[16 January 2008]
A recent column by Tyler Cowen (of Marginal Revolution fame) in the New York TImes caused a little flap in the econoblogosphere recently about whether lenders or borrowers are more to blame for the recent credit crisis/subprime meltdown/imminent recession. Inhis piece, a sort of year end wrap up of things that surprised economists, Cowen offered this
IT’S NOT JUST THE LENDERS
There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.
Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter.
In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years.
Perhaps because this plays faintly echoes a particularly repugnant free-market talking point—caveat emptor ad omnium—or because Cowen was sounding like an apologist for a typically exploitative and greedy industry, Barry Ritholtz of the Big Picture went apoplectic.
Anyone who works in this area knows that the reality of the situation was far more blatant. To begin with, most people are naive when it comes to any financial product. They rely on the experience of the professional they are working with, even if this person is a SALESMAN or another party in an ADVERSARIAL NEGOTIATING ROLE.
I work with many builders and mortgage lenders; I take personal responsibility for a major builder selling much of his company’s stock in 2005 (more than $100 million worth). The rest of the family hated me—for about 6 months. I know how their company works, and I know what they and others in their field do in actuality.
During the hey day of the no-income verification, “No Doc” loans, the builders finance people, as well as other mortgage brokers walked people through the application process. Mr. Cowen writes that “Too often, mortgage originators and middlemen looked the other way.” That’s a rather generous read on it. The reality is that THEY TOLD PEOPLE WHAT INCOME TO WRITE. They used sentences such as “Put down $150k.” OTHER TIMES THEY APPLICANTS LEAVE THE INCOME SPACE BLANK; The reps later conveniently filled in the data on the own.
To claim mortgage originators and middlemen only looked the other way is putting too fine a point on it. THEY WERE ACTIVE COLLABORATORS IN ANY FRAUD.
Oh, and, don’t take my word for it—find some people from the industry and ask them yourselves. This is a very well known fact amongst real estate agents, mortgage brokers, and builders.
I side with Ritholtz here, because I think in order to commit fraud, you have to understand the meaning of what you are doing, and most people, I’d guess, have no idea what is going on in the midst of the mountains of paperwork necessary to secure a mortgage and buy a house, something we are all led to believe is as fundamental to being an American as pledging allegiance to the flag and eating hamburgers. And unlike the brokers, the borrowers have the loans in their name and ultimately would be held accountable for the lies by having to pay the consequences, while brokers skate away relatively scot-free—at least until they started becoming unemployed—permanently if our society has any justice.
Housing blog Calculated Risk today excerpted comments by Chase CEO Jamie Dimon in which he seemed to imply that brokers were not doing such a good job assessing risk, to put it euphemistically.
This is a lesson that’s been learned over and over about broker originations, they perform much worse than our own originations, and if you separate home equity into we call it kind of good bank, bad bank, and broker so I would say it’s less than 20%, but a lot of the losses are coming from that 20%, which is high LTV [loan-to-value], broker originated businesses. High LTV business is also bad in its own.
And the 20% you referred to a minute ago in round numbers is the sort of specifically high LTV and originated away [by brokers] is that right?
It’s been very consistent In both our own originated and broker originated, high LTV, stated income is bad. It is three times worse in broker than it is in our own.
Wow, indeed. This suggests that banks were constrained by the size and nature of their institutions, but brokers had no such scruples; they behaved like the fly-by-night operators they so often seem to be. The Caluclated Risk post prompted Felix Salmon to wonder why brokers have not yet been disintermediated (to use another fun euphemism), drawing the same conclusion that prompted me to start this entry:
Frankly, in an era where people can get mortgage quotes online almost as easily as they can buy car insurance, I fail to see why mortgage brokers should exist. It would be an industry crying out for disintermediation even if it weren’t obvious that mortgage brokers are top of the list of people to blame for the current mortgage crisis. In the debate about “predatory lenders” and “predatory borrowers”, the bigger truth is that the real problem was predatory brokers - people who abused the trust of both lenders and borrowers. If they do disappear, they shan’t be missed.