Table of Contents
Title Page
Copyright Page
Dedication
Acknowledgements
Introduction
CHAPTER 1 - Why I Bailed Out of the Industry
Good Lending Gone Bad
Watching It Crumble
What Were We Thinking?
Time to Get Out
Moving Forward
CHAPTER 2 - The Gunslinging Business of Subprime Lending
The Business of Subprime Lending
Subprime Borrowers and Credit Scores
The Evolution of Subprime Lending
The Economics of the Business
The First Crisis—1998
Understanding the Players and the Process
A Culture All Its Own
How to Start a Subprime Company with No Money Down
CHAPTER 3 - The Underbelly: Mortgage Brokers
What Brokers Do, and What They’re Supposed to Do
The Business of Brokering Mortgages
Mortgage Fraud
Broker Tactics
Losing Faith in Humanity
CHAPTER 4 - Making Chicken Salad Out of Chicken Shit: The Art of Creative Financing
Understanding Risk
How Creative Financing Works
Appraisals
Understanding the Impact
Laying the Blame
CHAPTER 5 - Wall Street and the Rating Agencies: Greed at Its Worst
The Impact of Securitization
Understanding Mortgage-Backed Securities
Wall Street Enters the Mix
The Rating Agencies
Who’s Running the Show?
Rating New Products
Slow to Respond
How Securitization Impacts the Borrower
What the Future Holds
CHAPTER 6 - Secondary Contributors: The Fed, Consumers, Retail Lenders, ...
Secondary Contributors: The Federal Reserve
Borrowers
Retail Mortgage Lenders
Homebuilders and Realtors
The Demise of the Industry
New Products—A Meltdown of Epic Proportions
The Walls Come Down
CHAPTER 7 - How to Fix a Broken Industry
A Plan for Change
Investment Banks—Creating Liability
The Rating Agencies—A Major Overhaul
Mortgage Broker—Fixing the System
Fiduciary Duty—Start with the Money
Licensing and Accreditation
Tackling Fraud—Thinking Outside the Box
Appraisers
Lending Guidelines—Meaningful Changes
Taking the Cheat Out of the Liar
The Current Crisis
Final Thoughts
GLOSSARY
RESOURCES
Copyright © 2008 by Richard Bitner. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data
Bitner, Richard.
Confessions of a subprime lender : an insider’s tale of greed, fraud, and
ignorance / Richard Bitner.
p. cm.
Includes index.
eISBN : 978-0-470-44061-2
1. Mortgage brokers—United States. 2. Mortgage loans—United States.
I. Title.
HG2040.B58 2008
332.7’220973—dc22
2008019035
.
To
Deborah, Andrew, and Matthew
For always inspiring me
To Mom and Dad,
Thanks for never letting me forget
the difference between right and wrong
ACKNOWLEDGMENTS
There are numerous people to thank for their contributions. First, my thanks to Michele Burke and Rich Trombetta, who provided critical feedback during the earliest phase of my writing and encouraged me to keep going.
I’d like to acknowledge Ryan Miller, Rob Legg, Vince Dimare, Annie Nguyen, Tres Petree, and Frank Partnoy for their contributions. I also want to thank the numerous mortgage industry professionals who provided their insights but asked not to be identified.
Lisa Gold, my editor, was instrumental in helping me work through the writing process to produce the final product. You are a gem.
To my former business partners, Mike Elliott and Ken Orman, for helping to build Kellner Mortgage Investments. You were the greatest business partners a person could have asked for.
In addition, I’d like to recognize Bob Kellner for his patience, guidance, and wisdom. Bob truly embodied the spirit that was Kellner Mortgage.
Finally, a special thanks to Ken Orman. Your willingness to help me work through the details of this story was invaluable. This book would not have been possible without your help.
INTRODUCTION
A year ago, I never thought there would be a need for me to write about the subprime industry. I knew the business was flawed, but it seemed inconceivable the events of 2007 would play out as they did. An entire segment of the lending industry has disappeared and the news gets worse by the day. Home sales have slowed, prices have fallen, credit has tightened, and the true extent of this problem, I believe, is still unknown. It has left many people wondering how bad the crisis will get.
