Today a reader sent in a link to an article that was published in the Fort Worth Weekly regarding predatory lending and how Americans are being put in the poor house.  Does this story sound familiar?  For all the rhetoric about people not seeing this crisis coming there has now been a release that the FBI knew the damage of mortgage fraud many years ago but was unable/short-staffed to do any significant thing about it.  This article given the traffic to the site, is one of those Cassandra articles that no one wanted to read when it was published in August 10, of 2005.  Three years ago at the height of the bubble the author Dan McGraw had the ability to put together a nice piece of journalism as opposed to massive salivating love most media outlets had for the housing market at the time.

I want to highlight a few items in the article which is a must read for anyone that has any serious desire to learn about the housing market and genesis of this mess.  Here is the link to the article:  Wolves in Small Print

It is a rather long article put I want to refer to a few passages in the article and add my own comments since we now know the outcome of how things turned out.

“But around 2000, Garcia started seeing cracks in the walls, and contractors told him the concrete slab was the problem. It was going to cost about $7,200 to fix, and Garcia figured he could get the money with a home equity loan.

That’s where the real problem started. About that time, Garcia, 48, said he started getting cold calls - he’s not sure why - from all sorts of mortgage lenders, including California-based Ameriquest Mortgage Co. Garcia just wanted to borrow $7,200, but when he started talking to the Ameriquest representatives, they convinced him he would save money by wrapping that loan into a refinancing of his mortgage. “What they said was that if I just got the $7,200, I would have two loan payments,” Garcia said. “If I refinanced the whole thing, they said I would get the money to fix the foundation, but my monthly payments would be the same as before.”

First point to address here.  Ameriquest was one of the largest subprime lenders this country has ever seen.  Ameriquest was a private company held in private by ACC  Capital Holdings which was owned by Roland Arnall.  ACC Holdings announced in August of 2007 that it would be closing Ameriquest and would no longer be taking any loans.  Ameriquest was one of the first lenders to use computers to search for prospective borrowers.  Borrowers like Mr. Garcia above.
The fact that loan representatives managed to contact a borrower in north Texas about refinancing a loan should speak volumes of the financial cesspool of easy credit that was released during the heyday of the housing market.  Ameriquest became a household name sponsoring rock bands, NASCAR, and also renaming a baseball stadium to Ameriquest Field.  It is estimated that Ameriquest had $50 billion in subprime loans originated.

The problem with the easy credit market is that companies like Ameriquest became push-men for people.  Some in the Midwest might be saying that California’s housing problems are contained unto itself.  Look at this article and you’ll understand why the tentacles of this mortgage mess spanned all over the nation.  Continuing with the article:

“So, Garcia went with the bigger loan, one he thought was going to be for about $70,000 with about the same interest rate. But when closing day arrived, the figures had changed, he said.

“The final figures came out to around $100,000 with all the fees and closing costs, and when I read the papers a few days later, I said ‘Goll-ee,’ ” Garcia said this week. “The new loan payments were about $900 a month. With my original loan I was paying insurance and taxes in the loan, but with the new loan I found out that that stuff wasn’t included. They told me it was a fixed interest rate, but I found out later it was variable. So every few years my interest rate was going to go higher. I found out I was going to be pricing myself out of my own home.”

Another lame trick with many of these toxic loans which isn’t really addressed is that escrow accounts were largely optional and many times defaulted to opting people out.  Normally an escrow account is setup so your monthly payment includes principal, interest, taxes, and insurance.  The ability to remove insurance and taxes especially in a state like Texas with extremely high property taxes may leave someone facing an unexpected 2 or 3 thousand dollar bill.  Ameriquest also lied to Mr. Garcia above telling him his mortgage was fixed when it was variable.  These practices were practiced over and over.  You need an industry with all players complacent on contributing to this fraud for this to work:

“Buyers aren’t the only ones screaming. Nationally and in Fort Worth, some of those working in the real estate and mortgage business are also coming forward to charge that the real estate lending business is fraught with fraud. Those professionals say that appraisals are being inflated to buoy up higher housing prices, bigger loans, and higher fees for the industry. First-time home buyers without down payments and with poor credit histories are being pushed through the mill, critics say, and come out the other side with loans they have little chance of repaying. That in turn is pushing foreclosure rates to alarmingly high levels.

Garcia remembers sitting in Ameriquest’s Arlington office, with three loan agents swarming around him pushing papers at him. “When it got closer to the deadline for closing, they pushed me and pushed me and wanted it done quickly,” he said. “I was like most people taking out loans like this. I wasn’t knowledgeable of the fine print, and they did like they do, telling me to sign here, sign here, sign here. I was done with the closing in 10 minutes, but I feel I was taken advantage of because of being naïve.”

