Mortgage-Whacked Security: an Underwriters take

by 28 Feb 2012
( Over a 25-year career in mortgage lending, I observed that loan officers shared an almost universal preference for originating loans with as little documentation as possible.  Is it any wonder that alternative products such as “low-doc,” “no-doc,” and “no income-no asset” took off so precipitously during the hybrid mortgage boom?  Just preceding the “boom time,” those of us who nostalgically recalled tried-and-true methods of risk-based underwriting shook our collective heads in incredulity as the menu of non-traditional loans grew more diverse and risky.

I witnessed the pressure applied by loan officers to provide them the tools and products they felt they needed to compete and win on the street ultimately lead to management’s decision to utilize rogue mortgage loan products.  A palpable, strange dichotomy existed where, on one end of the spectrum, real estate sales professionals, loan officers, retail, and wholesale sale managers – tasked with enriching the company’s bottom line – enthusiastically promoted, utilized, and were completely enamored of hybrid mortgage loan products.  On the other end of the spectrum, however, mortgage loan underwriters – tasked with assessing risk in order to protect the company and investor bottom line – were, eh, not so much enamored with the introduction and intrusion of this new and ever-evolving mortgage beast.

Mortgage loan underwriters, a rather perspicacious lot, suspicious of anything resembling a free lunch, well, they had their doubts all along.  With squinty-eyed suspicion, mortgage loan underwriters nonetheless dutifully performed their due diligence on every file, underwriting each loan package in compliance with program guidelines established, and then firmly entrenched in the mortgage lending industry by the creators of this financial Frankenstein.  I recall that time, harkening back uncomfortable memories of the debacled 125% CLTV second mortgage boom and bust (another brilliant idea that ultimately led to the demise of many mortgage lending shops whose owners woke up one day to find they had to pay points to get those loans off their books).  I was dispatched in the third round of layoffs in that era.

We who were actively working the mortgage lending front lines and real estate sales trenches were not privy to the covert, back-room machinations going on at the time in the wood-paneled, book-lined, private offices on Wall Street.  In my view, and in the view of many others long-in-the-tooth in mortgage lending, Wall Street deal makers set up the industry to buy into the notion that a new brand of collateralized debt obligations (CDOs), collateralized mortgage obligations (CMOs), et al., containing a patchwork quilt of securitized mortgages of varying levels of credit risk, were legitimate, low- to moderate-risk investments. In an excellent two-part column written for Bloomberg, “Ending the Moral Rot on Wall Street, Part 1,” author William D. Cohan referenced various investigations into the scandal of this century and the shocking acts of irresponsibility those investigations uncovered: Each examination revealed layer upon layer of behavior that should make us seethe with anger.  [ . . . ].  Also the business model that encouraged bankers and traders to take asynchronous risk with other people’s money with the knowledge that by the time things went wrong, billions of bonus dollars would be paid out, and no effort would be made to hold anyone accountable. [1]

On its face, the mortgage-backed securities at issue with their novel, catchy acronyms, appeared to be relatively safe bets.  The collateral (the residence) used to secure the underlying debt would provide some form of hedge against potential future losses.  For example, if the borrower defaulted on the mortgage, the home, acquired through the foreclosure process then liquidated at market, would recompense the investor to, at minimum, cover the principal balance owed against the property plus any peripheral expenses incurred by the investor.  Losses realized in the CDO, CMO, et al., MBS pool would be ameliorated by virtue of the inclusion of prime, A-paper mortgages in the same MBS pool (prime paper is associated with relatively low risk of mortgage default).  The industry placed a high degree of confidence in the ratings agencies’ final assessment of the revolutionary products.  According to the staid, neutral ratings agencies, these new investments on the block were determined to be safe, sound, and worthy of AAA ratings.  A win-win all around, right?  Uhm . . . wrong.  A clear-cut conflict of interest existed where the ratings firms “were paid by the sellers rather than the buyers.  Some of those mortgage securities turned out to be worth less than buyers thought.” [2]

