The Greed Frenzy
Recent troubles in the lending industry have dramatically affected the entire economy of this country. The facts clearly show reason for concern and cause for careful consideration and planning to recover from what is now called “The Mortgage Meltdown.”
Let me voice my opinion on what happened from my point of view. I was one of the coaches on the sidelines with 20/20 hindsight.
Beginning in the last quarter of 2006 and first quarter of 2007, very dramatic and alarming conditions began unfolding in the lending industry. To date, over 260 lenders have closed shop, countless others have downsized and re-organized to avoid total collapse. The companies that were left had to overhaul their products, guidelines, and rates in order to be poised to survive. The situation is critical. Another huge refinance boom is looming over the next 18 months as over a Trillion dollars worth of adjustable rate mortgages will reset. The losses are continuing to mount and the industry is in damage control mode.
There is opportunity for correction due to this enormous amount of available need for financing. But, whether or not it will be to the benefit of the consumer remains to be seen. The following are reasons for the dilemma:
1. Many borrowers did not put money down when they purchased their homes two and three years ago.
2. Real Estate prices have softened and even declined in many areas.
3. A large number of products were interest-only loans, so no principal reduction has occurred.
4. Lending guidelines on refinances now mostly cap off at 90-97% LTV. Add closing costs to their balance and many borrowers may be faced with not being able to refinance. (Their only hope is that maybe they had marginal credit scores then and, because of their timely payments over the last few years, they are now in a stronger credit position. If that is the case, they may be okay because there are good products available through FHA, Fannie Mae and other A paper providers. FHA offers the Secure program for some if they qualify, but the guidelines are certainly not as liberal as the Sub prime products they were placed in.)
Unfortunately, if you look at just the last year, default rates and foreclosures are at record highs. Many people could barely afford the homes when they bought them and, with adjusting rates, increasing payments, and little or no equity, they are choosing to walk away. As these bank-owned properties begin to hit the market, existing home prices are being affected. We have already seen a slowdown in new housing starts because of market saturation. With tighter guidelines, fewer buyers can purchase.
It is a typical cycle change from a seller’s market to a buyer’s market and, with fewer qualified buyers, prices will continue to deflate. So, for those in position to take advantage, it is a good market. Real Estate investors have already been a major part of the market over the last five years as they pulled out of Wall Street and invested in Main Street. Good deals will be even more plentiful now. However, financing for investors is almost non-existent.
What caused all this mess? Who is at fault? Can we overcome this downturn? There is a lot of blame pointed towards Fannie Mae and Freddie Mac. Some of that blame is justified, but they were mostly the end buyer of bad paper. I will give you my opinion on these questions. Let’s begin with what started all this mess:
After 9/11 the economy took a major downturn. The stock market crashed and panicking investors pulled out of the market. To prevent a total collapse, Fed Chairman Alan Greenspan began lowering the costs of funds. That saved this country from a recession and possibly a depression. Mortgage interest rates hit all time lows, making spending and home buying more affordable.
This helped spark the housing industry boom from 2001 to 2006. It also had a huge impact on the American Economy. The housing industry single-handedly rescued this country from certain economic doom. For proof, just consider all the other industries that thrive off of the housing industry: Construction, real estate, finance, insurance, lumber, shipping, trucking, etc. Even the government made more money from property taxes, sales taxes, transfer taxes, etc.
The investors who pulled out of the stock market then saw real estate as the safe way to go with their money. With investors and homebuyers competing for houses, real estate prices began to increase. This was good overall for the entire economy. .It boosted business, created jobs and needs for additional services.
The booming housing and financing industry experienced a frenzy of competition. One didn’t need any down payment to borrow money or have any equity to refinance. Houses were selling as fast as they could be built, or put on the market. Prices started inching up because of the demand, reaching double-digit appreciation in a single year in some areas. All of this was great for the economy and the morale of this great country. People quickly forgot how bad the devastation was after 9/11 and no longer seemed to care about the rest of the world.
Foreign investors were amazed at how quickly the American economy rebounded from disaster. They jumped on the bandwagon and began investing in the US. To keep up with the exploding demand and competition for money, lenders began to offer more competitive rates and pricing incentives to gain more market share. It seemed that lenders couldn’t give away the money fast enough.
There was a HUGE secondary market buying the paper as fast as the paper could be printed. This created a very competitive market. To keep up, lender’s loosened guidelines to bring in more volume. A new term to lending showed up on the scene called Derivatives. The marketing of derivatives enabled previous conservative guidelines to be discarded or relaxed. Credit standards were lowered on some products, New Niche products for real estate investors and self-employed borrowers were created, as well as relaxed income and asset verification guidelines, even No Doc and what I call NINJA loans, (No Income, No Job, No Assets). Debt-to-Income ratios were increased as high as 65% on some products and not even calculated on others (No Ratio). (This Derivative Market was one of the major reasons for the threatened collapse of AIG. They were insuring a lot of the derivatives and mortgage backed securities that started the meltdown.)
These more aggressive guidelines created new problems. Most of these new products also allowed lower credit qualifications, which means higher interest rates and a lot of them were attached to ARMS (Adjustable Rate Mortgages). Amortization periods were extended to 40, 45, and even 50 years. You could even get a loan and pay just the interest, or if you have good enough credit even pay less than the interest. As long as you didn’t have horrible credit and you could fog a mirror, there was money available to you for the taking.
Brokers flourished, real estate agents sold houses. Loan officers made huge commissions and became heroes to thousands of new homeowners. They were all so busy raking it in that they never considered the long-term effect this would have on their clients and our entire economy. They didn’t care if the money got paid back or not because they were busy doing the next deal, it wasn’t going to affect them because they weren’t the ones taking the risk. They just wanted their fat commission checks.
