How Lenders contributed to the Financial Crisis by AnthonyT

REAL WORLD EVENT DISCUSSIONS

How Lenders contributed to the Financial Crisis

POSTED BY: ANTHONYT
UPDATED: Thursday, September 22, 2011 05:10
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Monday, September 19, 2011 11:57 AM

Freedom is Important because People are Important

Hello,

I posted this on another thread, but that thread became polluted, and I was concerned this would get lost. In any event, the discussion of the financial crisis was off-topic for the thread where it appeared.

I posted this in response to assertions that the government was solely responsible for the financial crisis, and that the actions of banks were forced upon them by government. I contend that lenders were only too happy to make their own contributions to the problem, independent of government mandate. I make this assertion based on my own observations from within the field. I have edited for clarity, but some of this material is rather dry and difficult to process for individuals not in the field. I apologize for that.

********************

Let me give you an example of specific Home Equity bank behaviors that were not ordered or even encouraged by the Federal government. These behaviors were common in varying degrees amongst multiple institutions, and helped contribute to the Real Estate Bubble and subsequent financial crisis. Note that I will only mention behaviors I am personally aware of from personal experience.

1) Using corrupt appraisers who would return the precise value you require in order to lend on a property, regardless as to whether that value is actually supportable by evidence.

2) Increasing DSR, or Debt-to-Service ratio lending limits. In 2004, the common acceptable DSR was 45%. That is, your monthly debt commitments could be up to 45 percent of your monthly income. Within a few years, that limit was at 55% even within 'responsible' lending institutions. In less responsible institutions, it could climb as high as 65%.

3) Increasing LTV, or Loan To Value lending limits. In 2004, a common acceptable limit was 80%LTV. That is, the bank would lend up to 80% of the value of a home. Within a few years, some loans were being offered at 110%LTV. That is, we are loaning you 10% more money than your house was actually worth.

4) Calculating DSR on a dual-feature product based on the lowest rate even when that rate wasn't practical. I will explain: Lines of Credit have a low, low interest rate that fluctuates. They also sometimes have an option to convert to a loan at a much higher interest rate. This option could be chosen at inception, so that you could get a Line product and Lock it immediately at the higher rate as part of the initial product. However, when computing the customer's ability to pay, the Line of Credit rate was used, and not the Loan rate, even though the customer was already converting to a Loan. This caused loans to be issued in cases where the DSR exceeded lendable limits because the phantom line rate was being used inappropriately for such calculations. Sometimes this was done specifically so a customer who could not qualify for a loan could get the loan anyway by exploiting the Line conversion feature EVEN THOUGH IT WAS KNOWN THE CUSTOMER WOULD HAVE TROUBLE MEETING THEIR OBLIGATIONS.

5) Failure to Verify or Secure Lien Position. The Banks grew lax in their verification of lien position. This means that in the event of a foreclosure, they may not be able to recoup losses because they are not where they thought they'd be in the sequence of collection. This also caused a peripheral problem. When you do not accurately identify all the liens on a property, you may miss the presence of other loans and mortgages. This caused some homes to be indebted to 2 times their already inflated value.

6) Failure to Verify Income. This was, to me, one of the most incomprehensible decisions the banks made. No paystubs, No W2's, No Tax Returns. The customer says they're earning tons of money? Fine. We just write down the amount and take their word for it. So our inflated DSR figures were probably based on inaccurate data anyway. This is just the customer's problem, right? Wrong. The banks usually lose money on foreclosures (especially when you don't secure your lien position and lend in excess of the home value) and so the banks were setting themselves up for incredible losses. You never want to foreclose, and you don't want to set up a situation where your customer is likely to default.

******************

I do blame government quite strongly in one regard. The only penalty an irresponsible institution is guaranteed to suffer as the result of irresponsible business practices is failure. Banks were shielded from this consequence, and I believe that shielding will prove to be detrimental in the long run.

--Anthony

_______________________________________________

"In every war, the state enacts a tax of freedom upon the citizenry. The unspoken promise is that the tax shall be revoked at war's end. Endless war holds no such promise. Hence, Eternal War is Eternal Slavery." --Admiral Robert J. Henner

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Monday, September 19, 2011 12:24 PM

M52NICKERSON

DALEK!

