Sub Prime Mortgages

Sub prime mortgages suddenly became a major issue. It looked as though the financial system might collapse. This would cause a lot of pain. We saw a lot written and lot of nonsense. Special pleading was going on. Various directors were talking to the government asking them to bail them out with tax payers' money.

We know that financial outfits are regulated by the Financial Services Authority [ aka the Fundamentally Supine Authority ], a very large government outfit with power. What was it doing when companies were pushing dodgy loans to people who should never have had them? Not a lot is the answer. Were they incompetent, idle, indifferent or corrupt? The answer to the last point will be revealed when various highly paid civil servants walk away with their golden handshakes and come in for their golden hellos from the firms they were allegedly regulating.

Private Eye, which is the nearest thing to honest journalism in England explained it at Subprime made simple. Here is their update which demonstrates gross incompetence at best. It is fair to say that a man on a mere £408,000 a year, including a £65,000 bonus might not feel obligated to do much in the way of work. Notice that the little people who told fibs find themselves charged with fraud while the big men walk away laughing.

Private Eye 1207 takes up the story on page 20:-

FUNDAMENTALLY Supine Authority insiders insist there was little interest in policing the booming "sub-prime" mortgage business which the FSA had taken over in 2004 until problems started to appear in 2006.

Then, last autumn, the FSA discovered that it had concerns about mis-selling by mortgage brokers and poor lending practices by the major providers. This followed a survey of the 11 lenders who controlled more than half the "sub-prime" market. Some of these had not been inspected by the FSA until 2007.

What the Bank of England describes as "other specialist lenders" - as distinct from banks, former building societies like Northern Wreck and the fuddy-duddy mutuals such as Nationwide they had left behind - saw their share of mortgage lending overtake that of building societies. Their market share doubled to around 15 percent in the 10 years to 2006. Much of that business was increasingly coming from "subprime" borrowers riding the housing bubble, plus "buy-to-let" investors. This is the home of the neutron loan - it removes the borrower but leaves the home standing and available for repossession and resale.

One of the biggest and fastest-growing players in the booming "sub-prime" market - along with GE Money Home Lending (Eye 1188) - has been GMAC-RFC, the UK subsidiary of the giant auto finance business originally built by Detroit car makers General Motors. At the end of 2006, control of GMAC was bought by a consortium led by private equity group Cerberus, which was briefly interested in buying Northern Wreck last year.

GMAC, like GE and other American-owned lenders, introduced to Britain the aggressive 0some prefer predatory - lending techniques that created the US sub-prime crisis whereby cities such as Cleveland and states such as California and Florida are seeing unprecedented waves of home repossessions among those who were only ever bad risks.

GMAC has seen its UK business accelerate in recent years, increasing its market share every year from 1999 to 2006 on the way to becoming the 10th biggest mortgage lender. In 2006 its loans grew by 75 percent to just over £12bn. Like Northern Wreck, GMAC relied on the money markets and securitising mortgages to fund this explosive growth. One of its big customers was Bradford & Bingley, which now has its own problems due to its appetite for "sub-prime" business and the wholesale money market.

GMAC's motto was "Mortgages for everyone in a fast, easy automated process". That process was designed in some cases to take just 25 minutes! All of which generated profits in 2006 of £ 11 Om - down on 2005 due in part to selling off chunks of the loan book.

Using a network of brokers highly incentivised by commission, GMAC is well represented among what are known as "medium to heavy adverse" customers - in other words, those who would find it difficult to borrow from High Street banks and building societies at the best of times, never mind now.

During 2006, the FSA carried out a wide ranging "ARROW" risk-assessment inspection of GMAC. Unlike at Northern Wreck, with whom it found no problems, the FSA inspection of GMAC highlighted several matters which insiders say caused concern - in particular, insufficient verification of borrowers' incomes. The GMAC model relied more on credit scores and historic propensity to pay, plus a loan-to-value margin of 10-15 percent. Full status income verification was estimated to take place in less than 10 percent of all loans. Lenders have a duty to ensure affordability under FSA rules.

