Jim Hamilton on Reputational Failure in the Mortgage Market

One thing that happens in bubbles is that organizations begin viewing the current period as the terminal period capital-T, and thus see their reputations as things to be cashed in. Jim Hamilton:

Econbrowser: No-doc loans: Just an anecdote, but an interesting one. From SFGate.com (via Calculated Risk):

One Oakland woman, who asked not to be identified, explained how she exaggerated her income-- with encouragement from her mortgage broker-- when she refinanced her home. "He didn't say anything illegal out loud," she said. "He didn't say 'lie,' he just made a strong suggestion. He said, 'If you made $60,000, we could get you into the lowest interest level of this loan; did you make that much?' I said, 'Um, yes, about that much.' He went clickety clack on his computer and said, 'Are you sure you don't remember any more income, like alimony or consultancies, because if you made $80,000, we could get you into a better loan with a lower interest rate and no prepayment penalty.' It was such a big differential that I felt like I had to lie, I'm lying already so what the heck. I said, 'Come to think of it, you're right, I did have another job that I forgot about.'"

The transaction between the broker and customer was just the first link in the mortgage securitization chain. To the extent that the originator washed his hands of the whole thing by immediately selling off the loan to the next sucker in the chain, you can understand the incentives for the originator to cheerfully go clickety clack on his computer. But as I've said many times, the big question (and fundamental problem) arises from the incentives for investors further up the chain who willingly poured in the cash necessary to fund these deals.

One key problem with that chain of incentives seems to be the off-balance-sheet status of the bankruptcy-remote trusts that ultimately held the loans...

Comments

[Bernard Yomtov]

Why is it that when we look at these messes we always find the phrase "off-balance-sheet" buried somewhere in the pile of garbage?

[Barry]

Yes, it's like saying 'except for expenses, I made a large profit!'.

[David Lloyd-Jones]

Bernard and Barry: Agreed! Utterly correct.

A balance sheet balances because after you've filled in the known numbers you then fill in the rest with the unknown, typically capital after depreciation and its close relative current period income.

Fiddles that you choose to leave off the balance sheet are all known, and leaving them out *necessarily* falsifies the determination of the important unknowns that you are going through the exercise to find.

I.e., imho, anyone who *ever* uses the phrase "off balance-sheet" about their work is running around with a neon sign and a megaphone blazing and blaring "I'm lying, I'm lying."