demands that surfaced as early payment defaults rose in 2006 and 2007.<sup>34</sup> These demands forced many mortgage banks into bankruptcy.

- d) Traditional MI provided a third party quality control of the credit underwriting process. Lenders and investment banks bypassed this role by using simultaneous second liens at origination, by structuring the securitization with deeper subordination, and by purchasing credit enhancements from monoline insurers. But these substitutes included no third party review of the loan documents

**Non-bank lenders dependent solely upon securitization found themselves unable to sell their loans once the crisis hit.** The lack of funding diversity is most pressing for non-depository lenders that depend solely on securitization or portfolio sales. As the subprime crisis grew in 2007, issuance and trading in subprime and prime mortgagebacked securities stopped for months at a time as investors fled the sector in its entirety. Major lenders, such as Northern Rock in Great Britain and Countrywide Financial in the U.S., suffered serious liquidity shortages even though neither was primarily a subprime lender.<sup>35</sup> Although each had thousands of high quality loans in its pipeline ready for sale, they could not find buyers. Eventually, Northern Rock was acquired by the Bank of England. Since Countrywide had as a part of its assets a Federally-chartered thrift, it was able to tap lines of credit at the Federal Home Loan Bank of Atlanta. Even this proved inadequate, and eventually Countrywide also was required to sell itself to a larger commercial bank with greater resources, Bank of America.

# **Consumer Protection Failures in Subprime Lending**

**Many subprime borrowers had good enough credit scores to be considered prime, but took out loans with features that made them subprime.** Foote, et al (2008) report that in New England, the fraction of subprime borrowers with a FICO score greater than 620, a widely accepted cutoff for subprime, rose from 40 percent in 1999 to 70 percent in 2004, and that the portion of high-FICO score subprime borrowers rose in nationwide datasets over the same period. However, at the same time, other risk measures, such as rising LTVs and DTIs deteriorated for these same borrowers. Some high-FICO score borrowers may have been inappropriately steered to subprime products, but others would have had to take out subprime loans if they were to take advantage of riskier loan features.

**Predatory subprime lenders have misled borrowers and convinced them to take out loans that they did not understand or that carried inappropriate risks.** Statistics show subprime borrowers to be higher risk than prime borrowers, to pay more for loans, to be predominately minority, to have lower income, be less well financially educated,

> 34 For a detailed exploration of the inadequacy of such reserves, see the Final Report of the Bankruptcy Examiner in the New Century Bankruptcy case.

> 35As defined in the U.S., there was very little subprime lending in Great Britain, and Northern Rock was predominately a prime lender. Between 2001 and 2006, about 10 percent of the loans that Countrywide originated were subprime.

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