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Failed Lenders Created Their Own Crisis

The top 25 subprime lenders, whose risky mortgage loans triggered the near-collapse of the nation’s financial system, were largely owned or heavily financed by the same banks now getting federal bailout funds, according to a study by a nonprofit watchdog group.

Far from being victims of the financial meltdown, the lenders were “directly responsible for their own demise,” Bill Buzenberg, executive director of the Center for Public Integrity, said at a briefing Wednesday. “This was a self-inflicted wound.”

The center’s report, “Who’s Behind the Financial Meltdown?” also said that as subprime loans boomed over the past decade, those 25 lenders spent nearly $370 million on lobbying and campaign contributions in efforts to block stricter rules on lending.

The center found that the top 25 subprime lenders lent nearly $1 trillion to unqualified borrowers between 2005 and 2007, nearly three-quarters of the total for that type of loan. The report said that 21 of them were financed—through direct ownership, credit agreements or huge purchases of “securitized” loans—by banks that participated in the Treasury’s Troubled Asset Relief Program (TARP).

‘Too connected to fail’

The banks now receiving billions from TARP are “too politically connected to fail,” Buzenberg said. “Predatory lending is at the heart of what happened, and stricter regulation could have prevented that from happening.”

The study found that the subprime lending machine that generated millions of high-interest loans to unqualified borrowers—and also millions of dollars in processing fees to those originating the mortgages and millions more to those selling them as securities to third parties—was heavily concentrated in Southern California. Seven of the 10 worst offenders were based in Los Angeles or Orange counties.

Many of the nonbank lenders that failed did not have to meet Federal Deposit Insurance Corp. guidelines, and in states like California, regulators were often “outmanned and outgunned” by the slew of originators that streamed into the housing finance market, said John Dunbar, the center’s project director.

Dunbar noted that demand for high-yield mortgage-backed securities was so high, and the profits so lucrative, that financial institutions pushed into riskier loans to keep the pipeline full of loan products. The bundles of loans could then be securitized—that is, broken into pieces that could be sold off to investors, with banks earning millions for making the sales.

“There was an enormous demand for these securities,” said Dunbar, “but there was no one watching the store.” Federal regulators assumed that rating agencies such as Moody’s and Standard & Poor’s would stringently analyze the underlying risk attached to these pools of risky loans, “but it didn’t work out very well.”

Even though many of the mortgages were offered to homebuyers with unsteady work histories or incomes too low to qualify for conventional mortgages, many of the securities making up these bundled loans gained top credit ratings.

Faced with enormous losses on risky loans, some major banks are now depending on federal bailout funds to survive. Advocates say that without major injections of funds from taxpayers, the entire financial system will collapse.

‘Catastrophic regulatory failure’

“If the only way we can keep the wheels on the financial system is to give trillions to private companies to keep them in business … then what we’ve got is a catastrophic regulatory failure,” Dunbar said. On Thursday, the Treasury Department is announcing the results of “stress tests” designed to show whether banks can remain solvent even if the recession drags on.

For the report, the center used government-generated data to analyze nearly 7.2 million high-interest loans made from 2005 through 2007, a period that marks the peak and collapse of the subprime boom.

Among the study’s findings:

• As long as a decade ago, Washington was warned by bank regulators, consumer advocates and a handful of lawmakers that these loans represented a systemic risk to the economy. Yet Congress, the White House and the Federal Reserve all hesitated while the subprime disaster spread, even as the financial firms spent millions on lobbying.

• The top 25 originators of high-interest loans, led by failed Countrywide Financial Corp., accounted for nearly $1 trillion, or about 72 percent of such loans made during that period.

• Most of the top subprime lenders were high-volume, nonbank retail lenders that advertised heavily, generated huge profits and collapsed when Wall Street pulled their funds. Nine of the top 10 lenders were based in California, while 20 of the top 25 subprime lenders have either closed, stopped lending or been sold to avoid bankruptcy.

• Seven of the top 25 subprime lenders have subsequently received government assistance—at least $90 billion in direct TARP funding—while AIG’s bailout may add up to as much as $187 billion.

• Investment banks Lehman Brothers (which declared bankruptcy last year), Merrill Lynch, JPMorgan and Citigroup “both owned and financed subprime lenders.” Others, including Goldman Sachs and Credit Suisse First Boston, were major financial backers of subprime lenders.

Michael Zielenziger lives in the San Francisco Bay area and writes about business and the economy.


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