One of the questions I am often asked is how mortgage lenders could have made so many crappy loans over the past several years and not know it? While there is no simple answer, I do have my own theories as to what happened. Greed is the obvious answer, but I believe the real answer is efficiency. Yes, efficiency.

It used to be when you needed a mortgage, you put on a suit and went down to your local community bank and explained to the loan officer why you deserved to get a mortgage loan. The loan officer carefully looked at your situation which included verifying income, assets and credit. If the loan officer decided that your loan made sense, he then took your file to make a case to the bank’s credit committee who then made the final decision since the bank had to keep the loan on their books.

Due to advances in technology, statistical analyses and loan securitization the scenario above is a thing of the past in all but the rarest of circumstances. Nowadays, loans are made based on whether you fit into a predetermined “product matrix” and if automated underwriting systems from Fannie Mae and Freddie Mac like your credit profile or if you fit into a secondary marketing investor’s box so the loan can be sold on Wall Street.

Common sense is a thing of the past with mortgage lending. No longer do loan officers and underwriters look at you as an individual, but whether your loan can be profitably sold on Wall Street. Despite what the commercials say, you really are just a number. This is how banks decided to offer mortgages to people with 580 FICO scores, no assets and no income verification with 100% financing. The statistical models said the default rate is low and Wall Street said we will buy all the loans like this you can bring us.

Naturally, consumers who couldn’t pay a cell phone bill on time aren’t going to say no to free money either. As we are seeing now, this all ground to a halt when the banks were surprised that the 580 FICO score consumer actually didn’t pay things on time which ultimately meant Wall Street would stop buying the loans, and now the banks can’t offer the products.

Of course, ANY layman on the street could have told the banks that it wasn’t a matter of if the loan would go bad, but a matter of when. No one stopped to ask if the loan would actually perform. Performance of the loan didn’t matter. Wall Street determined the loan was a good risk, so who cares? So what if the borrower has 50 cents to their name? The banks were too caught up in their fancy models instead of using the tried and true method of evaluating credit, character, capacity and collateral of the individual loans they were making.

This odd way of doing business has resulted in every loan officer being able to share illogical war stories about verified millionaires not being able to get a mortgage over a seemingly minor issue versus verified deadbeats getting 100% financing with no problem just because Fannie Mae’s automated underwriting engine liked the loan.

Unfortunately, due to consumers’ quest for the ultimate low rate mortgage combined with big businesses’ desire to quench that thirst, we aren’t likely to go back to the old days anytime soon. All I can tell you is when your loan officer asks for documentation that doesn’t seem to make sense, now you know why.