Mortgage Monsters: Party's Over

[FRED]

Mortgage Monsters: Party's Over

In the Wild Wild West of mortgage sales, the hills were full of mortgage gold

by Bryan Copley


Editor's Note: iTulip is pleased to add Bryan Copley to its lineup of finance industry insiders writing about what they know. He worked in the mortgage industry during the bubble years and continues to work in the industry today. These are his war stories from the front lines of the credit bubble.


Picture this: you’re standing shoulder to shoulder in a room the length of a football field overflowing with howling, raucous young men. The leader of the pack is being hoisted upside down over a freshly primed and pumped keg full of beer. The whole throng erupts as he performs an honorary keg stand, suds gushing from his mouth, an appropriate salute to the members of this wild organization. You’re no doubt present for the induction ceremony at a local university frat house.

Not quite. In fact, you’re taking part in the awards ceremony at one of the largest wholesale mortgage brokerages on the US west coast. Welcome to Merit Financial in Kirkland, WA, a ritzy lakeside Seattle suburb, circa 2005. You’re standing in the heart of the mammoth mortgage company. Everyone just made a lot of money and you can’t help but feel a little giddy, too, like someone just filled the room with nitrous-oxide or your junior high crush passed your note back and you’ve unfolded the note to a blissful "yes."

Following suit, you glance to where the room’s collective eye is fixed, near the beer source. A notoriously prudish manager, eschewing his standard calm deportment and sporting full suit and tie, has consented to an upturned swig on the keg. Pandemonium ensues. Cups are raised in victory and in slow motion liquid golden pirouettes shower the crowd.

Unlike a rowdy college kegger, this party was never stopped by the police, or anyone for that matter. As fast as subprime mortgages flew out its doors, alcohol and drugs were flying in. Rumors of illicit goings on were the norm.

From the moment you walked in the door you got the feeling that Merit wasn’t like other mortgage companies. A gargantuan-font slogan shone down from the marble and waterfall adorned entrance: “That was then, this is Merit.” The motto claimed correctly that your perception of the mortgage finance industry would be forever modified by this mortgage giant. Anybody could walk into this place with decent sales skills and no industry experience (you didn’t even need a high school diploma) and quadruple their income–and I’m being conservative here–within a month.

In this Wild Wild West of mortgage sales, the hills were full of mortgage gold.

Back to the conclusion of the awards ceremony. Before the brouhaha concludes, a loan officer in his twenties walks out of the room carrying a check the size of a Geo Metro for over $100,000, grinning like the Cheshire cat. Good month. The lot of loaded loansmen leaves the halls of Merit, and a Wells Fargo nearby will soon be calling in the par-tay "reserves."

Then, across the nation, for a spell the financial front falls silent. It is Friday evening. The 400+ cubicles usually producing cash nourishment like cells in this 80,000 square foot Godzilla building are empty. Following the evening’s revelry, drunken mortgage makers nationwide stagger outside to pass out in a corner, their money and party fueled by the ignorance of American consumers, to take the weekend recoup.

Let me pause. To our collective lexicon I would now like to add my own little piece of gobbledygook, a necessary new layman’s term, which we can use in our daily financial-speak: the mortgage monster. This term would describe any mortgage company which preys on the ignorance or misfortune of the consumer, neglecting its fiduciary duty to protect a client’s best interest, to extract the maximum amount of profit from each transaction. And make no mistake: the majority of subprime lenders fit this category, in 2005 and now. The only difference is the margins have been pared down considerably.

Since 2005, Merit Financial and countless other mortgage monsters have been swallowed whole by the leviathan which is the subprime mortgage crisis. In early 2006, the owner of Merit gathered his faithful hundreds into the same room where earlier the beer flowed freely to break the news that Merit had filed for bankruptcy protection – less than a year after their most profitable month. The multi-million dollar head gave the news, cried, slammed the door with his fist, and walked out on a stunned audience.

It was awkward. In that moment, the financial Disneyland of debauchery morphed into Unemploymentville faster than Angelo Mozilo can say “sell.” Loan officers scattered out the doors like cockroaches. The light went out and stayed out. At Merit alone, 400 employees lost their jobs, and their last month’s income. Some law suits gained steam, but then faded away. Commissions were never paid. There was no money.

