The Mortgage Crisis

I finally figured out why the mortgage fueled real estate crisis happened on what seemed to be my 20th trip back from New Delhi, India. You see, I was part of a team who had convinced Indian Investors to invest in the US, in “rolling up” several Mortgage Software Companies. By jumping into a business where we mapped software to fit every aspect of the whole Mortgage Industry I had a bird’s eye view of the Mortgage meltdown. Here’s what I learned was really going on.
Let’s start this sad tale by relating how Mortgages were created when many of us were buying our first home. We went to our local Bank or Savings & Loan and filled out a Mortgage application. We were asked basic questions such as how much money do you earn, how much you have in your asset column, and how much do you owe to other creditors. The rules were straightforward. You had to have 20% of the price of the home to put down. The lender calculated the”PITI” payment (principle, interest, taxes and insurance) and that sum had to be no more than 33% of your income. The home’s value had to be checked by a professional appraiser, and then you could buy a home. The Bank that loaned the money would collect the payments on the loan for all 30 years, so they were pretty strict who they loaned to.
In the last 10 - 15 years this simple financial contract changed to a very complex multi-tiered transaction. Today you start the loan process with Mortgage Brokers or Website’s, where you can instantly shop rates, points & credit restrictions, then click thru to a lender. Loan originators make money from the upfront interest, or points charged on a loan. In the wild days of 2002 – 2006 originators earned big money by selling what are called subprime loans. If you had really bad credit, they loved you, as they could charge you a fee of 5% (5 points) of the loan amount and add a full percentage point or two to the loan rate. The Institution that funded that loan, let’s say “Bank of The Lost Souls” would take your loan, process the first six payments, and sell that sucker to the mysterious cabal of investors known as the “secondary market” . The secondary market buys blocks of hundreds of mortgages in a big package. Lastly, there is another group called Servicers who collect the payments for a fee. The system evolved to fund more loans than ever before and with semi-reasonable controls. That is, until the Sharks smelled blood.
Enter the Wall Street crowd, who, running perilously short on diamond studded chauffeurs caps, decided to jump into the Mortgage business and teach the rubes a thing or two. They created the concept of “Securitized Mortgage Funds” which were huge blocks of mortgages, both good and bad bought from the secondary market. They began to sell these as high yielding stock funds to all of us. This fueled the demand for subprime loans like never before. Artificially high demand coupled with huge commissions on subprime paper meant brokers pushed loans to people who could not pay them back. The concept of loan qualification was almost lost in this mortgage rodeo. You could get a 100% loan on a property that appraised for more than the sales price. Buyers could have just defaulted on two other loans and erase that problem by paying 4 points upfront and two percent higher on the loan rate. The secondary market securitized by Wall Street (instead of conservative old Fannie Mae)took all this bad paper and rolled it into a Mortgage fund, as the high priced risky loans were needed to make their mortgage fund s seem more investible.
I went to Washington DC in 2006 to meet with Fannie Mae, to present a software backbone for their new subprime Mortgage business. Folks - Fannie Mae is the most conservative Mortgage underwriter in the US - who in the past would NEVER guarantee a subprime loan. Fannie Mae was forced into underwriting the worst, most risky loans because Wall Street demanded it. A few weeks ago The Feds had to bail out Fannie Mae and Freddie Mac as they were getting their heads handed to them by the mortgage crisis.
When normal financial sanity hit, the Mortgage Industry just melted down. We were left with homes where average folks owed more on their home than it was worth. Faced with huge losses, the Lenders had to soak up every rate hike they could get. With variable rate loans and rising interest rates Lenders raised existing variable loan rates every 6 months, hoping to offset their bad subprime loans. The poor borrowers saw their payments double in three years on a home that was going down in value, and many abandoned their homes, making the whole cycle deepen.
I honestly believe that this mess was largely fueled by the Wall Street gang. The pressure for more profits from risky financial instruments overrode common sense controls. This accelerated the mortgage industry meltdown and is pummeling the average American big time. This is one crisis where we all got fleeced by Wall Street.