by Tanta on 11/03/2007 12:12:00 PM

Good morning, everyone. I slept better than Citicorp's board did last night. But didn't we all?

Yves at naked capitalism has an interesting post up this morning on risk perception. The text is this essay, "Researchers study how people think about what is and isn't risky," at PhysOrg.com, which takes as its point of departure the question of why people live in fire-hazard areas like Disneyland. And thereabouts.

I was struck by this paragraph:

Researchers found people link perceived risk and perceived benefit to emotional evaluations of a potential hazard. If people like an activity, they judge the risks as low. If people dislike an activity, they judge the risks as high. For example, people buy houses or cars they like and find emotionally attractive, then downplay risks associated with the purchase.

Without having seen the original research, I can't tell if the word "activity" here is meant literally or is simply infelicitous phrasing. My intuition, at least, is that what people like in the above examples is more usefully described as a state of being rather than an activity: people like owning nice homes and cars, not the activity of purchasing homes and cars. In fact, my intuition is that on the whole most people seriously dislike at least certain parts of the activity of purchasing such things. It is only the emotional lure of getting past the purchasing activity that keeps them going.

Anyone who has purchased a home knows that once you get past the early steps--perusing the McMansion porn in the Sunday papers, touring the open houses with a flattering, obsequious real estate agent--it gets to unpleasantries like contracts, inspections, lawyers, financing. Recreational home shopping certainly exists as a phenomenon, as any disappointed broker or home seller will tell you, but recreational home buying is certainly rare. It's just not like whipping out the Visa to snap up another pair of Nikes that you don't really need. Not even the most devoted flipper or serial homebuyer can pull that off every weekend.

I bring this up because I have contended, for some time now, that it is a mistake to see lowering of credit standards as the only real problem we've had going in the mortgage industry lately. It is the attempts to make the process of financing or refinancing a home quick and "painless" that is at the root of the problem. Certainly part of the way you make it "painless" is by relaxing credit standards; these things are related. But the important effect is that borrowers no longer feel put under a microscope (or a proctoscope, as those who borrowed mortgage money ten years or more ago are likely to describe it).

How does that change a prospective mortgagor's perception of the risk of buying a home or refinancing an existing mortgage? It doesn't seem unreasonable to conclude that making the activity less intrusive, in the borrower's subjective experience of it, means that the borrower is less likely to take seriously the written disclosures that describe the risks.

Back when the mortgage process was a great deal more "intrusive," borrowers used to complain bitterly about it. This perception of "intrusiveness" didn't arise simply in the matter of the borrower's credit and financial history; borrowers would routinely moan about lenders "interfering" in sales contracts. Why does some appraisal matter? I should be able to pay whatever I decide the property is worth. Why should the lender delve into my "side agreements" with the seller? Why should the lender be able to delay closing over incomplete items? If I don't care whether the driveway is done or the sod laid, why should the lender care?

The usual lender retort was always that you're doing all these things with someone else's money, and that you pay a lower interest rate for secured money than for unsecured money, implying that the lender has to care as much about the quality of the collateral as about the quality of the borrower. Don't like the lender's view of your collateral? Put it on the Visa; Visa doesn't care what you buy with the loan proceeds. But one of our most powerful ripostes, particularly in the case of cash-out refinances, was the old "paternalistic" standby: you are hocking the roof over your family's head! Take this seriously, will you?

Of course all of that lender "interference" and borrower complaining made for some tense, unpleasant transactions for both sides. And since no "sales oriented culture," which is what even depository mortgage lending operations became once the consultants got done with us, can stand to have unpleasantness, we began easing up on precisely those credit and collateral processing standards that drew the most complaints.

I've heard a number of folks argue that the genesis of recent wretched lending standards is the growth, over the last 20 years or so, of "affordable lending" programs, as if those efforts, led mostly by HUD and the GSEs, to put first-time homebuyers in low-down programs were the main impetus, a number of years later, for stated wage-earner programs using an AVM to offer 1-hour approval for a 95% LTV cash-out refinance on a jumbo property. There may be some truth to the idea that the success of older affordable housing programs was used as a justification for letting subsequent homebuyers and current homeowners do any stupid thing they wanted to do, but to argue that none of it would have happened if those "government" programs hadn't existed is to display one's political biases.

The fact is that those older "government" programs were the most "intrusive," "red-tape"-laden loans that have ever existed. FHA and the GSEs steadily lost market share in the purchase-money mortgage business over the last seven to ten years, as did the private mortgage insurers, even in those markets in which loan amount limits weren't an issue, and even when the rates on their products (30-year fixed) were highly competitive and attractive. "Private" programs were being developed to meet a fairly specific "need," encapsulated by the name of the famous Countrywide product, "Fast and Easy."

I think you can argue that consumers paid more attention to disclosures, spent more time reading documents, and generally proceeded with more fearfulness when things were "Slow and Difficult." It's not because they used to be smarter or we used to disclose more; in fact, just about every year the number and timing of mortgage- and RE-related disclosures has increased in the last two decades. But because the activity of getting a mortgage was painful, the seriousness with which borrowers viewed the risks of it was heightened.

