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“A Primer on the Subprime Mortgage Mess” by Joe Fritz

Posted on | January 20, 2009 | 13 Comments

Full Disclosure: from 1987 through 2002 the author was a NYS licensed mortgage broker.  The author is a reader and contributor to Subprime Blogger.  If you are interested in contributing articles to Subprime Blogger, please contact us at jwojdylo@subprimeblogger.com

With the demise of AIG via a  government takeover, the  fire sale demise of Bear Stearns , Lehman Brothers, the Merrill Lynch buyout, the failure of Indy Mac Bank,  Countrywide meltdown and, yada, yada the chief reason for the meltdown was the ability of the homebuyer  being able to buy a home  with no money down.  This was the catalyst for the crisis known as the subprime mortgage mess.

Lest I be accused of laying the blame on the homebuyer you are wrong.   There are many culprits in the above scenario, the last being the unsuspecting homebuyer.   Shortly after the dawn of the new millennium, the rules for mortgages ostensibly changed.  It changed from a basis of purchase from a loan ratio method of buying a home to a credit score method.  Simply put, the loan ratio method that was used for over a century pegged a homeowner’s ability to pay the loan.  It was based on a

28% /32% ratio.  It means that a home mortgage should not exceed 28% of his gross income and the mortgage and outstanding other debts (car loans, boat loans, credit card debt) should not exceed 32% of the buyer’s gross income.  If it exceeded those ratios the loan did not fly.

Shortly after George W Bush took office, the rules changed.  The government in an effort to encourage everyone to be a home owner changed the rules from a debt/income formula to a credit score formula.  The government threw away a formula used for a century to one which essentially espoused the idea, if you pay your debts in a timely fashion and you will have a good credit score.  If you had a high credit score your mortgage rate would be lower than one who did not have a good credit score.  But the mortgage broker wanted to make a loan no matter what.    The mortgage broker was the next piece in the puzzle.  He was able to cook up a deal based on a good credit score and by taking advantage of a lax guideline was able to hatch a deal.

The Real Estate market after the turn of the new millennium started to heat up. Real Estate Brokers and mortgage Broker’s were able to corner this avenue that had lied dormant for almost a decade.  The homebuyer market was moribund because the economy   (at least as far as buying a house was concerned) was soft and the mortgage rates were high.  After 2002/2003, the economy got out of the 9/11 doldrums.  Realtors were able to get low interest mortgage and a new wrinkle was added to the mix, closing costs borne by the sellers.  This meant that a buyer could buy a home with a good credit score, with little or no money down because the banks permitted up to 6% of the purchase price to be used as buyers closing costs.  A buyer needed next to nothing to buy a home.  The government of George Bush encouraged this culture of laissez faire capitalism by when they changed the rules that permitted this.

The next player was the appraiser.  To incorporate closing costs the appraiser kept an acute eye for value, and was encouraged to stretch out values to get a deal cooked by the real estate broker and mortgage broker.  If either the mortgage broker or appraiser raised an eyebrow to this routine, he was cut out of the equation by the real estate broker and the banks.

The next player was the Title Company who was willing to overlook title defects and kept the deals together even though the buyer had judgments or incurable credit problems that could only be cured by faking affidavits or instruments.

Lastly on this list was the Attorney who was usually referred the the homeowner by the Real Estate Broker.  This part of the puzzle supposedly represented a client.  But individual the attorney should have represented was the home buyer. However, his real client was the Real Estate Broker.  A broker would refer attorneys on the basis that they did not kill deals, not on the basis of zealously representing clients.  Like Billy May the barker on television, there’s more…

Once the loan closed the bank would zealously shift the mortgage to those who bought mortgages, to a pension fund, to an insurance company to a brokerage firm or to the federal markets.  The function was to take the money and run. If the loan went south the problem was like in musical chairs, last on the chair was “it”.

By manipulating the rules, buyers got mortgages where they should not be homebuyers.  Those who purchased these mortgages held these securities (“mortgages”) until the economy went south, when the values of homes went down, when inflation started to go up and when homeowners lost their ability to pay, because the homeowner lost their jobs.  At that time the last step came in, the home value was less than the mortgage held by the bank.   Game set and match.  The crisis essentially was fuelled by greed of the above players who were aware that the government was lax and encouraged a culture of voo doo economic practices that were dormant since the early days of the Reagan Administration.

The upside is that everything is cyclical. After a period of soul searching, chest beating, fraud, trials indictments, bank closings etc. the economy will be back in place and get ready to start all over until the next clever idea occurs.  Unfortunately, people’s fortunes do not have decades to right themselves.  Especially with the “baby boomers”, the largest class of Americans who are about to start drawing on their pensions, 401k’s, 403 b’s IRAs etc.  What will occur in the next five years remains to be seen? Stay tuned.

JOE FRITZ is a practicing attorney (30 years), and former mortgage broker, (15 years) who has been a community activist and sometime political candidate.

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Comments

13 Responses to ““A Primer on the Subprime Mortgage Mess” by Joe Fritz”

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