Mortgage Lending: Partying Like It's 2005

"If you could fog a mirror, they'd give you a mortgage."

We've heard some version of that quip over and over again. In years past, lenders happily fulfilled the dreams of eager borrowers, sight unseen. Income unseen. Assets unseen. Washington Mutual, now part of JPMorgan Chase (NYSE: JPM  ) , promoted this view with a slogan: "The Power of Yes." The industry as a whole coined another clever term: NINJA loans, short for "no income, no job, no assets."

Without question, such mindless lending pushed the housing boom into crazy territory. In his recent book, CNBC's David Faber interviewed a mortgage lender who succinctly stated, "Fully documenting the borrowers' income could have stopped it [the crisis]. If I had said to you, the borrower, 'Fully document your income or you won't get this loan,' it would have ended."

Seems reasonable enough. And common sense tells you that banks, learning their lesson, would have buried such ridiculous lending standards six feet under.

You'd be wrong.

In an article discussing how Bank of America (NYSE: BAC  ) has been slow to get mortgage modifications up and running, The Washington Post had some interesting tidbits (emphasis mine): "The company was also slow out of the box because it initially took a more conservative approach than some other banks, requiring that borrowers document their income and complete other paperwork before granting preliminary approval for a modification. In August, Bank of America softened the requirement and began authorizing some modifications without getting all the documents first."

Wonderful. One year after meltdown, we're back to the days when little things like, you know, facts, are beside the point. Don't have your paperwork? Can't prove you're a worthy borrower? Your name's Bernie Madoff? Don't worry about it. Take the money and run, dear homeowner. We'll worry about the consequences later, when someone else is in charge.

Why are such boneheaded moves prevailing? It's no secret: Most of the loans eligible for modification are already backed by Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) . Thus, those modifying the loans don't bear the credit risk. As I showed earlier this week, officials in charge of this program have been quite eager to trumpet the volume of modifications in play, but data on the outcome of those modifications shows nothing short of what you'd expect from a program focusing on quantity over quality.

We all knew folly in financial markets would make a comeback someday. But so soon?

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (15)

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  • Report this Comment On October 14, 2009, at 5:37 PM, miteycasey wrote:

    Makes me want to go get a second house.

    This time it would be a mansion with a pool and hot tub.

    I'd never make a payment.

  • Report this Comment On October 14, 2009, at 5:42 PM, Dwdonhoff wrote:

    The lenders have very little incentive to put any hustle into Loan Modifications... there is no real upside to it for them, their only incentive is the <I>POTENTIAL</I> of keeping a performing loan... performing.

    Problem is;

    A) Loan Mods are having a hellaceous rate of recidivism (default occuring after the bailout of the previous default... starting to sound familiar?)

    B) Loan Mods cost more to process & manage than the stipend the government dangles to the servicers (the branches of the banks that collect and manage payments.)

    We already have a system for unwinding bad loans... it includes foreclosure & re-sale, bankruptcy, deed-in-lieu of foreclosure, and voluntary loan modifications (when they actually make economic sense based on actual equity, actual payment capability, and actual borrower character (credit track records.))

    The current scheme is a wasteful and troublesome distortion which will do nothing but deepen the bleeding and extend the misery across more participants.

    Dave Donhoff

    Leverage Planner

  • Report this Comment On October 14, 2009, at 8:49 PM, xetn wrote:

    When you have a concept of "to big to fail" with government bailouts and FDIC, you create moral hazard resulting in reduced need for avoiding risk. We are seeing a reemergence of that mindset.

    It would be much better for the economy to let the market work and clear all the garbage, wipe the slate clean and start anew.

  • Report this Comment On October 14, 2009, at 9:21 PM, standridge wrote:

    This is the problem. I have taken many risks as a business owner and won some and lost some. Right now its lost to people just like the one's mentioned above. These people it seems never see the loss and its always the majority paying for a few large mistakes. That won't last so get ready for change which ever way it comes.

  • Report this Comment On October 15, 2009, at 11:08 AM, Clem72 wrote:

    This article, as so many do, does not tell the whole picture. Simply saying "undocumented loans are bad" and lumping them all in together is wrong and is NOT the problem.

    I am self employed, have an 800 credit score, have never once been late on a mortgage payment, and now can't get a loan since I could only do "undocumented" loans. Why? Because I can't prove my income. A bank doesn't care that I drive older cars 40k miles a year so when I rightfully deduct x dollars I didn't actually spend that much money, rather a lot of it is in my pocket. They don't care that I paid my own health insurance instead of some employer, they don't care that the deduction for depreciation is a created number that lowers your taxes and so your "income" but in reality is leaving more money in your pocket etc etc etc.

    In other words I have the income, I am a good risk, but because the way the tax system is in this country I (perfectly legitamently) on paper do not document enough income.

    The system is set up for people with w-2 income working for employers. Now if they were going "undocumented" fine there is a problem, they should have been proving their income and if they were not it was just a lie, but now thousands of people just like me can't get a loan anymore. That is a problem. It is people like me who actually work who are being hurt because everyone simply has the limited herd mentality of "here is the problem, lets eliminate this and all will be ok" That mentality hurt most the one group of people who were not the problem.

  • Report this Comment On October 15, 2009, at 2:32 PM, plange01 wrote:

    with the US now just over 10 months into a depression the problems with real estate have not even started.rising forclosures and declining prices will accelerate over the next 3 to 5 years..

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