Why You Should Live in a Van Down By the River: You Can Move It.

I read a lot of economics blogs and columns, in part because I am a masochist but I also really like to see what economists are saying or not saying about housing.  At Marginal Revolution today there is a discussion about theories behind the involvement of Fannie and Freddie in the mortgage market.  The post states that the old consensus was that the GSE's were in place to make housing more affordable.  EPIC FAIL ALERT.  The notion that Fannie Mae, Freddie Mac, and the Federal Reserve have ever made housing more affordable is ludicrous and comical.  If you define affordable as low interest rates then you can definitely argue that they succeeded but you are ignoring the most important factor in whether housing is affordable:  your income.

We used to consider housing affordable if you spent roughly 25 percent of your gross monthly income on housing.  During the peak of the housing boom, Fannie Mae was routinely backing loans at 65 percent of  people's gross monthly incomes.  If you expand your definition of affordable to mean, "at the cusp of bankrupting you" then well done, Fannie.  You made housing more dangerously affordable than ever.

What we have in many parts of this country is a mismatch in the supply of housing with what consumers can actually afford, you know, given their crappy job prospects.  The government inflated housing bubble changed what we view as affordable and made a 3 bedroom house in the suburbs with granite countertops seem like a public good.  It's not.  We have a vast amount of homes that are affordable to a small amount of people.  This cannot be fixed by government intervention, it will require rising incomes and economic growth which will increase demand for what is currently, unaffordable housing.

HUD projections show that in my region, housing demand will be for homes in the $125,000 to $200,000 price range.  This is affordable given our median income levels and these are the homes that are actually selling right now.  What we have is a plethora of homes priced from $250,000 to $350,000 that even if you have 20 percent to put down (a modern miracle), once you factor in taxes and insurance you would need income in excess of $72,000 a year to afford.  This is assuming that you don't have any other debt.  If you have a car payment, student loan, and an average credit card balance this ups your income requirement to $100,000 a year to afford the payment.  Better get on the The Ladders website.

On the other end of affordability we have many families that are working class, what is quickly becoming a class of the working poor.  They may have combined incomes of $45,000 per year and they have consumer debt and spend virtually all of their incomes monthly.  For this family, an affordable house carries a mortgage payment of  $1125 including taxes and insurance.  For this family, a home that costs $150,000 is affordable.  Unfortunately, many of these families are living in $250,000 houses because they qualified for twice what they could actually afford with the help of Fannie, Freddie, and the Federal Reserve.

We have a number of housing problems which are exacerbated by our poor economy.  People underwater on their mortgages are trapped unless they say screw it and walk away and why wouldn't they; what incentive do they have to stay?  Do you really think people struggling to stay afloat are going to put the virtue of their word over a rational economic decision?  Didn't think so.

A bigger problem exists for unemployed homeowners.  Because economies tend to have local and regional agglomeration characteristics in particular industries, you end up with a lot of unemployed people in one area with similar skill sets.  If these unemployed people were mobile, as in able to sell their house and not take a complete financial schlacking, they could move to where their skills might be employable.  Unfortunately, we have a labor force that is very immobile right now which makes unemployment even worse.  Being a renter right now has tremendous advantages, particularly if you can move to take advantage of opportunity.

Perhaps, the Banks should become landlords and turn short sales and foreclosures into rentals.  This would slow down the decline in housing values because the properties wouldn't go to market and then drag down appraisals for the next two years for other homes in the area.  Bankers would make great Slumlords, they wouldn't even require training.

Just when you thought it couldn't get worse....

This article in the WSJ is today's reason that I am fast tracking my plans to become a pirate.  Here is the opening sentence:

"The U.S. government will likely continue to play a role in guaranteeing mortgages, but policy makers must figure out how to design a system that doesn't lead to a rerun of the collapse of mortgage-finance giants Fannie Mae and Freddie Mac, Treasury Secretary Timothy Geithner told attendees at a housing summit convened on Tuesday."

