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Losing their homes in...
The great mortgage swindle

September 21, 2007 | Page 12

PETRINO DiLEO explains who benefited from the mortgage boom--and who's paying for the bust.

MICHELE McINTOSH, a single mother in Far Rockaway, N.Y., used to be happy.

In 2002, she bought a condo for $110,000. Her 30-year mortgage loan, at a fixed rate of 10.5 percent, required her to pay $1,000 a month--expensive, but something she could afford.

Then one conversation changed everything. A mortgage broker promised he could get McIntosh a mortgage at 7.5 percent. McIntosh figured her monthly payments would go down dramatically and happily agreed to the refinancing.

But after six months, the required monthly payments on the new loan began to jump. By October of last year, they had risen to $1,585 a month--far higher than what she had been paying before. The new mortgage turned out to have an adjustable interest rate--the 7.5 percent had only lasted for an introductory period. "I had no idea about this resetting rate every six months," she told the Queens Courier.

To make matters worse, McIntosh lost her job. Unable to make payments, she reached a deal with Saxon Mortgage, the company that the broker had sold her loan to. In January, she made a $1,300 down payment to Saxon, but her monthly payments soon soared again, to $2,700.

McIntosh quickly fell behind--and on June 13, one day after her 44th birthday, she got a foreclosure notice in the mail.

About 50 miles to the east on Long Island, in Medford, N.Y., Malinda Matus was having a similar experience.

Faced with a growing pile of medical bills due to her brain-damaged son's hospital care, Matus, too, went to a broker to refinance her mortgage. But instead of the $1,700-a-month payment on what she thought was a fixed-rate mortgage, she began getting payment notifications for $2,049 a month for a floating-rate mortgage.

The papers Matus had signed were for a different loan than she was told about. "I was railroaded--there's no two ways about it," the 61-year-old told New York Newsday.

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THIS IS the reality of the unfolding mortgage mess--a rapidly deteriorating crisis that is ruining people's lives across the U.S. By the end of the year, estimates are that 2 million homes will be in foreclosure.

Right-wing commentators and politicians claim that irresponsible borrowers are to blame--that they snookered poor, defenseless mortgage companies into giving them loans by lying about their income or credit.

"What is often overlooked," Nixon speechwriter-turned-actor Ben Stein wrote in the New York Times, "is that many borrowers, people who look at themselves in the mirror every morning, lied like madmen to get their mortgages...[They] would say anything, sign anything, to get a loan."

Stein has it upside down and backward. In reality, it was the whole rotten system of real estate and high finance that "lied like madmen"--saying and doing anything to satisfy the craving for the super-profits to be made off the housing bubble.

Now that the bubble has burst, some of the filthy truth is starting to emerge.

From the storied Wall Street banks and investment firms, to the big mortgage companies, to the storefront mortgage broker operations, everyone had an incentive to push the boom forward--even if that meant making loans to borrowers who wouldn't be able to afford the terms, or steering customers with better credit into more unstable mortgages that, at first glance, appeared cheaper.

On the cutting edge of it all were the so-called "sub-prime mortgages"--loans made to people with a poor or nonexistent credit history that were much more lucrative for big business.

The mortgage holders stood to gain millions, whether borrowers missed payments, refinanced their loans or paid off the mortgage too early. Also, the sub-prime loans were enticing to a secondary market that emerged on Wall Street--in which bankers packaged mortgage loans in large numbers and sold them to the biggest investors as giant bonds.

For the brokers at the street level, there were higher commissions dangled before their eyes if they could get a borrower to take a sub-prime loan instead of a prime loan or Alt-A (the notch between the other two ranks).

Countrywide Financial, the nation's largest mortgage lender, offers an illuminating illustration of why and how the system pushed sub-prime loans on borrowers.

An exposé in the New York Times cited regulatory filings that show profit margins on sub-prime loans sold by Countrywide to investors last year were 1.84 percent, versus 1.07 percent for prime loans--in other words, almost double the return for a sub-prime loan. A couple years earlier, the gap was even greater--in 2004, a 3.64 percent margin on sub-prime loans and 0.93 percent on prime.

