Sex, Lies, and Subprime Mortgages

The sexual favors, whistleblower intimidation, and routine fraud behind the fiasco that has triggered the global financial crisis
By Mara Der Hovanesian

It may seem like ancient history now, but not long ago the mortgage industry was turning ordinary people into millionaires. One of them was Sharmen Lane, a high school dropout who, like many other young women during the boom, found her way into an obscure banking job with the clunky title "mortgage wholesaler." Her experience—and the experiences of other wholesalers like her—offers a glimpse into the recklessness and indulgence that drove the industry to ruin.

The rise of mortgage wholesalers from grunts to rainmakers is one of the more curious developments of the housing bubble. Wholesalers work for banks and other lenders. The wholesaler's job is to buy loan applications from independent mortgage brokers so that lenders can turn them into loans. Wholesalers are paid on commission: the more loans they generate, the more money they make. During the housing boom, lenders typically approved the loans and then packaged them into securities. That path—from mortgage brokers to wholesalers to lenders to securities—turned out to be a road to disaster.

But as the housing bubble inflated, wholesalers—though hidden from public view—became high-earning superstars. Lane, a manicurist before joining now-defunct subprime lender New Century Mortgage in 1997, says she brought home $1 million in 2002 and $1.2 million in 2003.

Eventually the deal-making turned frenetic. Multiple wholesalers began inundating mortgage brokers with offers for the same applications. Some brokers chose to exercise their power by asking for something extra in exchange for their business: sex.

Dozens of former brokers and wholesalers say the trading of sexual favors was so common that it came to be expected. Lane recalls one visit to a mortgage brokerage near San Jose (Calif.) in which the manager lewdly propositioned her in his office. She says she declined the advance, and he didn't sell her any applications. But other female wholesalers didn't have the same qualms about crossing the line. "Women who had sex for loans were known very quickly," says Lane, who left New Century before it failed in 2007 and now works as a $200-an-hour life coach and motivational speaker in New York. "I didn't want to be a mortgage slut."

WHOLESALE CORRUPTION
Investment bubbles always spawn excesses, and housing was no exception. The abuses went far beyond sexual dalliances. Court documents and interviews with scores of industry players suggest that wholesalers also offered bribes to fellow employees, fabricated documents, and coached brokers on how to break the rules. And they weren't alone. Brokers, who work directly with borrowers, altered and shredded documents. Underwriters, the bank employees who actually approve mortgage loans, also skirted boundaries, demanding secret payments from wholesalers to green-light loans they knew to be fraudulent. Some employees who reported misdeeds were harassed or fired. Federal and state prosecutors are picking through the industry's wreckage in search of criminal activity.

Now wholesalers, who for a brief moment rose to prominence, are an endangered species. The failures of large subprime lenders like New Century, BNC (a unit of Lehman Brothers), and GreenPoint Mortgage, owned by Capital One, threw thousands out of work. Some lenders still in business have curtailed or shuttered their wholesale operations.

In the end, the wholesalers were undone by the same people who allowed for their rise: their Wall Street overlords. During the boom investment banks bought as many loans as they could to pool together and turn into securities. In 2006 the top 10 investment banks, which included Merrill Lynch (MER), Bear Stearns (BSC), and Lehman Brothers, sold mortgage-backed securities worth $1.5 trillion, up from $245 billion in 2000. To keep the supply of loans coming, the investment banks increasingly took control of the industry's frontline players as well. First they started buying small, independent wholesaling firms. Next they extended billions in credit to subprime lenders. Then they took stakes in some, and bought others outright. At the height of the frenzy in 2006, six top investment banks shelled out a total of $2.2 billion to buy subprime shops.

That gave Wall Street the power to demand more subprime loans, which carried the highest interest rates and were the most profitable. As a national account director for Deutsche Bank (DB), Mark D. Toomey bought loans from mortgage lenders to turn into securities. Sometimes, he says, he "twisted arms" to get more loans. "Nobody had the [guts] to say no," says Toomey, who left the bank in 2007. Deutsche Bank declined to comment.

But mostly, brokers and wholesalers were happy to comply. The more loans they made, after all, the more they got paid. One former wholesaler in Northern California who requested anonymity joined subprime lender GreenPoint Mortgage in 1997, right out of college. By 2004, she says, she was pulling in several hundred thousand dollars a year. She kept a chauffeur on call to shuttle her and her friends to "exclusive clubs, restaurants, and parties," and treated friends to shopping sprees at Neiman Marcus, Gucci, and Louis Vuitton. "It was the time of our lives," says the woman, who now works as an account executive for another lender in the area.

Brokers say some female wholesalers weren't up on the finer points of finance—but exploited other assets in their quest for more loans. "You had boiler rooms of younger, predominantly male brokerage operations and in would walk a gorgeous, fit [wholesaler] who would go desk to desk," says Rick Arvielo, president of New American Funding, a mortgage brokerage in Irvine, Calif. "Most of them didn't know the product."

Of course, it's accepted practice in many industries for companies to hire attractive saleswomen. What's more, on Wall Street, lurid tales of erotic dancers livening up after-hours events are common.

"INDECENT PROPOSALS"
But in the mortgage business, it went further: The women allegedly offering sexual favors were bank employees. Evan Stone, president of Walnut Creek (Calif.) mortgage brokerage Pacific Union Financial, says "minimally trained and minimally dressed" wholesalers often wooed brokers. He says he regularly got visits in his suburban office from representatives wearing unusually short skirts to entice him and his team of brokers to party at the local Ruth's Chris Steak House. Stone says one New Century wholesaler offered to fly him to Chicago to "have a good time." He says he declined all offers of sexual favors. "There were some indecent proposals made," he says. "That was part of building the relationship."

