It Was All Liar’s Loans
My friend William Black has an excellent (if badly proofread and edited) analysis of our economic situation here at HuffPo (via Benzinga). He explains how the liar’s loans—those no-documentation, no-underwriting home mortgage “products” that took over the market in the mid-2000s—caused all the trouble. The main problem is that the industry never defined its products in such a way as to allow easy categorization now that everything’s gone to hell. So the true number of liar’s loans—the percentage of the total market—is still unknown. But what is known is that those products exploded in popularity during 2006-2007, and that most of the loans made in those programs were fraudulent on their face. Not some. Not many. Most.
I’m going to quote Black’s piece and add just a couple caveats and clarifications. William Black:
It was the industry that created liar’s loans and it is liar’s loans that made so many [loan] officers wealthy.
Right. This was a central point of Mike Hudson’s excellent book, The Monster, reviewed here. A lot of subprime loans were liar’s loans, but not all, and a lot of liar’s loans were made to people who were not prototypical subprime customers. Liar’s loans were made to folks in the mortgage industry so that they could get in on the frenzy. Black continues:
There were two groups of borrowers who had acute needs to avoid disclosing their income and wealth — those engaged in tax fraud evaders and those seeking to deceive their spouses or defraud their prior spouses and children in order to evade alimony and child support payments. (Remember when one of “C’s” in lending referred to “character” and we taught loan officers why one should not lend to those of bad character?) People who will cheat their kids are certain to be willing to cheat their lender.
There is, of course, a third group: criminals. In Baltimore, as in other cities, drug dealers (who actually have money, but for reasons of personal philosophy often choose not to pay income taxes on it) and hustlers (who often have no money but just know they’re gonna make it really big in, say, six months) saw great advantage in buying houses with borrowed funds. The first group wanted to launder their drug proceeds—remember, the profits from the sale of a home are often tax free—while the second wanted to profit from the flips until it went to hell and they could walk away with the banks’ cash. Black:
and private and public investigators have confirmed that it is lenders and their agents (loan brokers and loan officers) who overwhelmingly put the lies in liar’s loans.
This is an often-missed detail, but it is central. In many cases—not all; many—the person who took the loan was something of a patsy, a naïve tool of the loan officer or paid off with trinkets. Sometimes they didn’t exist at all. Black:
Consider what would have happened if the securitizers, credit rating agencies, or auditors had actually looked at any reliable sample of the liar’s loans for evidence of fraud. They would have reported, as did Fitch in November 2007, that there was evidence of fraud in the nearly every file.
Again: Fraud was not the exception. Fraud was the rule. Fraud was the business model. That this is still news to anyone in America in 2011 says volumes about the failure of our journalistic institutions and our law enforcement system.
Only the lenders and their agents had the inside information and expertise to know how to optimize the deceit in the loan application process. Many of the housing speculators who bought a material number of homes and sought to flip them were industry insiders, and many of them also committed fraud by indicating that they intended to make each of the houses (simultaneously) their principal dwelling.
We saw a little of that here in Baltimore, eh? Because tax-free profit (as well as tax breaks for ownership) come only from sale of a “principal residence.” Black:
Yes, it does appear to have been common for the loan brokers and officers to create the false loan applications and even forge the borrowers’ signatures. Some of the lenders are reported to have referred to these practices as “Arts and Crafts” weekends. We don’t know how common this level of lender fraud was because the regulatory agencies and prosecutors have not publicly reported their investigations. Indeed, there is no public evidence that the regulators or prosecutors are even conducting comprehensive investigations. . . .
Oh wait, there’s that “Operation Broken Trust” sweep the Justice Dept did a few weeks back. Oh, wait, that was mostly window dressing.
So there it is, laid out: What happened to our economy was a huge crime wave, and basically nobody has yet been put in the dock for it. Which means the people who did the crimes are still at large, still in business. (Forbes says that’s probably a good thing.)
No one ought to think those folks are retiring.