Very well done.

You also have to remember # 5-6 at least partially came about because banks could simply bundle loans into investment assets and sell them.

I do not fear God, I fear the ignorance of man.

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Monday, September 19, 2011 1:54 PM

RIONAEIRE

Beir bua agus beannacht

A Anthony a chara, I doubt that any reasonable folk would disagree with this post. This is what everyone I know has always said and its true. Nicely organized and presented here.

"A completely coherant River means writers don't deliver" KatTaya

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Monday, September 19, 2011 3:53 PM

ANTHONYT

Freedom is Important because People are Important

Hello,

Thank you both.

I have occasionally said something or other about the banks over the past couple of years, but I don't think I ever put my observations succinctly in one place before.

Sometimes I hear someone grasp onto the idea that the government single-handedly engineered the financial crisis, which is a popular view in the Tea Party and even with Ron Paul, who I generally like. They have some theories and presentations to support their position.

However, I think their theories overlook a lot of the actions banks took willingly and eagerly that helped to create this crisis. Actions I was in a position to observe as they were happening.

This is certainly a case where the industry did not successfully restrain itself or self-regulate. Meanwhile, they were largely protected from the consequences of their actions. I hope we can avoid a re-occurance of this problem in the future.

--Anthony

_______________________________________________

"In every war, the state enacts a tax of freedom upon the citizenry. The unspoken promise is that the tax shall be revoked at war's end. Endless war holds no such promise. Hence, Eternal War is Eternal Slavery." --Admiral Robert J. Henner

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Monday, September 19, 2011 4:09 PM

PIZMOBEACH

... fully loaded, safety off...

Thanks Anthony - the scope of this is what astounds me. If it were one branch, or one giant bank with a corrupt lending division I might understand, but there seem to be so many disconnected people involved. How many people would it take to sign off on this bad behavior for these bad loans to happen at a single bank?

Scifi movie music + Firefly dialogue clips, 24 hours a day - http://www.scifiradio.com

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Monday, September 19, 2011 5:15 PM

ANTHONYT

Freedom is Important because People are Important

Hello,

Well, it's easy to think of this happening suddenly, but the nature of the degradation in lending standards was insidious because it was gradual.

Someone didn't wake up on a Monday and say, "We're going to do this and this and this and this, because we are evil, buahahahahah!"

You start with one lender doing something. Let's say Countrywide shifts their DSR from 45 to 50.

Now people who could not qualify for a loan before all flock to Countrywide.

And Bank of America sees that they are losing business to Countrywide and the higher ups say, "What's going on at Countrywide? Why are our customers going there for loans?"

And then someone says, "I hear they shifted their DSR to 50."

And the muckety muck at Bank of America says, "Really? Isn't that dangerous?"

And someone says, "Well, possibly. But they're pulling in X millions in business each month thanks to this policy. The revenue may offset the risk."

And the muckety muck says, "Well, let's try increasing our DSR to 50 for clients with really good credit scores and see what happens."

And over at Chase, someone sees Bank of America and Countrywide are getting a lot of new business.

And so on, and so on.

This is how a risky idea becomes an industry standard practice. The nature of a competitive business like lending means that banks don't feel comfortable watching thousands of customers flock to a competitor who has 'innovated' this 'bold new tactic.' Some banks hold back longer than others, but sooner or later almost all of them caved in order to compete.

The degradation starts small, and escalates. It starts in one lending parameter, and spreads. It starts with legal but questionable practices, and spreads to illegal but not easily proveable practices.

Like I said, my own bank was one of the 'good' ones, but even they were being pulled into this competition and were degrading their standards. If the wild ride had gone on for another year or two, it might have become hard to tell the difference between the best and worst lenders.

There is also another problem. Let's say you are the stalwart honest guy, and you're willing to lose customers because of your honesty. If everyone else is cheating, it impacts you regardless.

Your appraiser can be brutally honest, but if everyone else is using dirty appraisers, the market is going to go for a ride whether you like it or not. Your values won't be any good- not because you schemed, but because everyone else did and part of the appraisal process involves 'comperable' properties.

When all the comps sold at inflated values because of dishonest lending practices, you are stuck overvaluing a property even if you don't want to.

It was terrible to see this happening, but I think even people who recognized the problem never imagined how awful the impact would be when the bubble burst.

