Who Stole the American Dream? (28 page)

But if credit standards are relaxed and poor credit risks are accepted, Lannoye asserted, the only way to cover the losses from bad credit risks would be to unfairly sucker solid middle-class prime borrowers into taking subprime loans at higher interest rates. “
Predatory lending means finding uneducated, uninformed borrowers to take subprime loans—people who qualify for a prime loan,” Lannoye explained. “You have to charge them a higher rate and a higher fee in order to subsidize the losses that will occur [on loans] to people with bad credit. This kind of lending did not fit the character and culture of our bank. It would have violated our family-friendly motto.”

Twice, Lannoye fought against buying Long Beach, and it got him
fired. Not literally—he got pushed into premature retirement by Killinger, who not only bought Long Beach in 1999, but also changed WaMu’s operations. “He put underwriting and quality assurance under sales management,” Lannoye said. “When you put credit under someone whose responsibility is sales, credit quality goes out the window, you eliminated the checks and balances. There was nobody to say ‘No…. Hey, wait a minute. We’re out of control.’ ”

Long Beach Mortgage Company may not have been out of control in 1999, but it was pushing the limits.
Congress had opened the door for high-cost subprime loans in 1980 by effectively eliminating the ceiling on mortgage interest rates set by state usury laws. In the 1990s, subprime had been an iffy business. It often lacked the capital to make large volumes of loans. But in 2001, Federal Reserve Board chairman Alan Greenspan gave subprime banking a shot in the arm. By dramatically cutting interest rates, Greenspan opened wide the profit margins on lending, especially subprime lending, and ignited the real estate and financial boom that powered the U.S. economy up to the financial bust of 2008.

Subprime lending was heavily promoted by Presidents Bill Clinton and George W. Bush. Clinton’s White House had urged
Fannie Mae (the Federal National Mortgage Association), Freddie Mac (the Federal Home Loan Mortgage Corporation), and other lenders to ease credit requirements and offer subprime loans to lower-income Americans, especially to ethnic minorities whose credit records were too weak to qualify for prime. In the late 1990s, Fannie Mae and Freddie Mac, the quasi-governmental companies that guarantee about half of the nation’s home mortgages, pressed banks to lend to minorities and to be more flexible on loan standards. In the next administration, President Bush championed the “ownership society” for lower-income Americans, later boasting that home ownership reached record levels in his tenure—temporarily.

Long Beach Mortgage thrived in this New Mortgage Game. It was an edgy lender, always testing the limits, cutting corners, riding the fast track. So fast that in a confidential report to Washington Mutual, the Federal Deposit Insurance Corporation (FDIC) said that in reviewing four thousand
Long Beach loans made in 2003, they found that only one in four qualified for sale to investors; half were deficient and needed to be corrected; the final quarter were totally disqualified for resale. As Lee Lannoye had warned Killinger,
Long Beach’s record was so bad that WaMu’s legal department stopped all Long Beach securitizations, or sales of its bundled mortgages, to Wall Street. But the suspension was temporary. Long Beach was soon tripling its loan volume from $11.5 billion in 2003 to nearly $30 billion in 2006.

As a mortgage loan officer at Long Beach, Bre Heller worked frenetic, fourteen-hour days. She was constantly on the road, dealing with one hundred different mortgage broker firms, all pushing loans as fast as possible. The incentives at Long Beach and Washington Mutual were all based on volume—volume, not reliability or prospects for the loans’ being repaid.

“
We were paid by the total volume of loans that we handled, and the [commission] percentage was tiered,” Heller explained. “The larger the volume, the higher the percentage. If you handled $5 million a month, that would pay you $20,000 a month. In a normal month, we would each handle from $3 million to $10 million worth….

“At twenty-three and twenty-four, I was making $200,000 a year,” she said proudly. “I bought my first house in 2004. I had it only two years, sold it, and made over $100,000 on it.”

Strange as it may sound, Heller almost never met a live borrower. Banks such as Long Beach and Washington Mutual were by then doing the bulk of their sales through legions of independent mortgage
brokers, most of whom were hustling newcomers in their twenties and thirties with little experience in finance.

Brokers were the powerhouses of the subprime market. Like Long Beach account executives, they were paid on loan volume, and they got fat bonuses for talking borrowers into high-interest junk mortgages. The bonus could go as high as 3 percent: On a single $300,000 loan, a broker could make $9,000. Turn fifty or sixty of those loans in one year, and a hustling young broker could make $500,000 a year.

