Who Stole the American Dream? (27 page)

The state of Nebraska actually ran a test of this concept, using two different retirement plans. Starting in 1964, one group of Nebraska’s state employees went into a traditional, professionally managed lifetime pension plan, and another group went into a 401(k)-style plan funded and run by employees. Both plans set mandatory participation and contribution levels. Both got the benefit of a generous, steady 6 percent state employer match.

About a decade ago, retirees in the do-it-yourself plan complained that their retirement funds were insufficient. The state legislature demanded an outside study, which examined results from 1980 to 2004, one of the best periods for stock investing in U.S. history. The study delivered the unambiguous finding that the pooled funds in the professionally managed defined benefit pension had done far better than the 401(k)-style funds. With pooled assets and professional management, “the average rate of return for the last twenty-plus years has been over 10½ percent,” reported Anna Sullivan, executive director of Nebraska’s state retirement funds agency. In the employee-run plan, she said, “the average rate of return was somewhere between 6 and 7 percent.”

That may not sound like much of a difference, but it is huge. Compounded over twenty years, that 4 percent earnings gap meant that the retirement accounts in the professionally managed program were double the size of the do-it-yourself accounts. The study also
confirmed the retirees’ complaint—that the 401(k)-style plan left them short of retirement funds. “
It’s just not adequate,” Sullivan reported. So Nebraska killed its 401(k)-style plan and put everyone into a state-run lifetime pension.

“
This is a national problem and we have to come up with a national solution,” asserted Karen Friedman, executive vice president of the Pension Rights Center, a public advocacy group.

“
We need a new tier of retirement savings,” echoed Alicia Munnell. “The 401(k) system has proven to be totally inadequate. It can’t do the job. I don’t think the answer is to throw it away. But we need a new program with pooled assets, mandatory contributions, funds professionally managed, and assets locked up so that people can’t get at them until they retire.”

Jack Bogle advocates something like the Nebraska model on a national scale: converting people’s savings from their 401(k)’s, IRAs, and other plans into personal retirement accounts with one big new U.S. retirement fund run by America’s best professional money managers. These experts would be picked and overseen by a new Federal Retirement Board. Bogle urges that the plan include the 50 percent of Americans whose employers currently offer no retirement plan.

Teresa Ghilarducci, the pension economist from New York, has proposed a similar idea but with one important wrinkle:
Participation by all employees and all employers should be mandatory, with an annual contribution of 5 percent of pay, shared equally by employers and employees.

Any reform of this nature faces an uphill battle as long as Corporate America, the mutual funds, and the banks are reaping huge financial benefits from the current 401(k) system and while politicians at the state and federal levels are pushing public employees
away from the old lifetime pensions into 401(k)-style programs.

For a people-first program, it will take a populist revolt among baby boomers—the people who face possible poverty in retirement, unless the current system is changed.

WHEN YOU THINK OF THE HOUSING CRISIS
and millions of Americans being foreclosed out of their homes, you don’t imagine a bright, successful thirty-year-old like Bre Heller. When I met her, Heller was still reeling from the forced sale of her home in Orlando, Florida, stuck with a mountain of debt and furious at her bank. She didn’t seem like a typical victim. She’s street smart, quick as a whip with numbers, and a picture of cool composure. From the knowing way that she marched me through her loan documents, it was clear that she understood home finance.

Even so, she got stung. She got locked into a mortgage loan that she did not qualify for. By the time it was approved, she couldn’t afford it and did not want it. So on October 22, 2008, with the ominous shadow of foreclosure looming over her $513,000, four-bedroom home, she emailed the Florida attorney general’s “fraud hotline.”

“
I am a victim of predatory lending practices executed by Washington Mutual Bank in November 2006,” Heller told the attorney general’s office, “and would like to know the necessary steps to filing a formal complaint. I do have a full breakdown of fair lending practices that were violated, inclusive of:

What made Bre Heller’s case so striking was that her mortgage lender, Washington Mutual Bank (WaMu), was also her employer.
For almost four years, Heller had been a very successful loan account executive in the white-hot Florida home loan market for the Long Beach Mortgage Company, a subsidiary of Washington Mutual.

So in her email to the Florida attorney general, Heller was accusing her own bank of locking her into two loans totaling $513,525 by falsifying her loan application, downgrading her to a below prime loan, and charging her a higher rate of interest—all without telling her. It was a story familiar to legions of middle-class Americans.

In 2003, fresh out of Seattle Pacific University with a major in business and sociology, Bre Heller had joined Long Beach Mortgage and had ridden its rocket growth until suddenly, in 2006, Heller found herself a casualty of her own business.

Heller had applied for a half-million-dollar loan in September 2006 when she was easily making enough to cover that loan. But just two months later, in November 2006, her salary had fallen off a cliff. Washington Mutual, spotting big trouble at Long Beach, had suddenly put restrictions on the riskiest—and most profitable—loans in the Long Beach portfolio. The Long Beach mortgage business hit a wall. Suddenly, loan officers in Florida were doing only one-fifth the volume they had done a month or two earlier. Incredibly, Heller’s pay fell from $13,374 in September to $2,288 in November.

