One early reform that missed the mark was the Home Valuation Code of Conduct, or HVCC, which sought, in part, to stop
appraisers from colluding with homebuilders and their affiliated
mortgage banks. Such fraudulent appraisals were used in some
cases to close sales of subdivision homes at inflated prices during the final stage of the real estate bubble. Although addressing
a legitimate problem, HVCC had several negative side effects,
including increasing costs, decreasing portability and lowering
quality, because appraisals are awarded to low bidders.
Many reforms were directed at restricting or eliminating mortgage programs or options that were demonized as causing
the crisis. These included subprime loans, negative amortization
mortgages, low- and no-doc loans, and interest-only products.
None of these are inherently dangerous. They only created
problems when given to inappropriate borrowers.
With broad-brush reform essentially eliminating these so-called “dangerous” loans, millions of qualified borrowers were
shut out of the mortgage market, and millions of existing borrowers were deprived of the ability to refinance and take
advantage of lower interest rates. In addition, cutting millions of
would-be borrowers out of the market during the recovery unnecessarily exacerbated the drop in real estate prices by reducing demand. More finely-tuned reforms could have retained the
programs and/or options for appropriate borrowers.
Questioning program reforms
Properly used, subprime loans perform a valuable function, allowing borrowers with atypical — and often temporary — problems
to obtain mortgages. Some borrowers have limited credit but
good jobs. Other may have late payments due to messy divorces.
These are the types of borrowers that subprime loans can help.
Unfortunately, far too often, originators put borrowers into subprime loans that were inappropriate, which led to the horror
stories. Reform effectively eliminated subprime loans even for
appropriate borrowers. Some subprime financing, however, is
starting to be offered again.
Negative amortization loans, or neg ams, were another favorite
target of reformers. As with subprime, the problem was not the
government guarantee and promote the Home Equity Conversion Mortgage — the Federal Housing Administration’s
reverse mortgage program — that is a 100 percent neg
The criticism of low- and no-doc loans is similarly
misdirected. Those loans originally had very conservative guidelines. A borrower might need at
least 35 percent equity, for example. The default rate in those cases was predictably low.
Low- and no-doc loans only became a problem when the
exploding demand for loans to fill residential mortgage-backed
securities (RMBS) caused lenders to offer such programs at limits finally reaching 100 percent loan-to-value ratios. This misuse
begs the question: Why shouldn’t borrowers with a demonstrated history of financial competence be rewarded with
lessened-documentation requirements? There has been some
recent, limited re-emergence of low-doc loans, but pricing has
The loss of interest-only loan options was especially harmful
and, once again, misguided. Properly used, this option provided the most powerful financial-planning tool offered by
the mortgage industry. The problems with interest-only loans
occurred when borrowers and originators gave no consideration to any plan for payments other than the initial interest
payment. Naturally, after 10 to 15 years of only paying interest,
the full-amortization payments would be a huge jump for borrowers who had no viable plan.
As with low- and no-doc loans, some recent loans do offer an
interest-only option, but the pricing has been so poor that the
interest payments are higher than the principal and interest payments on comparable loans. Sadly, the loss of a viable interest-only option deprives borrowers approaching retirement with a
valuable planning tool.
By making predetermined principal payments during the
interest-only phase, aging borrowers could preselect a workable
retirement mortgage payment without the uncertainty of refinancing, because the fixed-rate interest-only loans would
automatically re-amortize at the end of the interest-only period
to give the desired retirement payment.
It was the misuse of these loan types and options that caused
many of the problems during the housing crisis. Having failed to
recognize that distinction, reformers not only eliminated abuses,
they also eliminated all the beneficial uses of those loans and
options. This has had a significant impact on borrowing capacity
and the real estate market. Reform has been the equivalent of
banning automobiles because some people drive drunk.
Providing an alternative
So what alternative approach to reform could have prevented
the crisis — without the attendant side effects? It has become
clear in the aftermath that most problem loans resulted from
originators who were unaware of the larger financial picture
and put borrowers into inappropriate loans out of ignorance or
a more culpable desire to reap the largest compensation.
This front-end problem could be stopped — or at least
substantially reduced — if two things were required of all loan
n Reasonable amounts of financial education and
n A fiduciary duty toward each borrower.
William P. Matz has been an attorney and broker for 30 years. His office is
in Windsor, California. His law practice focuses on real estate, finance and tax.
Having also run an active mortgage business since 1992, Matz has a unique
perspective on the mortgage crisis. Reach him at (707) 837-2161.
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