FRB: Federal Reserve Bank of San Francisco - June 16, 2006 - Transcript

Building Sustainable Homeownership:
Responsible Lending and Informed Consumer Choice

Federal Reserve Bank of San Francisco
101 Market Street, San Francisco, California 94105
June 16, 2006

Agenda | Transcript

Pages 1-25 | 26-50 | 51-75 | 76-100 | 101-125 | 126-150 | 151-175 | 176-200 | 201-225 | 226-250 | 251-254

Transcript	Line	Page
We think that's a big problem, that the initial	1	51
interest rate and the prepayment penalty must be tied	2	51
together, especially given the fact that people do not	3	51
understand these new -- these newer nontraditional loans that	4	51
are being pushed.	5	51
And three years it's expected that they're going to	6	51
roll over. WE see these new 50-year products. And it all	7	51
kind of predicated on the idea that everyone knows people are	8	51
in trouble and they're going to have to refinance. And how	9	51
many of those folks are going to have prepayment penalties?	10	51
And in our study nobody understood that their prepayment	11	51
penalty extended beyond the initial interest rate of the	12	51
loan. And that's why we think yield spread premiums,	13	51
prepayment penalties need to be included.	14	51
And the point about counseling -- so I had six	15	51
recommendations. I got through five. I thought we had six	16	51
minutes to present. But six is we need to support home loan	17	51
counselors, who, as you said in your opening remarks,	18	51
Governor, are part of this -- are part of the dynamic and are	19	51
part of the solution and really can help people understand,	20	51
especially --	21	51
I mean, we support the idea of more disclosure, more	22	51
information, but we also think we need to have regulation.	23	51
And if there's some way we could tie counseling to HOEPA and	24	51
to these problematic questionable nontraditional products, we	25	51
think that would go a long way towards people understanding	1	52
and less abuse occurring.	2	52
MR. LEONARD: I'm going to just make -- one more	3	52
point about prepayment penalties. My organization has done a	4	52
substantial amount of research on prepayment penalties, one	5	52
of which we used proprietary database to look at and see	6	52
that, in fact, when you look out across a huge scale of	7	52
subprime loans, there is not the interest rate disparity that	8	52
you would expect to see.	9	52
I mean, again, the argument is you're getting an	10	52
interest rate benefit from having a prepayment penalty. And	11	52
when we did a carefully controlled regression analysis to	12	52
look at that question, we did not see -- find the results	13	52
that you would expect to see, which is that there would be a	14	52
substantial lower interest rates for folks who had -- who had	15	52
taken out prepayment penalties on their loans.	16	52
That and the fact that we've also looked at the	17	52
differing effects of state laws and found that state laws,	18	52
strong state laws, have worked very effectively to eliminate	19	52
the penalties that -- eliminate the kinds of predatory	20	52
products that we're concerned about and which they were	21	52
intended to do, without having any deleterious effect in	22	52
terms of the availability of credit or in terms of rate -- of	23	52
substantial rate impacts.	24	52
And that includes a number of states that have	25	52
substantially scaled back and limited the availability of	1	53
prepayment penalties on subprime loans.	2	53
MR. LIEBER: One point. I'd be very curious to see	3	53
the analysis, Paul. And hopefully you can share it.	4	53
MR. LEONARD: Absolutely.	5	53
MR. LIEBER: My guess is that you'll find an	6	53
analysis and certainly what we've seen is prepayment	7	53
penalties aren't impacting interest rate as much as they are	8	53
impacting the cost of closing the loan, so that you get the	9	53
prepayment penalty that says I will get the lender, whether	10	53
it's us directly or World directly or a securities investor,	11	53
we'll get that interest rate for three years, or expect to.	12	53
Then, in exchange, the borrower doesn't have to then pay many	13	53
of the costs up front that can be several thousand dollars	14	53
for the loan. So I would say the trade-off is most likely	15	53
going to show up in cost to close the loan rather than the	16	53
direct interest rate.	17	53
MR. CHANIN: Following Kevin, I want to talk a	18	53
little bit about disclosures. My sense is you'd go through	19	53
Dante's inferno and you'd have one disclosure, abandon hope	20	53
all ye who enter here. Or my wife works for a spy museum and	21	53
has a hat that says "trust no one." Either of those would	22	53
work.	23	53
But I guess my question is -- and you can break it	24	53
