Rise and Fall of Subprime Lenders Began on Wall St. It all started last November, when a relatively small lender, Own-It Mortgage Solutions, defaulted on its loans to JP Morgan Chase. Since then, more than 24 subprime lenders have folded, victims of rising default rates — but also of rising suspicions that the entire subprime market is teetering.
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Rise and Fall of Subprime Lenders Began on Wall St.

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Rise and Fall of Subprime Lenders Began on Wall St.

Rise and Fall of Subprime Lenders Began on Wall St.

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ROBERT SIEGEL, host:

From NPR News, this is ALL THINGS CONSIDERED. I'm Robert Siegel.

MELISSA BLOCK, host:

And I'm Melissa Block.

It all started last November, when a relatively small lender - called Own It Mortgage Solutions - defaulted on its loans to JPMorgan Chase. Since then, more than two dozen subprime lenders have folded, as one after another fell victim to rising default rates, but also to rising suspicions that the entire subprime market is teetering.

SIEGEL: One of the nation's biggest subprime lenders, New Century Financial, is expected to file for bankruptcy any day now. Like a lot of lenders in this market, New Century specialized in zero down and no interest loans, loans marketed to people with credit problems.

BLOCK: For years, the company was able to prosper because of the financial support of much bigger Wall Street banks. Now the housing market has slowed and that support has quickly dried up.

Coming up, Robert, we'll talk about what subprime borrowers are and aren't told when they sign on the dotted line.

First, NPR's Jim Zarroli has this report from New York.

JIM ZARROLI: Subprime lending has long been the forgotten, low rent corner of the mortgage business. It has a kind of down market taint. But the image is deceiving. Guy Cecala, the publisher of Inside Mortgage Finance, says subprime lending wouldn't exist without Wall Street and its blue chip banks.

Mr. GUY CECALA (Publisher, Inside Mortgage Finance): It encouraged it. It funded it. Since the mid-'90s, lending by Wall Street firms is what's kept companies like New Century in business.

ZARROLI: Cecala says at one time companies that were in the mortgage business would lend out their own money. But the explosion of mortgage-backed securities in the '90s changed that. Mortgages could now be repackaged as bonds and sold to investors, often a big mutual fund or a pension fund.

Investors loved these securities. It was a way to invest in mortgages when the housing market was strong. They even loved the risky subprime mortgages that came from customers with weak credit. And lenders aggressively marketed to customers who once didn't stand a chance of getting a mortgage.

(Soundbite of mortgage company ad)

Unidentified Man: Homeowners, every month gets more bills, higher interest payments, and you get deeper in debt with no end in sight. With an all-in-one loan, Countrywide's full spectrum lending can help you even if you have less than perfect credit. In just 15 days...

ZARROLI: To make sure they had a steady supply of mortgage-backed securities to sell, big banks like Wells Fargo and Citicorp started their own subprime divisions. But they also did something else. They courted smaller lenders by offering them as much capital as they needed. And almost overnight, Cecala says, certain companies became huge.

Mr. CECALA: New Century is essentially a type of subprime lender that didn't exist fifteen years ago. And they were effectively created by Wall Street.

ZARROLI: The big banks had another reason to like subprime lending. Keith Ernst of the Center for Responsible Lending says many subprime companies are state-chartered, which means they aren't always highly regulated.

Mr. KEITH ERNST (Center for Responsible Lending): I certainly think this helped the volume grow as quickly as it did, and I also think it's part of the reason the quality is not what anyone wishes it would be.

ZARROLI: Ernst says that under federal law, banks have to meet certain safety and soundness requirements. So if they go out too far on a limb by making too many questionable loans, for instance, the regulators will reel them in.

Mr. ERNST: But in this marketplace there are no regulators playing that role. I mean because there aren't deposits at risk, because the money is coming from Wall Street and not from deposit accounts, there is no one there reeling lenders back in.

ZARROLI: Now, Ernst says, the real estate market has slowed and the foreclosure rate has risen. And some of those banks have been rushing for the exits of the subprime industry. Big banks like Wells Fargo are tightening credit standards. Guy Cecala says they've also stopped lending money to other subprime companies, and they are invoking clauses in their contracts demanding that these lenders take back their loans.

Mr. ERNST: What we're seeing now in the subprime market is when the Wall Street firms get cool on the mortgage on the subprime market, they just cut the funding and the loans vanish overnight. And that's what puts a company like New Century out of business.

ZARROLI: The upshot is that there will be fewer companies offering loans to people with weak credit scores, which means home ownership will get a little more elusive for low-income people. But it will also wash a lot of the risk out of the mortgage market, making it safer and more stable, at least until housing boom occurs.

Jim Zarroli, NPR News, New York.

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