Maintained by John M.

On September 20, the US Senate held a very important hearing [1] titled "Calculated Risk: Assessing Non-Traditional Mortgage Products". Press coverage was pretty extensive considering it was just a hearing hosted by two obscure sub-Committees of the Senate Banking Committee. The main theme was new non-traditional, "toxic", mortgage products like interest-only or option-ARM loans. Witnesses were a half-dozen director-level loan regulators (all but one female, for what it’s worth) and five mortgage industry / consumer group representatives (all male). The Senators hammered away seeking assurance that the new loan products would not go out of control and harm consumers.

This page is not yet a finished product. The intention is to provide a resource with links to key news reports and resources, and a guide to the three hour long audio transcript. There is a tremendous amount of good stuff packed in the hearing site, and much of it may prove to be of enduring value. This is still a preliminary version of the project with construction cranes swinging around. Put on your hard-hats and come on in if you dare. Let me know if you find the idea useful. I’ll be updating this page in place from time to time and it will stay at this URI. I’ll post announcements as new phases of the "study guide" are completed.

You may want to skip around in this study guide and the resources at the ends of the numerous links. The hearing site contains the prepared testimony of all eleven witnesses, divided into two panels, and a three hour long audio recording of the actual testimony and Q&A sessions between the Senators and witnesses. Doom’s Phoenix readers might be interested to note that the State level regulators were ably represented by their own Felecia A. Rotellini from Governer Napolitan’s office.

One good place to start is Rex Nutting’s MarketWatch article [2] which came out on the same day as the hearing. I have included this and links to several other articles [3] [4] [5] [6] [7] in the "Notes and References" section toward the bottom of the page. For a really quick overview of the general gist of the hearing, scan the bolded passages in the quotes I placed there.

Here’s a summary of the first half, ninety minutes (00:00 - 1:28:20, all times approximate) of the hearing audio. This part covers prepared testimony and Q&A with Panel I (the regulators). I’m presently (late Sept ‘06) working backwards from the mid-point to fill-in-the-blanks. When I’ve completed that, I will continue on to the second half of the three hour tape, which has the testimony and Q&A with the industry and consumer group representatives.

  • 0:00:00-0:00:29 Senator statements
    • Item summary.
    • 0:00:00-0:13:00 Sen Wayne Allard (R-CO) Chairman Housing/Transport Sub-committee
      • Item summary.
      • 0:00:00 "Quotable quote"
    • 0:13:00-0:16:00 Sen Jack Reed (D-RI) Ranking Member Housing/Transport Sub-committee
      • Item summary.
      • 0:00:00 "Quotable quote"
    • 0:16:00-0:21:00 Sen Jim Bunning (R-KY) Chairman Economic Policy Sub-committee
      • Item summary.
      • 0:00:00 "Quotable quote"
    • 0:21:00-0:28:00 Sen Paul Sarbanes (D-MD) Ranking Member Banking Committee
      • Item summary.
      • 0:00:00 "Quotable quote"
    • 0:28:00-0:29:00 Sen Thomas Carper (D-DE) Member Housing/Transport Sub-committee
      • Item summary.
      • 0:00:00 "Quotable quote"
  • 0:00:29-1:03:00 Witness Statements (Regulators)
  • 1:03:00-1:28:20 Senator’s questions / witness’s answers. Senators asked when the new guidance would be forthcoming. Regulators insisted REAL SOON NOW but would not be pinned down to a deadline. They then focussed on safety issues and when the complex Truth-in-Lending Rule "Z" would be updated. The regulators insisted Rule Z would have to take a long time, but that at least they would have an updated consumer information package about ARM loans, a new CHARM booklet out soon. Sarbanes insisted strongly that mortgages must be for the purpose of homeownership and not just a collatoralized loan. Finally the Federal/States split in regulation was addressed, with Phoenix’s Routillini holding up the end for the State regulators.
    • 1:03:00 (Allard) When will you issue final guidance on mortgage products?
      • (Thompson) "very close"
      • (Dick) "weeks not months"
      • Witnesses resisted being pinned down, much to Allard’s annoyance.
    • 1:04:00 (Allard) Why just "guidance" and not direction?
      • Guidance is traditional in bank regulation. It "sets expectations".
    • 1:09:00 (Reed) To what extent are loans securitized so not held by originating financial institution?
      • A large proportion securitized. Increasing amount of private label securitization.
    • 1:12:30 (Reed) How to treat NegAm, Reduced Doc, etc. and risk layering?
      • 1:14:00 (Dick) Bank does no favour if loan evaporates home equity 5 years down the line.
    • 1:14:28 (Bunning) Race to bottom - have lenders used underwriting standards or are borrowers trapped?
      • No huge defaults yet, but few recasts yet
      • 1:17:?? (Dick) some underwriting standards eased recently
    • 1:17:40 (Bunning) What happens when the homeowner has to "ante up" to huge interest rate of original loan?
      • That’s why we issued the guidance, because ARMs are still a small proportion but growing.
      • (Albinson) trajectory is higher than other cohorts
    • 1:19:20 (Bunning) Fed says will update truth-in-lending Rule "Z", when will this happen?
      • No exact date (very time consuming). Consumer testing and focus groups ongoing. Lengthy process. A new CHARM booklet out before end of year.
      • 1:21:40 (Rotellini) States are very concerned defaults will increase. The train has left the station with respect to the types of loans on the books now.
    • 1:22:30 (Sarbanes) Each lender must assure that the borrower has the ability to repay the mortgage at the fully amortizing repayment schedule. This important for lender and borrower. If not this business is really collatoral based loans and the guidance already calls these unsafe and unsound. So do you guys concur the guidance will focus on borrower’s long term ability to repay mortgage?
      • 1:25:00 (Dick) yup (all others solemnly nod)
    • 1:26:30 (Sarbanes) Proposed guidance for Federal regulated only, lots of players, esp. sub-prime, not Fed regulated. Should states adopt similar rules to Federal?
      • CSBS is applauded, all regulators concur
      • (Braunstein) federal regulation has 70% coverage of the market
      • 1:27:55 (Routillini) States committed to professionalism, ethics, and a lending community under State regulation that considers the borrower’s repayments & abilities as well as the concerns about disclosure.

