All The Devils Are Here: Unmasking the Men Who Bankrupted the World (29 page)

Besides, with Wall Street willing to buy anything, mortgage issuers willing to guarantee anything, and estimates about the probability of default open to assumptions, Kurland’s rules could be rendered basically meaningless. Indeed, one former executive says that if he could go back and do one thing differently, he would look at the models about how loans were supposed to perform and say, “I’m not going to believe them.”

“We had meetings where I would say, ‘Are you sure you’re comfortable with that?’ ” says this person. “And they would bring in the quants!” And so, the matching strategy came to mean that Countrywide repeatedly loosened its guidelines for both the loans its own sales force originated and the loans it purchased from others, according to the SEC. Other subprime companies, for instance, adopted a loan strategy called risk layering, in which two or three different risks—no-doc, adjustable-rate, credit-impaired
borrower—were wrapped together in one loan. These were risks that were never meant to coexist, and blending them greatly increased the chances of default. Yet since Countrywide’s competitors were making risk-layered loans, Countrywide made them, too. It was madness. “Subprime one was just really high rates for borrowers with bad credit,” says Josh Rosner. “That’s different than the loan itself being a bad product.”

“When you are the biggest, you have a responsibility to not give credibility to bad products—whether you’re Countrywide, Fannie, Freddie, or any of the big mortgage lenders out there that were doing this,” says a former Countrywide executive. Countrywide did just the opposite: by mimicking the products of competitors, no matter how dangerous, it gave them an imprimatur they didn’t deserve.

There was a final problem with the company’s subprime guidelines. If a borrower couldn’t meet the guidelines, Countrywide would try to make the loan work anyway. This was not some rogue effort by aggressive branch managers to sidestep the rules. It
was
the rule: Countrywide called it the exception pricing system. Every lender had some version of this, but, according to the SEC, Countrywide “liberally” used its exception policy for loans that didn’t fit into even the loosened guidelines. One former Countrywide executive says that Mozilo told the sales force to listen to Sambol, not Kurland; in its complaint, the SEC corroborates that in part, saying the company’s rules about a kind of subprime loan known as an 80/20—the customer took out two loans in order to borrow 100 percent of the money needed to purchase a home—“were ignored by the production division.”

In 2005, John McMurray, Countrywide’s chief risk officer, wrote in an e-mail to Sambol, “As a consequence of [Countrywide’s] strategy to have the widest product line in the industry, we are clearly out on the ‘frontier’ in many areas.” The “frontier,” McMurray added, had “high expected default rates and losses.”

Those in the industry could see the change, even if Mozilo still refused to acknowledge it. Says a former industry executive: “Roland [Arnall] thought he [Angelo] was a hypocrite. It was an odd thing, Countrywide acting holier than thou. Countrywide was in the same game.”

But to the outside world, the picture couldn’t have seemed more glorious. By the end of 2004, Countrywide had leaped in front of Wells Fargo to be the nation’s largest mortgage company. It originated a stunning $363 billion in mortgages that year. A year later, Countrywide originated almost $500 billion in mortgages. Sambol and other executives had taken to telling
investors that Countrywide expected to originate $1 trillion worth of mortgages by 2010. They were halfway there.

It was pointless to expect Washington to do anything to stop the abuses that characterized subprime two. In addition to Ned Gramlich, the only people in Washington who seemed to care about the issue were Senator Paul Sarbanes and Sheila Bair, the assistant secretary of the Treasury for financial institutions during the first few years of the Bush administration. But as a Democratic senator, Sarbanes had no leverage in the Republican-dominated Senate. And Bair, a moderate Republican from Kansas, didn’t have much leverage, either. Realizing that pushing for new regulation was futile, she tried to get the industry to write a voluntary code of conduct for subprime lending. She chaired a big meeting that included Ameriquest, Citibank, J.P. Morgan, Countrywide, and others. But that idea soon petered out. “The problem,” says one former regulator, “is that they were all making too much money.”

So it was left to local officials to try and stop the abuses. And try they did. But at every level, those who took on the lending machine found themselves stymied by lender lobbying and federal bank regulators who actively—and successfully—sought to thwart local officials. It would be hard to imagine a more telling example of how the nation’s bank regulators had become captive to the institutions they were charged with regulating.

Take Cleveland, which had been hit hard by the first subprime bubble and feared the consequences of a second bubble. In 2001, the city council passed a law banning balloon payments and mandating counseling for borrowers who were seeking certain loans. The law also required lenders to submit key information, including the total points and fees paid on each loan. In response, the Ohio state legislature, which was controlled by Republicans, passed its own, much meeker law, saying that only the state had the right to regulate lending. Mortgage lobbyists proudly acknowledged that they had largely written the state’s bill. Then a group of lenders called the American Financial Services Association sued Cleveland, arguing that the city’s law was now illegal. A court ruled in favor of the AFSA in 2003; Cleveland’s law was overturned.

That same story played out in Oakland, Los Angeles, and elsewhere. Communities tried to strengthen state laws that had been watered down by lender
lobbying, only to face lawsuits from the AFSA. The AFSA dubbed this its “municipal litigation” program; in most of these battles, the AFSA’s most public spokesman was its Ameriquest representative. From 2002 to 2006 Ameriquest, its executives, and their spouses and business associates donated at least $20.5 million to state and federal political groups, according to the
Wall Street Journal
.

