I’ll sum it all up in four words - deregulation, unscrupulous, predatory, greed.

There you have it. And now, here we are, in up to our necks, even atheists helplessly praying, watching as our 401ks shrink from ripe plump grapes into shriveling raisins, hoping we still have our homes and some retirement money left when the subprime drama finally plays out.

How did this mess happen?! Where did it start?

Hi-ho, hi-ho, it’s googling I go.

And as I read through article after article, it became utterly clear that the subprime debacle is a stark example of human greed at its worst.

Here’s my chronological history of what happened. How do you feel about it?

1977- Solomon Brothers and Bank of America jointly introduce the first mortgage backed securities (MBS). Lewis Ranieri, a college dropout initially hired to work in Solomon’s mailroom, is assigned the task of selling these securities (bonds). (See the appendix at the end of this article explaining the complicated MBS system.) They are only legal in 15 states. Ranieri, with “a trader’s nerve and a salesman’s persuasiveness” wins lobbying battles in Washington that remove legal and tax barriers. He heads up a Solomon team that develops “collateralized mortgage obligations”- 2, 5 and 10 year MBS, packaged to appeal to a variety of low, medium, and high risk investors.

And subprime mortgages are born.

Definition: High risk bonds are backed by more speculative, or “sub-prime” mortgages, loans made to higher risk borrowers. These bonds yield more interest than low risk bonds.

1980’s-1990’s- The MBS market explodes. Growing deregulation in the ’80’s provides an environment where unscrupulous people on Wall Street can take advantage of others’ ignorance. And anyone with a phone and a web page becomes a mortgage broker. These brokers are paid by both the borrower and the bank purchasing the loan, and because of this, rather than looking out for the borrower’s best interests, often steer home buyers towards banks that pay the broker the most money.

Broker critics feel that “The system gives brokers powerful incentives to push consumers into toxic loans, and little to fear if their customers can’t handle them.” The more loans they originate, the more money they make. Brokers practicing predatory lending practices especially target subprime borrowers and what are considered high risk groups, such as lower income, minorities, and the elderly.

Spring 2005- It’s clear that the mortgage industry has deteriorated. Fraud of all types is rampant. 68% of all home loans are originated by mortgage brokers.

December 2005- Regulatory agencies offer a set of rules on what is politely called “non-traditional mortgages. Mortgage bankers are outraged. They accuse the agencies of “stifling innovation, regulatory overreach, and substituting bureaucratic judgment for the collective experience and wisdom of thousands of industry leaders.”

January 2006- The National Association of Realtors reports the staggering statistic that 43% of first time home buyers have “taken advantage” of no money down loans. Yet predictions are greater than 50% that home prices will drop, and owners will owe more than their homes are worth.

August 26th 2006- Barron’s reports that strong indicators point to an imminent housing crisis. Since January, the national median price of new homes has dropped 3%. New home inventories are at a record high. Existing home inventories are 39% higher that just one year ago. Home sales are down 10%. Meanwhile, the stock market and many analysts continue ignoring what is now inescapable.

March, 2007- As the number of home foreclosures continues escalating, it can no longer be ignored, and the subprime melt-down rears it’s ugly head, Steve Pearlstein, of the Washington Post, and others, ostracize the mortgage industry for creating mortgage deals too good to be true. Money Magazine reports that 1.4 million Americans will see their mortgages double in the next five years. Foreclosure rates are up 30% from one year ago. Home values continue to fall.
Below is a list of some “creative” mortgages used by mortgage brokers(compiled by me from Pearlstein’s and others’ articles.)

The No Money Down Loan- the borrower purchases a home paying more then the seller’s asking price. The seller gives the extra money back to the buyer at closing.
The Balloon Mortgage- the borrower pays only interest for 10 years before a big lump-sum payment is due.
The Liar Loan- the borrower is asked merely to state his annual income, without presenting any documentation.
The Option ARM Loan- the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
The Piggyback Loan- a combination of a first and second mortgage eliminates the need for any down payment.
The Teaser Loan- the borrower qualifies for a loan based on an artificially low initial interest rate, even though he or she doesn’t have sufficient income to make the monthly payments when the interest rate is reset in two years.
The Stretch Loan- the borrower has to commit more than 50 percent of gross income to make the monthly payments.

