Correspondent lenders are small lenders who do have the right to extend loans on their own risk and have the necessary funds to do so. After a loan is closed a correspondent lender will rarely keep it in their portfolio, selling it to a larger wholesale lender.

Sometimes it is hard for the borrower to tell the difference between a mortgage broker and a correspondent lender. One reader voiced frustration over the time it took to close his loan. “I know they have the money, so why don’t they just do it”, he asked. Near the start of the mortgage crisis, his lender was actually a mortgage broker with no money at all.

Banks such as HSBC exited correspondent lending in part because they could not trust the loans submitted from correspondents.

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Unlike a commercial bank, which offers checking accounts, CDs and loans, an investment bank finances offerings of stocks, bonds and other investments.

Investment banks help companies sell their stock to the public and help cities and towns raise money by issuing municipal bonds. Investment banks also offer advice on corporate mergers and acquisitions. If investment banks can’t function, the financial system could grind to a halt. Companies and municipalities would have a hard time raising money. Businesses would be unable to expand and create jobs, and municipalities would find it difficult to fund construction projects, such as roads, bridges and airports, or just finance ongoing operations.
(courtesy of USA Today)

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Piggyback home loans, defined:

A piggyback is a second mortgage taken out at the same time as a first mortgage, as a way of borrowing a larger total amount. The first mortgage is for 80 percent of property value, and therefore does not require mortgage insurance, while the piggyback is for 5 percent, 10 percent, 15 percent or 20 percent of value. Instead of a mortgage insurance premium, the borrower pays a higher rate on the piggyback than on the first mortgage.

When mortgage and subprime difficulties became apparent in 2007, the default rate on piggybacks soared, and investors in second mortgages began paying a high price for their mistake. With home prices declining, there is no equity protecting many of these seconds, and it doesn’t pay the lender to foreclose.

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Definition – the difference btween a write-down and a credit loss:
Investment banks and the investment-banking units of financial conglomerates mark their assets to market values, whether they’re loans, securities or collateralized debt obligations, and label that a “writedown” when values decline.

Commercial banks take charge-offs on loans that have defaulted and increase reserves for loans they expect to go bad, which they label “credit losses.” Commercial banks can have writedowns on holdings of bonds or CDOs as well.

A CDO is a collateralized debt obligation

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SIVs are investment vehicles which raise money in the short-term commercial paper market and use it to invest in longer-term assets, such as mortgages. In many cases investors let their money roll over, but recently investors have been demanding their money back. It has obliged many of the SIVs to make a forced sale of their assets at a time when the assets themselves are also losing their value.

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The stock market was down sharply Monday as news that major U.S. banks will set up a fund to help bail out the credit markets stirred concerns about bad debt. Bonds fell after an upbeat economic reading. The stock market’s pullback follows concerns about debt but also as investors also await third-quarter reports due this week from more than 80 members of the Standard & Poor’s 500 index. In addition, oil pushed to new highs.

The major U.S. banks were reported to be Citigroup, JPMorgan Chase, and Bank of America Corp. It is interesting to note that HSBC is not classified as a major U.S. bank, although some analysts think HSBC might have been partially responsible for worldwide subprime problems, buying and funding contracts until a sudden and abrupt pullout caused fears around the world.

The banks, minus HSBC, announced the creation of a fund used to help revive the asset-backed commercial paper market. The fund will buy assets from structured investment vehicles, also known as SIVs, which buy corporate bonds and subprime mortgage debt. The bailout was orchestrated by the Treasury Department to avoid a fire sale in the market.

January 2008 update: The super SIV never happened. The banks said it was not needed.

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Economists in any country in the world – except the United States – should study the “interest only” loan. It is imperative so your economy doesn’t get hurt in the future. Just consider the United States as a training ground. We all saw the ripple effect around the world. If your country’s stock market lost $80 million in one day, or if your country’s central bank pumped billions of dollars into your economy, your economists should study the interest-only scam so you can prevent it.

More specifically one should look at the effect of these loans when they are extended to the general population, including those who cannot afford them. Originally designed for well-qualified borrowers expecting a large dividend or perhaps a salary bonus, interest-only loans made sense. They were designed so one would not be required to touch their assets while repayment was virtually guaranteed.

Consider what happens when traditional banks and loan companies adopt this type of loan. A borrower calls each bank, asking about the amount of a desired loan, interest rate, and payment. Look at it a different way. A person unknown to you calls you one day, says you don’t owe his company any money, but wants you to pay him $275 a month for five years, and at the end of five years you still won’t owe him any money. Stupid, is it not? Yes it is, but in the United States it is the basis of subprime lending. Here is how it works.

Using your home as collateral you get a second mortgage. The amortization period is much longer than the payback period. That means the payment is so low you never pay anything on the principle, and all you ever pay is interest. At the end of the repayment period you owe as much as you borrowed years before. (See footnote 3) If the finance company tells you the truth before you sign the contract it is your decision. If they lie to you, or leave out pertinent facts through acts of omission, they are predatory lenders. HSBC’s Household International is a prime example of predatory lending. (1)(2)(3)

Take the example one step further. In an effort to profit from low interest rates and lax lending standards, mortgage lenders learned from HSBC and Household International. They decided to call the product an interest-only loan. Just pay the interest for a year or two and everything else will be packed on to the back end of the loan. A product for the wealthy is now marketed to the masses. If you use this kind of financing to buy a house, fix it up, and flip the property before a payment is due, the product might work for you. If you use this kind of financing to buy or refinance your primary home you might have a problem unless your huge year-end bonus will pay off the loan. If everyone on earth knows you will not get a year-end bonus somebody will sell you this mortgage product anyway.

