About those greedy banks and how to deal with them in the future

As a financier who deals on a regular basis with all size and type banks, I thought I’d address in here why did banks give home loans to people who they knew couldn't repay over the last couple of years, and how to deal with them in the near future.

Basically, I personally believe that most of those “liar’s loans” were fraudulent because even minimal underwriting of the loan files was sufficient to detect the overwhelming majority of them. No honest, rational lender would make such a large number. The epidemic of mortgage fraud was in fact so large that it hyper-inflated the housing bubble, which allowed refinancing to further extend the life of the bubble and the depth of the recession.

I guess “liar’s loans” were done for the usual reason – they optimized (fictional) short-term accounting income by creating a “sure thing” . A fraudulent lender optimizes short-term fictional accounting income and longer term (real) losses by maximizing fictional profits and real losses. This destroys the lender, but it makes senior officers that control the lender wealthy.

Home lending is a mature, reasonably competitive industry. A lender cannot grow extremely rapidly by making good loans. If he tried, he’d have to cut his yield and his competitors would respond. His income would decline. But he can guarantee the ability to grow extremely rapidly by being indifferent to loan quality and charging weaker credit risks, or more naïve borrowers, a premium yield.

In order to become indifferent to loan quality the officers controlling the lender must eviscerate its underwriting.

There is no honest reason for a secured lender to seek or permit inflated appraisal values. This is a sure marker of accounting control fraud – a marker that juries easily understand.

By allowing the banks to use their political power to gimmick the accounting rules to permit them to hide their massive losses on liar’s loans we have made it far harder to take effective administrative, civil, and criminal sanctions against the elite frauds that caused the Great Recession. Prosecuting the elites control frauds can though be done successfully.

Create a new “Top 100” priority list and appoint regulators that will make supporting the Justice Department a top agency priority. That’s how over 1000 priority felony convictions of elite S&L criminals were obtained.

On a related note, it is clear that the collection of credit default swap payouts might also have played into the banks extending loans to borrowers who couldn't repay.

There are some really bad incentive structures in this industry. Default increases servicing fees, .. And the wonder of CDS lets us all bet that the other’s home burns down. Speculative madness, consistent for a culture that prizes sales about all else, etc...

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