Not long before Hank Greenberg was ousted, an FP executive named Gene Park got a call from an old high school friend who was trying to buy his first house. The price of the house was $250,000. The friend didn’t make a lot of money. Yet two mortgage originators had lined up to give him loans—one for the first mortgage, and the second for a loan to cover the down payment. The friend wanted to know if Park would lend him $5,000 to cover the closing costs, which he also didn’t have. Though a little startled by what he’d heard, Park loaned him the money.
Shortly before the closing, the man lost his job. He called Park again, worried that the deal would fall through. But it didn’t; when the friend told his mortgage broker that he was now out of work, the broker simply told him not to mention it. Sure enough, he closed on the house. Now Park was really startled.
A few months later, Park read an article in the Wall Street Journal touting the high dividend being paid by a hot mortgage company, New Century. He decided to take a closer look at the stock—and realized that New Century was a subprime lender that specialized in no-doc loans. He quickly dropped the idea of investing in it. Then a third data point popped up on his radar screen: in a trade publication somewhere, he read that multisector CDOs had very large concentrations of subprime mortgages.
By the spring of 2005, Al Frost was marketing a veritable assembly line of multisector CDO deals—FP had ten or fifteen in the pipeline at any given time. “It was almost mechanical,” says someone who was there. They were so routine, they got very little scrutiny from the risk managers or anyone else at AIG-FP. Every firm on Wall Street was going to AIG to buy credit default swaps on their super-senior tranches. Though the spreads remained small, the sheer volume of business made it a big profit center for FP.
Nor did the credit default swap deals slow down after Greenberg left. Although the business had its best quarter ever in late 2004, its second biggest quarter was in the spring of 2005, after Greenberg’s departure. From $50 billion in 2004, the business ballooned to $110 billion by the end of 2005, according to the Congressional Oversight Panel. (By September 2008, when AIG was bailed out by the government, the exposure had been reduced to $60 billion.) Though it was still a small portion of AIG’s $2.7 trillion derivatives book (in notional value), the run-up was startling nonetheless. And Frost wasn’t the only one putting the pedal to the metal now that Greenberg was gone. The securities lending program also went into overdrive, and the mortgage insurance unit threw caution to the wind. The whole company, it sometimes seemed, was doubling down on subprime mortgages.
At both FP’s and AIG’s headquarters, the increasing number of multisector CDO deals was not viewed with alarm. On the contrary, Frost was seen as a hero. The downgrade to double-A had hit AIG-FP hard—it had to unwind billions of dollars worth of complicated transactions that had been dependent on the triple-A rating. A large part of the FP staff spent 2005 either unwinding deals or dealing with the restatements. Neither activity put money in the till. Frost’s multisector CDO business was something everyone else at FP could be happy about.
Which is also why Cassano decided in the fall of 2005 that the time had come to give Al Frost a promotion. At the same time, he decided to put Gene Park in charge of the multisector wrap business.
Park, however, wanted nothing to do with multisector CDOs. By then, he had done a little experiment. He had asked some people involved in the FP business to guess the percentage of subprime mortgage-backed securities in some of the recent CDOs that FP had wrapped. Most of them had guessed it was around 10 percent. Then he asked one of them to look up a few recent deals. What he found was stunning. The percentage of subprime securities in the CDOs wasn’t 10 percent—it was 85 percent! Without anybody at FP noticing, the multisector CDOs had become almost entirely made up of risky subprime securities.
Seriously worried, Park took his concerns to Andrew Forster, one of Cassano’s chief deputies in London, who had begun to have thoughts along the same lines. The two men then made the rounds of the Wall Street underwriters to better understand the collateral. What they heard was not comforting. The firms all acknowledged that the credit histories were not very good—but they all insisted it was okay because historically, housing prices only went in one direction: up. As long as that was the case, homeowners would be able to refinance and repay the debt.
