How The Economy Fell
“Greed is good.” That is the motto of Gordon Gekko, a major character in Oliver Stone’s movie, “Wall Street.” We all have experience with the benefits of this character trait, as well as the costs.
Before we entered into the new century, the mortgage industry was embargoed from making loans to borrowers with a poor credit history and lack of supportable income because we were all operating under the guidelines established by the consortium of Fannie Mae, Freddie Mac and the FHA. They collectively created the guidelines for loan underwriting that proved to be appropriate for the secondary market institutional investors, including the Wall Street community, retirement funds, insurance brokers, and other investors in mortgage related securities. The lending companies and brokerage firms that issued these loans to applicants, whether for refinance transactions or new purchases, had to abide by those guidelines for underwriting, unless they could hold them in their own portfolios as an asset.
Savings and Loans across the country also looked at mortgage lending products as either salable in the secondary market, therefore subject to the same basic guidelines, or produced their own products for their own portfolio. The now reviled “Option Arm,” “Interest Only,” and “Stated Income” loan products were initially developed by some major S&L’s and Commercial Banks as portfolio loan products. They had been utilized by these institutions for more than 20 years and were available to clients who would qualify for them. The exception to these commonly used underwriting guidelines were those of the then-evolving Alternative-A paper lenders and “sub prime” lenders that became the 21st century dominant sources of mortgage capital to potential borrowers who had income documentation problems, credit issues and/or credit backgrounds that made them more challenging to the prime institutional lenders.
During this time, the amazing growth of companies like New Century, Ameriquest, Option One, and the other participants in that marketplace democratized these more conservative lending option programs to borrowers that would not have had them available five years earlier. Thus was started the slippery slope that enriched many people in the years from 1997 through 2005, which ultimately caused most of these participant companies to close their doors by the end of 2007.
Greed has many handmaidens. In this case, you would have to include the borrowers who wanted to speculate that they could manage more debt than they could and buy a bigger more expensive home. There were mortgage brokers who didn’t live up to their professional responsibilities and mortgage lending companies that ignored many of the warnings that were there to be seen. Rating agencies like S&P, Moody’s, and Fitch hid behind financial structures that were truly halls of mirrors created by financial intermediaries that also paid their fees for the ratings they issued. There were also the institutional consolidators like the major Wall Street companies and the institutional investors who bought these products after they had been converted into Mortgage Backed Derivative financial instruments and given Investment Grade ratings.
As in most major screw ups, including financial upsets, every player had a role in its success – and failure. “A rolling loan gathers no loss,” was the way of business, and as these mortgages passed through many hands, no one saw a need to consider the implications of their actions – as long as they made their money. As a consequence, no one is exempt from the recognition that they helped cause the current industry challenges.
“Back to the Future” was the title of a series of movies in the late 1980s and early 1990s that is also the vision of our collective financial near future in Mortgage Lending. By near future, I mean within the next three to five years. We have looked back to the time when we made loans that required loan underwriting standards would be universally understood and applied. Home purchases would typically require a down payment, and borrowers could expect that their credit scores and histories would be reviewed, leaving them little chance of getting a loan they were unqualified for.
That image seems to be what’s in store for us, because timidity and dejection always let up eventually. There will sometime soon be a persuasive financial professional who will convince himself and his industry that there is great wealth to be made just by being a little more lenient with applicants, and concentrating on short term benefits instead of the long term implications that come with those benefits.At this time, numberous banks and brokers will no doubt assure themselves that they are wiser this time around, know what mistakes to avoid, and can can deal with any hike in default risk, all in the name of a prettier balance sheet.
And so it will start again. Just wait and see.
The author of this article is a 43-year mortgage lending professional and legal mortgage expert witness providing professional consultation and expert witness testimony. He is listed with Consolidated Consultants, an expert witness services company along with many other legal technical expert witnesses. Get their full C.V.’s online. This is a free service.
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