The mortgages on the first four homes I owned were all provided by local institutions, Pasadena Federal Savings, Idaho First National Bank, Winnetka Bank and Trust, and Security Pacific Bank.  The underwriting was done by a career employee of the institution who met with you, reviewed your job and income, and approved your loan.

This was in the days before the development of the Secondary Market where banks sold loans to outfits like FannieMae, FreddieMac, or Wall Street. The banks kept the loans so they obviously had a real vested interest in only doing good loans.  It was also before credit reports so the loan officer&39;s job was, in large part, sizing you up as an individual and ascertaining if you would be a good customer for the bank.  I will call this Character Based Lending, meaning the decision to lend you the money was based, in large part, on the Loan officer&39;s assessment of your character.

In the late 1980s’s and early 1990’s FannieMae, FreddieMac, and Wall Street firms really took over the mortgage business. If you have not read Michael Lewis’s book LIAR’S POKER, you really ought to.  The banks were there and some of the S&Ls were still left, not many, and they originated loans and sold them back East. Of course, there was no way anyone back there could meet you and assess your character. 

What this caused was a transition to Asset Based Lending.  The plain truth is that an asset based lender looks long and hard at the collateral you are providing to them as security for your loan. They know that, ultimately, that while they want you to make the payments, and they know that most people will make payments, they will end up owning some of the homes.  We used to kid about the old Home Savings, saying that if they held a mirror under your nose and could detect a sign of life, they&39;d do your loan, the one caveat being that they had to like your home.

Truthfully, that&39;s actually not a bad way of lending.  If people have equity in their homes, they will work hard to protect it. And if you are in a market where values go up substantially year after year, people have more and more equity to protect and the default rate stays real low.

But in the last few years with the rise of sub-prime lending – what I call junk lending – there was no basis for doing loans. Oh, they started out talking about "under-served" markets and minority borrowers. Honestly, I think that there were a lot of employees in those lenders who really thought that they were helping people who never would have had a shot at owning a home without them.

They also threw out most of the rules. Bad credit? We don&39;t care: No paycheck stubs or W-2s?  We don&39;t care. No down payment?  We don&39;t care.

They plain truth is that those people at the lenders who were making obscene profits on their customers and the Wall Street companies that were making so much money throwing them at their customers, got hooked on the volume! What they were doing was Volume Based Lending that had little to do with loan quality. It had to do with how much money they were making. As someone once said about these guys: If you want a friend on Wall Street, get a dog.

What happens next?  Hard to tell, but what our industry kindly calls "non-traditional" mortgages are going to be very hard to get for a while. The market for full documentation, good credit, lower LTV loans is alive and well, but for the rest, someone is going to have to find a new formula.  Stay tuned.