I Am John Galt (17 page)

Carnival Barker of Loans

If you had influence, you got a great deal from Countrywide. But if you were just a nobody, you still got a mortgage even if you were a deadbeat—as long as you paid Countrywide's full-fare rates and fees. According to Countrywide's own product list, it would lend $500,000 to a borrower rated C-minus, the second riskiest grade. It would lend to borrowers with credit scores as low as 500 out of 850. It would lend to borrowers who had filed for personal bankruptcy or those who had been delinquent for more than 90 days on a previous mortgage twice in the previous 12 months. One Countrywide manual stated that a loan could be made to a borrower even if he or she had just $550 of income left to live on each month after making the housing payments.
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If you paid the up-front fees, apparently all that Countrywide required was that the borrower exist—and if the game could have gone on a little longer, we have no doubt it would have relaxed even that last remaining standard by creating exceptions to the definition of existence itself.

Mozilo prided himself on the explosion of new products he created to lure even the most unqualified consumers into his lending trap. At one point during an investor presentation, he sounded like a carnival barker as he listed some of the 180 loan products Countrywide offered. “We have ARMs, one-year ARMs, three-year, five-year, seven- and 10-year,” he said, rapid-fire. “We have interest-only loans, pay-option loans, zero-down programs, low-, no-doc programs, fast-and-easy programs, and subprime loans.”
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For the once-staid company that had prided itself on conservative lending practices and below-average defaults, Countrywide might as well have been standing up on a packing crate with a megaphone crying, “Step right up and see the freak show!”

One particularly devious loan structure was called the pay-option adjustable-rate mortgage (ARM). A pay-option ARM allowed a borrower to pay only a fraction of the loan interest due each month and none of the principal. Designed to put the financially strapped into homes they couldn't afford with conventional financing, the product was a disaster in the making. For starters, any payment shortfall was added to the mortgage balance, which would then grow in size and accrue interest. Even if the borrower made a down payment in a steady or rising housing market, over time the loan balance owed could easily exceed the home's value. Then, the A in ARM meant that interest rates could adjust or reset higher—sometimes dramatically—slamming unexpected costs on a homeowner who was already hanging by the fingernails on a reduced mortgage payment.

Heroic banking executives like John Allison at Branch Banking and Trust Company (BB&T), whom we met in Chapter 3, “The Leader,” had the courage and discipline to walk away from seemingly easy profits, shunning pay-option ARMs like radioactive sludge from Chernobyl. Countrywide slurped them up with gusto because the profit on them was so huge—at least in the short term. Talking points on one internal sales document called “Pay Option A.R.M.'s Made Simple” asks, “What kinds of customers would be interested in these loans?” The answer: “Anyone who wants the lowest possible payment!” It should have read, “Anyone who wants the highest possible risk of financial ruin!” In 2005, the year of peak home prices in the housing bubble that was about to burst, pay-option ARMs accounted for over one-fifth of Countrywide's mortgages versus just 3 percent the previous year.
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Bad loans were starting to collect like raw sewage in Countrywide's basement, 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. Senior executives had taken to telling investors that Countrywide expected to originate $1 trillion worth of mortgages by 2010.
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Mozila was halfway to that goal—though without knowing it, a few steps away from the gates of hell.

Exceptions Are the Rule

Over time, even the risky borrowers of our nation became fully leveraged. So Countrywide began using more aggressive tactics—it started treating even the most creditworthy borrowers as though they were deadbeats. In other words, brokers and sales reps were encouraged to peddle risky high-commission subprime loans to customers even if they could qualify for a safer low-commission loan a notch or two up the quality scale. Mozilo incentivized his brokers with commission rates based on the value of the mortgage, not on the quality of the credit. “The whole commission structure in both prime and subprime was designed to reward salespeople for pushing whatever programs Countrywide made the most money on in the secondary market,” an unnamed Countrywide sales executive said.
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Let's say a customer with documented income, a 10 percent down payment, and a 620 credit score could qualify through the FHA for a standard 30-year fixed-rate mortgage at a payment of $1,829 a month. The very same customer priced through Countrywide would have been offered a subprime loan at $2,387 a month—a difference of $6,696 a year.
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Why would such customers pay more than necessary? Because at those rates, Countrywide would lend them more money, using exotic gimmicks like pay-option ARMs to make it seem practically as though the loan would never have to be paid back.

But ultimately, in the last gasp of the housing bubble, Countrywide wrung the last drops of commission dollars out of the exhausted marketplace by basically lending any amount of money to anybody, on any terms, provided the commissions were large enough. Subprime borrowers could get a loan up to $1 million. The maximum loan-to-value ratio was by then 100 percent. The only qualification for doing a stated-income loan—that is, a loan based on what you state your income is, not what you can actually prove it is—was that you were a “wage earner.” Countrywide offered interest-only loans to borrowers with 580 credit scores.
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According to Dave Zitting, an old-fashioned mortgage banker at Arizona-based Primary Residential, the standard became “Breathe on a mirror, and if there's fog, you got the loan.”
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Countrywide then adopted a “matching strategy,” which committed the company to offering any product or matching any underwriting guideline available from at least one “competitor,” which included subprime lenders. If Countrywide's stated minimum credit score for a product was 600, but a competitor's minimum score was 560, Countrywide would reduce its minimum to 560 in order to match its competitor and make the loan. What resulted was a race to the bottom—an amalgamation of the very worst underwriting standards in the industry all under one roof. Countrywide also prohibited its loan officers from the common industry practice of referring risky loan applicants to other brokers or institutions in exchange for a small referral fee.
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These combined practices all but ensured Countrywide would become like a drain trap for the kitchen sink, catching and retaining the foulest of sludge from the market's garbage disposal.

