In the current issue of The Pomerantz Monitor, Adam Prussin writes about the role of “Liar’s Loans” in the subprime crisis. We did not make up the term Liar's Loan, which is actually a term of art in the mortgage industry. Its official designation is a "stated income" mortgage, a loan given without any verification of the buyer's income. Originally such loans were intended for people whose income fluctuated greatly from year to year, and therefore could not be reliably estimated. But according to a recent article in Slate Magazine, at the height of the housing bubble, the Liar's Loan became routine. This was especially true in high priced markets, and particularly for mortgages issued by Countrywide and WaMu. For some markets, they accounted for half of all mortgages written in 2006, both for subprime borrowers and prime borrowers as well.
According to the WSJ, the ongoing FBI investigation of Countrywide is turning up evidence that sales executives deliberately overlooked inflated income figures for many borrowers, especially those in the "Fast and Easy" program, which is what Countrywide calls its "stated income" loans. Reportedly, Countrywide often did not even verify the borrower's employment, much less his or her income; and mortgage brokers and former Countrywide executives have said that brokers and Countrywide employees "eventually figure out that if they had borrowers who might have trouble qualifying for a desired loan on the basis of their income, “Fast and Easy” would allow them to inflate that income and ensure an approval."
The FBI, the IRS, and prosecutors from New York, Los Angeles, Philadelphia, Dallas and Atlanta have formed a task force to investigate Liar's Loans, which will take this investigation even further.
Countrywide has admitted its "Fast and Easy" loan borrowers were 50% more likely than others to fall behind in their payments. Fannie Mae, which purchased loans from companies like Countrywide, has reported that the performance of these "stated income" loans has deteriorated and that it will no longer purchase such loans.
According to the article in Slate, most of the people who took out "stated income" mortgages -- both prime borrowers and sub-primers -- lied big time about their income. The Mortgage Brokers Association for Responsible Lending reportedly did a study in 2006 comparing a sample of applications for 100 stated income mortgages to the borrowers' tax returns. The group found that more than 90% of the borrowers overstated their income, and that over 60% overstated it by at least 50 per cent. While this sample is far too small to constitute a rigorous study, and whereas it could well be that some of the tax returns were wrong, rather than the mortgage statements, the findings are consistent with what the Countrywide investigation is uncovering.
The Slate article also reports that a blogger tracked 1,765 mortgage loans extended in May of 2007 by WaMu, totaling $519 million. The borrowers were credit-worthy, with average credit scores of 705; yet eighty-eight percent of these loans were "stated income" loans. The histories of those loans is, once again, alarming. Typically, less than 1% of prime loans would be 30 days late or more within one year. The blogger found, however, that of these loans almost 20% were 30 days late within 8 months. Two months later, 18% of the loans were in foreclosure, and 25% were 60 days or more past due. OK, so we are talking about the "findings" of an unidentified "blogger." But they are consistent with the information reportedly coming to light in the government's investigation.
Mortgage lenders had no incentive to be more cautious in their lending practices because they were selling them to companies like Fannie Mae or "securitizing" them in packages and selling them off to investors. If the loans went bad, that was somebody else's problem. Meanwhile, "stated income" loans bore a higher interest rate, and higher fees, benefiting the lender.
As the horror has faded from the near-death experience of the collapse of Bear Stearns, the mortgage industry apparently believes that it is now acceptable to push back against newly proposed regulations to tighten up mortgage lending practices. The regulations, they claim, will make it "more expensive" for borrowers to get loans. These people have no shame.
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