Wholesalers also offered sexual favors to co-workers. To drive up their commissions, some enticed loan underwriters at their companies to approve questionable applications. A vice-president at Washington Mutual who once wielded $500 million to make loans recalls an incident in which a female wholesaler wanted him to approve a loan that didn't fit guidelines. The manager, who requested anonymity, says the co-worker, wearing a low-cut shirt, knelt down at his desk and said: "I really need this. What do I have to do?"

Some wholesalers turned a blind eye to broker fraud, too. "I'd walk into mortgage shops and see brokers openly cutting and pasting income documents and pay stubs, getting out the Wite-Out and changing Social Security numbers," says Melissa Hernandez, a former wholesaler for Argent Mortgage, a unit of now-defunct Ameriquest Mortgage, who says she never knowingly bought bogus applications. "There was no ambiguity."

Other wholesalers took matters into their own hands, doctoring documents to qualify borrowers for loans. A former Wells Fargo (WFC) wholesaler says he regularly used the copiers at a nearby Kinko's to alter borrowers' pay stubs and bank account statements. He would embellish job titles—turning a gardener, for instance, into the owner of a landscaping company—and inflate salaries. "I knew how to work the system," the former wholesaler says. Wells Fargo spokesman Kevin M. Waetke says the bank "does not condone any misrepresentations in the loan-underwriting process. We thoroughly investigate any incident that comes to our attention. Where necessary, we will take the appropriate disciplinary action."

Employees who resisted making bad loans ran the risk of being penalized. Shortly after Rachel Steinmetz joined GreenPoint's Manhattan branch as a senior underwriter in September 2005, wholesalers at the bank started asking her to approve loans "under terms that the borrower did not qualify for," according to a wrongful termination suit filed in June by Steinmetz in New York federal court. She says she told her superiors that the applications contained suspect details and that the loan files didn't have enough paperwork to back up borrowers' claims. "Notwithstanding [her] concerns, management overrode her decisions" and approved the loans anyway, the complaint says.

In April 2006, Steinmetz claims, she rejected a loan application that inflated the borrower's income and the home's appraisal value. While Steinmetz was out of the office celebrating Passover, she says in the complaint, her superiors signed off on the loan. A month later, Steinmetz says, her boss asked her to compile the paperwork on the same loan in preparation for closing. "Although she protested," the complaint notes, "the loan was funded in her name."

Steinmetz says through her attorney that there was retribution for her reluctance to make bad loans. Even though her bosses knew she was devoutly religious, the complaint says, they often would inundate her with "additional work and unnecessary meetings" on the eve of the Sabbath and religious holidays. In May 2006, she says, her superiors nixed her bonus even though she made her loan quota. Steinmetz is now suing Capital One (COF), which bought GreenPoint Mortgage in 2006 and shut it down less than a year later, for $10 million in damages. "We believe these claims are without merit, and we are confident that we will prevail in this litigation," says Capital One spokeswoman Diana Don.

DEMANDING "SPIFFS"
Whistleblowers at other firms complain of similar treatment. Coleen Colombo joined the Concord (Calif.) branch of BNC in 2003. The small office, next to a Mercedes-Benz dealership and a run-down Kmart (SHLD), was part of a regional group that funded some $1.2 billion of loans a month. Colombo initially thrived in her job as a senior underwriter. In a performance review, she received a top rating of "exceeds expectations," according to a wrongful termination and harassment suit filed in California Superior Court on behalf of Colombo and five other female employees.

The environment turned hostile in 2005, the suit says. One fellow employee, a male wholesaler, began bringing Colombo questionable loans with incorrect salaries, occupations, and home values, she says. In one instance, she claims in the suit, the wholesaler "tried to bribe [Colombo] to allow a loan with fraudulent information to go through."

The bribes, known as spiffs, were common at the BNC branch, says Sylvia Vega-Sutfin, a former wholesaler who left the firm in 2005. The mother of four, who says she made $16,000 a month during the boom, says that some underwriters demanded spiffs of $1,000 for the first 10 loans and $2,500 for the next 20 loans, whether they approved the mortgages or not. When she refused to pay them, Vega-Sutfin says, her loan files started to go missing and the size of her commission checks plummeted. Her bosses "said they would make an example of me to others: 'If you complain, this is what will happen,' " she says.

Colombo says in the suit that she e-mailed the regional vice-president for operations to report the wholesaler who tried to bribe her. She claims the vice-president brushed off her complaints in a meeting. Colombo "left the office in tears," the suit says. After she returned from a short leave of absence, the branch manager told her a co-worker "wanted her terminated for making the complaints," Colombo claims.

Meanwhile, the wholesaler who tried to bribe Colombo started sexually harassing her, according to the suit. The male colleague made her feel "uncomfortable and fearful" by "intentionally rubbing his body against hers." Colombo resigned from BNC in 2005. "You would have thought he was the pimp and we were his prostitutes," says Linda Weekes, another underwriter who is part of the suit. "It felt like a dirty, sleazy place to work." The case has been on hold since its owner, Lehman Brothers, filed for bankruptcy on Sept. 15. "We dispute the allegations made by these former employees and will be contesting them on the merits in the pending litigation," says a Lehman spokesman.

The world came crashing down for wholesalers in late 2006, when subprime loans started going bad. Wall Street quickly reined in its mortgage factories, tightening lending standards, pulling credit lines, and forcing lenders to buy back the same risky loans it once voraciously consumed. For the thousands of wholesalers swept up in the excitement and excess of a manic market, it was time to find a new job.

Source: BusinessWeek, November 13, 2008

US bank backstop could need rescue of its own!

Boston.com

IndyMac collapse and mounting failures could sap FDIC reserve
By Bloomberg News | September 25, 2008

Deborah Horn tugs on the handle of the glass-paned entrance of the IndyMac Bancorp Inc. branch in Manhattan Beach, Calif. The door won't budge. The weekend is approaching, and Horn, 44, the sole breadwinner in a family of three, needs cash.