up for purchase money or refinancings if it makes sense. But	25	53
we're going to begin reviewing the truth in lending	1	54
Regulation Z disclosures presumably next year and really step	2	54
back and take a look at all the disclosures, the ARMs	3	54
brochure, et cetera. Is there simply -- are these products	4	54
too complex to describe them to consumers?	5	54
I mean, they're out there and consumers are making	6	54
choices, for better or worse, on these. And an integral part	7	54
of this is consumers, you know, decide one way or the other	8	54
what to get. I mean, is there no real role for disclosures	9	54
or --	10	54
MR. STEIN: I think there's certainly a role for	11	54
disclosures. And to the extent they can be simplified as it	12	54
sounds like the panelists are trying to do, that's important.	13	54
At the same time I think we have to appreciate the	14	54
limitations of disclosure.	15	54
And the Governor noted -- and I believe that there's	16	54
virtually nobody that completely understands their home loan	17	54
documents and the home loan process. And what determines how	18	54
much trouble you get into is really more a function of who is	19	54
on the other side of the closing table from you.	20	54
And for most folks it doesn't -- it's not a problem	21	54
that they don't understand everything or they haven't read	22	54
the disclosures, which many people don't, because they're	23	54
dealing with a reputable lender.	24	54
But unfortunately, we think in California and other	25	54
places, if you live in the certain neighborhoods, you're more	1	55
likely to be dealt with someone who is not reputable where	2	55
you're going to suffer for not knowing.	3	55
And it's frustrating for people then to use	4	55
disclosure and consumer education as kind of a sword to say,	5	55
you know, it's your fault because you didn't do what nobody	6	55
does, fully appreciate what your loans are.	7	55
So having said that -- still some people read the	8	55
disclosures. Everyone should read them. To simplify them is	9	55
important. I certainly wouldn't urge the reduction in	10	55
disclosure.	11	55
And to follow up on an earlier point, in California,	12	55
and perhaps in other places, English is not the language	13	55
spoken by everyone. It's not the main language. And	14	55
certainly when the contract is negotiated in another	15	55
language, we think it's very important that disclosures like	16	55
TILA, like the promissory note, like the HUD1 and the GFB, it	17	55
be required that those be required in the language of the	18	55
negotiation.	19	55
And then again, I think it kind of circles back to	20	55
counseling as being the last stop gap measure to make sure	21	55
people understand what they're getting, especially if these	22	55
are kind of questionable, problematic loans.	23	55
MR. LEONARD: I have to admit I'm not the disclosure	24	55
expert in our organization. I will also say I was struck by	25	55
the Ameriquest settlement with the 49 attorneys general. And	1	56
in reading that settlement, I was struck at the need for the	2	56
attorneys general to have to specify in a settlement at this	3	56
level plain language recitation, literally scripted	4	56
recitations between representatives of the company and the	5	56
borrowers about what the terms of the loan were, whether or	6	56
not there was a prepayment.	7	56
I mean, it was quite striking to me that what I	8	56
would consider to be an absolute bare-bones necessity is	9	56
something that had to be included and specified in an	10	56
attorneys general settlement with at the time the largest	11	56
subprime lender in the country.	12	56
MS. BRAUNSTEIN: To follow up for a second on the	13	56
issue of housing counseling, we talked about this a little	14	56
bit in the Chicago hearing with people, but I'd like to hear	15	56
your -- all your views on this.	16	56
You know, it's -- that's been a burning issue for a	17	56
number of years. And even going back six years ago when we	18	56
first did -- when we did the last set of HOEPA hearings it	19	56
came up. And from time to time people would raise to us that	20	56
they thought one of the things that we should have required	21	56
for HOEPA loans and when we changed our regulations was the	22	56
requirement that people have housing counseling before	23	56
entering one of these products.	24	56
And I'd just like to get some of your views on this.	25	56
I hear, you know, about strengthening the housing counseling	1	57
market, and I don't disagree with that. I think, you know,	2	57
it's kind of like Mom and apple pie; it would be hard to	3	57
disagree with that.	4	57
But one of the concerns we always have about this is	5	57
that, you know, there are some bad actors out there. And how	6	57
