“What do Asian carp, kudzu and collateralized debt obligations all have in common?

Did expanding their use seem like a good idea at the time?

Did they need globalization to change their nature?

Did they all generate unintended consequences?

Yes, yes and yes.

Globalization really does change everything, and has been doing so for a long, long time.

On Christopher Columbus’s second voyage to the new world, he brought with him wheat, onions, citrus, melons, radishes, olives, grapes and sugarcane, none of which existed over here. Those amber waves of grain we sing about? Didn’t exist—there was no wheat in the Americas. 

And he brought back to Europe corn, sweet potatoes, tomatoes, peppers, pumpkins, squash, pineapples - and potatoes.

Potatoes….a few hundred years later, Ireland was so dependent on them that the potato famine would wreak havoc on the Emerald Isle and propel millions of families to Boston and New York.

Who knew the astonishing influence a bushel of potatoes would have on the flavor of life here in the United States?

No one knew.

No one knew that Kudzu, introduced to help control soil erosion, would simply take over great swaths of the Southern U.S., or that Asian Carp in the Mississippi would threaten the Great Lakes. 

Three years ago our former defense secretary, in response to a question about the gathering and sharing of intelligence said “We don’t know what we don’t know.”

He was roundly lampooned for it.

But it was probably one of the truest things he ever said. Indeed, it is a fairly basic tenet of risk intelligence, and a commonly employed fundamental in creating intelligence scenarios. It just sounds odd.

As we look back on the last year in real estate finance, we now know what we didn’t know --- how the many innovations in products and securitization implemented in an up market would respond during a down cycle. 

And because we didn’t know those things, the alarming events unfolding weren’t really in anyone’s projections—at least not in the “connect the dots” way that we can now see them: a process beginning with the borrower and winding all the way through to the pension fund manager and touching everyone in-between.

Like the effect of kudzu, carp and potatoes, some broad societal lessons are only learned the hard way. 

Unfortunately, we learned a lot the past two years.

It’s easy to think that if we’d just had enough info, we could have acted differently.  But insight doesn’t come from simply gathering the data that’s out there, it’s also anticipating how human nature will shape a circumstance—in our case, largely the level of risk a person is willing to undertake.

Late last month Alan Greenspan said he would trade all of his econometrics on any subject for a graph that shows fear in relation to euphoria.   He said it was a far greater predictor of any event than the hard numbers, because fear and euphoria are primordial aspects of humankind.

The good news is that we can, we must, take advantage of the lessons learned this year, lessons that run the gamut from economic and market realities to human frailty.  We must integrate what’s been learned into behavior that prevents so many people from ever again losing their homes.

I believe there are five primary lessons we all learned this year.  Each was well known to some pockets of specialists, but each must now become a cornerstone of a larger point of view – fundamental truths that must remain part of our thinking in order to build on the hardships of last year.  Let me share them with you.

Lesson 1:
As much as we might like it to be otherwise, prices don’t always go up and interest rates don’t always go down. Too many people bought homes thinking this was the case, too many people were told that this was the case. And what’s a perfectly fine plan when prices are appreciating can be a disaster when prices fall.

Lesson 2:
The best homebuyer is an educated one. We need greater financial literacy in this country.
Knowledge is indeed power--- the best protection against a fluctuating market, interest volatility, and the actions of unscrupulous players. Our internal research shows that as many as 75% of homebuyers do not fully read their loan documents at closing. Yes, they should be easier to read, but buyers also have a responsibility that extends far beyond just signing on the dotted line. A clear understanding of the terms of that mortgage is essential to a successful transaction.

Lesson 3:
The unscrupulous appear in direct proportion to the belief that it’s easy to make money through ownership.  Back to lesson 1--- even after we’d long since warned that the loan portfolio had a historically high percentage of Adjustable Rate Mortgages, bad apples were touting the “can’t miss” mortgage market.

“I got a dynamite teaser rate for you.  Don’t worry about interest rates adjusting, you can refi again before that.”

As hard as the mortgage lending industry works to police itself and put sound practices in place, some unscrupulous people always seem to try to make a quick buck by taking advantage of unwary consumers.
This is as unacceptable to us as it is to you and we are committed to keeping them out of the industry.   But the real key to consumer protection is not in just policing a single industry.  It’s in cultivating a societal expectation that no one would “ever” invest in a home without wrapping themselves in the protective cloak of understanding.

Anybody picking up on how these lessons all dovetail with one another?

Lesson 4:
Nobody wins in a foreclosure. The idea that lenders make loans and then prosper when a loan enters foreclosure is a myth that must be dispelled. On average our industry loses $40 - $50 thousand on every foreclosure, and the homeowner loses even more; their credit rating, their equity and their home.  This is not the business we’re in and is decidedly not the outcome we desire; lenders want their borrowers to be successful homebuyers and long-term homeowners. 

Lesson 5:
Owning a home is still the American dream.
As Americans, one of our greatest liberties is the freedom to take risk, to make individual choices.  Subprime or not, people are often banking on themselves when they take a mortgage, banking on their vision of a future that’s more rewarding than where they may be today.  For the vast majority of people, it works out fine. 