A small notice taped to the window on this Friday afternoon in mid-July tells her why she's been locked out. IndyMac has failed, the single-spaced, letter-size paper says; the bank is now in the hands of the Federal Deposit Insurance Corp.

Inside, an FDIC examiner is talking to six IndyMac employees. "I don't know when I'm going to be able to get my money," Horn says. "I'm a single mom. This is the money I live on."

Don't worry about Horn. She'll be all right, as will most of Pasadena, Calif.-based IndyMac's 200,000-plus customers. That's because the FDIC, created in 1934, insures all accounts up to $100,000 at its member banks, and it has never failed to honor a claim. The people to worry about are US taxpayers.

The IndyMac debacle is taking a large bite out of FDIC reserves, and if scores of other banks fail in the year ahead, the fund will be depleted. Taxpayers will have to step in.

Americans have gotten used to the idea that bank failures were as rare as a category 5 hurricane. No banks went bust in 2005 or 2006. Seven collapsed in 2007 as the credit crisis began to exact a toll. So far in 2008, 12 more, with total assets of $42 billion, have fallen - that's the worst wave of bank failures since 1992.

IndyMac, which had $32 billion in assets when it went into receivership, is the most expensive bank failure the FDIC has ever covered. And that record may not stand for long.

By the end of 2009, about 100 US banks with collective assets of more than $800 billion will fail, predicts Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, Calif.-based firm that sells its analysis of FDIC data to investors.

"It's not going to be Armageddon," says Mark Vaughan, an economist at the Federal Reserve Bank of Richmond, Va. "But it's going to be bad."

The FDIC knows which banks are at risk; it has a watch list with 117 institutions. The agency won't disclose their names because doing so could cause depositors to panic.

It won't take many more failures before the FDIC itself runs out of money. The agency had $45.2 billion in its coffers as of June 30, far short of the $200 billion Whalen says it will need to pay claims by the end of next year. The US Treasury will almost certainly come to the rescue.

Emergency federal funding of the FDIC could swell the cost of government rescues of failed financial institutions to more than $400 billion - not including the $700 billion Wall Street bailout now under discussion.

The subprime crisis - which started in the suburbs of California and Florida and migrated through the alchemy of securitization to Wall Street investment banks - has come almost full circle, spreading its toxins to the very lenders who first extended those teaser-rate, no-document mortgages to homeowners.

In 2006, IndyMac was the largest provider of mortgages that didn't require borrowers to provide proof of income. US lenders, in their embrace of subprime lending, committed the same analytical fallacy as their Wall Street counterparts. When it came to assessing risk, they relied on the recent past to predict the near future.

They were blinded by years of rising home prices and low mortgage default rates.

The FDIC fell into the same trap. As recently as March, an FDIC memo estimated the cost to cover bank collapses in 2008 would be just $1 billion, dropping to $450 million in 2009. It wasn't even close. The IndyMac failure alone will cost the FDIC $8.9 billion.

FDIC chairman Sheila Bair says depositors shouldn't fret about their banks. "We do have a handful with some significant challenges," she says. "Overall, banks are quite safe."

America's Deeper Financial Crisis

Subprime Is Really SubCRIME: America's Deeper Financial Crisis
By Danny Schechter, AlterNetPosted on February 21, 2008, Printed on February 21, 2008http://www.alternet.org/story/77375/

At long last, the Democrats are talking about the economy and the need for serious relief and reforms. The reason is simple. The people are feeling the squeeze.
Reports the Baltimore Sun:

"Since January alone, the public's perception about the state of the economy has plummeted -- with just 17 percent calling the nation's economy excellent or good -- down from 26 percent last month. The percentage rating the economy poor has grown from 28 to 45 percent."

Hillary Clinton and Barack Obama now have their instant 10-point plans and programs. They have dipped into John Edwards' tool chest for ideas on fighting poverty and listened to policy advisors who have come up with a laundry list of proposals for stop-gap measures from hikes in the minimum wage and middle-class tax cuts. All of these proposals will take time to implement and probably will be forgotten by the time one of them becomes president, if they do.

Meanwhile the economy is collapsing because of crimes and irresponsibility on Wall Street, and no one is really talking about that. An inequality gap and structural crisis compounded by profiteering in high places goes on and is largely ignored.

The media is not investigating the profiteers and, in fact, continues to contribute to the problem by accepting millions for dubious ads for more loans that end up getting more Americans in debt. Prosecutors are not prosecuting wrong doing. No fundamental new regulations and oversight are being proposed.

The candidates don't even seem to know the extent of damage that is being done by the subprime crisis and its assignees. Andrew Abraham reports:
Bank of America delivered a report last night highlighting the current losses of the "credit crisis."

According to the report, the meltdown in the U.S. subprime real estate market has led to a global loss of $7.7 trillion in stock market value since October.
Quoting Bank of America's chief market strategist, Joseph Quinlan, the crisis, which has spread beyond U.S. shores to banks and other sectors worldwide, is "one of the most vicious in financial history."

That number again: $7.7 TRILLION. That phrase again: "the most vicious," that is, worse than 1929 and all the financial crises since.

Who is responsible for this, and who is being made responsible? Why aren't we talking about these massive losses and the growing debt burden? Why is this issue not on the political agenda save for the efforts of a few advocacy groups on the left and Ron Paul on the right?
It was discouraging when our government's leading critic of these practices got so discouraged that he quit last week. David Walker, the comptroller of the currency had warned back in 2005 (as reported in my film In Debt We Trust):
Continuing on this unsustainable path will gradually erode if not suddenly damage our economy, our standard of living and ultimately our national security.

And guess what? Just two years later, our economy was "suddenly damaged." The damage is "affecting our standard of living," and very few public officials or political candidates are connecting the dots. Why not?