As a 14-year veteran of the mortgage industry, five of which were spent as the owner of a Dallas-based subprime lender, Kellner Mortgage Investments, I sat front and center in the middle of this debacle. Compared to the big boys like Countrywide Financial or Washington Mutual, my firm was a small player. At our
peak, we were on pace to close $250 million a year in subprime mortgages—not an inconsequential figure, but only a fraction of what the largest players were funding.
Being a lender of this size, however, afforded me a unique perspective. A typical day involved working with small mortgage brokers as well as the largest mortgage securitizers in the country. I saw the inner workings of the subprime industry from one end to the other.
Although this book is based on my experiences as a lender, it’s also representative of how the entire subprime industry operated. Part of my research included interviews with numerous colleagues, many of whom worked for, managed, or owned subprime mortgage companies. I wanted to be certain that the business practices I describe were typical of the subprime industry and not isolated to my world. The insight and feedback from these colleagues were invaluable to my portrayal of the volatile mortgage business.
This is the second go-round for this book. It was originally developed as a self-published work called Greed, Fraud & Ignorance: A Subprime Insider’s Look at the Mortgage Collapse, which I began writing in August 2007. I knew we were facing a problem of historic proportions and I felt the United States was about to experience the worst business debacle in modern history. Little did I know how right I’d be.
The problem is huge in part because so many things went wrong. First, unlike most business disasters driven by the malfeasance of a few leaders sitting at the top of the food chain, the current crisis is a result of systemic problems that extended from one end of the industry to the other. There is no single person or group who bears the greatest responsibility. Second, with 65 percent of all Americans owning a home, no other business disaster has had such a broad impact on so many people. Third, once the real estate market stops its current freefall and the gains and losses are tallied, both from the rise and fall in home equity and from losses sustained in the mortgage-backed securities market, the loss figure will reach into the trillions. Yes, trillions.
I started writing this book believing that somebody who experienced the debacle first-hand should tell the story. I quickly realized, however, that wasn’t enough of a reason for writing. For me, there had to be more.
Having spent most of my business career in mortgage lending, I’ve generally considered myself to be an industry lifer. I want to see the mortgage industry find its moral compass and get back to the business of intelligently lending money. This can’t happen without some significant changes taking place. While this book is an insider’s perspective on what went wrong, the final chapter focuses on the solution. My hope that these critical changes will be made became, ultimately, my motive for writing.
Before John Wiley & Sons, Inc. entered the picture, Dan McGinn at Newsweek wrote an article about the earlier version of this book. Since subprime had become the newest four-letter word in the American vernacular, I knew there would be some negative reactions, but nothing prepared me for the unmitigated hatred that was directed my way. Like it or not, by putting pen to paper I had become the poster child for the subprime industry. I was guilty by association. Reading through the several hundred comments that were posted online, which recommended everything from jail time to my being drawn and quartered, I’d be lying if I said they didn’t bother me. If you’ve been raised to believe that you should do right by others and you attempt do so on a daily basis, it’s impossible not to be affected by such comments.
Let me be clear. I’m not looking for sympathy or validation. I hang my hat on the fact that during my five years as a subprime lender, my firm had an average delinquency rate of less than 3 percent. If you compare that to the current subprime delinquency rate, which hovers around 20 percent, it means my company was effective at putting borrowers into mortgage loans they could afford. That is the only criterion, in my opinion, by which a lender should be judged.
That aside, one thing is clear. Even those of us who operated with the best of intentions, and who believed in the economic benefits subprime lending had to offer, found it increasingly difficult to effectively manage risk during the last few years before the collapse. It was also difficult just to stay competitive in the marketplace. When that happens, errors in judgment take place and mistakes get made. Certainly there was no shortage in that department.
This book is about only the subprime industry, but I hope most readers will understand that the mortgage crisis is not isolated to the subprime segment of the mortgage business. Significant mistakes were also taking place with other mortgage product offerings, including those for borrowers who had good credit. They’ve just taken longer to show up in the delinquency reports. I discuss this more in the final chapter.
Although the book chronicles the history of my organization, Confessions of a Subprime Lender is not about the actions of a single person, company, or even a segment of the lending business. It’s a look at how the mortgage industry collectively lost sight of its intended purpose and set off what is arguably the worst credit crisis in modern history.
