Jon Lafferty:
What is that old commercial, “Bah, bah, bah, dah, dah, dah, wouldn’t you like to be a butter too?”

Tony Abate:
No.

Jon Lafferty:
Where is it from?

Tony Abate:
“Wouldn’t you Like to be a pepper?”.

Jon Lafferty:
Oh! It’s to be a pepper. You know I hate that soft drink. I’ve never liked it, but their commercials are pretty cool. Hey everybody. Welcome to Avoiding Real Estate Turbulence Podcast. This is your pilot, Jon Lafferty with CENTURY 21 Town & Country.

Tony Abate:
And copilot Tony Abate, with Ross Mortgage and we are your Real Estate pilots. I do like Dr. Pepper by the way just so you know. Hate the commercial. I’m on the polar opposite of you. Our job is to be your real estate advocate, and also make sure you’re educated about the buying and selling process. We’ll keep you informed throughout until we get you safely closed.

Jon Lafferty:
In a real estate transaction, there are many reasons why you can encounter turbulence. Today, we are going to talk about, I guess government oversight, and how it can help you in this discussion today.

Tony Abate:
Yeah, this is an interesting topic. It’s really amped and flowed since before the recession, and then through this recession, and then back out of the recession.

Jon Lafferty:
I think what interested me about this topic, Tony, I came across a law that was passed in Canada back in 2016. The reason for it was because in Toronto and in Vancouver, housing prices were out of control. They were appreciating at such a rapid rate that people were getting priced out of the market. And so this was their attempt to try and adjust, to make a change so that people weren’t buying above their means, and setting themselves up for failure.

Jon Lafferty:
So one of the first things that they did was they said, “Hey, if you’re a first-time home buyer, and let’s say the interest rate is three and a half, well, whatever you qualify at three and a half, you have to be able to qualify at four and a half. And if you can’t qualify four and a half for that, well what do you qualify four and a half for?” Whatever that number is, that’s what you qualified for.

Jon Lafferty:
So apparently the Canadian government in all their wisdom said, “Hey, this program is working fantastic. So why don’t we just make it the law for everybody for any house that they want to buy?” So in the secondary mortgage market … I’m sorry, not the secondary mortgage market, but in the buy up market, where people are selling that first home, or that next home to buy a bigger home, or something that is in a better area, now they have to go through the same test.

Jon Lafferty:
“Hey, I can buy a 600,000 dollar house at 3.5%. Would you be able to buy at 4.5%?” “Not a 600,000 dollar house. No, my purchasing power is only maybe 500,000. Well, crap, I can’t buy in the area that I want to buy in, so where the heck’s my incentive to move. There isn’t one anymore. I might as well just stay put. I’m kind of happy with my house and so we’ll just stay put and not sell.”

Jon Lafferty:
And so it’s created an arbitrary shortage of inventory now because people aren’t moving up, and you’ve got the high-end houses, that are sitting longer and can’t sell. So what’s happening? It’s forcing prices to come down.

Tony Abate:
Oh, man. Unintended consequences.

Jon Lafferty:
Unintended consequences.

Tony Abate:
Yeah. So it’s interesting, sort of the opposite of what’s been going on here, right? Where people are afraid to move, because they don’t see anything that they like at the higher end, or at the higher price range, or maybe even taking a step down into a smaller home, or right sizing as you like to say. So you have a lot of people who have empty nesters, who are in 2000, 3000, 4000 square foot house, three, four or five bedroom homes. All the kids are gone. They moved out, they’re married, they’re in college, they’re on their own, and they don’t want to sell. Why would I sell and buy something that I either A, don’t want or B, have to find something that’s maybe equivalent of what I currently own, and I don’t want that. So I’ll just stay put.

Tony Abate:
Yeah. What’s the point if you’re not getting a benefit? Why go through the emotional roller coaster, the expenses, the whole thing, if it feels lateral?

Jon Lafferty:
Yeah. What’s the point?

Tony Abate:
Yeah. So, Canada is watching out for its citizens whether they want to be watched out for or not, is how that works.