Park and Forster both knew this was a terrible rationale. The collateral, clearly, was unsound. The supposed diversification benefits of having a variety of credits in a multisector CDO had disappeared. They knew they needed to get out of the business.
And yet, how to break this news to Cassano without having him blow his stack? How to explain that this seemingly great business was exposing the firm to enormous risks that no one had been aware of? They couldn’t. Park himself never spoke to Cassano, but Forster decided that the best way to approach him was to say that the business had changed and the underwriting standards were deteriorating. “We’re comfortable with the portfolio today, but we’re not comfortable going forward,” Forster told Cassano, according to several former FP executives. “They were afraid to say they had made a mistake,” adds one of them. “They couldn’t admit to that.” After listening to Forster’s argument, Cassano agreed that, yes, they should stop writing new CDO business. But because nobody had been willing to tell Cassano how dire the situation really was, he—and AIG-FP—remained far too sanguine about the risks that remained on its books.
Park had wanted AIG not only to stop writing new business, but to begin hedging its exposure—and even to begin shorting securitized subprime mortgages. But that never happened. Most people at FP still couldn’t envision the possibility that their deals might ever go sour. At one point, Park spent about a month trying to work out a deal where FP would buy credit default swaps from one of its clients for some of its super-senior exposure. But the cost—20 basis points, or two-tenths of a percent—was considered too high for so unlikely an event. So Cassano and Forster vetoed the deal, according to several FP executives. (Cassano, through his lawyers, denies that he vetoed a hedging deal. Rather, he says, FP executives concluded that hedges were generally ineffective.)
In February 2006, Frost and Park went to the big annual asset-backed securities convention in Las Vegas. There were thousands of people in attendance; everyone who was anyone in the securitization business was there. They had meetings with all the firms they did business with. Frost introduced them to Park, and explained that AIG-FP “would be taking another look at the business.” Everyone knew what that meant. “During that period, he was not happy,” recalls someone who worked with Frost. “He thought Park was trying to undermine his business to make him look bad. He thought he was turning over the crown jewels. He personally took offense.”7
After the crisis, it would be revealed that FP did not completely turn off the spigot at the end of 2005, even though that is what the company later told the world. By the time 2005 had come to a close, the firm had a number of deals still in the pipeline. Not wanting to anger its clients, AIG-FP decided to close those deals, which meant it was continuing to insure multisector CDOs well into 2006. What’s more, under the terms of the swap contracts it wrote, CDO managers had the right to switch collateral to help maintain the yield—without having to inform AIG. As borrowers prepaid mortgages, for instance, the CDO managers would replace those earlier mortgages with mortgages that had been written in 2006 and 2007. Those latter mortgages, written as the housing bubble was reaching its peak, were far worse than even the mortgages written in 2005. And with Greenberg now gone, there was literally not a single executive at AIG’s headquarters who knew that a decline in the market value of the tranches AIG wrapped could trigger a collateral call.
But that would only emerge much later. Over the course of the next year, as the subprime bubble peaked and then began to crack, Cassano, Forster, and Park all truly believed they had dodged a bullet.
14
Mr. Ambassador
From the early days of s
ubprime lending, there was a small, lonely group who sided with the consumer advocates fighting the subprime companies: the attorneys general in a handful of states like Iowa, Minnesota, Washington, and Illinois. They, too, had heard borrowers’ complaints firsthand, and saw the havoc that subprime lending was wreaking on communities. Some of them also understood that this wasn’t just about the borrowers. “It’s not in anyone’s long-term interest for consumers to get loans they can’t pay back,” says Prentiss Cox, the former attorney with the Minnesota attorney general’s office. “It’s only in the short-term interest of those who are raking in fees.” On a conference call with several other AGs in 2005, he said bluntly, “This whole thing is going to collapse.”