 

________________________

Notes and References

[1]: "Calculated Risk: Assessing Non-Traditional Mortgage Products", Hearing: Senate Banking Committee, September 20, 2006. The emphasis in all the quotes is mine.

[2]: "Exotic mortgages sow confusion, senators told: Regulators to issue stricter guidelines to lenders soon", by Rex Nutting, MarketWatch, September 20, 2006.

"Homeowners don’t fully understand the risks associated with taking on alternative mortgages that allow interest-only payments or that eat into the equity in a home, federal officials told senators Wednesday.

At a hearing on so-called exotic mortgages before the Senate Banking Committee, U.S. banking regulators promised that long-awaited guidance to lenders on "exotic" mortgages would be released in final form in a few weeks.
…
‘These nontraditional mortgage products may make a "soft" landing more unlikely,’ said Felecia Rotellini, superintendent of financial institutions for Arizona."

 

[3]: "Nontraditional Mortgages Pose New Risks:Regulators", by Damian Paletta, Dow Jones, September 20, 2006.

"Federal bank regulators on Wednesday acknowledged the risks posed by the recent explosion of exotic mortgage products and told a Senate panel they are monitoring the impact these loans could have on borrowers and lenders as interest rates increase. Exotic mortgages, such as interest-only loans and payment-option credits, became very popular with lenders and borrowers during the recent real estate boom, in part fed by historically low borrowing rates. To compete, many lenders lowered their underwriting standards, making the loans available to more borrowers. "

[4]: "GAO: mortgage risks need more explanation to consumers", Associated Press, September 20, 2006.

"Exotic home loans were once mostly the domain of the wealthy, especially interest-only mortgages and option adjustable-rate mortgages. But they’ve exploded in popularity in recent years, in some cases accounting for nearly a-third of new mortgages, concentrated along the East and West Coasts. It happened as consumers stretched to buy high-priced homes during the housing boom."

 

[5]: "Federal regulators urged to do better job of explaining risks to mortgage holders", by Jeannine Aversa, Canadian Press, September 20, 2006.

"Interest-only mortgages require that the homeowner initially pay only the interest on the loan for a set period. Option ARMs give the homeowner flexibility to decide how much to pay each month. One of the options is a minimum payment that covers only a portion of the monthly interest.

These mortgages are appealing to people who need cash for other expenses. But it also exposes them to far greater risk - if housing prices drop, their loan could be worth more than their property. If interest rates rise, their loan will become expensive to pay off.

The GAO said that from 2003 to 2005, non-traditional mortgages comprising mostly interest-only and payment-option ARMs grew from less than 10 per cent of all residential mortgage originations to about 30 per cent. They were highly concentrated on the East and West coasts, especially California, the GAO said."

 

[6]: "Regulators hit backloaded mortgages", by Patrice Hill, Washington Times, September 21, 2006.

"Sandra Thompson, a director at the Federal Deposit Insurance Corp., testified yesterday that some borrowers were not qualified to make escalating payments required under the loans, and the banks loosened their standards considerably to enable buyers to qualify, including ‘layering on’ risks such as requiring no down payment or proof of income."

 

[7]: "Rise in nontraditional mortgages is worrying U.S. lawmakers", by Alison Vekshin, Bloomberg, September 21, 2006.

"Poor underwriting standards and unclear information about the loan terms could undermine a borrower’s ability to repay the loan, lawmakers said at a Senate Banking subcommittee hearing yesterday in Washington. Senators underscored the need for new federal consumer protections.

The loans ‘are destroying the lives of a whole lot of people,’ said Sen. Charles Schumer (D., N.Y.). ‘They are sold to people who are least experienced and most vulnerable.’"

 

[13]: Testimony, FELECIA A. ROTELLINI, ARIZONA SUPERINTENDENT OF FINANCIAL INSTITUTIONS On behalf of the CONFERENCE OF STATE BANK SUPERVISORS, September 20, 2006.

"… CSBS and AARMR have discussed how our two organizations could best combine the immediacy of local supervision and enforcement with a system that would provide nationwide information sharing and other resources, while at the same time modernizing the state systems.

The result of this discussion was a residential mortgage licensing initiative to create uniform, national mortgage broker and lender licensing applications and a centralized database to house this information. The uniform application and database will significantly streamline processing of licenses at the state level. …"