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Nonprime and Subprime News | Subprime Statistics
Stories about non-QM products. Coverage of subprime, Alt-A and
hard money lending. Home-equity loans and home-equity lines of credit.


Report analyzes what mortgage industry did wrong before crisis

May 26, 2010

By staff

A new study attempts to answer how mortgage bankers could have gotten it so wrong before the bubble burst. Among the biggest culprits were silent second mortgages and bad risk models.

Anatomy of Risk Management Practices in the Mortgage Industry was conducted by Professor Cliff Rossi of the University of Maryland. It analyzed risk management processes used by lenders during the period leading up to the housing crisis.

The report was released today by the Mortgage Bankers Association, which sponsored the report through its Research Institute for Housing America.

"Multiple factors including poor data, incomplete performance metrics, and, short-term focus and unrealistic optimism among senior business managers contributed to the collapse in the U.S. housing and mortgage markets," MBA said.

Pressured to provide loan programs that enabled borrowers to afford rising home prices, lenders used modeling that proved completely unreliable -- with defaults on 2006 originations eclipsing by four times the level of defaults expected from pre-2004 models.

The study found that subprime risk increased between 1999 and 2006 with the expansion of several risk attributes. But of most concern was the increase in subprime loan-to-values as the rate of silent second liens jumped.

"The resulting increase and expansion of risk layering and change in borrower behavior, left risk managers unable to offer reliable risk estimates," said Rossi -- who reportedly has more than 20 years' experience in mortgage lending and regulation.

Also contaminating the mix was corporate culture and cognitive bias, according to the report. Senior mortgage executives became less risk averse because of the long run-up in home prices and consistently low default rates.

In addition, investors were unconcerned with the lack of geographic and product diversification at large lenders, while better-than-average economic conditions created a false sense of security for mortgage executives.

"Moving forward, it will be essential for the industry to develop early warning measures of the level of risk in new originations and less reliance on imprecise historical performance of new loan products," Rossi added.

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