When will we condemn the false prophets of the free market and their misguided policies? When will we indict those who cashed in on our country's misery?
Notes scholar Lionel Tiger:

Those who have been operating the managerial levers of the financial system have failed embarrassingly and massively to comprehend the processes for which they are responsible. They have loaned money avidly and recklessly to people who couldn't pay it back. They fudged data to get loans approved and recalculated. Then they sausaged fragile figments of money-reality into new "products" which could be sold around the world to investors eager to enjoy the surprising returns which often accompany theft, managerial incompetence and fraud. When it comes to responsibility for all this, there appears to be no one here but us spring chickens. Not only that, but the overseers of the bitter debacle may lose their jobs for a month but nonetheless fill their wheelbarrows with company money and "severance" when they leave to tide them over until the next corner office becomes available."

And what is to be done about this white-collar crime wave? At long last even shamed executives in the financial industry are joining those of us who long ago charged that subprime is really subcrime. Basil Williams, chief executive officer of Concordia Advisors, a hedge fund, says we need "a safety net for the innocent and a dragnet for the guilty."
Writing in the Record in Bergen County, N.J., he says that the greedy should pay to help the needy:

"The costs can be recouped by going after those who profited handsomely and unfairly from the multitude of transactions that touched the industry, including:
Mortgage brokers who originated loans to those who didn't understand the conditions, couldn't afford them and should not have qualified.
Appraisers who overvalued homes, knowing that the higher the value they gave a property, the more business they would reap from a dishonest broker.
Banks and brokerage firms that purchased, packaged and resold the mortgages for huge fees."
He goes on to discuss ratings agencies and more. This is a litany that the candidates and activists should sign on to.

With millions facing foreclosure, we have to expose those responsible and mount a movement for economic justice. It can be done. It should be done. Who is ready to stand up and organize a national mobilization to stop this outrage? Who is ready to fund it?
Who?

Danny Schechter writes a blog for MediaChannel.org. He is the author of Embedded: Weapons of Mass Deception: How the Media Failed to Cover the War on Iraq (Prometheus).
© 2008 Independent Media Institute. All rights reserved.View this story online at: http://www.alternet.org/story/77375/

Subprime Loans = Primetime for Vampire Lenders

One of the most dramatic stories from the New Testament is of the time that Jesus encountered money changers in the temple. Enraged by their usury and sacrilege, he went on a tear -- overturning their tables, physically driving them out and chastising them for converting the temple into a "den of robbers." The Bible doesn't say where these bloodsucking lenders went, but now we know: They have re-emerged in recent years to set up their tables right here in America, working a dark alley of homeowner financing called the "subprime mortgage market." The what? Don't be deterred by the finance industry's jargon (which is intended to numb your brain and keep regular folks from even trying to figure out what's going on). At its core, this is a classically simple story of banker greed and outright sleaze. And the astonishing part is that nearly all of the rank injustice perpetrated by today's money changers is considered legal and is practiced by supposedly reputable financial firms.

That's when avaricious mortgage hucksters and high-finance manipulators looked upon this broad pool of needy, vulnerable castoffs and suddenly shouted, "Eureka, GOLD!" With interest rates remarkably low, housing prices seemingly on a nonstop rise, and (this is the Big One) practically no regulation of this low-income market, the money changers promptly began to devise clever, Enronian schemes to entice such "subprime" borrowers into high-interest, high-fee loans. Never mind that these families really could not afford (and mostly did not understand) the level of debt being piled on their backs. That was a matter for manana. Today was for raking in profits from the poor.

The subprime schemes are run through an intricate, intertwined system of loan brokers, mortgage lenders, Wall Street trusts, hedge funds, offshore tax havens and other predators. To entrap borrowers, the industry created an arsenal of arcane financial devices and maneuvers known by such exotic names as "exploding ARMs," YSPs, teaser rates, low-doc mortgages, loan flipping and equity stripping. Ultimately, these schemes are scams, extracting high payments from the families, sucking out any equity they might build up and stealing their homes.

This is one of those economic stories, like the savings-and-loan scam of the 1980s, that are usually buried back in the business section of newspapers. But, just as with the S&L collapse, this debacle is growing too big to contain, and all of us need to be paying attention. The built-in traps of the subprime mortgage market have already taken the homes of more than a million people in just the past year, and the dangers are quickly rising for millions more. This collapse in homeownership for the working poor has begun seeping into the rest of the economy, causing thousands of job losses, shaking the soundness and reputations of some major Wall Street firms, and slowly -- ever so sloooowly -- forcing lackadaisical bank regulators and clueless politicians out of their laissez-faire stupor.

How it works

You might have seen some of the come-ons: "Bad Credit? No Problem!" "Zero Percent Down Payment!" "Creative Financing!" "No Documentation Needed!" "Quick and Easy Money!"

The key to building the subprime market is hustle and flimflam -- trying to rush anxious, uninformed people into signing on the dotted line for what they're assured is the deal of a lifetime. Of course, the mortgage industry casts its work in a noble light, asserting that its primary purpose is to help extend the joys of homeownership to the masses. But an examination of key players reveals little altruism.

BROKERS. These are independent, local operators who troll for borrowers in your town and mine, using flyers, doorbells, phone calls, personal contacts, websites, late-night TV ads, data banks and every means imaginable to get low-wage renters to sit still for a home-loan sales pitch or to find vulnerable homeowners who can be talked into taking out a refinancing loan. Brokers don't actually make the loans, service them or have any stake in whether the deals work out. Rather, they are simply "finders" who are paid an upfront fee by the mortgage lenders for every borrower they deliver. And 71 percent of all subprime mortgages come through them.

The pretense is that the broker is the borrower's trusted advisor in the shark-infested waters of banking. Au contraire, Bubba. In most states, agents have no legal responsibility to represent a buyer's best interest. And, in fact, they don't, for the system gives brokers lucrative incentives to deceive borrowers.

