The Basic Math Behind Subprime Foreclosures

The Daily Reckoning ^ | 05/14/10 | Rocky Vega

[An Old Man]

05/14/10 Geneva, Switzerland – The foreclosures that led to financial crisis began with homeowners falling behind on their mortgage payments. Yet, have all the factors behind the foreclosures been uncovered?

To date, much of the blame has been assigned to predatory lenders. However, a new and strikingly simple finding explains another significant factor. The Atlanta Federal Reserve has recently released a paper that shows that the numerical skill of homeowners has a meaningful impact on the rate at which they fell behind on mortgage payments.

According to The Economist:

“The economists tracked down a large number of subprime borrowers in New England on whom they already had detailed information, including the terms of their mortgages and their repayment histories. These borrowers were then subjected to a series of questions that required simple calculations about percentages and interest rates.

“Even accounting for a host of differences between people—including attitudes to risk, income levels and credit scores—those who fell behind on their mortgages were noticeably less numerate than those who kept up with their payments in the same overall circumstances. The least numerate fell behind about 25% of the time. For those who did best on the test, the number of payments they missed was almost 12%. A fifth of the least numerate group had been in foreclosure, but only 7% of those who were more numerically adept had.

“Surprisingly, the least numerate were not making loan choices that differed much from their peers. They were about as likely to have a fixed-rate mortgage as the more numerically able. They did not borrow a larger share of their income. And loans were about the same fraction of the house’s value.”

The Atlanta Fed has managed to show that homeowners that are better at these math skills tend to also be better at managing household finances. In and of itself, it’s a hardly surprising finding. However, it also goes to show that basic numeracy offers some ability to predict the outcome of subprime homeowners, much like other factors generally used to judge creditworthiness, such as income and credit scores. Maybe loan officers should start including a math test in their assessments.

You can visit The Economist to read more details on how subprime mortgage defaults resulted in part from the fear of all sums.

[An Old Man]

Who was it that said "We have nothing to fear but fear itself"

the fear of all sums

I bet he didn't know about that!

[griswold3]

the fear of all sums

LOL Thank your government schools. I could give a back in the day story.

[ETL]

“Shocking Video Unearthed Democrats in their own words Covering up the Fannie Mae, Freddie Mac Scam that caused our Economic Crisis”

http://www.youtube.com/watch?v=_MGT_cSi7Rs

___________________

Bailout Politics: The Congressional Dems who enabled this crisis are now being trusted to fix it?
Thomas Sowell, September 30, 2008

http://article.nationalreview.com/?q=OWE3OWU3OTExYzNlNTUzMzY2YmJmOWZjMzcwN2M1NjU=

___________________

Guilty Party: ACORN, Obama, and the mortgage mess
Mona Charen, September 30, 2008

http://article.nationalreview.com/?q=Mzk4MmVkNzA1NGQ2NGRkZjQ2YjNmYjdlODZkMmQ4N2I=

[OneWingedShark]

>the fear of all sums Σx = y

[FreeKeys]

The foreclosures that led to financial crisis began with homeowners falling behind on their mortgage payments

No, no, no, NOOOO!!!
   THEY BEGAN WITH THE GOVERNMENT FORCING THE BANKS TO MAKE ALL THOSE BAD LOANS SINCE THE 1970s.

The financial disaster is COMPLETELY traceable to the millions of bad loans THE POLITICIANS FORCED THEM TO MAKE SINCE THE DAYS OF JIMMY CARTER.  Even the derivatives the current Goldman Sachs charges are based on have to do with trying to find people to finance that garbage in the first place (I am NOT endorsing the way they decided to do it).   "Congressman Frank and Senator Dodd wanted the government to push financial institutions to lend to people they would not lend to otherwise, because of the risk of default.    "The idea that politicians can assess risks better than people who have spent their whole careers assessing risks should have been so obviously absurd that no one would take it seriously." -- Dr. Thomas Sowell, Professor Emeritus, Economics, Stanford University, HERE

CLICK ON THIS TO FIND WHERE YOU CAN GET A FULL-SIZE PDF:

AND FIND A LOT MORE POSTERS HERE.

