Way Too Big to Fail: How Government and Private Industry Can Build a Fail-Safe Mortgage System [Paperback]

William A. Frey (Author), Isaac M. Gradman (Editor)

Book Description

Publication Date: October 31, 2011

With the consequences of the subprime mortgage crisis still making headlines more than four years after its onset, there can be little doubt that we are facing one of the greatest financial calamities in United States history.  Although many accounts of this crisis have pointed fingers at particular villains or causes, none have offered a complete plan for rebuilding the all-important U.S. mortgage market - until now. Investor advocate and structured finance expert William Frey has proven that he is one of the few people in the world with the expertise to build a successful mortgage finance market, having created from scratch a mortgage backed securities market in Russia in 2006 that continues to thrive today. In Way Too Big to Fail, Frey reveals why we are at a critical crossroads as a nation between a future mortgage market dominated by the government and one that is powered by the private sector. If, consistent with the statements of this administration, we are working towards the latter, important changes must be made right now. Drawing on his colorful experiences as a banker, trader, researcher, and salesperson throughout the twists and turns of the mortgage boom and the resulting mortgage crisis, Frey lays out in clear and accessible language how realigning economic incentives in the U.S. mortgage market can bring back private capital, revitalize a broken system and make the dream of homeownership a reality once again.

Editorial Reviews

Review

"Way Too Big to Fail is an essential book on the mortgage crisis. The book is invaluable for understanding not just what made the bubble, but everything that transpired after it burst. It should be required reading for anyone thinking about how to rebuild U.S. housing finance."

Adam J. Levitin, Professor of Law, Georgetown University

From the Inside Flap

About the Editor: ISAAC GRADMAN is an attorney who was involved in some of the earliest litigation arising from the subprime mortgage crisis. He authors the law blog, The Subprime Shakeout and is the managing member of IMG Enterprises, an MBS consulting firm. Isaac received his B.A. in Political and Social Thought with Highest Distinction from UVA, where he was a Jefferson Scholar, an Echols Scholar and a member of the Raven Honor Society, and received his J.D. cum laude from N.Y.U. Schoolof Law, where he was a Dean's Scholar. Isaac also clerked for two years for the Hon. Joan Lenard in the United States District Court in the Southern District of Florida.

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Product Details

• Paperback: 358 pages
• Publisher: CreateSpace Independent Publishing Platform (October 31, 2011)
• Language: English
• ISBN-10: 1463660464
• ISBN-13: 978-1463660468
• Product Dimensions: 9 x 6 x 0.7 inches
• Shipping Weight: 1 pounds (View shipping rates and policies)
• Average Customer Review: 5.0 out of 5 stars  See all reviews (6 customer reviews)
• Amazon Best Sellers Rank: #1,824,471 in Books (See Top 100 in Books)

More About the Author

About the Author and Editor

WILLIAM A. FREY is the Principal and CEO of Greenwich Financial Services (GFS). Bill began his career in the securitization industry on Wall Street in 1981 during the industry's infancy. After nearly fifteen years in various major firms, including Morgan Stanley, Smith Barney, and Bear Stearns, Bill founded GFS in 1995. At GFS, Bill structured and sold billions of dollars in MBS securities structured from various types of collateral. In 2003, recognizing that the US market was likely to undergo a substantial decline, Bill began evaluating MBS securitization opportunities in other countries. In 2005, GFS completed the first Russian securitization and then the first securitization of mortgage certificates in 2006. Both transactions won acclaim and industry awards.

Recently, Bill has emerged as the most vocal advocate for bondholder rights in the U.S. MBS market. The central theme of Bill's bondholder advocacy is that the legislative response to the current financial crisis and lack of support for the underlying contracts supporting MBS transactions will massively increase bondholder losses and devastate American credibility in the world financial markets. Bill has long argued that America's ability to re-establish a private mortgage finance system is critical to the recovery of the housing market and the resumption of overall economic growth. His work in helping mortgage investors enforce their contracts with banks has shown him to be one of the few members of the financial community with the courage to stand up to the nation's largest financial institutions and tackle this nation's mortgage problems.

Bill received his B.A from Cornell University and his M.B.A. from Carnegie Mellon University.

