Bankers’ Hours column: Surplus money led to major banking failures |

Bankers’ Hours column: Surplus money led to major banking failures

Pat Dalrymple
Bankers' Hours

Now comes the Great Meltdown of 2008, aka the The Great Recession, aka the Financial Crisis. As Yogi Berra would have said, “It was déjà vu all over again.” If we stay on topic, we find the same thread connecting the S&L crisis of the mid-’80s and the 2008 crash, and we see that thread dangling out of the isolated incidents of banking booboos, such as the recent Credit Suisse debacle.

A surfeit of money on the table just lying there for the taking, drove banks off the bridge in 1985 and 2008. Which makes you wonder: Could it happen again? Of course, it could, but will the stars line up exactly right to make it happen? Well, we had a perfect storm of circumstances just 21 years apart, so we’re not talking about, say, a 500 year flood here.

Both events have been blamed on a long list of causes, by a lot of people much smarter than this writer: i.e. regulatory oversight failure; lack of adequate laws; pressure on the GSE’s (Fannie Mae and Freddie Mac) to depart from their traditional, and proven, role as the gold standard for underwriting and creating mortgage-backed securities, guaranteed by the U.S. government, as well as the oldies but goodies of fraud and incompetency. And, yes, all of these factors were present.

But in both cases, an enormous amount of money was rapidly made available, and there was plenty to go around, which created mortgage assets, which triggered a construction frenzy, which resulted in too many houses backing too many mortgages, and the law of supply and demand was, once again, dramatically demonstrated.

The Great Meltdown (my favorite eponym, since I made it up) also had a lot of help from a new, and unexpected source. The players in the S&L (thrift) crisis were the usual suspects: bankers, developers, builders and a nice sprinkling of scam artists. In 2008, there were thousands of unindicted co-conspirators — borrowers — who found that they could borrow a lot of money with little effort. Which led to fraud becoming virtually a cottage industry as Americans rushed to take down loans that used a new underwriting tool: the fever thermometer. If your temp was 98.6 F, you qualified for a mortgage, which meant you could buy a house, certify that you intended to occupy it as your primary home and then flip in in 30 or 60 days without making a payment. (OK, the thermometer bit was an exaggeration, but just barely). At the thrift where I was employed in August 2007, just a year before the collapse, a whopping 51% of our problem loans were a result of borrower fraud.

Why did this happen, and how? The why was the ravenous planetwide appetite for mortgage-backed securities. The lust for yield and perceived safety brought a deluge of investment cash from investors of all types, from individuals to sovereign funds. The yield was high, and the world’s perception was that mortgage-backed securities paper from the U.S. was a very secure investment; after all, the track record of Freddie, Fannie and Ginnie Mae proved it, didn’t it?

Problem was, the U.S. housing market, operating in a traditional mode, couldn’t supply enough single-family mortgages. So private mortgage wholesalers, including big banks, investment houses and a couple of new thrifts chartered just to produce home loans for resale, created a variety of loan products, eschewing those stodgy underwriting protocols that required borrowers to prove they earned enough to afford the house payment, and had a probability of continued sufficient income.

Rather new loan types were created with less documentation required and increasingly lower standards. The less documentation, the fewer guidelines controlling loan quality, the higher the interest rate on the loan, which investors liked; a lot. Some examples: “Stated income” is exactly what it says: you want to qualify for a mortgage, figure out what it takes to handle the debt and say you make enough to cover all of your debts and expenses. Then there was “stated, stated,” wherein a borrower could offer up a monthly income number, and get creative on the asset side with deposits and investments; not to worry, we’ll not embarrass you with those pesky deposit and employment verifications, and we’d never, ever insult you by asking for your tax returns.

Loans became very easy to get. There was Money on the Table, on steroids. Developers developed, builders built, and banks, big and small, were eager to join the feeding frenzy, lending to help create a massive oversupply of housing. Borrowers did their best to absorb it, buying two, three or even more putative primary homes. Freddie and Fannie, not wanting to look like wallflowers, started buying into mortgage creativity in a big way.

By 2006, everything was in place for the crash. The edifice was built, ready to fall. Mortgages weren’t getting through the pipeline to mortgage-backed securities creation, because borrowers were defaulting on their new loans during the first six months after closing. Or, often, not even making the first payment. Loans that became delinquent later were audited and shipped back to originators for repurchase. Ghost towns of new homes were sitting unoccupied.

At this point, nobody had the courage to say that the emperor had no clothes. All, from the mortgage-backed securities people at Bear-Stearns, Lehman Brothers and Merrill Lynch, to the regulators at the FDIC and OCC, mortally feared rocking the boat. So they did the only thing they could do, like dinosaurs waiting for the weather to change. They created more mortgages.

I remember the words of a senior exec of a small bank that had bet the farm on one business line: producing a high volume of loans nationwide through a network of loan production offices: “The only way out is up.” Meaning that the source of salvation is more mortgage production, more fee income that could bolster the balance sheet against failure.

It worked just like you’d expect if a wildfire was threatening Downriver, Montana, and the boys at the Volunteer FD mistakenly filled up the pumper truck with gasoline instead of water; a lot more bad loans didn’t help a bit. Got the doors closed sooner, though.

Next: The cracks crumble — from bubble to rubble.

Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His email is

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