It is easy to get lost in the negative headlines. The other day I found myself fall prey to a negative article that spoke poorly about the subprime companies that failed and how they were the impetus for this current financial debacle. This article was specific to one of the largest subprime mortgage companies. Yes, the company made poor decisions and some awful loans, but what the article failed to mention was how so many honest people, doing what they were told, lost jobs.
The article failed to talk about all of the men and women who lost deferred income, bonuses and most importantly — jobs. Some of those people may be your friends, co-workers or classmates. However, sadly, they are marked with the subprime scarlet letter, which reflects a time in our lives that will live in finance infamy.
What I find interesting about the subprime business is the loans that were made and the people that were affected. I work across from a former subprime employee and I asked her what happened. How could so many people let this awfulness take place?
The company, like many companies today, had many layers of management along with different departments and even when things were going south, they still had rules and regulations to uphold. She noted that the reason a lot of bad loans were made was because of a competitive market.
Now I have nothing but respect for my co-worker and I know she is an honest person who was just doing her job, just like so many other subprime employees who believed they were helping people get homes. However, if I cut away at the subprime onion, I think there are two major factors that led to the excesses of the subprime boom and bust — loan structure and pay compensation.
Now coming out and saying the collapse of an industry was due to “x, y and z” is naïve at best, as I have the benefit of hindsight on my side. Regardless, I believe it is important to learn from our mistakes. Taking an unemotional view is necessary in order to prevent these same mistakes from happening in the future.
Competition is great for the marketplace. It was competition and intelligence that helped humans reach and stay at the top of the food chain. In the United States, we have anti-monopoly laws that keep companies from gaining too much market share and buying up too many of their competitors. Regardless, the ugly truth is that competition has a dark side — moving forward with no regard to future consequences.
To survive in a competitive environment you must keep up with those around you. Subprime companies began making decisions over time that sealed their destinies. The first nail in the coffin was a change in loan parameters.
Loans can be great when purchasing a real estate asset as they provide a means of spreading the cost over time with little money upfront. However, when a lender takes all the risk on a loan, the borrower has little reason to continue paying if things go bad. And that is exactly what happened with subprime loans.
Loans went from being full documentation, where a borrower provided tax returns, bank statements and W-2 forms to prove income, to limited documentation. Just as it sounds, a limited documentation loan may not need tax returns or even bank statements. But the granddaddy of them all was what was known as the no documentation loan or no doc loan.
It is said that the best intentions pave the road to hell and there are few examples that exemplify this sentiment as much as the no doc loan. Intended for business owners, no doc loans were loans where no documentation needed to be provided. The only thing the borrower had to do was complete a loan application, usually no more than three pages. These loans had higher rates than full or limited documentation loans because they were considered riskier and usually only reserved for those who could not show income.
No doc loans were brought to a new level when wage earners were allowed to get them. This meant wage earners did not have to prove their income and this is where fraudulent behavior transpired. To top it all off, subprime lenders began selling 80/20 loans. This was a 100 percent financed loan, 80 percent coming in the form of a first trust deed and the additional 20 percent coming from a second trust deed. Ultimately that meant the borrower did not have to put down a down payment, which also meant the borrower did not have to take on any risk, all they had to do was make the monthly payment.
If competition drove the marketplace, compensation was the gas that fueled the greed and bad decisions of the subprime machine. Many of the brokers, loan officers and producers who worked for subprime mortgage companies were paid on a commission only basis. That means they were driven by production and paid a percentage of the loans they closed.
I am for people making money for whatever the market will bear. If a person can make $800,000 a year and do it in a legal manner, it is not up to me or anyone else to tell them to stop. However, it is one thing to make a lot of money and quite another to actively participate in fraudulent behavior.
Luckily, I had the benefit of speaking with my co-worker and getting an inside view of what happened in one of the largest subprime mortgage companies before it collapsed. After speaking with her, I truly feel for all those employees who were “just doing their jobs.” Hopefully we will learn from this debacle and future generations will not follow in our mistakes.
Mike Heayn is a Commercial Loan Consultant, specializing in Multi-Family Lending. He can be reached at (310) 428-1342 or e-mailed at email@example.com.