Sunday, February 15, 2009

Mortgage Industry Implosion

One favorite response regarding the mortgage industry implosion is the who could have known attitude. Everything was working perfectly. The industry started giving loans on assets not for what could be repaid. The industry started giving loans where people could have several options, one being to pay only a portion of the interest. The industry stopped requiring people to prove the money they had or they made - a good credit score was enough. Why would anyone ever envision anything wrong with these business models?

The Feb. 15th episode of 60 Minutes provides a great story about the fact that people did know in their story titled World Of Trouble. People did know that there was something wrong with the bubble business practices but they were dismissed or ignored. The money coming in was more important than using good business practices. From the video below it shows that the better the business practice the less money one would make. The story focused on World Savings that was bought by Wachovia (Wachovia now folded into Wells Fargo). Lets take a look at the story -

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For those that can not watch here are some snippets from the accompanying article -

But Paul Bishop says he watched the bank famous for quality begin to emphasize quantity. World relied on outside mortgage brokers to bring in 60 percent of its customers. The more loans that were approved, the more the brokers, and World Savings, made in fees.

By 2005, 38% of World's clients had subprime credit scores. And customers were shown fliers that told them their income would not be checked by the bank.

"So I don't really need to know what you make. I don't need proof. You tell me you make $200,000 a year? You make $200,000 a year," Bishop said.

"When one lender dropped standards, another lender felt that they had to do the same," [Bob Simpson, whose company, IMARC, investigates failed mortgages] told Pelley.

Simpson says World and other lenders were in a ruinous competition for customers. "There are people inside of every institution that have been screaming for years about these terrible loans. Don't fund these. These are horrible loans. And they were routinely ignored inside of their own institutions."

Asked why they were ignored, Simpson said, "Because there's no money in common sense. There's no money in stopping a loan. There's only a payday when that loan closes."

The short term closing was the only part of the loan that mattered during the bubble. Whether the loan was viable was of least importance. As long as housing prices continued to have double digit gains year after year no one would get stuck with over priced houses or bad loans. But values did not only stop increasing, they went down. Business practices that made no sense but were highly profitable brought giant companies and industry leaders down in one fell swoop.

As in many cases the best line of the story is left for last -

"We have talked to some former executives of the bank who tell us that they listened to your complaints, they investigated your complaints, and they found that there was nothing to them," Pelley told Bishop.

"Are they employed today?" Bishop asked.

"No," Pelley said.

"Surprise. They lost their job. The bank went bust. They took down the fourth largest bank in the country with them. But there was no problem," Bishop replied.
Classic. Hopefully some governmental agency hires Bishop to help sort out the issues. He has the background and the insight to help straighten some of the issues out.

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