It was uncharted territory: Fannie Mae and Freddie Mac (GSEs) used to be the only game in town for mortgage originators and their strict guidelines limited the number of people able to get mortgages. After the GSEs' accounting scandals, suddenly mortgage originators both new and old found someone to replace the GSEs deep pockets: Wall Street. If you're a mortgage originator you obviously want to make more loans and now it was easier than ever. Combining an unregulated Wall Street with a bunch of new money begat a new and experimental wave of securitization. The greed stretched from unqualified borrowers all the way to the international finance arena.
The beginnings of the Global Economic Collapse was the result of a perfect storm of events. More money than ever was pouring into Wall Street because of mortgage originators making more loans and rising economic stars like China, India and the Middle East who were flush with cash and looking for good returns for that money. Wall Street had exactly what they countries were needing: securities backed by the American homeowner.
Investment banks on Wall Street were being fed loans by mortgage originators and mortgage originators, started obtaining more of these loans to feed the investment banks by questionable methodologies. It was not unusual for the mortgage originators to inflate the income of prospective borrowers by triple and quadruple amounts sometimes without the applicant's knowledge. Previously the strict guidelines that allowed responsible home loans via the GSEs were being replaced by the honor system. Incomes weren't verified, and home loans that would take a few months were now being done in a couple of days. It was to everyone's benefit that these loans were made: previously unqualified people were being placed into homes, mortgage originators were producing a hefty revenue stream and the investment banks were bringing in tremendous revenues for new securitization instruments being sold to the international community.
Greedy mortgage originators were seeking new and unique ways to get more people into more homes to make more loans. A whole new crop of loan programs sprang up to enable sub prime borrowers to enter the ranks of home ownership. The loans were vastly different than the traditional 20% down mortgages. People who had bad credit and could not come up with a down payment could now get a home. They did not need to verify their income or even prove that they had assets of any kind.
Investment banks saw the tremendous value in this. If mortgage originators could generate ridiculous numbers of loans, it worked to the investment banks' advantage. Why did so many investment banks turn a blind eye? Competitiveness. Seeing the tremendous amounts of money being pushed around made all the investment banks realize that there was big money to be made and not participating was the equivalent of sitting on their hands. They had to be competitive with each other, even if it meant undertaking questionable business practices.
There were a dizzying number of ways that people could get a mortgage. Mortgage originators began to push loan programs like Adjustable Rate Mortgages (ARMs). This program would offer extremely low interest rates for the first couple of years and then reset to a higher rate that dramatically increased the monthly mortgage. Even though it was a ticking time bomb on the surface, people would agree to these loans with the intention of refinancing before the rates went up. It was assumed that house prices were going to continue to appreciate dramatically.
In some cases mortgage brokers were saddling borrowers with two loans: one for the down payment and an ARM for the balance.
As if this wasn't precarious enough homeowners, who were unqualified to begin with, were taking loans out for equity in their homes when they refinanced. Sometimes these homeowners would be in their homes for only a year before refinancing and taking out equity loans that were used for improvements or for other things like college, new cars, paying off credit cards, etc.
All of this spending stimulated the economy in the area of consumer spending. The Fed's insistence of keeping interest rates low, in the interest of growing the economy post 9/11, only served to heighten the frenzy.
Everyone wanted a home, everyone could have a home and people were afraid of missing the boat as home prices continued to increase and there was money to be made if you were a loan officer.
The ranks of mortgage brokers began to swell. People from all walks of life became loan officers. Kids who worked in fast food could become loan officers. There were incentives to these officers to keep making more loans and refinancing.
There was no oversight or regulation of any kind. It became an issue of how many loans could be made no matter what it took to make them.
It's the refinancing aspect of the housing boom that brought the crisis to a new level and greed fed upon greed. All of the new unstable loans served to drive home prices up. People not wanting to miss the boom created more demand which drove prices up even more. As home prices went up to unprecedented levels, people were refinancing and taking out loans against what was, unbeknownst to them, artificially inflated equity.
Every new and refinanced loan led to the same place: Wall Street investment banks.
Julian Cook/March 9