Despite official lending standards that were, in Countrywide's own words, “among the most aggressive in the industry,”
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Mozilo would allow loans to be approved on an even more lax, ad hoc basis. Countrywide's automated underwriting system, called “CLUES,” didn't even have a “reject” option. Loans were either, (1) approved, (2) approved with caveats, or (3) “referred” to another loan desk for further consideration or manual underwriting. Manual underwriting consisted of overriding Countrywide's own already lenient internal checks and balances on an “exception” basis. The exceptions culture, which started and ended at the top with Mozilo himself, became the rule. So when it came to creditworthiness, Countrywide may have had CLUES, but it didn't have a clue.

After three separate attempts to underwrite failed even on an exception basis, loan applications would be referred to Countrywide's Secondary Markets Structured Lending Desk, where no attempt at all was made to underwrite the loan. The sole criterion for approving the loan was whether the secondary marketing desk could sell it to someone else. This is the dark secret at the core of Mozilo's otherwise seemingly impossible scam factory. How could Countrywide have made such bad loans? Simply because it immediately sold them to someone else. It's history's most egregious example of the “greater fool” theory of investing: it's okay to be a fool, as long as someone else is a greater fool.

That fool was likely to be Fannie Mae. As of 2007, Countrywide alone originated 23 percent of Fannie Mae and Freddie Mac's total volume of mortgages.
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The greatest fool, then, would ultimately be the American taxpayer. And the problem wasn't just limited to the explicitly labeled subprime category. Countrywide's chief risk officer, John McMurray, later revealed to analysts that Fannie would classify loans as prime to meet its affordable-housing goals even with credit scores that would typically be considered subprime. “There is a belief by many that prime FICOs [credit scores] stop at 620,” McMurray said. “That's not the case. There are affordability programs and Fannie Mae expanded approval, as an example, that go far below 620, yet those are still considered prime.”
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In his capacity as risk officer, McMurray repeatedly lobbied the financial reporting department to disclose more information about Countrywide's credit risks. He was unsuccessful.
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In 2007, well before that year's first-half earnings call, he presented Mozilo and other top executives with a summary of where the company was likely to suffer losses and urged them to report it publicly. They didn't.

Mozilo himself often personally approved loans that were in direct contravention of Countrywide's own credit policies and underwriting guidelines. When McMurray attempted to intervene in one instance, Mozilo berated him for becoming involved in loans that Mozilo had “already approved” and asserted that Countrywide's balance sheet was “big enough” to handle his exceptions.
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By Force or by Fraud

In the final days, Mozilo, like James Taggart in the climactic final scenes of
Atlas Shrugged
, seems to have suffered a complete break from business reality. No businessman truly interested in success would have done the things either man did. “When I look a homeowner in the eye, I can tell if they'll pay,” Mozilo would tell his staff. Never mind that eye contact isn't a proven method for measuring default risk any more than it can ID serial killers in a lineup; Countrywide didn't even conduct personal interviews any longer as part of the loan application process.

In other instances, Mozilo seemed to genuinely believe his own irrational assumptions that the party would continue, propped up by permanently increasing asset values. “Over the entire history of this country, housing prices have never gone down nationally,” he told CNBC in early 2005, a few months before a peak in prices preceding a 35 percent drop.
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Then, in other cases, he allegedly lied outright to cover knowingly fraudulent activities of his company and their collaborators. According to a lawsuit filed by the Mortgage Guaranty Insurance Corporation (MGIC), Countrywide deliberately disregarded signs of fraud in order to increase its market share.
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By about 2006 Countrywide's internal risk assessors knew that in a substantial number of its stated-income loans—fully a third—borrowers overstated income by more than 50 percent. Mozilo also knew that many appraisers were overstating property values to drive originations by making loans appear less risky.

“I think the primary issue has been an issue of speculation, rather than fraud,” Mozilo would tell investors in 2007. “I mean, I think, it's probably nonexistent today, because everything has tightened up so much, that everybody's antenna has been so sensitized to all the possibilities here that it's pretty hard to get through the system now if you're not telling us the truth.”
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Later evidence would reveal a dramatically different reality, including facilitation of rampant borrower, broker, appraiser, and other fraud stemming from documents riddled with materially false information.

In one case, a part-time Chicago housekeeper applied for a mortgage, truthfully telling a Countrywide loan officer that she earned just $200 per week. Instead of rejecting her application outright, the loan officer prepared a false document stating that the borrower was an employee of Paulen Auto Body Shop earning $6,833 per month. Based on the falsified paper trail, she was given a $339,000 mortgage loan; she then promptly left the United States and returned to her home in Poland without ever making a single payment.
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In another case, Countrywide gave a $350,000 loan to an illiterate California dairy worker making just $1,100 per month, by deliberately misstating his income. The loan payment alone represented four times his actual monthly pay. Another Countrywide lender gave a $398,050 loan to a woman in Ceres, California, who had been unemployed since 1988.
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These were just a few of the many jokers dealt out by Countrywide's originators that were holding up Mozilo's house of cards.

The Rats Flee the Ship

By 2007, the housing engine, pumped full of cheap high-octane government fuel and then run all-out for years well beyond the redline on the tachometer, finally started to sputter and smoke. Some of the latest, most egregiously reckless loans signed by the greatest fools from the dregs of the market began defaulting almost immediately, even before the ink was dry on their contracts. Housing prices in the hottest sunshine states of California, Nevada, Arizona, and Florida began to slow and then decline.