The shakeout in the subprime area is the latest of the mortgage industry's periodic purges of dubious practices and weak lenders.
In the mid-to-late 1980s, savings and loan institutions moved into risky lending, sometimes to cover losses after interest rates turned against them. Courts found that some executives looted dying S&Ls. A 1989 government bailout ultimately cost hundreds of billions of dollars.
The collapse of many S&Ls, once the dominant force in home mortgages, opened the way for specialist mortgage-banking firms and commercial banks to take more of the business. Today, Countrywide and Wells Fargo & Co. have a combined share of around 30% of all home loans originated each year, but the rest of the market is splintered among more than 8,000 lenders affiliated with banks, thrifts or credit unions, while those that don't take deposits are regulated by state agencies.
While companies are free to lend through branch offices, Websites or call centers, their main way of reaching customers has been via independent mortgage-brokerage firms, generally tiny local outfits. Mortgage brokers find customers, advise them on which types of loans are available and collect fees for handling the initial processing. There are more than 50,000 mortgage-brokerage firms and they are involved in 60% of all home loans, up from 40% a decade ago, says Tom LaMalfa, managing director of Wholesale Access, a mortgage research firm in Columbia, MD.
But by outsourcing much of its direct contact with consumers, lenders also lost some control over the screening of borrowers and the presenting of loan choices. Some lenders and industry consultants say subprime lenders' dependence on brokers partly explains the industrywide surge in mortgage fraud. Fraud appears to be one reason for a recent rash of defaults occurring within the first few months of subprime loans. New subprime loans made in 2006 totaled about $605 billion, or about 20% of the total mortgage market, up from $120 billion, or 5% in 2001, according to Inside Mortgage Finance, an industry newsletter.
Wall Street is deeply entrenched in the entire mortgage market, including loans to more creditworthy borrowers, on which defaults so far have remained low. Last year, banks and brokerage firms pocketed $2.6 billion in fees from underwriting bonds that use mortgages as their collateral, nearly double 2001's figure. Wall Street banks also extended billions of dollars of short-term credit, called warehouse lines, that allowed lenders to fund mortgage loans.
Source: The Wall Street Journal, March 12, 2007