would you handle things like quality control? If you've got	7	57
a bad actor out there that's making a loan to a vulnerable	8	57
consumer, they could, you know, have business cards printed	9	57
up saying they were also a housing counselor and that met	10	57
that requirement. Or maybe that's a little stretch but they	11	57
have a friend, you know, here, let me refer you to somebody	12	57
who had business cards printed up that said a housing	13	57
counselor on it and they met that, you know, criteria.	14	57
Plus, as we know, those of us who have been in this	15	57
industry a long time, there's housing counseling and there's	16	57
housing counseling. There's the, you know, 45-minute phone	17	57
conversation with somebody that some people call counseling	18	57
and then there's very rigorous counseling where people go for	19	57
months. Literally sometimes it could be 18 months, even to	20	57
straighten out credit reports, you know, learn how to budget,	21	57
actually start saving money towards down payment, learning	22	57
how to deal with after purchase issues, post-purchase issues.	23	57
So where do you -- you know, how do you sort all	24	57
this out to make it meaningful and helpful to consumers?	25	57
MR. STEIN: I mean, I think all those issues are	1	58
important. The issue of capacity, I mean, are there enough	2	58
of the counselors who are qualified? Issues about integrity.	3	58
Are they affiliated with lenders who might be bad actors or	4	58
getting financing from lenders who might be bad actors?	5	58
But at the same time -- I mean, we do have a good, I	6	58
think, example in the HUD certification process. So there	7	58
you have an independent -- you know, you have HUD, government	8	58
agency that will certify certain counseling agencies, and	9	58
that maybe could be a model. And I just lost my train of	10	58
thought, so maybe I'll leave it there. But certainly there	11	58
are challenges, but it -- what we have now is a big problem.	12	58
And so in terms of how long the counseling would	13	58
need to be, I mean, that's maybe a question for others to	14	58
think more about. But what we're -- I think what we're	15	58
focusing on today is how do we ensure that borrowers	16	58
understand their loan terms so that they're getting loans	17	58
that they know are in their interest. And that might require	18	58
a certain amount of counseling.	19	58
We also don't want the counseling to extend so long	20	58
that it frustrates the loan transaction. We appreciate that	21	58
that's a time-sensitive matter for the lenders and for the	22	58
consumers. But there has to be a better way than what we	23	58
have now, and we think that that ties into and depends upon	24	58
somehow building the capacity of counseling through funding.	25	58
And we would support the idea of requiring it for HOEPA and	1	59
these nontraditional loan products as well.	2	59
MR. LEONARD: I think there are some precedents of	3	59
mandatory counseling. There is a precedent for -- in the	4	59
reverse mortgage program, which you'll hear more about this	5	59
afternoon.	6	59
Again, I think it's explicitly established because	7	59
it was relatively new product, being introduced at a much	8	59
broader scale, very complex. And in that case there was a	9	59
specific requirement at the federal level that all folks who	10	59
would go through that process in an FHA insured, in a HECM	11	59
reverse mortgage would receive a mandatory counseling.	12	59
I mean, I think the other thing to think about	13	59
beyond that -- I mean, beyond the idea of building on the	14	59
HUD-certified system of housing counseling, I mean, in --	15	59
what I think about is some sort of a third-party independent	16	59
review mechanism that isn't necessarily even the extensive	17	59
kind of counseling, you know, educational function but rather	18	59
some -- a third party to which a borrower could easily and	19	59
quickly go, have their documents reviewed and say, "Does this	20	59
loan make sense for me? Are there some features that I --	21	59
that are problematic? Are there some changes that I should	22	59
be seeking based on a current knowledge of the marketplace?"	23	59
And that's a -- it's a different model. I do not	24	59
claim to have any idea about how to build the capacity to do	25	59
it. But I think I would echo what Kevin said, is that this	1	60
is really a large problem and we shouldn't be put off from	2	60
the idea of attempting to address it simply because we don't	3	60
have the existing capacity to do it today.	4	60
MR. LIEBER: Like I said, we fully support the	5	60
consumers understand the loans products they're getting into,	6	60
whether that be through forced counseling, which I personally	7	60
