October 25, 2014


No, Americans Are Not All To Blame for the Financial Crisis : Exposing the big lie of the post-crash economy (Dean Starkman, 10/23/14, New Republic)

To say that borrowers don't deserve equal blame for the crisis doesn't mean that every individual borrower was innocent. There is no question that "mortgage fraud"--which the FBI defines as misrepresentations relied upon by underwriters, i.e. banks--did account for a percentage of the losses. It's just that the amount of borrower behavior fitting that definition is vanishingly small. Before it collapsed, for instance, New Century reported that borrowers had failed to make even the first payment on 2.5 percent of its loans. That doesn't speak well of borrowers, at all. It's also only 2.5 percent. Zooming out, the Treasury Department reported that so-called "suspicious activity" reported by banks peaked at 137,000 incidents in 2006. But even if every single one of those reports represents actual borrower fraud (spoiler: they don't), that's still only about 1 percent of the 14 million mortgages made that year.

One way a borrower can defraud a lender is to pretend to plan on living in the home--because mortgages on primary residences are easier to obtain and carry lower rates--when in fact you're buying it as an investment or vacation property. We know from lawsuits brought by the conservator for Fannie Mae that the number of owner-occupied houses in the mortgage pool was off by as much as 15 percentage points. Some portion of those houses belonged to people who said they lived in them, but didn't. That's definitely something buyers fib about. On the other hand, it often requires a wink from the bank, since residency is easy to check. But most important: Even if the number is the full 15 percent, that's still well south of EITB.

In 2010, an FBI report drawing on figures from the consultancy Corelogic put total fraudulent mortgages during the peak boom year of 2006 at more than $25 billion. Twenty-five billion dollars is obviously not nothing. But here again, teasing those mortgages out of that year's crisis-related write-downs of $2.7 trillion from U.S.-originated assets leaves our infamous "cagey" borrowers to blame for only a tiny share of the damage, especially since not all of the fraudulent mortgages were their fault. The ratio looks roughly something like this: 

Yes, some of our cab drivers, shoeshine boys, and other fellow citizens tricked a lender into helping them take a flyer on the housing market. But the combined share of the blame for bad mortgages that can be placed on the public sits--and I'm really rounding up here--in the high single digits, and not the much larger, fuzzier numbers in our heads.

The fact is that defrauding a bank that actually cares about the quality of a loan is actually rather difficult, no matter how aggressive or deceitful the borrower. Lenders, on the other hand, can lie with relative ease about all sorts of things, and mountains of evidence show they did so on a widespread basis. For starters, it's lenders who establish the loan-to-value ratio for a property: how much money the buyer is borrowing versus the house's estimated worth. Banks didn't used to let you take out a mortgage too close to the home's total cost. But play with those numbers and, voilĂ , a rejected loan application turns into an accepted one. Leading up to the crash, some banks' representations about loan-to-value ratios were off by as much as 40 percentage points.

Then there was the apparent rampant corruption of appraisals, which also have nothing whatsoever to do with borrowers. Before the bubble popped, appraisers' groups collected 11,000 signatures on a petition decrying pressure by banks to arrive at "dishonest" or inflated valuations.

And that's to say nothing of lenders misleading borrowers directly--a practice that the Financial Crisis Inquiry Commission, the Levin-Coburn report, and lawsuits by attorneys general around the country have all found was very much systemic. Mortgage brokers forged borrowers' signatures and altered documents; Ameriquest (those guys again!) had its own "art department," as it was known internally, for precisely that function. Oh, and remember those 137,000 instances of "suspicious activity" about possible borrower misdeeds? For the sake of perspective, Citigroup settled a Federal Trade Commission case alleging sales deception that involved two million clients in a single year. That's what we call wholesale, and it was happening before the mortgage era even really got started.

Today, there's a big and growing body of documentation about what happened as the financial system became incentivized to sell as many loans as possible on the most burdensome possible terms: Millions--and millions--of borrowers were sold subprime despite qualifying for better.

Perhaps the most astonishing and unappreciated finding comes from The Wall Street Journal, which back in December 2007 published a study of more than $2.5 trillion in subprime loans dating to 2000 (that is to say, most of the subprime loans of the era). The story, by my former colleagues Rick Brooks and Ruth Simon, painted the picture of a world gone upside-down: During the worst years of the frenzy, more than half the subprime loans issued went to borrowers who had credit scores "high enough to often qualify for conventional loans with far better terms." In 2006, the figure hit 61 percent.

The fact is that credit wasn't too easy, but too hard.  And given the deflationary climate mortgage rates should have been much lower, making payments easier for even the highest risk borrowers.  The crisis occured because the people selling mortgages on were lying about how much risk they entailed.

Posted by at October 25, 2014 8:41 AM

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