Monday, April 20, 2009

Were Mortgage Brokers the Real Culprits to Blame for the Demise of Financial Companies?

Jeff Mathews makes this argument in his post “The New McCarthyists, Part II: Where the Culprits Are.” Some excerpts:

In April 14th's “Older Borrowers, Out in the Cold,” reporter Ellen Schultz lays out in cold, hard facts—as opposed to the vague, nameless short-selling conspiracy theories—how mortgage brokers destroyed the banking system along with peoples’ lives:

YUBA CITY, Calif. -- In 2006, Carol Couts, a 66-year-old widow in Yuba City, Calif., was living in her home, payment-free, when a mortgage broker persuaded her to refinance her no-cost mortgage for one that exceeded her monthly income by more than $400.
She can't afford the payments, and unless her lender modifies the loan to make it affordable, she'll lose her home of 25 years. She's given away most of her furniture and her cat, and packed her belongings in cardboard boxes. "We've got nowhere to go," she says, referring to herself and her dachshund, Ollie….

Here’s the link to Ellen Schultz’s story in the Wall Street Journal.

This is indeed a sad story, and the mortgage broker has a lot to answer for. But, this is also a good example which illustrates it takes more than one party to drop the ball to create a mess this big. First, there’s Mrs. Couts. Why does someone sign up for a mortgage that exceeds their monthly income by $400? The Wall Street Journal explains:

In 2007, she received numerous phone calls from a mortgage broker named Daniel Lewis. According to Mrs. Couts, he told her he was contacting seniors to warn them that banks were canceling reverse mortgages because they were unprofitable. She would have to refinance her home, he told her, or lose it. (This wasn't true; reverse mortgages generally aren't repayable until death.)

Mrs. Couts signed a document that said she could cancel within three days, and also signed documents that she thought were for a 30-year conventional loan with low monthly payments. The next day she saw that the application listed her income as $5,075 a month. She called Mr. Lewis to point out the error and to cancel the loan, but says he told her it was too late to change anything.

The broker had used a "no doc" application, which doesn't require proof of income. Many brokers used these stated-income applications when borrowers' incomes were too low to qualify them for loans. All of the other boxes for listing income and assets in Mrs. Couts's application, which was obtained by The Wall Street Journal, were blank.

Mrs. Couts's first statement showed she had an adjustable-rate mortgage with an initial interest-only monthly payment of $1,333. She soon defaulted, and Wachovia Corp. -- which had acquired World Savings & Loan, the firm Mr. Lewis worked with -- started foreclosure proceedings.

It seems fairly clear Mrs. Couts made some mistakes; it was a mistake to believe Mr. Lewis when he said she needed to refinance her mortgage, a mistake to believe him when he said it was too late to withdraw a fraudulent loan application, and a mistake not to seek advice from someone other than Mr. Lewis.

It also seems fairly clear World Savings was asleep at the switch. A retired senior with a $5,000 monthly income in 2007 suggests she has around $1 million in interest earning investments, which is not exactly the profile of your typical interest only ARM borrower. And, while I know there are many ethical loan brokers, anyone in the lending business know there are unethical ones too. Loans submitted by brokers should get more scrutiny, and this loan makes no sense on its face.

So, for this default to happen, you needed Mr. Lewis to get the ball rolling, Mrs. Couts to make her mistakes, and World Savings to turn a blind eye. I’ve previously posted about how the housing crisis was created by multiple errors by multiple parties, and this is just another example.

It’s also important to remember that it was not the loan defaults like this one which created the crisis; it was the bets traders placed on the mortgages. As Matt Taibbi (via Rortybomb) says:

Do you actually think that it was a few tiny homeowner defaults that sank gigantic companies like AIG and Lehman and Bear Stearns? …What we’re talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan. Which do you think has a bigger effect on the economy?

Saying loan defaults triggered the crisis is like betting a trillion dollars on a horse race, and then blaming the horse if you lose. No one made the financial firms place their bets.