From the Wall Street Journal:
LENDING A HAND
How Wall Street Stoked The Mortgage Meltdown
Lehman and Others Transformed the Market For Riskiest Borrowers
By MICHAEL HUDSON
June 27, 2007; Page A1
Twelve years ago, Lehman Brothers Holdings Inc. sent a vice president to California to check out First Alliance Mortgage Co. Lehman was thinking about tapping into First Alliance’s lucrative business of making “subprime” home loans to consumers with sketchy credit.
The vice president, Eric Hibbert, wrote a memo describing First Alliance as a financial “sweat shop” specializing in “high pressure sales for people who are in a weak state.” At First Alliance, he said, employees leave their “ethics at the door.”
The big Wall Street investment bank decided First Alliance wasn’t breaking any laws. Lehman went on to lend the mortgage company roughly $500 million and helped sell more than $700 million in bonds backed by First Alliance customers’ loans. But First Alliance later collapsed. Lehman landed in court, where a federal jury found the firm helped First Alliance defraud customers.
Today, Lehman is a prime example of how Wall Street’s money and expertise have helped transform subprime lending into a major force in the U.S. financial markets. Lehman says it is proud of its role in helping provide credit to consumers who might otherwise have been unable to buy a home, and proud of the controls it has brought to a sometimes-unruly business.
Now, however, that business is in deep trouble, and some consumer advocates and policy makers are pointing the finger at Wall Street. Roughly 13% of subprime loans stand in or near foreclosure, bringing turmoil and sometimes eviction to tens of thousands of homeowners. Dozens of lenders have gone out of business. Bear Stearns Cos. is trying to bail out a hedge fund it manages that was hurt by subprime mortgage losses.
Critics say Wall Street firms helped create the mess by throwing so much money at the market that lenders had a growing incentive to push through shaky loans and mislead borrowers.
At a hearing in April, Sen. Robert Menendez (D., N.J.), said Wall Street firms “looked the other way” as they profited from questionable loans, “fueling a market that has very little discipline over itself.”
Federal Reserve chief Ben Bernanke said in a May speech that some lenders focused more on feeding the marketplace than on the quality of loans, in part because most of the risks that loans would go bad were passed to investors. As a result, “mortgage applications with little documentation were vulnerable to misrepresentation or overestimation of repayment capacity by both lenders and borrowers,” he said.
At the sector’s peak in 2005, with the housing market booming, loan defaults remained low. Wall Street pooled a record $508 billion in subprime mortgages in bonds, up from $56 billion in 2000, according to trade publication Inside Mortgage Finance. The figure slid to $483 billion last year as the housing market slumped and subprime defaults picked up.
Lehman’s deep involvement in the business has also made the firm a target of criticism. In more than 15 lawsuits and in interviews, borrowers and former employees have claimed that the investment bank’s in-house lending outlets used improper tactics during the recent mortgage boom to put borrowers into loans they couldn’t afford.
Twenty-five former employees said in interviews that front-line workers and managers exaggerated borrowers’ creditworthiness by falsifying tax forms, pay stubs and other information, or by ignoring inaccurate data submitted by independent mortgage brokers. In some instances, several ex-employees said, brokers or in-house employees altered documents with the help of scissors, tape and Wite-Out.
“Anything to make the deal work,” says Coleen Columbo, a former mortgage underwriter in California for Lehman’s BNC unit. She and five other ex-employees are pursuing a lawsuit in state court in Sacramento that claims BNC’s management retaliated against workers who complained about fraud.
Lehman officials say there’s no evidence to support such claims. They say the firm has tough antifraud controls and goes to great lengths to ensure that it works with mortgage brokers and lenders who meet high standards and that loans are based on accurate information.