[Oceander]

All of which suggests a simple solution to helping to prevent future subprime meltdowns - you must pass a college-level math test before you can be permitted to take out a large mortgage.

[Gay State Conservative]

Translation...when Baaaaaarney Frank & Friends decreed that everyone in the country who wanted a mortgage should get one the policy pulled in millions of the country’s least intelligent.but then the lest intelligent among us have always depended on the RATS for handouts.

[Gay State Conservative]

Translation...when Baaaaaarney Frank & Friends decreed that everyone in the country who wanted a mortgage should get one that policy pulled in millions of the country’s least intelligent.But then the least intelligent among us have always depended on the RATS for handouts.

[Pelham]

“No, no, no, NOOOO!!!
THEY BEGAN WITH THE GOVERNMENT FORCING THE BANKS TO MAKE ALL THOSE BAD LOANS SINCE THE 1970s.”

A nice explanation. Too bad it’s not true. First you need to learn the difference between investment banks and commercial banks. Commercial banks were regulated by the CRA, investment banks were not.

The vast majority of toxic paper was cranked out by investment banks and their related hedge funds, none of which were regulated. By the end of the bubble subprime loan brokers couldn’t keep up with the immense demand for that paper from the investment banks and hedgies who were rolling it up into CDOs and writing credit default swaps against it. The CDO, CDS, Synthetic CDO and CDO Squared paper was issued in the trillions of dollars. These derivative products were not based on some attempt to deal with government mandated loans to unqualified buyers. They were based on making huge returns for the firms that dealt in them. You need to study the subject a bit deeper.

http://www.lazardnet.com/LAM/us/tpd/pdfs/Inv_Research_Mortgage_Crisis.pdf

[Pelham]

Prior to the financial innovations of the late 1990s lenders wouldn’t put you into a mortgage that you couldn’t handle. They often kept their own paper, giving them a definite interest in your ability to pay. And if they did sell off loans to Fannie or Freddie it had to be conforming paper which itself is inherently safe.

But these structural safeguards disappeared when lenders outsourced loan origination to mortgage brokers and sold off all of their paper as CDOs. No originator then had any interest in the quality of the loan being issued. Only size and yield mattered.

[Oceander]

And who was doing due diligence on the other side, or rather, who was supposed to be doing that due diligence? Heck, who needs due diligence when you have government-sanctioned ratings agencies that absolve you from most liabilities once you get their blessing. Bankers are, at heart, rather simple folk - they follow economic incentives - so to the extent that the incentives were distorted, look to who was doing the distorting - you'll find the grinning rictus of Barney Frank and the whole liberal posse looking back at you, not this mythical herd of "greedy" bankers and mortgage-brokers (they've always been, more or less, just as greedy as they've always been since time immemorial, so the level of bankers' greed didn't change, and therefore cannot be used to "explain" why things crashed now when they never did in the past).



bumper sticker

[FreeKeys]

Okay, thanks. Will do.

[CurlyDave]

Maybe loan officers should start including a math test in their assessments.

The result of such a test would show a racial disparity and it would immediately be forbidden by the government.

[gleeaikin]

Screaming red capitals do not a true argument make. See the much more realistic explanation in Comments 9 and 10. Yes, the government did encourage banks to look at more marginal buyers. It never said they should make loans at unrealistic terms, and sell them off while profiting from the commissions.

Nor did it anticipate Paulson, Magnetar, and Goldman Sachs actually assembling bundles of loans likely to fail and then betting against them without informing the people they handed them off to. Sounds like fraud to me. But what do you expect of a company, GS, that raised it’s CEO salary of 5/3/07 from $37 million almost double to $74 million on 4/30/08. [source: Forbes CEO Compensation on those dates] This when the banking industry is already in serious trouble over the housing bubble.

[FreeKeys]

Prior to the financial innovations of the late 1990s lenders wouldn’t put you into a mortgage that you couldn’t handle.

I may be mistaken, but it is my understanding that the bank sit-ins staged by ACORN and other "community organizations" started around the time of the CRA -- and I believe the commercial bankers caved. I supposed I could look it up, but it's after midnight where I am, and I ain't doin' it at this hour. Maybe another day.