don't think makes sense, or just ongoing access to	8	60
information.	9	60
And I think much of what has changed in not just the	10	60
lending business but the entire commerce in the last several	11	60
years with the Internet is that access to information has	12	60
expanded tremendously. And I think much of the technology	13	60
that is available -- and I mentioned ours but we're not alone	14	60
in it -- will allow borrowers to say -- to computer model,	15	60
"Here's who I am. Pull my credit score. Tell me what loan	16	60
type is available to me and what price I should pay." I	17	60
think that access to information is the key.	18	60
And I personally would be very skeptical of any	19	60
forced counseling. And then how do you confirm that the	20	60
counseling itself is appropriate? And who is going to decide	21	60
what is appropriate for a borrower? Because I personally	22	60
would not want to decide who should or should not be able to	23	60
have a certain loan type. I don't know how I would make that	24	60
decision on some of the tougher cases.	25	60
MR. LEONARD: One other thing I would point out --	1	61
and I think it's actually also really important in the	2	61
subprime part of the marketplace -- is that shopping and	3	61
transparency are not nearly as available as it is in the	4	61
prime sector of the marketplace. I had to look long and hard	5	61
to find this rate sheet on their web site. Largely a web	6	61
site advertised as being for brokers only.	7	61
You know, but if I'm a prime borrower, you and I can	8	61
go to Mortgage.Com and pull up 50 different quotes based on	9	61
the specific -- our specific circumstances. If you're a	10	61
subprime borrower, the ability to do that shopping is not	11	61
nearly as transparent.	12	61
MR. OLSON: Would those of you who would care to	13	61
comment on differences you see if the mortgage -- the end	14	61
product is a purchase mortgage product as opposed to a refi,	15	61
if that makes a difference in terms of the abuses that you	16	61
see or the -- or the counseling needs or whatever? Are the	17	61
fundamental issues that we're discussing, are they different	18	61
for a refi product as opposed to a purchase product?	19	61
MR. STEIN: Well, I don't know that there is. And I	20	61
guess all I'd say on this is that we are seeing more problems	21	61
in the home purchase market than we did before. And I know	22	61
in a way it kind of calls into question -- and so HOEPA is	23	61
what we have for anti-predatory lending regulation, which is	24	61
focused on refinance, probably for good reason.	25	61
But I think we're seeing things shift so that we do	1	62
see more of these products being sold, nontraditional and	2	62
subprime, and more problems reported from borrowers in the	3	62
home purchase side.	4	62
So I don't know about the differentiation, but I'm	5	62
glad that you raised the question and I think we need to look	6	62
to both.	7	62
MR. LEONARD: I would just say that in -- I'm	8	62
familiar with data from 2004, purchase data from 2004, in the	9	62
state of California and nationally, and what we know is that	10	62
in the subprime marketplace, huge proportions of folks are	11	62
using interest only, especially here in California where you	12	62
have unbelievably high housing costs. Huge proportions are	13	62
using interest only and option ARMs.	14	62
And so it seems to me that to the extent that you	15	62
have folks who are stretching to get into homeownership, some	16	62
appropriately, some not I suspect, using these alternative	17	62
kinds of products, I suspect you're going to have increasing	18	62
concerns about protecting folks in the purchase market in	19	62
addition to the historical ones that have clearly been a	20	62
problem in the refi market.	21	62
MR. CHANIN: So can we follow up on the purchase	22	62
money issue? Then there may be, depending on what you view	23	62
as the problem, different solutions. I mean, one is these	24	62
people should not be purchasing homes. Or a second solution,	25	62
if you will, depending on the problem, is that these	1	63
individuals got the wrong product, that is, their credit	2	63
score was such that they shouldn't have gotten this product.	3	63
Or perhaps that they could have gotten a product more	4	63
suitable for them.	5	63
So what exactly is the problem? Are people being	6	63
stretched or is it all of those? And if you could address	7	63
those issues.	8	63
MR. FULLER: So, you know, I'll start. I think one	9	63
thing you also have to realize on the purchase market is I'm	10	63
not sure it's the product. I think another thing we hear at	11	63
least is you have a high incidence of very high LTVs, which	12	63
aren't option ARMs. You know, it's people getting 100	13	63
