'Liar loans' threaten to prolong mortgage crisis

By Staff and wire reports | Tuesday, August 19, 2008 7:50 PM PDT ∞

In the mortgage industry, they are called "liar loans" ---- mortgages approved without requiring proof of the borrower's income or assets. The worst of them earn the nickname "ninja loans," short for "no income, no job and (no) assets."

The nation's struggling housing market, already awash in subprime foreclosures, is now getting hit with a second wave of losses as homeowners with liar loans default in record numbers. In some parts of the country, the loans are threatening to drag out the mortgage crisis for an additional two years.

"Those loans are going to perform very badly," said Thomas Lawler, a Virginia housing economist. "They're heavily concentrated in states where home prices are plummeting" such as California, Florida, Nevada and Arizona.

Many homeowners with liar loans are stuck. They can't refinance because housing prices in those markets have nose-dived, and lenders are now demanding full documentation of income and assets.

In San Diego County, home prices have dropped 29 percent from a November 2005 peak, according to Standard & Poor's Case-Shiller Home Price Index.

Across the nation, losses on liar loans could total $100 billion, according to Moody's Economy.com. That's on top of the $400 billion in expected losses from subprime loans.

Fannie Mae and Freddie Mac, the nation's largest buyers and backers of mortgages, lost a combined $3.1 billion between April and June. Half of their credit losses came from sour liar loans, which are often classified as Alternative-A loans (Alt-A for short) because they are seen as a step below A-credit, or prime, borrowers.

In California, there are about 689,000 Alt-A loans. Of those, 82 percent were made with little or no documentation, according to data from the Federal Reserve Bank of New York.

As of June, 20 percent of California's Alt-A loans have a late payment or are in foreclosure, according to the data.

Many of the lenders that specialized in such loans are now defunct ---- banks such as American Home Mortgage, Bear Stearns and IndyMac Bank. More lenders may follow.

The mortgage bankers and brokers who survived were more cautious, but acknowledge that they, too, were swept up in the housing hysteria to some extent.

"Everybody drank the Kool-Aid," said David Zugheri, co-founder of Texas-based lender First Houston Mortgage. They knew if they didn't give the borrower the loan they wanted, the borrower "could go down the street and get that loan somewhere else."

The loans were also immensely profitable for the mortgage industry because they carried higher fees and higher interest rates. A broker who signed up a borrower for a liar loan could reap as much as $15,000 in fees for a $300,000 loan. Traditional lending is far less lucrative, netting brokers around $2,000 to $4,000 in fees for a fixed-rate loan.

During the housing boom, liar loans were especially popular among investors seeking to flip properties quickly. They were also commonly paired with "interest only" features that allowed borrowers to pay just the interest on the debt and none of the principal for the first several years.

Even riskier were "pick-a-payment" or option ARM loans ---- adjustable-rate mortgages that gave borrowers the choice to defer some of their interest payments and add them to the principal.

While some borrowers were aware of their risky features and used them to gamble on their home's value or pull out money for vacations, others such as Salvatore Fucile insist that they were victims of predatory lending.

Fucile, who is 82, and his wife, Clara, wound up in an option ARM from IndyMac after consolidating two mortgages on their suburban Philadelphia home. Fucile was attracted by the low monthly payments, but says the mortgage broker who signed him up for the loan didn't tell him that the principal balance could increase. It has risen about $24,000, to $276,000.

"He put me in a bad position," said Fucile, who fears he will be forced into foreclosure. "He misled me."

IndyMac was taken over by the Federal Deposit Insurance Corp. last month.

FDIC spokesman David Barr declined to discuss the Fuciles' case, but said the agency has temporarily frozen all IndyMac foreclosures and is working on a broad plan to modify mortgages held by the Pasadena-based bank.

The low monthly payments of liar loans helped many home buyers afford to buy in areas of the country where prices were skyrocketing. But they also helped drive up prices by allowing people to buy more than they could truly afford. Case in point: About 40 percent of loans made in California and Nevada in 2005 and 2006 were either interest-only or option ARMs, according to First American CoreLogic.

"It was pretty evident that the only thing that was supporting these loans was higher home prices," said Tom LaMalfa, managing director at Wholesale Access, a Columbia, Md.-based mortgage research firm.

Now that prices have fallen, almost 13 percent of borrowers with liar loans were at least two months behind on their payments in May, nearly four times higher than a year earlier, according to First American CoreLogic.

Countrywide Financial Corp., now part of Bank of America Corp., was one of the top providers of liar loans. The company is now is paying the price. More than 12 percent of Countrywide's $25.4 billion in pick-a-payment loans are in default, and 83 percent had little or no documentation, according to a Securities and Exchange Commission filing last week.

Critics say Fannie Mae and Freddie Mac, which bought or guaranteed liar loans from lenders including Countrywide and IndyMac, should have stuck with traditional 30-year, fixed-rate mortgages.

"I personally think that they ventured beyond their mission," said Richard Smith, a mortgage broker in Chattanooga, Tenn. Because of their decision to back shakier loans, he said, "the home-buying public is going to have to pay."

Fannie and Freddie entered the market for risky loans just as they emerged from accounting scandals. At the time, Wall Street giants such as Bear Stearns and Lehman Brothers Holdings Inc. were backing a growing share of ever-riskier loans, and both government-sponsored companies felt pressure to compete.

Freddie Mac wanted "to stay competitive in the market and take steps to preserve market share," spokesman Michael Cosgrove said.

Fannie Mae increased its purchases of liar mortgages "at the requests of many of our customers," according to spokesman Brian Faith.

Both companies also were able to use subprime and liar-loan investments to meet government-set affordable housing goals.

Now Fannie, Freddie and other mortgage investors are reviewing defaulted loans to see if lenders committed fraud. If they find enough evidence, they could force lenders to assume responsibility for losses.

But it's unclear how much money they might recover, especially from lenders that have gone under or been seized by the government.

North County Times staff reportter Zach Fox and the Associated Press contributed to this report.

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