ISAAC GRADMAN is an attorney who was involved in some of the earliest litigation arising from the subprime mortgage crisis. He authors the law blog, The Subprime Shakeout and is the managing member of IMG Enterprises, an MBS consulting firm. Isaac received his B.A. in Political and Social Thought with Highest Distinction from UVA, where he was a Jefferson Scholar, an Echols Scholar and a member of the Raven Honor Society, and received his J.D. cum laude from N.Y.U. School of Law, where he was a Dean's Scholar. Isaac also clerked for two years for the Hon. Joan Lenard in the United States District Court in the Southern District of Florida.

Most Helpful Customer Reviews

3 of 3 people found the following review helpful

5.0 out of 5 stars Essential Reading On The Mortgage Crisis, By Reviewer Michael Ginsborg January 7, 2012

By Paula P Ginsborg

Format:Paperback

(Fairness requires me to disclose that I was a colleague of editor Isaac M. Gradman when he worked at the law firm of Howard Rice.)

William A. Frey has distilled penetrating insights from his career in what may be the most comprehensive, accessible primer on residential mortgage securitization. (H even includes a glossary for further guidance.) Using lucid explanations and examples, he has written his book for policymakers and lay readers new to the subject, with the hope that legislators, regulators, and MBS participants will adopt his proposals.

Frey offers much more than a much-needed introduction to the complexities of mortgage securitization. He provides a short overview of the historical context for the mortgage crisis. He not only explains its causes and government failures to remedy it, but also proposes specific MBS reforms that rationally realign incentives of all participants in the MBS market. He finds that the crisis will continue unless the federal government stops interfering with MBS contracts and helps MBS investors resolve conflicts of interest among servicers and other MBS participants.

Frey's insights will help fill a gap in the public's understanding of the mortgage crisis, whether or not his reform proposals merit wider political support. In fact, in at least two of his proposed reforms, Frey appears to aim at the wrong target. He singles out the perceived risk-advantages of homeowners as a primary culprit in the crisis, without fully considering the role of systematic, regulatory failures, especially by the Federal Reserve.

Frey identifies large interest rate movements as a significant cause of both the savings-and-loan and MBS implosions. Interest-rate swaps, MBS insurance, and other hedging devices have not sufficed to protect MBS investors from the risk of large interest rate swings, because swings of sufficient magnitude overwhelm the capacity of their counterparties. Homeowners have shifted the burden of this risk on MBS investors, because homeowners have what Frey calls an "interest rate option" built into their fixed-rate mortgages. If interest rates fall, many or most homeowners could, until recently, refinance their mortgages at lower fixed rates, with MBS investors losing the additional years of higher interest that they would have otherwise earned. On the other hand, if interest rates rise, homeowners will gain advantage from continuing to pay lower fixed rates on their mortgages, depriving investors of higher returns on mortgages at the new rates. In response to interest rate swings, homeowners will exercise these mortgage "prepayment" choices en masse, with destabilizing consequences for the MBS system.

Moreover, homeowners who can not refinance their mortgages may "strategically default." Where they owe more on their mortgages than the value of their homes, they may decide to stop payments that they can still afford, allow their mortgages to default, and then "walk away" without financial penalty. (Frey does not appear to consider a ruined credit record a significant financial penalty.) Strategic defaulters compound losses for MBS investors and prolong the crisis by further depressing home values, and consequently increasing defaults.

As a result of these circumstances, homeowners enjoy a "win-win" advantage over MBS investors. Because "it is practical if not impossible" to mitigate or prevent large interest rate movements, MBS investors bear too much risk when they occur. Among his reforms, Frey therefore recommends eliminating the interest rate option in mortgages: under his reform, homeowners would have no financial incentive to refinance when interest rates fall and no disincentive to pay off their mortgages more quickly if interest rates rise. He also favors ending strategic defaults by requiring homeowners to bear liability for their foreclosed properties.