Through a common practice called "steering," unsuspecting families are guided into the most expensive, riskiest subprime loans. For doing this dirty job, brokers are paid cash bonuses called "yield spread premiums" (YSPs) -- though you would call them by their more common name: kickbacks. The Center for Responsible Lending reports that these YSP payoffs, averaging $1,850 per loan, are added to about 90 percent of all subprime loans. That's right, struggling families are silently assessed an extra fee for being secretly steered into a loan with higher interest rates and worse terms than they're entitled to get. They're literally being robbed by their bankers.

LENDERS. These are the brand-name players you might recognize. They include nonbank lenders -- for example, New Century Financial, Ameriquest, Option One, Countrywide and Ownit Mortgage Solutions -- that sprang up to tap into the new subprime gold rush, and several of them are now bankrupt or under investigation. Many big banking firms, including Wells Fargo, Lehman Brothers and Citigroup, also joined the free-for-all by setting up their own subprime subsidiaries,

Brokers are on the front lines, but the lenders are the ones who invented the scams that are bleeding borrowers. Only a decade ago, subprime loans were a mere fraction of the home-loan market. Today, these financial instruments are an $800 billion business -- about 20 percent of all housing loans.

How did the subprime market mushroom? The lenders -- again, they are not subject to regulation -- drastically and deceptively lowered normal banking standards to draw in low-income borrowers. As one broker says, "The culture around all these subprime lenders has been, 'Hey, bring it to us. We'll make it happen.'" If a borrower can pay little or nothing down, recently had a bankruptcy, and doesn't have the income to keep up payments, the bankers say, "That's OK. Bring us that loan."

Rather than do due diligence, lenders cavalierly offer "low-doc" and "stated income" loans -- i.e., they make little or no effort to document an applicant's ability to take on this burden, instead accepting almost anyone's word about having the income to meet monthly payments. "You could be dead and get a loan," says one broker.

The loans themselves are doozies, filled with numerous and nasty provisions that set unwitting borrowers up for failure. These are tucked into 20-page loan agreements written in legal gibberish. A friendly, reassuring, always smiling loan agent flips through the pages saying, "It's simple, just sign here ... and here ... and here." Among the nasties are:

* TEASERS. Subprime interest rates are loudly advertised to be only 7 percent or so, with only small-type notice that these are "adjustable rate mortgages" (ARMs). This means that the interest rate will explode to 11 percent or more after a couple of years, causing the families' monthly payments to jump by half or more. Over 90 percent of subprime loans contain ARMs.

* BLOATED APPRAISALS. Subprime lenders are notorious for pressuring appraisers to inflate the value of a house, thus causing the borrower to take out a bigger loan than the house is worth.

* HIDE-THE-ESCROW. In conventional loans, the borrower's property taxes and mortgage insurance premiums are figured directly into the monthly loan payments, with these monies set aside in an escrow account. For subprime loans, however, lenders often don't include these costly items in the mortgage, thus making the loans appear more affordable than they really are. This leads to borrower shock (and sometimes default) when the tax and insurance bills arrive separately in the mailbox. At this point, ever-helpful lenders offer to refinance the loan, thus collecting additional fees.

* EXCESSIVE FEES. On conventional mortgages, various lender fees typically total less than 1 percent of the loan amount. By contrast, subprime borrowers commonly are hit with fees (hidden in mortgage payments) totaling more than 5 percent.

* PREPAYMENT PENALTIES. Obviously, it's in a borrower's interest to get out of an abusive subprime loan as soon as possible and to refinance on better terms. But --Gotcha! -- more than 70 percent of these loans carry a penalty fee of several thousand dollars for paying off the loan early. In the prime market, only about 2 percent of loans contain such punishment.

* WALL STREET. None of the above would be happening (and certainly not on such a massive scale) if the fast-and-easy money crowd on Wall Street hadn't seen a chance to make a killing on lowly subprimers. Lured by the flow of sky-high interest rates being charged to these borrowers (and abetted by the lack of government regulation in this market), Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and other giants lumbered into the action.

They set up special investment units within their banks to buy these risky mortgages from the lenders. Then the Wall Street behemoths consolidated this bulk debt, leveraged it into complex IOUs called "mortgage-backed securities," and sold these packages to wealthy speculators around the world. This Rube Goldberg financial mechanism has shoved hundreds of billions of dollars of capital into the subprime market, fueling lenders' enthusiasm for making even more of these shaky loans.

What a system! Lenders mislead borrowers, collect fat fees from them, then shift the risk of any bad loans to Wall Street. The Wall Street repackagers then transfer the bad-loan risk to their rich investors, drawing even fatter fees. These investor elites get phenomenal yields on the IOUs, then plant their profits in tax-free havens like the Cayman Islands.

It's a brilliant Ponzi scheme ... as long as all those Mr. and Ms. Subprimes keep putting their little dabs of cash into it every month. Oops! There's the rub.

The bust

Mr. and Ms. Subprime live on the economic edge, with little margin for financial downturns. In the last couple of years, three bad storms hit them. First, falling wages combined with growing inflation (fueled by rising prices for gasoline, utilities, healthcare, etc.) to squeeze their meager household finances to the breaking point. Second, their adjustable-rate mortgages began exploding; someone who was paying $1,000 a month at the start of a $150,000 loan had to pay $1,400 a month two years later.

Third, housing prices (which the whole system claimed would only rise and rise and rise) began tumbling, making it impossible for these borrowers to refinance or sell their homes to avoid financial foreclosure. When home sales were booming, George W declared this proved that his push for economic deregulation was creating a glorious new "ownership society." He was so enthused that he even designated June as National Home Ownership Month. But his laissez-faire "success" turns out to be a house of cards. As one market analyst says, "The gain in home ownership over the last four or five years is almost entirely due to looser lending standards [for subprime mortgages]."

