Trading Prudence for Profit

TASA ID: 2763

I have been reading and listening to a great many commentaries about the state of the economy, the mortgage industry, the reasons for the problems and the wide range of suggested solutions.

My initial reaction is mostly embarrassment since this was my industry and one that served me well, as I served it well. My subsequent reactions are those of amazement, anger, and finally, disgust. Everyone now has an opinion, an empathetic attitude to the borrowers in trouble, and a solution. Where were these scholars while the absurdity was taking place?  Why does everyone get religion after the indictment?

The bad guy here is the entire mortgage industry-----the entire mortgage industry.  Some were more proactive than others, some simply participants, others unwitting accomplices without the knowledge or expertise to be doing what they were doing. The bottom line is that this industry knowingly and willingly traded prudence for profit.  And let's not forget all those with oversight responsibilities who eased the rules and seemed to be looking away while the good times were rolling. Everyone involved in the industry should have known that this result was inevitable; it was the talk of the industry while it was happening.

But the issue isn't a matter of making money in good times. The issue is how that money was made. Products so removed from practical, prudent lending that the borrowers, the mortgage industry and, eventually, the economy, had to arrive at this place.  Let me be more specific in my rationale.

What are the basics of prudent lending?

• Credit history----the record of how someone pays their debts
• Pay ability--------does the borrower have the regular income to afford this debt?
• Collateral --------is there adequate security in the underlying asset?

Over the years, the parameters surrounding these basics have been tweaked as circumstances changed. As the tweaking got too extensive, rational minds stepped in with limits. The system worked fine. It had its ups and downs, but for the most part, the rules kept the risk contained.  The GSEs were the keeper of the gate---they were the heart of the secondary market; they set the rules; they were the standard.

Enter private label securitization and Wall Street-----Exit common sense under the guise of advanced, sophisticated products.  Rates were falling, and opportunity was there. Sell around the things that were seen as constrictive; down payment, private mortgage insurance, credit score, verifiable income and let's not forget those pesky "ratios."  Picture this scenario with a borrower------

• TELL ME WHAT YOU MAKE A MONTH, AND IT WILL NOT BE VERIFIED.
• YOU DON'T NEED ANYTHING DOWN.
• IN SOME CASES, WE WILL EVEN GO ABOVE 100% LTV TO COVER SOME CLOSING COSTS.
• DON'T USE MORTGAGE INSURANCE, and WE WILL DO IT AS A " PIGGYBACK."
• THE RATE WILL ADJUST, BUT WITH THE PROPERTY VALUES GOING UP, YOU CAN REFI TO A FIXED RATE LOAN.
• WEAK CREDIT----NO PROBLEM

How could an instrument with these characteristics be rated comparable to one with verified income, established, sound credit and adequate down payment?  The term " sub-prime" was much used, but seemed to have a dynamic meaning. In my opinion, the majority of the loans being done in the first 5-6 years of this decade were "sub-prime"----the definition was used more to limit responsibility than to truly define a product type.

How can anyone, much less a whole industry, do business in good conscience based on a product known as a "liar loan"? 

Now we have blood in the water and the frenzy takes over----people get houses they can't really afford, house prices artificially inflate because of the demand and readily available money---there is no more "value," only volume.

Given the environment, refinances became rampant, and the equity is drawn out and put into consumer spending---an artificial housing market is driving the economy. The inevitable happens, and the result is a mortgage crisis.  Mortgage equity is eroded through refis, values fall and homeowners become strapped by values below debt level: both those who refinanced and those who purchased. 

The borrowers can only be held so responsible; they rely on the integrity of the mortgage professional-but the borrower must share, to some extent, in the responsibility; did they really sign an application where they attested to an income that was misrepresented?  

Who will pay for this?  I suspect it will be those who were honest about their income and prudent about their debt. We have seen a variety of proposals to benefit the homeowners who are upside down.  But these are blanket proposals without regard for the individual facts.  I was in conversation with a state that was setting up a department to modify/help borrowers in this bind.  I asked one basic question----What if the homeowner misrepresented his/her income on the mortgage application?  The answer was that the state didn't care about that. I decided not to help.

I understand that some homeowners need some assistance.  I also understand that everyone who gets help is essentially discriminating against me.  We are not being treated equally for our credit decision-making and further, they get a distinct financial advantage in that either some monthly payment or some principal is altered. Even worse, someone who misrepresented information may be given a financial advantage-----------grounds for litigation?

Do I have the solution? No, it is quite complicated at this point, but I do know some steps that need to be taken.  The first is recognizing that this is a man-made crisis, and the second is punishing those who made it. Greed at the expense of prudence should not and cannot be rewarded. Companies not directly held accountable and responsible will only repeat the wrongs when the next opportunity arrives---history has proven this.  There are only losers in this, but those who played by the rules should not be made to pay for it. Already they are paying in lost real estate value.

Helping those who contributed to it is insulting and shows a lack of understanding ( or caring ) of the issue. Posturing and warning without punishment is only rhetoric.

My opinion is just that----my opinion.  It is one of frustration over what I see as a national excuse for so many being caught with a hand in the proverbial cookie jar.

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