Wednesday, June 25, 2008

Money for Nothing

Confessions of a Subprime Lender
By Richard Bitner
(Wiley, 186 pages, $19.95)

Three years ago, I had lunch with several mortgage-bond traders and analysts at Bear Stearns. The investment bank, already a huge trader and underwriter of securities backed by mortgages, had recently begun making home loans to consumers via brokers. I wondered why my hosts were getting even deeper into what seemed like an increasingly risky business.

After all, home prices couldn't keep soaring forever, and lending standards were growing more and more lax. Mortgage lenders were congratulating themselves for finding "innovative" ways to help people buy homes that, by traditional standards, they couldn't afford.

The Bear Stearns people dismissed my questions with ill-concealed contempt. Their computer models told them that home prices wouldn't fall much and that few people would default on their loans, barring another Depression.

About the same time, Richard Bitner, the co-owner of a small subprime mortgage bank in Dallas, was coming to a different conclusion. Mr. Bitner wasn't relying on mathematical formulas. He was dealing with actual subprime borrowers, including one named Johnny.

As Mr. Bitner recounts in "Confessions of a Subprime Lender," Johnny worked at a gas station, and his wife, Patti, was a cashier. By living with a relative for three years, they had managed to save $5,000 for a down payment on a house. But their dismal credit scores showed that "paying bills had never been a priority for them." The mortgage payments would eat up more than half of their combined pretax income.

Despite his misgivings, Mr. Bitner made the loan. Shortly after the couple moved into the house, Patti got sick and lost her job. They had no medical insurance and chose to pay their hospital bills rather than the mortgage. With a sick feeling in his gut, Mr. Bitner took the keys from Johnny and wrote off his losses on the loan.

Within a few months, Mr. Bitner sold his stake in the mortgage company and began work on his memoir. The result is an unflattering portrait of an industry that claimed to be all about helping people like Johnny achieve the American Dream but was really about grabbing loan-origination fees and foisting the dud mortgages on investors.

Yes, borrowers like Johnny made poor decisions and needed to learn their lesson. But so did the lenders, brokers, rating agencies, regulators and Wall Street financiers who all thought, or pretended, that Johnny was a good bet. To his credit, Mr. Bitner owns up to a fact that many lenders still haven't admitted: Just because Wall Street was willing to supply endless funding for crazy mortgages didn't mean that lenders were forced to make the loans. "We decided whether a borrower was a good credit risk and we funded the loans using our own money (before selling them to investors). No one else made that final decision," he writes.

Not everyone in the business was corrupt, of course. But too many were. After giving a concise overview of how mortgage loans are made and sold, Mr. Bitner exposes some of the industry's dirty little secrets for making borrowers look more creditworthy than they are:

- A large car payment keeps a couple from qualifying for a loan. But, in a fluke, car debt is recorded by only one credit bureau; the loan officer simply "drops that bureau from the borrower's credit report and the debt disappears."

- If a borrower's credit score is too low, it can be manipulated. "A person with good credit is paid a fee for each account they let someone else use. The person with the challenged credit doesn't get access to the account, just the benefit of the performance history that comes with it." (A spokesman for Fair Isaac Corp., a provider of technology for credit scoring, says that a new formula, being adopted this year, will thwart such abuses.)

- Does the borrower's bank statements show bounced checks? Never mind. Just give the underwriters copies of the first page from each month's statement, leaving out the grisly details.

- Is the borrower's income too low? "Desktop publishing programs allow for near-perfect replication of pay stubs and W-2s."

Mr. Bitner also offers proposals for reform. Among the better ones:

- Require people who have regular salary income to document it with pay stubs and tax forms. Reserve "stated-income" loans – those that don't require proof – for self-employed people with fluctuating incomes. But they should qualify only if they have good credit scores and plenty of savings.

- Require brokers to disclose from the start – to the borrower – how much compensation they will get from arranging a loan. That way there should be less incentive to push the types of loans that are more profitable for brokers but less favorable for borrowers.

- Certify the expertise of loan originators – whether independent brokers or bank officers – with training standards akin to those required for certified public accountants.

As for Bear Stearns, losses from mortgage investments and other risky trades sank the firm in March, prompting its eventual sale to J.P. Morgan Chase. More than 7,000 jobs vanished. The Bear mortgage mavens would have been better off listening to Mr. Bitner or Johnny three years ago than relying on their computer models. They had plenty of brainpower but fell short on common sense. I look forward to reading their confessions.

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