By late 2006 Ameriquest was searching for a buyer, and by early 2007 ACC was running low on cash. Then came a revealing moment, one that gave a glimpse into just how clever Roland Arnall could be. In 2004, he had invited Deval Patrick—the same Deval Patrick who had led that early Justice Department investigation into the lending practices at Long Beach—to join ACC’s board. Patrick was paid $360,000 a year. He resigned from the board two years later to run for governor of Massachusetts, and he won. In March 2007, as ACC was flailing, Governor Patrick made a call on behalf of Arnall. According to the Boston Globe, he phoned Robert Rubin, who was then the vice chairman of Citigroup and someone Patrick knew from the Clinton administration. A week after the call, Citigroup agreed to put fresh working capital into ACC. Arnall also contributed some of his personal wealth to keep the company going.
By the fall of 2008, Ameriquest had been shut down; Citigroup took over the $45 billion portfolio of loans that needed to be serviced from ACC’s Argent division. Patrick later apologized for making the call, acknowledging that “financial exploitation of the poor, elderly, and minorities [was] pervasive at Ameriquest.” But that call, as it turned out, wasn’t the only favor he did for Arnall.
In 2008, the OCC put together a document called “Worst Ten in the Worst Ten.” It listed the ten worst lenders in the ten metropolitan areas with the highest rates of foreclosure. The document vividly displayed the havoc that Arnall’s companies were wreaking on the American landscape. There were a total of twenty-one companies on the ten lists. Arnall’s Argent made the top ten in all ten cities, and was number one in Cleveland and Detroit. Long Beach made nine of the ten lists, landing the top spot in Sacramento, Stockton, Memphis, and Denver. And Ameriquest made seven of the ten lists, despite having slowed down its lending significantly since the settlement with the state attorneys general. (ACC says that it is “unfair and inaccurate to tie” Long Beach to Arnall’s other companies, given that ACC had severed its links to Long Beach more than a decade before the OCC’s report.)
And yet, at the time, it was as if the Ameriquest investigation and settlement had happened in a parallel universe. In the spring of 2005, after the Los Angeles Times exposé had been published but before the big AG settlement, President Bush nominated Arnall to be the U.S. ambassador to the Netherlands. Maybe this shouldn’t have been a surprise—according to the Los Angeles Times, between 2004 and 2008 Arnall and his wife, Dawn, raised and gave more than $12 million to GOP causes and candidates. The donations included $5 million from Dawn to the Progress for America Voter Fund, which shared some donors with the Swift Boat ads that helped bring down the 2004 Democratic presidential candidate, John Kerry. Shortly after winning reelection, Bush announced the appointment of the Arnalls as honorary cochairs of the inaugural fund-raising committee. That wasn’t really a surprise either: As USA Today wrote, “Inaugural fundraisers Dawn and Roland Arnall found a creative way to pump more than the $250,000 limit into the event. Their mortgage firm, Ameriquest Capital, contributed the maximum, as did three subsidiaries, for a total of $1 million.” Arnall said that he supported Bush’s stance on Israel, but few believed that was the only explanation. “Many of his philanthropic pursuits and major marketing campaigns were designed to generate the greatest political influence,” says a former executive.
Arnall’s confirmation hearing took place in November 2005. His wife and his brother Claude sat proudly in the audience. Tom Lantos, a Holocaust survivor and a Democratic congressman from California who Arnall had long supported, introduced him. “I strongly believe, Mr. Chairman, that Roland is one of the great anonymous philanthropists of our time,” said Lantos. Norm Coleman, the Republican senator from Minnesota, called Arnall a “friend,” and said, “I’m particularly proud of Mr. Arnall’s achievements.” Senator George Allen, the Republican from Virginia, noted that the governor of Mississippi, Haley Barbour, had sent a thank-you note for Arnall’s generosity in the wake of Hurricane Katrina, and he pointed out that letters supporting Arnall had arrived from the speaker of the California State Assembly, the governor of Pennsylvania, and the mayor of Los Angeles. Not surprisingly, Ameriquest—or Dawn Arnall personally—had given generous political contributions to all three.
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:
Every one of them would ask the same thing: “Lemme take a look at whatcha working on? Anything I can close?” Imagine all the small broker offices like mine, with all these account executives coming in every day looking for business. They would bring cookies, sandwich platters, candy, all kinds of little chotskies.
