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Monday, June 4, 2007

Lenders implosion

Subprime meltdown:

Greed is to blame!

The nonprime mortgage business is in a mess because during the boom years, hardly anyone had an incentive to say no. Each reason had a dollar sign attached to it. As long as each participant kept saying yes to risky borrowers, everyone made money.

The people who take applications, the companies that lend the money, the appraisers who check property values, the investment banks that sell mortgages to investors and the investors themselves -- all had millions of reasons to keep mortgages flowing to borrowers who couldn't afford them.

There are individuals and folks in the supply chain here and there that don't care, or don't necessarily have the borrower's best interest at heart. But that can be said about just about any industry where people are paid on commission.

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The mortgage industry is set up in such a way that the participants chase after profits while dumping the risks onto someone else. Brokers and loan officers make their livings by persuading people to get mortgages. There's no profit in telling an applicant that he has no business buying a house.

Except in cases of flagrant fraud, brokers and loan officers are disconnected from poor loan performances so long as there's no fraud. Most brokers are ethical, but there are some bad actors who will do anything to get a commission.

Behind the brokers and loan officers are the companies that do the actual lending. During the nonprime boom years of 2003 to the middle of 2006, lenders had an incentive to approve mortgages to uncreditworthy borrowers because lenders don't hang onto loans for long.

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If the borrower fell behind on the payments, the investor -- not the lender -- would face the consequences.

For their part, investment banks and a few big lenders collect fees by packaging and selling bundles of mortgages. As long as borrowers keep getting approved for mortgages, these companies earn fees. It's not in their interest to halt the gravy train.

Investors greedily scooped up nonprime mortgage-backed securities. Because one of the best ways to create high-yield bonds is to underwrite high-interest, risky mortgages.

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It turned out that investors can force lenders to buy back loans that go bad soon after the loan is sold. Troubled borrowers could sell their houses quickly and for a profit, removing bad loans from investors' books.

But in many places, house prices stagnated or fell in 2006 and fewer people applied for mortgages. Nonprime lenders became more reckless in their lending decisions in an intensely competitive market.

Lots of new borrowers fell behind on their house payments within just two or three months. Rather than lose money on the inevitable foreclosures resulting from these early payment defaults, investors forced lenders to buy back hundreds of millions of dollars in bad loans.

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Some of this could have been avoided if property appraisers had done a better job of identifying situations where home buyers were borrowing more than the houses were worth. But appraisers have long been complaining that they are at the mercy of lenders that lean on them to make sure deals get done.

All these people are behind the carnage we see now. More than 20 nonprime lenders have gone out of business or declared bankruptcy since December because they didn't have enough cash to buy back bad loans.

Lenders aren't going to return to the days of mandatory 20 percent down payments, but they are tightening guidelines. Some nonprime borrowers won't qualify for being homeowners or refinancing.

Ask A Mortgage Related Question

Everyone dreams of owning their own home. But can you afford the house and all of the expenses associated with it? You should be told how much you can afford in the first place before getting the loan.

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