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How The Economy Fell

“Greed is good.” Those are the now famous words spoken by Gordon Gekko, one of the lead characters in Oliver Stone’s movie, “Wall Street.” We have all experienced both the good side of this motivational tool and the bad.

Before we entered into the new century, the mortgage industry was embargoed from making loans to borrowers with a poor credit history and lack of supportable income because we were all operating under the guidelines established by the consortium of Fannie Mae, Freddie Mac and the FHA. Together, they created the loan underwriting guidelines that were acceptable with the secondary market institutional investors, including Wall Street, insurnace firms, pension funds, and other investors in mortgage backed securities. The Mortgage Lending companies that were in the business of offering loans for borrowers, whether for new purchase loans or refinance transactions had to abide by those underwriting guidelines, unless they were capable of holding them in their own portfolios as an asset.

Savings and Loans across the country also looked at mortgage lending products as either salable in the secondary market, therefore subject to the same basic guidelines, or produced their own products for their own portfolio. The now reviled “Option Arm,” “Interest Only,” and “Stated Income” loan products were initially developed by some major S&L’s and Commercial Banks as portfolio loan products. They had been used for over twenty years, and clients who fit the qualifications were able to take advantage of the benefits. The exception to these commonly used underwriting guidelines were those of the then-evolving Alternative-A paper lenders and “sub prime” lenders that became the 21st century dominant sources of mortgage capital to potential borrowers who had income documentation problems, credit issues and/or credit backgrounds that made them more challenging to the prime institutional lenders.

During this period, the stunning growth of companies like Ameriquest, New Century, Option One and the other players in that area made these usually conservative lending option programs available to borrowers that would not have been able to use them in the years earlier. Thus was started the slippery slope that enriched many people in the years from 1997 through 2005, which ultimately caused most of these participant companies to close their doors by the end of 2007.

Greed has many handmaidens. First off, you have the home buyers, who realized their fantasies of a bigger house by taking on more debt than they could handle.  There were mortgage brokers who didn’t live up to their professional responsibilities and mortgage lending companies that ignored many of the warnings that were there to be seen. Rating agencies like S&P, Moody’s, and Fitch hid behind financial structures that were truly halls of mirrors created by financial intermediaries that also paid their fees for the ratings they issued. There were also the institutional consolidators like the major Wall Street companies and the institutional investors who bought these products after they had been converted into Mortgage Backed Derivative financial instruments and given Investment Grade ratings.

As in most major screw ups, including financial upsets, every player had a role in its success – and failure. “A rolling loan gathers no loss,” was the operative idea and ultimately, as these loans passed through the system, no one felt seem to take responsibility for their viability – as long as they made their monies. As a consequence, no one is exempt from the recognition that they helped cause the current industry challenges.

“Back to the Future” was the title of a series of movies in the late 1980s and early 1990s that is also the vision of our collective financial near future in Mortgage Lending. By near future, I mean the next three to five years.  We have looked back to the time when we made loans that required loan underwriting standards would be universally understood and applied. Down payments for home purchases were expected in most situations and borrowers knew that their credit backgrounds would be reviewed and if found to be inadequate, they would and could be denied the loan.

That seems to be what’s coming up, because people can never stay afraid and despondent for too long. There will sometime soon be a persuasive financial professional who will convince himself and his industry that there is great wealth to be made just by being a little more lenient with applicants, and concentrating on short term benefits instead of the long term implications that come with those benefits.When this happens, many of the lenders will surely believe they’ve learned their lesson, understand the risks, and can handle the increasing chances in defaults, in the name of a higher profit margin.

And so it will start again. Just wait and see.

The author of this article is a 43-year mortgage lending professional and legal mortgage expert witness providing professional consultation and expert witness testimony.  He is listed with Consolidated Consultants, an expert witness services company along with many other legal technical expert witnesses. Get their full C.V.’s online. This is a free service.

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