CHAPTER 1
Why I Bailed Out of the Industry
Looking back, the idea of starting a subprime mortgage company seems crazy. That conclusion has nothing to do with the industry’s implosion six years later. When we opened Kellner Mortgage Investments in September 2000, I finally realized just how little I knew about lending money to borrowers with bad credit. During the first six months in business, I felt no more qualified to pilot the Space Shuttle than to be the president of a subprime lending company.
Seven years in mortgage banking provided a solid foundation, but coming from the ranks of companies like GE Capital, my schooling was largely driven by a conservative mind-set. Lending money to borrowers with bad credit was never a part of the curriculum. When I first learned about subprime mortgages, the high-risk nature of the business made me think it was best suited for those who suffered from low morals or head trauma. Lending money to people with bad credit just seemed like a terrible idea. It wasn’t until I got a taste for this business that my feelings started to change.
Taking a position as an account rep for the Residential Funding Corporation (RFC) division of GMAC in 1999 introduced me to the world of niche lending. As the largest securitizer of nonagency mortgages in the country, RFC bought loans that didn’t fit the conforming guidelines of Fannie Mae and Freddie Mac. While most of the products were geared toward borrowers with good credit, RFC was just starting to make a name in subprime. It didn’t take long for me to realize that buying high-risk mortgages held a lot of promise.
A few months before I took the job the subprime mortgage industry imploded for the first time, forcing most of these specialty lenders out of business. When the dust settled, RFC was one of the few survivors, which created an opportunity. My income was directly proportional to the revenue I generated, and subprime was three to five times more profitable than any other type of loan we securitized. Even though RFC gave me seven different products to sell, ranging from jumbo mortgages to home equity lines of credit, I ditched most of them in favor of subprime.
While RFC wanted us to push all their products, I saw no logical reason to sell something that made less money and carried no competitive advantage. The best way to succeed, I thought, was to take advantage of RFC’s position in the subprime market.
That was the same year I met Ken Orman, the head of secondary marketing and operations for First Consolidated Mortgage Company, my best customer. It took me only a few months to realize Ken understood the business at a deeper level than most of us. He could look at a deal, size up a borrower, and immediately determine if the loan was a good risk. What impressed me most was how his gut feeling, whether or not to write a mortgage, was usually correct.
Since he was unhappy with his job and we had quickly developed a mutual respect, I saw an opening and sold him on the idea of starting our own company. Saying I was underqualified to run a subprime company isn’t an exaggeration. Eighteen months at RFC introduced me to this specialty business, but it didn’t prepare me for what I wa
s about to encounter.
At RFC I bought mortgage loans that were already closed. Kellner Mortgage, our new company, was going to be a wholesale lender. We were going to target mortgage brokers, independent agents who needed help putting difficult loans together. This required a level of understanding I hadn’t needed while working for RFC. Since all Kellner would look at were tough deals, the challenge was figuring out which ones were a good risk and which ones had no business getting financed. I was hoping that some of Ken’s intuitive skill would rub off on me.
It’s easy to lose sight of what constitutes a good credit risk when you spend all day looking at marginal deals. Fortunately, Ken taught me that the key to evaluating a loan started with asking two fundamental questions. If you can answer “yes” to both of them, he’d tell me, then you’ve got a subprime loan worth pursuing.
Question 1—Can the borrower afford to make the monthly mortgage payment?
Question 2—Will closing the loan put the borrower in a better position than he is in today?
At first I thought he was joking.
“That’s it?” I asked him. “You’ve spent 10 years in subprime and your secret is asking if they can afford the payment and are they better off?”
They were simple questions but I quickly realized their true value. Being a subprime lender means living in a world of gray. Most deals aren’t clear-cut and if we get bogged down in the minutiae, we’ll spend all day second-guessing our own decisions. Of course, there are product guidelines to direct us, but many deals require us to make an exception. This means sound judgment, a willingness to accept risk, and the ability to trust our instincts are critical to survival. In 18 months at RFC I watched several lenders implode because they didn’t possess these traits.
Confessions of a Subprime Lender Page 1
