The competitive market for risky loans supported the inflation of the subprime bubble and the run-up in housing prices, according to testimony provided to the Financial Crisis Inquiry Commission (FCIC) today. HousingWire associate publisher and former mortgage lender Richard Bitner told the Congressionally-appointed panel there was “significant financial gain” for mortgage brokers to sell consumers loans at interest rates above par. Following up on initial remarks over the subprime industry’s lax underwriting, Bitner noted that his now defunct lending firm — which initially engaged in subprime lending — would usually consider whether a borrower had the ability to pay the loan. If not, he said, a lender probably had no business making the loan. Ultimately, some loans closed that were unsustainable, even from the very first payment due. Bitner’s firm would sometimes receive repurchase requests on a small portion (2-4%) of the loans it sold to the big banks. Usually these returns were due to first payment defaults, sometimes linked to cases of fraud, he said. For instance, in 2005, Citigroup (C) saw 2% of loans it purchased end up in early-pay default, though that rate increased to around 5-6% in 2007, according to Susan Mills, managing director of mortgage finance at Citi Markets & Banking. “We were fairly successful in getting firms to repurchase early pay defaults until those firms went out of business. And then we were stuck,” she told the FCIC. Despite the rare occurrence of early pay defaults, there was “tremendous demand” from fixed-income investors to buy prime, Alt-A and subprime securities, Mills said. Risk exposure among subprime loans and linked investments for years went unmeasured and unchecked, according to Thomas Maheras, former co-chief executive officer at Citi Markets & Banking. “We in the industry and the regulators missed this particular aspect of risk management. We were negative on subprime,” he told the FCIC. “We were logically not focused on those areas where we all believed system-wide the securities were safe enough to withstand very significant pressure.” But it took a step-down in housing prices to force the industry and regulators — and the public — to realize investments based on housing were not always immune to severe economic pressure. “[F]rom the very earliest part of ’07 and the end of ’06, in most of our business areas we were reducing our risk around subprime,” Maheras said. As the subprime contagion spread through structured vinance vehicles, synthetic structures quickly came under scrutiny, according to Nestor Dominguez, former co-head of global collateralized debt obligations (CDOs) at Citi Markets & Banking. He told the FCIC Citi became concerned in mid-to-late ’07 when CDOs began to collapse. As of August 2007, Citi began discussing the collapse of subprime and the knock-on effect it could have on the payment waterfall, right up to super-senior debt. In fact, the global proliferation of securitized US subprime mortgages acted as the “immediate trigger” to the current crisis, according to earlier testimony of former chairman of the Federal Reserve board of governors, Alan Greenspan, before the FCIC. Write to Diana Golobay. Disclosure: the author holds no relevant investment positions.