--Anthony

_______________________________________________

"In every war, the state enacts a tax of freedom upon the citizenry. The unspoken promise is that the tax shall be revoked at war's end. Endless war holds no such promise. Hence, Eternal War is Eternal Slavery." --Admiral Robert J. Henner

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Tuesday, September 20, 2011 3:13 AM

PIZMOBEACH

... fully loaded, safety off...

Quote:
Originally posted by AnthonyT:
... I think even people who recognized the problem never imagined how awful the impact would be when the bubble burst.

Thanks - that's the world of business for sure. People get so focused on competing that they don't assess risk properly - to do so would be "weak."

I never saw much said about the culpability of the people who got these loans. I'm thinking the MSM didn't want to shoot themselves in the foot by portraying their viewership (every day folk) as having much part to play in it. It's better business for them to target EVIL BANX

as the fall guy. Did you ever hear anything like that from your perspective? "Well, they signed the loan... they should have read the document...it was all right there in front of them...?"

Scifi movie music + Firefly dialogue clips, 24 hours a day - http://www.scifiradio.com

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Tuesday, September 20, 2011 3:30 AM

SIGNYM

I believe in solving problems, not sharing them.

Problems with the people who got the loans... mostly, they got sucked in by low rates at the beginning, but weren't told the rates would rise, or failed to realize that these rates would rise later, or were told that they could easily "refi" later because property values were going up and up and up... there was a lot of fast talking, a lot of LACK of disclosure, and a lot of outright fraud. (For example, many people shunted over into sub-prime loans actually qualified for regular home loans, which they could have easily afforded). So people who could swing a $1000 a month mortgage suddenly found they couldn't swing a $1500 per month mortgage. There was short-sightedness on both sides, but fraud on only one. And then even people who had conventional loans got into trouble as the economy shed jobs.

Yes, I would blame those who offered complex loans with lots of fine print and mumbles to people who were barely literate, let along literate on financial legality... and I also blame the people who SHOULD have known better who overlooked their better judgment when they signed on the dotted line. I also blame the banks and investment firms for packaging these deals and selling and re-selling them and swapping default risks and selling naked CDSs, which contaminated not only the initial lenders but also investment banks, insurance companies, bond issuers, and pension funds with junk product.

If the government had forced the banks to freeze their mortgage rates at 4% (because, don't forget banks WERE making money on the initial rates, just not as much as they were hoping for later) the whole financial collapse could have been avoided.

But that, of course, would have interfered with "capitalism", which- as we all know- every day in every way makes the world better and better.

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Tuesday, September 20, 2011 4:37 AM

ANTHONYT

Freedom is Important because People are Important

Hello Pizmo,

I lost a home myself during the financial crisis, and I definitely knew better.

My wife chose the height of the boom as an opportune time to get into home ownership. Everyone was doing it. I wasn't quite ready, but the idea of owning property, even on a tiny scale, had always appealed to me.

The small house she selected was at the upper limit of our financial capability. We had previously agreed that we would not get an ARM, but when that was the only loan we could qualify for, that's exactly what we did. And when I hesitated at the signing table, and told my wife, "You know, we said we wouldn't do an adjustable rate loan, and now here we are..."

She and the mortgage rep were of a like mind. "We can always refinance in a year, once we've established a good payment history, and get a fixed-rate loan then."

And even though I knew better. Knew better to the center of myself... I signed.

And before the next year rolled around, everything tanked.

We lost that home. Though God only knows what the bank will end up doing with it. When property values crashed, it shed tens of thousands of dollars of value each month. It's currently worth little more than the plot it's sitting on, because it was an old, small house and the surrounding houses (also available to a buyer) were bigger and newer and better in every way.

I tried to contact the bank to negotiate when the ARM reset was approaching, to tell them that I wouldn't be able to make the new payment. They said they couldn't work with me until I failed to pay my mortgage. Which seemed a ridiculous stance.

Once I was in default with ruined credit and the property values were crashing around me, I decided it was better to just let them have the place. This was a selfish decision, and an irresponsible one. But I was somewhat bitter at the time and I told myself that I had signed on the promise of ever-inflating home values and the ability to refinance. They could foreclose on that same promise.