Jon Lafferty:
Yeah. So you can see if you back up and look at it from 30,000 feet, the intention was to stop appreciation from pricing everybody out of the market. And the unintended consequence was, people aren’t moving anymore. They can’t afford to buy what they normally would be able to afford to buy.

Tony Abate:
Oh yeah. I think whenever, in this case the Canadian government and certainly our government too, feels that people are being harmed by transactions such as this. They feel the need to step in. And that’s what’s happened in Canada and happened in the US as well.

Jon Lafferty:
Yeah. So here’s something that the Canadian government does with the good intention in the outset. Anything that the American government has done at the outset that you get into and say, “Oh crap, this was not what was intended.” They created the CPFB in reaction to the housing bubble. That was one of the things that they did. They also passed Dodd-Frank with the intentions of stopping predatory lending, and banks getting involved in investments, and doing these other things. Right?

Tony Abate:
Yeah. My goodness, we could do a whole podcast on just the progression of things that happened in the recession, that’s for sure. But you nailed it. So-

Jon Lafferty:
And we’re going to.

Tony Abate:
I think we should.

Jon Lafferty:
I’m looking forward to that podcast that, where I want to hear about your experiences, and maybe we can start, I don’t know, 2000, 2001, 2002, when you can start to see the ramp up. From your perspective, from the lending perspective, what you saw as we got into 2006, 2007, and 2008 when the bottom fell out, and boy, I saw a lot going up to that too. It was some pretty crazy times. There was money laying all over the place and being thrown around everywhere.

Tony Abate:
That’s going to be a colorful podcast Jon. I mean it was a crazy race to the bottom on a lot of levels. And boy, you talk about some unintended consequences along the way. It was quite a ride.

Jon Lafferty:
I felt like a rockstar during that time. Let’s just rock and roll was what was going on in real estate lending at that time, it seemed like.

Tony Abate:
Sure. Yep. No doubt about it. So yeah. Because of the recession, because of lending practices that the US government also got into some guardrails, some checks and balances, whatever you want to call it, through the CFPB, which has been renamed but the regulatory body said, “You know what, we need to put some curbs in here to prevent certain lending practices.” So, what happened, and this happened in January of 2013, there were a couple of things put into place.

Tony Abate:
One was called the ability-to-repay rule. And that dovetailed into what was defined as a Qualified Mortgage. The whole intent was to put regulations in place, really to stop some careless lending practices that were going on, going into the recession. I’m not an advocate of regulation for regulation sake, but I would be the first to say that things were really out of control from a lending perspective prior to all this, and there needed to be something in place.

Tony Abate:
What’s really hard in my opinion is for regulations to be put into place, that are going to provide the adequate protections, but are applied fairly to everybody. I mean, everyone’s financial situation is so darn different. It’s a little bit difficult to have a filter that’s put into place that number one accomplishes the goal, which keeps people out of financial trouble but then also treats everybody fairly.

Tony Abate:
So what Canada did is that they applied an arbitrary indexed rate, if you will, that says, “Well, even though the rate is at three, we’re going to qualify you as if it’s at four.” The intent is just to apply some cushion that keeps people from overborrowing. Where a 1% index came from is unknown, and arguably it’s arbitrary.

Tony Abate:
I mean why does somebody decide that, “Well, it’s a risk at 3%, but it’s safe at 4%.” Why not three and a half? Why not four and a half? It’s just a number that’s pulled out of the air really. But it allows the parties that be to say, “Hey, we’re doing something. We’ve done something, and we’ve got your back.” Good, bad, or indifferent, who’s to say.

Tony Abate:
Our regulators here in the States did something a little different. They took an approach that says, “We need to really just make sure that lenders are doing, at least in the regulator’s mind, the best practices before approving loans.” And so this ability-to-repay rules, were set out to accomplish that. So the ability-to-repay, it protects consumers from risky lending practices that certainly contributed to the real estate downturn and the recession.

Jon Lafferty:
What would be an example of a risky lending? What would be an example of that?

