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Global Economic Intersection Article of the Week
A reader has asked several important questions about liar's loans that are critical to understanding the causes of the ongoing U.S. crisis. By 2006, half of all loans called "subprime" were also liar's loans. Roughly one-third of all home loans made in 2006 were liar's loans. The crisis was originally called a "subprime" crisis, but it was always a liar's loan crisis. The reader is correct to inquire about causation and moral culpability.
"Dr. Black, are liar's loans the same as stated income loans? In either case, how do we know whether buyers or loaners put the income for the loan? If most of these reported incomes were entered by borrowers, I would think most of the blame falls on them."
Yes, "liar's" loans are what the industry called "stated income" and "alt-a" loans when they were talking among themselves. Income was the primary category that was "stated" – i.e., listed without any verification as to accuracy – in a liar's loans. Some liar's loans, however, also "stated" employment, assets, and liabilities. "Stated income" is a euphemism for a liar's loans, but it is at least honest about its insanity. Readers get it right immediately – they understand that no honest mortgage lender would make loans on this basis. (I expand on this point below.)
"Alt-a" is a bright shining lie. "Alt" is short for "alternative," where the lie is that the loans are "underwritten" through an "alternative" methodology. True, if not underwriting can be considered an "alternative" to underwriting. Relying on a credit score is not underwriting, particularly in the home lending context. The borrower's credit score does not tell the lender whether the borrower has the capacity to repay a $600,000 home loan. "A" is an even more blatant lie, it claims that the loan is "A" quality, i.e., "prime."