Arggh.  My immediate irritation is with the word "design".  The government couldn't design an exit strategy from a wet paper sack yet they can design a system to prevent financial ruin?  No, they cant and the fallacy that you can design a system to control a spontaneous order like our market economy is mortifying and dangerous.  I was even more disturbed to find out that two economists I greatly respect  seem to be throwing support to Geithner on their blog.

The argument pervasive at the moment is that without government backing there will be no private capital in the mortgage markets and this will lead to a further decline in housing prices, more underwater homeowners, and more stress to the economy.  Currently, the government is involved in backing 90 percent of mortgages whether implicitly or explicitly.  As far as I can tell the idea is to wean the government out of its involvement in the business of housing by temporarily increasing its role, an idea that is so profoundly crazy I cannot believe it is being taken seriously by smart people.

I agree with the ultimate goal that the government (read taxpayers) will not be intimately involved in every loan made for housing.  The problem lies in the fact that once the government is involved, it changes the expectations of the private players and becomes the new rule of the game.  The incentives will not be there for the private sector to take a role because the expectation will be that the government will continue to prop up the market.  Private capital will flow into areas other than mortgages and the taxpayer will end up with the flaming crap bag on their steps.  Temporary government intervention typically turns into permanent government intervention because it distorts market signals and diverts investment to alternative sectors.


I don't know about you but if I hear the phrase, "Mortgage Rates are at historic lows," one more time I am going to exercise my second amendment rights and blow up my television.  Mortgage rates have been too low for too long, another part of the problem.  The Treasury officials are arguing that without a government guarantee on mortgages, mortgage rates will soar.  Fantastic!  Let them soar, they have been distorting the real cost of lending and altering borrowers decision making calculus for too long.  Interest rates are prices and as such, they should reflect the risk associated with lending and the cost of doing business.  Let interest rates rise and more private investors will enter the mortgage markets.  Keep interest rates below the actual market rate and the government will be the only entity dumb enough to jump in.

I am so tired of government stimulus that I think I need a Valium to cope with my over-stimulation.  

Return to the Scene of the Crime

I haven't blogged in awhile, not because I am uninspired but rather, I have been busy turning parts of this blog into a book.  Well that and I took a vacation back to the land where all the debauchery described here occurred. 

Returning to the place where I worked as a loan officer for three years and lived for twice that time brought mixed emotions.  My hope was to avoid running into any of my previous costumers or real estate contacts, unless of course by choice.  That mission was accomplished.  I didn't want to see old customers because I was in fear of getting physically or verbally assaulted because of the loans I had done for them. and frankly, I feel sorry for a lot of people who are trapped in the sandbox where I made a ton of money for awhile and then fled.

I was struck immediately by the impacts of the housing crisis on the entire region and while it should have come as no surprise, I still was shocked to see predictions I had made long before coming to pass.  My friend and co-blogger, A.Hole, and I met my friend and real estate agent, Judy Moody, for happy hour.  Of course, we drank a lot and as to be expected, talked about real estate and gossiped about former colleagues we still didn't like.  I heard stories of homes purchased for $800,000 in 2006 selling at short sale for $350,000.  One of these homes was purchased by a gentleman that only earned $50,000 a year.  Obviously, he was the beneficiary of a liar's loan but he was just one of thousands who purchased a home he couldn't afford in a highly speculative market.

Economics 101 as it applies to housing is that housing demand is driven by employment.  In theory, people need income to buy a home.  The housing boom took this fundamental tenet of economics and spit on it.  In the area where I lent money, we had very little employment and most of it was tied to tourism.  A great number of people in the sandbox are reliant upon unemployment in the winter as their jobs are seasonal but, the vast majority of people were self employed or directly employed by industries associated with housing.  This includes a plethora of self employed individuals, real estate agents, and construction contractors.  Our housing boom was driven by people on the other side of the bridge purchasing second homes and investment properties and our local speculators, who behaved like they were players in the gold rush.  People who had no business owning one home found themselves temporarily exercising domain over small, crappy housing empires.  It couldn't last.

A number of things conspired to cause the decimation of the housing market in the sandbox.  Fannie Mae, the Federal Reserve, and government policies were the catalyst but, the local developers and real estate players pushed the market over the edge. 

