August 26, 2007

Anatomy of a Corrupt Mortgage Market

The NY Times has an excellent article covering the Mortgage side of the Housing Bubble. WaPo had noted in March this concise list of the toxic mortgage offerings that had been flooding the market:

Which of these products do you think makes sense?

(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.

(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.

(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.

(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.

(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.

(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.

The Times reports that Countrywide was a key player in creating these dubious offerings because that was where the money was. Let's count the ways that Countrywide made money.

  1. Making loans: in 2006 Countrywide made $470 billion in writing up loans, and some 45% of the loans Countrywide made were Adjustable Rate Mortgages.
  2. Servicing loans: collecting the mortgage principal and interest from borrowers for paying the investors brought in $660 million in 2006.
  3. Prepayment fees:in 2006 they made $268 million when borrowers paid earlier than the contract allowed.
  4. Late fees: $285 million in 2006.
  5. They specialized in finding extremely risky borrowers to sell loans to: people who had been 90 days late on their mortgage payments 2 times in a 12 month period, people who had very low credit ratings. Why? Because the returns were so good.

    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.

  6. And anyone who did business with Countrywide were good targets for expensive fees.

    According to dozens of loan documents, LandSafe routinely charges tax service fees of $60, far above what other lenders charge, for information about any outstanding tax obligations of the borrowers. Credit checks can cost $36 at LandSafe, double what others levy. Some Countrywide loans even included fees of $100 to e-mail documents or $45 to ship them overnight. LandSafe also charges borrowers $26 for flood certifications, for which other companies typically charge $12 to $14, according to sales representatives and brokers familiar with the fees.

The incentives of the company were to always push the most risky loan because that was where they could charge the most.

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. It was not until last September that the company changed this practice, as part of what was called in an internal memo the “Do the Right Thing” campaign.

Other questionable practices didn't get phased out until this year: in February they stopped issuing "liar loans" and in March they stopped making piggyback loans.

But what if you couldn't afford the loan they wanted to sell you? No problem: They put in place rules where they would sell loans (with teaser rates, one assumes) so that a family of 4 would be left with $1000 in disposible income after paying the mortgage. Or if one was single, loans were written so the borrower was left with $500 per month.

This crisis will go down in history as one of the biggest scams on the books. You won't go wrong in believing that our current housing woes are due to the "Greed is Good" gang, led by Angelo R. Mozilo, the CEO of that reputable firm, Countrywide. But, of course, we also need to thank Alan Greenspan and the Bush administration for hating regulations so much that this type of business practice was rewarded rather than condemned.

Posted by Mary at August 26, 2007 04:17 PM | Economy | Technorati links |

the news is reporting that the prices for homes are expected to drop for the first time since 1950

That can't be good and doesn't help the mortgage situation.

Posted by: polishifter at August 26, 2007 04:59 PM

In all of your research, which by the way I'm sure you exhausted, did you happen to find out who actually originated these loans? Was it Countrywide or was it a mortgage broker that used the loan program to its own advantage? Programs were designed by Countrywide to assist certain real estate buyers for certain reasons. If the program selected was used improperly and expained improperly shame on Countrywide? I think not. Certain programs are designed to benefit certain types of buyers. Not one of your critical comments makes mention as to how many FHA, RD, and low cost mortgages Countrywide did and still do to assist people into homes that they do qualify for and can afford, just to make them home owners. Report on that!! Of course you won't because that's not where the story hotline is at. I highly suggest you research the whole story before you print just the hot stuff because your all that. Bottom line is this, don't blame the lender for the mistakes and the fraud that was committed by the few individuals to take advantage of what could have been a great deal.

Posted by: Guy Cole at August 26, 2007 05:06 PM

Guy, if you had read the article you to would have gotten some information about Countrywide and their use of FHA loans.

According to the former sales representative, Countrywide’s big subprime unit also avoided offering borrowers Federal Housing Administration loans, which are backed by the United States government and are less risky. But these loans, well suited to low-income or first-time home buyers, do not generate the high fees that Countrywide encouraged its sales force to pursue.

A few weeks ago, the former sales representative priced a $275,000 loan with a 30-year term and a fixed rate for a borrower putting down 10 percent, with fully documented income, and a credit score of 620. While a F.H.A. loan on the same terms would have carried a 7 percent rate and 0.125 percentage points, Countrywide’s subprime loan for the same borrower carried a rate of 9.875 percent and three additional percentage points.

The monthly payment on the F.H.A. loan would have been $1,829, while Countrywide’s subprime loan generated a $2,387 monthly payment. That amounts to a difference of $558 a month, or $6,696 a year — no small sum for a low-income homeowner.

“F.H.A. loans are the best source of financing for low-income borrowers,” the former sales representative said. So Countrywide’s subprime lending program “is not living up to the promise of providing the best loan programs to its clients,” he said.

Mr. Simon of Countrywide said that Federal Housing Administration loans were becoming a bigger part of the company’s business.

You also might want to send your complaints to the NY Times if you think my "reporting" is not up to snuff.

Anyway, it is pretty plain to see that Countrywide participated in every one of the shoddy loan practices and incented their sales people to buy loans that were not good for them in order to make more money for the company. You might not think that is bad, but I do.

Posted by: Mary at August 26, 2007 05:18 PM