The Story Behind the Mortgage and Housing Meltdown: The Legacy of Greed

CONTENTS

Preface

Introduction: The Purpose of This Book

1. The Real Estate Finance Business in America

2. The Crisis Looms

3. Agents of the Apocalypse

4. The Meltdown Begins

5. The Foreclosure Epidemic

6. Living with the Aftermath

7. Taking Back Control and Ending the Black Box Era

8. I’m from the government and I’m here to help.

9. Where Do We Go From Here?

10. Back to the Future

PREFACE

WRITING A BOOK IS NOT A SMALL JOB, especially for someone who has made a living with mortgages and not with words. While I believe that everyone has a story and many would make interesting reading, putting it all down requires a good amount of effort and commitment.

In my case, I felt compelled to tell the story of the mortgage and housing crisis. I just had too much on my mind to keep it all in. So many things happened that were foolish and unnecessary, and it became enormously important to me to put it all down in a form that would make sense for the people who were affected. Most people see a book about business or on an arcane aspect of finance and pass it by. I wanted this story to be more than that. Getting it all down on paper became a big priority for me.

After years of making a great living in government insured loans, the FHA programs we all grew up with, the market changed. Mortgage originators who wanted to thrive needed to diversify their offerings a bit, including the alternative loans, the ones that didn’t require much documentation. The property values were increasing so rapidly that it didn’t seem to matter if people made the income they claimed they made. If they got into trouble making payments, they could sell or refinance, making a tidy sum in the process from the home’s appreciation. This Alt lending was providing huge volume, and the companies to whom we sold loans – our investors – were constantly clamoring for more. But it gnawed at me. It just didn’t feel right, even though lots of people I respected were going at it full throttle. If the really smart guys in the business felt this was a good business, who was I to disagree? But after a while, I became more and more worried that a great many of the loans out there were like a magician’s trick, all smoke and mirrors.

So I decided to semi-retire to Florida and let the existing management run my company, buying almost half of it in the process. I would come back up to Maryland periodically and check on things, and I spoke to the management every day or two. The practice of requiring more information on the loans we made than was required by investors meant we had achieved lower delinquencies than many other companies, but I still felt the basic concepts of Alt loans were flawed. Everything was reliant on the credit score, known popularly as the FICO, and I’d never trusted the scores. Wall Street investment banks were buying the loans no matter what. So deep was their faith in the three-digit number on the credit report that even when some of the loans stopped paying early after closing, they were asking for more even while requiring us to buy back the ones that were delinquent. It struck me as crazy, so I decided to put an end to it.

Even though I was semi-retired, I insisted my company exit the Alt lending business and return to FHA loans. Now my people thought I was crazy, but my mind was made up. What I was seeing truly scared me, and all that needed to happen next was for property values to stop climbing for things to really hit the fan. Which, of course, is exactly what happened.

Hundreds of mortgage companies have gone out of business and billions in public funds have been spent to prop up the economy and many of its institutions deemed too big to fail. We have since learned a lot about how smart the Wall Streeters really were, these shadow bankers trusted to operate with little regulation and oversight. We’ve learned that when something seems too good to be true, like the steady appreciation of real estate to ridiculous proportions, it probably is. And we’ve learned that it would have been a lot easier to plug the dam early than trying to repair the damage after it burst.

There are lots of patches being applied to the problem, some of them more effective than others. In the process of coming up with fixes, we’re also seeing some basic systemic problems with the curative process itself. People wholly unqualified to make decisions are making them, and bureaucracy, long a specialty with governments, is causing delays and obstructions that are costing innocent bystanders their homes. Through it all, well-intentioned efforts are also costing people their credit ratings, imposing huge impact on scores that will slow the recovery for years longer than necessary.

This book is not a venting of frustrations – though parts of it may seem that way. It is an earnest effort to inform people who are not mortgage professionals on how this all happened and some of the things that need to change to minimize the damage for all of us. There are things you are not being told – some because there are those who don’t want you to know them, and others because many people in power aren’t aware of them. Either way, we will all benefit from an informed public, so this is my effort toward that end.

It is my fervent belief that we are truly all in this together. Politicians can point fingers in partisan quibbling, but they don’t live in the same world as the rest of us and their main worry is their next election. It is important for the future of our children and grandchildren that we, as a country, become financially literate and responsible. The way that happens is by understanding how the system works and how it can be improved. The goal of this book is to provide a good place to start in that process of understanding.

