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Preparing the Way…

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This article is kind of fabulous, in the sense that it clearly lays out the connection between a lax attitude towards regulation and the production of bad loans:

Simeon Ferguson, an 85-year-old Brooklyn resident with dementia, according to his attorney, signed up in February 2006 for an option ARM. The monthly cost was $2,400, but the terms of the loan from IndyMac Bancorp, a major thrift based in Pasadena, Calif., allowed Ferguson to pay less than that each month, the way people can with a credit card. Many of the loans made by IndyMac and other thrifts were extended to borrowers without ensuring they could afford their full monthly payments. Ferguson, who lived on a fixed monthly income of $1,100, was one such borrower, according to a pending lawsuit filed on his behalf in federal court…

Concerns about the product were first raised in late 2005 by another federal regulator, the Office of the Comptroller of the Currency. The agency pushed other regulators to issue a joint proposal that lenders should make sure borrowers could afford their full monthly payments. “Too many consumers have been attracted to products by the seductive prospect of low minimum payments that delay the day of reckoning,” Comptroller of the Currency John C. Dugan said in a speech advocating the proposal.

OTS was hesitant to sign on, though it eventually did. Reich, the new director of OTS, warned against excessive intervention. He cautioned that the government should not interfere with lending by thrifts “who have demonstrated that they have the know-how to manage these products through all kinds of economic cycles.” Reich, through a spokesman, declined to be interviewed for this article.

The lending industry seconded Reich’s concerns at the time, arguing that the government was needlessly depriving families of a chance at homeownership. IndyMac argued in a letter to regulators that in evaluating loan applications it was not fair to rule out the possibility that a prospective borrower’s income might increase. “Lenders risk denying home ownership to qualified borrowers,” chief risk officer Ruthann Melbourne wrote.

The proposal languished until September 2006, when it was swiftly finalized after a congressional committee began making inquiries.

The long delay in issuing the guidance allowed companies to keep making billions of dollars in loans without verifying that borrowers could afford them. One of the largest banks, Countrywide Financial, said in an investor presentation after the guidance was released that most of the borrowers who received loans in the previous two years would not have qualified under the new standards. Countrywide said it would have refused 89 percent of its 2006 borrowers and 83 percent of its 2005 borrowers. That represents $138 billion in mortgage loans the company would not have made if regulators had acted sooner.

See also Prarie Weather and Calculated Risk.

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