Much like the Tragedy of the Commons, where everyone acting in their self interest brings about a negative outcome for themselves and the greater good, real estate developers went nuts.  With no consideration to the sustainable supply of certain types of housing in the region, condo developers saturated the market with units that demand could not possibly keep up with.  Planned urban developments went up everywhere, even where they shouldn't.  Development in a protected wetland was possible if you knew the right people; no one thought about whether they should do it, they just doled out favors and protected the fat cats of the region.  The spoils of the boom went to the early developers and investors who amassed wealth at an unprecedented rate.  Seeing the gains to these early entrepreneurs, every Tom, Dick, and Harry wanted in on the splendor.  The last to get in are suffering the most as profits were driven out and then the market collapsed completely, much like the species crash of an unsustainable animal population.  The housing market is very Darwinian, but the fittest in this case were those who got in first and then had the good sense to the get the hell out while the gettin was good and those who had political ties to avoid silly things like zoning laws and environmental regulations that the unconnected were subject to.

At a particularly drunken happy hour at a bar by the Bank of Hell ruled by the Mortgage Devil, I got in an argument with people who had invested in a condo development on what they call a river.  Growing up on the Mississippi, I felt the need to point out that their so called river looked like a polluted ditch and bore no resemblance to a real river.  They argued with me and then realizing I wouldn't change my stance that not all waterfront property is created equal, they changed their tactic to arguing that the new condo development would appeal to young professionals.  I responded, "To attract young professionals you must have jobs and this town doesn't so I think there is a pretty major flaw in your understanding of the demand for these units."  No amount of Ketel One keeps me from making sound economic sense but these people were having none of it.  They told me I didn't understand real estate and they would prove me wrong.  Yeah, right.  I went by the project and one whole building is sitting sheathed without Tyvek, unfinished and blighted.  The other condo building they actually finished has a vacancy rate that appears to be 90%.  As I predicted, young professionals go where the jobs are and are not swayed to deviate from their economic self interest by a creek filled with litter and surrounded by crime. 

The entire region looked sad to me despite the flood of tourists from Pennsyltucky, New Jersey, Washington D.C., Baltimore, and surrounding cities.  The housing market in the sandbox looks to be at least a year away from even the seeds of recovery and with the economy still struggling, financial distress for people underwater in their homes or turning their second homes into rental properties is nowhere near over.  A glance at the rental listings for the area show how the flood of housing units for rent has depressed rental prices.  Great for renters?  Perhaps, if they could find a job. 

Buying at the beach became the American Dream with the help of incentives from the Federal Government yet, our government is accepting no responsibility for its contributions to the crisis.  Even those people in the sandbox who have encountered economic ruin due to their belief that the housing market was a never ending path to wealth blame the "Greedy Bastards on Wall Street."  Ummm, people want to make more money, duh.  That is only a problem when the government provides incentives to do so at the expense of common sense, economic sustainability, and future economic growth.

If the government gives your kids free reign in a candy store for a decade, you will get a bunch of fat kids with cavities.  What happens when you give adults these same incentives but trade the candy store for the housing market, oh yeah, an incredible bust and recession. 

On a positive note, if you are independently wealthy and require no employment, I can guide you to some tremendous values in a resort community.  If however you want to live at the beach but need income to support the habit, I got nothing.

It's the Banks, stupid!

I love underdog stories, particularly sports ones but really, any underdog tale will do.  I was born with a soft spot for the underdog, the scapegoat, and the misrepresented.  This tendency makes me feel bad for mortgage brokers and sub-prime loans because big banks, the Federal Reserve, and Fannie Mae have really let them get thrown under the proverbial bus.

When I left a brokerage to go to the Bank of Hell I had no idea how uneven the playing field was.  In terms of checks and balances on loan fraud and quality, brokers were way ahead of the game.  The wholesale system has one inherent check on fraud, the underwriting of a loan took place outside of the office where the loan was originated.  This prevents a loan officer from having a personal relationship with their underwriter which goes along way in making sure loans are properly handled.  At the Bank of Hell, The Mortgage Devil's mantra was that we should sell real estate agents on the fact that we had local underwriting because it implied we could get loans done more quickly and also, it made real estate agents  feel good to know that if the loan had problems the loan officer could walk to the next office and shakedown the underwriter.  The truth is that local underwriting creates the opportunity for fraud.  Frankly, loan officers shouldn't be able to touch their loan files once they are done with the application, no good can come from it.

