US MARKET:A former sub-prime lender explains how the industry was brought down by the need to compete with even the 'dumbest' of lenders
RICHARD BITNER witnessed it all. As co-owner of a subprime mortgage company based in Dallas, Texas, he saw how the boom in easy money led to a free-fall in standards in the highest risk sector of the US home loans industry.
This 14-year veteran of the mortgage industry ran a home loans business as US lenders threw money at borrowers with poor credit histories to buy homes only to see many of them repossessed soon afterwards.
Bitner's new book, Confessions of a Subprime Lender: An Insider's Tale of Greed, Fraud and Ignorance, should be required reading for anyone working in the mortgage lending business. It explains on a local level how the global financial world has been rocked by an out-of-control industry.
The story is essentially about the fraud and greed that permeated the US subprime industry. As a wholesale lender, Bitner's firm Kellner Mortgages targeted mortgage brokers who needed help sourcing difficult loans for customers. Kellner weighed up marginal borrowers working out the risk and sourced the money by selling the loans on to investors who set the rules for the game.
He saves the most scathing criticism for brokers and appraisers who bent rules that had been put in place to make sure risk could be evaluated. Bitner tried to vet loans but was ultimately unable to gauge the risk involved.
He sold his interest in Kellner to his partners in 2005 - well over a year before the industry started seeing "significant cracks".
Two unconnected events prompted him to bail out - a home loan provided to a couple, Johnny and Patti Cutter, who were never able to make a single repayment (see panel), and a fire at his house that had nothing to do with his mortgage business, but which "created clarity" in his life. Bitner told Innovation that the loan to the Cutters "served as a turning point". Kellner technically did nothing wrong on the Cutter mortgage.
The company followed the rules, but the loan was "indicative of how far the industry had come". "To compete in a marketplace we were finding ourselves writing riskier and riskier loans."Bitner said that after a while the company became "only as competitive as the dumbest lender in the sandbox". He said the industry had ended up in "a race to the bottom" and he could no longer manage risk.
Bitner presents the US mortgage business as an industry in conflict - in the chain were brokers, lenders and investors working to different agendas with lenders sandwiched between the other two parties. Lenders answer to investors who monitor loan quality and performance. If a lender does not maintain good loans, the investor can end the relationship, so lenders want their loans to perform well.
However, brokers only make money if a loan closes and have no financial interest in the performance of a mortgage and face no liability if it fails.
Lenders must therefore scrutinise the activities of brokers carefully.
"A lot of the business was being driven by independent mortgage brokers, commission- based salespeople. They don't really have a fiduciary responsibility or duty to anyone in this case, be it lender or borrower, even though they should be representing the borrower's best interest," says Bitner.
What emerges in the book is lenders trying to manage struggling borrowers through various crises. One type of mortgage - the two-year adjustable mortgage with a three-year prepayment penalty - was favoured by investors because it "maximised revenue for everyone in the food chain", but "handcuffed" borrowers.
If a customer tried to re-finance after the interest rate was adjusted upwards after two years, they were hit with a penalty (as much as 5 per cent of the loan amount) or they had to make higher payments for a year. If they did not have much equity built up in the house, they were stuck with the loan until the penalty period expired.
Bitner's recollects some hair-raising moments. The cast of characters in his world of US mortgage broking offers some reason why the subprime sector has sparked the meltdown that has brought to global banking sector to its knees and bank losses to about $500 billion (€340 billion).
Mortgage lending might be about "suits and ties" on the prime end of the industry while subprime was "more of a jeans and t-shirts crowd," says Bitner.
Take Luther, for example, who portrayed himself to Bitner as the manager of a branch office of one of the largest brokers in Cleveland, Ohio. Bitner flew out to meet Luther to "further the relationship" and discovered that Luther was a convicted felon who enjoyed throwing knives at a wooden board in his office.
Bitner believes that the current financial crisis could potentially take more than eight years to recover and could cost trillions when the final tally is counted. He says the problem might be far deeper than first estimated when banks take securitised mortgages back onto their balance sheets under new regulations next year.
He says that Wall Street is also "only waking up" to the fact that the deterioration in loan underwriting standards was not only seen in the subprime sector but also on the A-side of the mortgage industry.
"What we are seeing is an increased level of deterioration in the performance of loans for people with good credit," said Bitner who believes the US mortgage business will be changed utterly by the crisis. The reality is that I don't know if we are going to see the US market return to anything like it was in its previous form."