This implies that more disclosure, or more vivid disclosure, is not the answer. We have to go back to a mortgage process that is, intellectually and emotionally, commensurate with its risks. This position can easily be mocked as a suggestion that we do our civic duty by providing wretched customer service. Of course you have to argue, rather than merely assert, that "good customer service" includes removing all visible traces of risk assessment from the process. Nobody is saying you should be rude when you demand those W-2s, or that you should "forget" to ask for them up front, and badger some borrower the day before closing about it. At least one of us is willing to say that that kind of half-assed "customer service" is most likely to thrive precisely in an environment in which our view of risk analysis is totally incoherent to start with.

There's a perfectly silly e-mail making the rounds, asking people to sign a petition opposing H.R. 3519, which the authors of the petition believe would outlaw yield spread premiums (money paid to a broker in exchange for a customer taking a higher rate). The unproven assertion is that all YSP is used to "pay" the borrower's closing costs via a credit, and therefore outlawing YSP would make loans more expensive to consumers. (Yes, the "closing costs" that are "paid" by the YSP include the broker's fees. This is different from the broker just taking YSP from the wholesaler in cash and not charging its compensation in the closing costs because.) It's really a lovely composition, purporting to be from "President" of mortgage company, not third-grader of Mother Khazakstan:

I need all the help I can get this morning. We have U.S. House of Representatives that are considering changing law that would eliminate the use of yield spread premiums in the mortgage place. This bill, H.R. 3915 will affect every one of us weather you are in the mortgage industry or if you are a consumer. This will allow the banks to take full control of all pricing and products available to all Americans. This would make it impossible for third party mortgage loan origination, which would reduce the number of real estate transactions for attorneys, appraisers and home inspectors. This bill would make it impossible for anyone to negotiate an interest rate with lower closing costs associated with the loan or if a borrower has credit issues may not get a loan at all.

Nobody is asking what the effect on consumer perception of risk is in a situation in which not only is no cash down payment required for a purchase, no actual cash outlay for closing costs on a refi is required. It is unpleasant to cough up even a token contribution toward closing costs in actual cash. But that moment of concentration of the mind--writing a check for a thousand or two to a mortgage lender--has been eliminated from the process. It really isn't that the financial facts of this are not disclosed: the TILA disclosures do pretty clearly show the effect on APR of these "no cost" deals. But people do not perceive that "real money" is at risk when they are not asked to pay "real money" in order to close the transaction.

Back in the old days, we referred to that deposit that a property seller requires before signing a sales contract as "earnest money." As in, proof that the buyer is in earnest about going through with the transaction, as it was nonrefundable. Earnest money weeds out recreational and impulse buyers, and also forces serious buyers to pay attention to the process. (It appears to have little effect on manic speculators, but how manic do speculators get when 20% down payments are required on non-owner-occupied properties?)

Removing all the unpleasantness as well as the cash outlays from mortgage transactions, and speeding them up enough to seriously cut into the "cooling off period," is like removing earnest money from RE transactions. I seriously doubt that any study of consumer ability to read and comprehend mortgage loan disclosures is going to tell us anything useful, unless and until the researchers can find a way to approximate stakes for it: the experimental subjects need to have the emotional pull (buying the house, getting the cash) as well as the emotional push (you forfeit your privacy, your time, and a hefty check in the process). It would be enlightening to see a control group with the pull but not the push (no docs required, 1-hour approval, no cash fees). My guess is that more people can spot the difference between the APR and the "payment rate" on an Option ARM if you tell them they forfeit $1,000, payable immediately in cash, if they get the wrong answer, than if they face a monthly payment that is $5.00 higher (because the $1,000 is financed in the loan).

There really isn't anything you can do about the pull: as long as people like to own homes--this isn't an intellectual matter at this level--the pull will be there, as it will be for that big fat check you get in a cash-out. There isn't any particular reason for people not to enjoy those things. My point is that you can waive disclosure documents in front of people all day long, but if the pull is strong enough and the process is so painless that there is no countervailing pain in the activity of getting what you want, the disclosures will strike people as involving remote, rare, manageable risks if they bother to read them at all.

There is some evidence to suggest that borrowers don't actually read them, based on oral representations by interested parties that they are "just legalese": a perfect illustration of an attempt to make the homebuying or refinancing process "painless" (don't subject yourself to the unpleasantness of having to read awkwardly-written, math-heavy documents). A common sense response to this is to make the first disclosure a one-sentence form in 36-point boldface on neon orange paper that says "ANYONE SUGGESTING THAT YOU NOT READ EVERY WORD OF EVERY DOCUMENT YOU SIGN 24 HOURS PRIOR TO CLOSING IS NOT YOUR FRIEND AND IS TRYING TO MAKE MONEY OFF OF YOUR FOOLISHNESS AND IS VIOLATING FEDERAL LAW." But if you did that, you would, well, be taking the "Fast and Easy" part out of the whole transaction.

I expect, by the way, that a real-world example of this dynamic is underway around some preternaturally-waxed conference table in some climate-controlled high-rise office building in New York as we speak. The risk of all those CDOs was undoubtedly presented in the board packets, but the CEO assured the board members that it was just a bunch of "legalese."