Obviously, there were shady brokerages and independent mortgage companies doing business during the peak and yes, a lot of these were sub-prime, but, there is a bigger story about the preferential treatment of banks over brokerages that isn't getting told.

The fundamental difference between mortgage operations was whether the company had a direct and contractual relationship with a bank or not.  The firm I started with had correspondent and wholesale relationships with investors and banks.  The firm was not owned by a bank nor directly affiliated with one but, because of our relationships I could sell the loan products of these other companies, including banks like Wells Fargo.  In contrast, the Bank of Hell owned its mortgage division while companies like Countrywide, owned a small bank.  There were tremendous advantages to having a direct relationship with a large bank and now I know that the major advantage of this was the bank's relationship with Fannie Mae and the Federal Reserve.

There are numerous examples of how these relationships allowed for more risky lending but I want to start with everyone's favorite loan, the Liar's Loan.  When I worked as a broker, very few of our investors allowed stated income loans to close without something known as a 4506-T, a form that the borrower would sign allowing the company to pull copies of tax transcripts.  The only investors we had that would allow stated income loans without this form were, shockingly, large banks.   Why does this matter?  Well, for starters a 4506-T pulled during the processing of a loan could confirm whether the borrower was lying about the income or whether they even had a job.  Smart loan originators knew better than to grossly overstate income on a loan with a 4506-T because there was the fear of getting caught, not getting paid, and potentially getting fired.  There were probably a number of loan originators who weren't aware of the potential for disaster but the majority that I knew, were very aware and this helped to reduce the risk inherent in a stated income loan.  My first manager in the industry hated the notion of tax transcripts, as he would say, "If underwriters can see your tax return it isn't a stated income loan."  That statement is what F. Ross Johnson referred to as a BGO or a blinding glimpse of the obvious.

So tax transcripts helped to reduce fraud by the loan officer but they served many functions.  A tax transcript pulled after the loan closed, but before it was sold, could have identified whether the loan carried more or less risk than the investor would expect. Sometimes investors wouldn't buy loans after pulling tax transcripts leaving correspondent lenders stuck with a loan they thought they could sell.

Tax transcripts could have prevented a number of issues with loan quality.  Imagine catching liars before the loan closes or before the loan was sold with an understated amount of risk.  In terms of mathematical assessment of loan quality, a random sample of the tax transcripts might have provided a firm with information on the thresholds of risk; ie, what percentage of liar's loans overstated income by 5%, 10%, or 20%.  This type of information could have been used to create thresholds for underwriters.  I'm sure some companies did use this information to reduce risk but the most important players in the industry weren't doing this and that includes Fannie Mae and big banks.   

At the Bank of Hell, we were able to do a number of Fannie Mae backed Liar's Loans.  There seems to be a huge misconception that Fannie didn't do these loans but the truth is that only large banks and large mortgage companies like Countrywide were given the ability to do these loans by Fannie.  I have heard a story that the Bank of Hell got access to these loans after pissing a bitch to Fannie Mae because Countrywide and Wells Fargo had them.  Who knows what kind of sketchiness went on behind the scenes as banks lobbied Fannie for the right for more risky, but prime, Fannie Mae loans.

The beauty of a Fannie Mae stated income loan was that there was no 4506 required, meaning there was no way that anyone would know how extreme the risk was or how bad the lie was.  Perhaps, that is how Fannie Mae wanted it.

At the Bank of Hell we had our own Fannie approved stated income/stated asset loan that A. Hole already blogged about.  Let me be perfectly clear, many of these loans were way riskier than sub-prime loans.  These loans were given to people with fair to excellent credit so while they didn't carry the credit risk, there was tremendous opportunity and incentive for loan officers to commit fraud with this program.  As A.Hole explained, the Mortgage Devil encouraged us to lie about borrower's income to get them into this easy loan program because you could take a loan from application to settlement in seven days. If you have been reading this blog you aware that we were doing Fannie Mae loans at 65% debt to income ratios.  This loan allowed loan officers to do loans with high debt to income ratios by falsely stating the customer's income so that it looked like it was 45% or less.

