SEC close to settlement with mortgage agencies

The Securities and Exchange Commission is said to be close to a settlement with mortgage insurers Fannie Mae and Freddie Mac over allegations the two failed to properly disclose their exposure to low quality loans.

A weak point in the SEC’s case is the muddy definition of what constitutes a subprime mortgage. During the late 1990s and early 2000s, the proportion of adjustable-rate mortgages given to buyers whose credit scores weren’t high enough to qualify for conventional underwriting increased. It reached a high of 62% in 2006.

Overall, when you look at both fixed and adjustable mortgages, subprime originations acounted for 5% ($35 billion) of market activity in 1994, but soared to 20% ($600 billion) by 2006. Meanwhile, a Federal Reserve study found the rate markups usually tacked on to cover risk associated with lending to less creditworthy borrowers declined significnatly during the same period.

In part, the increase was sparked by 1990s-era government policies aimed at getting more lower-income Americans into their own homes. Those policies were cancelled in the late 1990s, after reports of increased defaults spooked lenders. But they were reinstated during the early 2000s following political pressure from some large mortgage originators, and robust housing markets that made many feel even the riskiest of borrowers were a safe bet.

The ability for mortgage originators to wash their hands of the loans via investments markets was the final piece of the puzzle. A stock market boom running alongside the housing boom made it easy for investment products creators to use loans as a basis for a far wider range of collateralized debt obligation products. This led to a tripling of mortgage-backed securities between 1996 and 2007 to $7.3 trillion—and the portion of subprime loans packaged into those securities rose form just over half in 2001 to 75% in 2006.