In no small bit of irony, I am now in a bigger, newer house in a better neighborhood that was hit hard by the crash. I bought this home for a small fraction of what I paid for the other one. And I have it without an Adjustable Rare Mortgage. But this is by no means typical. Most people did not have the resources to reverse their fortunes and take advantage of the depleted market. In my misfortune, I turned out to be very fortunate. So many people have gone to darker places.

There were seven rounds of layoffs at work during the recession/depression. Almost everyone I knew at the start of it all was gone by the time I thought it had ended. I never understood why I had survived, and I had a bit of guilt about it. Better men and women than I were laid off, and I stood standing, for no good reason I could identify.

An upcoming merger of two departments means we will soon be looking forward to round eight. I wonder if my luck will hold out. I hope so. I very much enjoy have a roof over my head and food in my belly.

--Anthony

_______________________________________________

"In every war, the state enacts a tax of freedom upon the citizenry. The unspoken promise is that the tax shall be revoked at war's end. Endless war holds no such promise. Hence, Eternal War is Eternal Slavery." --Admiral Robert J. Henner

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Tuesday, September 20, 2011 4:39 AM

ANTHONYT

Freedom is Important because People are Important

"which- as we all know- every day in every way makes the world better and better."

Hello,

I hope the human race stops fooling itself into thinking that any single "ism" will make the world better every day in every way. That kind of thinking destroys lives.

--Anthony

_______________________________________________

"In every war, the state enacts a tax of freedom upon the citizenry. The unspoken promise is that the tax shall be revoked at war's end. Endless war holds no such promise. Hence, Eternal War is Eternal Slavery." --Admiral Robert J. Henner

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Tuesday, September 20, 2011 5:05 AM

SHINYGOODGUY

Hi Guys,
It is my understanding that the Big Boys also made a killing in the "dirivatives" market (in the trillions) and that these self same "Streeters" who were too big to fail secured "loans" from the Federal government through the Bailout Pact. They cause the near-collapse; make trillions and then have the nerve to ask for money to keep from failing (at least on paper that is). BTW: The dirivatives market was wholly unregulated by any government entity. As a matter of fact there was a woman within a division of the Treasury Department who wanted to regulate the banks trading in dirivatives and she was ordered by her overboss to keep her hands off (saw this in a Public Television white paper). She saw the bubble and how it was about to burst, but was told hands off including Greenspan. One question though: Who walked away with those trillions? Somebody, somewhere made money. It's like the Madoff mystery: How can $65 billion dollars up and vanish? He knows where the bones are buried but is not telling.

Anyway, the so-called Tea Party (the GOP in lamb's clothing) prime the pump to the bilge-water propaganda mill and have folk believing the rhetoric. If you say it loud enough, long enough and often enough it develops a life of it's own. But I have yet to see, or hear, anyone of these folks offer a real solution. All they do, it seems to me, is talk negative about any plan Obama or any democrat offer up to pick the country's chin up off the ground. It's like a mantra - Palin good, Obama evil.

SGG

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Tuesday, September 20, 2011 5:42 AM

PIZMOBEACH

... fully loaded, safety off...

Quote:
Originally posted by AnthonyT:
And even though I knew better. Knew better to the center of myself... I signed.

I'm glad it worked out for you in the end. It's damn hard to listen to those *rational* voices sometimes - someone should teach a class.

I think some of the folks giving out those loans had a hard time hearing them as well.

I just looked into refinancing. Rates are at an all time low so I thought I'd check it out, but something about the loan officers... didn't sit well with me. The rate was there but it felt like there was a Saruman in the back room somewhere doing some evil math.

Strictly out of curiosity I called Quicken Loans. It was interesting - so many red flags, so many salesie techniques. "We're doing more loans than ever, but we have to act fast..." "I love your city! My husband and I visited there 8 years ago..." Hmmokaybye.
Same players, same game, different rules.