percent financing. So there's kind of a whole different	14	63
dynamic there that you factor into.	15	63
Now, what the solution of that is I don't know.	16	63
We're not in that market certainly, so we don't have any	17	63
great solutions. But I think it's -- the issue around	18	63
purchase may not just be, you know, what product to use or	19	63
something. It's -- there's a lot of 100 percent financing	20	63
and other things maybe you're getting people into loans that	21	63
maybe they're not comfortable with.	22	63
MR. OLSON: Jack may know more about what I'm about	23	63
to talk about than I do or somebody else here from the San	24	63
Francisco Fed maybe.	25	63
Ten years ago or so, I was involved in a -- in	1	64
looking at a circumstance in Hawaii, in Oahu, where we were	2	64
looking at the mortgage loan business. And Hawaii at that	3	64
time, Honolulu basically, had some of the highest property	4	64
values in the country, and certainly if you consider the	5	64
ratio of property values to income, disposable income. But	6	64
people still bought homes, and at a fairly high rate.	7	64
But what happened is that the lenders had to rethink	8	64
the front end and back end ratios that were used in approving	9	64
those loan products but those loans continued to perform.	10	64
Now, the only thing you can -- one of the things	11	64
that you can clearly deduce from that is that people made	12	64
lifestyle choices, to become house poor in that market	13	64
because the house was important to them and discretionary	14	64
purchases were not made in order to be in the house.	15	64
That could be happening in California as well, that	16	64
there is some stretching to get into a house for that reason,	17	64
but there will be -- that there will be an adjustment in	18	64
lifestyle so that more discretionary income will go to that	19	64
house.	20	64
And I'm wondering -- what I'd be interested to know	21	64
is -- my point is that if the ratios are different from what	22	64
they may have been historically or that values are higher	23	64
than historically that that may not necessarily translate	24	64
into problem credits and, therefore, borrowers in difficulty.	25	64
And as we look at -- this is now -- I don't think	1	65
I've looked at first quarter '06 figures yet but I have	2	65
through fourth quarter of '05. And in the banking industry,	3	65
we have not seen an increase in delinquencies in the	4	65
residential mortgage portfolio. As a matter of fact, it's	5	65
been extraordinarily strong with the exception of some	6	65
pockets in the subprime market.	7	65
There clearly are some prime -- and we're looking at	8	65
those carefully because there's -- we are starting to see	9	65
that there may be some evidence of predatory lending in some	10	65
isolated markets. Well, we know it's there but it's	11	65
reflecting now in delinquencies.	12	65
But I wonder if you could take into consideration	13	65
what some of those fundamental lifestyle choices -- how that	14	65
might affect -- and the incidence of homeownership and the	15	65
value that homeownership has been given and how that might	16	65
affect some of the other judgments that have been made thus	17	65
far.	18	65
MR. LEONARD: Clearly the underwriting standards and	19	65
the debt-to-income ratios that are reasonably and normally	20	65
used are -- have gone up considerably. My sense is	21	65
particularly in a place like California where prices have	22	65
been -- are high and appreciating, there hasn't been -- there	23	65
hasn't been any -- we haven't seen -- clearly people have	24	65
stretched. Clearly a lot of people have benefited. We	25	65
haven't seen what happens through a full cycle yet.	1	66
And I think that, you know, as I made reference to	2	66
pretty clearly in my opening remarks, the issue of payment	3	66
shock, looming payment shocks, particularly at the -- deep in	4	66
the subprime market and for lower income households who don't	5	66
have many choices, you know, I think the story isn't over	6	66
yet, and I don't think we really know whether or not it was a	7	66
responsible stretching and lifestyle changes or whether the	8	66
payment shocks are going to force folks into mortgage	9	66
payments that are going to exceed the commonly used income --	10	66
debt-to-income ratios and other ratios and have some	11	66
significant negative consequences yet.	12	66
Again, interest rates were at all-time low in 2004.	13	66
Vast proportion of subprime loans were moving to the -- 70	14	66
percent of the loans initiated in the subprime market in 2004	15	66
were the standard 2/28 mortgages. We've seen a huge amount	16	66
of refinancing in those mortgages before they reach their	17	66
two-year time frame. So there's something else going on	18	66