What followed is history. Tens of companies followed suit, prompting websites like “The Mortgage Lender Implode-O-Meter” into existence. Merit is imploded lender #1.) Millionaire reps for subprime mortgage companies were suddenly unemployed. Some sold what assets they had left, while many others were, ironically, forced to file bankruptcy or go into foreclosure on their own mortgages. Lenders’ stock halved, halved again, then evaporated. Ameriquest went bust. Subprime rates adjusted dutifully upward to price in the dearth of demand on the secondary market, pricing most subprime borrowers right out of the game.

I recall telling borrowers with poor credit, “I can’t help you, and even if I could you don’t want this kind of help.” Interest rates continued to adjust, raising payments for many borrowers by hundreds of dollars a month. Investors, foreign and domestic, watched in denial as asset-backed securities values and returns collapsed with each default.

All the while the subprime pied piper continued playing and the mortgage monsters followed each other off the cliff. The pileup and its full effects are still unknown. Even the “experts” have no idea exactly what the crash portends.

Still, there is a silver lining. Reform is in the wind. In the state of Washington, for example, new laws have been enacted requiring loan officers to pass state mandated exams which were, encouragingly, difficult. New restrictions on licensing barred all felons with convictions within seven years from originating loans. Many moved to California where, incredibly, law does not prevent felons, even those convicted of financial dishonesty such as fraud or embezzlement, from practicing in the finance industry.

Lenders have tightened their long lax lending standards to preclude those who lack creditworthiness. More rigid guidelines entice lenders to court those who have always qualified for loans, but are less profitable borrowers. Lenders are also abandoning high-risk (stated income, interest only, short term, and negative amortization) programs because demand for securities that created the debt that back these loans on Wall Street vanished almost overnight. Investors have all but abandoned these and opted for safer, lower rate, longer term and more secure conventional products. FNMA and FHLMC mortgages as well as FHA and VA programs will see huge volume increases in months and years to come.

Correction is in train, and if you’re thinking that's all good ask yourself why the Great Depression was called a “depression.” Banks, consumers, investors, loan officers, speculators, Wall Street… an entire nation is now being force-fed responsibility. With regard to the subprime mortgage crisis, many are relearning basic economic principles: "There is no free lunch." "Caveat emptor." "If it looks to good to be true..." and so on.

The heyday of irresponsible mortgage lending is over, much to the chagrin of predatory lenders nationwide. The house of one-eyed jacks is crashing down and even political conservatives are taking cover from the fallout.

Appears the party really is over. Will the age of 20% down, good collateral, and good credit will make a comeback? Perhaps Americans will change their minds about leveraging themselves to the hilt and begin living within their means. But in the words of the late John Kenneth Galbraith “In the choice between changing ones mind and proving there's no need to do so, most people get busy on the proof.”

See also:
Frankenstein Economy
Dancing, Booze and Overpriced Houses
The New Road to Serfdom

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[Corporate Plebe]

I've passed by Merit on my way to work during the year described. They used to have a major parking problem and one had to be careful not to hit them on their way in (no sidewalks, and they were parling on the shoulder). I was wondering where all the cars had gone the other day. Thanks for the "local" story on the W. Coast.

[c1ue]

Will the age of 20% down, good collateral, and good credit will make a comeback?

I think all 3 assumptions are going to be tested should the R.E. collapse reach anywhere near iTulip anticipated levels.

80% LTV is not going to mean much if there is a mean reversion to 2001, or even 2003.

Collateral: since no one has cash, real estate prices are falling, and a recession will almost certainly hurt stocks with inflation affecting bonds, I suspect 'good collateral' is going to be difficult to find.

Good credit: credit ratings are crap - it is quite clear that the business of selling individuals the monitoring of their credit ratings has created a feedback loop of 'gaming' credit ratings. Thus like the court system - there will be a constant arms race of credit rating changes vs. credit gamers until finally the lenders conclude that the system is fatally flawed.

That, or the ratings agencies remove this feedback loop and thus a significant income stream.

[Spartacus]

Looking for an article, or confirmation -

I read an article (by Gary North I think) that claimed if you pay off your credit cards completely every month you will have a slightly lower score than if you leave some small balance for a while (but never missing a payment)

The reasoning is that those who issue credit want to reward those who pay regularly AND pay interest - so clearing off the balance makes you a less valuable credit customer (a 'free rider' as North calls it)

I think all 3 assumptions are going to be tested should the R.E. collapse reach anywhere near iTulip anticipated levels.

