Monday, February 25, 2008

Banks: "The Feds Made Us Do It"-- Oh, Really?

One of the memes about the mortgage situation (a meme straight from the Banks' hymnbooks) is "the Feds MADE us do it..." That is, that the Federal bank regulators forced the Banks to make lousy loans.

Not really, folks. Quoting an essay on the implosion problem, Calculated Risk sheds light:

At the loan origination stage of the securitization process, there was a continuous lowering of credit standards, misrepresentations, and outright fraud. Too many mortgage loans, which only benefited the loan brokers, were securitized. This flawed origination process was ignored by the security underwriters, regulators, and ultimate investors. . . .

Note "lowering of credit standards", "misrepresentations," and "outright fraud."

But the key words are in red.

Here's how it plays out.

Notice how, in the first paragraph, we slip in the first two sentences from "the quality of the origination process" (something quite obviously under the control of the originator) to "underwriting guidelines," which in any securitization practice I know of are either outright stipulated by the issuer in all respects (Ginnie Maes, standard-contract Fannies and Freddies, a lot of private pools) or are at best negotiated between lender and issuer (most private pools, some GSE business). Once the guidelines are either published by the issuer or agreed to in negotiation between issuer and originator, then it is indeed the originator's job to meet them.

But a whole lot of these loans that are failing right now were originated as 100% CLTV stated-income loans, because the guidelines agreed to by the issuer allowed that.

In fact, the packagers/re-sellers, not the "Feds" were allowing crap to be called Ivory Soap:

I spent most of the early years of this decade, just as a for instance, blowing my blood pressure to danger levels every time I looked at the underwriting guidelines published by ALS, the correspondent lending division of Lehman. ALS was a leader in the 100% stated income Alt-A junk. And I kept having to look at them because my own Account Executives keep shoving them under my nose and demanding to know how come we can't do that if ALS does it. I'd try something like "because we're not that stupid," and what I'd get is this: "But if ALS can sell those loans, so can we. All we gotta do is rep and warrant that they meet guidelines that Wall Street is dumb enough to publish." Every lender in the boom who sold to the street wrote loans it knew were absurd, but in fact they had been given absurd guidelines to write to. What on earth good did it do to have those originators represent and warrant that they followed underwriting guidelines to the letter, when those guidelines allowed stated income 100% financing on a toxic ARM with a prepayment penalty?


The essential confusion here is between failure to follow responsible guidelines and faithful following of irresponsible guidelines. My sad news for the investment community: a whole lot of what you are suffering from is the latter, not the former.

The "Feds" (do-gooder mortgage regulators) did NOT create, nor enforce "irresponsible guidelines." The slop was written based on guidelines provided by Lehmann, (among others).

But that's not what you'll hear from the Banks as they work over Congress to bail them out of $700++ BILLION in bad loans--at the expense of the taxpayer.

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