It is my belief that President Obama, whose popularity and success has been sliding downward, has been trying his best. He needs advice from authentic experts in the field, people who are demonstrating effectiveness in this challenging crisis. The President continues to take advice from people who have never been involved in the loan business and who has never so much as taken a loan application. Taking a cue from the Obama campaign, its time for change.

The unbridled use of FICO score is, in my considered opinion, the main reason we are in the position we find ourselves in today. That number was developed for buying washers and dryers and later for big ticket items like cars. Home buying was never part of the thinking for that three digit number, yet it was allowed to replace the complex analysis and experience used in mortgage lending for decades. Enough is enough.

I would be remiss in failing to acknowledge people with whom I have worked over the years. I have been extraordinarily fortunate to be surrounded with highly professional individuals during my career and I am grateful to them for their dedication and expertise.

I am eternally grateful for my great family. I have three wonderful children, and their mother and I are tremendously proud of them. I am in a constant state of wonder at the people they are becoming as they grow and accomplish. My wife and her two children inspire me as well with the beauty of their character and the richness they have brought to my life. I am truly and enormously blessed.

Ultimately, it is the people with whom you share your life’s journey that bring quality and meaning to that experience. I credit any success I have achieved in life to them.

I also want to acknowledge the help, research and dedication of James Hennessy, Jr. in helping me write this book.

INTRODUCTION: THE PURPOSE OF THIS BOOK

THE MORTGAGE CRISIS DID NOT HAVE TO happen; like many disasters, it was avoidable. But also, like many disasters that have far-reaching effects on large numbers of blameless people, the mortgage meltdown had numerous contributors who made bad decisions. Employing an overused expression, it was a perfect storm of bad decisions, rotating around a central theme in its outwardly calm eye: Everyone is doing it—and everyone is getting rich. The people who caused it were in all walks of life, wore collars of every hue, and believed that there was no real harm in what they were doing. They were wrong.

The American mortgage crisis has wrought destruction that even the most jaded cynic would have not dared to imagine in 2007. Huge corporations have disappeared, the global economy has been crippled, the American dream of home ownership has been left in tatters, and the government of the United States has put every man, woman, and child in debt to the tune of about $40,000. That same government is also now in the insurance, automobile, and banking businesses and is the conservator of the world’s largest mortgage investors, Fannie Mae and Freddie Mac. The results have been devastating, leaving the mainstream American wondering how it happened and wondering, "Where did all the money go?"

The purpose of this book is to address that question and many others, as well as to look at ways the crisis might have been easily avoided this time and might be avoided in the future. As a mortgage banker for more than twenty years, I have been privileged to enable home ownership for thousands of families. I have seen my industry transform from its roots in building a great nation to being an agent of destruction for millions of hopes and dreams. It is my desire to offer some clarity to those in the mainstream who want answers and are not finding them in a decipherable form amid the thousands of stories and reports they have been exposed to over the last several years. Those who want to know in plain English what happened and why will find answers here, if I have completed my task as I intended. This is not a book for industry insiders or others seeking scandals or people to blame for what has happened. It is for readers who might know little or nothing about the residential finance business but who feel compelled to understand how the mortgage meltdown came to pass. After all, banking and finance are so heavily regulated, aren’t they? The answer is yes—and no. Many aspects of the business are vigorously overseen by regulators, congressional committees, and federal agencies, and still the collapse occurred. So, obviously, whatever regulation was in place was insufficient for the task it was intended to perform.

It is also important to understand that a new entrant into the mix of players was largely unregulated in its dealings in the mortgage business yet waded into the mainstream of lending with little thought of disaster. This entrant was the collective talent of Wall Street’s investment banking community, and before long, they were calling the shots on the types of loans that were being made all across the country. These new types of loans were unthinkably dangerous, and they ultimately delivered the downfall not only of the mortgage industry but of Wall Street as we had known it for generations. Before Wall Street arrived on the mortgage scene in a big way, the industry had been generally stable but always subject to cycles. With all the money pumped into the capital markets system by the pension funds and other investors in Wall Street’s securities, supposedly backed by well-made mortgages and rated highly by renowned rating agencies, the mortgage industry went out of control. There was very little emphasis on making loans that made sense—only in making more loans to turn into gold on Wall Street.

These are the parts of the story that most people struggle with. Understanding what happened doesn’t have to be difficult, and you certainly don’t have to thoroughly comprehend the fine points of the capital markets system to get a clear picture. Just as we can drive complex automobiles without being able to take them apart and reassemble them, a basic familiarity with the way the industry works is all you need. The rest can be understood by applying a fundamental knowledge of human nature, especially the part of human nature that so easily succumbs to greed.

