Looking Back: The Subprime Meltdown Explained By The NYT… In 2002

The end of the year is a time for looking back and reflecting on the past. Perhaps learning from it. With that in mind we poked around the NYT archive and found a great article on the subprime mortgage market and predatory lending from 2002.

THE subprime mortgage industry, which serves people with bad or blemished credit histories, has burgeoned in the economic boom of the last 10 years, allowing people previously deemed uncreditworthy to buy a home or to raise funds by refinancing their mortgage. But as the industry has expanded, so has its dark seam — predatory lending.

And as subprime loans have increased, so, too, have foreclosures.

Here’s how the March 24, 2002 Times explains the proliferation of subprime lending:

Whatever its degree, the proliferation of predatory lending is certainly the outgrowth of an explosion in the subprime market — distinct from the prime or conventional mortgage market, which serves buyers with satisfactory credit histories. And the subprime explosion since the early 1990′s has been fueled by both the booming economy and the creation of new tools that allow lenders — including Wall Street investors — to rapidly assess the risk posed by a whole new group of potential borrowers.

T HIS came about because of computerized credit scoring,” said Keith Gumbinger, a mortgage analyst and vice president at HSH Associates, a financial publishing company in Butler, N.J. Computerized scoring allows a would-be borrower’s credit history to be assigned a single number — between 300 and 900 — by which a lender or an investor in mortgage-market securities can determine how likely the applicant is to repay the loan.

”Borrowers can be placed anywhere along that scale,” Mr. Gumbinger said, ”and investors and lenders adjust their rates and fees to compensate for riskier borrowers.”

”It’s the big mortgage lenders who fund smaller lending firms and street-level mortgage brokers that pressed these subprime products and predatory products onto the market in order to serve new audiences and get more people to owe them money,” Mr. Gumbinger said. For a fee, packed into the loan, brokers bring borrowers and lenders together.

Ms. Ludwig agreed: ”It’s not just your rogue broker or lender on the street. This is very much built into the whole investment machinery so that even some of the large banking institutions, Wall Street investment houses and bond insurers have figured out a way to profit handily from this market segment.”

Lenders provide the capital and either hold the loan or, more commonly these days, sell it either to another financial institution that buys up bundles of loans or to Fannie Mae or Freddie Mac, the federally chartered corporations that buy first mortgages at discounts, insure and then resell them. ”Or it’s often securitized through the packaging of these loans, which are then sold through Wall Street investment houses,” Ms. Ludwig said, ”usually to institutional investors. Without the secondary market, without securitization, you wouldn’t have this proliferation of subprime and predatory lending.”

The article also concentrates on “predatory lending” techniques that probably seemed much more isolated than they really were. For example, one profiled consumer was told she was signing up for a 30-year fixed rate mortgage, only to find out that (you guessed it) she’d signed a ARM with a 1-year teaser rate of 5.5%.

A Wider Loan Pool Draws More Sharks [NYT]
(Photo:meghannmarco)

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  1. tcm22 says:

    “For example, one profiled consumer was told she was signing up for a 30-year fixed rate mortgage, only to find out that (you guessed it) she’d signed a ARM with a 1-year teaser rate of 5.5%.”

    I call maximum bullshit on this statement. Anyone who has ever taken out a mortgage knows you have to sign literally dozens of documents that specify the interest rate, what you’ll be paying, and for how long. There are other documents you sign that verify you’ve been given all that information. For anyone with two working brain cells, it’s patronizing at best. For someone to claim they didn’t know they were signing a teaser ARM is absolutely non-credible in today’s marketplace.

  2. esqdork says:

    BTW, sub-prime mortgages and borrowers with good credit scores are not mutually exclusive. Some unwary people with good credit scores but who did not understand the choices that were available signed up for sub-prime loans, others with good credit did it because it made sense for their plans to house-flip.

  3. Meg Marco says:

    @tcm22: In a lot of cases the paperwork was forged and/or inaccurate, and the borrowers were being defrauded.

