ABS East report: Contract sanctity, mortgage lemons and Lewis Ranieri
While at the ABS East I had the good fortune to hear Lewis Ranieri of Ranieri Partners Management speak on the return of the private RMBS market.
When Mr. Ranieri talks on this subject we all listen. After all, he does have some experience with these matters.
Ranieri described one of the key principles of a revitalized private RMBS market as the sanctity of contracts. We heard about the “wackadoodle” idea of seizing performing mortgage notes under the auspices of eminent domain and the sentiment was echoed by Ranieri today. If the sanctity of contracts does get trampled by jurisdictions seizing mortgage contracts it would have significant ramifications for capital markets in general as investors would have to consider this risk before choosing to invest in private RMBS securities. I have to assume that if this risk is priced the consequences would be less credit, more expensive credit, or a combination of both. Not necessarily an outcome anyone likes to see!
A second principle of Mr. Ranieri’s needed for the return of the private RMBS market is that the mortgages loans need to be “good loans.”
Of course, when you first hear this the immediate question what is a “good loan”? There is the obvious — meeting reasonable credit, sustainable payment, down payment, and documentation criteria. Additionally, and potentially more importantly, Ranieri described the goal of striving for all defaults to be because of life events, not defects in the mortgage manufacturing process. Now this is something I agree with!
If manufacturers can apply Six Sigma principles to their manufacturing processes and reduce their “lemon” rates why can’t the same, or something similar, be done in the origination, manufacturing, process for a mortgage loan?
The product that we are selling to investors needs to be a good product, devoid of defects. We need to be able to provide the transparency into the manufacturing process so that investors can determine we are doing a good job of manufacturing good loans for the securities. With today's technology and yesterday’s principles of sound underwriting we can do this. Data validation, due diligence and more broadly collected and standardized mortgage data can facilitate an improved manufacturing process for mortgage loans and empower underwriters with information they need to make good lending decisions.
Of course, none of this matters if we choose to publicly finance mortgages in the United States. Ranieri rightly points out that the FHFA can’t simply price a private RMBS market into existence. Reducing the loan limits back to their pre-crisis levels would make a big difference, as well as resolving much of the regulatory uncertainty.
The roadmap is a good one- insure the sanctity of contracts, manufacture good loans, reduce the federal government from the mortgage finance market, and let the private market know what the rules of the game are but allow them to actually make a market. It seems so obvious as described by Ranieri.
I knew he would be worth listening to.
Mark Fleming is the chief economist for CoreLogic. The opinions expressed here are his own.