Tony Abate:
Well, there’s a few. Probably the one that is most egregious and most known, is when lenders were doing loans without any income verification to be had. The rationale was, “Well. Hey, based on a person’s credit score, maybe based on a person’s down payment, we don’t need to verify, and we don’t really care what that income of that person is.” Sounds a little crazy, but that was the rationale at the time.

Tony Abate:
And then what happened is, lenders would get into a horse race as to who could get a little more aggressive with that approach. Because you could arguably say, “If somebody is making a 30%, 40%, 50% down payment, and they’ve got stellar credit, in many levels what they’re earning is not really an element of that risk evaluation.” There’s already a lot of built-in protection there.

Tony Abate:
But then what happens is that a lender says, “Well I’ll do this at 40% down, with a 760 credit score.” Well and the competitor says, “Well, you know what, I’ll do it at 30% down, with a 720 credit score.” And it kept happening, and happening, and happening, and we got to the point, where lenders were doing no income verification loans with a 580 credit score. It was just a recipe for disaster. And sure enough, that’s what happened.

Jon Lafferty:
Stated income, stated asset. Well you bring up a good point. So would a lender today touch a purchase from a buyer with 50% down, and a job per se, and makes income but works part-time, and then has let’s say, social security, or disability income, and maybe the debt to income ratio is higher than what you’d like to see, but they’re putting 50% down. Where’s the risk?

Tony Abate:
Right. Well the scary and maybe surprising answer is that, those are coming back in. Let’s continue on down the path of that ability-to-repay rule, because there’s a couple of elements that come into play. So what the regulators decided is that, lenders have to follow these ability-to-repay rules, which in essence basically said, “You need to verify sufficient income. You need to verify sufficient assets. That debt load can’t exceed a certain percentage, et cetera, et cetera.”

Tony Abate:
All really common sense things when you get right down to it. And then they went on to say, “If you do those things, then that mortgage is considered a Qualified Mortgage or a QM that you often see it abbreviated as. And if you’re doing that Qualified Mortgage, you as the lender are protected against liability if that person goes into default.”

Jon Lafferty:
So let’s explain that. Flush that out. So what do you mean by that? Do you mean, “Hey, if that loan defaults, you as the lender don’t have to buy it back, or don’t have to pay a penalty because it fails?”

Tony Abate:
Well, no, it’s more so you can’t be held accountable for running afoul of the ability-to-repay rules. And so the regulators can’t say, “Look, we’re going to sanction you. We’re going to penalize you, we’re going to take action against you because you did this loan outside of the rules.” If you did it within those rules, and the loan goes into default, all those remedies still come into play. There’s foreclosure, there’s a lender who might have to buy a loan back, but the regulators can’t say, “You’re coloring outside of the lines. We’re going to fine you, or sanction you, or something like that.” Because you closed what was defined as a Qualified Mortgage.

Tony Abate:
Now, fast forward. So let me give a short explanation on that. It didn’t say that lenders could not do them. It just said that lenders could not do them, and still throw that into the bucket of what was called the Qualified Mortgage. So now as the economy has improved, administration has changed, et cetera, et cetera, what some lenders have chosen to do is say, “You know what, we feel that a 50% down loan, and a high credit score, and no income verification is an appropriate lending risk, and therefore we’ll do that loan with the knowledge that that loan will not be classified as a Qualified Mortgage.”

Tony Abate:
So lenders do expose themselves to some risk that the regulators might say, “Hey, you know what? You’ve done some egregious things, and we’re going to come and get you.” But their conclusion is, “We vetted this product thoroughly enough that we feel that the risk level is appropriate.” And there’s thresholds. If your default level is below a certain level, and you’ve done certain things to ensure that it’s been handled properly, then you’re okay, but it’s lender … Here is what it is in a nutshell. Lenders are choosing to take on additional risk because of where the economy is, and because of where certain rules are right now, even though they won’t have that QM protection as it’s called.

Jon Lafferty:
And obviously the more risks that they take, the more riskier a loan is per se, the higher the return on it. Because you’re charging a higher interest rate to that [inaudible 00:15:27] .