  4. JustRunTheDamnBallBillick. says:

    @Meg Marco: If that was the case we would be seeing tons of brokers sued for fraud, and a lot in jail. We arent. Dont get me wrong, lots of people got mislead about the nature of the market, but I dispute your contention that “In a lot of cases the paperwork was forged and/or inaccurate, and the borrowers were being defrauded” because its wrong.

    The biggest arguement for fraud was people who were expecting one rate (cause they saw something in the paper or on TV) and wound up in ARMS because that was the only way the lender to get it that low.

  5. wesa says:

    I am betting that many people just didn’t read the paperwork and only have themselves to blame for jumping into something this big without fully thinking through the consequences.

  6. rphoenix says:

    TCM22 — Many disreputable firms would have the buyer sign two sets of documents, one with the correct 30 year and one with the ARM. For many people signing loans documents is stressful and confusing, try having a little compassion.

  7. tcm22 says:

    There’s always fraud. That certainly doesn’t define the industry. I fully support and commend any prosecution of lenders who lie and defraud customers. However, I’m guessing that 99.9% of the subprime ARMS that were sold in recent years were fully compliant with state and federal laws.

    The example in the article says nothing about how the lender defrauded the poor, unsuspecting borrower. It certainly hints at some sort of bait and switch, but I’m suspicious of the carefully chosen language and the lack of follow-up or specifics. It’s easy to paint a picture of a victim of the evil mortgage lenders if you don’t bother to list all the facts.

    No one held a gun to anyones head and forced them to take the loans. As I mentioned, volumes of state and federal forms are required to ensure consumers are protected from themselves. Even with all the mortgage disclosure laws there’s people out there that will claim to be victims even though their own stupidity drove their situation.

    Fact: No one who pays their mortgage on time gets foreclosed.

  8. nichomiz says:

    I think we just need to file the whole thing under “A fool and his money” and move on, regardless of whether they were misled or not.

  9. rphoenix says:

    BTW Conseco insurance company, one of the largest bankruptcies (3rd largest, if memory serves) in US history was primarily due to subprime lending and it happened in 2003 (I think), so I do think the crisis was foreseeable. No one wanted to break up the party. After all, there was a lot of money being made.

  10. nichomiz says:

    BTW, few things can take the happy out of a box of Cap’n Crunch. Thanks, Meg. :(

  11. rphoenix says:

    I think you are correct that most buyers just bought more than they could afford. They wanted to believe the fantasy being peddled in the housing market. When I bought my house everyone involved thought I was crazy for spending as little as I did and for getting a 30-year fixed rate mortgage. Who is laughing now (me)?

    However, there was a significant amount of fraud and misinformation. Perhaps the area that caused a lot of these problems was mortgage brokers falsifying paperwork so people could meet loan qualification and get loans that they could clearly not afford. I am not entirely sure why, but a lot of people believe that the bank will not loan them more than they can afford…

    People should take responsibility for their own actions, but the industry also needs tighter regulation.

  12. brennie says:

    What about the ‘no-doc’ portion of the loan? Anyone who signed a stated income contract should have at least noticed that their income was inflated. Folks might not be able to navigate the ins and outs of variable interest rates, but for pete’s sake, they at least know how much they make don’t they? If they signed those things, they have committed felony fraud and are out in the cold. No one can or should help them.

  13. tcm22 says:

    @brennie:

    No, no, there all victims of the greedy banking industry! Don’t you read the NYT?

  14. Me - now with more humidity says:

    BRENNIE: Those were often altered after being signed.

  15. quail says:

    @tcm22: As one person said, it wasn’t too uncommon for paperwork to be forged or changed at the last minute by the broker or lender. And I can’t begin to tell you the number of times my friends or I dealt with an unscrupulous broker or lender. They’d ‘help’ you fill out the paperwork to give you the best chances of getting the worst/best deal possible. Or at the time of signing would insist something was in the paperwork but would fail to find the specific paragraph for you. I walked away from all of those situations. Some of my friends unfortunately did not.

