As the Housing Bubble Implodes

Mollenkamp, Carrick. 2007. “In Home-Lending Push, Banks Misjudged Risk.” Wall Street Journal (8 February): p. A 1.

“When the U.S. housing market was booming, HSBC Holdings PLC raced to join the party. Sensing opportunity in the bottom end of the mortgage market, the giant British bank bet big on borrowers with sketchy credit records. Such subprime customers have always been risky, but HSBC figured it could control that risk. In 2005 and 2006, it bought billions of dollars of subprime loans from other lenders, lured by the higher interest rates they carry.”

“Assessing the quality of big mortgage pools and predicting how many of the loans will go bad is a tricky business. Typically, HSBC would first specify to a mortgage wholesaler what kind of loan pool it was looking for, based on the income and credit scores of borrowers. Then it would send in its analysts to review the portfolio.”

“After the deal was announced, Household’s then-chief executive, William Aldinger, bragged that Household employed 150 Ph.D.s skilled at modeling credit risk. Household had developed a system for assessing consumer-lending risk — called the Worldwide Household International Revolving Lending System, or Whirl — which it used to underwrite credit-card debt and to collect from consumers in the U.S., United Kingdom, Middle East and Mexico.”

[The good book tells us: “For they sow the wind, and they reap the whirlwind.]

“The mortgage market in the U.S. is a complicated web of mutually dependent businesses. Mortgages are frequently bought and sold several times over, and the default risk often lands far from the institution that originated a mortgage. Banks and mortgage brokers size up would-be borrowers and make the loans. These lenders sell many of the loans to mortgage wholesalers, which gather them into pools and flip them to large financial institutions or banks like HSBC.”

“Assessing the quality of big mortgage pools and predicting how many of the loans will go bad is a tricky business. Typically, HSBC would first specify to a mortgage wholesaler what kind of loan pool it was looking for, based on the income and credit scores of borrowers. Then it would send in its analysts to review the portfolio …. To speed up these purchases from other lenders, HSBC accepted loan paperwork that didn’t verify whether borrowers made as much as they claimed. Mortgages that rely on the borrower’s word about that are called “stated-income” loans.”

[Of course, people who processed the loan, working for companies that flipped the loans, had good reason to encourage borrowers to overstate their income. Alas, the Ph. D’s never figured that out.]

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