Tony Abate:
Correct. Now putting some perspective here, this bucket of loans that are what would be called non-QM Loans, that are out there right now, it’s a fraction of what was out there going into the recession. I will say that lenders overall are being far more careful with that kind of thing. But it is telling that lenders have gotten back into that, where such loans were absolutely unavailable in the years coming out of the recession, and for good reasons, lenders got their clocks cleaned with defaults on carelessly underwritten loans that fell into that category.

Jon Lafferty:
Can we just talk a minute about, how loans are packaged, and sold, and are grades put to them? So this is an A portfolio, this is a B portfolio of loans, and we’re going to sell it for this. So the high-end portfolios that you put together are highly unlikely to default. That’s why they’re all A-paper. So therefore you can charge a premium when you sell those. And then as you get to the ones that are more likely to have issues that goes down the line, now those obviously have a higher return for whoever purchases that, because of the interest rate being charged. But the person who’s selling that package, is going to get a lower return, because of the risk involved for the person buying.

Tony Abate:
Well, higher risk, higher return is what typically happens. And the answer is yes and no. So right now, no secret, the predominant purchasers of loans are, Fannie Mae and Freddie Mac, and they have the bible of rules, and underwriting, and all the things that have to be done in order to close what would be considered a conforming loan. Provided that those guidelines are met, those loans are then sold to Fannie and Freddie Mac at whatever the market will bear, which fluctuates with interest rates. What used to be around is another secondary market made up predominantly of investment houses, Merrill Lynch, et cetera. Many of which are gone now, post recession.

Jon Lafferty:
Lehman Brothers?

Tony Abate:
Exactly, exactly. The way that worked is when you had this bucket of loans, that were not purchasable by Fannie and Freddie, you remember the term Alt-A, Alternative-A-paper as it was called, there would be rating services such as Moody’s that we’ll say, “This bucket of loans has this type of a credit grade, and therefore its value is X and it’s risk level is X.

Tony Abate:
And so the Lehman’s of the world will look at that and say, “Well, hey, it’s throwing off a rate of whatever, 7%, 8% et cetera, that’s valuable. So we’ll pay for that bucket of loans.” The problem was that the Moody’s of the world, got a little sloppy, and loans that were filling in that bucket, covered a much larger spectrum of risk, than what that credit rating would lead a person to believe.

Tony Abate:
So right now, Jon, there’s a great deal of sale going on to Fannie Mae and Freddie Mac, and Ginnie Mae for the government loans. But there is not much of a secondary market for this newest batch of Alt-A loans, that are coming back into the fray. Basically a lender makes that offering, and then they’re going to keep that. And the reason is that, it became a known conclusion that there was really no real effective way to rate those Alt-A loans. And so there just isn’t a market for it like there used to be. So banks and lenders are doing those loans, but they’re doing those with the intent of we’re probably going to hold onto those loans, and not market them to a secondary market such as a Lehman.

Jon Lafferty:
Do you see a point down the road where banks are, well, rating services actually get hyper focused in specific areas, really micro focus? So for instance, let’s just take somebody who lives in West Virginia, just as a random thing, and they work in the coal industry, they’re a coal miner, and they have good credit. They’re putting money down to buy the house, got a good interest rate from their bank. This bank turns around and says, “Hey, we want to sell these loans from all these people here.” Do you see a point down the road where somebody’s rating service may say, “West Virginia, coal, dying industry, boy, inherent risks involved here if we sell these loans as A-paper.”

Jon Lafferty:
Or in Florida with all the hurricanes and everything, anybody that’s along that coast, right. With all the hurricanes happening up and down the Eastern Seaboard in fact. I mean, do you see a point where those loans for anybody that buys their home up and down there could be affected, and no longer A-paper, no matter what their credit score is, or how much they’re putting down. They’re in the path of a hurricane so there’s going to be damage to that house and that asset eventually. We can’t rate those A-paper anymore.