States that wanted to do something about subprime lending didn’t fare much better. In the fall of 2002, Georgia governor Roy Barnes, a Democrat, signed into law the Georgia Fair Lending Act, which prohibited loans from being made without regard for the borrower’s ability to repay. It also provided “assignee liability,” meaning that the investment bank that securitized the loans—and the investors who wound up owning the mortgage—could both be sued if the loan violated the law. The outcry was instantaneous. Mozilo called the new law “egregious.” Ameriquest said that it could no longer do business in Georgia. A group of Atlanta lenders filed a class action lawsuit. The rating agencies jumped in on the side of the bankers, with S&P and Moody’s both saying they would no longer rate bonds backed by loans that were originated in Georgia.

But the most crushing blow came from the national regulators—especially the Office of Thrift Supervision and the OCC, which oversaw roughly two-thirds of the assets in national banks. Siding with the banks against the states and cities that were trying to stop abusive lending, the two federal regulators asserted something called preemption. What that meant, in effect, was that institutions that were regulated by the OTS or the OCC were immune from state or local laws. In theory, preemption makes sense—companies always want to be able to play by one set of rules, instead of having to adapt to fifty different laws in fifty different states. Federal preemption basically says that federal rules always take precedence over state rules.

But in this case, there was no meaningful federal rule. “[N]either of these federal agencies replaced the preempted state laws with comparable, binding consumer protection regulations of their own,” wrote Patricia McCoy, the director of the University of Connecticut’s Insurance Law Center, in 2008. And the preemption doctrine was never intended to give banks free rein to make abusive loans to people who had no chance of being able to pay them back. But perhaps the most important thing was the message it sent. “It gave lenders a sense that they had a protector in the government,” says Prentiss Cox, who ran the consumer enforcement division in the Minnesota attorney general’s office until 2005.

Preemption also became a recruiting tool for the regulators trying to expand their own empires. Incredibly, American financial institutions had the ability, under certain circumstances, to switch regulators—an idea that had long been promoted by Alan Greenspan. His essential belief was that having multiple, overlapping regulators was good for the system because, as he once put it in testimony before the Senate banking committee, it served as a “valuable restraint on any one regulator conducting inflexible, excessively rigid policies.” (“The present structure,” he added, “provides banks with a method … of shifting their regulator, an effective test that provides a limit on the arbitrary position or excessive rigid posture of any one regulator.”) Jerry Hawke, the comptroller of the currency, took that idea a step further—rather than sit back and wait for institutions to come to the OCC, he actively talked up the “advantages” of being regulated by the agency he headed. In early 2002, for instance, the OCC issued a press release with this startling headline: “Comptroller Calls Preemption a Major Advantage of National Bank Charter.” A former regulator says that he viewed his job as “a salesman for the national charter. He would make sales calls. The OCC used preemption as its advertising.”

Just about a year after the OCC first began trumpeting the virtues of preemption, the OTS joined in, announcing that the thrifts it oversaw were exempt from the key provisions of Georgia’s new law. The OTS’s move helped make the state’s law moot. “Either we will have an unlevel playing field and a rush of people to go get OTS charters or we will see a leveling out of the playing field by having the state legislature” change the law, said a spokesman for the mortgage lobby. Sure enough, by the spring of 2003, the law had been replaced by a much weaker one.

The OTS had long asserted preemption when states passed laws that it didn’t think its thrifts should have to follow. But in early 2004, the OCC went all in, decreeing that
all
institutions under its watch would be exempt from
all
state and local laws aimed at predatory lending.

After Wachovia moved its mortgage company into its federally chartered bank in order to take advantage of the OCC’s preemption policy, the state of Michigan argued that it should still be able to regulate Wachovia’s local lending unit. Wachovia sued. The OCC filed a supporting brief. The fight went all the way to the Supreme Court, which in 2007 sided with Wachovia.

And so it went. New Jersey, which passed a predatory lending law in the fall of 2003, repealed it a year later after the lending community, along with the rating agencies, followed the Georgia playbook. In New York, the OCC
asserted preemption when then attorney general Eliot Spitzer simply tried to get data from national banks in order to see if they were complying with fair-lending laws. “I think the reality is that the refusal to permit our inquiry, and the assistance of the OCC in helping the banks stop it, was symptomatic of a world where nobody wanted to look at anything,” Spitzer later said.

John Dugan, who replaced Hawke in 2004 as comptroller of the currency, would later argue that national banks were only a small part of the problem. He wasn’t completely wrong; by the OCC’s calculation, national banks originated 12.1 percent of nonprime loans between 2005 and 2007. But his argument missed the larger point. Preemption created competition between the OCC and the OTS—and the OTS, which regulated institutions like IndyMac and WaMu, was indisputably a weaker regulator. Secondly, preemption meant that even the state-chartered lenders didn’t have to curb their abuses, because states were reluctant to pass or enforce strict rules for their institutions that federally regulated institutions were allowed to duck. Says Kevin Stein, the associate director of the California Reinvestment Coalition: “Banks said, ‘We don’t have to comply.’ The OCC said, ‘They don’t have to comply.’ The state legislatures said, ‘If we can’t pass a law that regulates federally chartered banks operating in our state, then we’re not going to regulate state-chartered lenders, because then they can’t compete.’ It was a legislative and regulatory race to the bottom.”

Finally, subprime loans continued to make their way, unchecked, into the national banking system, thanks to securitization. It really didn’t matter who originated them. States had no way of cutting off that all-important funding source. And the national regulators, with their energy focused on making sure that “their” institutions were free from pesky state laws, idly stood by.