STEVE INSKEEP, host:
The president's plan also takes aim at all those bad home loans that were made during the housing boom. Some experts think that mortgage companies were sloppy in part because they did not have so called skin in the game. And that phrase - skin in the game - is the latest phrase we will take apart as we look at the language of the financial crisis.
Here's NPR's Chris Arnold.
CHRIS ARNOLD: During the housing bubble, mortgage companies were throwing money at just about anybody who wanted it and getting a home loan started to feel sort of buying a used car.
(Soundbite of commercial)
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Unidentified Man: Then come on down to Sam's Used Car Lot, where there's free money…
ARNOLD: It didn't used to be like that. Banks used to be really careful about who they loaned money to. That's because they had skin in the game. That means their own skin, their own money was on the line.
Mr. BERT ELY (Banking Industry Consultant): I can remember those days well, since I'm 67 years old.
ARNOLD: That's Bert Ely. He's a banking industry consultant and he remembers when sitting down to apply for a home loan was like going before a judge.
Mr. ELY: You sat down with a sober banker.
ARNOLD: And then in recent years, though, it got more like buying a used car or something, right?
Mr. ELY: Yes, and what's important here is that these mortgages are made with the intent of selling, not keeping.
ARNOLD: Ely explains that over the years, banks and mortgage lenders started making loans and then selling them off to investors, and when that happened, lenders became more like salespeople. Mortgage brokers and loan officers got their commission regardless of whether a loan was good or not, and it was somebody else's problem if the loans went bad.
Mr. ELY: The lender doesn't care as much about the riskiness of the loan or the eventual likelihood of default if he's going to sell it and not retain any risk.
ARNOLD: So basically lenders often don't have skin in the game the way that they used to, because they're not loaning out their own money anymore.
There were plenty of other problems. Ratings agencies failed to determine how risky a lot of these home loans were. But this skin-in-the-game issue has now become one of the targets for reform — both for the Obama administration and top Democrats in Congress. Barney Frank chairs the House Financial Services Committee.
Representative BARNEY FRANK (Democrat, Massachusetts): If I can make a whole bunch of loans and sell the entire right to collect those loans to somebody else, at that point I don't care, in my own financial interest, whether or not they pay off. We have to prohibit that.
ARNOLD: We sat down with Frank after he co-sponsored legislation that has now been passed by the House. It would limit how many loans lenders could sell off to investors. That's called securitizing the loans, because you bundle them up into securities when you sell them.
Rep. FRANK: We're basically saying now, you've got to keep five percent of that so that if there are losses, you lose money too.
ARNOLD: So you've got to have some skin in the game basically to give you a reason not to just, you know, throw money at people…
Representative FRANK: Exactly right. I'm convinced now, if you do not diminish the number of bad loans made at the outset, you cannot solve this problem. And one way to do that is to say to the people who are the originators, yes, you can securitize, you can take 95 percent of that and sell it, but you've got to hold five percent, and that way we'll just get better quality loans made in the future.
ARNOLD: The Obama administration is pushing for this five percent change as well. The president also wants to have mortgage brokers' commissions tied to the longer-term performance of the loans that they make.
And all this might sound reasonable. But the industry has some concerns. Tom Deutsch is one of the top directors at the American Securitization Forum, which represents mortgage lenders.
Mr. TOM DEUTSCH (American Securitization Forum): On its face, it sounds like a good idea, but there are some unintended consequences.
ARNOLD: Deutsch says that retaining more risk would require lenders to have more cash on hand to cover losses on loans. So he says that could make it harder for banks to loan out money. And Deutsch doesn't think the reform is necessary. He says that mortgage lenders' inherent interest in their own reputation already gives them enough skin in the game.
Mr. DEUTSCH: Hundreds of mortgage originators have gone out of business because they sold bad products to investors who wouldn't buy their product again.
ARNOLD: Still, others think that the five percent proposal doesn't go far enough. Bert Ely, the banking consultant, would like to see the U.S. shift more towards what are called covered bonds to finance mortgages. That approach is widespread in Europe. And with covered bonds, the banks stay on the hook for 100 percent of the loans that they make. With that much skin in the game, he says, lenders would be much more careful about making loans.
Chris Arnold, NPR News.
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