Subprime Daily Briefing, Dec. 19
By Arnold Kling
Predatory borrowing, Samuelson, Krugman…On fraud, this summary describes some analysis by Fitch.
Fitch’s findings from this review include:
–Apparent fraud in the form of occupancy misrepresentation;
–Poor or lack of underwriting relating to suspicious items on credit reports;
–Incorrect calculation of debt-to-income ratios;
–Poor underwriting of ‘stated’ income loans for reasonability;
–Substantial numbers of first-time homebuyers with questionable credit/income.
‘In the absence of effective underwriting, products such as ‘no money down’ and ‘stated income’ mortgages appear to have become vehicles for misrepresentation or fraud by participants throughout the origination process,’ said Fitch Managing Director Diane Pendley. ‘During the rapidly rising home price environment of the past few years, the ability of the borrower to refinance or quickly re-sell the property prior to the loan defaulting masked the true risk of these products and the presence of misrepresentation and fraud. With home prices now falling in many regions of the country, many loans that would have paid off in prior years remain in the pool and are more likely to default.’
Occupancy misrepresentation is a serious issue. These are not pathetic homeowners on the verge of losing their homes. They are speculators and thieves. I propose that we describe this phenomenon as predatory borrowing.
Thanks to Tyler Cowen for the pointer. If you read the quote at his blog, you will see that something like 70 percent of early-payment defaults have fraud. As I’ve said several times, when a mortgage defaults within the first twelve months, you should presume fraud.
Speaking of predatory borrowers, here is a view of hedge funds as doing nothing but writing out-of-the-money options and living off the management fees until they blow up.
The subprime debacle also posed a question: What if it’s not the only problem? Consider “credit default swaps” (CDS) as a possible sequel. CDS’s are, in effect, insurance contracts on loans or bonds…
Possible losses could dwarf those on subprime mortgages, argues Ted Seides of Protege Partners, an investment fund. In a strong economy, defaults on corporate bonds and business loans have been low. On “high yield” bonds (a.k.a. “junk bonds”), they’ve been about 1 percent recently, compared with a historic average of about 5 and 10 percent in recessions.
Finally, courtesy of Calculated Risk, we have a Youtube of Paul Krugman telling the story of the current crisis at a talk last Friday at Google. Paul seems to be telling the story basically correctly (I’m about halfway through listening), but it’s not a very linear talk. When you have a very active mind, speaking without a tight outline means that you go down a lot of side alleys, which Paul does in this case. But he is funny–the talk has a Mort Sahl/Woody Allen sort of tone to it.