Link between mortgages and Wall Street securities rewarded risky loans, panel told

The rush to profit from turning subprime mortgages into top-rated Wall Street securities encouraged loan originators, investment bankers and speculators “to push risk tolerance to its limits,” a Chapman University law professor told a federal panel Thursday.

The profit motive also discouraged due-diligence experts from blowing the whistle on faulty underwriting, Kurt Eggert, an expert on predatory lending, testified at the final field hearing of the Financial Crisis Inquiry Commission.

The national commission, led by Chairman Phil Angelides of Sacramento, a former California Democratic Party leader and state treasurer, and Vice Chairman Bill Thomas, a former Republican congressman from Bakersfield, has been investigating the causes of the financial crisis that crippled the U.S. and global economies two years ago.

The panel will distill input from 700 interviews, millions of documents and testimony from hearings in Washington, Sacramento, Bakersfield, Miami and Las Vegas for a final, book-length report to be delivered to Congress by Dec. 15.

Thursday’s hearing focused on “the financial crisis at the community level,” using Sacramento and cities in California’s hard-hit Central Valley as reference points.

Much of the testimony focused on the explosion of often complex loans that were made with few checks of borrowers’ ability to meet payments. Typically, the mortgages were subprime loans, given to buyers with little or no credit.

Companies bundled those mortgages and used the packages as the basis for securities, a process known as securitization.

That process encouraged brokers and lenders to “make the largest and riskiest loans borrowers will sign” and rewarded investment houses by “creating the riskiest loan pool that the rating agency would bless with high ratings,” Eggert said in prepared testimony.

What’s more, appraisers got financial incentives to overstate the value of homes, he said.

“It was easy money,” said Karen J. Mann, president of a Sacramento appraisal and consulting company.

Poorly qualified appraisers were persuaded to perform superficial, “drive-by” valuations with “no thought to the collateral value” of a property, she said. And the slipshod work was rarely reviewed by state banking or mortgage regulators.

The result, Angelides said, was that “one of the safest purchases traditionally made by families — a home with a mortgage — became the beating heart of a financial monster.”

Sacramento’s 12.8% unemployment rate — along with 43% of homes now worth less than the loans on them — contrasts with the rise in Wall Street’s fortunes, Angelides said. Profits at surviving financial institutions are up along with executive salaries.

“We’ve seen a stunning disconnect between Wall Street and Washington and the rest of the country,” Angelides said.

“Many in authority in New York and the nation’s capital claimed they ‘did not see it coming.’ But if they had paid a visit to Bakersfield, Las Vegas, Miami or Sacramento,” he said, “they would have seen how dry rot was eating away at our financial system.”