Imagining ‘It’s a Wonderful Life, 2017’

 The holidays would not be the same without watching “It’s a Wonderful Life” and feeling every moment of struggle as George Bailey discovers that riches are not measured in dollars and cents. The film highlights the importance of family and love and celebrates civic and familial virtues.

Those of you who have seen the classic 1946 movie will remember one of its most famous scenes. George Bailey runs a small community bank with a mortgage business. One day, as he is headed out on his honeymoon, George is confronted by a group of depositors wanting to withdraw their savings because they are nervous about the bank’s solvency.

He explains that he doesn’t keep their savings lying in the bank safe. Instead, he has invested most of the money in affordable mortgages on the homes they own.

Sam’s money is in Chuck’s house. And Chuck’s money is in Dick’s house. And Dick’s money is in Sam’s house…

So it goes, with customers able to own their homes instead of having to pay rent to Old Man Potter, the predatory capitalist villain who owns the leading commercial bank in Bedford Falls – and most everything else in town.

In George Bailey’s day, a lending institution would keep a home mortgage on its books until it was fully paid off. The default risk was held by the bank, which sought to protect itself by granting mortgages only to clearly creditworthy borrowers with stable incomes sufficient to meet monthly mortgage payments and the ability to invest a significant portion of their own money in a down payment.

In a modern “It’s a Wonderful Life”, director Frank Capra could have contributed to an understanding of the financial crisis by turning George Bailey into a rapacious mortgage broker willing to do almost anything to maximize his mortgage origination volume.

A modern-day Capra would present a series of fast-paced sequences showing how George converted low-income homebuyers with non-existent credit into qualified sub-prime mortgage applicants.

No money for a down payment? “Not a problem,” George reassures the applicant. “You can take out a small first mortgage to cover the down payment, then a larger second mortgage to cover the rest of the purchase price.”

“But won’t that mean high monthly payments?”

“Not with adjustable rate mortgages that charge interest only for the first two years.”

“But after two years, when the much higher monthly payments kick in …?”

“Nothing to worry about. The way house prices are skyrocketing, you’ll be able to refinance with a single bigger mortgage to pay off both original mortgages, and give yourself enough extra cash to cover the monthly payments for several years.”

“And after that?”

“As long as home prices keep going up, you’ll be building equity in your house, which you can tap for ready cash by refinancing yet again.”

“So the house keeps paying for itself?”

“That’s what it amounts to.”

“Sounds great. What’s next?”

“Let’s fill out the mortgage applications together right here on my PC. I know how to word the answers to give banks what they’re looking for.”

“Do I need documentation for my income?”

“Nah. It’s all streamlined these days. The banks run your applications against their crazy computer models to see if you qualify for the mortgage. And you will. It’s just a formality.”

“A formality?”

“Banks are mainly interested in generating new mortgages to sell to Wall Street. Each mortgage they sell increases their servicing fee volume, so they approve as many applicants as possible.”

Just then, George gets a phone call from Old Man Potter, George’s hungriest lender for the sub-prime mortgages he sells to his Wall Street buddies.

“Hi Mr. Potter,” George says, leaning back in his desk chair with a big smile. “Just going to call you … No, a first and second mortgage this time … Yeah, I thought you’d like that … Great. I’ll see you at the club around six.

A wonderful life indeed.

Originally Published: Dec 9, 2017

The beginning of another bank crisis?

One definition of insanity is doing the same thing over and over and expecting a different result. Late  last month, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced that the two institutions would start purchasing mortgages with down payments as low as 3 percent instead of the already absurdly low 5 percent minimum both institutions currently require. These FHFA-insured loans are for borrowers with weak credit.

Also, the federal regulator announced loosened mortgage lending rules. It removed the 20 percent down payment requirement for high-quality mortgages that banks determine to have low risk of default and made it less likely that Fannie and Freddie will force lenders to buy back mortgages that go bad.

By expanding the types of mortgages Freddie and Fannie will buy, the FHFA hopes to spur banks to make more loans to first-time buyers and increase homeownership among those with low and moderate incomes. These watered-down underwriting standards are a big win for affordable housing advocates and the banking and real estate industries.

But the feds are sowing the seeds for another meltdown by loosening recently enacted safeguards. Bookshelves sag with encyclopedic volumes arguing that a major factor in the financial apocalypse of 2008 was relaxed lending practices that led to the housing bust. How quickly we forget.

Back then the weakening of underwriting standards, and especially low down payments, increased home ownership and housing prices, which led to a housing price bubble. The banks had packaged and sold to investors bundles of risky mortgages with teaser rates that ballooned after a few years. Many borrowers ended up defaulting on the loans when the interest rates spiked. As a result, the value of the mortgage securities plummeted, and banks and investors holding them lost billions.

The debacle helped ignite the financial meltdown that plunged the economy into the deepest recession since the 1930s and necessitated taxpayer bailouts of banks and Fannie and Freddie. Following this debacle, there was a push to tighten mortgage lending standards and have banks retain a small portion of the loans they sold as stipulated in the Dodd-Frank Act of2010.

Those of you who’ve seen the classic movie “It’s a Wonderful Life” will remember George Bailey describing to his nervous depositors how the home mortgage business worked. You would visit your local bank and, among other things, the institution would require you to pay a significant portion (like 20 percent) of the purchase price upfront. Along with this down payment, purchasers would be required to demonstrate proof of income.

By granting a home mortgage, George’s thrift institution was exposing itself to risk. A buyer could fail to make the monthly mortgage payments. And since the institution kept the mortgage on its books as an asset, it remained exposed to this risk until the mortgage was paid off.

This process meant the initial lending decision was based on careful consideration of the customer’s creditworthiness. To the extent feasible, the institution would seek to grant mortgages only to its own customers so it could be confident that the homebuyers were safe credit risks. The pluses and minuses of this simple model are obvious.
By selling the packaged loans to others, banks could remove the loans from their balance sheets, which allowed the banks to increase their loans without technically violating the rules in regard to minimum capital ratios.

Providing low down-payment loans to borrowers with weak credit, then bundling and selling those loans drove the American financial system to the brink of collapse. Less than a decade later it appears that no one remembers.

originally published: November 8, 2014