Those cards are now crashing down. In the first half of this year, home foreclosures are up by 41 percent. Today, a record number of subprime borrowers have fallen behind in their monthly payments and face eviction (once you fall 90 days behind, lenders typically proceed with foreclosure). More than $2.28 trillion worth of ARMs are scheduled to explode to their higher interest rates between now and 2009. Two million families are expected to have the wrenching experience of losing their homes, as well as losing all the money they invested in them.

All of this is working its way up the economic chain. More than 80 lenders have gone out of business in the past six months, thousands of jobs are being cut, and hundreds of thousands of houses are being dumped on an already-saturated market (causing a further decline in prices, which makes other subprime homeowners even more vulnerable to foreclosure, which dumps more houses onto the market ... and the downward spiral continues).

Wall Street big shots are being stung as well. Bear Stearns, for example, has had to scramble to keep its two subprime hedge funds from imploding, bailing out one of them with a panic infusion of $1.6 billion. Analysts estimate that these funds are holding more than $200 billion worth of subprime loans that are in danger of default.

Regulatory shame

This abuse of vulnerable families and the resulting economic mess would not have happened without the hands-off regulatory ideology that has infected our government. There are no less than five financial agencies at the federal level that could have protected people, yet the subprime surge was allowed to proceed on the fantasy that the financial players would police themselves. The Federal Reserve Board, for example, has direct authority under the Home Ownership and Equity Protection Act to "prohibit acts or practices in connection with mortgage loans that the board finds to be unfair, deceptive or ... associated with abusive lending practices, or that are otherwise not in the interest of the borrower." The Fed simply ignored this law.

Finally, with the entire subprime system crashing around them, the regulators issued "guidelines" on June 29 requiring banks to stop some of the worst abuses, including prepayment penalties. But the new rules still allow many of the predatory practices and -- worst of all -- do not apply to the nonbank lenders that make a large share of subprime loans. In addition, the guidelines do not directly address the role of Wall Street in pushing such loans.

The subprime industry disingenuously asserts that any attempt to regulate it only hurts the poor people who receive these mortgages, for they have nowhere else to turn for homeowner financing. What self-serving hogwash! There could be subprime loans -- from public, if not private, sources -- structured and administered without deceit. Rather than target lower-income families as suckers to be had, packaging their dreams into investment playthings for speculators and tax dodgers, let's view these folks as assets to the larger community and realize that homes for them are investments in the common good. And while we're at it, let's recognize that the need for "subprime" mortgages is driven by our low-wage/no-benefit economy and by our country's growing scarcity of affordable housing. It's not merely a low-income mortgage system that must be fixed -- our leaders' pursuit of a low-income America must be stopped.

From "The Hightower Lowdown," edited by Jim Hightower and Phillip Frazer, Aug. 2007. Jim Hightower is a national radio commentator, writer, public speaker and author of Thieves In High Places: They've Stolen Our Country And It's Time to Take It Back. (c) 2007 Independent Media Institute. All rights reserved.


From:
Z Net - The Spirit Of Resistance Lives
URL:
http://www.zcommunications.org/znet/viewArticle/14642

Housing Bubble Boondoggle: “Is it too late to get out”?

By Mike Whitney
04/24/07

Treasury Secretary Henry Paulson delivered an upbeat assessment of the slumping real estate market on Friday saying, "All the signs I look at" show the housing market is at or near the bottom.”

Baloney.

Paulson added that the meltdown in subprime mortgages was not a “serious problem. I think it’s going to be largely contained.”
Wrong again.

Paulson knows full well that the housing market is headed for a crash and probably won’t bounce back for the next 4 or 5 years. That’s why Congress is slapping together a bailout package that will keep struggling homeowners out of foreclosure. If defaults keep skyrocketing at the present rate they are liable to bring the whole economy down in a heap.
Last week, the Senate convened the Joint Economic Committee, chaired by Senator Charles Schumer. The committee’s job is to develop a strategy to keep delinquent subprime mortgage holders in their homes. It may look like the congress is looking out for the little guy, but that’s not the case. As Schumer noted, “The subprime mortgage meltdown has economic consequences that will ripple through our communities unless we act.”

Schumer’s right. The repercussions of millions of homeowners defaulting on their loans could be a major hit for Wall Street and the banking sector. That’s what Schumer is worried about---not the plight of over-leveraged homeowners.
Every day now, another major lending institution unveils its plan for bailing out the housing market. Citigroup and Bank of America have joined forces to create the Neighborhood Assistance Corporation of America which will provide $1 billion for the rescue of subprime loans.

This will allow homeowners to refinance their mortgages and keep them out of foreclosure. The new “30- year loans will carry a fixed interest rate one point below the prime rate, putting it currently at 5.5 percent. There are no fees, and the banks pay all the closing costs.”
But why are the banks being so generous if, as Paulson says, “the housing market is at or near the bottom.” This proves that the Treasury Secretary is full of malarkey and that the problem is much bigger than he’s letting on.

Last week, Washington Mutual announced a $2 billion program to slow foreclosures (Washington Mutual's subprime segment lost $164 million in the first quarter) while Freddie Mac committed a whopping $20 billion to the same goal. In fact, Freddie Mac announced that it “would stretch the loan term to a maximum of 40 years from the current 30-year limit.”
40 years!?! How about a 60 or 80 year mortgage?

Can you sense the desperation? And yet, Paulson says he doesn’t see the subprime meltdown as a “serious problem”?!?

Paulson’s comments have had no effect on the Federal Reserve. The Fed has been frantically searching for a strategy that will deal with the rising foreclosures. On Wednesday, The Washington Post reported that “Federal bank regulators called on lenders to work with distressed borrowers unable to meet payments on high-risk mortgages to help them keep their homes”.

