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The existing residential lending model is inherently flawed. (If you don’t believe this, save yourself the time and stop reading.) The root cause of the structural issues can be attributed to a number of factors, but can generally be attributable to one primary root cause: the deep chasm between lenders and borrowers.

Some examples of this deep chasm include the following:

  • Loan documents are made overly complicated by lawyers and financial engineers and not clearly explained to borrowers by brokers. There is little incentive for the broker to clearly explain all the terms and point out potential pitfalls.
  • Exotic products and minimal documentation requirements engineered by “Wall Street Wizards” enabled certain borrowers to take out credit inappropriately.
  • Brokers have no long-term vested interest in the lending decision. Quite the contrary –
    “churn and burn”, “rinse and repeat” for maximum margins has been the motto.
  • Banks and lenders are motivated to offload risky loans as quickly as possible.
  • Rating agencies inadequately performed due diligence and are slow to react to market conditions.
  • Investment banks provide vehicles to sell securities to investors without providing adequate transparency.
  • Investors over-relied on Lenders, Investment Banks, and Rating Agencies to manage their risk.

Arguably, the system has been set up in a way to obfuscate accountability and make something fairly simple (i.e., lending) overly complex.

This flawed system has led to unprecedented defaults and a lack of credit availability.

 

Industry Turmoil Prevails

  • Warehouse lenders have gone out of business creating a scarcity of credit short-term funding to originate new credit.
  • MBS/ABS markets have dried up; their future role in mortgage lending is unclear.
  • The future of quasi governmental agencies (e.g., Fannie Mae, Freddie Mac) is unclear.
  • Banks “too big to fail” are operating on inadequate servicing fee revenue and lack resources to properly invest in infrastructure to handle default volume.
  • A patchwork of state and local legislation has contributed significantly to the cost/complexity of the national servicers and provides little value on balance to borrowers.

 

Warehouse Lending

Warehouse lending has dried up as major lenders focus on retrenching their own operations….

Securitization Markets

The level of securitized issuance is significantly lower in most asset classes, creating limited opportunities for banks to deploy funding…

 

Banking Industry

Only one de novo institution to open its doors in 2010 (organizing groups have been asked to withdraw applications) ….

 

Banks are closing and/or consolidating….

 

 

No “Silver Bullet” In Sight

Attempts to “fix” the residential lending model to date have at best masked some of the symptoms; at worst they have contributed to the further market dysfunction.

  • Governmental programs don’t address the root cause – they only delay the inevitable default of “underwater” borrowers.
  • Modification programs reward non-performing borrowers and encourage arguably encourage non-performance (i.e., performing borrwers strategically default to get a lower interest rate).
  • Regional banks are on the brink of insolvency or have been “managed out” of business by the FDIC further exacerbating the lack of credit.
  • Servicers are not equipped to handle default volumes contributing to delays in providing assistance to borrowers. Strategies to create scalable “Special Servicing” are ill-conceived.
  • Politics prevail – lending fundamentals and “real” transparency (using modern technology) are not on the agenda.

Many modifications delay the inevitable default. Lenders have simply “kicked the can down the road”

Real, material “game changers” are mired in competing agendas and politics. These will take time
and may never materialize (at least in a fully functional way).

In the meantime, borrowers have “negative equity” and are locked into “renting” their homes – pride of ownership is gone; the dream of homeownership has become a nightmare.

It is time to hit the “reset” button on the residential lending model.

© 2012 inherently flawed Suffusion theme by Sayontan Sinha