Tony Abate:
Right. Yeah. That’s a great question, and I’m fast forwarding into the future, but my prediction is no. I don’t see that happening. I will give a caveat and say that my success rate on predictions maybe runs 50-50 and that’s about it. But here’s why I say that. So go back to your example with coal, which is a very real and good example of what you’re talking about.

Tony Abate:
Nothing happens in a linear fashion. So as that industry is impacted, you got companies where therefore employers that might still have a good 15 year life span going forward, and you have other companies that might be on the rocks within the next 12 to 18 months. So I would say that type of a conclusion might be a little bit macro in order for our industry, or the rating industry to say, “Well, we’re just not going to touch anything that meets that criteria.”

Tony Abate:
But having said that, you start to see certain trends where the likelihood of continued employment is not great. So I would expect that to be more case by case based on the employer itself. Let’s face it, some of these coal mining companies, they’re parts of conglomerates, and much like GM is doing right now, they might shut a plant here, but they’re going to offer relocation to somebody over there.

Tony Abate:
And then in cases like what you’re talking about with high risk areas because of weather, hurricanes, what have you, there’s a couple things that are really already in place. So when an area is impacted, what automatically happens is that lenders, Fannie, Freddie, et cetera, will say, “Okay, we all know what happened here. For whatever you have going on in the pipeline right now, you’ve got to have re-inspection on these properties before you close them.”

Tony Abate:
So, that happens for protection for those short-term scenarios. For the longer term scenarios of areas that become riskier, I would say that our reliance right now is going to be based on FEMA evaluations. So, which is, I’m not so sure it’s a super comforting way to look at it. But what ends up happening is that in the areas that are impacted like you’re talking about, as the frequency increases, and as areas become more dangerous, FEMA simply says, “We’re not going to put flood insurance in these sections. It’s out.” And then as you know, if you have a property that’s in such an area, and you can’t get flood insurance, there is no financing to be had.

Jon Lafferty:
Or they just make flood insurance so fricking expensive that people can’t afford to have it. So you have a bunch of people in homes who have to go without it. I mean things are different now for sure. But you remember the ’94 Northridge earthquake, and a lot of structures were destroyed. A lot of damage after that ’94 earthquake, and they haven’t had one since. But earthquake insurance was so outrageously expensive, that I’d say probably 75% to 90% of anybody who owned a home, just went without it, just couldn’t afford to pay for it. Just said, “To hell with it. I’ll roll the dice. I’ll take my chances.” I don’t know how many people have it currently, but at what point does the lender say, “You either buy this insurance or else. It has to be on this property or else.”

Tony Abate:
Right. Well, yeah, that’s pretty clear cut when we get into the things like the flood insurance, and I’ll be a little cynical, but I’ll say the lender draws that line when it feels it’s going to stop making money on loans in that area. It does dwindle down to the dollar bill, and it’s tied in with the risk, right? I mean, now you’re talking about collateral that just flat out has a higher risk than maybe something 100 miles away. So, these are some curbs that the government puts into place.

Tony Abate:
The other thing, Jon, as it relates to when you’re comparing the US and Canada piece, you see loan products that are just not on the menu anymore that used to be on the menu. So interest only loans next to impossible to find anymore. Balloon loans, next to impossible to find anymore. And they’re absolutely not conventional loans because those are non-QM loans.

Jon Lafferty:
How about some of that, one of those fabulous products at Neg-AM?

Tony Abate:
Well, my California friend, you know they-

Jon Lafferty:
Fantastic.

Tony Abate:
They were so popular there, weren’t they?

Jon Lafferty:
And Arizona.

Tony Abate:
Yeah, you’re right. And yes, those are absolutely off the menu as far as conventional loans go, for reasons that are obvious. I’ll tell you something that was prophetic. I was on a round table prior to the recession and there were representatives from all over the country, and we were just talking about, which loan programs are still relevant, which ones aren’t. The individual from California, and he was dead serious, he said, “You have to consider the price of our real estate. If we did not have negative amortizing loans, a huge section of the buying public simply could not buy homes.” At the time that individual’s conclusion, he felt was absolutely appropriate. You look back-

Jon Lafferty:
His name was Angelo Mazilo.