Many account executives were good, honest, ethical people who were truly just trying to do their job. But there were also AEs who sold only by price. They would lead off with “We’re offering an extra point for this or a ½ point for that” or “Hey, get two on the front and two on the back.” And it wasn’t just subprime lenders. It was all the big banks, too. They all had Alt-A and subprime products.
It wasn’t subprime products alone that put us where we are. Option ARMs can be an appropriate product for a certain kind of borrower. We never thought of them as subprime. It was the behavior, the mind-set that took hold. The gun didn’t kill the market—the shooter did.
Twenty-six-year-old college grads, with their navy blue suits and cuff links and slicked-back hair, would come in to broker shops acting all full of themselves because they were pulling down $150K a year. They didn’t know anything about the business, but they were inviting us to parties and conventions and the music played, and the booze flowed.
I had an originator that made $31,200 on one loan that I referred to her at a 40 percent split, yet she had the audacity to tell me that it should have been a 50/50 split. That one loan paid her more money than her salary for an entire year at her previous job. That exchange was eye opening to me about a dark mind-set that had taken over.
There were commission incentives for prepayment penalties. Lenders enticed originators offering bigger YSP8 on specific products they wanted to sell and would charge hard discounts on those they didn’t. The entire industry was driven by yield. Lenders were simply driving volume, any way they could. The fight for loans and market share was fierce. All that marketing power slowly evolved into a way of life. We were hammered every day.
I ran an accounting business before I got into the mortgage business. My perspective was one of how to be creative and stay within the guidelines. At one time, there was a clearly delineated line of who qualified and who didn’t. With each new day came a new product that moved that line ever so slowly away from prudent risk management into the world of high fees. There were those in the business who couldn’t get it done within the lines—they just moved the lines. It was known as “structuring” the loan. That meant if it didn’t qualify one way, make it qualify another way.
I remember giving a Realtor seminar one day and not only saying, but actually believing, “The lenders are offering these products…. They have lots of brain power in their risk, legal, compliance, and secondary market departments. They know the risk they are taking and they price for it. Who was I to question them?” So much for that! I remember a woman who worked for me making incredulous statements like, “Hey, they just dropped the FICO requirement to 580!”
“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.”
A Senate investigation later concluded that during the drafting of the guidance, the OTS had argued for less stringent standards. It was very much in keeping with the turn the agency had taken. Under James Gilleran, the agency
’s director from late 2001 to the spring of 2005, the OTS had shrunk disastrously: Gilleran chopped 20 percent of its staff in 2002. The OTS’s new goal, it said, was to “place emphasis on institutions, not the regulator, to ensure compliance with all existing laws, including consumer protection statutes.”
What’s more, the OTS was funded from fees paid by the thrifts themselves, based on their size. When Gilleran had taken the job, the OTS had been, as he later put it, “in a deficit financial position.” WaMu’s rapid growth, thanks to its exploding subprime business, meant that it was becoming an ever more important source of funds for its regulator. Between 2003 and 2008, for instance, WaMu’s fees represented 12 to 15 percent of the agency’s revenue, according to the Senate Permanent Subcommittee on Investigations. Perhaps that explains why John Reich, Gilleran’s replacement at OTS, once described Kerry Killinger, WaMu’s CEO, as “my largest constituent asset-wise.”
When Washington Mutual executives analyzed the consequences of implementing the regulators’ guidance, they concluded that it would reduce volume by 33 percent. So they didn’t do it. As late as June 2008, an FDIC examiner found that WaMu was “not in compliance with Interagency Guidance on Nontraditional Mortgages.”
That it took regulators until so late in the subprime madness to announce the guidance can’t be blamed only on the OTS. There was another culprit: the Federal Reserve. The Fed’s mind-set was on display in a late 2004 piece, published by the New York Fed, entitled, “Are Home Prices the Next ‘Bubble’?” The answer: “As for the likelihood of a severe drop in home prices, our examination of historical national home prices finds no basis for concerns.” Even after Ben Bernanke had replaced Greenspan as chairman in February 2006, it remained, in spirit, Greenspan’s Fed. The market still knew best. The market knew better than career bureaucrats how to properly price risk. Market discipline would prevent truly bad things from happening. The most important task of the banking regulators was to get out of the market’s way.
All the Devils Are Here Page 29