By the time you finish this book, you should have a reasonably clear picture of how the mortgage industry developed over the course of generations, how it evolved to offer more opportunities for deserving Americans, the ways in which it evaluates risk, and how it lost its way as it went beyond the boundaries of common sense. You also will be pondering some fairly simple concepts for keeping the long-term damage to a minimum and avoiding a similar episode ever again. Our homes are our castles, and keeping them safe and secure is a task that requires effort, study, and financial literacy. Consider this book part of a course that might help you avoid losing your home to poor financial choices you might otherwise make. It also might provide you with the capacity to sense the next time the nation’s financial leaders are following a dangerous path—even before they do.

1

THE REAL ESTATE FINANCE

BUSINESS IN AMERICA

WHEN I STARTED IN THE MORTGAGE BUSINESS over twenty years ago, I found an industry that worked quite well for a wide variety of customers. It was fully formed, in the sense that it had processes and procedures in place that protected borrowers from lenders who might take advantage of them, protected lenders from unqualified borrowers who were likely to default, and protected the government from calamities like the financial meltdown we have recently experienced. As I learned more about the business, I realized this structure didn’t develop by accident. The industry had learned some tough lessons in the past and the system was designed to prevent similar things from happening in the future.

To understand where we are, you really need to look back and see how things evolved. This is a bit of a history lesson, but it’s important, as the seeds for the mortgage meltdown were sown in an eventful past. Keep in mind that up through 2006, our system of real estate finance was the envy of the world. No overstatement there; many other nations in Europe, Asia, and elsewhere had crafted entities similar to ours in order to emulate the American system. It was circular in design. Money from institutions was lent to borrowers at an interest rate that created a margin, just like those you see in any business where the objective is to buy low and sell high. Lending margins are historically small, measured in one hundredths of 1 percent, also known as basis points. But companies made money by making lots of loans, and these loans were sold to other companies that pooled them and issued securities backed by those loans. The shares of these pools—the securities—were in turn sold to investors that were typically pension funds and mutual funds. If you have any money invested in these types of companies, you are an investor in mortgages. You may also have a mortgage that resides in one of these securities, and that is what I mean by the system being circular in design. It’s a great system, self-sustaining in nature and benefiting everyone involved, at least as long as the mortgagors—the people who have taken out mortgages—continue to pay them as agreed.

It was an evolutionary process to get to this circular, self-replenishing system. Hundreds of years ago, things were very different, and mortgages were very difficult to obtain for residences. Most people were renters, and typically only those who had saved enough money to build a home owned them. Companies were created in America, similar to ones created in Europe, to pool money to enable members to buy homes. These early lenders were called building and loan societies, and they did pretty much what the name describes. Money was pooled, and when enough was available, it was lent out at a reasonable rate of interest to enable a member to acquire a home. That borrower paid the loan back over time, and those who put in the original money received a portion of the monthly payment, including a share of the interest. Building and loan societies were a tiny microcosm of the larger system that would come later, and you can see the same circular nature of the design. These companies continued well into the twentieth century – Jimmy Stewart worked at one in It’s a Wonderful Life – when many of them became known as savings and loan associations, chartered by the federal government. They were heavily regulated and supervised, and they were very different from the more traditional financial institutions, the banks.

Banks have been part of human society for thousands of years, presumably in some form since before recorded history began. The idea of lending something in order to gain a benefit certainly predates the concept of money. Tools, weapons, food, and just about anything else was lent for a price, and the history of banking could fill volumes. Suffice it to say that the ancient Greeks and Egyptians developed the practice to a high art, and moneylenders operated in many forms and in many places, including the temple in Jerusalem, as the New Testament describes. It is an idea as old as man himself. Interestingly, however, banking and housing in America were not as closely related as you might think, based on where we are today. Whereas all of the top mortgage lenders today are banks, that wasn’t the case a century ago.

THE MORTGAGE BANKERS

A new type of lender sprang up in the nineteenth century in this country, spurred by several events that made this new sort of company uniquely American. We all learned in school about the age of expansion that was kicked off by the acquisition of huge amounts of land in the early 1800s. Lewis and Clark went out to explore it, and it stretched from the Gulf of Mexico to the Rocky Mountains. People interested in real estate should think of this transaction as the most amazing real estate deal ever made; it doubled the size of the United States and instantly turned the new, upstart nation into