Reckless Endangerment and the Mortgage Crisis

Bill Berliner Asset Securitization Report August 3, 2011

Originally published in the August 2011 issue of Asset Securitization Report (www.sourcemedia.com)

I recently completed the book Reckless Endangerment, a widely discussed and heavily promoted perspective on the mortgage and financial crisis. While the book is quite interesting and illuminating at times, it is a poorly written, incomplete and flawed analysis of recent events.

The book's strength is its description of how the fixation on affordable housing was allowed to morph into a goal that eclipsed other issues such as loan quality and institutional safety and soundness. It also describes how Fannie Mae, Freddie Mac and the lending industry exploited this to dominate housing finance and, for many years, defeat all attempts to circumscribe their activities. (Full disclosure: I worked for Countrywide Securities from 1996 to 2008.)

However, I thought the book was the weakest of the works I've read on the activities and events leading to the mortgage and MBS collapse. The writing is poor; its annoying and condescending tone is combined with an inability to explain relatively simple concepts without indulging in caricatures. While it's common for writing to be tailored to a non-technical audience, describing the Glass-Steagall Act as a measure that "protected consumers and individual investors from rapacious bankers" is ludicrous. (As the authors must surely know, it essentially protected one set of bankers from another.) It also has a strange pace, as if the authors were rushing to meet a deadline. One of the book's better sections discussed the GSEs' accounting scandals in depth, while the subsequent events leading to their being placed into conservatorship were crammed into a few paragraphs.

The authors are clearly trying to stoke anger and outrage at the various players that they view as being responsible for the financial crisis. However, their arguments and credibility are undermined by a large number of errors and misconceptions that betray a limited grasp of the mortgage market and securitization practices. Among these mistakes:

In addition, the book makes a number of dubious and unsupported claims. For example, the authors state that "(b)orrowers who could prove that their incomes and assets were ample were pushed into more expensive loans that required no documentation"¦These and other tricks hurt borrowers." Without some elaboration, this contention is highly questionable: Why would rational borrowers take unnecessarily expensive loans?

The apparently weak and unsophisticated understanding of market practices exhibited by the authors also contributes to one of the book's glaring deficiencies "” their unwillingness to examine critical issues in anything but superficial terms. For example, they write that investors bought securities backed by subprime loans (in this case, originated by Fremont) "because they offered a higher income stream than more conservative mortgages backed by Fannie Mae or Freddie Mac." This statement overlooks the fact that the largest tranches in subprime deals (about 75%, in most cases) were generally LIBOR-based floaters with reset margins of 20"”25 basis points. (The large amounts of interest thrown off by the loans were primarily utilized as credit support for the senior bonds. Only the more junior tranches and interests in subprime ABS received relatively large income streams.) This begs a series of questions, the most important of which is why large numbers of institutional investors found the senior securities attractive and continued to purchase them even as collateral performance noticeably weakened in 2006. (An ABS trader once told me that he was asked the same two questions at every client meeting: 1) "When's your next deal?" and 2) "How can I get my full allocation?") The notion that ostensibly sophisticated investors were simply "stuffed" with securities, as the book relates, is at best highly simplistic and ignores the different clienteles that were active in the MBS market.

There are numerous other examples of the book's superficial treatment of complex issues. For example, what were the actual ramifications of the repeal of Glass-Steagall on the financial system? (I'd argue that it ratified a reality that had evolved over the previous 20 years.) Is the securitization process itself inherently corrupt? Can it be policed successfully, and how? Anyone seeking an intelligent discussion of these issues will need to look elsewhere.

Finally, the authors are unwilling or unable to forthrightly address the roles that borrowers and home buyers played in the mortgage debacle. These actions included massive amounts of speculation on real estate, income misrepresentation, overleveraging (through both the cash-out refinancings cited by the authors and loans taken with absurdly high DTIs), and the pervasive mishandling of personal finances. Economists and financial advisors have been warning for decades about Americans' low savings rate, dependence on debt, and irrational activities (such as utilization of expensive credit card debt). Unfortunately, Americans have exhibited a short-sighted propensity to buy the things they want (whether they are houses or consumer items such as cars and vacations) whether or not they can realistically afford them.

An alternative to the look-what-those- evil-people-did-to-us narrative advanced by books like Reckless Endangerment is to view the mortgage debacle as an economic disaster that resulted when the home financing industry (which includes both lenders and Wall Street firms) figured out how to make enormous amounts of money by helping borrowers carry over their dangerous financial practices into their residential real estate under the guise of expanding home ownership opportunities. However, the exceedingly complex web of activities leading to the mortgage crisis defies any single explanation.

Books such as Reckless Endangerment represent the zenith of the finger-pointing game that, in my mind, is dangerous and delusional. At this point, the right approach is to work toward restructuring and rehabilitating the mortgage and housing markets. A good first step would be to implement Dodd- Frank without destroying the mortgage market, as the recent interagency proposals on risk retention would do.

Bill Berliner is Executive Vice President of Manhattan Capital Markets and runs the firm's Manhattan Advisory Services (MASI) subsidiary. His email is This e-mail address is being protected from spambots. You need JavaScript enabled to view it . The views expressed in this column are solely those of the author.

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Reckless Endangerment and the Mortgage Crisis

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