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FINANCIAL MISCONDUCT: What is a liar's loan?

By Steve Lombardi

What is a liar's loan? A liar's loan has to do with mortgages. The "liar's loan" is a phrase and in many instances is a misnomer. It was a misnomer because the borrower wanted to tell the truth about their income but the loan broker or even the lending officer at the bank entered the incorrect income information on the loan application. And that is where we start. Let's start with the loan application.

As many of us know, to get a home mortgage you must first fill out a loan application. That application requires the applicant to disclose their income. A normal loan process requires additional proof other than the simple disclosure of income. Most lenders require production of a W2 or current pay check stub; some even require a signed information waiver allowing the lender to contact the borrower's employer to confirm income.

The purpose of disclosing income is to establish a basis that the applicant can afford the mortgage payment. Income levels allow different loan amounts. You can't pay off a $2,000.00 per month loan payment if your income is only $1,500.00 per month. But you may be able to afford a $900.00 per month loan payment.

What went wrong were greedy loan brokers and lending officers who allowed incorrect or no income disclosures to be reported on the loan applications or many would-be borrowers. This allowed loans to be made (processed through underwriting) and the loans to be quickly packaged with other mortgages and sold into securitized loan packages where the investors didn't appreciate what they were buying. The lenders did it to earn fees and commissions paid by investment bankers who wanted the loans to create theses packages of loans to sell.

So the nondisclosure or disclosure of incorrect income information is a liar's loan.

Of course the liar's loan is a time bomb of sorts. It's just a matter of time before it blows up because the borrower, sooner or later can't afford the loan and defaults. The lenders didn't care because they would sell the loans and weren't holding the paper. They were, like the loan brokers, selling the loans. Their only interests were in earning fees not in receiving monthly loan payments.

'The biggest Alt. A lender is Pasadena, Calif-based IndyMac Bancorp. (Charts) Trade publication Inside Mortgage Finance estimates it did $70.2 billion of the loans in 2006, up 48 percent from a year earlier. As the sector grew, its shares shot up nearly 50 percent in a year and hit a record high in April 2006. But with rising concern about the mortgage sector, its shares have plunged 36 percent since the start of 2007.

But it's not just the smaller lenders like IndyMac in the sector. Like subprime, some of the nation's largest finance firms are major players. Countrywide Financial (Charts), one of the nation's largest mortgage lenders, is the No. 2 Alt. A lender with $68 billion in loans, according Inside Mortgage Finance.'

The financial markets like the liquidity this system creates when lenders don't own the paper and instead sell it to investment bankers who create securitized loan packages; but human nature being what it is greed creeps in and the system of checks and balances breaks down. Without regulation greed pushed the liar's loans out the door in great numbers and into the investment portfolios of pension funds around the world.

According to the Urban Dictionary a 'liar's loan' is defined as, a 'no-doc' or 'low-doc' mortgage that does not require documentation of income.

For your enjoyment here is a PowerPoint presentation of the sub prime mortgage mess that included liar's loan process. Sub prime loans are high risk loans. The higher the ration of monthly loan payment to monthly net income of the borrower the more likely it is the borrower will default on their mortgage. It's more likely someone will fail to make a loan payment when their loan payment is $800.00 per month and they have only $900.00 of income than if the monthly loan payment were $400.00.

The reason why this is a tort is because the loan officer's are ripping off the investors. But the loan officer's weren't alone in this tort. The tortfeasors, as we call the wrong doers are loan brokers, investment bankers to some extent, the appraisers, the builders, the realtors and everyone who earned a fee of some sort and knew these were loans were destined to fail due to income issues. The victims included stockholders at the bank, the investment firms, the pension funds and everyone who bought the securitized loan packages.

Even you may unsuspectingly be a victim. If you own stock in a company that has a financial unit you expect to earn a return on your investment in the stock. But if that investment unit bought securitized loan packages your stock price likely dropped due in part to defaults on subprime mortgages.

'GMAC, the finance unit of General Motors (Charts) that is now 51 percent owned by Cerberus Capital, is No. 3 on the list at $44 billion, and a unit of General Electric (Charts) is No. 4 at $28.3 billion, just ahead of Washington Mutual (Charts), the nation's largest thrift with $25 billion in the loans.

What is not known is which Wall Street firms, banks and hedge funds have bought hundreds of billions of dollars worth of mortgage-backed securities comprised of Alt. A loans, or have lines of credit out to the smaller Alt. A lenders.'

Essentially all involved were selling a dream that didn't exist.

And what did they use to create the bomb? They used tic tock docs.

http://desmoines.injuryboard.com/uploadedFiles/subprime.ppt

Originally posted at InjuryBoard by Steve Lombardi

Full post as published by Des Moines Personal Injury Lawyer on April 03, 2009 (boomark / email).