there as well.	19	66
But within the next few years, and especially as	20	66
housing prices slow down, I think we'll see whether or not --	21	66
you know, there's innovation and there's individual --	22	66
individuals have made prudent decisions about getting into	23	66
and building wealth in their housing investments or whether	24	66
or not, you know, ultimately a lot of folks are going to be	25	66
put out of their houses and ultimately worse off.	1	67
MR. FULLER: So from World's standpoint, certainly	2	67
we can't comment on the subprime market. Weren't not in	3	67
that, so we wouldn't know. From our standpoint, underwriting	4	67
standpoint, we're so conservative we stay pretty much where	5	67
we're at forever and don't see that in the loans we get.	6	67
I think Paul does bring up an interesting point that	7	67
one of the points is what rate are people underwriting people	8	67
at? And certainly for us, and I'm pretty sure most	9	67
reputable, heavily-regulated companies that are doing option	10	67
ARMs, we're underwriting them at the fully indexed rate, not	11	67
at the discounted payment.	12	67
So that lends credence to the fact that, hey, they	13	67
can be okay. If there's other people that aren't doing that,	14	67
that's certainly a big issue, a very big issue for the	15	67
borrowers and the market in general.	16	67
MR. STEIN: I just -- I'm sorry, Jack. I was just	17	67
going to quickly say the issues around choices that people	18	67
make, I think those are issues that are discussed every day	19	67
by housing counseling organization that are working with	20	67
people to help them sort out whether they are ready for	21	67
homeownership or not. And certainly given our housing	22	67
prices, people do have to make certain sacrifices.	23	67
We also have larger problems as a society with	24	67
increased burden, financial burden, on households because of	25	67
health care costs and other matters, and people are looking,	1	68
for those who have homes, looking to their equity as a way to	2	68
kind of get themselves out of trouble, and that's a troubling	3	68
trend.	4	68
We have -- my understanding is that foreclosures are	5	68
going up and defaults are going up. In fact, there was a	6	68
study done by a public policy student spent some time working	7	68
with the Fed and she looked at few counties within California	8	68
and found some correlation between subprime higher priced	9	68
loans and notices of default and noted they're going up even	10	68
though in California we've been relatively -- we've been	11	68
relatively low in foreclosures given our high housing costs	12	68
and we're concerned that that's changing, in large part	13	68
because given the decreasing mortgage volumes, we think and I	14	68
think other industry folks believe, too, that the result is	15	68
relaxed standards.	16	68
So World may be having -- staying with their	17	68
conservative standards, and we'll see if they maintain them	18	68
if they're purchased by Wachovia, but what we're seeing is	19	68
that people are looking for the money. I mean, that's what	20	68
the problem is. It always comes back to what are the	21	68
incentives?	22	68
Brokers want to make money, lenders want to make	23	68
money. And if there are fewer loans to be made, people are	24	68
going to relax their standards. So we're going to see	25	68
problems because of loans that have been made with the	1	69
nontraditional products and subprime loans to people that	2	69
didn't deserve them or can't afford them, but we're going to	3	69
see I think even worse loans continue to be made because of	4	69
the pressure on brokers and lenders to do deals that maybe	5	69
shouldn't be done.	6	69
MR. LIEBER: Well, I think it's very clear that the	7	69
housing market has been very strong over the last several	8	69
years and mortgage defaults have been very low, very clearly	9	69
as a result of that.	10	69
I think, Governor, you make a key point, though,	11	69
that the ability for people to -- the ability and the	12	69
willingness for people to put more and more of their income	13	69
into homes is evident in places like Hawaii and has been	14	69
evident in places -- high-cost areas, California, New York,	15	69
east coast and west coast, for several years.	16	69
But I do think that with what looks like maybe an	17	69
ongoing trend of house price appreciation slowing, we'll	18	69
definitely see a higher default rate. And logic would tell	19	69
you that borrowers who are subprime, who have historically	20	69
not had a perfect record of making payments, will have higher	21	69
default rates. That's one of the key reasons the interest	22	69
rates are higher, is to cover the expected higher costs of	23	69
