The Liarâ€™s Loan?
study by economists Wei Jiang, Ashlyn Aiko Nelson, and Edward Vytlacil
of over 700,000 mortgages issued during the Housing Bubble by an unnamed financial institution focusing on the "low documentation"
mortgages brought in by independent brokers (now that`s a trustworthy-sounding combination) raises questions about exactly what kind of borrower wants to pay higher interest rates in return for hiding facts about themselves.
Although this mortgage bank handed out fewer subprime loans than the national average, it still rode the Housing Bubble hard:
First, the bank experienced a rapid increase in loan production during the mortgage boom, followed by a sharp decline during the housing bust; new loan originations increased from about 20,000 in the first half of 2004 to a peak of over 154,000 in the second half of 2006, followed by precipitous decline starting in the second half of 2007.
It`s specialty was low-doc loans:
Finally, the low-documentation loans represent just 20% of loans in the McDash database, but represent 70% of our sample. The difference is due to the lenderâ€™s specialization in low-documentation loans.
Like the lab rat that keeps hitting the button that dispenses more cocaine, the financial institution kept hitting the Low Doc / Broker channel harder and harder:
Figure 2 also shows that the rapid expansion in loan production was driven almost exclusively by increased loan originations through the broker channel, and expansion of low-documentation loans through the broker channel in particular. Broker-originated loans represented 73% of all loan originations in the first half of 2004, increasing to 94% by the second half of 2006; while broker low-doc loans accounted for 39% of originations in early 2004, they comprised 75% of loan originations by late 2006.
The creditworthiness of the four different channels is exactly what you`d expect:
The median duration times (in months) reported at the bottom of Table 3 reveal that a loan originated with full documentation by the bank has a median life of 25 years (300 months) before delinquency; the same median lifetime drops steeply to 8.4 years for Bank/Low-Doc loans, and to 7.9 years for Broker/Full-Doc loans. Finally, the median life is a mere 4.6 years for Broker/Low-Doc loans.
Not surprisingly, by 2009 the cumulative delinquency rates for 2007 loans were about 2.5X higher than for early 2004 loans.
So, what exactly was the business strategy behind pursuing the low documenation Don`t-Ask-Don`t-Tell borrower?
A 2006 MSN tried to put a good spin low-doc mortgages, it but it still comes out sounding sleazy:
No-doc mortgages let you pay for privacyIf your income doesn`t come from a paycheck or you don`t want to reveal all to some lender, you can still get a home loan, but you`ll pay more. Here`s how.By Bankrate.com Most homebuyers work for a steady paycheck and are willing to divulge details of their finances in exchange for the best available mortgage loan.But a lot of buyers don`t draw a steady paycheck from a boss. They own businesses, make commissions, live off investments, get their income in cash or live a life of crime. Others don`t want to give up their financial privacy. Limited-documentation mortgages are available for these people. ...Ethical mortgage brokers and lenders generally try to talk customers out of getting low-doc and no-doc loans because they cost more.
There are three main types of low-doc/no-doc mortgages.
Stated-income mortgagesSomeone who gets a stated-income mortgage must disclose annual earnings, usually for the last two years and sometimes more. Instead of backing up the income statement with pay stubs and W2 forms, the borrower might have to show tax returns, bank statements and even profit-and-loss statements.The borrower must list assets and debts. That`s why the term "low documentation" isn`t always accurate.Stated-income mortgages are for people who make the money they say they make, but that amount doesn`t show up on the bottom line of their income taxes, says Hugh McLaughlin, president and CEO of KMC Mortgage Services Inc., a lender and broker in Naples, Fla."They work for cash. They might be cleaning people or people who work in restaurants," McLaughlin says. "It is also good for self-employed borrowers who actually make gross sufficient amounts of income, but write off a lot on their taxes. They have the capacity to pay the loan back, but what they file with the IRS doesn`t reflect their real income." ...
- Stated-income mortgages tend to be for people who work but don`t draw regular wages or salary from an employer. That includes self-employed people or those who make a living off commissions or tips.
- No-ratio loans are often the right call for wealthy people with complex financial lives, retirees who live off investments and people whose lives are in flux because of divorce, recent death of a spouse, or career change.
- No-doc or NINA (no income/no asset verification) mortgages are for creditworthy people who want maximum privacy and can afford to pay for it.
No-ratio mortgagesWith these mortgages, the borrower doesn`t declare income. No pay stubs, no W2s, no tax returns. Think of it as the "don`t ask, don`t tell" mortgage: The lender doesn`t ask how much the borrower earns, and the borrower doesn`t tell. ...But the borrower does list assets — money in the bank, stocks and bonds, real estate, ownership stakes in businesses."The purpose of the no-ratio program is to provide expedited processing for creditworthy borrowers," Pawsat says. "It`s not intended as a means to qualify marginal borrowers."Someone who owns 10 car dealerships might apply for a no-ratio mortgage because a conventional loan could require submitting personal and corporate tax returns and a year-to-date profit-and-loss statement for all the dealerships. ...He says these loans also are for people "who say, `I don`t want to tell my whole life story to someone, so I want to pay a premium rate not to do that.`" ...No-income/no-asset verification mortgagesThese loans, sometimes known as NINAs, need the least documentation. In some cases the borrower provides his or her name, Social Security number, the amount of the down payment and the address of the property being bought. That`s it. The lender gets a credit report and a property appraisal.The line gets fuzzy between no-ratio and NINA mortgages, McLaughlin says. A lot depends upon the borrower`s credit score. The better the score, the less documentation the lender will demand. In many cases, the lender will want to know what the buyer does for a living, and for how long. Lenders feel more comfortable with a borrower who has been doing the same job for at least two years.In any case, an excellent credit score is required. These mortgages are for people who never, ever fail to pay bills on time. Actually, they`re for people who employ assistants to pay the bills on time.They`re meant for people who zealously guard their privacy — the movie star who doesn`t want someone in the loan office selling copies of her tax return to The National Enquirer, the mobster who doesn`t want to leave a paper trail.
In summary, these loans were invented for well-to-do tax evaders.
Yet, classy criminals, the kind who will lie to the IRS but not to the bank, the honor-among-thieves crowd, are fairly thin on the ground. If you go looking for liars to lend money to, you`re likely to find ones who will lie to you, too.
One thing that would be worth exploring is how the interaction of illegal immigration and the Housing Bubble helped make liar loans so plausible sounding. Lots of who employed illegal immigrants, such as building contractors, were making lots of money during the Bubble, but doing much of it on a cash basis. Their employees wanted to be paid in cash, so that gave them an excuse to demand cash, too. Moreover, they tended to be speculators in housing, so if, like most of the financial community, you assume that we need ever more housing for our ever growing population which leads to ever increasing land prices, then they were good bets.
Of course, lots of people who implied they were making a lot in the untaxed market weren`t.
You know, it`s just hard to tell.