Deregulation led to fragmentation of the industry which gave a financial incentive to everyone in the mortgage origination-to-sale chain to create profitable as opposed to performing loans, which are loans that people pay every month. In 1995 the Republicans in control of Congress changed the RESPA anti-kickback rules for mortgage brokers, thereby allowing lenders to pay brokers a yield spread premium (also called a par plus payment). In a nutshell, this is a payment made by the lender to the broker if the broker originates a loan that is a higher than par rate for that borrower. For example if a broker has an “A” rated borrower based on his loan application, and now his FICO/Fair Isaac score, that qualifies for the lender’s best 6% loan, the lender will pay the broker a premium if the broker can close that “A” borrower into a higher 8% loan. That 8% loan has more value to the lender than a regular “B” borrower’s 8% loan because an “A” borrower, who is less likely to default, is paying an interest rate that a “B” borrower would pay, who is more at risk of default. I and several other consumer lawyers around the country argued that this payment was a kickback for the referral of business, the higher par loan, made illegal under RESPA because the broker does no more work to close the loan at 6% than he does at 8%. The broker is being paid by the lender to refer the lender the higher than par rate loan, which is an illegal kickback for the referral of business. The mortgage industry got Congress to eliminate this anti-kickback rule so that consumers had to prove the overall broker compensation was unreasonable, an impossible task because most states allowed lenders to charge up to 10% of the loan amount for his commission. The non bank lenders led by Countrywide, Ameriquest, Home Eq., etc., saw this as a means to eliminate the overhead and management issues of having an office in every city. Countrywide created a nationwide network of brokers who they would pay yield spread payments for originating higher than par loans. Countrywide would get short term money to fund the loans, which had to be “qualifying loans” (meet minimum underwriting guidelines for credit and loan to value rations) for Fannie and Freddie to buy, then turn around and sell them on the secondary market. The broker would qualify the borrower by giving him an adjustable loan with a 1 year discounted teaser rate and qualify the borrower at the lower monthly payment. So, for a simplified example, an “A” borrower goes to a mortgage broker and says “I need a $100,000.00 loan”. Since he is an “A” borrower he qualifies for 6%, but the broker would search for the lender who would pay him the highest yield spread, usually Countrywide and tell the borrower: “all you can get is a 8% loan, but I can discount that to 4% for the first year.” The broker would also tell the borrower to pay down non-secured debt to make the loan more attractive to the lender i.e. the credit cards and car loan, thus driving up the total principal and their yield spread payment. Now the loan is $125,000.00. At closing Countrywide would draw $125,000.00 on its short term line of credit and fund the loan, paying the broker the yield spread. Countrywide would then sell these qualifying loans in the secondary market. The loan was “teased” to 4% for the 1st year so the borrower qualified under that lower rate. If the borrower questioned the ability to pay the higher rate on adjustment, the broker would tell the borrower “Do not worry about the increase, just come back when the loan increases and I will refi you.”

Even with par plus payments pre-1999, lenders and mortgage brokers still had to qualify borrowers because the non-deposit banks (Merrill, Goldman, etc.) were prohibited from entering into the mortgage business. However, the mortgage brokerage business for consumer home mortgages took off based on the Countrywide par plus model. Countrywide had no local offices so no local overhead, and borrowed short term to fund loans, then sold in the 2nd market within 30/60 days of closing. However, the loans still had to qualify, 90% LTV for purchase and 75% LTV for refis, and FICO scores with proof of income. After 1999, with advent of deregulation and interstate banking, the Countrywides of the world were no longer limited to originating qualifying loans – they could sell to the now deregulated investment banks who now competed with FANNIE and FREDDIE to buy loans. Now you begin to see 100% LTV and non-qualifying “liars loans” based on stated income. Since they were non-qualifying, FANNIE and FREDDIE could not buy them, but Merrill and Goldman and Lehman and all the investment banks ate up as many as could be originated. They even encouraged the brokers and showed them how to “cheat” the now computerized qualifying process so that they could originate and sell more loans.

