by Matt Taibbi
In fact, they did become friends. Edwards, Williams recalled, took a look at the mortgage on the three-decker and did indeed find some irregularities. He told Williams about RESPA, the Real Estate Settlement Procedures Act, designed to prevent scam artists from burying hidden commissions in the closing costs for urban and low-income homebuyers in particular. And Edwards found some hidden costs in Eljon’s mortgage and helped him get some of that money back. “He saved me money,” Williams recalls now. “I really trusted him.”
Edwards ended up getting so close to Williams that he came over to his house from time to time, even stopping by for his son Eljon Jr.’s birthday party. (“Even brought a present,” Williams recalls.) In their time together Edwards sold Williams on the idea that he was an advocate for the underprivileged. “He would talk to me about how a rich man doesn’t notice when a biscuit is stolen from his cupboard, but a poor man does,” he says now. “He had the whole rap.”
Fast-forward a year. Williams and his wife decide to make their move. They find a small two-bedroom home in Randolph, a quiet middle-class town a little farther outside Boston. Williams had a little money saved up, plus the proceeds from the sale of his three-decker, but he still needed a pair of loans to buy the house, an 80/20 split, with the 80 percent loan issued by a company called New Century, and the 20 issued by a company called Ocwen.
Edwards helped him get both loans, and everything seemed kosher. “I was an experienced homeowner,” Williams recalls. “I knew the difference between a fixed-rate mortgage and an adjustable-rate mortgage. And I specifically asked him, I made sure, that these were fixed-rate mortgages.”
Or so he thought. The Williamses moved in to their new home and immediately fell into difficulty. In late 2006, Eljon’s wife, Clara Bernardino, was diagnosed with ovarian cancer. She was pregnant at the time. Urgent surgery was needed to save her life and her baby’s life, and the couple was for a time left with only Eljon’s income to live on. Money became very, very tight—and then the big hammer dropped.
In mid-2007 the family got a notice from ASC (America’s Servicing Company), to whom New Century had sold their 80 percent loan. New Century by then was in the process of going out of business, its lenders pulling their support and its executives under federal investigation for improper accounting practices, among other things—but that’s another story. For now, the important thing was that Eljon and Clara woke up one morning in June 2007 to find the following note from ASC in their mailbox:
This notice is to inform you of changes to your adjustable rate mortgage loan interest rate and payment …
The principal and interest due on your loan will be adjusted from $2,123.11 to $2,436.32…
Effective with your August 01, 2007 payment your interest rate will be adjusted from 7.225% to 8.725% …
Eljon, not yet completely flipping out, figured a mistake had been made. He called up Edwards, who was “weird” on the phone at first, mumbling and not making sense. When Eljon insisted that it was not possible that their mortgage was adjustable, since Edwards himself had told them it was fixed, Edwards demurred, saying he, Eljon, was wrong, that it was adjustable and he’d been told that.
Soon after that, Edwards stopped answering his phone. And soon after that, Edwards disappeared entirely. He was no longer at his office, he was no longer anywhere on earth. And the Williamses were left facing cancer, a newborn baby, and foreclosure. They subsequently found out that Edwards had taken more than $12,000 in commissions through their house deal—among other things by rigging the appraisal. Edwards, it turned out, was the appraiser. This long-conning grifter had taken a perfectly decent, law-abiding, hardworking person and turned him and his mortgage into a time bomb—a financial hot potato that he’d managed to pass off before the heat even hit his fingers.
Realizing that he’d been scammed, Eljon now went into bunker mode. He called everyone under the sun for help, from the state attorney general to credit counselors to hotlines like 995-HOPE. At one point he called ASC and, in an attempt to convince them to modify their loan, simply begged, telling them about his wife’s bout with cancer, the dishonest loan, their situation in general. “I offered to bring them documentation from the doctors, proof that we were in this spot because of a medical emergency, that what they were doing would put us into a life-and-death situation,” he says. “And they were like, ‘Whatever.’ They just didn’t care, you know.”
The family missed several payments and were, technically, in default. Williams dug in and prepared for an Alamo-like confrontation. “I would have barricaded myself in the house,” he says. “I was not leaving. Not for anything.”
In the end … but let’s leave the end for later. Because that’s where the story gets really ugly.
Every country has scam artists like Solomon Edwards, but only in a dying country, only at the low end of the most distressed third world societies, are people like that part of the power structure. That’s what makes the housing bubble that burst all over Eljon Williams so extraordinary. If you follow the scam far enough, it will literally go all the way to the top. Solomon Edwards, it turns out, is not an aberration, not even a criminal really, but a kind of agent of the highest powers in the land, on whose behalf the state was eventually forced to intercede, in the fall of 2008, on a gigantic scale—in something like a quiet coup d’état.
At the lower levels anyway, the subprime market works almost exactly like a Mafia protection racket.
