How home loan boom went bust

How home loan boom went bust

Ron French / The Detroit News

Derek Brown knew Detroit had a problem when a grocery clerk he knew quit his job to become a mortgage loan officer.

"Everyone was selling mortgages. There were mortgage offices on every block," said Brown, president of Quorum Commercial and past president of the Detroit Real Estate Brokers Association. "One day bagging groceries and the next day selling my mother a mortgage? What the hell is that?"

In few places did the subprime mortgage frenzy hit with such a dramatic impact as in Detroit where, almost overnight, residents went from struggling to get loans from banks to having loan officers knock on their doors, offering subprime refinance deals -- with interest rates that are higher than those on conventional loans.

Today, many of those sweet deals are turning sour. In August alone, there were 3,900 new foreclosure notices in Detroit.

Those foreclosures are the hangover from a heady time, when almost anyone could get -- or sell -- a mortgage.

Foreclosures have existed since there were mortgages. Money is lent on the condition of repayment. When homeowners don't make payments, the institution "holding the paper" can demand return of the house.

In the past, banks lent their own money to home buyers; if they weren't paid, banks often lost money. Thus, banks had an interest in making good loans. Today, the vast majority of loans aren't held by the institution that made the loan. Instead, loans are bundled with others and sold to bigger lenders, until they end up as mortgage-backed bonds on Wall Street.

Mortgage-backed bonds today are a Wall Street staple. Most people own some of them in their 401(k)s. With thousands of loans bundled in one bond, the financial risk of any particular loan failing is diluted.

In effect, mortgage lenders today act less like banks than like car dealers: Once a mortgage is sold, their interaction with the homeowner is done. Instead of making money on 30 years of interest, lenders make their money on closing fees.

As lenders became further separated from the risk of bad loans, their goal changed: Quality didn't matter; quantity did.

No licensing required
In 2005, at the peak of the subprime mortgage market, an estimated 30,000 people were selling mortgages in Michigan -- a number inflated by the fact that Michigan is one of only a dozen states that does not require licensing, training or background checks to make loans.

"There was no policing of the industry and no barrier to get in," said Emil Izrailov, who started his career selling subprime mortgages and is now chief operations officer of Kaye Financial Corp. in Bloomfield Hills. "There were people who couldn't read or define a loan application who were selling $300,000 loans."

On the other side of the table, home buyers were asking for loans that would have seemed outrageous a few years earlier.

In Shelby Township, John Karpinki got a $650,000 no-money-down mortgage just 22 months after he was released from prison, where he spent 12 years. The home is now in foreclosure.

"People would come in and tell me what kind of loan they wanted," said Nicole Jackson, who worked in the subprime market in Detroit for years. "If I didn't sell them a loan, the person down the street would."

Jackson said she believes she treated home buyers fairly, but she knows some loan officers took advantage of buyers to make more money.

She recalled sales representatives from big subprime lenders such as Countrywide Financial and Long Beach Mortgage bringing lunches to her office as they pitched their new mortgage products. Loan officers decided which loan to offer buyers "by profit, by ease of use, by how much it worked for our clientele, even by how much we liked the sales rep," Jackson said.

Sometimes, she and others would sell home buyers risky mortgages when there were better loans available through government programs. "There were bad products out there we were selling," Jackson said.

Modern get-rich scheme
Types of loans that had been reserved for homeowners and businesses with unusual circumstances began being applied to everyone who walked in. There were low-document loans and no-document loans (that quickly earned the nickname "liar loans"); there were loans made for 100 percent of an inflated appraised value of a house, and loans in which the payment was so low, debt actually increased each month.

The result was an anything-goes atmosphere where almost anyone could qualify, if they or their loan officer were creative.

Izrailov worked at a loan company where he was trained to answer the phone with, "Yes, you're approved."

"You weren't allowed to sell (home buyers on) the rate," Izrailov said. "If they ask your rate, you tell them the payment instead. You weren't selling the (best) rate; you were selling the savings they'd have per month."

Homeowners were able to get home improvement loans and loans to move to better neighborhoods. As prices rose, many took out loans turning that equity into cash. Those making the loans were making $2,000 to $10,000 on every mortgage and refinance. It was quick and easy, and highly profitable.

Selling mortgages between 2002 and 2005 became a get-rich scheme much like day trading in the late 1990s.

Izrailov knew a doctor who sold mortgages in the evening from his home.

The lack of training and porous policing led to abuses. Thomas Stallworth, executive director of the Black Caucus Foundation of Michigan, said he believes Metro Detroit was targeted by "aggressive salespeople, taking advantage of people with a lack of sophistication." The bigger the loan, the more those loan officers make in commission. "So they encourage consumers to take out larger loans than they can afford or they really need," he said.

"They don't get paid unless they sell a mortgage," Brown said. "Nobody thought about what would happen when the music stopped."