default.	24	69
MR. OLSON: We see -- I'm sorry, Jack. Go ahead. I	25	69
apologize.	1	70
MR. RICHARDS: No problem. Thank you. I hope it's	2	70
a worthwhile question now.	3	70
MR. OLSON: I have every confidence that it will be.	4	70
MR. RICHARDS: Well, I'm switching gears a little,	5	70
so if you would prefer --	6	70
MR. OLSON: Please.	7	70
MR. RICHARDS: I read a number of news stories	8	70
lately about people who probably should be under a full doc	9	70
loan who are actually not forced to disclose income and,	10	70
therefore, get in these situations where they can't afford	11	70
the mortgage. I just wonder how are those decisions made, in	12	70
your view, about whether a loan should be fully documented or	13	70
not and do you feel that there are abuses?	14	70
MR. LIEBER: As a major lender who does significant	15	70
amount of reduced documentation lending, I think there are a	16	70
couple keys points I would make. One, that much of the	17	70
stated income business is there because there are a lot of	18	70
borrowers who do have difficulty documenting their income.	19	70
They either could have very complicated tax returns, they can	20	70
be commission-based. Frankly, some may be cash-based. And	21	70
the stated income does actually expand homeownership in a	22	70
very legitimate manner.	23	70
Stated income lending is not new. It has existed	24	70
through different cycles and it is proven that the slight	25	70
premium, generally speaking -- and ours is relatively modest	1	71
but a premium -- in interest rate covers the slightly higher	2	71
default rate that's expected.	3	71
I think there's another very key component that's	4	71
occurred in the last several years with reduced doc lending.	5	71
And it's not unique just to IndyMac but even with the GSEs,	6	71
Fannie Mae and Freddie Mac. They have effectively created	7	71
what I would call a documentation waiver program where if you	8	71
run a loan through their automated engines, they say, "This	9	71
borrower is strong enough based on their credit score. I	10	71
have enough confidence in the value of this home and the	11	71
loan-to-value is moderate enough that I don't need to see	12	71
additional data. I know that this is a sophisticated	13	71
borrower who knows how to make lending decisions on their	14	71
own, or borrowing decisions on their own, and we don't,	15	71
therefore, need that additional information."	16	71
If you look at the pricing structures of ourselves	17	71
and many of our other lenders, at certain loan-to-value	18	71
ratios, the odds of default are so low that that additional	19	71
information doesn't bring anything to the table and,	20	71
therefore, doesn't change the pricing.	21	71
So in our case, the smart borrower, the smart broker	22	71
or banker will say, "You've got a 60 percent loan-to-value.	23	71
You can provide your pay stubs, you can provide your tax	24	71
returns, you can provide all your bank statements, but it's	25	71
not going to generate a different loan rate for you because	1	72
your odds of default are so small that we don't need them."	2	72
MR. STEIN: You know, I believe that the level of	3	72
documentation is determined in large part by -- that decision	4	72
is made by the loan seller and not the consumer, that we're	5	72
concerned about both sides of the equation.	6	72
Certainly and more importantly, I think, consumers	7	72
who are being sold these stated income loans and their income	8	72
is inflated by the broker -- and I'll reference my friend	9	72
James Sirocca who is here and hopefully will testify later	10	72
who referred to them as non-stated income loans because the	11	72
consumers often don't state the income. It's the broker or	12	72
the lender that will fill in the amount.	13	72
And I think that, in part, those are being pushed	14	72
because they might be quicker and there's -- there are	15	72
greater costs associated with them. Maybe not in every	16	72
instance but there are greater costs to the consumer.	17	72
On the other side, I'll reference someone else who	18	72
is here, a broker who also may speak at 3:00, who talked --	19	72
spoke with me yesterday who noted that some consumers -- and	20	72
this is I'm hoping something that the Fed and the regulators	21	72
might look at. It may be the case that brokers are seeing an	22	72
inventive to write CRA loans to actually reduce income in a	23	72
stated income loan context so that there are lower -- the	24	72
borrower is seen as a lower income borrower and, therefore,	25	72
the loan might qualify for CRA credit, which I -- which is	1	73
incredible. So we think stated income is a big problem.	2	73
MR. LEONARD: Just quickly, I think that stated	3	73
income loans can clearly serve a useful purpose for a number	4	73
