For a glimpse of the risks that infected the mortgage business in recent years, consider a small slice of what happened at Freddie Mac, the giant home-loan investor chartered by the government to bring stability to the housing market.
Before the era of easy credit, home buyers were ordinarily required to come up with down payments, which gave them an equity stake in their property.
That equity reduces the danger of foreclosure, and federal law prohibits Freddie Mac from buying mortgages that cover more than 80 percent of a home's value — unless the loan comes with a safety net, such as an insurance policy that would kick in if the borrower defaults.
However, in recent years, Freddie Mac permitted home buyers to borrow all or part
of the remaining 20 percent by using second loans, or "piggyback" loans, with no safety net.
As early as 2005, an industry group protested that the practice was designed to get around the law and should be stopped.
Regulators let it continue, and Freddie Mac financial disclosures were silent on the subject until last month, when the company noted that such loans could leave borrowers more susceptible to foreclosure.
"As home prices increased during 2006 and prior years, many borrowers used second liens ... thus avoiding requirements under our charter," Freddie Mac said in a quarterly financial report.
Nothing prohibited Freddie Mac from taking on uninsured piggyback loans, Patricia Cook, Freddie Mac's executive vice president and chief business officer, said in an interview.
"I don't think we viewed it as our role or responsibility to say to the market that seconds were inappropriate," she said.
Loans in piggyback arrangements are "a very small piece" of the company's investment portfolio, and their performance "is markedly better than any of the toxic mortgages that have been originated," said Anthony "Buddy" Piszel, Freddie Mac's chief financial officer.
Others say the purchase of piggyback loans is one of many factors that have left Freddie Mac exposed to potentially larger losses as a nationwide debt bubble deflates.
Last month, Freddie Mac announced a $2 billion loss for the third quarter. Since early October, its stock has dropped 41.5 percent, erasing billions of dollars of shareholder wealth. Last week, it cut the dividend it pays stockholders by half and borrowed $6 billion to meet federal capital requirements.
Career Institute Newsletter, December 7, 2007
Don't spend a PENNY 'til you call JENNY!
Jenny Markham, 615-812-4174