80% LTV is not going to mean much if there is a mean reversion to 2001, or even 2003.

Collateral: since no one has cash, real estate prices are falling, and a recession will almost certainly hurt stocks with inflation affecting bonds, I suspect 'good collateral' is going to be difficult to find.

Good credit: credit ratings are crap - it is quite clear that the business of selling individuals the monitoring of their credit ratings has created a feedback loop of 'gaming' credit ratings. Thus like the court system - there will be a constant arms race of credit rating changes vs. credit gamers until finally the lenders conclude that the system is fatally flawed.

That, or the ratings agencies remove this feedback loop and thus a significant income stream.

[Rajiv]

I think this is probably what you want. Though it is in the members only area -- and I have not read it.

How I Lowered My Credit Rating by Mistake

[Lukester]

Spartacus -

I carried a large revolving balance for two years while paying interest on it and aggressively paying it down. It was from a home remodel, and after selling the home in Nov. 2004 I had the means to pay off that revolving debt in one sum. Rather than avoid the high interest charges by paying it all off up front, I decided to pay it off slowly out of income, figuring it would build my credit rating towards an eventual home re-buy.

So I may have paid out 3K or even 4K in interest over the past two years but I "bought" the highest credit rating available, although I don't necessarily have any great vrtues as a pure credit risk.

I carried 18K on the card and paid it down over twenty four months. My credit rating gradually built up from the mid sixes to the low sevens in the process.

Finally I got sick and tired of carrying these leeches and paid off the last $3000 in one lump sum a couple of months ago. My credit rating jumped in one month from 730 to 790. Of course it's a scam, but if I wanted to pick up one of the 150K idscounted foreclosures lying around in San Diego now I could get the best going terms on mortgage rates. Borrowing 300K at the best possible rate is worth a hell of a lot more than the 3K I spent to buy this credit rating.

Rather than being pleased with how this has all turned out, I'm really more disgusted with the way the entire credit system works, with the Fed egging borrowers into a highly leveraged pen and the EZ Credit companies culling the herded at the other end. First time in my life I've ever had such a credit score, and I'm not inclined to do a damn thing with it as I see coyote traps everywhere I look. There's irony in there somewhere, but I'm too weary of the entire mess to even be amused.

BTW - for your interest Spartacus (take note!) in reference to our discussions on gold and silver? This weekend's financial sense first segment interview with the gold stock techncian Frank Barbera, he's normally quite guarded and moderate in his statements. Well this week he's noting we all may have a quite "provincial" view of where precious metal prices may go. I was startled to hear him mention the numbers "five to ten thousand" for gold, and suggest silver would outperform even that 700% up-move in gold.

This is why I suggested to Zoog, who is mired in a home he wants to sell, that he may take a good part of the disappointment out of living there another decade, if he can scrape up 100K from equity or elsewhere to dump into plain humble gold metal for a decade.

God bless all of us poor benighted and long suffering bears in this community, as we've all been well aware of this slow train wreck for the past five years or more. May the God who smiles on people who employ a scrap of wisdom, are financially modest, and distrust rampant greed, guide us to our just rewards! Amen!

[metalman]

Looking for an article, or confirmation -

I read an article (by Gary North I think) that claimed if you pay off your credit cards completely every month you will have a slightly lower score than if you leave some small balance for a while (but never missing a payment)

The reasoning is that those who issue credit want to reward those who pay regularly AND pay interest - so clearing off the balance makes you a less valuable credit customer (a 'free rider' as North calls it)

of course. you're a "deadbeat" if you pay off your bills. read james scurlock's book "maxed out" see the interview here.

all these frat boys who worked for merit ought to be forced to take a ride on the amusement ride from hell! can anyone imagine doing this for fun?

[c1ue]

Lukester,

You've hit the nail on the head.

It is not the ability or desire to repay a loan that is in question - rather this is secondary to the ability and desire to take on interest paying debt and not default.

Thus for someone who doesn't carry credit card debts, has never bought a house on a loan, and/or never had an auto loan, your score will likely be very low (unless you shared a card with a high credit score person).

Someone who has taken on large debt, paid large interest, and now has large debt carrying potential freed up - that's good scoring!