When these loans were bundled into pools they looked like low risk loans, they were Fannie Mae prime backed loans and had the implied backing of the United States government.  Fannie Mae pimped these pigs in dresses.

The scam gets worse when you add the folks on Wall Street to the mix.  When loans were bundled into securities for trade, these prime loans were mixed with sub-prime loans to reduce the risk.  You offer a lower rate of return on the non-risky piece (the Fannie Mae piece) and a high rate of return on the sub-prime piece which frankly, everyone knew had a very high probability of default.

In my opinion, Fannie Mae fucked it up for everyone.  There so called "prime" loans were riskier than a lot of sub-prime loans.  Perhaps the borrowers weren't credit risks, but they were overextending themselves with the help of Fannie Mae and the biggest players in the mortgage industry.  This means that virtually every loan pool sold understated risk substantially and investors who thought that Fannie Mae was synonymous with low risk, eventually found out that Fannie Mae was a giant phony. 

We have all bought things based on the implied quality of a brand name only to find out that we bought a name and nothing else.  This in a nutshell is one of the major reasons we are in this mess.  Most of our financial innovation and trading during the housing boom was based on Fannie Mae's name and the implied quality of the loans.  There were a lot of lemons in that pool and as I said before, Fannie Mae is a bitch.

For those of you that have seen the movie Tommy Boy, Chris Farley provides the perfect metaphor for what happened to our economy.  Fannie Mae was selling boxes of crap with a stamp that said "Guaranteed" and now we know what the guarantee was: our money and future economic prosperity.

This one time...at Loan Officer Academy...

Ok, this isn't going to be an "American Pie...One time at Band Camp" story where a flute is inserted into some orifice....but who knows.... it could have been because I am not exactly sure what Curly Sue was doing with that Loan Officer from Florida. Now that I have your attention....I previously wrote about the overall experience of “Experienced Loan Officer Academy”. But, I wanted to save a chapter for what I actually learned in training.

Apparently, The Bank of Hell had unleashed a loan product they were very proud of and encouraged us to use whenever possible….and if you followed the steps I was taught, you could almost use it all of the time. More on that a little later.

The new “Super” loan product they taught was a Fannie Mae Stated Income/Stated Asset loan. Why is this so special? Let me explain. The acronym loans that Turdy wrote about previously carried a higher interest rate due to the inherent perceived risk of those products (i.e. NINA, NINANE). Fannie Mae backed loans had the lowest interest rate of all the loan products because they were supposed to be A+ “prime” loans. They carried the lowest risk and therefore had the lowest rate. But this whole system got bastardized by the Bank of Hell. But to be fair, it was with Fannie Mae’s blessing…and no, I am not trying to incite Barney Frank.

How did this work? Well, I was taught in training that if I had a client with a credit score of 680 (decent score) or higher on a purchase or 720 (good) or higher on a cash out refinance transaction it could be eligible for the “Super” loan. If you met these score requirements you didn’t have to verify the borrower’s income with pesky paystubs or W-2’s and you didn’t have to verify that the money they told you about for their down payment and closing costs actually existed….and the “beauty” of this was the rate and terms on the loan were the same as someone who fully documented their loan. Brilliant!! But wait ...there is more…if the value you have listed for the property they were purchasing or refinancing was acceptable to the automated underwriting program….you didn’t have to get an appraisal. You could get use an automated value from the “internets”!! Ok, so no income verified, no assets/down payment verified, and no physical appraisal needed to be completed…..and still the interest rate was no worse than the suckers that fully documented their loan with their “primo” credit.

