How the mortgage industry nurtured deceit.

Commentary about business and finance.
April 24 2008 11:25 AM

Inside the Liar's Loan

How the mortgage industry nurtured deceit.

(Continued from Page 1)

These were not "subprime" loans. The borrowers' average credit score was 705, well within prime territory. This is a fairly typical package of loans for amortgage-backed security, but one thing that does make it stand out is the proportion of these loans that didn't ask for income documents: 88 percent.

Historically, a year into the life of a loan, well less than 1 percent of typical prime loans would be 30 days late or more. By the end of January, when Shedlock first looked at it, just eight months after the loans were made, almost one in five were at least 60 days overdue.

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Shedlock looked at it again two months later, at the end of March. The results:

  • Eighteen percent of the loans are already in foreclosure—or have already been seized by Washington Mutual.
  • One in four of this bundle of liar loans is already 60 days past due.

Remember, these are folks with good credit histories—and one in four of them is well on his way to losing his home, or has already lost it.

Think about that city center again. All those cars speeding through those red lights. And crashing.

None of this could have happened without everyone's willing participation. If a car rental agency put up a huge sign saying, "We don't check your driver's license," you wouldn't imagine it really meant anything but "Come on in, we don't care if you have one." The word fraud really doesn't conjure up anything close to the real moral or financial reality.

Clearly, amazing degrees of stupidity and mendacity were involved. Some of the sob stories that have come out of the mortgage crisis, unhappy as they are, raise the question: "These folks earned $3,000 a month and had mortgage payments of $2,700. Was it so hard to see this was a mistake?"

But consider the position of borrowers in markets where close to half the people taking out mortgage loans were lying. Keep in mind that in some places (for instance, San Diego), half the people in the market were taking out stated income loans and so bidding up prices to points where almost any house became impossible to finance for someone who did not lie.

Then try to imagine the broker hovering over your shoulder, like the scientist in some mortgage-world version of the Milgram Experiment. In ordinary circumstances, the people and institutions you deal with reinforce social norms. They say it's not OK to lie. But what happens when the structures and institutions break down and start telling you the opposite?

In that case, the honor system that we take for granted goes out the door. You wind up with the situation in many countries—Russia, India, Italy—where, say, not paying taxes is not aberration; it's normal. What might be most worrisome is that once you get to that point, it's hard to get back. You don't just have to restore the structures. You need to restore the norms, too.

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