The inspection also discovered that, as with many similar US lenders such as leading US "subprime" pump feeder Countrywide Financial, customers were "cascaded down" to more expensive "sub-prime" terms, but they were rarely "cascaded up". As a result, GMAC borrowers who might have justified better, near prime terms were being offered, via their brokers, more expensive "sub-prime" loans. Such loans generate much bigger interest and fees for brokers and lenders.

A subsequent general market survey suggested that at least 5 percent of all "sub-prime" borrowers could be the victims of such treatment. This is clearly in breach of the FSA's "Treating Customers Fairly" policy. 

Those with knowledge of the ARROW inspection at GMAC say there was discussion of its lending procedures, including the reliance on self certification and whether the terms on offer were made clear enough to customers. GMAC insisted its credit controls were adequate and that it was not treating clients unfairly. The software used by brokers, it claimed, could only "cascade down"! It agreed to make this clear to brokers.

The FSA subsequently issued a risk mitigation programme (RMP) to GMAC - the norm where there are concerns. An RMP sets out the issues identified by the ARROW, the outcomes sought by the FSA, the action to be taken and the timescale for compliance. Some involved in the process believed that the FSA was too soft in its approach, given the evidence. The FSA accepted GMAC's assurances of improvements and took no further action. But all this was before "sub-prime" became a dirty word for financial regulators.

Subsequently, last year, two case studies justified the concern expressed by some inside the FSA. Carer Sandra Ashcroft was charged with obtaining money by deception by mis-stating her income on mortgage applications to GMAC and "sub-prime" rival Southern Pacific Mortgages, owned by Wall Street investment bankers Lehman Brothers. Ashcroft claimed to be a senior nurse with a good salary and was loaned £120,000 earning only £6,000 a year. Evidence was given that she had been encouraged to provide misinformation by her mortgage advisers. Hi counsel told Manchester crown court: "Very questions are asked and the price is higher fees and higher interest rates." Ashcroft was given a suspended sentence last August because the j found: "You appear to have been steered tow, giving misleading information."

In January 2007, retired sailor Ismail Ali was made homeless when his east London ex council flat was repossessed. He had obtained £75,000 mortgage from GMAC in 2004, despite income of only £517 a month. His mortgage { £430 a month. It was claimed he earned £24,0 year as a bookkeeper. Ali blamed his brokers J the misinformation.

"Sub-prime" lenders such as GMAC represent a greatly disproportionate share of repossession according to a 2007 study by Citizens Advice; other research. As the numbers of repossessions rise this year, that share is set to increase.

In both the Ashcroft and Ali cases, GMAC denied any complicity or wrongdoing, insisting acted in good faith. A GMAC spokeswoman confirmed that the FSA had issued the RMP. " is normal practice by the FSA following an ARROW visit and is nothing unique to GMAC," she said "GMAC-RFC is not at liberty to disclose the contents of the RMP. Nothing contained in the RMP required material change in the way GMAC-RFC operates. All actions were implemented to the satisfaction of the FSA wit the required time-frames."

But the evidence of the flaws in GMAC's approach to its customers' ability to repay has grown in recent months, especially in the US. Last November, the ultimate parent company, GMAC Financial Services, disclosed that it ha; lost $1.8bn at its home lending arm, Residential Capital, by the end of September. In February, GMAC disclosed that ResCap, which owns GMAC-RFC, had lost $4.35bn in 2007. The rating agencies have cut their rating on both GMAC and ResCap bonds to junk status.

In Britain, GMAC-RFC has cut staff, curbed lending and is now looking for much higher loan to-value margins. Mortgage applications are said be down from 700 a day a year ago to sometime; just 10! It will be interesting to see whether the FSA response will be the same come the next ARROW visit.

CLEARLY FSA chief executive Hector Sants. like soon-to-be-gone retail markets division managing director Clive Briault, had no idea how little regulation there had been of Northern Wreck when quizzed by MPs on the Treasury select committee last October.

