When it began, "subprime lending" wasn't a term in common usage, let alone understood outside financial circles. One of its late 1990s originators was Obama campaign finance chairperson Penny Pritzker when she served on the Board of the failed family-owned Hinsdale, IL Superior Bank. It cost the FDIC $700 million and depositors another $65 million, while Pritzker made millions on predatory lending now called "subprime" mortgage schemes. One definition is as follows: "the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history." Another in the recent environment was to force-feed them to the largest number of homebuying prospects possible.
There's lots of them, and predatory lenders took full advantage until things erupted into scandal, and the economy headed south. Only then did regulators take notice and decide to investigate - into how "banks, credit rating firms, and lenders value and disclose complex mortgage-backed securities." Three areas specifically, according to Reuters: "the securitization process, the origination process and the retail area." Also insider trading, a common illegal practice that's rarely caught or even looked for. However, the scope of the investigation would be narrow, and its aim was "deterrence." Of what, asked Schechter, now that the horse is out of the barn, and investors and mortgage holders are left holding the bag?
When it's too late to matter, they agree, along with critics, that "inadequate disclosure (or lack of transparency) was at the root of the problem." According to a Senate report, it began in 1997 when house prices began appreciating and registered a 124% gain by 2006. Housing was driving the economy with seven million subprime mortgage loans. Business boomed. Underwriting standards deteriorated, while banks and other lenders invented new ways to make money - "fast" and easy.
In the 1980s, state usury rate ceilings were lifted, creating a whole new market for people who previously couldn't qualify. At higher interest rates, fees, and other add-ons they did. Most borrowers got so-called "2/28" and "3/27" hybrid adjustable rate mortgages (ARMs). They originated with low fixed "teaser" rates, good for a two-year period. Afterwards, they're reset semi-annually based on an interest-rate benchmark, or the current going rate. For many holders, payments soared 30% and became unaffordable, and by 2004, 90% of subprime loans were these type ARMs. It was well-known in the industry that "these borrowers (are) most likely to default or become delinquent (and) face foreclosure." The idea was to cash in and let holders take the pain.
Here's how the scheme worked. "So-called 'intermediaries,' unregulated and often unscrupulous mortgage brokers, hustled their way into the housing market" and took over. Using a range of tactics, including "deceptive advertising to block-to-block solicitations to get people to buy and sell, always promising more than they (could) deliver."
So-called "birddogs" were used to get prospects, and all kinds of practices were employed - "abusive, illegal and predatory." They pushed, "enticed...seduced (even) threatened." According to the Joint Economic Report, "For 2006, Inside Mortgage Finance estimates that 63.3% of all subprime originations came through brokers....19.4% through retail channels (and) 17.4% through correspondent lenders....broker share increas(ed steadily) from 2003 through 2006." These companies aren't regulated and pretty much operate freely. By 2005, the percent of securitized subprime mortgages reached "a peak value of more than 81%...."
Housing sales were on a roll, and so was Wall Street, quick to see a lucrative new income stream and ready to cash in. "Now they could make fees originating loans and even more money selling the paper into (the) secondary market, where mortgages could be securitized and sold again for even more money as investments."
The Finmanac financial blog explained its origination:
-- when Solomon Brothers launched Mortgage-Based Securities (MBS) in the 1980s - "bonds with bundles of mortgages, bought from bank lenders, as collateral;"
-- they used a "special purpose vehicle known as Collateralized Mortgage Obligation (CMO);"
-- monthly installments were used to pay interest; and
-- others were quick to cash in on the scheme.
The secondary market became a marriage between "the most reputable financial organizations and the sleaziest grass-roots operators. As is often the case, sleaze moved upwards" because the potential profits were huge but so are the risks.
"Since anyone can originate a loan and sell it to the Investment Banks (to package and sell as MBS), it tempts originators (to write) risky loans (without) worry(ing) about payback(s):"
Labels: criminal banks