All The Devils Are Here: Unmasking the Men Who Bankrupted the World (30 page)

What none of the regulators could see was the most obvious fact of all: if cities and states all over the country felt the need to enact their own laws—as twenty-five states, eleven localities, and the District of Columbia had by 2004, according to a GAO report—didn’t that suggest there was a problem that needed fixing? Even the FBI seemed to think so. In October 2004, Chris Swecker, the assistant director of the criminal investigative unit of the FBI, told Congress that “mortgage fraud is pervasive and growing.” He explained, “The potential impact of mortgage fraud on financial institutions and the stock market is clear. If fraudulent practices become systemic within the mortgage industry and mortgage fraud is allowed to become unrestrained, it will ultimately place financial institutions at risk and have adverse effects
on the stock market. Investors may lose faith and require higher returns from mortgage-backed securities.” And
still
the regulators remained unconcerned.

There was one halfhearted effort to enact a national law to curb some of the subprime lending abuses. But while some lenders, including Ameriquest and New Century, did want national legislation to avoid the constant need to beat back state and local laws, the powerful Mortgage Bankers Association didn’t put its weight behind a law. One former lobbyist says that the deciding factor was Angelo Mozilo, who told him, “No regulator is going to tell me what kind of products I can offer.” According to the
Wall Street Journal
, Countrywide spent $8.7 million between 2002 and 2006 on political donations, campaign contributions, and lobbying to defeat antipredatory lending legislation. Old-school Republicans always felt, here’s the channel of commerce and here are the curbs, says Chris Hoyer, who runs the plaintiffs’ firm James Hoyer in Tampa, Florida. “Go over them, and we’ll kill you. As soon as someone starts to cheat to get market share, and their market share gets bigger, well, guys are gonna cheat to keep and get market share. That’s why you have old-school rules. Bad shit happens if you let the curbs down.”

For the few who remember the old world of mortgages, and the concept of risk, those were surreal days. Dave Zitting, an old-fashioned mortgage banker with a homespun style, runs the Arizona-based Primary Residential, which makes mortgages across the country. Zitting started in mortgage banking in 1988, when he was eighteen, and aside from one year spent bagging groceries, he’s never done anything else. He grew up in a world where making a loan was all about the four Cs—credit, collateral, capacity, and character. “We thought of a loan like an airplane,” he says. “It couldn’t fly unless it had all four parts.” As he watched the growing insanity, he says he went from feeling scared to leave a C out to thinking, “What good am I? Have I just been fooling myself that I’m doing a job? Holy shit, maybe these guys are on to something—maybe paying for a home has nothing to do with the four Cs.” When he started in business, there were three loan products. By 2005, there were six hundred. The rule, Zitting says, was “Breathe on a mirror, and if there’s fog, you got the loan.”

In 2005, Zitting began to dip his toe into the subprime market, although he insisted on tight controls. Every subprime loan that was offered at a branch was underwritten again at headquarters. He still remembers the day in June 2005 he got a call from a wholesaler who bought his company’s loans. This
wholesaler was “one of the largest organizations on the planet.” (Zitting, who is still in the business, won’t name the company, other than to say, “They’re not around anymore.”) They flew him to their headquarters because they wanted to talk to him. Around a conference table sat a dozen men in suits. “They said, ‘Dave, what’s going on? Your company sells us the lowest amount of approved loans of anyone we do business with,’ ” Zitting recalls. Because Zitting used this company’s software, they could see that their system was approving loans that Zitting was then rejecting at headquarters.

“Oh, it’s simple,” Zitting told them. “We check the credit at corporate, and not a lot make it through.”

“That’s why we flew you out,” one of the suits responded. “We don’t like that. You need to trust our system, and if you do, your volume will go up by leaps and bounds.”

“How do I know the borrower will pay?” Zitting asked.

“You don’t need to worry about that,” they responded.

The next day, Zitting says, he got the “trade tapes” for the subprime loans he was selling, which showed the prices various buyers were willing to pay. June had been a big month for him: Primary Residential had underwritten $9 million of subprime loans. Usually, the offer was close to what the buyer had been promising verbally, but this day, the offer was surprisingly low. So Zitting called up the guy he dealt with. “I said, ‘Something is screwed up in the secondary market,’ ” he recalls. “He said, ‘I’ve been fielding those calls all day.’ ” It was a moment when the subprime market was tightening up, almost as if the bubble was coming to an end. Although the moment didn’t last very long, it was enough for Zitting.

“Dave,” the man said. “I like you. Get out.”

“Excuse me?” Zitting replied. He thought to himself, “I just came from a meeting where people were telling me not to turn down loans.”

The man said, “If you ever say I said this, I’ll deny it, but if you want your company to be around, you will not fund another subprime loan. There is going to be a bloodbath.”

And so, Zitting says, he called an emergency board meeting and he shut down his tiny subprime business, even though his firm had just spent $400,000 buying some necessary software. “All my friends in the business were laughing all the way to the bank,” he says. Over the next two years, he watched his business pals make millions and buy private jets and mansions. He remembers thinking to himself, “What the crap?”

