SUBPRIME MORTGAGES

From 1998-1999, subprime mortgages accounted for 5% of all mortgages. Within
ten years that number would hit 30%. So what exactly are subprime mortgages?
Very simply, subprime mortgages are loans to borrowers that don’t meet credit
worthiness standards, and thus have a greater likelihood of default. One rule of
thumb is subprime mortgages are loans made to borrowers with a FICO credit
score of less than 620. FICO (Fair Isaac Corporation, named after its two
founders) is a fairly simplistic measurement of credit worthiness. Over 90% of
SPMs were adjustable rate mortgages (ARMs) in 2006. By 2008, it was clear to
anyone who bothered to look, that nearly 1/3 of all mortgages had a reasonable
likelihood of default.
Another fact to keep in the back of your mind: In 1997, the average U.S. household
had a debt to disposable income ratio of 77% (disposable income is all of your
personal income less your personal taxes). So, on average, after paying taxes,
people borrowed 77 cents for every dollar they earned. That’s a pretty high
number. But by the end of 2007, people borrowed $1.27 for every dollar of
disposable income earned (most of that debt was mortgage-related).
Why take on so much debt? One reason is that, similar to the tulips in 1600s
Netherlands, pretty much everyone thought that the value of houses would never
go down. Moreover, the values would only go up! So if one got into trouble, they
could refinance – again, use their homes as an ATM. Another explanation for the
debt explosion, is that home ownership, for generations, has been and continues to
be pushed by the government and American culture. In one speech, George Bush,
Jr. actually said that "part of being a secure America is to encourage home
ownership." The company slogan of Ameriquest, one of the most fraudulent and
worst abusers of ethical lending practices, was "Proud Sponsor of the American
Dream." Why is home ownership the “American Dream”? Think of the home
mortgage interest tax deduction. You can’t deduct the rental expense on an
apartment, but home interest you can – why? The 30-year fixed mortgage is
standard in only the U.S. and Denmark. Fannie, Freddie and Ginnie Mae all allow
for government-insured mortgages, which helps keep mortgage interest rates low
and encourages home ownership. The last reason to mention regarding our
proclivity for taking on debt ... because it was there – credit was plentiful. For
years before the crisis hit, the world was awash with capital. Asia and the oilproducing
countries poured money into the U.S.. Interest rates were low, and
temptation was high.
The denial rate for a conventional home loan in 1997 was roughly 28%. Five years
later it was roughly 14%. Another telling statistic, according to a U.S. treasury
report: between 1997 – 2005 there was a 1400% increase in mortgage fraud
(essentially where one intentionally materially misrepresents or omits information
on a mortgage loan application such as altering W2s and other income
submissions, as well inflating appraisals, etc.). Much, if not most, of this fraud
was conducted at the behest of unscrupulous loan officers. In fact, in October of
2004, the assistant director of the criminal investigative unit of the FBI, Chris
Swecker, told Congress that "mortgage fraud is pervasive and growing."