Worst Practices

The option ARM trend is only the most obvious example of shaky lending during the bubble. Some banks slackened their standards even when making Federal Housing Authority loans, which are insured by the government and must conform to strict rules. On Aug. 10, for example, the U.S. Housing & Urban Development Dept.'s Office of Inspector General found that National City Mortgage, a unit of National City Corp. (NCC ) in Cleveland, "did not fully meet HUD's requirements" on any of the nine loans the agency sampled randomly during a routine audit. HUD also said National City failed to follow up on iffy employment and credit information in all nine cases. In a statement provided to BusinessWeek, National City said it found errors in just seven loans. "This is an instance of a failure to meet our own stringent internal standards on a very small percentage of our production," it said, "and is certainly not indicative of a loosening of standards."

Others are seeing slackening as well. The U.S. Office of the Comptroller of the Currency has surveyed the underwriting practices of retail banks for 11 years. Last year it found a third of the largest banks had lowered their standards -- a record. "Lenders have abandoned all standards in an effort to maintain short-term earnings," says Peter Schiff, president of Euro Pacific Capital Inc., an investment firm in Darien, Conn. "Now we have people in houses who have no prayer of making the payments or even selling their houses."

How bad have things gotten? In 2005 banks gave 43% of first-time home buyers loans for fully 100% of their house value, says the National Association of Realtors. Until recently "these loans did not exist," says Walter Molony, a NAR spokesman. The ultimate sign of lax lending: so-called no-doc loans, which don't require any documentation on the part of the borrower. Anything goes, it seems, to keep the money flowing.

Consider Greg, a single father earning about $45,000 a year as a baker in San Diego who asked BusinessWeek not to use his last name. A decade ago a bank might have given him a mortgage for about $100,000, or 2.5 times his income, the rule of thumb. Yet he's on the hook for about $940,000, or nearly 21 times his pay, with two loans on two houses from Countrywide and Accredited Home Services. (Neither would comment on an individual case.) Says his bankruptcy attorney, Ray Schimmel: "He got those loans in about a year. How crazy is that?"

Greg started by borrowing $4,500 from his 401(k) -- not even enough to the cover closing costs. When he couldn't make payments on his first house, he rented it out and moved into a utility closet. Then he tried to get out of trouble by buying another house and flipping it. No dice. To cover his three mortgage payments, he has racked up $55,000 in credit card debt. Both houses are for sale, but in a slumping California market Greg will be lucky to break even.

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