All The Devils Are Here: Unmasking the Men Who Bankrupted the World (41 page)

When it was Arnall’s turn to speak, he began by saying, “I have made ‘Do
the right thing’ my motto.” He added, “I would consider our company the antipredatory company. In the late eighties when we founded the company, we provided credit to folks who did not have the opportunity because of their credit history to borrow directly from the institutional banks.” And so it went.

There were only two senators that day who seriously challenged Arnall. One was Paul Sarbanes, who pointed to the still ongoing Ameriquest investigation and asked whether Arnall had truly lived up to his motto. Arnall responded with his “few bad apples” line: “Some of our employees did not do the right thing. When we found out, they were let go and action was taken so that it wouldn’t happen again.”

The other senator was Barack Obama. “I mean, if you go through the record of the allegations that were made, they were allegations that I think most of us would consider to be very problematic,” said Obama. “And I’m wondering whether it is appropriate for us to send someone to represent our country with these issues still looming on the horizon.”

“Thank you, Senator,” Arnall responded. “I’ve read up on your background and I’m very impressed with your life history, and I can appreciate your concerns. I can assure you, Senator, that I have absolutely nothing to do, nor does my wife, in terms of these negotiations.”

Then Obama said, “I’ve gotten a couple of letters here from people who were previously antagonistic to Ameriquest’s activities that are now writing letters of support, which I think is a testament to you and your capacity to win over and work with people who may not have been on the same side initially. I’ve got a letter from Deval Patrick, who actually is a good personal friend of mine….”

“As you know,” Arnall replied, “he’s a man of high integrity, and would not sit on my—on our board unless he felt that it was worthy of who he is and what he represents.”

“Absolutely,” said Obama.

Says one person who was fighting Arnall’s nomination: “We were absolutely devastated. Here was a prominent African-American Democrat saying that this guy was giving opportunities to minorities, and providing cover for Democrats.” On February 8, 2006, Arnall was confirmed by the Senate. The vote took place one month after the announcement of the $325 million settlement with the state attorneys. Press reports said that the payment “cleared the way” for Arnall’s confirmation. One last time, Arnall’s willingness to pay to make problems go away had served him well.

Prentiss Cox had not been among the state officials pleased by the Ameriquest settlement. Yes, it was likely to put an end to the worst of Ameriquest’s lending abuses, but Cox didn’t believe for a second that the settlement was going to slow down the seamy practices that permeated the subprime mortgage industry. These tactics were the only way these companies knew how to do business.

He was right. It was in almost exactly the same time frame as the Ameriquest settlement—early 2006—that the subprime mortgage business went truly mad. Or as Lisa Madigan, the Illinois attorney general, later told Congress, it was “the moment when we began to see the underwriting practices of mortgage lenders erode at a disturbingly accelerated pace.”

According to an SEC report, those 2/28 mortgages, whose rate shot higher after two years, made up 31 percent of subprime mortgages in 1999, and almost 69 percent in 2006. Loans with a combination of incomplete documentation—so-called liar loans—
and
low or no down payment rose from almost nothing in 2001 to almost 20 percent of subprime originations by the end of 2006, according to a working paper by the Federal Reserve Bank of Atlanta. Overall, nontraditional mortgages like pay option ARMS and other subprime mortgages grew from almost nothing to almost half the total volume of mortgage originations in 2006, according to Susan Wachter, a professor of financial management at the Wharton School.

One former subprime executive says that his “aha” moment came in late 2005, when an underwriter at his company said, “We need to have a policy for no-doc loans when there’s a doc in the file.” What the underwriter meant was that the broker had been stupid enough to include a W-2 showing that a borrower whose income was supposed to be, say, $90,000 only made $40,000. “The decision,” this executive says, “was to send the file back to the broker and tell them to ‘clean it up.’ We knew if we declined the loan, the broker would just take it to the guy down the street.”

Robert Simpson, a mortgage industry veteran whose company, IMARC, investigates the reasons that loans fail, remembers reviewing a stated-income loan where the woman’s occupation was “ferret farmer.” Her stated income: $15,000 a month. In reality, she made $1,500 a month and worked in retail. “The loan officer decided to see if he could get away with it,” Simpson says. “You see loans like that, and it tells you two things: the loans are going to go bad, and any system that makes these loans is broken.”

For brokers who believed in old-fashioned underwriting, it was a deeply disconcerting time—a little like trying to remain a disciplined value investor at the height of the Internet bubble. You felt as if you were stuck in mud while the world was passing you by. Eventually, you rationalize that it all must be okay because, after all, it wasn’t the brokers who approved the loans. Surely, the originators know what they’re doing.

One such person was Debbie Killian. A mortgage broker in Danbury, Connecticut, she had housing in her blood: her parents had owned a real estate company, and it was what she had done most of her career. In 1996, she and her husband founded a small local company, Charter Oak Lending Group. She watched the growing madness with distaste, but she also put a handful of her clients into subprime loans. Subprimes were the loans originators were peddling. And they were the loans that many borrowers wanted. Her business grew during the bubble.

“At one time I had fifty-seven lenders all competing for our business,” she recalled in an e-mail, describing the bubble years from her perspective:

“It is clear to me,” Killian concluded, “that a
slow creep
took over … a slow moving slime that ultimately permeated the industry. I have this picture of lava … just creeping along until every business was covered with it, eventually getting smothered.”

What infuriated Prentiss Cox more than anything was the realization that no one cared. “The war was lost,” he says.

Even as the subprime business descended into true madness, the national banking regulators remained hopeless. In late 2005, the bank supervisors asked for comment from the industry on proposed “guidance” for “nontraditional” mortgages. The industry pushed back. The American Financial Services Association argued that it was “unnecessarily stringent” to require lenders to assess whether a borrower would be able to pay the full cost of a loan. The American Bankers Association said that the guidance “overstates the risks of these mortgage products.” It was “incorrect,” said the ABA, that they were riskier: “[R]ather, they simply present different types of risks that may be well-managed by prudent lenders.” The AFSA also asked the regulators to make it clear that “guidance” was “not intended to be statements of absolute rules.”

Consumer groups pleaded for stricter rules. The California Reinvestment Coalition argued that regulators shouldn’t allow certain kinds of risk layering, such as stated-income option ARMs, calling such loans a “deadly combination for unsuspecting and uneducated consumers.” Wrote Kevin Stein, the CRC’s associate director: “Underwriting practices that misrepresent a subprime borrower’s ability to repay a loan benefit neither consumers nor the economic stability of financial institutions.” He added, “Borrowers are increasingly stuck with loans they cannot afford … all the ingredients for a financial disaster are in place.”

When the regulators finally issued the guidance in the fall of 2006, it required lenders to include “consideration of a borrower’s repayment capacity.” But the guidance applied only to the category of mortgages that allowed borrowers to defer the payment of principal or interest. And, most important, it was just guidance. It didn’t carry the force of law. Subprime companies could ignore it.

To see what that meant in practice, you needn’t look any further than the Office of Thrift Supervision, which supervised Washington Mutual. After a meeting with the OTS in the fall of 2006, a WaMu executive wrote an e-mail in which he summarized the regulator’s position: “Their initial response was that they view the guidance as flexible. They specifically pointed out that the language in the guidance say [sic] ‘should’ vs. ‘must’ in most cases and they
are looking to WaMu to establish our position on how the guidance impacts our business practices.”