It is unclear how U.S. homeowners would prove any better prepared than MBS investors to assume the risk of interest-rate swings, especially given staggering consumer debt combined with current mass unemployment and stagnant or reduced wages. In addition, Frey exaggerates the problem that strategic defaulters pose to systemic risk and the ongoing crisis, even as he points out that they represented just "19% of total mortgage defaults by mid-2009." "Given how much housing prices have fallen," New Yorker's finanical columnist James Surowiecki asks, "the question is why more people aren't just walking away." (http://www.newyorker.com/talk/financial/2011/12/19/111219ta_talk_surowiecki)

At any rate, the Federal Reserve has been able to respond to large interest rate swings. Between 1979 and 1983, the Federal Reserve under Chairman Paul Volcker steeply raised the federal funds rate, bringing inflation - and ultimately high interest rates - under control, although at the cost of a severe recession. The Fed also has the authority to prevent and deflate housing-price bubbles as mortgage rates rapidly decline. In fact, the Fed had compelling evidence of a housing-price bubble just as it was inflating, but decided not to investigate and to take commensurate action by raising the federal funds rate. (...) If the Fed and other agencies had intervened in the earliest stage of the mortgage crisis, they would have not only minimized fallout for MBS investors, but prevented or shortened the economic downturn.

Michael Ginsborg

2 of 2 people found the following review helpful

5.0 out of 5 stars A Bright Light Into A Den of Cockroaches+Real Solutions February 29, 2012

By Steve Dietrich VINE™ VOICE

Format:Paperback|Amazon Verified Purchase

OK the title might be a little over the top. However, you may very well agree with me when you finish the book and look at the impact this issue and its deliberate mismanagement has had on your nation, your state and your family and how the public continues to be raped by those who claim to be doing good.

One of the great tidbits of the book is back on page 264, a letter from Barney Frank acting as Chm of the House Committee on Financial Services and signed by 6 members. Most likely the letter was drafted by outraged banks whose blatant attempt at theft by government gift from the noteholders had been dragged into the light. The letter from Barney begins with "We are outraged...."and continues on to demand that Frey appear before the Committee to explain his crimes of free speech. Frey relates his amazement that during the pre appearance interviews, Barney's staff demonstrated time and again that they had no concept of how the securitization process worked or the content of the basic documents. In the end they decided that hauling Frey into the tv lights would simply prove what the public had come to suspect, they were idiots on the payroll of the perps.

Most of us are likely to finish the decade from 2005 to 2015 poorer than we started. OK our financial statements may not reflect the loss, but that's only because we do not carry our share of the national, state and local debt plus underfunded government pensions on our financial statements. The primary cause of this debacle was the widespread malfeasance and corruption in the real estate and securities industries during the middle of the last decade.

A few hours before starting the book I read an article on the California AG and the 49 state settlement in one of the national magazines. Nowhere in the article did it mention that the settlement is a sellout to the banks. The essence of what the Frey documents is that all of these settlements have enriched the banks at the expense of the innocent investors who in most cases suffered due to corruption in the banking and investment banking industries.

Frey continues on to explain that the stakes are much higher than the press discusses. In order to make the investors responsible for the bank's corruption, greed and/or stupidity the government is trashing the contracts between the investors and the banks and wall street. All of us in the United States have enjoyed a lower cost of capital and loans than the rest of the world due in large part to the perception that we are a nation of laws. That includes the laws of contracts.

Frey infuriated Barney Frank and Diane Watson (perhaps the dumbest person to ever be elected to the house) and 4 others when he wrote and editorial pointing out that Congress, under a flood of bank money, was robbing the innocent to reward the guilty. Barney called him irresponsible; but later backed down on calling Frey to testify after Frey showed the congressional staffers that they simply did not understand what they were doing.

Frey does not just criticize, rather he goes on to analyze the foundational problems and provides real solutions. I may not agree with some of his solutions but overall he has done an incredible job.

Isaac Gradman, who edited the book offers priceless wisdom in subprimeshakeout.com, a great site focusing on the ongoing problems in the industry.

In the runup up to the collapse we were surrounded by early warning signals that a crash was near certain. Prof Cauley at UCLA made no friends when he told a large audience of largely financial services folks that there was simply not enough personal income to support the housing prices and that a 30%-40% correction was near certain. My former grad students were picking up the same vibrations. One commented that they decided to get out of the development business when their deadbeat, blue collar tenants were able to move into new homes. A Saturday morning spent in the offices of a real estate agent or loan broker would have exposed the chilling truth, that the pyramid was built on falsified financial statements or no statements. Home appreciation had become an entitlement. A very few like Andrew Lahde understood that the rotted foundation of the securitized debt rested on and even more unstable base of wishful debt ratings, credit default swaps designed to produce reportable income with little thought to the risks and end to end greed.

