Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [42]
The way the loans were made was bad enough, but some of the new risky loan products made it difficult for homeowners to pay back the loan, even if their house increased in value, and if the value of the home stayed the same or declined, the homeowner would have a huge incentive to default.
These dodgy loans were so laughable that the risk was an open secret. The market made up pet names with catchy tags for this trash. NINJA loan: no income, no credit, no job, no documentation, no down payment, no problem. Get a loan and get in over your head. Liar loans will let us take your homes.You will choke your credit trying to pay back strangulation loans. Vampire loans will suck your blood dry.
In 2002, when Warren Buffett took losses due to Oakwood Homes’ bankruptcy and was coming to grips with the credit derivatives losses in his Gen Re unit, President George W. Bush announced his intention to increase minority homeownership by 5.5 million by 2010. It sounded like a great idea—who isn’t for home ownership? He lacked a sound plan to achieve it, and the regulatory policies of his administration enabled fraud fueled by greed. It sounded great to say in 2004 that homeownership had substantially increased. But by the beginning of 2008, homeownership was back down to 2002 levels, and minorities are most at risk for losing their homes—and their creditworthiness potentially ruined for years.4 Furthermore, the population is still growing as homeownership declined, so we have lost ground. Wealth transferred to the wealthy from the poor, and what cannot be wrung out of distressed borrowers is ultimately being subsidized by tax dollars as the Fed bails out investment banks, banks, and thrifts.
The national tragedy is that the Bush administration apparently neither read Berkshire Hathaway’s shareholder letters nor sought Warren Buffett’s advice.
In 2003, while Warren Buffett was acquiring ethically run Clayton Homes after having taken the lesson of Oakwood to heart, the Office of the Comptroller of the Currency, the OCC, subverted the states’ ability to defend the rights of mortgage borrowers against predatory lenders. The OCC examines national bank books and inquires about risk management practices in their capital markets areas. In an unprecedented move, it exercised an obscure power in the 1862 National Bank Act countermanding states’ predatory lending laws over the unanimous objection of all 50 states.5
Ameriquest was alleged to be among the worst of predatory lending offenders. Forty-nine state regulators and the District of Columbia claimed it ran a boiler-room operation slamming borrowers with loans they could not pay back, hidden fees, and undisclosed escalating interest rates. The U.S. Senate delayed Ameriquest founder, Roland E. Arnall’s, confirmation to the post of U.S. Ambassador to the Netherlands, but approved it in February 2006, after Ameriquest paid a $325 million settlement.6
Fair Isaac Corporation developed a scoring system (FICO) as a rough guideline of consumers’ ability to pay debts. Subprime borrowers have low credit scores; typically FICO scores are below 650. Lending problems were not limited to subprime borrowers, however. Risky mortgage products combined with overleveraging created problems for borrowers at all income levels, but subprime borrowers were hit the hardest. Subprime borrowers tend to be less sophisticated and include a higher percentage of minorities. Unscrupulous lenders prey on the relative naiveté of these borrowers.
In the United States in the last part of the twentieth century, an illegal practice called redlining denied sound mortgage products to eligible minorities. As we entered the twenty-first century, redlining was replaced with a perverse spin called reverse redlining. This was supposed to help minorities buy homes, but instead Reverse Robin Hoods stole from the poor and gave to the rich. Since many subprime loans do not meet the standards of Fannie Mae and Freddie Mac, mortgage lenders borrowed most of the money from a handful of investment