Allowing interstate banking, then Gramm-Leach-Bliley that eliminated the wall between investment banks, deposit banks, and insurance companies, with a boost from the parity statute created a huge pool of money to lend from investment banks – the shadow non-regulated banking industry. The Countrywides of the world did not have to sell the originated mortgages as qualifying loans eligible for purchase by Fannie or Freddie. They could sell to the newly deregulated investment banks with no “qualifying” requirements. This allowed Countrywide to lend money at 100% loan to value to borrowers who could not afford payments, then take this pool of loans, a mixture of “A” “B” “C” and “D” grade borrowers and go to someone like Merrill Lynch and say “I have 1,000 loans average $125,000.00 each with an average 10% yield over 30 years with a present value of $150,000.00 (consisting of 100% LTV loans and very risky borrowers). I will sell you the loans for $140,000.00.” Countrywide would then pay back its credit line and just made $15,000.00 per loan less its yield spread less its costs of money for 1,000 loans, or say $10,000.00 per loan which is $10 million. Meanwhile Countrywide kept the servicing rights for these loans which also generated another income stream for Countrywide. Merrill Lynch before deregulation was prohibited from entering the mortgage business. Gramm’s bill made the investment banks an unregulated lender, with an income stream from Countrywide as the servicing agent. Merrill would then securitize and sell the pool of loans to Bank of America as Trustee (after buying Countrywide and Merrill Lynch, BOA has a vertical monopoly in the mortgage business from Countrywide’s network of brokers, to BOA’s ability to short term fund the broker’s loans, to Countrywide’s mortgage servicing business to Merrill Lynch who would securitize the pool, to BOA who acts as Trustee for the securitized loans), as a non-regulated security. They in essence sold shares of stock in the pool of mortgages. The rating of these pools of loans was privatized, which means that a company like Moody’s was given the rating task. Moody’s had no idea how to rate a pool of loans which had a mix of “A” through “D” loans, all with greater degrees of risk of default because these borrowers were now paying slightly higher interest rates than they would be expected to pay, and would probably not pay when the rates changed. Moody had no idea if the homes, the collateral, were properly appraised and had sufficient equity to cover a default. Moody’s essentially saw a pool of loans with “A” to “D” borrowers with 15%-20% of the pool as “A”, and so rated the pool as AAA which was its highest degree of safety. In other words, Moody’s rated a pool of junk loans as AAA rated securities, which entities like Bank of America, as Trustee for “ABC” asset backed securities bought and sold as great investments. (As I understand it they later divided these pools into tranches or 3 different degrees of safety and sold them accordingly).

No one had a financial incentive to make sure the originator closed a performing loan – a loan that the borrower would pay back, and if not, that the collateral had sufficient equity to pay back the principal. The Broker and Countrywide as originator, only had an incentive to close profitable loans – loans they could sell. They could care less if the borrower made his first mortgage payment. All loans were “sellable” as long as the pool was sold before too many of the loans started to default. They were very likely sold before any default because mortgages are paid in arrears and closing agents collected the 1st fragmented month’s interest at closing. So the first payment was not even due until anywhere from 30 to 60 days after closing – a window in which the mortgages were often sold twice.

There were no underwriting rules because the originators and lenders, Countrywide and Merrill, were unregulated, and did not have to sell to Fannie/Freddie, so the loans were also non-qualifying. The industry then began to originate non-income qualifying loans i.e. stated income. Many people gave the correct income info to the broker, who then submitted an application to the lender with false income information. These loans were justified because of the values of the properties. The brokers would get friendly appraisers to give a high-ball appraisal then submit the loan package. The appraiser would either give the broker a higher appraisal or he would lose that broker’s business. This was the first wave of foreclosures that went through the courts. These sub-prime loans defaulted because they were based on one or all or a combination of these factos: 1) borrowers who qualified for lower (teased, discounted rates, or interest only loans); 2) inflated income by the broker who wanted to close the loan and get paid; 3) high-ball appraisals, 4) and all the borrowers were paying higher interest than they should have paid after their discount expired because of the yield spread.

Around 2001, post-deregulation, the non-deposit banks like Merrill and Lehman and Goldman were buying up all of the non-qualifying mortgages from the Countrywides that sprung up across the country, securitizing them and selling the securities, completely cutting Fannie/Freddie out of this lucrative business. The loans were all non-qualifying because they were more profitable than qualifying loans sold to Fannie/Freddie. No one was selling to Fannie/Freddie because brokers were originating “non-qualifying” loans that Fannie and Freddie could not buy – they were too risky. As quasi public companies, Fannie and Freddie had to drop their qualifying standards via regulatory changes. Fannie and Freddie then had to lower their “qualifying” standards so they could buy these otherwise non-qualifying mortgagees and join the securitized gravy train. If they did not, the now deregulated investment banks would force Fannie/Freddie out of the mortgage business and into bankruptcy. The Republican majorities in the Senate and House along with a Republican president were more than glad to deregulate Fannie and Freddie so they could compete with the unregulated investment banks. So Fannie and Freddie wound up with a lot of these toxic mortgage pools. This is how deregulation caused this mess.

“The fundamentals of this economy are sound.” J. McCain

Mommy: Now Johnny, you know that’s not true. Tell me, who broke the economy?
Johnny POW: It wasn’t me. It was that one.
Mommy: Now Johnny, you know it isn’t polite to say that. Tell the truth.
Johnny POW: I don’t wanna. You can’t make me. Nyyyyyaaaa nyyyyaaaaaa!

Seriously though, I think Senator McCain was broken during the Vietnam war and it has become very clear, via various events and speeches, that he just isn’t fit to be given great power. Aside from his politics he just doesn’t seem to be capable of envisioning a way forward and of creating a plan he can consistently follow. He’s still a POW in some ways and we can’t afford that at this time.

I suggest he coast to the end, be gracious, try to regain some composure, declare some kind of victory and return to the Senate to serve his state with such honor as he can muster.

Further rallies with anger, hate and threats of violence do not reflect the person he wants to be and they’re not good for America. He should put America First and end that kind of talk at the rallies.

but like i said in my comment @54 – in a heart beat.

it’s not about personality.

Got A NEW PC YET????