Bailout Nation (20 page)

That wasn't how the newfangled lend-to-securitize originators worked. In one of many examples of misplaced compensation schemes we have seen, they were paid on the volume, not the quality, of their loans. Besides, they didn't need to find a buyer who was a good risk for 30 years—they needed only to find someone who wouldn't default before the securitization process was complete. Thus, they had very different standards from the traditional lenders. The sellers of these mortgages made warranties to the Wall Street buyers of this paper that the borrowers would not default for 90 days—enough time for the loans to be sold off and repackaged as residential mortgage-backed securities (RMBSs).

This was a radical change in lending standards.

In the past, lenders had to make sure the borrower was good for the full 30 years of a mortgage. In the old days, a bank would make a mortgage loan and hold on to it until the home was either paid off or sold. If there was a default—even 20 years later—it was the original lender (the mortgage originator) that was on the hook. Some securitization took place, but it was a small percentage of outstanding mortgages. That was why the borrower's ability to repay the loan was the primary basis of all lending.

What happened in the recent housing bubble—it's more accurate to describe it as a credit bubble—represented an enormous paradigm shift. Mortgage originators no longer had to find someone who could carry the debt for three decades—they had only three months to worry about! Hell, practically anyone could meet those requirements!

That alone was enough to guarantee trouble. However, for the most part, the industry itself was lightly regulated or, in some cases, not regulated at all. It was ripe for lots of abuse. By the middle of the decade, the mortgage lenders had become the new boiler rooms.
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The many sleazy mortgage brokers and originators who sold loans they knew were likely to default were most definitely the inferior men Confucius warned of. And the banks that underwrote these loans certainly weren't superior.

B
anks that were originating mortgages for securitization found that their manual processes—humans pushing paper around—could not keep up with the now insatiable demand. So they did what other industries throughout time have done: They automated.

Ultralow rates drove the initial demand for mortgages, but it took new a technology—evaluation software—to allow mortgage applications to be processed in numbers never before possible. Computers replaced what was previously a human judgment process.

The nearly insatiable assembly line Wall Street was running for mortgage-backed securities drove the demand for bundling mortgages; home price appreciation kept even poor credit risks from defaulting for some years. These factors are what led to the huge spike in real estate sales from 2002 to 2007 and the accompanying explosion in issuance of mortgage-backed securities. It was a vicious, self-reinforcing cycle, but a highly profitable one as long as the real estate sector kept growing.

Farmers say you have to “make hay while the sun is shining.” Bankers saw the nearly unquenchable demand for mortgages, and they knew it was time to make hay.

The automation systems permitted rapid processing of bad credit risks, but it was the outstanding sloppiness and violation of the banks' own internal procedures that allowed even more bad loans to get written. Hard as this may be to imagine, some loan documentation was so incomplete that federally mandated Truth-in-Lending Disclosure Statements were omitted. Without the proper disclosures, a mortgage could become unsecured—meaning the bank no longer has a first priority lien on the mortgaged property.

Across the mortgage industry, corner cutting and shortcuts were official corporate policy. There was headlong rush to originate, process, and securitize mortgages—and the wherewithal to repay the mortgages be damned. Loans were written to people with low FICO scores, on properties with very high loan-to-value (LTV) ratios; documentation was often poorly filled out. An entirely new category was created: so-called no-doc (no-documentation) loans. Today, we know these products as “liar loans,” thanks to the commission-driven mortgage brokers who encouraged borrowers to get creative when filling out the no-doc applications.

For one of the most astounding examples of the industry's grotesque role in the housing boom, consider this JPMorgan internal memo, titled “Zippy Cheats & Tricks.” Zippy was the name of JPMorgan's automated loan processing software. The memo taught loan officers how to “cheat” the firm's own system. It offered some “handy steps”—workarounds, really—for getting questionable loans approved:

Try these steps next time you use Zippy! You just might get the findings you need!!

Try these handy steps to get SISA findings
. . .

Let me point out this was not some little fly-by-night outfit; it was JPMorgan Chase bank. This internal Chase memo accidentally found its way into the hands of Jeff Manning, a journalist with the
Oregonian
. It was the basis for an article titled, “Chase Mortgage Memo Pushes ‘Cheats & Tricks.' ”
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Tammy Lish was subsequently fired from Chase for releasing the memo publicly. Before then, it had been circulated only internally within the firm.