  16. tcm22 says:

    I’d submit that it’s very uncommon. There’s always fraud and criminal attempts to fool gullible people, but I don’t think it’s a defining feature of the sub-prime mortgage market. That’s the implication of the NYT article, yet it’s totally unsubstantiated.

    Between home purchases and re-financings, I’ve probably shopped and signed for 8-9 different mortgages. I’ve never had an unprofessional experience. Some lenders are certainly better organized than others, but never has anything smelled of fraud or deception. I’m not sure where all these unscrupulous lenders or clueless borrowers are residing, but I don’t believe they are a significant portion of the industry.

    People borrowed more money than they could afford, and banks bet the market would continue to rise. Sometimes risk is poorly managed. Looking for corporate bogeymen is counterproductive.

  17. CumaeanSibyl says:

    @tcm22: However, I’m guessing that 99.9% of the subprime ARMS that were sold in recent years were fully compliant with state and federal laws.

    You’re right to point out that we haven’t got evidence of widespread fraud in the mortgage industry, but I’d remind you that “guessing” doesn’t constitute evidence either.

  18. Sudonum says:

    @JustRunTheDamnBallBillick.:
    Ever hear of Ameriquest?
    [en.wikipedia.org]
    And yes I know that this still does not equate to “tons of brokers sued for fraud, and a lot in jail”, but it has happened and more cases may come to light as this thing progresses.

  19. GreatCaesarsGhost says:

    My god, has anyone here ever bought a house? The documentation is literally half an inch thick. You’re in a room with half a dozen other people that are telling you “sign here, initial here” and it can be quite intimidating.

    I bought my house with an ARM through a broker. These guys are salesmen. They play up the loan being approved, not the shoddy terms. My guy lied about my income and other debts. They may mention you’re getting an ARM, but not explain what that is. These people got suckered, just like your average used car buyers. They’re victims, plain and simple. (thankfully I knew what I was getting into and was able to refi later)

  20. anatak says:

    @JustRunTheDamnBallBillick.: Fraud is widespread, and no, they are not getting thrown in jail for it. Thats why its widespread. ID theft is fraud. Forging loan apps is fraud. Happens every day.

  21. howie_in_az says:

    @GreatCaesarsGhost: “They may mention you’re getting an ARM, but not explain what that is.”

    And nobody thinks to ask, “hey what’s an ARM” ? This is more than likely the single biggest monetary transaction of their entire lives and they don’t ask questions if they’re unsure of something?

  22. lboyette71 says:

    We were two weeks late with our closing date changing on the fly. When we finally got to closing all of a sudden we had a lender from another part of NC doing our paperwork that we never talked to the day of closing. We waited four hours in the lawyers office with a U-Haul full of our belongings. We had to wait for this new lender to fax over the entire documentation before they were about to close the office. Our credit scores were 685 and higher at the time there was no need for them to put us in this mess.We did not know about this process but when your a first time home owner, the first generation to own a home you are uneducated about the process. Your parents were not homeowners so they could not teach you this process. When you build a KB Home they make the process out to be painless and they are so helpful. We could afford what we started on. My main concern was telling the first lender on an everyday basis I don’t want a mortgage over $1000.00 I could not stress that enough. not everyone wants or plans to live beyond there means,not on purpose. I knew what I was capable of paying for. When I looked at my 1000 sheets of paper work I was too tired and they gave us less than an hour to finish reading and processing. Don’t act as though you were there for every situation and no one chose to read their paper work. We were purposely delayed so we would not have time to read all the sudden changes that took place in those long four hours. Put yourself in my shoes. Maybe some of you grew up with both your parents who may have been homeowners, who had the education about purchasing a home. No one wants a hand out but I did not sign up to be used and blamed for the economy going bad. This is for those of you who feel we bit off more than we could chew. There are different circumstances for every situation. Place blame on them if it were a few people but this is affecting the entire 50 states, we can not all possibly want to live outside of our means. When your child is in class and the entire class fails a course who do you blame the child or the teacher.Preach about what you know from experience not about what you think.