The emergence of the modern mortgage finance system as conducted by multiple players on the origination, securitization and servicing sides led to an environment where no one party is forced to take responsibility for failed loans, according to HousingWire associate publisher and former mortgage lender, Richard Bitner: As he testified today to the Financial Crisis Inquiry Commission (FCIC), the fragmented subprime mortgage market began loosening underwriting standards to such an extent that eventually a letter from a borrower's mother sufficed as proof of rental history. Lax underwriting and ineffective risk management led to the current mortgage crisis, he said. He noted that, if a lender offers a high-risk product and profit margins continue to drop, one of two things must happen: The lender either increases interest rates or tightens underwriting guidelines to compensate for the reduced margin and subsequent risk. "Not only did the industry choose to ignore both principles, it went in the opposite direction by developing more aggressive products, as indicated earlier, and not pricing for the associated risk," Bitner said. "Ultimately, these were the primary factors that contributed to the demise of the subprime lending industry and served as the catalyst for the financial crisis." Bitner told the FCIC the separation of third-party originators from large bank lenders, servicers, securitizers and bond investors contributed to the shifting of liability. "This fragmentation gave each player a claim of plausible deniability," Bitner will tell the Congressionally-appointed panel. As a result, the mortgage finance industry saw a growth in the number of originators with little to no financial interest in a borrower's ability to pay, according to his testimony (download here). Although FCIC members grilled other hearing witnesses on the financial firms that hold no financial interest in the mortgages created, former chairman of the Federal Reserve board of directors Alan Greenspan shifted his focus to the role credit-rating agencies played. The agencies are often attributed with artificially inflating the credit quality of securities formed with subprime mortgages by assigning triple-A status to what became a junk investment. This ultimately shifted the fallout to bondholders that stood to lose millions of dollars on subprime investments. "The major source of the problem was that because of the complexity of the types of products that were being issued, otherwise sensible people in despair relied on the credit ratings issued," Greenspan said. "[If] instead of giving triple-A designations to a lot of these [deals], they gave them B or triple-B, which many of them were, people wouldn't have bought them and the problem being raised would not have happened." Bitner noted that, while securitization -- perhaps "the single greatest innovation to mortgage lending" -- helped segment the mortgage market, it was not the only innovation to fail in the long term by inflating the housing bubble, Bitner said. The income potential for brokers of subprime mortgages and wholesale lenders, as well as a lack of industry oversight and a faulty appraisal process, also helped to run-up home prices in the height of the boom, he told the FCIC. Bitner said the mortgage lending industry was quickly "losing touch with reality" as home prices and profits grew wildly. The high-income opportunity inherent in competitive fees charged to borrowers and the interest rates achieved contributed to the lack of judgment that grew in the mortgage finance industry and led to the inflation of house prices, he said. The subprime industry also consistently accepted overvalued home value appraisals, partly because "a home is worth whatever someone is willing to pay for it," Bitner said. "If the appraisal process had worked correctly, a significant percentage of subprime borrowers would’ve been denied due to a lack of funds." Write to Diana Golobay. Disclosure: the author holds no relevant investment positions.