This alliance of attorneys general had investigated First Alliance (aka FAMCO) and then struck a landmark $484 million settlement with Household Finance in 2002. “I first heard about FAMCO when someone walked into my office with a complaint from a consumer that he had paid 20 percent of the loan amount in fees,” says Cox. “I said, ‘That’s a typo. Call ’em back.’” It wasn’t a typo. Cox’s second big wake-up call came after the Household settlement. “We thought we had done a big thing,” he says. “We thought we had solved the problem of predatory lending. Stupid us. Immediately after we did this, the industry tripled.”
By 2004, the AGs were targeting another lender, one that Cox called the “prototype” of the new breed of subprime lenders. Its loan volume was enormous. “We had these spreadsheets showing all the loans,” Cox says. He recalls thinking to himself, “Oh my God. The scope of their lending is unbelievable.” The company was Roland Arnall’s Ameriquest.
That summer, Cox first started hearing complaints from consumers that Ameriquest had inflated the value of their homes, qualifying them for loans they couldn’t afford. In fact, all over the country, complaints were flooding in that Ameriquest had not only inflated appraisals, but had encouraged customers to lie about their income or their employment and had misled borrowers about the fees embedded in their loans. They had promised people they’d be able to refinance out of expensive loans without disclosing that Ameriquest had stuck on hefty prepayment penalties if they did so. And on and on.
By then, Cox knew not to expect help from federal regulators. He started calling the OCC the “Office of Corporate Counsel” for the banking industry. The Fed, he says, viewed the AGs as “mosquitoes.” After all, those smart bankers on Wall Street wouldn’t securitize subprime loans if they were that terrible—would they? “Who do you trust?” Cox says. “A bunch of stupid public service lawyers who mostly aren’t even making six figures, or the people on Wall Street who are making eight or nine figures? It was an easy answer for the Fed.” He adds, “The regulators were totally uninterested in looking on the ground at what was happening to actual human beings. We were the only cops on the beat. And we were the people with the smallest hammer.”
In August of 2004, a group of Ameriquest executives, including general counsel Tom Noto, flew to Iowa to meet with Iowa attorney general Tom Miller and several others. The Ameriquest executives were cooperative. Their response to the complaints was consistent: “We don’t do that”; “That’s not the kind of company we are.” When faced with a particularly ugly loan, they’d say, “That’s an outlier.” How could that be, the AGs wondered, when the horror stories were so uniform—and came from all over the country? “I think they were clever,” says one participant. “This was a clever company led by an exceedingly clever man. I mean clever in the sense of shrewd, street smart.”
In early 2005, as the negotiations were getting under way, the Los Angeles Times published a scathing exposé of Ameriquest. The headline read “Workers Say Lender Ran ‘Boiler Rooms.’” Among other things, the story noted that lawsuits filed by consumers in California and at least twenty other states “allege a pattern of fraud.” One person who read the article was Robert Gnaizda, the general counsel of the Greenlining Institute. Over the years, Gnaizda had become friendly with Arnall, seduced by his charm and his seemingly sincere commitment to good lending practices. “He said they were trying to be the best subprime lender in the country, and I thought, ‘This guy could do it,’” Gnaizda recalls. His nonprofit had taken grants from Arnall for affordable housing and was in discussions with Arnall about an additional $1.5 million grant.
When the Times’s expose was published, Gnaizda called Arnall. One of Arnall’s executives called him back and told him the story was all wrong. “I said, ‘This is too disturbing,’” says Gnaizda. “I need a written refutation, or I’m out.” He also insisted that Arnall call for an independent investigation of the allegations. Arnall refused. Gnaizda sent back a $100,000 check that Greenlining had received from Ameriquest. “I was told that Roland was infuriated.” He adds, “I got to know Arnall very well, I got to like him, and then I was very disappointed by him, to put it mildly.”
