Anatomy of a Confession: Wells Fargo Pulls Plug On Popular Subprime Mortgage Loan

Wells Fargo & Co. ended offerings of 2/28 subprime mortgage loans, in a decision the company directly attributed, in part, to market pressure. In an article written by Reuters reporter Al Yoon, Wells Fargo Pulls Popular Subprime Loan From Mix, Wells says the $583 billion market for such loans relies on opinions of rating companies such as Moody’s Investor Services. [Moody’s made the news a few days ago when Raphael Nach filed a class action suit, case number 07CV4071, in federal court in the Northern District of Illinois against Moody’s Chief Financial Officer for alleged misrepresentation of the rating assigned to bonds backed by subprime mortgages. Watch for my blog scheduled for publication next Saturday, Blood In The Water: Investor Bites Back.] Moody’s joined Standard and Poor’s Rating Services and Fitch Ratings to unleash a flood of downgrades on subprime bonds in response to rising delinquencies and increased their assumptions of losses that new loans will produce.
Wait a minute, guns don’t kill people, people kill people. The party line used to be 2/28 loans were a proper investment vehicle for the right people in the right situation, those expecting real estate appreciation to create equity and permit refinancing before the rates reset. Yoon says, “Payments on 2/28 adjustable-rate mortgages (ARM) are based on rates that are fixed for two years and then are adjusted twice a year for the remaining 28, if the loan is not refinanced.” It is a teaser and a come on - a lower interest loan and affordable payments without regard to the amount of the payment after bi-annual resets. And it was only the bad brokers who took advantage of those who could not afford this type of loan, or so we were told. But what about liar loans and no document loans and stated income applications, which did not require the first “d” in due diligence?
Yoon says 2/28 loans are the staple of the industry, comprising 65 percent saturation of the subprime market last year. Surely such a popular product, offered by the largest banks that drive our economy, must be a reasonable investment for the buyer of mortgage backed securities and a reasonable loan product for the common homeowner. Yes, let us not forget the home buyer who borrowed through these 2/28 loans.
Now, Wells, the nation’s fifth largest bank, joins Countrywide Financial Corp., Washington Mutual Inc., Merrill Lynch & Co.’s First Franklin and H&R Block Inc.’s Option One Mortgage in pulling out of the market.
Wait a minute, if the problem is bad brokering then putting the due in due diligence should restore credibility in the 2/28 loan products and financial institutions could continue offering these loan products to risk savvy borrowers and investors. Now listen to this excuse. Yoon says these lenders are following “guidance from the Federal Reserve and four other regulators that urges banks to qualify borrowers based on the highest rate the loan could incur after it resets, instead of the lower, initial rate. By using only the lower rate, it was easier for home buyers to qualify.” But if this is a product designed for sophisticated borrowers, Wells should stand tall and defend the product. Retreat is a sign of weakness in the argument. I am reminded of the quote attributed to Captain John Parker of the Lexington Militia, “Stand your ground…if they mean to have a war, let it begin here.” Where would this country be if subprime lending decision makers from Wells were in charge of defending greater Boston.
In my opinion, this is an admission that the loan itself is defective. By defective I mean a high risk loan deceptively designed to appear affordable to the least sophisticated consumer. Is that too cynical? Not when you read what Yoon says about second quarter profits, “Wells Fargo this month said its second-quarter profit rose 9 percent to a record, as higher customer fees offset a decline in mortgage banking income and a jump in loan losses. [Customer fees offset the huge decline in mortgage losses? Just how high are those customer fees? But that is another story.]
Folks, this is a Pepsi moment where the other guy blinked. Consumer groups have been warning that subprime loans were detrimental to the health of the home buyer. A cut and run from the subprime market condemns the lending industry in the face of this retreat.