If somebody tells you that nobody saw this coming, ask them to watch the hearing on YouTube where Congress (Barney Frank and friends) killed the investigation into the true condition of the GSE's. Raines and Gorelick were looting the GSE with manufactured earnings which lead to millions in unearned bonuses.

If there is an area where I disagree with Frey it is in some of the factors leading up to the debacle and the treatment of borrowers who go to foreclosure. It may be related to us looking at the problem from opposite ends of the financial pipeline. My experience is focused in real estate development as a developer, educator and consultant.

I believe that homebuyers acted in a somewhat rational manner given what they were seeing in the market and what incentives they were offered to participate in the process. While I share the belief that more prudent lending practices would have largely stemmed the flow of capital into the bubble, the problem was largely concentrated in the seller, broker, loan broker, originator, appraiser and escrow functions. While reducing non-recourse loans might help bankers it would serve only to move more borrowers from foreclosure to bankruptcy.

Shortly after the debacle I was asked to look at a deal entered into by a young woman. She was in the entertainment business and had a highly variable income. A promoter sold her on the concept of making a no cash investment in a beachfront condo across the country. The promoter assured her that he would cover any negative cash flows.

The promoter and notary arrived at her home with all the documents (150 pages) ready for signature. The first TD lender was one of the government GSE's, the originator of the first, maker of the second and escrow holder was the local (to the project) office of a national bank. For purposes of the discussion we'll call them Stagecoach Bank . The package assembled by Stagecoach's escrow dept included an appraisal at the purchase price, a closing statement that disclosed a normal real estate commission to a local broker and an additional payment of 10% of the purchase price to the promoter, an agreement that the property was the borrower's primary residence and would not be rented and a few pages later a rental pool agreement. With the first and heloc the borrower even got some cash back from escrow. In the words of our Senator, it requires the willing suspension of disbelief to accept that Stagecoach was not a well informed participant in the process which violated virtually every principle of sound lending along with a number of laws.

Other investigations have documented large lenders and developers demanding that appraisers increase values to facilitate making loans that were doomed to fail on day 1. There's also a vast amount of email traffic documenting that originators knew the loans were toxic from day 1 and were in a mad rush to get the loans out the door before they collapsed. Perhaps that why some retained the first loan payment at closing so that the loan would be "seasoned" when passed on.

Giving lenders access to buyers assets may improve the lender's position. However, any increase in security is likely to be offset by a decrease in lender standards. Commercial real estate lending works with non recourse lending at more conservative underwriting standards.

In summary, my belief is that the problem is not the borrower but the chain of self serving financial intermediaries who were thoroughly corrupted by their greed. Yes, in some cases the borrowers submitted falsified statements regarding income and assets but all too frequently that was at the instigation of the loan originator.

If the government paid one of the Beltway Bandits $50 million to write an analysis of the failure and how to prevent it in the future they would fall far short of a report of this quality. Simply put, Frey has a unique background and skillset that has allowed him (with the assistance of Gradman) to write the textbook analysis of the crash and how to avoid it in the future. He accomplishes the task in less than 250 pages and then added extensive references, the infamous Barney Frank letter and other source material, all in a highly readable format.

We are fortunate to have people of Frey's and Gradman's intellect and integrity. The author notes that he worked hard to steer a middle course, presenting the facts but not making a political statement. It's a plague on both political houses and perhaps time for a wholesale housecleaning in Washington, including the Czars, agencies and wonks. We were threatened with 8% unemployment if we did not fork over a trillion dollars. But, unemployment rose far above 8% and real unemployment is much greater.

If you read only one book on this issue , read this.

1 of 1 people found the following review helpful

5.0 out of 5 stars Enjoyable and Informative February 7, 2012

By Jonathan M. Prober

Format:Paperback|Amazon Verified Purchase

Way Too Big to Fail is an important book focusing on the vital issue of the (surprisingly large to many folks) securitization market.

In particular, the book excels in two major ways:

First, it discusses important issues regarding the U.S. real estate market and overall economy in an easy and enjoyable way.

Second, it proposes solutions rather than just re-telling the story of how we got into this mess (although it also does an excellent job of providing a holistic historical backdrop in addition to proposing solutions on how to best fix the mess).

I highly recommend all citizens concerned with the future of our economy to add this insightful book to their collection.