As a kid, I remember the popular dress-down phrase: “You couldn’t hit the broad side of a barn.” Fast forward to today and the phrase becomes: “You don’t even know what your mortgage amount and terms are.” (note: this is a clue to how boring I was as a kid, especially on the baseball field.)

One of the things that occurred in the housing boom of the past decade was the detachment of risk from the borrowing equation. It didn’t matter how you got there, you simply wanted the property or the loan.

The LA Times reports (via Seeking Alpha) that a Federal Trade Commission study shows that despite (or because of) a myriad of closing documents, borrowers only had a 50/50 chance of finding the loan amount on their loan documents.

View the study.

Peter Coy of Businessweek concurs and lays blame on lenders, not borrowers in his Hot Properties post:

  • Half the 819 borrowers surveyed could not correctly identify their loan amount.
  • Two-thirds did not recognize that they faced a two-year prepayment penalty.
  • Three-quarters did not recognize that they were paying extra for optional credit insurance.
  • Nearly 90% couldn’t identify the total amount of upfront charges in the loan.

It’s easy to blame the borrowers…But when so many people can’t understand the loan documents, I put most of the blame on the lenders.

Ok, so now we have loan applicants not understanding what they are actually borrowing.

Now the Federal Reserve, who is responsible for overseeing the banking industry, has less influence on the economy, and perhaps by extension, less influence on credit quality.

But a new study by the Federal Reserve shows it has much less control over economic growth than assumed by many. The study, completed by Fed economists, found little evidence that tighter monetary policy has much impact on bank lending via deposits.

Greg Ip, the WSJ reporter who covers the Fed, writes about this in the WSJ Real Time Economics Blog:

banks with more deposits than loans, and banks with far less deposits than loans (because they relied more on wholesale markets), didn’t change lending much when deposits shrank. Only banks whose deposits were about equal to loans significantly reduced lending. These banks only represent 6% of of U.S. bank assets. Thus, the “bank lending channel seems limited in scope and importance” in the U.S., the authors conclude.

6% is pretty low.

But lending standards are getting tighter. Where is this coming from?

The Federal Reserve seemed to back away from the potential subprime problem back when Greenspan was there. This laissez-fare policy would likely have applied to all types of bank lending.

So bank underwriting is getting tougher on its own initiative, probably only after seeing the damage occurring to the housing market as of late.

Lets summarize:

  • Borrowers don’t know how much they borrow.
  • Bank regulators say themselves, that they have no significant influence on the economy and, it follows by past action, no significant desire to reign in the banks they regulate (admittedly a stretch, but let me have it).
  • Banks have now become tougher on borrowers which will further damage the collateral on their outstanding home loans as restrictions to credit will constrain demand.

Everyone seems to be counting on someone else to take care of things – thats a disfunctional financial community.

As former presidential candidate Ross Perot once uttered: “Its time to pick up the shovel and clean out the barn.”


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5 Responses to “Broad Side The Barn, Waiting For The Shovel”

  1. […] Jonathan Miller lays out the difficulties so many borrowers have understanding their loans in Broad Side The Barn, Waiting For The Shovel […]

  2. WT Economist says:

    Although I would know better now, when I signed for my mortgage in 1994 I didn’t read all the documents. My lawyer read all the documents ahead of time, and then went through them at the closing table to ensure there was no stealth change in terms.

    What I knew was I had a fixed-rate 15-year loan for a given amount at 7.0% APR with no points. I relied on the lawyer to make sure that was so.

    In all the mortgage brouhaha, I haven’t heard anything mentioned about the responsibility of the buyer’s lawyer in all of this. Those lawyers aren’t cheap, and pretty much everyone gets one especially in NYC. If not for this, what are they for?

  3. Bond investor says:

    Jon, check out slide 26 of this presentation on Household Finance by Harvard professor John Campbell:

    Older, less well-educated, lower-income people mis-state their rates more often. Those are sadly intuitive. What’s interesting is that people with HIGHER home values mis-state their rate more often.

  4. Marmotton says:

    Actually 50/50 is good: it means documents are written for the average American…. I think it’s unreasonable to expect more.

  5. Burbed says:

    Using lawyers for RE transactions seems to be an east coast thing.

    In California, if you ask someone if they used a lawyer to buy a house, they’ll look at you like you’re on meth.

    I wonder if it’s just that laws are different, or if it is a cultural thing.