But however it turns out; society deems this investment an acceptable risk.  And we like people who bet on themselves.  We are indeed a risk and reward society, and owning one’s own home has become the reward to attain for one’s self and one’s family.  According to the Federal Reserve, the average homeowner enjoys a net worth of $180,000, as compared to a net worth of $4,000 for renters.

Even with all the attendant risks and responsibilities, people want to own their own homes.

Now I can stand here before you and describe the lessons I believe we have learned.  But the larger question is how we avoid replicating the mistakes of those last few years.

From a pure data collection standpoint, MBA has been one of the more conservative voices.  We clearly pointed out the high number of re-finances within the loan portfolio and the unprecedented number of ARMs re-setting.  And when our data forecast a rise in delinquencies and foreclosures, we said so early and often.

But that’s just the data collection aspect.  What about the human behavior part?

We—and now I mean the entire real estate finance industry and all who followed it, regulated it and reported on it —didn’t know that the ratings given higher risk securities were inaccurate.  And yet asking the simple question “how are subprime loan packages getting a AAA rating?” — might have triggered a line of questioning and perhaps challenged the ratings issue sooner. 

What basic belief was at play that led to the rating agencies bestowing that rating?  Was it a faith in the way these products had worked in the very recent past?  A belief that housing values would always go up?  Or simply a fascination with a promised rate of return that pushed investors to want to believe in an unrealistic level of risk?

It doesn’t matter.  What matters was that nobody questioned it and that’s a behavior we have to change.

We’re embarking on a brave new age of global capitalization and increased liquidity.  This new model for a new age was developed in tandem with an old financial tool — leverage.  Yet no one looked ahead to the potential effects of a sudden repricing of risk for these highly leveraged entities.  The new financial instruments like CDOs and new financial investment firms like hedge funds had no history together, had never been through anything but good times together. But no one went there because this new, basically untested model, was working like gangbusters. Who wants to be the spoilsport?

There’s a lesson to be learned there as well, one I didn’t include before because I’m not sure we’ve really learned it yet. 

Now before I go further with this line of thought, let me assure you that I’m not passing the buck, not trying to abrogate responsibility for the bad loans that were made.  In no way am I attempting to justify the very real excesses that occurred.  Yes, some lenders were indeed reckless, and those that were, have paid, and are paying, the ultimate price.

My question is how do we protect ourselves from the excesses of human nature?  Or put another way, how do we make sure that everyone actually buys what they think they are buying?

First, make it easier to understand.  The whole process needs greater transparency, but let’s start with your average borrower.  Has anybody in this room read every word of every piece of paper you signed at your closing? 

I don’t see any hands.

These disclosures are meant to protect the borrower, but how any piece of paper that is so daunting for most people to get through can be expected to protect them is beyond me.  The irony is that all these disclosures have an opposite effect.  Their sheer volume – coupled with the fact that they’re written by lawyers and bureaucrats – allows predatory lenders to hide in plain sight. 

MBA has been asking for RESPA reform for years. RESPA stands for Real Estate Settlement Procedures Act, and was created by Congress in 1974 to be responsible for disclosures.  Maybe it took a crisis to get us there, but it looks like we now have some traction to improve and modernize these documents.

In fact, it’s actually long before closing when consumers need greater clarity.  MBA has worked with HUD on an easier to understand Good Faith Estimate —one that actually matches up with the HUD 1 form every borrower receives at closing.  Because really, how much good does it do a borrower to bring their GFE to the closing table when the HUD 1 format is completely different?  They may as well be in different languages.

Of course, that’s just one side of the equation.  Homebuyers must accept and embrace the importance of financial literacy, and we must make information sources as accessible and actionable as possible.  Our industry needs to address this mission with the understanding that our audience is enormously diverse, with differing needs, styles, languages and abilities.

One way in which MBA has undertaken this challenge is to create a home buyer’s tool called The Simple Facts.  It’s just what it sounds like — it covers the basics about mortgages and discusses the pros and cons, risks and rewards, of different types of products, explaining why people choose, or avoid, each type.  It identifies the typical needs and financial situation of borrowers who most often select a given loan type.

And it’s available on our consumer web site, HomeLoanLearningCenter.com.  Since its posting just this August, it’s been visited over 5 million times.
We’ve been doing outreach to spread the word – telling consumers about The Simple Facts through grassroots partnerships, paid advertising and public service announcements.  We recognize that this document does little good if nobody even knows it exists.

Beyond Simple Facts, we believe soup-to-nuts financial literacy needs to become a fundamental part of our public school curriculum, K through 12.  Since this is a major priority for the Mortgage Bankers, we will continue to do all we can to promote this concept.   It strikes me as ironic in this day and age when we still teach wood shop, auto shop and metal shop, that there are no courses on how to create a budget, manage credit card debt or balance a check book, much less one on purchasing a home or automobile.  We are the most complex credit society in the world and we need to arm our young adults with knowledge to help them live in this complex society.
 
That being said, there’s a related responsibility on the part of the borrower to be accountable and responsible as they enter into the home buying transaction, frequently the largest purchase people make in their lifetime.