G
oldman Sachs went public on May 4, 1999, ending a 130-year partnership and ushering in a new era, with shareholders to answer to, a board of directors to provide oversight, and a chief executive officer instead of a senior partner. Even at a time when Internet IPOs were all the rage, Goldman’s public offering stood out. The stock was priced at $53 a share, but it opened at $76—the opening was delayed an hour because the demand was so strong. By day’s end, it stood at $70 a share, giving it a market valuation of $33 billion. The $3.6 billion the company raised in the offering made it the second largest IPO ever. The
average
take for the 350 former and current partners who owned most of Goldman’s stock was $63.6 million. Senior partner–turned-CEO Jon Corzine held shares that were suddenly worth $305 million. Hank Paulson, who would become CEO within days of the IPO, had a stake worth $289 million. One Wall Street competitor told
BusinessWeek
, “To have priced this much paper—as a nontechnology stock—is incredible.”

To an outsider, the Goldman IPO must have seemed like a no-brainer. But people connected to the firm knew that the act of going public had been the culmination of a long struggle that had left many scars. As early as 1986 Bob Rubin and Steve Friedman, who were still co-heads of the fixed-income department—but were already pushing hard to reshape the Goldman culture—floated the idea of an IPO. It got nowhere. Over the next five or six years, the subject would occasionally bubble up, sometimes in small discussions, sometimes at firm-wide meetings, but the resistance to an IPO from the majority of the partners (and former partners, who retained an ownership stake in the firm even after they retired) remained strong. Some feared it would destroy what made Goldman special; some worried that they would
be disadvantaged compared to other partners who had larger stakes; some didn’t want to see Goldman’s financials—and their compensation—printed in the newspapers.

In truth, however, Goldman badly needed to go public. Merrill Lynch, Lehman, and Morgan Stanley were already public companies, as were most other big Wall Street firms. Big, publicly held banks like Citibank and J.P. Morgan were Goldman competitors. Transformational deals were taking place that were reshaping Wall Street, and those deals used stock as currency. Wall Street firms that went public suddenly had what Charles Ellis, the Goldman historian, calls “substantial permanent capital.” They could take more risk. They could grow more rapidly. They were no longer reliant on the partners’ capital. Firms that didn’t go public would, in all likelihood, be left behind.

When Corzine became senior partner in 1994, he made it his mission to persuade his partners about the necessity of an IPO. In this he succeeded. The deal was originally supposed to happen in the fall of 1998, but had to be postponed, embarrassingly, when Goldman got caught up in the Russian crisis and the collapse of Long-Term Capital Management. Even when the IPO finally took place the following spring, it was not without internal turmoil. Shortly before it finally went off, Corzine was ousted in a palace coup, replaced by Paulson. (Although the change in leadership was announced prior to the offering, Corzine stayed on until the IPO was completed.) And John Whitehead, he of the famous fourteen business principles, wrote an anguished letter to all the Goldman partners: “I don’t find anyone who denies that the decision of many of the partners, particularly the younger men, was based more on the dazzling amounts to be deposited in their capital accounts than on what they felt would be good for the future of Goldman Sachs.”

The IPO was a critical turning point for Goldman Sachs. Over time, its culture
did
change, as the company—you couldn’t really call it a firm anymore—became focused on such measures as return on capital, stock performance, and growth. A firm where senior partners used to say “Trees don’t grow to the sky” began instead to talk about aggressive goals for return on equity. The trading side of the firm—for which “substantial permanent capital” was its lifeblood—eventually overwhelmed the investment banking side, in terms of profits, stature, and ethos.

And starting in the early 2000s, Goldman, having adjusted to life as a public company and having transformed itself into a money machine, went on a run the likes of which has rarely been seen in the annals of corporate America. Its 2003 revenues were $16 billion. They rose to $21 billion in 2004,
$25 billion in 2005, and nearly $38 billion in 2006—more than double what it had been just three years before. Its market cap that year topped $88 billion. Somehow, Goldman always seemed to be in the sweet spot of every market. Somehow, Goldman always seemed to react to big market shifts faster than anyone else. Somehow, Goldman never seemed to make a wrong move.

But nobody could quite say how. As Goldman began generating most of its revenue from trading, it became impossible for outsiders to see how Goldman was making its money. Trading can mean a lot of things. It can mean acting as a market maker or trading for one’s own account—or both. It can mean treating clients fairly or “ripping their faces off,” as traders sometimes put it. It can mean trading plain vanilla bonds or peddling complex derivatives deals. Competitors began to whisper that Goldman had become increasingly ruthless, increasingly cutthroat, and increasingly concerned only about its own bottom line—and its bonuses. “They’d cut your ear off for a nickel, rip your throat out for a quarter, sell their grandmother for a penny, and sell two grandmothers for two pennies!” groused one private equity executive.

The rest of Wall Street watched Goldman’s metamorphosis with a mixture of envy, frustration, and resentment. But even as Goldman’s peers questioned and criticized its transformation, they also tried to copy it. The money—both the profits the firm produced and the paychecks its partners got—made Goldman the firm that everyone else had to keep up with. And to the outside world, it looked like they had become like Goldman. They all embraced risk taking and they all began to produce outsized profits. And yet the crisis would show that they weren’t like Goldman at all.