Pipeline: Mortgage Production News and Trends

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Too Excited?

Robert J. Shiller, the Stanley B. Resor Professor of Economics at Yale University, gave mortgage executives another reason to worry about the housing boom Tuesday.

The heart of his warning was a chart that purported to show zero net appreciation in home prices, after adjusting for inflation and quality improvements, between 1890 and 1997. According to the chart, since 1997 there has been a spike sharper than the only similarly large one, in the post-World War II years, when returning GIs and a baby boom stoked prices.

"It's a sign of the times" that people overestimate historical returns from real estate, Prof. Shiller said at a conference in New York. A revised edition of his book "Irrational Exuberance," with thoughts on the housing boom, was published last month.

Prof. Shiller said there is less than a 50% chance that the "epidemic of excitement" will lead to the type of national housing blow-up that would result in a worldwide recession. But he sounded like he thought the chances were pretty close to fifty-fifty.

He rebuked the idea that building constraints in some booming markets would support prices no matter what. In most places, construction costs remain low, and consumers and businesses can always move, he said. "You don't have to live in Los Angeles."

When asked whether the boom might be explained by a need for returns to catch up after lagging other risky investments, he replied, "That's exactly what they were saying about the stock market in 2000."

He also dismissed the notion that the growth of affordable mortgage products is a good thing; he noted that the Mortgage Bankers Association has said nearly two-thirds of last year's loans were either interest-only or adjustable-rate.

When "defenses are down" professionals offer "pie-in-the sky schemes," as they did in the 1920s, Prof. Shiller said. "I think this innovating in financing is a sign of the moral and cultural change we see during a bubble."

He bemoaned the recent erosion of the fixed-rate mortgage culture that emerged after the Great Depression, but he acknowledged that the best option for lending executives unhappy with the trend might be to retire early.

"That's the world we live in," he said. "That's a bubble world."

Flagstone Securities LLC, an underwriter of REIT issuances, organized the conference.

Long-Term Concerns

Similar themes emerged last week at a subprime lending conference in Las Vegas.

Jay BrayCentex Corp.'s Centex Home Equity Company LLC, addressed the question of the future of new products.

"In the short term, at least, there's plenty of liquidity out there to take out the [consumer] demand in the marketplace," including about 30 conduits, he said at the conference, which was sponsored by SourceMedia, the parent of American Banker.

But if the loans don't perform as well as expected, and subordinate bondholders' investments "blow up in their faces," the bondholders would suddenly step back from the market, Mr. Bray said. "You will quickly realize that some of these decisions are not being prudently made."

John Vella, the chief sales officer for H&R Block Inc.'s Option One Mortgage Corp., said originators might not want to hold on to credit risks in this environment. "Looking back, people that are holding residuals or risk on their books … that's where it's going to get difficult."

Jay Levine, a co-president and co-chief executive of Royal Bank of Scotland Group PLC's RBS Greenwich Capital, said in his presentation at the New York conference the use of collateralized debt obligations to finance many of the riskiest slices of mortgage securitizations plays a crucial role in those deals.

CDOs concentrate much of the credit risks in the hands of investors willing to buy the riskiest bonds in the obligations, he said. "Very few dollars in the capital stack are driving these transactions."

In a brief interview afterward, Mr. Levine said these investors probably will not back away from CDOs' equity pieces, though they may easily demand higher returns if credit quality worsens.

Like others at the Las Vegas conference, Joe McKone, the chief operations officer of National City Corp.'s nonprime mortgage unit, First Franklin Financial Corp., complained about the "lenders out there that are making what I would characterize as some very risky decisions" about what loans to offer.

"What keeps me awake at night is the pressure on us" from mortgage brokers to create new products that mimic those lenders' loans, particularly stated-income options, he said.

The challenge is to make loans that perform, and "we can't forget that the consumer in many cases is jumping into this product on the advice of their mortgage professional," Mr. McKone said.

A new part of First Franklin account executives' jobs is explaining to brokers why it won't make riskier loans, he said.

Come Together

At the New York conference, W. Coleman Bitting, a founding partner of Flagstone, repeatedly pushed mortgage real estate investment trusts and similar finance companies to form a trade group.

A sector that has financed $400 billion of currently outstanding loans, or 4% of the total mortgage debt outstanding, and has been responsible for 10% of the growth in such debt in recent years, needs to develop an "identity," he said.

A few companies have been the sector's public face, but "I think there's a fair amount of editorializing that goes on when we let a few voices speak for this sector," Mr. Bitting said.

"I think ignorance" on the part of policy makers, the news media, and the public "is going to become increasingly costly to this group," he said.

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