This created what I call “The Greed Frenzy.” which is the answer to the first question I asked. What caused all this mess?
Because of Greed and the competition to grab as much of the market as possible, lender guidelines continued to loosen, more new products were created. The Foreign investors were buying hundreds of millions of dollars in derivatives and mortgage paper by the bundle on Wall Street and they were extending and increasing credit lines to wholesale lenders. Everything was rosy, everyone was happy, making their quick fortunes. Life was good. It couldn’t get any better than this, right?
Wrong. What they didn’t know was that the market had grown so fast; and everybody was so busy making money, that a possible collapse was looming beyond the horizon. As the first wave of ARMs began to reset, default and foreclosure rates began rising, reaching all time highs. Paper Buyers began enforcing buybacks, tightening guidelines and cutting off credit lines.
The losses have continued to mount and are still mounting. The Bubble has burst. It kind of reminds me of the news reels of people frolicking and playing on the beaches in Sri Lanka just before the Tsunami waves hit.
So who is to blame? Who is at fault? There is enough blame to go around, but I will identify the guilty party as Irresponsibility. It was irresponsible for the wholesale lending industry to loosen guidelines to the point they did, when you consider they weren’t holding the paper and carrying the burden of risk. It was irresponsible for the brokers and loan officers to make loans to people, stretching the guidelines as far as they could and manipulating rates and margins to maximize commissions, because they also weren’t taking the risk. What happened to common sense and ethics? Some of that can be blamed on poor training and oversight, but most of it boils down to just plain GREED.
I place very little blame on the consumer. The majority of them were unaware of the looming danger. They were just pursuing their dreams. They made a few phone calls, found out they could buy and began chasing their dreams without taking time to consider the economic effect of their decisions. They trusted their loan officer or broker to help them make the right decision.
Were they betrayed for the sake of higher commissions? In a lot of cases, absolutely! I have recently seen three-year prepayment penalties on two-year adjustable rate mortgages; just for the sake of more commissions. That is a total disservice to customers, who are now stuck with higher rates and higher payments because they cannot refinance. Many of them will walk away in default.
Here is another common scenario that created some of the problem. Ask yourself, should people buy the maximum price house that they can qualify for? A lot of consumers made some quick phone calls to banks or mortgage companies, shopping rates and getting “pre-qualified.” They were given mixed and confusing signals, but ultimately got approved for usually up to their maximum. Then they informed their realtor of the amount they were qualified for. Of course, the realtor, also being on commission, started looking for homes in the maximum price range. They found a home, wrote a contract, closed the deal, and the clients moved into their dream home.
Here’s an even worse scenario, Dave sees his friend Steve move into a beautiful $300,000 home. He asks, “How can you afford that house Steve?” Steve replied, “I had such good credit that I could get special financing at 1% as long as I could put 5% down. My payment is only $1.350/month. We were paying that to live in our old $180,000 house. We decided we deserved to move up.”
So, now, Dave makes a few calls. Some lenders tell him he can only qualify for $200,000 because of his income. After a few more calls he finds Jason. Jason tells him, “Dave you have great credit, if you really want that $300,000 house I can get it for you. We have a special program that goes strictly off your credit, I don’t even need your pay stubs or W-2’s, I just need a contract and a check for the appraisal.” What Dave doesn’t know is that based on his documentable income he needs to stay in a lower price range. He grabs the opportunity to move into Steve’s neighborhood. His loan officer gets him a loan by using a “niche” product like a Stated Income, No Income Verification or No Ratio product. Needless to say Dave wasn’t Steve’s neighbor for very long and is now living in an apartment.
All of this “Irresponsibility” is due to circumventing Debt-to-Income ratios; which is probably the single most important factor in determining whether or not someone should buy a home. FHA and Fannie Mae guidelines have remained conservative.
For the sake of GREED, these guidelines have been compromised, manipulated, stretched, and even totally disregarded in recent years with all of the Non-Conforming products. These were created by the lending institutions and peddled by the commissioned brokers and loan officers, who are now whining and complaining about how slow their business is. Many of them will eventually change careers, and if they were guilty of some of the aforementioned scenarios, let me be the first to say, So long, farewell, sionara’, vaya con dios, adios, goodbye!
Those of us still standing need to regroup and recommit ourselves to being ethical and responsible. We should take the time to do the right thing for our clients and help them make wise decisions, not just tell them what they want to hear. Our industry can rebound from this debacle if we will all take a deep breath and humble ourselves. We have to; the entire economy of this great country is resting on our shoulders. Let’s face this reality with the determination to make a difference, do our part to take responsibility for the Greedy Irresponsibility of this industry, and begin rebuilding with honesty and integrity.
Being a mortgage professional at the broker or management level should require a code of ethics and level of training equivalent to other professionals in financial services like accountants, financial planners, economists, investment advisors, real estate brokers and property managers. If there is no quality control and responsibility at the point-of-sale, there is no protection for the consumer or the lending institutions. We are the ones who have to police our industry, and protect ourselves from the downfalls created by our greedy competitors and colleagues.
We all should be ashamed of ourselves. We need to repent for it, roll up our sleeves and start working together to repair it. We are positioned for the largest refinance boom in history. We created the mess by peddling these quick-fix, slam dunk purchases the last few years. It is now our job to responsibly clean it up correctly. Let’s do it right this time. As the saying goes, Well that’s my opinion, it ought to be yours.
Jeffrey L. Senters
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