Subprime Warnings

In a recent post I shared excerpts from a 1999 New York Times article which warned of a financial crisis that could stem from sub-prime mortgage lending.

That wasn't our only warning. Here is an excellent news story, complete with clips, from Fox News that illustrates the debate most people ignored over the past several years.

This is a good summary of how the politics of protectionism from Congress shielded these at-risk banks from close scrutiny until they could no longer withstand the pressures that resulted last year in the sub-prime crisis.

Subprime Prediction

Many of the current economic woes can be traced to the sub-prime mortgage mess--and like many catastrophes, this one had a tiny start with the Community Reinvestment Act (CRA). Our own Senator William Proxmire had a hand in the CRA's development in the 1970s.


But like a little snowball the CRA didn't amount to much until the 1990s. A decade ago there was pressure to increase home ownership among minorities and low-income consumers.

A September, 1999 New York Times article by Steven Holmes was prophetic. Here is an excerpt.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''


In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times.

But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison, a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''


Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

It took more than the CRA, the Clinton administration push and the greed of Fannie Mae to get us in this mess. There is considerable documentation surrounding the players (including mortgage lenders, Fannie Mae, Congressional influence peddling, Federal Reserve interest stimulus, shoddy rating agency work, inadequate regulatory supervision, ignorant or greedy consumers and more)--yet, isn't it quite prophetic that Peter Wallison so aptly foreshadowed this coming crisis?

Were We Forewarned??

Nassim Taleb studies randomness and the role of uncertainty in science and society, with particular emphasis on the philosophy of history and the role of fortunate or unfortunate high-impact random events, which he calls "black swans", in determining the course of history.



He wrote a highly popular book, called the Black Swan. As he writes, A Black Swan is a surprise event - like the discovery of the black bird in Australia, which was unpredictable because swans in the Old World were all white. But unlike the bird, my Black Swan carries large consequences.


He summarizes that a Black Swan event is:

• Highly improbable and unpredictable
• It will have massive consequences
• Afterwards, experts will invent reasons why it was predictable, and not random

Recently, staff of The Audit, the business-press section of the Columbia Journalism Review, prepared the List. The List is a comprehensive catalog of relevant stories about the lending industry during the run-up to the mortgage crisis.

They scoured over 1/2 million news articles from 2000-2007, and uncovered just 727 significant stories.

The Audit looked for the best pre-crisis stories during this critical period, after which it was too late for warnings. They found work that falls into three categories, ranging from investigative to non-investigative but otherwise useful service pieces to, for context, non-warnings.

These news articles came from such leading papers as the the Wall Street Journal, New York Times, Washington Post, Financial Times, Bloomberg, Forbes, Fortune and Business Week.

They explored the question of whether the business press provided the public with adequate warnings of the looming calamity—and The Audit concluded that NO, we were not adequately forewarned.

To the extent there were warnings, here are a few notable examples from The Audit's research files:

New York Times, 3/15/2000: A landmark probe of the Lehman Brothers subprime connection. A predatory lending firm closed shortly afterwards. Nothing like this appeared again for seven years.

New York Times, 10/22/2000: Along With a Lender, Is Citigroup Buying Trouble? An investigation of a notorious subprime outfit.

Wall Street Journal, 12/7/2001: How Big Lenders Sell A Pricier Refinancing To Poor Homeowners--People Give Up Low Rates To Pay Off Other Debts.

Forbes, 9/2/2002: Household International succeeds at lending to bad credit risks by managing smarter. People suckered into mortgages by lies and deceit.

Wall Street Journal, 11/10/2002: Friendly Watchdog: Federal Regulator Often Helps Banks Fighting Consumers--Dependent on Lenders' Fees, OCC Takes Their Side Against Local, State Laws.

Bloomberg, 6/26/2003: Credit Swaps, Some Toxic May Soar to $4.8 Trillion.

Washington Post, 11/22/04: Dozens of current and former rating officials, financial advisers and Wall Street traders and investors interviewed by The Washington Post say the rating system has proved vulnerable to subjective judgment, manipulation and pressure from borrowers. They say the big three are so dominant they can keep their rating processes secret, force clients to pay higher fees and fend off complaints about their mistakes.

Los Angeles Times, 3/28/2005: The three plaintiffs contend in court papers that Ameriquest had an art department in a Tampa office where loan documents were altered. In interviews with The Times, they've shown stacks of what they say are internal Ameriquest files proving their allegation. After the crash, such practices are found at Countrywide, WaMu, New Century and lenders across the board.

Los Angeles Times, 10/24/2005: Freddie Mac, the government-sponsored mortgage finance giant, estimates that more than 20% of people who get these so-called sub- prime loans could have qualified for more-conventional prime loans.

Bloomberg, 5/11/2007: Bear Stearns Funds Own 67 Percent Stake in Everquest. Important because the Bear funds were trying to offload their risk on to the stock market. When that failed, the funds went kablooey.

Bloomberg, 5/31/2007: CDO Boom Masks Subprime Losses, Abetted by S&P, Moody's, Fitch.

Bloomberg, 6/1/2007: Banks Sell 'Toxic Waste' CDOs to Calpers, Texas Teachers Fund. This is a good look at Wall St. dumping on clients.

Wall Street Journal, 6/27/2007: Debt Bomb--Lending a Hand: How Wall Street Stoked The Mortgage Meltdown --- Lehman and Others Transformed the Market For Riskiest Borrowers. This is an exemplary examination of the subprime/Wall Street connection. Interestingly, it cites documents from the same case that underpinned the NYT's fine story on 3/15/00.

Crisis of Credit

Jonathan Jarvis is a designer based in Los Angeles. He practices in the Graduate Media Design Program at the Art Center College of Design.

He has created an excellent video regarding the credit crisis that we are experiencing.

This video takes the complex situation about the credit crisis and distills it for those unfamiliar and uninitiated.