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borrower was a weak candidate for a loan. He may have had a relatively low income or a low credit score, past bankruptcies
or substantial credit card debt. With lots of money pouring in from the investment side, mortgage companies worked with
these subprime borrowers to qualify them for mortgages - sometimes bending or ignoring the rules in the process.
Larry Ziglar, president and CEO?of First National Bank in Staunton, said part of the problem was that the big banks were looking
for ways to try to generate more yield on their loans. He said that there was very little difference in the interest rates
paid on long-term or short-term bonds - what financiers refer to as a "flat yield curve." With tough competition, that left
very little profit in a standard, fixed-rate mortgage.
"Banks were trying to jump outside that yield curve to earn either
a higher rate or higher fees associated with these subprime loans to generate more income for the shareholders," Ziglar
said. "They were creating some loans that had yields of 7 percent, 8 percent and even 9 percent."
"It was the perfect
storm," said Dennis Terry, president and chief executive officer of First Clover Leaf Bank. "You had all three of these
factors that came into play: you had lenders that were offering these real attractive rates on a balloon loan; you had
people who thought they would stretch into a house because it will go up in value; and you had people who were out there
trying to make loans because they got paid on commission."
According to analysts, games were played to get around the
age-old rules of prudent lending - things such as debt-to-income ratio requirements and loan-to-value lending limits.
One example is the mortgage broker lending 80 percent of the value of the home on the first mortgage but then supplying a
"home equity" second mortgage to cover the remaining 20 percent of the purchase price.
Another trick was to find
compliant appraisers who were willing to inflate the appraisal on the home to show a sound loan-to-value ratio, knowing full
well that the stated value did not actually exist.
Adjustable rate mortgages, offering low "teaser" rates, became popular
and are at the crux of the current problem, bankers say. Borrowers were shown low initial monthly payments. But they either
did not understand the risk of the rate adjusting upward in the future and the effect that that would have on their monthly
payment, or they decided to ignore the risk - assuming that the home's value would continue to increase and they would be
able to refinance the mortgage if and when necessary.
For example, a recent Wall Street Journal article describes one
case that is common. A single mother earning $2,833 a month ($34,000 per year) got a no-money-down, adjustable rate mortgage
on a $385,000 home in 2005. The monthly payment of principal and interest on a normal 30-year, fixed-rate mortgage would
have been $2,308. Add taxes, insurance and other monthly expenses on top of that and she could not afford the home under
normal circumstances. The loan was made anyway because at the low initial rate, her payment was only about $1,200 per month.
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A third problem was that mortgage brokers were not verifying income. If people claimed a certain income on their credit
application, that number was used to qualify them for the loan - no questions asked.
"Then the mortgage brokers bundled
the loans and sold them to a variety of sources in the market," said Solon. "The mortgage originators package up these loans
in a big package and sold them to the banking houses and brokerage houses - all household names we recognize. And, because
it is offered to the market with that brokerage house's name on it, people see it as a trustworthy investment deal. Plus,
they helped promote that idea with some of the adjectives that they used like high-grade, structured or enhanced mortgage
funds," he added.
According to Solon, even without the games being played, the regulations governing the non-bank
mortgage market are much looser that what a bank has to follow.
"In a conventional bank's case, we have to adhere to
certain regulations and certain guidelines," said Solon. "And when we're examined both by our regulators and even our own
audit firm that we hire, they always evaluate what we're doing vis-a-vis what our policies are and what the regulations are.
There's a lot of scrutiny. I think in general there's much less scrutiny where the non-conventional banking sector is
involved."
These underlying problems were masked, according to analysts, when home prices were rising rapidly. The market
was so hot that people were selling their homes for more than the asking price - and speculators were buying condominium
units at groundbreaking and selling for a profit before construction was even finished. This house of cards all came
tumbling down when home sales slowed and interest rates rose.
"You had folks offering balloon mortgages and they would
throw out a very attractive low rate for the first three years, and they would show you that you can afford this house,"
said Terry, "because their interest rate was only X, which was generally maybe 200 or 300 basis points below the market. If
that borrower asked what his rate would be three years from now, I'm sure he was told that he didn't have to worry about it.
In fact, those balloons are coming due now. Those people are finding that their house in some cases not only didn't go up in
value, but maybe even went down. They can't really afford to pay for it and they can't afford to walk away from it, so you
end up with massive amounts of foreclosures. They woke up and saw their rate go from 4 percent to 8.5 percent and they're
hurting," Terry added.
The homeowner doesn't want to lose his home to foreclosure and the lender doesn't want to end up
with the house, but it all becomes much more complicated because the mortgage securities have been packaged and disbursed
around the world.
Because of the global nature of investments, the repercussions of the American subprime mortgage loan
bust are now ringing around the world. A quick scan of newspaper articles shows problems stemming from the American subprime
mess in England, Germany, Australia, India and Thailand, to name a few.
Solon says that the subprime mortgage crisis
reminds him of the junk bond crisis of the late 80s.
"I think it was Warren Buffett who said, 'Junk bonds were sold to
people who didn't know by people who didn't care.' You have the same thing here," said Solon.
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