In the midst of the current crisis facing the industry, it is not unusual to pause and wonder how things spun out of control. That consideration has been addressed in the new white paper ‘The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown’ by Katalina M. Bianco, a banking law analyst for CCH, a Wolters Kluwers business. MortgageOrb recently spoke with Bianco on what her research uncovered and what the industry can learn for the near-future.
Q: Could the subprime crisis have been prevented? Or was it an inevitable disaster, given the manner in which the industry evolved?
Bianco: I wouldn't say it was ‘inevitable,’ but certainly there were a number of factors that, when put together, makes it easy to see how the crisis happened. The U.S. had a housing bubble that burst several years ago. Housing bubbles are often seen only in hindsight. Added to the bursting of the U.S. housing bubble was the high number of adjustable rate mortgages and other riskier loans, often brokered by mortgage companies not under federal regulation.
In addition, with the advent of securitization, many mortgage lenders had passed the rights to the mortgage payments and related credit/default risk to third-party investors via mortgage-backed securities (MBS) and collateralized debt obligations (CDO). Corporate, individual and institutional investors holding MBS or CDO faced significant losses, as the value of the underlying mortgage assets declined.
Q: Does former Federal Reserve Chairman Alan Greenspan deserve any degree of blame for what transpired?
Bianco: That's debatable. There's been so much finger-pointing and blame-slinging over this crisis, and Greenspan has been a target of that, certainly. The low interest rates of the Greenspan era were a part of the development of the crisis. Some economists see his policy as an overreaction to the 2001 recession.
Also, former Fed Governor Edward Gramlich claimed in 2007 that Greenspan blocked a proposal to crack down on subprime lending practices back in 2000. However, there were other factors at play as well as low interest rates. Buyers overreached, taking on more debt than they may have done in an era of no housing bubble. There were certain brokers and originators that were predatory, the large role that securitization played, etc. And again, some of this is hindsight.
Q: The mortgage banking industry seemed very slow to respond to subprime's collapse – even as late as July 2007, Doug Duncan, the former chief economist of the Mortgage Bankers Association, was telling conference audiences that ‘subprime was alive and well.’ How do you explain the delayed reaction to what was taking place?
Bianco: The term ‘subprime,’ as it applies to U.S. mortgages, refers to loans that do not meet Fannie Mae or Freddie Mac guidelines. While generally, subprime is defined or defended as lending to borrowers with compromised credit histories, according to the Wall Street Journal, in 2006, over 60% of all borrowers receiving subprime loans had credit scores high enough to qualify for prime conventional loans.
While subprime lending is controversial, even after the crisis hit, the loans were still being made by lenders. In that sense, it was ‘alive and well’ at that time. I don't think it was until the public became aware of how extensive the crisis was and Congress and the state legislatures started talking anti-predatory lending legislation that many banks adjusted their policies on subprime lending. Also, many lenders themselves suffered financial fallout from the crisis.
Q: Have we seen the worst of the subprime meltdown? Or do you expect more rough times ahead?
Bianco: I don't think we've hit rock bottom yet. We have a way to go before recovering. Had the crisis been contained within the United States, recovery may have been easier. However, once the mortgage mess went global, affecting foreign markets, the crisis became a disaster.