Of course the Mortgage Devil used the powers of the “Super” loan for evil and not good. He took advantage of his self-employed borrowers by having them convinced he could do a stated income/stated asset loan for them a 1/2 % below the competition because he was “such a good guy”. But what he actually did was inflate the rate of the “Super” loan to make a bunch of overage (extra commission). For example…during the time period in question…a traditional stated income/stated asset loan would have a rate of 8.00% for a 30 year fixed while a Fannie Mae’s A+ loans had a rate of 6.00%. So, the Mortgage Devil would have his client call some mortgage broker who didn’t have the "Super" loan and get quoted 8.00%. He would then sell them a loan at 7.50%....he was a hero!! Wait, what is that you say? I thought the “super” loan was the same rate as Fannie Mae’s A+ rate? Well, you are correct. The Mortgage Devil would take that extra 1.50% as overage and make a ton of money of that one loan. As, I was told by my Munchkin Trainer this loan was supposed to give us a competitive advantage against the competition so we could close loans quicker and hassle our borrower’s less. But the Mortgage Devil found a sleazy way to take advantage of the system so that he could pay for all of his second homes.

When I returned from training to the Bank of Hell...I got the "real" training on how to use/manipulate/bastardize this "Super" loan. What was discovered by the Mortgage Devil or one his Minions is the exact sequence you had to follow to limit the paperwork and manipulate Fannie’s system. Here is the step by step way I was taught and why it needed to be done that way:

1) take loan application over the phone and enter into computer.
2) pull credit...if the score meets the requirement move to step 3.
3) go ahead and get an automated value for the property and enter it into the computer
3) make sure you have stated enough income to keep the debt ratio under 45%.
4) send the loan through Fannie Mae's underwriting system to get "Super" loan approval without having to verify the income, assets, and no physical appraisal..Brilliant!

Because if you just put a value based upon what the Borrower thinks their property is worth and you send it through Fannie Mae's automated underwriting it may get approved with that value. You excitedly call your customer and say..."Congratulations, you are already approved. Since your credit is so great...we don't need any documentation or even an appraisal". But what happens when the automated value is different than what the customer thinks the property is worth? If you enter the automated value and Fannie's automated underwriting doesn't like it...then it would red flag the whole loan for excessive value or cut your value where you may have a loan to value problem. No one wants red flag's on their loans or value issues. If you pull the automated value first as suggested in step 3 above, you can see if their is a potential problem ahead of time. Good deal, right? Actually, the system was set up for check and balances against over-inflated appraisals or potential for values exceeding loan amounts. By reversing the steps you circumvent that process. Brilliant!!..hmmm?

Why do you have to keep the debt ratio under 45%...well, because if it was higher it wasn't eligible for a "Super" loan. I know your next question will be..."well what if the income they told you that they made causes the debt ratio to exceed 45%?"....my answer comes from the Mortgage Devil...in his words...you "just bump up the income to make sure it is under 45%". Duh!! It's so simple...and so fraudulent at the same time. He honestly didn't see where this was a problem. You "just bump up the income!"....that was his war-cry that day. Ok....so, we learned today how to turn a Fannie Mae loan into a Liar's Loan....and still charge a higher interest rate to gain more commission...got it!!

Fannie Mae is a Bitch

If you haven't heard of Fannie Mae or her crazy ass cousin, Freddie Mac, then I am assuming the aliens have just returned you to earth.  Congratulations on your safe return from abduction.

Although Fannie Mae sounds like someone who could whip up some mean homemade potato salad and serve it to you in a kitschy Pyrex bowl, she really is a bitch.  Her cousin, Freddie Mac, probably beats his wife.  The whole family of Ginnie, Freddie and Fannie share more than just hillbilly names, they share government sponsorship.  Here is an oxymoron for you:  Fannie and Freddie were set up as private firms with government sponsorship.  Now obviously they functioned with the private sector motive of profit (How's that working out for you?) but they also were intended to lube the capital markets to foster the public good of homeownership, particularly for the middle class. Unlike Fannie and Freddie, who operated with the inherent assumption that they were government backed although they were private, Ginnie Mae actually was government backed.

I'm not going to wax indignant here about the inanity of this but I must get on my soap box briefly to point out a few things that are not getting enough attention.