[Pelham]

The rating agencies applied to the investment end of the process, not the loan origination end. And investment bankers are very, very far from being “at heart, rather simple folk”. Investment bankers are the biggest earners on Wall Street. They tend to have advanced degrees in finance. You are confusing investment banks with commercial banks.

“so to the extent that the incentives were distorted, look to who was doing the distorting - you’ll find the grinning rictus of Barney Frank and the whole liberal posse looking back at you, not this mythical herd of “greedy” bankers and mortgage-brokers “

Mortgage brokers had completely displaced in house loan originators during the bubble. Maybe that’s “mythical” in Fantasyland, I just don’t know. But it’s what happened in the real world where most mortgages were written. And once again investment banks were not covered by the regulations that dictated lending practices for deposit taking commercial lenders. You might want to learn the distinction, facts being stubborn things.

“(they’ve always been, more or less, just as greedy as they’ve always been since time immemorial, so the level of bankers’ greed didn’t change, and therefore cannot be used to “explain” why things crashed now when they never did in the past). “

The repeal of Glass Steagall in 1999 led to the bubble. The Commodity Futures Modernization Act of 2000 led to the bubble. The leveraging of financial firms at levels of 40 or more led to the bubble. There are many factors that led to the crash and they are easy enough to find in books and studies on the subject. When you get tired of strawman arguments over bankers’ greed maybe you’ll want to read some of them.

[Pelham]

CRA dates back to Jimmy Carter, circa 1977. Clinton expanded its scope while he was in office. But CRA applies to firms that take deposits from the public, such as commercial banks, S&Ls, thrifts.

Investment banks in contrast are Wall Street entities, not depository institutions. They get their money as partnerships or from the sale of stock. They aren’t covered by the same laws that apply to commercial banks.

[Trailerpark Badass]

Commercial banks were regulated by the CRA, investment banks were not.

Really?

Crucial to the passing of this Act was an amendment made to the GLBA, stating that no merger may go ahead if any of the financial holding institutions, or affiliates thereof, received a "less than satisfactory [sic] rating at its most recent CRA exam", essentially meaning that any merger may only go ahead with the strict approval of the regulatory bodies responsible for the Community Reinvestment Act (CRA).[18] This was an issue of hot contention, and the Clinton Administration stressed that it "would veto any legislation that would scale back minority-lending requirements." [19]

[Pelham]

“Paulson, Magnetar”

Those two hedge funds could be the key to understanding the Great Recession. If there is anything in all of this that constitutes a rigged market, or a fixed horse race, it’s what those two firms were involved in. And it’s hard to believe the size of the deals that the two of them were doing. Big enough to shake the world economy.

Yves Smith has a good chapter dealing with Magnetar in her book ECONned. Certainly a book worth reading.

[Intolerant in NJ]

However, it also goes to show that basic numeracy offers some ability to predict the outcome of subprime homeowners, much like other factors generally used to judge creditworthiness, such as income and credit scores...only problem is, the banks and other mortgage lenders didn't care a bit about the "creditworthiness", no matter how determined, of those to whom they were lending - not after the government stepped in and made it possible for them to pick up hefty fees for originating the loans and then dump the bad debt on Fannie Mae and Freddie Mac:
"Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton administration to expand mortgage loans among low and moderate income people and felt pressure from stockholders to maintain its phenomenal growth rate" ("Fannie Mae Eases Credit to Aid Mortgage Lending" - NY Times - 30 September 1999)

And now we have Andrew Cuomo, NY Attorney General but formerly HUD secretary under Clinton, undertaking an "investigation" of all those bad banks and how they preyed on all the poor innocent home buyers over the years. Sounds very noble, but wait...
"As Hud secretary Andrew Cuomo boasted in one report in the late 1990's that the new mandates he was imposing on Fannie and Freddie to ramp up subprime lending 'could be of significant benefit to lower income families, minorities, and families living in underserved areas'...When Andrew Cuomo succeeded Cisneros in 1997, he increased the number [of all mortgage guarantees set aside to serve what the government classified as low to moderate income borrowers] to fifty percent and began to pressure the GSE's to buy up mortgages of people classified as 'very low income'" ("The Sellout" - Charles Gasparino)

It makes my head hurt.....