Anyone who’s seen Goodfellas knows how it works. A mobster homes in on a legit restaurant owner and maxes out on his credit, buying truckloads of liquor and food and other supplies against his name and then selling the same stuff at half price out the back door, turning two hundred dollars in credit into one hundred dollars in cash. The game holds for two or three months, until the credit well runs dry and the trucks stop coming—at which point you burn the place to the ground and collect on the insurance.
Would running the restaurant like a legit business make more money in the long run? Sure. But that’s only if you give a fuck. If you don’t give a fuck, the whole equation becomes a lot simpler. Then every restaurant is just a big pile of cash, sitting there waiting to be seized and blown on booze, cars, and coke. And the marks in this game are not the restaurant’s customers but the clueless, bottomless-pocketed societal institutions: the credit companies, the insurance companies, the commercial suppliers extending tabs to the mobster’s restaurant.
In the housing game the scam was just the same, only here the victims were a little different. It was an ingenious, almost impossibly complex sort of confidence game. At the bottom end of the predator chain were the brokers and mortgage lenders, raking in the homeowners, who to the brokers were just unwitting lists of credit scores attached to a little bit of dumb fat and muscle. To the brokers and lenders, every buyer was like a restaurant to a mobster—just a big pile of cash waiting to be seized and liquidated.
The homeowner scam was all about fees and depended upon complex relationships that involved the whole financial services industry. At the very lowest level, at the mortgage-broker level, the game was about getting the target homeowner to buy as much house as he could at the highest possible interest rates. The higher the rates, the bigger the fees for the broker. They greased the homeowners by offering nearly unlimited sums of cash.
Prior to 2002, when so-called subprime loans were rare (“subprime” just refers to anyone with a low credit score, in particular anyone with a score below 660; before 2002 fewer than $100 billion worth of mortgages a year were to subprime borrowers), you almost never had people without jobs or a lengthy income history buying big houses. But that all changed in the early part of this decade. By 2005, the year Eljon bought his house, fully $600 billion worth of subprime mortgage money was being lent out every year. The practice of giving away big houses to people with no money became so common that the industry even coined a name for it, NINJA loans, meaning “no income, job, or assets.”
A class-action law
suit against Washington Mutual offered a classic example. A Mexican immigrant named Soledad Aviles with no English skills, who was making nine dollars an hour as a glass cutter, was sold a $615,000 house, the monthly payments for which represented 96 percent of his take-home income. How did that loan go through? Easy: the lender simply falsified the documentation, giving Aviles credit for $13,000 a month in income.
The falsification mania went in all directions, as Eljon and Clara found out. On one hand, their broker Edwards doctored the loan application to give Clara credit for $7,000 in monthly income, far beyond her actual income; on the other hand, Edwards falsified the couple’s credit scores downward, putting them in line for a subprime loan when they actually qualified for a real, stable, fixed bank loan. Eljon and his wife actually got a worse loan than they deserved: they were prime borrowers pushed down into the subprime hell because subprime made the bigger commission.
It was all about the commissions, and the commissions were biggest when the mortgage was adjustable, with the so-called option ARM being particularly profitable. Buyers with option-ARM mortgages would purchase their houses with low or market loan rates, then wake up a few months later to find an adjustment upward—and then perhaps a few years after that find another adjustment. The jump might be a few hundred dollars a month, as in the case of the Williams family, or it might be a few thousand, or the payment might even quadruple. The premium for the brokers was in locking in a large volume of buyers as quickly as possible.
Both the lender and the broker were in the business of generating commissions. The houses being bought and sold and the human borrowers moving in and out of them were completely incidental, a tool for harvesting the financial crop. But how is it possible to actually make money by turning on a fire hose and blasting cash by the millions of dollars into a street full of people with low credit scores?
This is where the investment banks came in. The banks and the mortgage lenders had a tight symbiotic relationship. The mortgage guys had a job in this relationship, which was to create a vast volume of loans. In the past those great masses of loans would have been a problem, because nobody would have wanted to sit on millions’ worth of loans lent out to immigrant glass cutters making nine dollars an hour.
Enter the banks, which devised a way out for everybody. A lot of this by now is ancient history to anyone who follows the financial story, but it’s important to quickly recap in light of what would happen later on, in the summer of 2008. The banks perfected a technique called securitization, which had been invented back in the 1970s. Instead of banks making home loans and sitting on them until maturity, securitization allowed banks to put mortgages into giant pools, where they would then be diced up into bits and sold off to secondary investors as securities.
The securitization innovation allowed lenders to trade their long-term income streams for short-term cash. Say you make a hundred thirty-year loans to a hundred different homeowners, for $50 million worth of houses. Prior to securitization, you couldn’t turn those hundred mortgages into instant money; your only access to the funds was to collect one hundred different meager payments every month for thirty years. But now the banks could take all one hundred of those loans, toss them into a pool, and sell the future revenue streams to another party for a big lump sum—instead of making $3 million over thirty years, maybe you make $1.8 million up front, today. And just like that, a traditionally long-term business is turned into a hunt for short-term cash.
But even with securitization, lenders had a limiting factor, which was that even in securitized pools, no one wanted to buy mortgages unless, you know, they were actually good loans, made to people unlikely to default.
