Longtime Boulder mortgage banker Lou Barnes remembers what happened as Wall Street investment bankers moved en masse into the mortgage industry.
“You would open up your e-mail in the morning, and you would find 10 guys wanting to buy mortgages from you,” said Barnes, of Boulder West Financial Services. “They said, ‘Sell us anything you’ve got. We’ve got new terms today. We’ve got loans for you that you didn’t even think you could make.”‘
The results of all this easy mortgage money are still just beginning to manifest. First came reports of record numbers of home foreclosures. Then came a subprime mortgage-industry meltdown that has already taken several lending companies into bankruptcy. More recently, it’s been ravaging hedge funds.
Bear Stearns, otherwise known for its risk-management prowess, has just blown up two of its hedge funds, which were heavily invested in subprime mortgages.
These are high-risk home loans to people with shoddy credit histories. Apparently, the risk managers at Bear Stearns decided it might be a good idea to invest in this concept with complete abandon. Now, they quite literally continue to tally their losses as homeowners increasingly default on the loans.
Lesser-known hedge funds run by United Capital Markets Holdings Inc. in Key Biscayne, Fla., on Tuesday took the unusual step of limiting withdrawals. Some of the funds invested in bonds backed by subprime mortgages. The company – which manages about $620 million – said it had received “an unusually high number of redemption requests” and sought to prevent a forced sale of assets.
These and other looming financial disasters are brought to you by the now- ubiquitous mortgage-backed security.
As interest rates fell to 50-year lows a few years ago, investors, flush with cash, wanted better returns. Wall Street answered the call by bundling mortgages together and selling them as securities.
For mortgage brokers, this meant a big pot of money to lend. And as demand for mortgage-backed securities grew, investment banks turned a blind eye to shoddy lending standards. All too eager to make loans, many mortgage brokers misled borrowers into taking out more loan than they could handle, spawning record spates of home foreclosures.
“If you are a retail mortgage lender and you meet with people every day, you have a pretty good sense who can handle their expectations and who can’t,” said Barnes, a more conservative mortgage banker who says he did not get swept up in the mortgage mania.
“Most of the mortgage retail industry knew that these terms were going to do grave harm to borrowers who took them,” he said.
But they made the loans anyway.
Many states, including Colorado, have responded by licensing mortgage brokers and sanctioning appraisers for padding deals with inflated appraisals. But little has been done to curb the excesses where they began – on Wall Street.
“It’s ridiculous to criminalize bad appraisers and pat yourself on the back because you’ve licensed brokers,” said Anthony Accetta, a Denver fraud investigator and former federal prosecutor who used to break up mortgage-fraud rings. “That’s too little too late. Because all of the fraud … has been tolerated, and even encouraged, by the investment banks.”
This has been going on for years.
In 2003, a federal jury found that Lehman Brothers helped a California-based lender, First Alliance Mortgage Co., defraud customers. Lehman had loaned First Alliance $500 million, and then it helped sell more than
$700 million in mortgage-backed bonds, according to a recent report in The Wall Street Journal.
A lawsuit filed by Florida authorities also alleged that Lehman was an “accomplice” in First Alliance’s frauds. Lehman settled the case and has called the First Alliance fiasco an aberration.
The subprime mortgage mess gets worse by the month, but high-level federal policymakers keep calming the market. In March, Treasury Secretary Henry Paulson Jr. said it was “largely contained.” And Federal Reserve Chairman Ben Bernanke has repeatedly said he does not expect it to spill over into the broader U.S. economy.
“The Fed is now in a bad box,” said Barnes. “If it acknowledges that there’s a problem, it makes the problem worse.”
Perhaps this is the beginning of the next savings-and- loan crisis. Or maybe mortgage-backed securities have spread the pain of defaults so far and wide that the U.S. economy can keep chugging along, even as it is plagued with rampant foreclosures and a housing recession.
“If we get lucky, Wall Street’s errors will be distributed so broadly that this is just embarrassing – careers end, there’s credit-tightening that makes it harder for housing to recover, but nothing really bad happens,” Barnes said.
That’s the big picture, at least, but some of the little mosaics that build it are a lot more dramatic.
“Every time you talk about a mortgage foreclosure,” said Accetta, “you’re talking about the crushed hopes of a family who once had a home, and now they don’t.”
Al Lewis’ column appears Sundays, Tuesdays and Fridays. Respond to Lewis at, 303-954-1967 or alewis@denverpost.com.
