Federal Reserve Chairman, Ben Bernanke, spoke just minutes ago to a UC Berkley conference on the mortgage market challenges moving forward from the current crisis.

Ben did a great job outlining the gestation of the crisis by outlining the difference in public versus private securitization. GSE securitization of mortgages is what he called “public” in that it was started and controlled somewhat by government mechanisms…and it held an implicit government backing.

Subprime Private Label Securitization The Cause

Private label securitization, securities created by private companies backed by mortgage obligations, was the main problem. Specifically he mentioned the “subprime with adjustable rates” private label securitization as the weak link in the system calling this type of securitization as “operating in unsafe and unsound manner”.

Bernanke is right. The subprime market grew at what should have been an alarming rate. Over a few years, the securitization of subprime mortgages grew so fast it made of half of all mortgage securitization. So there was as much subprime as prime mortgages being originated!

It was my contention at the time, the profits provided up and down the line in the subprime origination chain were so high, this increased desire to put folks into subprime products was too enticing. Many brokers we knew were actually funneling prime borrowers into subprime products just to earn the higher commissions.

This, of course, could be a personally risky option should the borrower discover another, better loan was available he was not made aware of, but most originators took that risk without thought.

Clients and Real Estate Agents Part of the Problem

The mentality of “get the deal done” and “use whatever product we are sure will get approved” was a mantra reverberated in the ears of every loan originator by their real estate agent and borrower clients throughout the real estate boom. To be fair, the customers and their agents are also to blame for the over-use of subprime mortgage products.

Having said that, the money is the real culprit. If an originator could make $4,000 on a $200,000 prime loan versus $8,000-$16,000 on the same size subprime loan…the temptation to put everyone in a subprime loan and to go find as many folks (qualified or not) to stick into a subprime loan…is simply irresistible.

I hope you can now see the link between an overpowering monetary motive for retail originators created by the high paying subprime private label securitization market. If this private label market was not offering such incentives, originators would have ignored selling subprime mortgages sticking instead with the tried and true prime market.

Good Luck!

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