The Housing Chronicles Blog: Little or no due diligence on mortgage loans during the housing boom

Tuesday, March 18, 2008

Little or no due diligence on mortgage loans during the housing boom

I wonder what Gordon Gekko would say today about greed being good, because in the long run it certainly didn't work so well for the housing & mortgage markets. In fact, it seems that it was greed which was a primary culprit in keeping loan reviewers at bay who were raising red flags as questionable sub-prime mortgages were taking off. From the L.A. Times:

Freelance financial watchdogs who examined the paperwork on sub-prime home loans being sold to Wall Street had an inside view of the boom in easy-money lending this decade. The reviewers say they raised plenty of red flags about flaws so serious that mortgages should have been rejected outright -- such as borrowers' incomes that seemed inflated or documents that looked fake -- but the problems were glossed over, ignored or stricken from reports...

In interviews with The Times, eight experienced loan reviewers said that as marginal lending increased, quantity took precedence over quality. Squads of 10 to 15 veteran loan checkers gave way, they said, to packs of 40 to 50 mostly novice reviewers posted at or near sub-prime factories such as now-defunct Orange County lenders New Century Financial Corp. and Ameriquest Mortgage Co.

Executives at the two main firms that hired the freelancers -- Shelton, Conn.-based Clayton Holdings Inc. and San Francisco-based Bohan Group -- say the reviewers weren't there to find every potential problem with a sub-prime loan. Rather, the executives say, the job was to perform specific tests to help buyers determine how much to pay for a pool of loans. In some cases, the investors wanted only minimal testing, said Frank P. Filipps, Clayton's chairman and CEO...

As time passed, Clayton and Bohan executives said, Wall Street firms and their investor customers accepted increasing levels of default and fraud in sub-prime loans as they grew to trust software designed to offset those risks by charging higher interest rates, extra fees and penalties for paying off mortgages early.

As Wall Street grew more comfortable, it demanded less of the review process. Early in the decade, a securities firm might have asked Clayton to review 25% to 40% of the sub-prime loans in a pool, compared with typically 10% in 2006, although the requirements varied, Filipps said.

By contrast, loan buyers who kept the mortgages as an investment instead of packaging them into securities would have 50% to 100% of the loans examined, Bohan President Mark Hughes said.

But the freelancers interviewed by The Times never got the memo that their reviews were supposed to be nice and easy. Flying from city to city and typically paid $30 to $40 an hour, with expenses covered, the reviewers say they worked conscientiously to assure the investment banks and mortgage-bond investors that no surprises lay in the files.

Loan reviewer Jana Lujan recalled showing a file to a supervisor in 2004, during a check of sub-prime mortgages made by a Brea bank that regulators later cited for unsound lending. A title report showed a tax lien on the property.

"I said we needed evidence it had been paid off and released," to ensure against foreclosure, Lujan said. "And he said: 'Just go ahead. Assume it's being taken care of.' "

Loan-buyer representatives who were on site during the reviews also showed little interest in the details, Lujan said.

Lujan said one Clayton supervisor would throw away documents that appeared to have been altered fraudulently. The lack of a document in the file meant the loan had to be sold at a slight discount, she said, but it still could be sold.

Lujan, Valenz and one other loan checker said supervisors at Clayton and Bohan also would change the way fees were described so that mortgages would not be red-flagged as potentially predatory under U.S. law, which would render them unsalable and force the sellers to take them back...

The reviewers said the less-thorough approach made their expertise irrelevant and led to pressure to work faster. Valenz and Lujan said they were told to check two or three files an hour when it took an hour or more to do one properly.

One Clayton project supervisor "told us if we spent more than 20 minutes on a file, we were spending 20 minutes too long," Lujan said.

Though quick checks called "data scrubs" could take 20 minutes per loan, Filipps said, complex reviews could take three hours, with the average review taking 80 minutes in 2006.

The biggest problems, the reviewers said, were appraisals that looked inflated and "liar's loans," so nicknamed because borrowers weren't required to prove they earned enough to make their payments.

"You can't tell me a Kmart or a Wal-Mart or a Target floor worker is making $5,000 a month, or a house cleaner is making $10,000," said former loan reviewer Irma Aninger of Palm Desert, a 40-year financial services industry veteran.

Aninger, who did work for Clayton and Bohan, said she tried repeatedly to have such loans marked as unacceptable but was overruled by supervisors, who were known as project leads. "The lead would say, 'You can't do that. You can't call these people liars,' " Aninger said...

THIS is why a federal bailout will be unpopular but necessary. It's simply too late now to punish all of those people who helped perpetuate the house of cards that was the housing boom.

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