William K. Black
February 3, 2016 Bloomington, MN
This is the third column in my series about the Wall Street Journal report that “big money managers” want to bring back “liar’s loans.” Here are the article’s first two sentences.
Wall Street wants to bring back the “low-doc” loan.
These mortgages, which are given to borrowers that can’t fully document their income, helped fuel a tidal wave of defaults during the housing crisis and subsequently fell out of favor.
The second sentence begins the lies with an important lie. “Low-doc” is a euphemism for endemically fraudulent “liar’s” loans. The second sentence repeats a lie that the fraudulent lenders have told for decades – it is their carefully crafted creation myth of liar’s loans. If the WSJ had done its job and exposed the lie, the creation myth and the fraud scheme would have died decades ago. Instead, the WSJ endorses the lie. Liar’s loans were not designed for or “given to borrowers that can’t fully document their income.” The two keys lies by the fraudulent lenders about liar’s loans arise from their use of the word “can’t.” As I explained in my second column in this series, the IRS created, decades ago, Form 4506-T, which allows the borrower to give the lender access to transcripts of the borrower’s two most recent tax returns. This means that the self-employed can easily and cheaply permit the lender to verify their income – and home lenders routinely require borrowers to sign the 4506-T as a mandatory part of the loan application. The first lie is that there are borrowers that are incapable (“can’t”) document their (purportedly ample) income.
The reporter inadvertently lets slip her knowledge of the first lie when she purports to describe the group that is incapable of documenting its (purportedly ample) income as the “self-employed or [those that] report income sporadically.” There are two reasons why people “report income sporadically.” One, because they earn income only sporadically and have no continuous employment in the last two years – in which case they can’t “verify” their income because they do not have any reliable income stream to report. That is an excellent reason not to lend to them to buy a home. Two, they are committing tax fraud, which is an excellent reason not to lend to them to buy a home. (Recall that one of the four minimum requisites of underwriting – the “Four Cs” is “Character.”)
The second lie in the use of “can’t” is more subtle and more fundamental. Liar’s loans did not reach volumes of over two million annually in the middle of the last decade because borrowers wanted such loans. The CEOs of “big money managers” are not desperate to bring back liar’s loans because of enormous demand by consumers for the return of fraudulent liar’s loans. Liar’s loans became endemic because they were the ideal fraud ammunition for lenders that were run by their CEOs as criminal enterprises. Liar’s loans inherently harm honest borrowers by charging them higher interest rates. In the peak of the hyper-inflation of the crisis, that premium yield (“spread”) was typically around 50 basis points higher than on a fully documented loan. The WSJ reporter claims that the spread today ranges from 150 to 400 basis points. Honest borrowers, therefore, who take out liar’s loans now, are by definition the victims of extreme predation that, in terms of the spread, is three to eight times larger than that inflicted on honest “liar’s” loan borrowers in 2006 and 2007.
That extreme predation explains why the Consumer Financial Protection Bureau (CFPB), which the WSJ never mentions, and the Congress in Dodd-Frank, essentially banned liar’s loans by federally insured banks on the grounds that they were inherently abusive to financial consumers. Congress, and the Fed (using its exclusive authority under HOEPA), found that liar’s loans were so “unsafe and unsound” from the bank’s perspective that they should essentially be banned.
The purpose of all these lies crafted by the fraudulent lenders is nasty propaganda – and the WSJ spreads this propaganda. The creation myth is that liar’s loans were conceived in an act of love. The banks and top bankers were the innocents trying to help some mythical group of high quality borrowers who could not get loans under the old system. The tragedy is that these kind bankers were betrayed by the rapacious hairdressers of the world who responded to the bankers’ act of kindness with fraud schemes in which the hairdressers claimed to be making $200,000 annually. That fraud scheme was so fiendishly clever that the hairdressers (or exotic dancers in the movie The Big Short) ran circles around the Lehman, Bear, Citi, Countrywide, WaMu, JPM, Wells, BofA, Ameriquest, and New Century senior executives making 500 times the hairdressers’ (real) income. Under this creation myth for liar’s loans, the bankers are so warm-hearted that they continue to make liar’s loans even when they are shown studies documenting that 90% of liar’s loans are fraudulent. The generosity of the bankers was such that even when regulators so weak that Tom Frank aptly labels them “The Wrecking Crew” recurrently advised against making liar’s loans the bank CEOs responded overwhelmingly by making ever more liar’s loans – to borrowers with subprime credit scores.
Of course, there is the small discordant note that it was actually the bankers who created the incentives for loan officers and loan brokers to systematically inflate the borrower’s income and that the top bankers maintained, or even at places like WaMu and Countrywide that have actually been studied, increased those perverse incentives in response to internal and external reports documenting endemic fraud. But that’s why DOJ and the FBI and bank “regulators” religiously refuse to publish real investigative reports on the bankers’ massive origination of fraudulent loans and why DOJ and the SEC push to prevent whistleblowers from presenting the truth. Whenever we look at lenders who made liar’s loans, we find endemic fraud, which is “off-message.” It is so much better, therefore, to not look and not analyze. This is why what was once America’s leading financial newspaper is now reduced to propounding a creation myth that was falsified 26 years ago as soon as our (OTS West Region) examiners first looked at liar’s loans in Orange County, California. Our examiners promptly figured out the scam in late 1990 and by 1991 we were driving liar’s loans out of the S&L industry. Note that our crackdown occurred while we were overwhelmed dealing with the broader crisis that used fraudulent commercial real estate loans as the “ammunition of choice” for accounting control fraud.