As the light from the torches gleans from a million pitchfork tines after Rick Santelli’s bizarre, gasket-blowing performance on CNBC yesterday, the Los Angeles Times finds an excellent story illustrating how the homeowner bailout is dividing otherwise like-minded Americans.
The LAT’s William Heisel finds two people who live on the same street in Long Beach, California, and are both underwater on their homes. One supports the bailout in part because it may help her stay in her house. The other opposes it. It’s a well-done exploration of both sides of the issue.
But what I really want to point out is how mortgage fraud rears its ugly head even in this story, where the homeowner isn’t exactly walking away from her note . That’s not surprising—it was an epidemic, but it’s one that many just don’t want to see.
Halloran blames herself for spending money she did not have, but she also says her mortgage broker and the bank that gave her the loan — the now failed Downey Savings & Loan in Newport Beach — promised lower payments. The loan documents she signed show an initial payment of $2,900 a month. Her first bill was for $4,200 a month.
That’s fraud point-blank. And this is a woman with a good job, hardly a subprime borrower. Imagine the wreckage unleashed by banks and brokers on actual subprime borrowers, who are much less wealthy and less educated. Don’t believe me? What about George W. Bush’s FBI? Here’s a story from nearly two years ago. And here’s the Seattle P-I’s good effort last month on mortgage fraud.
We know that some half of all subprime borrowers actually qualified for prime mortgages, with better terms, lower interest rates and lower payments, but were fraudulently put into more expensive ones by brokers who were incentivized with bonuses by the Countrywides of the world. But the vast majority of people, and I’ll bet you just about every last one of the commenters on my Santelli post yesterday, don’t know that.
Here’s the late Tanta, writing at Calculated Risk in May 2007, about why that is:
If you’re a reporter or editor who uses “ration” instead of “ratio” and “appraisal value” instead of “appraised value,” it is possible you haven’t had enough exposure to the industry and its lingo to know when smoke is being blown in your direction. And if I say you have no one to blame but yourself for printing nonsense from an industry shill, you better not start trying to explain to me why people who read CNNMoney are at fault if they don’t know more about their mortgage eligibility than their lender appears to. You are a reporter. You could have called Fannie and Freddie and asked them on what basis they have made these estimates. You could have asked Mr. Hardester about the exact nature of the “file review” he performed. You could have identified Guaranteed Rate as a mortgage banker who buys loans from brokers, not as a broker itself. You could have had a V-8.
What you did, though, is give us another “he said/she said” piece of tripe.
Here’s Gretchen Morgenson of The New York Times on why people were put into bad mortgages on purpose (she’s talking about Countrywide here):
The company’s incentive system also encouraged brokers and sales representatives to move borrowers into the subprime category, even if their financial position meant that they belonged higher up the loan spectrum. Brokers who peddled subprime loans received commissions of 0.50 percent of the loan’s value, versus 0.20 percent on loans one step up the quality ladder, known as Alternate-A, former brokers said. For years, a software system in Countrywide’s subprime unit that sales representatives used to calculate the loan type that a borrower qualified for did not allow the input of a borrower’s cash reserves, a former employee said.
A borrower who has more assets poses less risk to a lender, and will typically get a better rate on a loan as a result. But, this sales representative said, Countrywide’s software prevented the input of cash reserves so borrowers would have to be pitched on pricier loans.
Here’s the LA Times story again:
“The ugly part of it is that many of those people who were steered to loans that were not fixed-rate loans or not prime loans could have qualified for better loans,” said Los Angeles County Supervisor Mark Ridley-Thomas, who as a state senator last year introduced a bill that slowed the foreclosure process. “They were eligible for good loans, but there was more money to be made in the bad loans.”
That’s how the system was set up, starting with the Goldman Sachs’s, Merrill Lynch’s, and Bear Stearns of the world. Back to the NYT’s Morgenson (who also had interesting things to say in an Audit Interview last month):
Regulatory filings show how much more profitable subprime loans are for Countrywide than higher-quality prime loans. Last year, for example, the profit margins Countrywide generated on subprime loans that it sold to investors were 1.84 percent, versus 1.07 percent on prime loans. A year earlier, when the subprime machine was really cranking, sales of these mortgages produced profits of 2 percent, versus 0.82 percent from prime mortgages. And in 2004, subprime loans produced gains of 3.64 percent, versus 0.93 percent for prime loans.
One reason these loans were so lucrative for Countrywide is that investors who bought securities backed by the mortgages were willing to pay more for loans with prepayment penalties and those whose interest rates were going to reset at higher levels. Investors ponied up because pools of subprime loans were likely to generate a larger cash flow than prime loans that carried lower fixed rates.
As a result, former employees said, the company’s commission structure rewarded sales representatives for making risky, high-cost loans. For example, according to another mortgage sales representative affiliated with Countrywide, adding a three-year prepayment penalty to a loan would generate an extra 1 percent of the loan’s value in a commission. While mortgage brokers’ commissions would vary on loans that reset after a short period with a low teaser rate, the higher the rate at reset, the greater the commission earned, these people said.
This is the backdrop for the mortgage crisis. Here’s more on how Wall Street created it from Michael Hudson when he was at The Wall Street Journal (also read Hudson’s illuminating thoughts from his conversation with us a couple of months ago).
Critics say Wall Street firms helped create the mess by throwing so much money at the market that lenders had a growing incentive to push through shaky loans and mislead borrowers.
At a hearing in April, Sen. Robert Menendez (D., N.J.), said Wall Street firms “looked the other way” as they profited from questionable loans, “fueling a market that has very little discipline over itself.”
Federal Reserve chief Ben Bernanke said in a May speech that some lenders focused more on feeding the marketplace than on the quality of loans, in part because most of the risks that loans would go bad were passed to investors.
This is what caused lending and borrowing to get out of hand. The boiling anger we’re seeing by citizen against fellow citizen is understandable given that the press still hasn’t fully told the story of the boiler rooms, “the crooked heart of the credit crisis,” as Audit managing director Dean Starkman called it.
That this burst of outrage erupted after homeowners got a (relatively meager) bailout rather than after Wall Street and the banks got their trillions ($10 trillion by Bloomberg’s count) with repeated trips to the trough illustrates as clearly as I’ve seen it the failure of the press to fully portray the real cause of this catastrophe.Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at email@example.com. Follow him on Twitter at @ryanchittum.