There are many stories and crisis that doesn’t touch home and affect us as much as other, but this is one of those stories, or should we say a truth, not a story; that does. It is far more than one reason that this review has been made by so many and yet still being talked about. This has affected the balance of America, and still is, even as this is being composed. There is so much blame and everyone has a different story; some repeating what someone else has said or written and some just speculation.
The Subprime loans began to be originated in 1993. At that time in mortgage; loans were referred to as either prime loans or Subprime loans which meant “A” paper or “B” paper and below for Subprime. At first there were few lenders for who began making their portfolio and would close the loans for the Brokers. One must fully understand the difference in a Broker, a Mortgage Banker, Mortgage Company or Lender.
Broker: The Broker worked as an agent to help bring the applicant and lender together to originate and close the loan. A go between you might say. The Broker could only take the application and gather the documentation. They did not underwrite the loan, close the loan or fund the loan. They were not set up to funds loans. They did not want the liability anyway; who would? This is all they ever did except for those very few in the latter years who became self sufficient to fund their loans themselves; still they were underwritten by the lender who was buying the loan to put into a pool to sell the investor. They still assigned the loans immediately to the lender who sometimes sold the loan again to someone else or an appropriate investor/buyer.
A Mortgage Banker is an institution who makes mortgage loans, processes, underwrites the loan and closes the loan in their name. They sometimes hold the loan in their portfolio to service/take the mortgage payments and do not sell the loan until a later day. Then, sometimes they sell the loan to one of the investors such as Fannie or Freddie, but retain the servicing rights. Usually they sell the loan or at least the servicing of the loan to a servicing company, who only services loans. A Mortgage Company or Lender has the same capabilities. There are some small banks (sometimes a Correspondent Lender) who originate the loan, close the loan and then immediately sells and submits the to a larger lender. A Correspondent Lender, (do not have to be a bank, but have funds available) as mentioned; will originate the loan, underwrite the loan and fund/close it in their name but assign the loan immediately to another lender who purchases loans; who may then sell it to one of the investors. This is a never ending cycle. The loans can be transfered many times to different lenders and servicers.
Initially, in 1993, there were not that many Subprime lenders available. As the market grew, so did the Subprime investors who wanted to make more and more of these loan because the higher interest rates and the higher income for which they received from the people who bought portfolios of these loan that seemed to be giving higher profits.
The closing cost were higher (that is the only way the Broker made any money from these loans) and everybody had to make money. In some case it became totally ridiculous what was being charged on these loans. They all wanted to make this high dollar from these mortgages. No one excluded. The Prime agencies; Fannie Mae, Freddie Mac and FHA decided they want a piece of the pie and started lowering their standards and guidelines so that they could benefit from some of these loans and started making; less than perfect, risky loans.
Let me remind you that Congress passed these laws; in fact, Barney Frank was head of the committee that said; “everyone deserves a home.” That is how it all started and so almost everybody got a home. The banks did not make up the rules or go beyond what they were approved to do as a company. The people that committed fraud were individuals who worked for the companies and chose to do what was wrong and unethical. Not all people believe in fraud that works in the industry. Money can make people greedy and every basket has rotten apples.
The Subprime market grew faster and larger than anyone has anticipated. In 1994 Subprime loan counted for $35B or 5% in origination’s, in 1996 it grew to 9% by 1999 it was 13% and then by the year 2007 it amount to $600B or 20%.
The banks made the loan by the guides and regulations that the governing agencies allowed and Fannie, Freddie and FHA bought and insured them after they were originated. Yes, sometimes they were exaggerated guidelines and over the roof, but they did have guidelines. Let’s not forget that not any regulated Bank, Mortgage Company, Broker Office or any other financial institution cannot lend money, big sums of money, without being audited and governed by an agency; state and federal government. All of the above occurred; even the Brokers offices
The down-fall and collapse began after Fannie, Freddie started making as many of these loans as the Subprime lender. Everyone was making these kinds of loans:
• 2/28 ARM loans- mostly the Subprime lending
• Options ARM loans – Subprime lending loans; these loan allowed for three types of payment for the borrower. It included an interest only payment, a minimum payment and a fully amortizing payment at very low ARM rates. No one made the fully amortized payments.
When all of these ARM loans started to adjust to the higher rates; they payments were out of the borrowers reach because the debt to income ratios had been greatly exceeded when the loan was approved and actually the client’s could not afford the loans anyway.
• Fixed rate and ARM loans with 80/20 financing – 100% loans to avoid MI
• One loans of 100% no Mortgage Insurance – Subprime lending
• Stated Income and Stated Assets – No verifications of income or assets on salaried applicant and self employed applicants
• No Ratios Loans for self employed borrower with high loan to values
• Stated Income, Verified Assets
• Many ARM products used by Fannie and Freddie; just to get the payments in line so that the loan could close
• Loans were made to non-residents and did not have a green card, but had permission to work here
These are only some of the products that were closed to meet the applicant’s needs. Many applicants had unpaid collections accounts, bankruptcies, tax liens, delinquent credit obligations with high loan to values and no money in the transaction; period. In 2006; 43 % of all loans were made without the applicants paying any down payment. This and all of the reason listed above make up the mortgage mess. It was all because of greed and the lack of responsibility from Congress,up or down the ladder (one might say) to the state regulators who did the audits, to the originators and the agencies/investors who bought the loans. Everyone knew what kind of loans were being made, but no one wanted to rock the boat is what it amounted to. If you wanted a loan in the peak period; you could get one.
The seller was allowed to pay all of the closing cost in most instances which was added into the sales price of the loan which was already inflated. To top that off; if the appraiser did not get the value to cover the inflated sales price; everybody would be mad that had an interest in the loan. Sometimes they were. This is now why many properties are underwater or the correct term is: sitting with declining property values that do not support the balance on the loans.
Last but not least; yes, Wall Street was involved as they were selling the securities to these MBS (Mortgage Back Securities) pools with the higher interest rate loans that were now very much delinquent. The pools were falling apart and no place to send them as there was not a third or fourth parties with the cash to take the risk on all of these bad loans as everybody was in the same boat. All of the people who were hold pools of mortgage with these high delinquent loans like AIG, Lehman Brother, Bear Sterns, and Merrill Lynch, along with others not mentioned were left with no place to go but down. When you take these kinds of risk; who can you blames? Seems as if there is no way to pinpoint the blame; all involved were suppose to be intelligent people working for the good of all. My perception is that everyone was sound asleep and in denial when they decided to wake up…..and possibly too far gone to do anything about it.
“Take calculated risk. That is quite different than being rash.”
– General George S. Patton