Remember the mortgage losers -- all those irresponsible Americans who took out loans they could not afford at the height of the housing boom, but then got caught with their pants down by the bust? They're an ever-popular scapegoat for those whose preference is to blame the financial crisis on the moral failings of individual American homeowners, rather than on the lenders and financial institutions who created the incentives for so much bad behavior.
On Monday, the Securities and Exchange Commission charged three executives of one of New Century Finance Corporation with securities fraud. New Century was one of the biggest subprime lenders in the United States, and one of the first to declare bankruptcy in the spring of 2007, helping set off the chain of events that brought down Bear Stearns and Lehman Brothers and forced Washington into crisis bailout mode.
The complaint filed by the SEC provides some intriguing context for helping to decide who to blame for all the bad loans.
At the peak of the bust, in 2005, New Century originated nearly $50 billion worth of mortgage loans. Some 30 percent of those loans were so-called "80/20 Combo Product" loans. The 80/20 product was actually two loans piggybacked together, the first for 80 percent of the home's value, and the second for the remaining 20 percent. With an 80/20 loan, the borrower didn't have to put any money down at all.
Great deal for the borrower -- but not so great for the lender or whoever bought the loans from the original lender (whether whole or as part of a securitized pool of loans.)
From the complaint:
New Century's 80/20 product had a high risk of first or early payment default, as the borrower had no equity in the property securing the loan. Without placing any of his or her own money at risk, in the form of a traditional down payment, the borrower could walk away from the loan as soon as market conditions justified such a move, without suffering a loss. As soon the nationwide rise in home prices abated in late 2005 and early 2006, and home prices began to decline, these borrowers were among the first to default on their payment obligations, thereby triggering, in ever increasing numbers, New Century's loan repurchase obligations.
(New Century was obligated to buy back any loans it had sold off to other investors if borrowers defaulted on their payments within a specified period.)
So let's think about this. Who should we blame more for this mess? The borrower who is making a completely rational financial decision to walk away from a busted deal, or the lender who is stupid enough to push such a mortgage product in the first place? And what about the likes of Lehman Brothers and Morgan Stanley, who gobbled up as much of the mortgage-backed security crap created by New Century as they could?
Ideally, abuses such as the brain-dead no money down 80/20 combo loan would be precisely the kind of thing that a Consumer Financial Protection Agency would take a very dim view of. The irony being that it wouldn't be just the consumer that was being protected, but the lender, from its own folly.