Tony Abate:
Nobody might’ve been a friend of Angelo as they often refer to, but you look back now and you think, “Well how crazy is that?” Really all you’re doing is playing with the time machine. You’re without saying it, what you’re saying is, “Well you can’t afford this home but we’ll make it affordable now. But in the future you’re going to have to figure something out, because it’s going to be even less affordable now, or later when you have to start catching up on that negative interest.

Jon Lafferty:
They were banking on the appreciation of the real estate asset, and the building of it. That’s what they were banking on, especially in California. When you have a house that you can buy one year for $400,000, and sell it in a year for $540,000, and it continues to appreciate like that, then you’ve got these crazy ideas that show up, and while we can do this, because we’re going to bank on another a hundred grand or 20% in appreciation each year, it’s going to go on forever. It’s lolly pops and fruity charms.

Tony Abate:
Yeah. But-

Jon Lafferty:
Pretty pebbles.

Tony Abate:
Pretty pebbles. Yeah, but look at the logic there. That means that the only way that that person who bought the home with a negative amortizing loan, could afford that home. When that appreciation happened wants to sell it. That-

Jon Lafferty:
Sell it and move up and get another Neg-AM loan and hope it appreciates more.

Tony Abate:
Yeah. Exactly. It was like pre-programmed speculation, it’s really what it was, and it’s … In the end we see what happened. The bottom fell out. It didn’t work. And how does all that come together? “Hey, it works as long as it works.” And that’s really what it was based on. And then once the market turned, and property values sunk every- …

Tony Abate:
I mean, think about it, the all American financial safety valve for people for years, and years, and years was, “If things really get tough for me, I could always sell my home.” That was always laying in the background. That safety valve was removed when the recession hit, property values fell, and that all important, very legitimate safety valve, and people would not … That was a nuclear option, right? I mean, people would only do that if things really, really, really got bad. Well, things really, really got bad, and they couldn’t execute that nuclear option.

Jon Lafferty:
They had an asset that was worth 20%, 40%, 50% less than what they had bought it for.

Tony Abate:
Right. Yeah. So again, even though I would say I’m not an advocate for over-regulation, this type of regulation that says, “Hey, maybe balloon loans aren’t right for the typical consumer, may be interest only. Maybe negative loans are not right for the typical consumer.” This is appropriate legislation. Interestingly, five large banks have just written letters to the regulators to say, “Maybe we need to be doing away with the QM rules.”

Jon Lafferty:
Oh boy.

Tony Abate:
I know. Short memories. We’ll see where that goes.

Jon Lafferty:
We seem to have short memories or short. Yeah. Well I think this was fun to talk about. I mean, I think there’s a place for regulation, and I think it’s there for a reason, as you and I talking about this has, I think shown. And then you’ve got the example of the Great White North, where you can go, your intentions can be good, but you take it a step too far and you can stymie the entire market.

Tony Abate:
Right. One year especially I can’t speak for Canada, but goodness, in United States, the real estate is such a huge part of GDP. And you start poking at that with regulation that impacts the natural ebb and flow, boy, that gets a little dangerous.

Jon Lafferty:
Yeah, I agree. 100%.

Tony Abate:
Yeah. All right. Good topic.

Jon Lafferty:
Yeah, thanks. Hey, thanks for flushing that out. It was really interesting.

Tony Abate:
Yeah, absolutely.

Jon Lafferty:
Oh, I’m on the wrong page.

Tony Abate:
Oh, oh.

Jon Lafferty:
Hey. Thanks for listening to Avoiding Real Estate Turbulence podcast. If you’d be so kind as to subscribe, review, rate, we would appreciate it. Please share with your friends, family, and coworkers. You can find us on Apple Podcast, Google Podcast, and Spotify. Coming soon we’ll have a landing page where you can find all of our podcasts together in one spot. That is coming soon. Thanks for listening. Have a great day.