Steered to subprime

Tanta in her Calculated Risk blog post, Ranieri on the MBS Market: It's Broke, of April 28, 2007, quotes Lewis Ranieri, who pointed out that as much as half of the high-interest rate subprime loans that homebuyers were steered into by mortgage lenders and brokers during late 2005 through late 2006 could instead have been issued as government- or agency-insured loans, or as agency-purchased loans, at much lower interest rates:

... we had a two-day conference in Washington yesterday, which was called the Housing Round Table. It's all the participants in housing and we get together three times a year and at that there was an argument from a number of the economists in the room [... that] looking at the production, the subprime production, in those five or six quarters that as much as 50 percent of that production could have gone to the agencies, meaning, Fannie [Mae], Freddie [Mac] and FHA. That's a pretty profound statement because a subprime loan is, at best, [an] eight plus coupon.

And usually, there's a second mortgage with a 12 coupon, so you're talking about an average coupon, a little bit over nine and you know, an agency piece of paper would've been a 6.5, so if you translate that into what he said, in another way, he was arguing that half these loans, the homeowner could have been put into a coupon at 6.5 versus 9.5 [percent].

At those lower rates, one might surmise that fewer - perhaps significantly fewer - subprime homebuyers would now be defaulting on their mortgage loans.

Tanta notes that Ranieri "is generally given a large art of the credit for creating the private MBS [mortgage-backed securities] market, and would have to be considered, by anyone’s standards, a highly-informed participant in the mortgage credit markets."

We've now just seen an allegation that this practice regularly occurred at the nation's largest mortgage lender. Gretchen Morgenson reported in her article, Inside the Countrywide Lending Spree in the New York Times' Sunday edition of August 26, 2007, that salespeople at Countrywide Financial Corporation routinely steered homebuyers into high interest rate, high fee subprime loans even when they were eligible for lower cost prime loans or loans backed by the Federal Housing Administration:

... potential borrowers were often led to high-cost and sometimes unfavorable loans that resulted in richer commissions for Countrywide’s smooth-talking sales force, outsize fees to company affiliates providing services on the loans, and a roaring stock price that made Countrywide executives among the highest paid in America.

Countrywide’s entire operation, from its computer system to its incentive pay structure and financing arrangements, is intended to wring maximum profits out of the mortgage lending boom no matter what it costs borrowers, according to interviews with former employees and brokers who worked in different units of the company and internal documents they provided. ...

According to [a] former sales representative, Countrywide’s big subprime unit also avoided offering borrowers Federal Housing Administration loans, which are backed by the United States government and are less risky. But these loans, well suited to low-income or first-time home buyers, do not generate the high fees that Countrywide encouraged its sales force to pursue.

The monthly payment on [a representative] F.H.A. loan [at 7% interest with 0.125 points] would have been $1,829, while Countrywide’s subprime loan [at 9.875% interest with 3 points] generated a $2,387 monthly payment. That amounts to a difference of $558 a month, or $6,696 a year — no small sum for a low-income homeowner. ...

As of June 30 [2007], almost one in four subprime loans that Countrywide services was delinquent, up from 15 percent in the same period last year, according to company filings.

Updated January 2, 2008

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