Footnotes – (1) Practices with regard to home equity lines of credit: Plaintiffs allege that Defendant extended what was in substance closed-end credit disguised as open-end credit with the intent to avoid making meaningful disclosures concerning the payment terms, such as the existence of large balloon payments. Plaintiffs further allege that Defendant extended what was in substance closed-end credit with APRs in excess of 10% over the US treasury rate for comparable maturities, which Defendant disguised as open-end credit to evade the requirements of the Home Ownership and Equity Protection Act, 15 U.S.C. § 1639.

(2) Loan billing practices relating to simple interest calculations: Plaintiffs allege that Defendant’s practices by which payments were credited to accounts on the basis of the number of days between payments frequently resulted in situations in which scheduled payments were insufficient to pay accrued interest, creating a shortfall in interest (“interest short”), which resulted in excess finance charge costs for borrowers. Such shortfalls could occur even when payments were not late. Defendant further made representations concerning the opportunity to “skip a payment” without informing consumers that doing so would result in “interest short” situations. Defendant failed to provide borrowers with material information necessary to avoid such extra charges.

(3) Balloon payments: Plaintiffs allege that Defendant extended credit to borrowers on terms that would eventually require balloon payments, without disclosing to borrowers the existence or amount of the balloon payments.

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Years ago John Bley, Washington State’s Financial Institutions Director, at a Federal Reserve Board hearing in San Francisco once said “Predatory lending isn’t a new problem, it’s just that the name has changed. What was once called mortgage fraud is now called predatory lending. Under either name, our mission to investigate violations and enforce the law has remained the same.” If predatory lending is now called subprime that tells me that mortgage fraud and subprime are the same. Many investors are beginning to think so too.

It took twenty years for the name to change twice. But history does not change as one’s standards go down. Years ago a borrower needed an inflated appraisal, a false comparative market analysis and phony rental income to qualify for loans we commonly see today. Mortgage fraud by any other name is still mortgage fraud. When packaged as asset-backed securities it becomes securities fraud. If pension plans are tied to fraud perpetuated by more fraud everybody loses eventually. When scams are sold to overseas investors it also hurts the fabric of America.

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Credit card balances generate a continuing stream of income. Asset-backed securities are sold to investors, backed by these revenue streams. Investors may not get what they bargained for. Generally the biggest asset-backed securities are backed by home equity loans, auto loans, and credit cards. Here is how credit card asset backed securities can be inflated, defrauding investors in the process:

Bubba applies for a credit card and gets one with a $300 credit limit at 10 percent interest. They charge Bubba $99 for issuing the card, $99 as an annual fee, and Bubba can actually buy one tank of gasoline without going over the limit. Bubba gets a bill, pays it immediately, and the payment gets procesed one day after the due date. Bubba’s rate goes to 29.99 percent, he gets a $39 late fee, a $39 overlimit fee, and a bad attitude. The bank, however, has a false $350 credit card asset, rolls it into an asset-backed security along with 100,000 other cards like Bubba’s, and sells $35 million as asset-backed securities. The problem is there are no assets to back the security. There is no collateral. Recognizing that they have been scammed, twenty percent of the Bubba account holders don’t even send a second payment. After six months forty percent of the Bubba accounts quit paying. The rest pay off the account immediately and talk bad about the bank for the rest of their lives.

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Many people have asked why I predicted an implosion on or about August 15th. First let me be prefectly clear that I did not believe problems were contained to subprime, as we were told in earlier reports. Nor did I believe problems were contained to the United States, as others would like us to believe. In fact my partner and I tracked subprime and predatory loans every day since 1999, often receiving reports from borrowers. The problem is spreading to asset-backed securities and the credit card market. My position is supported by this article:

Dutch merchant bank NIBC disclosed on Wednesday 137 million euros ($188.6 million) of losses on U.S. asset-backed securities in the first half, and has indefinitely shelved plans for an initial public offering. NIBC, which had already postponed a planned IPO in March due to volatile market conditions, added that it expected further losses from its asset-backed securities holdings.

NIBC, which provided preliminary results ahead of its Aug. 15 earnings announcement, said it made a net loss of 3 million euros in the first half. NIBC blamed the investment loss on asset-backed securities on “severe instability in the U.S. credit fixed income markets and continuous credit spread widening”.

Asset-backed securities are short-term investments that contain stable or certain cash flows that are, for example, backed by the payment streams from a variety of loans, leases, or credit card receivables. The first public offering of a security backed by an auto receivable was in 1985, while the first credit card receivable was floated in 1987. Without the payment streams the securities are worthless. Many credit card companies forced credit card holders to sign binding arbitration agreements, attempting to strengthen such receivables. In the case of hard goods even the smallest credit card purchase may be collateralized by the credit card company.

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