Huh?!?

When was the last time the feds ordered the privately-owned banks to rewrite loans?

Never—that’s when.

That gives us some idea of how bad things really are. The details of the meltdown are being downplayed in the media to prevent panic-selling among the public. But the Fed knows what’s going on. They know that “U.S. mortgage default rates hit an all-time high in the first quarter of 2007” and that “the percentage of mortgages in default rose to a record 2.87%”. In fact, the Federal Reserve and the five other federal agencies that regulate banks issued this statement just last week:

"Prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower…Institutions will not face regulatory penalties if they pursue reasonable workout arrangements with borrowers."

Translation: “Rewrite the loans! Promise them anything! Just make sure they remain shackled to their houses!”

Unfortunately, the problem won’t be “fixed” with a $30 or $40 billion bailout scheme. The problem is much bigger than that. There is an estimated $2.5 trillion in subprimes and Alt-A loans---20% of which are expected to enter foreclosure in the next few years. Any up-tick in interest rates or unemployment will only aggravate the situation.

Kenneth Heebner, manager of CGM Realty Fund (Capital Growth Management), provided a realistic forecast of what we can expect in the near future as defaults increase.
Heebner: “The Greatest Price Decline in Housing since the Great Depression” (Bloomberg News interview)

“The real wave of pain and foreclosures is just beginning….subprimes and Alt-A are both in trouble. A lot of these will go into default. The reason is, that the people who took these out never really intended to fully service the mortgage---they were counting on rising home prices so they could sign on the dotted line without showing what their income was and then 2 years later flip into another junk mortgage and get a big profit out of the house with putting anything down…

“There’s a $1.5 trillion in subprimes and $1 trillion in Alt-A the catalyst will be declining house prices which is already underway. But as we get a large amount of these $2.5 trillion mortgages go into default, we’ll see foreclosed houses dumped on an already weak market where homebuilders are already struggling to sell there houses. The price declines which have started will continue and may even accelerate in some of the hotter markets. I would expect that housing prices in “2007 will decline 20% in a lot of markets”.
“What you are going to see is the greatest price decline in housing since the Great Depression.

The one thing that people should not do, is go near a CDO or a residential mortgage backed security rated Triple A by Moody’s and S&P because these are going to get down-graded by the hundreds of millions--because they are secured by subprime and Alt-A mortgages where there’ll be massive defaults”.

Question—Will the losses in the mortgage market exceed those in the S&L crisis?

Heebner: “They’re going to dwarf those losses because the losses could easily approach $1 trillion---that dwarfs anything that has ever happened. Enron was $100 billion---this will be far greater than that…..The good news is that most of these loans are owned by Hedge Funds…You hedge funds buying these subprime and Alt-A loans and leveraging them at 10 to 1. They buy a pool of mortgages at 8% and they borrow against it in yen for 3% and then lever it at 10 to 1so you have a lucrative profit And the hedge fund you are running, the manager is going to get 20% of the gain---so even if it’s a year before you go broke; you get rich until the fund is shut down”.

Heebner added this instructive comment: “The brokerage firms created “securitization” they know the products are toxic. I don’t think they are going to suffer losses; they simply passed them on to everyone else. The only impact this will have is the profits that flow from it will get less….But it is less than 3% of revenues in even the most exposed brokerage firm so THEY’RE NOT GOING TO GET CAUGHT.”

Although Heebner believes the brokerage houses will do fine; the same is not true for the small investor. Nearly 70% of subprimes have been securitized. That means that the vast number of shoddy “no down payment, no document, interest-only” loans (that are headed for default) have been transformed into securities and sold to hedge funds. As the housing market continues to falter, these funds will plummet at an inverse rate to the amount of leverage that has been applied. That may explain why, (according to Bloomberg Markets) the “wealthiest Americans have been bailing out” of hedge funds at an alarming rate.

A report in last Thursday’s New York Times stated: “Americans with a net worth of at least $25 million, excluding the value of their primary homes, reduced their exposure to hedge funds in 2006”-- The amount of money held by wealthy investors in hedge funds has dropped dramatically-- “The average balance, which was $2.8 million in 2005, was just $1.6 million last year, a 43 percent decline”.

So, what do America’s richest investors know that the rest of us don’t?
Could it be that the over-leveraged hedge funds industry is about to get hammered by the subprime implosion?

If so, it won’t be the brokerage houses or savvy insiders who get hurt. It’ll be the little guys and the pension funds that take a drubbing.

In Henry C K Liu’s “Why the Subprime Bust will Spread” (Asia Times) the author states that the bursting housing bubble will trigger a major pension crisis. After all, who are the “institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages”. (Liu)

The origins of the housing bubble are complex, but they are worth understanding if we want to know how things will progress. The housing bubble is not merely the result of low interest rates and shabby lending practices. As Liu says, “the bubble was caused by creative housing finance made possible by the emergence of a deregulated global credit market through finance liberalization. The low cost of mortgages lifted all US house prices beyond levels sustainable by household income in otherwise disaggregated markets” The deregulated cross-border flow of funds (via the yen low interest “carry trade” or the $800 billion current account deficit) have played a major role in inflating the US real estate market.

Liu adds, “Since the money financing this housing bubble is sourced globally, a bursting of the US housing bubble will have dire consequences globally.” Since nearly 50% of “securitized” mortgage debt is owned by foreign investors; the subprime meltdown is bound send tremors through the entire global financial system.

The housing decline is further complicated by Wall Street innovations in derivatives trading which has generated trillions of dollars in “virtual” wealth and is affecting the Feds ability to control inflation through interest rate manipulation. As Kenneth Heebner said, “You have hedge funds buying these subprime and Alt-A loans and leveraging them at 10 to 1. They buy a pool of mortgages at 8% and they borrow against it in yen for 3% and then lever it at 10 to 1so you have a lucrative profit.”