Here’s another problem.  If you were lending money out prudently you wouldn’t be rushed to get paperwork signed.  The only reason you would rush is if your main concern was churning large numbers of mortgages regardless of the borrowers ability to pay.  If you were lending money to someone with your own money you would take full diligence to make sure the borrower was vetted and could reasonably make the payments back.  In this toxic model, these originators wanted to push the loan balance as high as possible with the most toxic mortgage products to get their largest commission cut.  These interests of course are diametrically opposed to what the borrower is seeking which is the lowest mortgage balance with the safest mortgage product.  This article is simply a look at the utter malfeasance that went on in the industry and why there should be stiff criminal punishments on these institutions.  Yet this tangled web goes much further than you may think:

“In the same day that Ameriquest released the news of its $325 million lawsuit fund, the White House announced that President Bush nominated California billionaire Roland E. Arnall to be ambassador to the Netherlands. Arnall is Ameriquest’s principal shareholder, and he, his wife, and their companies have been the biggest political contributors (more than $250,000) to Bush since 2002, according to the Washington Post.

And maybe that says all one needs to know about why predatory lending practices seem to be flooding the country. Politicians, who credit the deregulated lending laws with opening up the housing market to people who couldn’t get a home loan before, generally don’t see much of a problem. And new housing is stoking the economy, providing 40 percent of the 2.3 million jobs added since the 2001 recession, according to economist David Rosenberg of Merrill Lynch & Co.”

As you may or may not know, Roland Arnall died this year in March.  To think that those at the top had know idea what was going on is simply naïve.  People knew what was going on and so long as those with money were funneling cash to their political cronies all would be well.  In addition as the estimates from Merrill Lynch came out, who would be the politicians to put a wrench in the industry that had created 40% of all jobs since 2001?  The needed regulation would actually put an end to the economy which was supposedly going strong at the time.  After all, you don’t get to name a baseball stadium with a few dollars.

“The relationship between subprime loans and foreclosures is a close and troubling one. The FDIC estimated that one out of 20 subprime loans landed in the foreclosure pipeline in 2003. Of those with prime-rate loans, only one in 100 had entered the foreclosure process.”
As we already know, default rates with subprime loans are at 25% with some portfolios seeing nearly 90 to 100 percent default rates.  These loans were so poorly underwritten that it took a matter of three years to reverse the entire boom time subprime mortgages.

“And that’s another part of the problem: The mortgage business has become almost too complicated for the average consumer to understand. A 30-year fixed-rate mortgage used to be what every home buyer got. But now there are at least 150 mortgage products offered: adjustable-rate mortgages; interest-only mortgages, in which only interest is paid for the first few years of the loan; loans with a lump-sum “balloon” payment at the end; “adjustable rate mortgages,” which permit borrowers to make a monthly mortgage payment determined by one of four methods; and even a 40-year mortgage.

But one thing has not changed. For real estate sellers, homebuilders, and mortgage lenders, the bigger the loan, the more money they make - usually in commissions.

“The lenders are putting people at risk, but they don’t really care because they have gotten paid, and they move on to the next sale,” said Bedford bankruptcy attorney Richard Venable. “The big killer is going to be the variable interest rates. People are going to have higher monthly payments, and they’ll have to deal with balloon payments. I just think more and more people are going to be squeezed out of their homes, and that is very difficult to come back from. The foreclosure rate in Texas is going to go through the roof in a few years.”

So no one saw this coming right?  Seems like many did.  Ironically we are still in the middle of this mess and when all is said and done, I have a feeling that we are going to chop down those 150 mortgage products and get back to more prudent lending standards.  The commission being tied to the actual sale is not enough.  Local lenders should be responsible for their own loans and should loans go bad, it is their balance sheet which should take the brunt of the pain.  The fee and commission structure was perfectly setup to commit widespread fraud.  Many people saw what was going on:

“Some people in the real estate business are getting tired of the racket and the fraud. “They are milking it as far as they can right now,” said Bob Burnitt, 53, who owned his own realty and appraisal company in Midlothian but has stopped doing appraisals. “Whatever it takes to keep the money circulating, the lenders and realtors and builders keep abusing the system.” If a prospective buyer really doesn’t qualify for a loan, Burnitt said, the lenders and sellers re-do the numbers until they come out right. “If the property value doesn’t work out, they inflate those numbers, too,” he said. “It’s all to make the housing prices high and the loans high. Then the commissions get higher.”

Burnitt worked in real estate appraisal for nine years but gave it up last year because he said he was forced to inflate property values, especially on refinance loans. In order to get around the Texas law that restricts refinance loans to 80 percent of the appraised home’s value, he said, the appraisal simply gets figured higher. Do that enough times, and the whole market goes up, since the real estate business is always based on comparison shopping.