of borrowers, depending on their certain circumstances. I	5	73
think it's useful to have it.	6	73
On the other hand, I think it's also ripe for	7	73
potential abuse. And we're hearing it all the time out here.	8	73
I got a call just last week from an FBI agent in San Diego	9	73
who was talking to borrowers and who said she could not	10	73
believe the extent to which borrowers were acknowledging the	11	73
inappropriate use of stated income, stated income to make a	12	73
loan pencil out.	13	73
So I think it's a real serious, serious concern and	14	73
I -- you know, I, for one, would not like to see the option	15	73
for stated income go away as an appropriate tool in the right	16	73
circumstances, but I think it is also a tool that is	17	73
increasingly being abused to create income levels to sustain	18	73
loans where the actual income levels are known to not be	19	73
sufficient to qualify for a loan.	20	73
MS. BRAUNSTEIN: I'd like to change topics just a	21	73
second and ask a question about the guidance that we put out	22	73
for nontraditional mortgages. And it was, you know, referred	23	73
to in several of your opening statements on both sides of the	24	73
issue.	25	73
One of the struggles we always have anytime we issue	1	74
regulations guidance on any of the topics we deal with is	2	74
that we are very strongly trying to balance the interests of	3	74
consumers and consumer protection, which is extremely	4	74
important to us, as well as concerns about regulatory burden	5	74
and unwarranted interference in the markets. And so it's --	6	74
you know, it's always a struggle as you know.	7	74
And one of the things we used to say I know when we	8	74
were writing CRA regulations is if at the end of the day the	9	74
bankers were unhappy with us and the consumer groups were	10	74
unhappy with us, we probably got it about right. Because if	11	74
one or the other was too happy with us, maybe we weren't, you	12	74
know, as balanced as we should be.	13	74
Okay. So given that, we issued this guidance on	14	74
nontraditional mortgages. And actually, what's been	15	74
interesting to me is less the comments we've gotten from the	16	74
consumer groups frankly but the comments we get from the	17	74
industry.	18	74
Because on the one hand, some of the industry people	19	74
have come back and said to us, "You didn't give us enough	20	74
structure to this. We want certainty. We want safe harbors.	21	74
We want regulations. We want forms. You know, we want you	22	74
to design model disclosures. We want certainty. We want to	23	74
know absolutely positively we're doing what you expect us to	24	74
do."	25	74
Then on the other hand we hear lenders -- and when	1	75
Bruce said this it hit me. We heard other lenders say, "But	2	75
no, we want flexibility and, you know, it's guidance, it's	3	75
not rules, and there should be flexibility there."	4	75
So I'd like to hear some -- a little bit of	5	75
discussion on that as to which way we go on this.	6	75
MR. FULLER: Well, I think for us there's a couple	7	75
of key points. One is there's -- there are certain areas	8	75
where we felt almost needed to be stronger because we think	9	75
it's at the heart of the issue, like the deep discount on the	10	75
payment that we discussed, where we feel like that's where --	11	75
you know, that's the issue of how fast neg am is going to	12	75
build up and how strong. And we discussed in our letter some	13	75
additional language you might use there.	14	75
As far as specific rules on underwriting and other	15	75
areas, I think what you hear from us really is that we're	16	75
afraid that we'll make rules and the bad actors will get	17	75
around those. And how we got to balance those to use the	18	75
benefit -- obviously we need to have guidance on this and we	19	75
need to know where people should be, but we have to balance	20	75
that to be able to still have the benefits of the loan and	21	75
not -- and not prescribe it in a way that just doesn't make	22	75
sense. So that's where you hear the balance from us I think.	23	75
MS. BRAUNSTEIN: And that's from you, but that's not	24	75
what we've heard from a lot of other lenders. They want	25	75

Professional Reporting Services, Inc., Walnut Creek, California, 800-261-4814

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2006 Hearings

Building Sustainable Homeownership: Responsible Lending and Informed Consumer Choice

Federal Reserve Bank of San Francisco 101 Market Street, San Francisco, California 94105 June 16, 2006

Building Sustainable Homeownership:
Responsible Lending and Informed Consumer Choice

Federal Reserve Bank of San Francisco
101 Market Street, San Francisco, California 94105
June 16, 2006