Monday, December 15, 2008

Subprime Defaults Are Just The Beginning

If you thought we were almost done with the collapse of the mortgage market, you are sadly mistaken. Last night 60 minutes did a piece about the looming wave of mortgage defaults, Alt-A and option ARMs. While, as Scott Wilson outlines below in his guest post on Your Mortgage or Your Life, 60 minutes did not do a fabulous job on this story, they did reveal some very interesting facts and figures. One that was especially scary occurs 3 minutes and 40 seconds into the video. This shows how most of the subprime mortgages have already reset, but what is looming over the next few years is a huge number of Alt-A and option ARMs due to reset. The graphic will definitely make you change your tune if you think this carnage is almost finished.

by guest author and good friend Scott J. Wilson

I know that I am just smart enough to get by, and I know am not a genius by any stretch of the imagination. I have just been in the mortgage industry - working everything from mortgage sales to secondary markets - for more than fifteen years.

I happen to be watching CBS’s 60 Minutes tonight (12-14-08) and they had a piece called Mortgage Meltdown: Where’s the Bottom? with Scott Pelley, who did the story, and not a very good job of it. Either he or his writers need to better research their topic before they to such a report.

Mr. Pelley failed to note that POA’s qualified borrowers with “teaser” interest rates, and not the actual “payment” interest rates. But that is not what I am griping about. My complaint lay in Pelley’s false assumption that no one but a few sage individuals could see these consequences of poor lending standards coming.

All of my experience is in the explosive Orlando, Florida area, so I know a thing or two about exotic mortgage products like the soon to be infamous Pay Option ARM (POA), ticking time-bomb of the mortgage world, and the subprime’s little brother ALT A.

During the bubble from in 2004-2006, I worked for one of the biggest lenders in the nation (one of the survivors thus far) and I doing a truckload of Condo-conversions. I sold a hell of a lot POA’s to borrowers during that period, and most will all be recasting over the next two years.

I tried to always do one thing when I did sell a POA, I tried to explain to the borrowers exactly what these loans were intended for - people with season variances in income like construction and tourist trades, or for those whose income is mostly delivered from quarterly bonuses like sales people.

I did my best to point out to the borrower advantages and traps in POA’s. That being said, I am no “expert” by 60 Minutes standards, let alone “one of (only) six experts in the nation who saw this (tsunami of foreclosures) coming,” as 60 Minutes called Mr. Eagan in tonight’s story.

I knew way back when in the bubble, as did most of the loan officers that I worked with, that these were potentially bad products if they were sold to the wrong borrowers, and that most would probably fail if they allowed more than 80% loan to value (LTV), or made them available to speculators and subprime borrowers.

I also know that most of these loan officers were not geniuses either. Could we have been the only ones to know? I doubt it. So to say that the banks that offered them had no idea that POA’s had a high risk of potentially failing is just completely incorrect.

The bank’s own greed got the best of them; all they saw was the dollar signs in their eyes, as fees and points that filled their coffers.

The borrowers were really no less greedy- like I said, I did my best to explain, even tried to talk some borrowers out of using a POA to buy the property that they were interested in. But most times, it was to no avail. They either didn’t care about the risks or worse yet, their Realtor “over talked” me and told them that I did not know what I was talking about, and that the POA was their best choice:

Real estate always goes up, remember? It’s different here! No need to worry about that negative amortization loan if you stick with the only payment you can really afford, the one with the 1% teaser, your house will be worth double what you paid for it in a year or two!

But, unfortunately, the problem as the banks saw it wasn’t that these loans were going to fail in droves, nope.

The problem the banks saw was that the people were using these loans as short-term real estate investment loans with a really low initial payment, giving the investors time to remodel the property in order to “flip” the house and then move on to the next investment without having to sink so much capital into principle and interest with a higher interest commercial loan payment.

The banks were not making enough money, so they started tacking on prepayment penalties, which investors took as a cost of doing business and the banks thought of as a new revenue stream.

So the big banks and mortgage lenders had to have done some sort of analysis of these POA loans (I know Anthony did when he worked for them, whether the executives ever really read them I don’t know).

Did they not anticipate that the loans would be bad? That if someone who was taking this completely unaffordable loan out for a long period of time they would get burned, especially if the borrower had a two or three year pre-pay penalty on it and the market took a quick downturn, leaving them unable to refinance - just like it did.

Come on though, everyone can’t be so smart that we all saw this coming, but the leadership at Corporate of these mega-institutions did not - especially when they were offering No Income/No Asset options as well - now commonly know as “Liar-Loans” for their lack of any documentation in exchange for a higher interest rate.

Again, profit driven.

At one point, I told people that it was not a matter of if you can qualify or not for an Option ARM or not, if you had below-average or sub-prime credit, you would qualify , with no problems. All I had to do, was run their credit and if they had a 620 credit score (below average credit at the time), then I told them that they were approved with out even having an underwriter look at it.

Underwriters could approve even lower scores with the advent of “risk-based” and “exception” pricing add-ons, basically charging more for the additional risk posed by a riskier borrower, hence the birth of the ALT A loan, among other expanded approval products meant to sell more loans to more people.

So to have Mr. Pelley and 60 Minutes do this completely un-researched and absolutely baseless story that has little or no semblance to the truth is a more than a shame - lots of people knew this crisis was headed our way.

Hell, I wouldn’t be surprised if close to a million people knew that these loans were problems and a lot of them were going to fail. Do you think that any of them just might have worked in upper management of a these now failing banks?

Or are we really all just geniuses after all?

Well in that case then, I’d say my superior intellect makes me really doubt it.

This article has been reposted from Your Mortgage or Your Life The full post can also be viewed on


Prof. Samuel D. Bornstein said...

Re: CBS 60 Minutes "The Mortgage Meltown" aired on Sunday 12/14/08.

Scott Pelley's piece on the 2nd Wave of Foreclosures overlooked a critical fact. The next wave of Foreclosures in 2009 Will Take Self-Employed and Smaller Businesses who have these TOXIC mortgages. In fact, ALT-A, Option ARMS, Interest-Only, the TOXIC Mortgages that are considered the "Troubled" assets in TARP were marketed to the self-employed who fell prey to them.

An NASE survey,, was the first to provide compelling evidence of small business involvement in the upcoming toxic mortgage crisis. The survey was created by Prof. Samuel D. Bornstein and Jung I. Song, CPA of BornsteinSong Consultants in Oakhurst,NJ,and was conducted by the National Association for the Self-Employed (NASE) which issued a Press Release on November 21, 2008. According to this survey, it is estimated that 3,709,800 small business owners hold Alt-A and other toxic mortgages, and 1,279,800 are already delinquent as they have missed one to three or more monthly mortgage payments at mid-November, before the expected Resets that are scheduled to begin in 4th Quarter 2008 through 2012. These small business owners will be at-risk of payment shock and default as their monthly mortgage payments skyrocket. Small business owners were especially targeted for these Alt-A loans which required little or no documentation of income which appealed to many small business owners who previously were unable to qualify.
The resulting defaults will be the cause of the upcoming second tsunami wave of foreclosures that will dwarf the subprime crisis and will take many homeowners and small business owners.

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Anonymous said...

...not impressed with the greed argument. Why would greedy lenders loan money with out sufficient collateral to people who can't pay. You can advance stupidity on those facts but not greed.