Bre Heller figured her loan and her dream house were history. She knew that Washington Mutual required an updated review of all loan applications prior to closing to make sure that the borrower’s income and bank balances had not changed and the borrower could still afford the loans. She also knew that as a Washington Mutual employee, her pay information was instantly accessible to the bank’s loan officers; they would see that under the bank’s loan standards, she no longer qualified for her loan, and it would be rejected. “If this had
been done the way it is supposed to be done,” Heller told me, “my loan should have been declined.”

Instead, without telling her, WaMu rewrote her loan application, stated her income as $1 a year, shifted her into a totally different kind of loan—a no-document, no-questions-asked loan—and charged her a higher interest rate. When Heller talked to the WaMu loan officer, she was told that using a so-called $1 stated income loan was a courtesy to employees. That kind of high-interest, high-fee loan was also widely used with other customers who had irregular income.

This was not unusual. I have talked to several other people who also had their loan terms altered by the bank, without being informed, and to lawyers who represented dozens of other borrowers caught by similar bank switches on their loans. During the go-go years of the housing boom, altering loan applications to qualify people improperly was a fairly routine maneuver by banks and mortgage loan companies to generate high loan volume and higher profits.

When Bre Heller was told about her new loan, she felt trapped by her bank and her building contractor, both of whom had a financial interest in pushing the deal through. Personally, she was in a jam. She had sold the home she was living in and had to move out. She had a signed contract with the builder and had put down a $24,000 deposit as a guarantee of her serious intent to buy. If the bank had blocked her loan and denied her financing, that would have annulled her builder’s contract and she would have recovered her $24,000. “But if I were to walk away on my own,” she explained, “I was going to lose that $24,000.” Plus, she might have faced a lawsuit for breach of contract.

So she took a risk. She went ahead with the deal, gambling at the age of twenty-six on the hope that the real estate market—and her salary—would recover. “We knew things were changing rapidly, but we didn’t know if this was temporary or whether it would turn around,” Heller told me. “We didn’t know at that time, at the end of November 2006, that our industry would die.”

Her personal plot unfolded inexorably like a Greek tragedy. Heller
spent much of the money she made from selling her first home to help pay for the big mortgage on her second home. She struggled gamely for a couple of years to make her payments, with the help of a boyfriend who moved in with her. But she couldn’t keep it up for years to come. Finally, she had to bow to the inevitable—the forced sale of her house in the spring of 2010 at a crushingly low price. Her home, by then in a neighborhood of foreclosed homes,
was deep “under water”—its market value well below her loan balance, like eleven million other homes across America at that time.

“
Considering that I lost $250,000 on that house,” Heller admitted in hindsight, “I would have been better off to have walked away and left that $24,000.”

The irony in that episode is that Washington Mutual had carefully cultivated the reputation since 1889 as a bank that was a “friend of the family”—a bank that earned the trust of its customers by knowing them personally, treating them like neighbors, and taking their interests to heart. But in the New Mortgage Game, Washington Mutual’s character and mantra morphed into “The Power of Yes!”—a tagline in its TV ads that meant you got a loan no matter what.

WaMu CEO Kerry Killinger was not satisfied with the plodding, modestly profitable business of plain vanilla thirty-year fixed-rate mortgages to carefully screened borrowers (the old “Power of No”). That strategy wasn’t getting WaMu or its CEO rich enough, fast enough. Killinger heard the siren call of Wall Street’s new mortgage money machine and its voracious appetite for high-interest, high-risk, high-profit mortgage bonds—in reality, “junk mortgages,” like the high-interest junk bonds of the 1980s.

Moving into junk mortgages required a radical shift in thinking at WaMu, but the financial calculus was seductive. Instead of the old business of selling mortgages, hanging on to them, and collecting interest, a home loan bank such as WaMu could make much more
money by originating high-interest loans and then selling them off to Wall Street.

Killinger’s fastest way of getting into the new junk mortgage game was to buy an existing subprime lender. So in 1999, WaMu bought Long Beach Mortgage Company, a high-flying, aggressive pioneer in junk mortgages.

Killinger was warned in advance that buying Long Beach was a dangerous, perhaps fatal, mistake. That warning came from WaMu executive vice president Lee Lannoye, whose job as WaMu’s chief credit officer was to protect the bank against bad credit risks. Within WaMu’s inner circle, Lannoye told me, he had vigorously opposed buying Long Beach. He said he had warned Killinger—prophetically—that the go-for-broke subprime culture at Long Beach would corrupt the “Friend of the Family” culture at Washington Mutual and would ultimately destroy WaMu.

As an old-line credit officer, Lannoye contended that the
subprime business had to be predatory to succeed. Lending to borrowers with bad credit histories, as subprime did, was bound to lead many of those borrowers to default on their mortgages. Those defaults would cause losses to the bank in the long run, even though selling subprime loans netted some short-term gains. That system would not work, Lannoye warned, because it violated the rules of sound lending, under which banks require a creditworthy record for someone to obtain a loan.