1. If the perception is that you are government backed then people will behave as though you are government backed.  If I hand you $100 and send you into a casino with the instructions that you can keep all of your winnings and not be responsible for your losses, you will behave more recklessly than if you were responsible for paying me back if you lost.  This in a nutshell is why Fannie and Freddie took on so much risk.  Also, they were explicitly encouraged by the government to do so.
2. I have a problem with the "homeownership is a public good" mentality.  I had a problem with it before I got into the mortgage industry and now it really makes me seethe.  Homeownership is not a fundamental human right.  Oh and turns out, homeownership isn't proving to be that great for people.  
3. What we know now is that the perception of government backing=government backing.  Go figure.

The point of this post isn't to pontificate about the unintended consequences of government intervention, no, I will save that for happy hour.  Really I just want to begin to describe the types of loans Fannie and Freddie allowed me to do that were considered prime, meaning low risk.  It will make you feel sorry for sub-prime loans, they took all of the heat in the beginning and were the tiniest part of the crisis.  Poor little scapegoats.

Fannie Mae and Freddie Mac had a monopoly over the secondary mortgage market.  If you have ever had a mortgage the odds are Fannie or Freddie had something to do with it.  For those of us on the front lines, the goal was to make every loan a prime loan which was a loan that Fannie or Freddie would approve.  The reasons for this were numerous but fundamentally, loan officers want to earn commission.  The more easy loans you can do, like those Fannie and Freddie approve, the more money you can make.  The folks at Fannie and Freddie understood that and they gave loan officers the tools to be lazy while making tons of money. 

Both Fannie and Freddie had proprietary automated underwriting systems, desktop underwriter(DU) and desktop originator(DO), that made being a loan officer less painful.  Anywhere I went with a laptop and an internet connection, I could run a customer's loan application through these underwriting systems and receive a loan approval in five minutes.  A. Hole and I have gotten loans approved at happy hour which is the ultimate in utility maximization.  Making money while drinking with friends, brilliant.

The loan approval from Fannie or Freddie would list the conditions for final loan approval, including the types of documentation the customer would need to provide so that they could close on their mortgage.  If a loan didn't receive approval through these systems it might qualify for a manual underwrite as an Alt-A (more on this later) or sub prime loan.

These automated underwriting systems were designed to approve loans based on the layers of risk.  The layers of risk in the industry included debt to income ratios, appraised value, cash reserves and assets, employment stability, property type, and credit profile.  All of this sounds sensible, right? 

In practice, this automated underwriting system was inconsistent and sometimes left you scratching your head.  My theory on this is that the underwriting system was tweaked on a regular basis as a method of controlling risk and liquidity.  I don't know this for a fact, but it makes sense given the fact that you could run the same loan through the system a week apart and get two different results.

At the peak of the housing boom these automated underwriting systems were spitting out approvals the way the Duggar Family spits out kids.  Nothing was finer than to be a loan officer with a whole stack of loan files with neat little Fannie Mae approvals in them.  As I said before, sub-prime loans have really been thrown under the bus by Fannie and Freddie.

During this glorious peak I was getting prime loans approved on a regular basis through Fannie for customers with debt to income ratios of 65%.  YES, I said 65%.  The debt to income ratio was calculated by adding up the mortgage payment, debts listed on the credit report, taxes, and homeowners insurance as monthly expenses and comparing them to the customer's GROSS monthly income.  Not only did we not include monthly expenses like utilities we calculated the ratios on pre-tax income.  Wow.

When I returned to the lovely world of economics I finally grasped what this meant.  For the average person, a 65% debt ratio to gross income would result in a monthly shortage.  Fannie was basically approving loans with the implicit assumption that the borrower would have to deplete their savings for luxury items, like groceries and child care.

I am not an idiot but when I say I was in true believer mode when I was in the industry, I mean it.  I really thought I was making people wealthier.  Now I know that a great majority of these loans depleted wealth by giving somebody a declining asset (their home) and encouraging them to drain their 401-K and savings just to pay their bills.  This tandem punch resulted in the largest ever decline in household wealth between 2007 and 2008.

Like I said, Fannie Mae is a bitch.