Vail Valley Voices: Blame crazy lending
Washington is continuing to search for individuals to blame for the sub-prime mortgage crisis. Politicians want people to grovel, and they want to embarrass bankers who contributed to the debacle. Recently, Charles Prince, former CEO of Citibank, and Robert Rubin, director of Citibank and former treasury secretary under President Bill Clinton, were on the hot seat. Why doesn’t Congress ask its own members to testify? After all, Barney Frank and his colleagues on the House Financial Services Committee were the greatest advocates of putting every family in a home, even if they couldn’t afford it. He’s also the guy who encouraged Fannie Mae and Freddie Mac to decrease long-time standards for mortgages. I’ve had numerous conversations about the most important issues that caused the current financial imbroglio. It’s dangerous to ascribe simple reasons for huge problems, but I’ll do it anyway. Home ownership is the largest asset of a vast majority of Americans. Over the years, homes have increased significantly in value. If you added up the current value of all homes in the United States, it would easily dwarf every other type of investment made in America. For as long as I can remember, to obtain a mortgage, a borrower needed to earn a gross monthly salary equal to one monthly mortgage payment. And the borrower had to provide 20 percent to 25 percent of the cost of the home in equity to protect the lender. That’s how I bought most of my homes over the years. All of the estimates for mortgage defaults used to create mortgage-backed securities were based upon borrowers having adequate income, a meaningful equity investment in the property and accurate documentation. When the standards eroded, the default probabilities naturally increased. Let me give you an example: Before the standards were relaxed, let’s assume a long history of mortgage loan performance data indicated that losses from large pools of mortgages were never more than 2.5 percent. When structuring mortgage-backed securities, bankers might insist upon 5 percent equity (double the maximum expected defaults) in the deal. This requirement would more than adequately protect the lenders in the securities who were superior to the equity holders. The amount of equity, as compared to expected defaults, would justify very high ratings on the debt (from Moody’s and Standard & Poors). When mortgages were made with only 15, 10, 5 and even 0 percent equity, the expected losses on the mortgages were not reconsidered. And so the equity in the mortgage-backed securities was insufficient to protect the invested capital superior to the equity. The rest is history. Millions of borrowers couldn’t service their mortgage debt because they didn’t have adequate levels of income. Since they didn’t have any equity in their homes, they stopped making mortgage payments and allowed banks to foreclose. These foreclosures, in turn, brought down the price of homes across the country. Exacerbating the situation were second mortgages and the like. In these cases, some borrowers had equity in their homes, but they borrowed it. So an original $25,000 equity in a $100,000 home was decreased to $5,000 with a $20,000 home equity loan. This effectively increased the risk of default, as well. Now, for an earth-shattering assessment: If standards for home lending weren’t decreased, the U.S. wouldn’t have experienced a mortgage crisis or a larger financial crisis. So who’s to blame? I wrote a piece about this question awhile ago in the Vail Daily. My updated answer is every party who made it easier for aspiring homeowners to borrow more money than they could afford. Included in this group are banks, mortgage brokers, Congress, packagers of mortgage-backed securities (who didn’t respond to lower standards) and a number of others. It’s the same group I identified in my previous essay on this topic.Sal Bommarito is a novelist and frequent visitor to Vail over the past 20 years.