As the negotiations with the AGs heated up, several state attorneys general and their aides flew out to Orange County for a meeting at Ameriquest’s headquarters. Arnall, who was not part of the negotiating team, asked Iowa’s Tom Miller and Arizona attorney general Terry Goddard to come to his office. “We’ve got a few bad apples, and we didn’t deal with it quickly enough,” Arnall told them. Miller quickly disagreed. “The problems are pervasive,” he said. Later that night, about a dozen people from both sides—“It was like the Arab-Israeli peace accords!” jokes Cox—went out to dinner at a restaurant in Anaheim. During the dinner, Arnall stood up and said, “I’m embarrassed that you all had to come out here. I’m ashamed.”
“I started thinking, well, just a few hours ago you were saying this was just a few bad apples,” recalls Miller. “When that didn’t work, you changed direction.”
Cox, for his part, was seething. After the dinner, he sent $50 to Ameriquest to reimburse them for his meal. Ameriquest told him that the cost was actually $98 per person. He forked over the remaining $48 with a note that said, next time, his treat—at a fast-food restaurant.
On January 23, 2006, the AGs announced that Ameriquest had agreed to pay $325 million to settle allegations from forty-nine states that it had engaged in extensive consumer abuse. (Ameriquest didn’t operate in Virginia because the state requires detailed financial disclosure by the main shareholder of any company doing business there, which Arnall refused to provide.) Ameriquest denied all the allegations but agreed to make major changes in its business, including changing how appraisals were handled, eliminating incentives to sales personnel to include prepayment penalties or any other fees, and charging the same interest rates and discount points to customers with similar credit profiles. It also set up a fund to make restitution to customers who could show they had been ripped off by the company. Most of the AGs were happy; they felt this established a model that the rest of the industry would have to follow. Indeed, after the settlement, New Century wrote in its annual report that if it had to follow the guidelines Ameriquest had agreed to, “some of our practices could be called into question and our revenues, business, results of operations and profitability could be harmed.” Which, in effect, was an admission that the entire industry had been built on a foundation of fraud.
As if to prove the point, Ameriquest never really recovered from the settlement. “Corporate is making a big push now to clean up its dirty image because of the heat coming down (they even took the Red Bull machines out of the offices),” wrote one employee on the consumer Web site Ripoff Report in the spring of 2005. (This employee added, “Good luck to everyone who is fighting this devil of a company. You will need it.”) A few months later, on the same site, someone who called himself Eric and said he was an Ameriquest executive wrote, “We will not come out stronger, the company will be better, cleaner, and less profitable…. The glory days are over in this company, so pack up your glory and head elsewhere.”
In May, less than five months after the settlement was struck, Ameriquest announced that it was closing all 229 retail branches and eliminating 3,800 jobs,
and would henceforth operate through four large regional call centers. “It seemed kind of heartless because they made such a big deal out of team, family, and then, all of a sudden—boom,” says one employee who was laid off. “The way it was done was especially impersonal.” Each department was called into a conference room to hear the news via a conference call—which wasn’t even live, but rather a tape loop that played over and over again. At headquarters, the mood was bleak. “Once the AGs really starting digging around, and more information became available to employees, that’s when people really began to question who we were and what we were doing as an organization,” says a former executive.
Aseem Mital, a veteran of Ameriquest’s parent company, ACC, became CEO in June. Mital insisted that Ameriquest could still succeed with its new model, and that growth would be steady. But it turned out “Eric” was right, either because Ameriquest couldn’t operate profitably under its agreement with the AGs or because it couldn’t operate at all. For instance, an appraiser Ameriquest hired to help clean up its practices discovered that in New York the company’s loan officers were paying huge sums to a group of appraisers—all of whom worked for the same outside firm—and these appraisers were consistently valuing the homes at 100 percent of the value that the loan officers had assigned the properties. (Inflated appraisals were one of the most common forms of fraud during the housing bubble.) Upon further digging, he discovered that the owner of the outside firm was the wife of one of Ameriquest’s employees. And while Ameriquest was supposed to install a new system that ferreted out appraisal fraud in its four new call centers, this person says that the company made a decision not to install it in its Sacramento office.
All the Devils Are Here Page 28
