Two of the most abusive practices that helped inflate the housing bubble -- stated income loans and broker bonuses for steering people to more expensive loan programs -- were harpooned by the U.S. Senate on Wednesday. The Senate passed an amendment to the financial reform legislation by a vote of 63 to 36. The amendment was introduced by Senators Jeff Merkley (D-Ore.) and Amy Klobuchar (D-Minn.). Sen. Carl Levin (D-Mich.), pictured at left, was one of its co-sponsors.
Senate investigations of Washington Mutual show how these types of compensation packages rewarded loan officers and processors on volume and not on the quality of the loans they were writing. Brokers were "paid more for issuing higher risk loans." They also got paid more "when they got borrowers to pay higher interest rates, even if the borrower qualified for a lower rate." This practice enriched Washington Mutual, but "made defaults more likely down the road."
While it's great that these "liar loans" might no longer pollute our financial system, some people could be hard hit by a ban.
Sen. Levin, chairman of the Senate Permanent Subcommittee on Investigations, said, "Washington Mutual built a conveyor belt that dumped toxic mortgage assets into the financial system like a polluter dumping poison into a river." He added that, "Using a toxic mix of high risk lending, lax controls, and destructive compensation policies, Washington Mutual flooded the market with shoddy loans and securities that went bad." From 2000 to 2007, Washington Mutual securitized at least $77 billion in subprime loans. Of course Washington Mutual was not the only source of these destructive loans. Two other major contributors were Countrywide and New Century.
But the Senate investigators found that Washington Mutual actually "selected loans for its securities because they were likely to default, and failed to disclose that fact to investors." It even sold loans that were identified as being fraudulent to investors. Washington Mutual's lax lending practices ultimately led to the nation's largest bank failure. At the time of the failure Washington Mutual had $300 billion in assets, $188 billion in deposits and 43,000 employees. Chase eventually took over the bank.
The practice of using stated-income loans was much more common throughout the financial world. Borrowers could state income and not be required to prove it by using no-documentation loans. If this amendment remains in the financial reform legislation that goes to President Obama for signature, underwriters will be required to request documentation that proves borrowers have the ability to repay the loan. That means you will need to prove income with pay stubs and/or tax returns or other documentation, such as investment holdings.
Not everyone will be thrilled with these changes. The self-employed, for example, could find it even more difficult to get loan approval. If, for whatever reason, you don't have at least two years' worth of tax returns to prove the income you claim, you likely will find it difficult to get a mortgage.
Lita Epstein has written more than 25 books, including "The 250 Questions Everyone Should Ask About Buying Foreclosures" and "The Complete Idiot's Guide to Personal Bankruptcy."