How else to explain Sants assuring sceptical MPs that the bank had been "under close and continuous supervision"? The FSA told the committee there had been "very regular dialogue with the firm on the full range of supervisory issues".

The FSA internal report summary last week revealed that there had been only eight meetings with the bank in total between February 2006 and August 2007, of which five were on one day in April 2007 and two were by telephone!

The report seeks to lay the blame firmly on the "manager and lead associate" supervisors in the major retail groups division who had been consistently involved with Northern Wreck from 2004. There were three heads of department in that period. But two key decisions in the failure to supervise Northern Wreck were taken much higher up the FSA food chain.

The damning FSA report - the full report seemingly needs a further month to be sanitised of names and supposedly sensitive commercial data before it is published - indicated that neither Briault nor David Strachan - head of major retail groups - showed sufficient if any interest in Northern Wreck despite its unique business model being so reliant on the wholesale money markets and general confidence.

The remarkable decisions in February 2006 to.........

a/bIIi- ~~ -::-;::-,:,,;: ffiree years before it would be ~ :.:: ;::'2mer --\.RROW inspection ØagaM ~ 1C-'~2'" of the manager and associate wOO =-J;;"':':.~-: the inspection, who wanted only two :-= - .:.::d not to issue any risk mitigation progr='-';o because the bank was considered 4ov,--probability" for risk were approved by an FSA internal ARROW panel. These usually consist of not just the two immediate s~pervisors and the head of department but also the relevant director - in this case Strachan - who is either present or consulted.

No wonder the internal report criticised the "level of engagement and oversight by supervisory line management" and failings "at the level of director and above". But it seems only Briault will walk the Canary Wharf plank. Strachan is still on board, even if it is suggested his role is now more directed to "financial stability" - a role he already had.

Luckily, all FSA executive directors are entitled to up to 12 months' "total remuneration" in the event of early termination. For Briault last year,

. that meant £408,000, including a £65,000 bonus. He also had a pension with a transfer value of £872,000 a year ago, which will probably be worth nearer £1 million when he leaves later this month.

FSA insiders reject the internal report's alibi that Northern Wreck was a regulatory aberration. The regulatory failures exposed by its near collapse were, they say, "entirely representative - this is the culture of FSA supervision". Northern Wreck was clearly high-risk. But the "highly dysfunctional culture" within the FSA meant it escaped action until it was too late.

As for Sants' "close and continuous" monitoring, this was described as meaning "undue reliance" on and accepting information from the regulated. Supervision was seen as a dumping ground for poor managers with resulting poor motivation among supervisors who were either "inexperienced or time-servers".

Hopefully the MPs - who decided without the benefit of the FSA internal report that the regulator had "systematically failed" - will give Sants a harder time when he returns for a second grilling next month.

RICHARD WHO? That was the underwhelming reaction to news that the new man at the head of the Serious Farce Office will be Richard Alderman, the lawyer in charge of Revenue & Customs' civil investigations.

"Nobody has ever heard of him," declared one source in regular contact with the SFO. Alderman, 55, was clearly seen by the Attorney-General Baroness Scotland, herself no criminal law expert, as the proverbial "safe pair of hands" so beloved by Whitehall and Westminster. This may well have swung the decision in Alderman's favour against the other, more imaginative names on the short list, discussed in Eye 1203, which also included a QC and one or more top white-collar crime lawyers. As a civil servant, he was also more quickly available.

No doubt Alderman, who replaces Robert Wardle later this month, has signed up for the reforms expected to be required from the De Grazia report and can be relied upon if, after that, the SFO is to be rolled into the Serious Organised Crime Agency during his four-year tenure. A previous Alderman gig involved setting up the short-lived Asset Recovery Agency, which has since been subsumed into SOCA. But whether such a low-profile figure will be the man to deal with the kind of high-profile problems regularly faced by the SFO director - or the man to stand up to the government as Wardle did initially over BAE - remains to be seen.