“What is going on is loan fraud, and everyone knows it,” Burnitt said. “It’s not just a violation of the state’s 80 percent rule, it is a violation of federal and state law appraisal standards. It happens mostly in refinancing.”

The reason many didn’t see what was happening is that they put on blinders and pretended everything was fine.  If there is rampant fraud and appraisal inflation in a neighborhood pretty soon the comps, even done without fraud will reflect these inflated prices.  That is why prices in certain areas like California and Florida are now down 40 to 50 percent because the unwinding mess is simply exposing the extent of this corruption.

This is stunning article and it is too bad no large media players covered stories like this back in 2005.  Keep in mind this is an article in Fort Worth Texas where prices didn’t even go up that high to begin with.  Can you imagine if an article like this was written for Los Angeles or Miami?  I have a feeling we’ll get plenty of details once many of these institutions and their leaders get their chance in front of a Congressional panel.

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There have been many theories floating around the financial press that the world markets are now independent and that having a global depression like times in the past was highly unlikely.  For the most part, since the credit crisis took on a full head of steam in August of 2007 most world markets are falling in tandem with each other.  The idea known as “decoupling” is largely untrue since each of the largest global markets based on their GDP are linked to one another.  These countries trade, exchange, and interact with one another in their markets.

The challenges are also similar across these economies.  Many became heavily dependent on easy access to credit and now face a market where credit standards are much tighter.  It is also the case that many economies like the United States, Europe, and Australia are facing their own housing bubbles.

So how have the world stock markets performed since the credit crunch of August of 2007?  We’ll be looking at a few charts to see how things are now one year into the crisis:

*Source:  Yahoo Charts

The Nikkei 225 is down 26% from its peak last year.  Given that Japan is the second largest economy in the world in terms of nominal GDP, this is important to take note of.  Recently we have also seen that quarterly GDP for Japan has contracted signaling that they are facing a recession.

Japan suffered one of the biggest booms and bust in the 1980s then faced a massive bust in the 1990s which is still being felt today.  In fact, the Nikkei hit a peak in 1989 which has yet to be revisited:

People forget that Japan had one of the largest asset bubbles ever witnessed in the financial history of the world.  The fact that the Nikkei is down 66% from a peak in 1989 tells us a lot.  What it tells us that it is possible for a global large economy to face stagnant growth for multiple decades.  Many people have seen this chart for Japan real estate:

What this allows us to understand is that it is very possible that we will face the same type of scenario that Japan did.  Keep in mind that the Bank of Japan lowered rates even lower than our Federal Reserve and the market still did not improve.  There is nothing that lower rates can do for asset bubbles that were too large to begin with.  The United States is seeing this on a massive scale but areas like California and Florida are going to see the worst of the bust given their massive increases.

The rising star economy is China yet they are not immune to the global slow down.  Let us take a look at what is going on in the Hang Seng market:

This index is setup to measure the largest companies in Hong Kong.  45 companies make up 67% of the Hang Seng Index.  The HSI was started in 1969 so it does carry some historical power.  As you can see from the above chart, there has been a major correction in the last year with the index being down over 33%.  The index has shaved off over 10,000 since the credit crisis started.

Again, as quickly as China is growing much of the growth is dependent on exports to other nations.  If these other nations are facing their own pain their isn’t enough internal demand to keep growth at current rates.  Clearly they are building their own domestic markets but nothing to support what is currently being produced.  That is why we are seeing a massive correction.

Let us now move on to the three major market indicators in the United States, the DOW, NASDAQ, and S&P 500.

The DOW is having some hard times given the current market climate:

The DOW is down by 19.4% from the peak reached during the credit crisis.  We’ve already trenched into bear market territory which is a technical decline of 20% from the peak price.  Given the Japan and Hong Kong markets you can see that the United States index is doing a bit better.

Let us now look at the tech heavy NASDAQ:

The NASDAQ, although being heavy with tech companies is down 17.1% as well.  It would appear that nothing is immune from the credit crisis since much of the business infrastructure is dependent on this easy access to money.
Let us take a look at a broader measure of the United States economy, the S&P 500:

The S&P 500 with a broader view of the economy since it incorporates many more companies is down 18.8%.  Clearly all these signs point toward a global recession.  Let us take a look at few in Europe:

Simply by looking at these charts you’ll be hard pressed to find any large global economy in the positive since August of 2007.  If anything the major markets throughout the world are telling us that this credit crisis is binding all of us at the hip.  The theory of decoupling doesn’t seem to be holding during this current market turmoil.

With many of the European counties having bubbles rivaling or even larger in percentage terms than the Untied States, they are only going to face more trouble.  In fact, many of these countries such as Ireland and Spain are a few years behind the U.S.  Overall, global markets are still shaky at the prospect that things will get progressively worse.

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