In response to yesterday’s "Remembering the Real Estate Debaucle of the 1990’s" John McLeod offered an enlightening response. He made a number of excellent points, but the one comment he made that particularly struck me was "Banks keep their risk down by reselling most of their mortgages into this market (Mortgage Backed Securities). This risk is then managed by housing Government Sponsored Enterprises (GSEs) including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (FHLBs). GSEs use some of the world€™s smartest economists and most sophisticated computer modeling software products to manage their risk, but I am not totally convinced that they do this well."
I couldn’t agree more- and I think the great vulnerabilities of these institutions lie in widespread lax standards and mortgage fraud.
Fifteen years ago my husband and I were purchasing our first home. As we were preparing the documents for the bank, they did not like the documentation we had for the source of part of the downpayment. (Boring irrelevant story- the money was ours though.) The lending officer told us to wire the money to a relative, who was to wire it back, stating the money was a "gift" not a loan, and there was no expectation of repayment.
We weren’t really comfortable with this- it seemed like money laundering, and we told the loan officer that we weren’t comfortable with the arrangement. She assured us it was just a formality- to fulfil the requirements for the loan package.
My husband and I talked it over for a bit, and decided to go ahead with the loan officer’s request. The money was ours from a legitimate source, and the bank knew of its real origin- there didn’t really seem to be any deception here- so we sent the wires. It did occur to me though, that had we borrowed the money from a credit card, or a loan shark, or robbed a bank for that matter, the wire transfer would have been a great way to cover it up. It was possible the loan officer made a similar request of people with less acceptable funding- and like I said, this was fifteen years ago- and lending practices have loosened since then.
The signs are posted along the roads, the ads are in the paper, "No credit, no money, no problem!"- Appraiser’s have been asking "What do you need this property to appraise for?" The industry has become plagued with a "Nod, nod, wink, wink" approach to lending. Lending institutions resell their loans so quickly though, there is little incentive to genuinely make sure a borrower has the means to repay. Too often, like the situation with our loan officer- the package just needs to "look good."
There is no way to track how many loans are out there of marginal quality, except by tracking when they fail. Right now, for the most part, these loans have been lying below the surface, masked by rising home values. As values decline, and more of these loans rise to the surface, the magnitude of the problem will be made known-and is likely to be huge. Risk is difficult to manage when it it widespread and systemic.