Scifi movie music + Firefly dialogue clips, 24 hours a day - http://www.scifiradio.com

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Tuesday, September 20, 2011 8:08 AM

KWICKO

"We'll know our disinformation program is complete when everything the American public believes is false." -- William Casey, Reagan's presidential campaign manager & CIA Director (from first staff meeting in 1981)

Makes me glad I didn't buy. I came close; I wanted a loan for a certain amount, my wife and I had discussed it - if one of us were to lose our job, or if both of us had to resort to something like washing dishes or waiting tables, we had to still be able to pull together a set figure every month. And of course, we went in, got approved, then they started raising the amount, stretching the mortgage period, pushing ARMs, telling us of course we could afford it, things were just going to keep getting better and better and better for everybody. I knew better. I've lived through economic cycles a time or seven, and knew full well that the entire Bush economy was built on sand and had no real foundation.

So we walked. Told 'em we had to think about it, and bailed out. A year later, things crashed, my wife's company went out of business, I bailed on the company I was with (which went under 6 months later) and took a more stable job for less money, and we've been able to weather the storm.

What's funny is that now I hear people saying it's a great time to buy. Now where have I heard that before? ;)

I guess what really bugs me about the banks and the way they pushed these loans on people they KNEW couldn't afford them is the sleaziness of it. I expect that kind of behavior from a shoddy used car salesman; I hoped I wouldn't have to expect it from my bank.

These days, it seems every industry in America is being run by used car salesmen.

"Although it is not true that all conservatives are stupid people, it is true that most stupid people are conservatives." - John Stuart Mill

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Tuesday, September 20, 2011 8:39 AM

ANTHONYT

Freedom is Important because People are Important

"now I hear people saying it's a great time to buy."

Hello,

It is. IF.

If you buy a foreclosure at a small fraction of its original value, in a neighborhood whose depreciation rate has bottomed out and stagnated, and if you have the cash for a 20% down payment, and if you get a fixed rate loan with a payment you can afford even if you lose a percentage of your income. And, of course, if you have the money to make the renovations or updates that will be necessary to restore the property to living condition after the former owners and/or thieves have ripped out or vandalized everything that has value.

That's a lot of IF.

Rent is cheap now. (Or at least cheaper than it used to be.) Waiting might not be an entirely bad idea, till you see where the wind is blowing.

--Anthony

_______________________________________________

"In every war, the state enacts a tax of freedom upon the citizenry. The unspoken promise is that the tax shall be revoked at war's end. Endless war holds no such promise. Hence, Eternal War is Eternal Slavery." --Admiral Robert J. Henner

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Tuesday, September 20, 2011 10:53 AM

NIKI2

Gettin' old, but still a hippie at heart...

Thanx, Anthony...I DID read it in the other thread, but I'm glad you made its own thread out of it, because it is THE pertinent point. I also have to giggle that none of our righties has shown his face yet to make some snark or claim you're wrong. Well done, my man!

Hippie Operative Nikovich Nikita Nicovna Talibani,
Contracted Agent of Veritas Oilspillus, code name “Nike”,
signing off

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Tuesday, September 20, 2011 11:45 AM

DREAMTROVE

Anthony,

That's pretty on target. Only problem I see is that I fail to see where the banks and the govt. are separate entities. The lending rules, LTV et al came in with the mark to market margin req. rules of the '90s, iirc. I don't see any resistance to them from the GOP of the '00s, outside of Rep. Paul, so they continue. I think Obama is a bank's best friend, so this nonsense will continue, and continues to make our economic system completely meaningless.

As for checking a lenders elligibility, with rules like this, who would bother? Just sign the loan, package it into a bond, and sell the bond, or its derivatives, get more solid assets into the bank and relend.

It's a completely absurd economic system.

That's what a ship is, you know - it's not just a keel and a hull and a deck and sails, that's what a ship needs.

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Thursday, September 22, 2011 3:50 AM

SIGNYM

I believe in solving problems, not sharing them.

Well, sorry about the house Tony. But if it makes you feel any better, I bought into a hedge fund a while back... Asian currency basket. GREAT prospects. Insured by Shearson Lehman....

If it hadn't been for my other investments, I would have lost a fair bit of money. A lot of people lost a lot in the crash, especially those with retirement plans in the stock market. .

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Thursday, September 22, 2011 5:10 AM

SIGNYM

I believe in solving problems, not sharing them.

DT.... The one indication that banks and government are NOT the same is that banks specifically created credit default swaps (neither insurance nor loan) to be outside of government regulation.

If the two entities were so joined at the hip as to be indistinguishable, that would not have been necessary.

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