The Menlo Roundtable

How the Roof Caved In

The facilitators of the housing boom in the early 2000s were the mortgage lenders.

In prior years, the banks who originated the mortgages would do a lengthy background check on the borrower before approving them for their mortgage. The borrower had to meet the 3 C’s: character, collateral and credit history. However, these background checks fell out of fashion, and in their place stated income mortgages became much more widely used. The stated income mortgages allowed the borrower to declare their income, whether it was true or not, and then the banks would give them a mortgage based upon that income. These types of mortgages were originally intended for lawyers or doctors, because they made lots of money but didn’t have a fixed income. However, they were widely exploited in the early 2000s by people with lower incomes who claimed that they made more money than they actually did. Concerningly, the mortgage lenders did not care about this problem, because they would just turn around and sell the rights to the mortgage revenue to investment banks on Wall Street. All that the mortgage originators had to do was make sure that the borrower did not default on their mortgage in the first three months, since they were liable for the mortgages in that case. Otherwise, the mortgage defaults were Wall Street’s problem.