Risky loans rewarded, panel is told
The link between mortgages and securities discouraged due diligence, an expert tells financial crisis commission.
After nearly a year of taking testimony from hundreds of witnesses and studying millions of documents, the chairman of the federal Financial Crisis Inquiry Commission said he believes that corrupt and abusive subprime lending practices were a prime cause of the deep recession.
At the end of a final hearing, held Thursday in his home town of Sacramento, former state Treasurer Phil Angelides said those risky mortgages triggered a wave of foreclosures, the failure of major financial institutions and the nearly double-digit unemployment rate.
“What’s been striking is the colossal failure of corporate leaders and management,” Angelides said. “They took enormous debts and, in the end, led this country over the cliff and the country’s economy with it.”
The commission will deliver a book-length report on the causes of the recession to Congress by Dec. 15.
Worse, Angelides said, many appraisers, real estate brokers and bankers who testified at regional hearings in Bakersfield, Miami and Las Vegas had tried to send warnings to high-level executives about “just how out of control subprime lending had begun.”
The rush to profit from turning subprime mortgages into top-rated Wall Street securities encouraged loan originators, investment bankers and speculators “to push risk tolerance to its limits,” said Kurt Eggert, a Chapman University law professor.
The profit motive also discouraged due-diligence experts from blowing the whistle on faulty underwriting, Eggert, an expert on predatory lending, testified at the final field hearing of the Financial Crisis Inquiry Commission.
Much of the testimony Thursday focused on the explosion of often complex loans that were made with few checks of borrowers’ ability to meet payments. Typically, the mortgages were subprime loans, given to buyers with little or no credit.
Companies bundled those mortgages and used the packages as the basis for securities, a process known as securitization.
That process encouraged brokers and lenders to “make the largest and riskiest loans borrowers will sign” and rewarded investment houses by “creating the riskiest loan pool that the rating agency would bless with high ratings,” Eggert said in prepared testimony.
What’s more, appraisers got financial incentives to overstate the value of homes, he said.
“It was easy money,” said Karen J. Mann, president of a Sacramento appraisal and consulting company.
Poorly qualified appraisers were persuaded to perform superficial, “drive-by” valuations with “no thought to the collateral value” of a property, she said. And the slipshod work was rarely reviewed by state banking or mortgage regulators.
The result, Angelides said, was that “one of the safest purchases traditionally made by families — a home with a mortgage — became the beating heart of a financial monster.”
Sacramento’s 12.8% unemployment rate — along with 43% of homes now worth less than the loans on them — contrasts with the rise in Wall Street’s fortunes, Angelides said. Profits at surviving financial institutions are up along with executive salaries.