It is about a year since the “shot heard around the world,” otherwise known as the subprime crisis, took hold and the misinformation is still circling the globe at the speed of sound. “They” are blaming the wrong parties for everything. Who are “they?” Just about everybody, including the public, the press, the lenders, Wall Street brokers, The GSEs (Fannie Mae and Freddie Mac), the government, the Federal Reserve and probably your hair care specialist. Let me list the culprits in order of blame, according to the above-mentioned, ubiquitous “they.”
1. The lying public which really means the borrowers who were stated-income wage earners.
2. The mortgage brokers
3. The appraisers
4. The underwriters
5. The credit agencies
6. The speculators
7. The lenders
In my humble but well-informed opinion, the list is wrong and really shouldn’t be discussed. What is more important is the fact that everything is being done to almost assure us that this can happen again! If you are chasing the wrong “bad guys,” you certainly haven’t the time to restructure the industry and be sure to get it right this time.
EVERYTHING THAT HAPPENED COULD HAVE BEEN PREVENTED, almost without exception!
Let us start with the stated loans. Every lender who offered a stated loan (no tax returns) had the right to have the borrower sign a Form 4506. Actually most lenders required the borrower to sign this form. It allowed the lender to send the form to the IRS and get the borrowers tax return. Therefore, stated income really didn’t have to be stated income at all. The lenders for the most part ignored this and only sent in 4506 forms in if the borrower missed the first payment. How is that for a simple solution! Check on the horse after he left the barn.
Next we have the appraisal problem. Apparently everyone thinks the appraisers raised the values at the behest of the mortgage brokers. It might have happened 5% of the time, at most, but appraisers aren’t really interested in not being able to appraise. They can only appraise for lenders who have approved their work and have place them on a list of approved appraisers. If they review their work and find them pushing values, then they simply remove the appraiser and he can no longer work for that lender and maybe others as well.
The lender had further protection. They could review the appraisal as a “desk review” or have an actual field review done. In a desk review, the underwriter checks the comps to see that they are really comparable and the analysis grid to see that the appraiser didn’t take to many liberties in his analysis. If they are really unsure, they can have a review appraiser go out to the property and drive the neighborhood as well to see if there are better comps that tell a different story.
Here’s the ironic truth: most of the subprime lenders were diligent in the reviews, while most of the prime lenders weren’t. Appraisals were especially vital on subprime loans where the collateral—the house—is more important because they were lending to a financially weaker borrower. Therefore they reviewed each and every loan, with very few exceptions. The problem came in the 100% loans because it didn’t take much to put the borrower “underwater.” (when the loan is higher than the value of the property). Prime lenders didn’t pay enough attention to the borrowers and the properties they owned when it came to Option ARMs. This proved very costly because these loans were amortizing negatively and the lender’s collateral was shrinking.
Mortgage brokers have been pointed out as scoundrels because they would sell Option ARMs with large margins, little documentation and longer prepayment penalties for the sole purpose of making excessive profits. And of course, we are led to believe the poor lenders were the ones who were victimized. The lenders were the ones who put out the rate sheets, setting the pricing and profit for the broker, and not vice versa. It was the lenders’ idea to have a higher margin (short for profit margin) which is added to the index being used to determine the actual rate. It showed the broker that he could make the most money by giving someone a higher margin and a longer prepayment penalty. If he would do that, the lender could hang on to this higher profit margin for a longer period of time, and the broker would be well paid. Unfortunately, too many brokers were enticed by the extra money.
Now let’s examine credit. We no longer look at the credit history of a person, we look at a score. Most of us haven’t any idea how the credit scoring works, yet it becomes a major factor, if not the major factor in our financial wellbeing. One current late can drop your score 100 points. That would take you from being able to get a loan, 670 score, to being unable to get a mortgage loan, 570 score. Other ways to hurt your credit is too much credit, even if it is paid on time and public records as judgments, tax liens and collections.
There are many problems with credit scoring mainly because the scoring companies do not have enough financial information on the borrower and make unfounded assumptions. There is also a slight bias in favor of the credit grantor. Many borrowers have suffered from credit card companies who charge late fees and go as far as recording a charge-off for renewal fees when you decided not to renew the credit card.
What has happened now because of all of this isn’t pretty. If you are self employed and need a stated loan because you write off every possible expense, you will have a major problem getting a jumbo loan. The credit market still isn’t ready to reestablish stated loans regardless how strong you appear. If you are employed, you are king. If you have tax returns, some reserves (not enough to really help you in a crisis) and decent credit, your loan is secured. From my experience, the financially strong are being victimized while those who are average to weak make it through because they fit in the mold.
You might say “who cares,” but someday it will be your turn to care and you will not be a happy camper.
Those who were called on to help, Fannie Mae, Freddie Mac and the FHA, started by hurting, not helping, and only the cold reception they received from the mortgage market is bringing them back to reality. The net result of what I am saying is that the market forces are beginning to work a bit, but the hopes of the nation that things would change for the better aren’t being realized. There are several reasons for this including the following one that really bothers me. The mortgage market’s statistics will not allow common sense evaluation to factor into determining the qualifications of the borrower. Our rules make borrowers fit into certain parameters and in conforming loan sizes, up to $417,000, the parameters cannot be overridden. If a loan is run through one of Fannie or Freddie’s automated underwriting systems, the findings stay regardless of what common sense would tell you. Only now are they slowly beginning to allow automated underwriting for the conforming jumbos, up to $729,750.
I wish to leave you with the thought that the situation isn’t hopeless, but to avoid another one of these crises we must pressure those who would set future loan qualification parameters to take a hard look at what happened. One can start examining the lenders’ practices and assessing how much of the blame is theirs before you start looking at everything and everyone else.