Dec 19, 2007

Housing Bulletin—Who’s to Blame for the Subprime Mortgage Mess?

Sometime last spring, when the present subprime mortgage crisis was on hardly anyone's radar screen, one blip showed up at the office of Lisa Madigan, the Illinois attorney general.

Some attorneys who work in Madigan’s consumer protection division had spotted newspaper ads for mortgages that seemed too good to be true—a suspicion confirmed by the attorneys’ subsequent investigation.

One ad in the Sun-Times offered a $250,000 loan for a payment of $656 a month—but made no mention that the only way to get that deal was to take out what’s called a Payment Option Adjustable Rate Mortgage. That is a loan where borrowers can opt to pay just a small part of the interest due each month, but by doing so, they add that month’s principal and interest to what they owe, potentially building up an enormous debt.

That, suggests Debbie Hagan, was when she began to suspect that some mortgage lenders were actively preying on unsophisticated consumers. “Anyone who looks at how complicated those loans are would easily see that borrowers couldn’t understand what they were getting,” says Hagan, chief of the attorney general’s consumer protection division. It appears some lenders knew they could dazzle cash-strapped borrowers with the promise of astonishingly low payments, then baffle them with impenetrable paperwork that concealed the truth about how those payments would skyrocket after grace periods, interest-rate adjustments, and refinancings.

Many pronouncements from the mortgage industry have blamed over-eager borrowers for the subprime mess. But yesterday, Ben Bernanke, chairman of the Federal Reserve, announced a proposed tightening of home-lending rules that put much of the blame on pushy lenders. Hagan points out that some mortgage lenders, at least, knew full well that they were using a loose system to their own advantage. In late November, Madigan brought a case against One Source, a now-closed Northwest Side mortgage brokerage. The attorney general’s office claims that, among other things, One Source: 

• blatantly exaggerated a borrower’s income on forms that would be forwarded to the actual lender;
• told borrowers only about the minimum payment on an option loan and didn’t mention that the borrower could also choose to make higher payments, keeping the debt from growing;
• quoted only the attractive initial interest rate, not mentioning that it would jump after a certain period.

“To think that homeowners would be put in very risky loans like this says something about the lax underwriting standards,” Hagan says. But, she suggests, the potential for high broker fees were just too great a lure for lenders to resist. Fees that One Source collected, according to the department’s research, ranged from about 3.8 percent to about 4.5 percent of the loans. On a $215,000 loan, for example, the company collected $9,150.

Hagan also notes that subprime loans that charged borrowers big penalties for early payment “made good money in securitization,” making predatory lenders especially eager to push them. The practice of bundling loans into packages to hand off to large-scale investors helped obscure the looming problems.

The One Source case got Madigan a nod in the New York Times, but Hagan emphasizes that One Source “is just a microcosm of what went on” during the height of the subprime lending boom. Her department is also looking at other mortgage brokers in the state. It has subpoenaed Countrywide, the biggest national home-lender and, according to the Chicago Reporter, the biggest lender in Illinois of the now-troubled “high-cost” loans. Countrywide was the lender of many loans that One Source brokered. “We’re taking this upstream, to see where it starts,” Hagan says.

More is likely to develop as the crisis broadens and Hagan’s department continues investigating. Check back here for updates. And if you are facing foreclosure or having trouble making mortgage payments after an interest-rate adjustment, a good place to start looking for help is at www.illinoisattorneygeneral.gov. At the bottom right, click on Illinois Mortgage Lending Guide.

Posted at 10:58 AM in Housing Bulletin | Permalink

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