September 2007- As Wall Street drowns in the subprime meltdown, Alan Greenspan, on NBC’s 60 Minutes, admits mistakes in the subprime mess.

“I was aware of “subprime” lending practices where homebuyers got very low initial rates, only to see them later jacked up, causing severe payment shock. But I didn’t initially realize the harm they could do…..I really didn’t get it until very late in 2005 and 2006.”

Greenspan retired in 2006.

March 2008- as the subprime crisis worsens, Bear Stearns Investment Bank is on the brink of collapse due to mortgage market losses. In an unprecedented move, Bernanke and the Federal Reserve rescue the bank by loaning money to JP Morgan, who will use it to purchase the failing firm.

What would have happened if Bear Stearns was allowed to go bankrupt? NPR states:

“If the bank did go bankrupt, an unbelievably long and complex legal process would begin. Thousands of Bear Stearns customers — from individual retirees to massive hedge funds — would have huge amounts of money just frozen. Imagine how complicated a personal bankruptcy is and multiply that by tens of billions of dollars in assets. The Federal Reserve wanted to avoid that.”

During this crisis, the Feds took a number of other aggressive measures to stabilize and restore confidence, hoping to ease worried investors’ minds, but at the same time, creating suspicion regarding just how bad the banking problem must be.

April, 2008- The Feds have reconstructed the subprime house of cards. But what happens when the next strong breeze comes along?

APPENDIX

Borrowing the MBS Way

(Diagram and definitions taken from a speech made by Sheila C. Baer, Chairman, FDIC, in April, 2007.

As the terminology is used in the securitization contracts and in the diagram above, the key elements to a typical securitization include the following:

• Issuer - A bankruptcy-remote special purpose entity (SPE) formed to facilitate
  a securitization and to issue securities to investors.⁸
• Lender - An entity that underwrites and funds loans that are eventually sold to
  the SPE for inclusion in the securitization. Lenders are compensated by cash
  for the purchase of the loan and by fees. In some cases, the lender might
  contract with mortgage brokers. Lenders can be banks or non-banks.
• Mortgage Broker - Acts as a facilitator between a borrower and the lender.
  The mortgage broker receives fee income upon the loan’s closing.
• Servicer - The entity responsible for collecting loan payments from borrowers
  and for remitting these payments to the issuer for distribution to the investors.
  The servicer is typically compensated with fees based on the volume of loans
  serviced. The servicer is generally obligated to maximize the payments from
  the borrowers to the issuer, and is responsible for handling delinquent loans
  and foreclosures.
• Investors - The purchasers of the various securities issued by a securitization.
  Investors provide funding for the loans and assume varying degrees of credit
  risk, based on the terms of the securities they purchase.
• Rating Agency - Assigns initial ratings to the various securities issued by the
  issuer and updates these ratings based on subsequent performance and
  perceived risk. Rating agency criteria influence the initial structure of the
  securities.
• Trustee - A third party appointed to represent the investors’ interests in a
  securitization. The trustee ensures that the securitization operates as set forth
  in the securitization documents, which may include determinations about the
  servicer’s compliance with established servicing criteria.
• Securitization Documents - The documents create the securitization and
  specify how it operates. One of the securitization documents is the Pooling
  and Servicing Agreement (PSA), which is a contract that defines how loans
  will be combined in a securitization, the administration and servicing of the
  loans, representations and warranties, and permissible loss mitigation
  strategies that the servicer can perform in event of loan default.
• Underwriter - Administers the issuance of the securities to investors.
• Credit Enhancement Provider - Securitization transactions may include credit
  enhancement (designed to decrease the credit risk of the structure) provided
  by an independent third party in the form of letters of credit or guarantees.

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