Lenders and Home Buyers Long Deaf to Mortgage Warnings

August 24, 2007 11:21 AM
by findingDulcinea Staff
As the sub-prime meltdown continues to hurt U.S. stock markets, the mortgage industry, politicians, and the public try to apportion blame for a crisis that was predicted years ago.

30-Second Summary

Sub-prime mortgages, designed for borrowers with poor credit ratings, are much more likely to end in foreclosure than conventional loans.

Since the end of the real estate boom, in 2005, lenders have increasingly found themselves unable to recover the full amount of the principal when sub-prime borrowers can’t make their payments.

As a consequence, a number of lenders dealing in these products, which are mostly adjustable rate mortgages (ARMs), have gone into bankruptcy, delivering a heavy blow to the U.S. economy.

Thus far, the situation is easy to understand. What is less clear is why these lending practices continued for so long. Back in 2004, British analyst Peter Schiff was not alone in defining the American economy as an “ARM time-bomb” when he discussed the prevalence of high-risk mortgages.

Neither buyers nor the mortgage industry heeded such warnings. Speaking at a Senate hearing in March, Sandy Samuels, the Executive Managing Director of Countrywide Financial Corporation, a major sub-prime lender, said that during the “cooling of the housing market” there was a “dramatic liberalization of underwriting guidelines” as “lenders vied to retain volumes and increase market share.”

In other words, according to Samuels, lenders made it easier for applicants to get a sub-prime loan as the risks of home ownership increased.

Such perilous behavior has prompted some pundits to accuse banks and brokers of “predatory lending.” Among them was Sen. Chris Dodd (D–CT) when he chaired the Senate hearing at which Samuels testified.

However, others have questioned how appropriate the term predatory is since both lenders and borrowers have followed a path to insolvency.

Schiff, writing in 2004, spread the blame for the crisis he foresaw among all participants: “Home buyers have been lured into this foolish choice [to invest in ARMs] by estate agents and mortgage brokers eager to earn commissions, their own avarice in pursuit of easy riches, and by central bankers desperate to keep the real estate bubble inflating.”

Headline: Stocks slip, Fed stays optimistic, and the forecast from '04

Background: Discount rate cut, New Century bankruptcy, and the Senate hearing

Senate Hearing into Mortgage Market Turmoil

Reference Material: Interest-only mortgages, ARMs, and Countrywide Financial

Opinion: Regulation, the analogue, and fiscal irresponsibility

History: Lenders' stocks rocket, analysts skeptical

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