Mortgage Meltdown - What Happened? 

by don parsons 

At the end of July, first of August, the secondary market (mortgage securities investors) woke up one morning and said “things are uncertain, there are hidden losses occurring in our loan portfolios (mostly sub-prime product) and we want more yield for the risk and loss we are subject to”.   Translated, Jumbo loans (over 417,000) sub prime loans, Alt A, Sub Prime and other exotic loans were priced substantially higher in rate.  Guidelines started changing on major sectors of loan product offerings, including income qualification, FICO scoring minimums, loan to values and occupancy. In addition to  the changes, hundreds of programs just simply disappeared.  A little known fact is  that most Banks and Mortgage Bankers DON’T lend their own money but rather fund mortgage loans on “warehouse” or “credit” lines, then sell them to Wall Street (the secondary market).  They may send you statements, collect your payments and pay your property taxes, but they don't literally have your loan, only the servicing rights for which they collect a nice premium  (which is part of your interest rate).  And they can sell those rights at any time to another lender or servicing entity.  When this major nervousness occurred in the markets, stimulate mostly by the "Sub Prime" defaults and potential ensuing losses, thousands of lenders were caught with hundreds of millions of dollars in the pipeline (approved loans waiting to fund or already funded) or already on the “warehouse line” waiting to be bought and no place to sell them! An example:  If you are the lender and you have 100 million to sell and the value of that portfolio is normally worth 101 million or 102 million, but now the market risk has discounted the value of the portfolio to 95 million, you are in deep yogurt.  Not only will you not make any profit, but you must write a check for 5 million to the investor to “take” the loans off your hands (warehouse line).  This was true of all Banks and Mortgage Bankers that were making mortgage loans.  To the rescue, sort of.....Fed Chairman Bernanke did something historic after seeing lenders collapsing like dominoes.  In order to allow the markets time to sort this out, and salvage consumer confidence, the Feds dropped the discount rate .50%, (the rate at which Banks borrow from the Feds overnight) and extended the overnight borrowing window to a 30 day window.  The next morning 3 of the largest banks in the country went to the Fed window and borrowed 2 Billion each.  Not only did the Banks have a huge potential loss on their hands from their own mortgage loan interruptions, but they also maintained the “warehouse lines” for the Mortgage Bankers.  So the Feds, in affect, became the lenders substitute "warehouse line".  Mortgage Lenders had 3 choices:  1) renegotiate all locked loans and face immense class actions suits 2) find, borrow, locate monies to pay the piper and suffer incredible losses hoping to maintain their market position, gambling on a quick recovery or 3) close their doors.  Over a hundred lenders closed their doors and even more have merged, been bought out or will close as the market tosses and turns.

The reasons touted for this financial upheaval have been numerous but there are really only a few.  1) Inexperienced and unethical loan officers who got in the business as part of the refinance “gravy train” in 2001-2002 or so. 2) Treating mortgage loans like a commodity  (TV, computer, appliance or automobile) instead of a sophisticated financial instrument requiring an experienced professional with license, designations, experience and skill sets to help clients navigate the dangerous waters of lending 3) young and inexperienced traders in the pits (Wall Street) who were on a hay-day structuring “mortgage securities” with great looking yields unaware or ignoring  historical risks, combined with age-old greed of lenders.  Decades of experience and success using prudent lending standards were abandoned. The risks being, stated income loans with bad credit and 100% financing, no reserves and no reserve verification and two to three year loan terms with “re-casts” of entry level low interest rates that would skyrocket, making the home totally unaffordable to many.  And a great deal of this type of lending was done with inexperienced first-time homebuyers.  Homeowners wanted to buy, builders wanted to unload inventory, Lenders and Realtors wanted to make commissions, and Wall Street and Europe had billions to invest.  The perfect lending storm.  It was lending's "musical chairs".  When values were skyrocketing, and the loans became ugly you could refinance into another similar loan or worse case, sell and take a profit.  But when the music stopped (values stabilized), and folks had to face the inevitable, higher rate re-casts, notices of default began being filed and foreclosures became the cure for the abandonment of decades of experience and prudence.  

The Feds and the European equivalent have poured billions into the system to prevent a total consumer meltdown of confidence and most don’t know how close we came to a serious breakdown in the financial markets unlike anything we have seen in decades. Fortunately, the markets are settling down and we are seeing some sanity begin to come back.  

But I must ask this question:  From the homeowner's perspective who may feel victimized, was the home affordable in the first place?  And should the prudent shopping maybe have been for a "certified mortgage planner" or real "lending professional" not a "nice salesperson"?   And just maybe a ¼% cheaper interest rate or saving 300.00 in fees is not where the real test or analysis is.  The original loan officer most likely has left the business, taking his commission, and gone back to selling some other “commodity” until the “refinance gravy train returns”.   There are many lessons for all to learn in this, but don’t for a minute believe you don’t get what you pay for.  There are no “free lunches “or “fantastic deals”.....Experienced, sound advice & counsel trump everything!  Call me to review your personal situation, or, if you have a friend, neighbor or work associate that does not have “bulletproof” counsel as a resource, I will be happy to contact them for a Mortgage Check Up.  I have just initiated the FREE ARM Analysis Review Program for those clients who don't have an expert coaching and counseling them on an ongoing basis. It is part of my Mortgage Adoption program.  If you or a friend, family member or associate have an ARM of ANY kind, you probably a good candidate for a "review".  You can contact me at 949-428-3099 or at don@donparsons.com.