It must simply become the case that the only way a buyer ever enters such a transaction is after they’ve become fully informed, aware of the options, risks and choices made. 

Make no mistake - it is every lender’s responsibility to insure this information is available to those borrowers.

Those are places where we’ve had a fairly immediate impact, places we were motivated to act because we recognized the need.

But what about those things we didn’t know were needed?

It’s now clear there must be greater transparency of hedge funds. Investors need to know what they’re actually buying.  Confidence in our rating agencies has been threatened and we need to take the steps necessary to regain that confidence.

If you know what the real systematic risks are, you can hedge them.  If you learn the risks are not what you thought they would be, well, here comes human nature again— investors stop purchasing what they don’t understand.

 In Greenspan terms, fear overtakes euphoria, which is clearly where everyone is operating today. 

You now have the credit crunch we warned against so strongly at the beginning of this year. 

For the very same reason, we need better securities contracts, something that can be accomplished only by the actions of federal regulators.  Again, this is necessary in order to lower risk premiums, volatility and uncertainty by improving the quality of information in the marketplace, all leading to greater liquidity.
 
Of course, until these actions are actually taken, there will be more uncertainty, because no one knows exactly which regulations will be enacted.  We know we need to move fast but must not overreact and set off a new torrent of unintended consequences.

Kudzu anyone?

This mess is not easy to clean up.  There is plenty of responsibility to go around.

It’s right to tighten underwriting, but suddenly some folks who counted on refinancing before their loan re-set can’t get that financing.  Remember that teaser rate loan? 

And they can’t sell either, because the value of their home is going down, so now they’re at greater risk of foreclosure.  Meanwhile, those same foreclosures keep investors on the sidelines, not buying the mortgage backed securities that supply the liquidity needed to provide loans to purchase or refinance American homes.

But if we can keep the fear to a minimum, the good news is that the pure data is fairly encouraging.  Delinquencies and foreclosures, were it not for seven states, would actually have decreased last quarter.  States where there was too much speculation; like here in California, Nevada, Arizona and Florida. 

And the other really hard-hit states are in the Midwest— Kentucky, Ohio and Michigan as an example.  There the problem is the local economies and loss of jobs.  Five of those Midwest states lost 750,000 jobs that aren’t coming back. 

They would have had problems regardless. In fact, the increase in subprime lending was actually a reflection of the general economic decline.  Clearly, the number of people who are poorer credit risks increases in bad economies. 

There have been a lot of good proposals brought forth for immediate relief, and I won’t go into all of them here, but they include freeing FHA, Fannie Mae and Freddie Mac to help more borrowers in trouble.

However, I’m more interested in the measures that will prevent this from recurring, because we have learned a few important lessons and identified many more of those….. “things we didn’t know we didn’t know”.

Such as what happens when people get loans that aren’t right for them and housing prices drop.  We know what happens when people are given two weeks of sales training and are sent out on the streets to drum up mortgage business because their companies know that investors in some other part of the world will buy just about anything they can write.

I represent a professional association, and we take that word professional seriously. We stand firmly for stricter licensing of loan originators.  Go into any doctor’s office—their diploma is usually on the wall behind them.  It’s no guarantee of sound treatment, but it’s a start. Borrowers should care as much about the qualifications of their banker or broker.  We would love it if every borrower asked to see the credentials of their advisor. 

We can use this crisis to make us stronger.  To help us simplify the mortgage process, promote financial literacy, increase transparency in the secondary market, and to remember that the housing market indeed goes down as well as up. By doing so, confidence will return at every level, from the first time borrower to the Wall Street investor.

You can’t say that the euphoria is entirely bad, however.  You don’t want to discourage people from betting on themselves.  That’s what this country has been built on. 

After all, our country needs homes and is stronger when people can own their own homes. That need is not going away. Minority and immigrant growth continues to boom. By 2050 we’ll need homes for 450 million Americans.   A Brookings Institution study states that half the buildings in which Americans will live, play and work in the year 2030 don’t even exist yet.

So the industry begins to move into another phase of its evolution, hopefully with the benefit of these lessons learned in its hip pocket. 

And while I urge us to all remember these mistakes and institutionalize these solutions in some new and modified regulations, there’s something else we should remember—something absolutely essential to a full understanding of this topic.

Innovative products used wisely are a boon to the home buying process.
80% of sub-prime borrowers, who would have been denied credit twenty years ago are in their own homes because of those loans, paying on time and building a better future.   They care more deeply, are more involved in their communities and create greater personal wealth through access to home ownership. 

And that is perhaps the greatest lesson learned.”

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The Mortgage Bankers Association (MBA) is the national association representing the real estate finance industry, an industry that employs more than 280,000 people in virtually every community in the country. Headquartered in Washington, D.C., the association works to ensure the continued strength of the nation's residential and commercial real estate markets; to expand homeownership and extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters professional excellence among real estate finance employees through a wide range of educational programs and a variety of publications. Its membership of over 2,200 companies includes all elements of real estate finance: mortgage companies, mortgage brokers, commercial banks, thrifts, Wall Street conduits, life insurance companies and others in the mortgage lending field. For additional information, visit MBA's Web site:  www.mortgagebankers.org.