail. Those scuzzy class action lawyers do serve a function in society.

 

[Jaskalas]

Originally posted by: ironwing

Originally posted by: daniel49
Wonder how much glue 700 billion buys nowdays?

That is the 700 billion dollar question. Might work, might just disappear into the rat hole.

700? Learn to count. More like 2,000.