It's obvious why Countrywide valued sub-prime loans over prime. A borrower with a 620 credit rating putting down 10 percent cash for a 30-year, $275,000 sub-prime loan from Countrywide would have payments of $2,387 a month. If the same borrower went instead to the Federal Housing Administration, they would get a loan with monthly payments of $1,829--$558 a month lower.

If Countrywide had good reason to push sub-prime loans, so did the investors in mortgage securitizations--the giant bonds built from pools of mortgages, usually worth $1 billion or more.

For the investment banks, pension funds, hedge funds and other institutional investors who buy these securities, the highest-rated and least risky bonds pay off at lower rates, while the riskier bonds--such as the ones tied to sub-prime mortgages--pay off at higher rates. With the real estate market booming, the higher returns won out over considerations of risk.

So mortgage lenders had a powerful reason to push people into sub-prime loans. They created incentives for their employees and third-party mortgage brokers to deliver as many risky, high-cost loans as possible.

In-house, this was done through commissions. As a former Countrywide sales representative told the Times, "The whole commission structure in both prime and sub-prime was designed to reward salespeople for pushing whatever programs Countrywide made the most money on in the secondary market."

With external brokers, mortgage companies also employed a "yield-spread premium" when awarding commissions. Essentially, the higher the interest rate on the loan, the more cash a company would pay to the broker. About 90 percent of sub-prime mortgages involve yield spread premiums, which can add up to thousands of dollars and constitute the biggest part of compensation for a broker.

Thus, Countrywide awarded brokers that delivered sub-prime loans commissions worth 0.5 percent of the loan's value--in contrast with 0.2 percent of the loan's value for mortgages rated a bit higher, the so-called Alt-A mortgages.

Anecdotally, borrowers have reported all kinds of shenanigans designed to drive them into mortgages that were more lucrative for the lenders.

For example, brokers would change loan applications to inflate salaries for workers who didn't make enough to qualify. On the flip side, if a prospective borrower had savings or a credit score that qualified them for a higher-class mortgage, the broker would encourage them not to report the savings, so they could get a sub-prime loan instead.

In probably the most absurd example, a 102-year-old man in Britain was approved for a 25-year, interest-only mortgage.

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THIS ISN'T the only way the industry cashed in. Mortgage lenders often throw in what are called "prepayment penalties"--fees that borrowers are charged if they pay off their loans early or refinance. Last year, Countrywide generated $268 million in cash through prepayment penalties. According to the Center for Responsible Lending, more than two-thirds of the adjustable-rate loans have prepayment penalties.

And when borrowers missed payments, Countrywide cashed in again, collecting $285 million in late fees last year.

Despite all this, the likes of Ben Stein can't muster any anger about, say, Angelo Mozilo, the CEO of Countrywide.

Countrywide is scrambling to stay out of bankruptcy after saddling millions of borrowers with loans that can't be repaid. The company has been stuck holding mortgages that previously would have been sold in giant bonds to Wall Street--but which now can't be moved for any price.

Mozilo, however, is doing just fine. Since 1984, he has made $406 million selling company stock--$130 million since last December alone.

Looking ahead, the picture does not look promising. Most mortgages enter foreclosure after deceptively low introductory interest rates on adjustable-rate loans "reset" to much higher rates.

And the largest numbers are still to come. The total value of mortgage loans resetting in September was $58 billion, three times higher than January. And starting in January 2008, the number of loan resets will jump again, peaking in March, when $110 billion worth of mortgage loans are due to reset.

Not all loans where the interest rates reset will enter foreclosure, but there surely will be in an increase.

Mortgage Broker Association statistics show that foreclosures in September were above the same level as last year in 47 states. On the sub-prime front, foreclosures are 70 percent higher than the same time last year, compared with a 21 percent increase on prime, fixed-rate loans.

This is the price that is being demanded of ordinary people as the mortgage crisis unfolds--all to pay for a boom that made incredible sums for the likes of Anthony Mozilo and the other loan sharks of Corporate America.

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