Mortgage bonds pioneer chastises industry

ARLINGTON, Virginia (Reuters) - A pioneer of mortgage finance who taught Wall Street how to make big bets on the U.S. homes market said on Tuesday that the lending industry must stop making risky loans to low- and moderate-income borrowers.

"It has been a mistake to think that yield and house price appreciation could substitute for solid underwriting," said Lewis Ranieri, who was an early wizard of the financial alchemy that turns home loans into mortgage bonds that let Wall Street claim a large stake in the housing market.

"Affordability is the essence to long-term stability," he told a conference on the future of mortgage lending for low- and moderate-income households.

Ranieri, while at Salomon Brothers in the late 1970s, helped create the mortgage "securitization" model that nurtured the home finance sector, but he said that investors acquired an unhealthy appetite for risk that grew stronger until 2006 when a five-year housing boom came to an end.

For more than a year now, world financial markets have been roiled by failing loans and tightening credit left in the wake of that housing boom.

As the housing and financial markets lick their wounds, Ranieri said, lenders must pull back from the easy terms and low early payments that many low-income borrowers used to buy unaffordable homes.

"The low- and moderate-income family should have to affirmatively choose to reject a 30-year, fixed-rate loan before taking an alternative," he said. "That is a really horrible statement to have to make but we have so many scars at this point that to go forward we have to limit free will at least for the foreseeable future."

Lenders and borrowers need to return to thinking about a home as shelter and not a swiftly-appreciating asset and source of cash, he said.

"Payment stability is essential to long-term affordability," he said. "Many affordable loan programs not only put homeowners at a risk of payment shock but also allowed them to leverage their income and assets unreasonably."

Ranieri is chairman and chief executive of Franklin Bank Corp FBTX.O, a Texas-based company that has come under investigation by the Securities and Exchange Commission over its lending practices.

Ranieri, who also manages a variety of financial interests as CEO of Ranieri & Co., said extensive risk-layering was one popular practice that took hold during the housing boom and must come to an end.

"As a result of piggybacks we now have hundreds of thousands of second mortgages standing in the way of restructuring (their loans)," he said.

Piggyback loans, which give two or more lenders a stake in its performance, are difficult to restructure because so many lenders have to agree to the terms.

(Reporting by Patrick Rucker; Editing by Leslie Adler)