Entranced by the sexy new moneymaker, industry movers and shakers, quasi-government sponsored enterprise organizations, and those who just plain should have known better, fell hard.  Had anyone thought to run their brilliant idea past a dozen or so seasoned mortgage loan underwriters before unleashing the sly beast on consumers, industry and the world, I might be writing a very different article today, or none at all.  Tragically, the calls for tightening of rules and more oversight went unheeded in favor of expediency and profit.  Messengers of the impending disaster faced hostility and were labeled “difficult” by those with vested interests. [3]

One sunny Monday morning in 2007, a corporate email essentially announced the end of a happy and fruitful relationship.  The mortgage company that I had devoted seven productive years to had just filed for bankruptcy protection.  The titanic alternative-doc, sub-prime mortgage market imploded, tanked, and sucked us down the drink with not a single lifeboat in sight. Game over. . . Old-school deliberation paid off for some captains of industry who saw through the lie that was mortgage pyrite then wisely responded, “Thanks, but no thanks.”  It can be said that Traveler’s Insurance Chief Executive Jay Fishman’s decision to forgo participating in the MBS folly was due, in great part, to a traditionally conservative approach to investments in general. [4]

This whole deregulation thing, well, it seems that plan did not work out so well for the American economy or for the global economy.  When you ask foxes to guard the hen house whadda ya’ get?  A bloodbath. Yet, some still have not learned a lesson from this tragic American tale.  Case in point: Taken from a New York Times article, Binyamin Appelbaum reported, “Last month a senior House Republican, Representative Darrell Issa of California, nevertheless dispatched letters to 150 companies, [ . . . ] asking them to identify federal regulations that are restraining economic recovery and job growth.” [5]

Really?!?!  What is the definition of insanity?  Doing the same thing over and over again and expecting a different result.  Mortimer B. Zuckerman, Editor-in-Chief for U.S. News & World Report, succinctly stated, “The world of finance will never escape the existence of fear and greed.  The appropriate degree of regulation will clearly be needed to prevent the kind of excesses that have now put at risk the entire economy.” [6]    Well said, Sir. May your words of wisdom infiltrate the Washington and Wall Street conscious collective to stave off future runs on mortgage pyrite.

Esperanza J. CreegerEsperanza J. Creeger was the bond program administrator for the Western Division of American Home Mortgage.  Esperanza authored an e-book, “Industry Guide to First-Time Homebuyer Programs.”  Espie currently lives, works, and writes in Dallas, TX.

1 William D. Cohan, “Ending the Moral Rot on Wall Street, Part 1,”  Bloomberg View.  8 Aug. 2011, 9 Aug. 2011 <>
2 Michael Barone, “The Old Economic Rule Doesn’t Work.”  U.S. News & World Report  Sept.-Oct. 2008: 26.
3 Michael Scherer,  “The New Sheriffs of Wall Street.”  TIME  24 May 2010: 22-27.
4 Nathan Vardi, “Wall Street’s Honest Man.”  Forbes  28 Feb. 2011: 70-77.
5 Binyamin Appelbaum,  “G.O.P. Asks Businesses Which Rules To Rewrite.”  The New York Times  5 Jan. 2011: B1+.
6 Mortimer B. Zuckerman  “Wall Street’s Day of Reckoning.”  Editorial.  U.S. News & World Report  Sept.-Oct. 2008: 92-94.


  • by Joseph Parker | 2/28/2012 1:27:14 PM

    To lump this into one short segment of time - or one side of the mortgage business is at best short sighted. Take for instance that the pay option had been around since the early 90's offered by Downey Savings and Loan, World Savings and a few Thrift's - at that time was just called a neg am mortgage. Like anything or anyone - it is how it is used and by whom that proclaims it's outcome. Including the politicians and soap boxers of the world.

  • by David Griffin | 2/28/2012 2:46:50 PM

    I hate it when people say that more government regulation is the answer. Government regulation and government bailouts are the problem, not the solution.

  • by Eric Emert | 2/28/2012 3:27:07 PM

    @ David/Joseph: You can make excuses and argue against regulation, the bottom line is massive deregulation over 30 years has sunk this country into a depression. The Owners at the top want us to keep arguing about trivial BS while they continue to rob us all blind without any risk or penalty on their part. They insure the bailouts, and yet are the same ones that decide ifl is a "Credit Event" or not, thus bypassing any payouts and prtecting them selves again and again. Derivatives and fractional reserve banking is the root of this evil. look it up and stop watching television for your info.


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