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The Mortgage Mess: Lender Myopia And The Race To The Dumbest

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“Don’t Buy Stuff You Can’t Afford” is a classic Saturday Night Live skit whose underlying lesson—that you shouldn’t buy what you can’t afford—seems to have been ignored by a lot of those whose financial troubles or outright failures have been making headlines lately. (And, frankly, making the job of writing about the follies, hogwash and bumble-buzzers a bit too easy here at DealBreaker.)
At the heart of the mortgage problem is that many home lenders seem to have adopted the opposite motto: buy what you can’t afford. And more importantly, lend money to customers who can’t afford the repayment terms. How did so many financial institutions—from smaller lending shops to prestigious banks—get drawn into this race toward the bottom?
An article in the LA Times yesterday suggests an answer: the supposedly smartest guys were following the stupidest. Because so many of the stupid guys were making so much money from fees built on stupid mortgages. Sure, they won’t admit that it was a competition to be stupid. Their word is “aggressive” but you know what they mean.
“Countrywide suggests that mortgage pricing and underwriting standards during the housing boom were set by the most aggressive -- that is, least rigorous -- lenders, and that it was all but powerless to impose its own standards,” the LA Times reports.

“Most of the large bank lenders, as well as Countrywide, were limited, slow, reluctant followers behind the lenders who most aggressively relaxed underwriting guidelines," the company said in a written response to a question from The Times.

Just in case this got lost in translation: super-tanned Angelo Mozilo now says his company was “powerless to impose its own standards.” How did it lose the power to set its standards? The answer seems to be that it was hypnotized by the lure of fees and profits that others would reap if it didn’t cast its standards to the wind.
A bit of historical reflection on how we got here after the jump.


Actually, this brings us back to a thought we had when writing about the Jim Cramer-style, Punch Bowl caucus Wall Street Populism. In the nineteenth century, the big lending banks on Wall Street were intense foes of inflation, and may even have been behind some of the deflation of the era. They wanted “sound money” and opposed any retreat from the gold standard. Now, many lenders are crying out for rate cuts and seem unphased by the threat of inflation.
So what changed? It seems to be the financial structure of lending itself, and a collapse of the time-preferences of lenders into very short terms. Where bankers once depended on interest on loans to earn profits—and therefore had relatively long-time horizons on investments and sought to keep inflation to a minimum—many lenders now rely on fees for profits. Because fees are payable immediately, they can boost balance sheets for quarterly financials. And lenders seem to have responded to this by focusing on deal churn, providing as many mortgages as possible. In other words, the profits from fees have given many lenders a kind of myopia that led us directly into the mortgage mess.

Countrywide's message of confidence turned to crisis
[Los Angeles Times]

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