To fix that problem banks came up with the next innovation—derivatives. The big breakthrough here was the CDO, or collateralized debt obligation (or instruments like it, like the collateralized mortgage obligation). With these collateralized instruments, banks took these big batches of mortgages, threw them into securitized pools, and then created a multitiered payment structure.
Imagine a box with one hundred home loans in it. Every month, those one hundred homeowners make payments into that box. Let’s say the total amount of money that’s supposed to come in every month is $320,000. What banks did is split the box up into three levels and sell shares in those levels, or “tranches,” to outside investors.
All those investors were doing was buying access to the payments the homeowners would make every month. The top level is always called senior, or AAA rated, and investors who bought the AAA-level piece of the box were always first in line to get paid. The bank might say, for instance, that the first $200,000 that flowed into the box every month would go to the AAA investors.
If more than $200,000 came in every month, in other words if most of the homeowners did not default and made their payments, then you could send the next payments to the B or “mezzanine”-level investors—say, all the money between $200,000 and $260,000 that comes into the box. These investors made a higher rate of return than the AAA investors, but they also had more risk of not getting paid at all.
The last investors were the so-called “equity” investors, whose tranche was commonly known as toxic waste. These investors only got their money if everyone paid their bills on time. They were more likely to get nothing, but if they did get paid, they’d make a very high rate of return.
These derivative instruments allowed lenders to get around the loan-quality problem by hiding the crappiness of their loans behind the peculiar alchemy of the collateralized structure. Now the relative appeal of a mortgage-based investment was not based on the individual borrower’s ability to pay over the long term; instead, it was based on computations like “What is the likelihood that more than ninety-three out of one hundred homeowners with credit scores of at least 660 will default on their loans next month?”
These computations were highly subjective and, like lie-detector tests, could be made to say almost anything the ratings agencies wanted them to say. And the ratings agencies, which were almost wholly financially dependent upon the same big investment banks that were asking them to rate their packages of mortgages, found it convenient to dole out high ratings to almost any package of mortgages that crossed their desks.
Most shameful of all was the liberal allotment of investment-grade ratings given to combinations of subprime mortgages. In a notorious example, Goldman Sachs put together a package of 8,274 mortgages in 2006 called GSAMP Trust 2006-S3. The average loan-to-value in the mortgages in this package was an astonishing 99.21 percent. That meant that these homeowners were putting less than 1 percent in cash for a down payment—there was virtually no equity in these houses at all. Worse, a full 58 percent of the loans were “no-doc” or “low-doc” loans, meaning there was little or no documentation, no proof that the owners were occupying the homes, were employed, or had access to any money at all.
This package of mortgages, in other words, was almost pure crap, and yet a full 68 percent of the package was given an AAA rating, which technically means “credit risk almost zero.” This was the result of the interdependent relationship between banks and the ratings agencies; not only were the ratings agencies almost totally dependent financially on the very banks that were cranking out these instruments that needed rating, they also colluded with the banks by giving them a road map to game the system.
“The banks were explicitly told by ratings agencies what their models required of the banks to obtain a triple-A rating,” says Timothy Power, a London-based trader who worked with derivatives. “That’s fine if you’re telling a corporation that they need to start making a profit or you’ll downgrade them. But when we’re in the world of models and dodgy statistics and a huge incentive to beat the system, you just invite disaster.”
The ratings agencies were shameless in their explanations for the seemingly inexplicable decision to call time-bomb mortgages risk free for years on end. Moody’s, one of the two agencies that control the vast majority of the market, went public w
ith one of the all-time “the dog ate my homework” moments in financial history on May 21, 2008, when it announced, with a straight face, that a “computer error” had led to a misclassification of untold billions (not millions, billions) of junk instruments. “We are conducting a thorough review of the matter,” the agency said.
It turns out the company was aware of the “error” as early as February 2007 and yet continued overrating the crap instruments (specifically, they were a beast called constant proportion debt obligations) with the AAA label through January 2008, during which time senior management pocketed millions in fees.
Why didn’t it fix the grade on the misrated instruments? “It would be inconsistent with Moody’s analytical standards and company policies to change methodologies in an effort to mask errors,” the company said. Which translates as: “We were going to keep this hidden forever, except that we got outed by the Financial Times.”
In this world, everybody kept up the con practically until they were in cuffs. It made financial sense to do so: the money was so big that it was cost-efficient (from a personal standpoint) for executives to chase massive short-term gains, no matter how ill-gotten, even knowing that the game would eventually be up. Because you got to keep the money either way, why not?
There is an old Slavic saying: one thief sits on top of another thief and uses a third thief for a whip. The mortgage world was a lot like that. At every level of this business there was some sort of pseudo-criminal scam, a transaction that either bordered on fraud or actually was fraud. To sort through all of it is an almost insanely dull exercise to anyone who does not come from this world, but the very dullness and complexity of that journey is part of what made this cannibalistic scam so confoundingly dependable.