In other words, low interest foreign capital has flooded US markets and contributed to distortions in housing prices.

In her recent article “War Drags the Dollar Down”, Ann Berg refers to Wall Street’s “swirling galaxy of exotic finance” which has “worked magic for the government and the elite”, but has yet to weather a severe downturn in the economy.

But how will market deal with sudden downturn in the hedge fund industry? Will the dodgy subprimes and shaky collateralized debt obligations (CDOs) trigger a crash or has the risk been wisely dispersed through derivatives trading?

No one really knows.

As Berg says, “Derivatives numbers are staggering. The Bank for International Settlements estimates that the notional amount of derivatives traded on regulated exchanges topped a quadrillion dollars last year and that the outstanding unregulated off-exchange (called over-the-counter – OTC) amount stood at $370 trillion in June 2006. Because the OTC market is composed of endless strings of bilateral transactions – the systemic risk is unknown.”

The comments of the President of the New York Fed, Timothy Geithner, help to clarify the abstruse activities of the modern market:
“Credit market innovations have transformed the financial system from one in which most credit risk is in the form of loans, held to maturity on the balance sheets of banks, to a system in which most credit risk now takes an incredibly diverse array of different forms, much of it held by nonbank financial institutions that mark to market and can take on substantial leverage.

Geither’s right. The markets now operate as unregulated banks generating mountains of credit through massively leveraged debt instruments---a monster credit bubble larger than anything in the history of capitalism.

So, where is all this headed?

No one really knows. But when the housing bubble crashes into Wall Street’s credit bubble,; we can expect the “big bang”. That may explain why America’s wealthiest investors are running for cover before the whole thing blows. (A number of investors have already cashed out and put there holdings into foreign funds and currencies)

One thing is certain ---time is running out. With $1 trillion in subprimes and Alt-A loans headed for default the system is facing its greatest challenge. US- GDP has been revised to a measly 1.8%, foreign investment is down, and the dollar is losing ground to the euro on an almost weekly basis.

Falling home prices have already precipitated a number of other problems. For example, Gene Sperling reports in “Housing Bust Meets the Equity Blues” that “The Fed data showed an amazing expansion (in Mortgage-Equity Withdrawal). In 1995, active MEW had been $37 billion. By the fourth quarter of 2005, it soared to $532 billion annualized, a 14-fold expansion”.

These equity withdrawals have translated into consumer spending which accounts for at least 1 full percentage point of GDP. Declining house prices means that extra boast for the economy will now disappear.

Foreclosures are soaring and expected to get worse for the next two years at least. In California foreclosure filings jumped 79% in March alone. Other “hot markets” are reporting similar figures.

The glut of new homes for sale on the market has slammed sales of the nation's major builders; most are reporting profits are down by 40% or more.
The collapse of the subprime mortgage market is also pushing some big U.S. homebuilders toward Chapter 11. According to Bloomberg News, “Some builders are staying out of bankruptcy by relying on the profits they made when sales boomed” in 2004 and 2005.

Starting next year they must begin to repay $3.6 billion in public debt in what will certainly be a falling market. The prospects don’t look good.

Also, Credit card debt is way up (nearly 7% in one year) and economists are predicting that the trajectory will continue now that home equity is vanishing. Americans savings rate is in negative numbers and the steep increase in credit card debt (with its high interest rates) only compounds the problem. The American consumer has now compiled more personal debt than anytime in history.

The Grim Reaper Meets the Housing Bubble

Those who follow developments in real estate have heard many of the wacky anecdotes related to the housing bubble. Stories abound of young people buying homes just to pay off tens of thousands of dollars of collage loans with their “presto”-equity ---or low paid construction laborers securing 105% loans without any proof of income and a poor credit history. One of the stories that got national attention was about Alberto and Rosa Ramirez, who worked as strawberry pickers in the fields around Watsonville each earning about $300 a week. They (somehow?) qualified for a loan of $720,000 which paid for a "new" four-bedroom, two-bath house in Hollister.

It’s sheer madness!

Obviously, those days are over. The speculative frenzy that was generated by the Fed’s low interest rates, the banks lax lending standards, and the deregulated global credit market is drawing to a close. The fallout from the collapse in subprime-loans will roil the stock market and hedge funds, but, as Heebner says, the investment banks and brokerage firms will escape without a bruise.

Where's the justice?

Despite Hank Paulson’s cheery predictions, we are no where “near the bottom”. In fact, a recent survey showed that only 1 in 7 Americans believe that house prices will go down. Even now, very few people grasp the underlying issues or the potential for disaster. We’re on a treadmill to oblivion and they think it’s a merry-go-round.

As housing prices tumble, more homeowners will experience “negative equity”, that is, when the current value of their home is less than the sum of their mortgage. This is the very definition of modern serfdom.

We can expect to see an erosion of confidence in the market, a rise in inventory, and a steady increase in defaults. More and more people will walk away from their homes rather than be hand-cuffed to an asset that loses value every day. This could transform a "housing correction" into a nation-wide financial calamity.

Many peoples’ futures are linked directly to the "anticipated" value of their homes. It is impossible to determine how shocked they’ll be when prices retreat and equity shrivels. The housing flame-out has all the makings of a national trauma—another violent jolt to the fragile American psyche.

So far, we're still in the first phase of a process that will probably play out for 10 years or more. (Judging by Japan’s decades-long decline) None of the bailout plans are large enough to make any quantifiable difference. The numbers are just too big.

Housing prices are coming down and the real estate market will return to fundamentals. That much is certain. The law of gravity can only be ignored for so long.

Just don’t count on a “soft landing”.

Special thanks to http://patrick.net/housing/crash.html (Housing Crash News)
See entire Heebner interview at http://patrick.net/housing/contrib/future.html