(Bloomberg) -- Imagine going into a community bank and getting a mortgage but not telling the lender exactly where the house you want to buy is. You give the lending officer the zip code, and a few other clues about the home, but you walk out of the bank without having given your name or a street address. Sounds like a scam, right? Well, that’s how most mortgages are financed in the U.S. Investors in private, residential mortgaged-backed securities (or RMBS) are prevented by law from knowing the address for the mortgages they purchase. Naturally, a bank wouldn’t want to lend a few hundred thousand without knowing this information. We argue in a recent study by Reason Foundation that mortgage investors should be allowed the same privilege. It’s an important part of getting the housing market on a path toward recovery. The market for mortgage-backed securities collapsed as a result of high foreclosure rates, particularly on subprime mortgages. Investors lost considerable sums on AAA rated mortgage-backed bonds and have been suing rating companies ever since. Critics of these lawsuits are correct in suggesting that many investors failed to perform due diligence, blindly trusted the ratings system and ignored prospectuses. But even greater investor attention probably wouldn’t have prevented the financial crisis. Since RMBS investors were given only partial details about the properties backing their bonds, and the borrower address wasn’t among them, they could conduct only a limited risk analysis.
Details, Details
Before the mortgage meltdown began in 2007, some had argued that investors shouldn’t have to worry about the exact details of underlying mortgage loans, because the large number of loans in a given portfolio reduced the risk posed by individual borrowers. Clearly, that logic was flawed. Many investors would prefer to do more research on their own, or work with analytic firms to do so. But ignorance of the borrower’s address and identity is a substantial disadvantage. Perhaps the single-most-important predictor of a mortgage default is the ratio between all mortgage debt on a property and its current value, the so-called combined loan-to-value ratio, or CLTV. Loan-level data provides the CLTV at the time a deal is originated, but this value isn’t updated over the life of the deal. When prices were soaring at the peak of the bubble, a mortgage in Phoenix or Las Vegas might have had a relatively safe CLTV, even on a mortgage with little down payment. But as prices rapidly declined, many of those homes began to slip“underwater” with a risky CLTV. Without address-level data, it’s impossible to get a precise fix on a mortgage’s value in real time. As a result, it was challenging for investors to understand how rapidly the value of their mortgage-backed bonds was declining. As we point out in our study, zip codes can contain several thousand properties and may also include large, often heterogeneous areas. For example, single-family homes recently listed on Zillow.com in zip code 20002 (in Northeast Washington) ranged from $250,000 fixers in the Little Trinidad neighborhood to a $2.8 million upscale townhouse on Capitol Hill. Zip codes simply don’t provide enough data to give more than an imprecise estimate of a change in property value. Lawmakers, regulators and industry leaders want to keep identifying information out of investor reports to protect borrowers’ confidentiality. The language of the Fair Credit Reporting Act of 1970 -- the foundation of consumer credit rights -- is a bit hard to interpret, but giving out borrower addresses to investors probably violates its intent. Doing so also clearly violates a nonessential clause of the proposed Private Mortgage Market Investment Act now pending before the House Financial Services Committee.
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