Back To The Future With Private Mortgage Lending Redux

The Best Of The Zola System

At this point in the Great Recession, the crash of the housing market due to the Sub Prime mortgage bubble is still causing the vast angst among Americans.  Foreclosures, the lack of available credit and the drop in value of real estate are all driving the average consumer to distraction.  Add in the small group of folks attempting to buy homes when mortgages are not readily available and it’s no wonder groups like Occupy Wall Street are protesting the usual suspects – the fat cats, corporate greed, corporations, the vast dark void of those unseen evil doers who are conspiring to take away the hard earned dollars of the ever shrinking middle class and the Jews.

The free market nature of the economy however is a remarkable thing. Private investors are filling the void created by banks that are either unable or unwilling to lend money to anyone.

(From the Wall Street Journal)

After years as the lending market’s undesirables, aspiring home buyers with less-than-stellar credit are being offered home loans again—with some of the same conditions and catches critics say tripped up subprime borrowers five years ago.

According to analysts, a handful of private investment firms have started making home loans to borrowers who fail to meet banks’ requirements, which got tighter post-crash and have largely stayed that way. And for now they are holding them on their books, which is novel. At least two, Athas Capital Group, of California, and New Penn Financial, which is owned by Shellpoint Partners, of New York, are also making jumbo loans, or loans in most parts of the country that exceed $417,000, as the federal government appears to be scaling its support of that market.

The loans are designed to include borrowers with credit scores deemed low by banks’ standards; they also have more-flexible requirements for proof of income. Banks have been too slow to extend credit to such people, the firms say, leaving otherwise responsible borrowers out in the cold—and potential profits on the table. “It’s often a minor detail, why banks won’t approve them,” says Brian O’Shaughnessy, chief executive at Athas Capital.

Banks are following standards set by the market and reinforced by regulators, which focus on avoiding risk and losses with the uncertainty that exists now, says Bob Davis, executive vice president at the American Bankers Association.

The firms say this is far from the subprime lending of the go-go years. While they may embrace slightly riskier borrowers, they require higher down payments, around 40% on average at Athas Capital, compared with roughly 10% for a bank loan, says Keith Gumbinger, vice president at HSH Associates. And while they are willing to be flexible with income documentation, accepting a workplace pay stub or a series of bank statements in lieu of tax-return documents, they still require documentation as proof a borrower can repay the loan. This opens the door to otherwise qualified borrowers who have been foreclosed on, for example, or who may be self-employed or recently unemployed but are now back to work, says Chip Cummings, president of Northwind Financial, a consultant to mortgage lenders.

Critics say the loans are similar enough to the subprime mortgages of old that would-be borrowers should beware. They often have a so-called balloon structure, which requires the borrower to pay the remaining balance after five or seven years, or to refinance. And they are expensive, with interest rates of as much as 13%, the loans can cost more than double the average for bank mortgages. “You’d have to be fairly desperate to take that in the current market,” says Guy Cecala, publisher of Inside Mortgage Finance.

Given the recent economy, that includes a lot of people.  With housing prices still so relatively low, many people may want to buy, which analysts say could fuel a boom in this sector.

Also, starting in October, the government is expected to lower the limit on the loans it guarantees to as low as $271,050 in some places, in some cases a drop of almost $100,000. That, too, could open the door for these private financing companies.

“There are a lot of borrowers out there who aren’t being provided for,” Mr. Cummings says. “Private investment firms are filling the gap.”

There are some out there who read the above and are shocked (shocked!) to find individual investment firms giving their hard earned money to create what appears to be another Sub Prime loan bubble.  The visceral fear of Mafia strong-arm tactics to foreclose on families is what the cynical critic will claim as rationale for stopping this form of investment before it embeds itself into the economic fabric of the country.

I have no such cynicism or fears and there are no drugs in my system on which to place blame.  Frankly, I am happy to see the average investor willing to once again put their money on the street so regular folks can benefit.  In truth, Sub Prime mortgages began in the wallet of the Upper Middle Class.

On the day after Thanksgiving 1984, I blew off the first major mandatory wrestling practice of the season to hang out with the Old Man, his business partner Mr. Levine and the Milt Wilcox, the #3 starter on the World Series winning Detroit Tiger team.  Wilcox and his mates got out to a 35-5 start in 1984 and effectively won the AL Pennant in May.  Ostensibly, the three were looking at various parcels of land for sale in the Detroit Metropolitan area.  In truth, the Old Man was showing Wilcox various homes in which he had invested.  Not as an owner but as the bank.  Milt Wilcox, along with several other members of that Tiger team, had my father invest their money for them in private mortgages.

Various members of the 1984 club were (to quote the Old Man) degenerate gamblers.  They loved to bet the trotters (Harness Racing) at the Detroit Race Course and the Hazel Park Raceway.  Harness Racing is the most corrupt sport known to man (every year the best drivers regularly go to prison for race fixing and corruption) and the two Detroit tracks were so corrupt Vegas refused to book their action.  The ball players were, initially, losing money hand over fist.  This meant borrowing money from the Old Man and his friends like Chi, the Loanshark.

This business arrangement may have been good for Detroit’s baseball hero’s, they got more money to bet and tips on which horses were due to win that day, but was lousy for Dad, Chi and the boys.  If the Tiger’s (and a few Red Wings, Pistons and Lions of the era) didn’t pay up, how were they going to explain to their wives and then their kids so and so wasn’t going to play for the next few weeks due to an off the field injury?  Thus, for the sake of harmony on the home front, a compromise was created: monies would be withheld tipped off wins (on top of the cash taken to pay their Vig) from the athletes and invested for them as a sort of bank in case the player in question blew all his money on gambling, drugs, booze, broads et al for the both the players and the guys at the track.  This bank was in the form of personal mortgage lending.

After taking the money from the players, the Old Man and his friends with merged it with some of their own cash and gave it to various uterrly legitimate private mortgage lenders and private equity firms to lend out. People with credit issues would apply for these home loans at two or three points above prime, just like the Sub Prime mortgages.  The key to this investment strategy was volume.  The more mortgages the group was involved in the more money they made, the same strategy employed by Freddie and Fannie.

These private mortgage lenders were so successful, larger mortgage companies took note and got involved.  Then came the banks and finally the government.  And you know why they all got involved?  Because that’s where the money was.

Of course now that private firms are once again involved with servicing this part of the economy the question is: how long before the big banks and government get involved because they see money being made?

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