Brokers learned how to game the system to get loans approved; often, instead of filtering out bad loans, Long Beach loan officers would coach brokers on how to jimmy loan applications for easy approval. Then both broker and loan officer would get bonuses. “
A lot of coaching takes place,” Bre Heller reported. “As a sales rep I could tell the broker, ‘This is how to get a loan passed. If you bring us this, this, and this, your loan will go through.’ You’re pointing out the loopholes. Every bank has loopholes.”

The loopholes, the exotic loans, and the aggressive marketing by New Economy mortgage firms such as Long Beach were planting a time bomb in the nation’s financial system that blew up on Wall Street in 2007. How? By creating volumes of explosive loans headed toward default and foreclosure and then selling them to distant investors who couldn’t see the flaws in the loans. The brokers and the banks didn’t care whether the mortgages would ever be paid back. They made their money by pushing volume and ignoring bad quality. Brokers got paid up front for floating the loan. Its ultimate fate was of no consequence to them.

“
It was a fast-buck business,” former Salomon Brothers mortgage bond trader Sy Jacobs told Michael Lewis in
The Big Short
. “Any business where you can sell a product and make money without having to worry how the product performs is going to attract sleazy people.”

To make matters worse, mortgage brokers pressured banks to ease their credit standards, thus generating more defaulted loans and foreclosures. In the New Mortgage Game, brokers had the whip hand. As the frontline salespeople promoting junk mortgages, they were the point of contact with buyers, scouring phone books and ethnic groups, finding borrowers, hawking loans. They could take their customers to any lender they chose—to Long Beach, to WaMu, to competitors such as Countrywide and Ameriquest, or to affiliates of big Wall Street banks. Competition was fierce. To keep brokers at their door, Long Beach and WaMu kept loosening their loan standards.

The mortgage banks had an arsenal of exotic loans that were far from the traditional thirty-year fixed-interest loan, where borrowers had to put 20 percent down and file pay stubs or W-2 forms to prove their income. In the New Mortgage Game, the banks’ loans of choice were Option ARMs, subprime loans, 100 percent financing, teaser rates, serial refinancing, negative amortization, yield spread premiums, or home equity loans, almost all of which carried a sting that few borrowers understood.

To qualify risky borrowers, a favorite tactic of high-volume brokers was to sell a “stated income loan”—the kind of loan Bre Heller was given. Originally, such loans made sense. Banks had invented them for self-employed business consultants, contractors, writers, actors, and others with good earnings but not a steady income recorded on W-2 forms. The borrowers stated their income and then submitted tax returns or bank statements to show enough assets to pay off the loan, and they provided a business license or some official document to prove that they were actually working as stated.

But in the fever of the housing boom, the stated income loan was corrupted. WaMu and Long Beach dropped their safeguards. They let practically anyone apply for a stated income loan. Instead of requiring
a state license, Heller said, they would accept letters of recommendation from anyone—easy to forge or fictionalize. Even when people had real documents, such as W-2 forms, checking on them slowed down the loan process, and that interfered with volume. So the trade gravitated in 2004, 2005, and 2006 to “no doc” loans, where no documents were required. One variation was the NINA loan—no income, no assets given. And finally came the NINJA loan—no income, no job, and no assets required.

“
Loan officers dropped their duty to truly qualify home buyers for homes,” Heller reported. “Instead, the loan officer did whatever was necessary to get them qualified. The system was very wishy-washy. We were pushing the boundaries.”

The obvious potential for fraud troubled Heller, but as she told me, lowering the bank’s standards “brought us a lot more customers.” Risk was piled on risk, increasing the odds that the borrowers would default and the house of cards would crash.

At Long Beach Mortgage, the vintage subprime loan was the 2/28 ARM—an adjustable-rate mortgage that lured borrowers with a low initial “teaser rate” that after two years abruptly shot up to the normal “fully indexed rate.” Some senior officials later admitted that these loans were designed to fail and to force borrowers into refinancing.

Often, to get poor credit risks approved, mortgage officers would grant loans on the borrower’s ability to pay the teaser rate, rather than making sure they could afford the normal monthly payment. So pervasive was this practice that one senior WaMu executive admitted that
one-third of the bank’s refinancing loans would have been rejected if loan officers had properly qualified borrowers. In other words, savvy WaMu loan officers understood that borrowers who were qualified by the lender only on their ability to pay the teaser
rate were headed for inevitable default, but the loan officers often ignored that reality to keep loan volume and profits rising.

Most buyers suffered severe “payment shock” when the interest rate reset after two years, potentially doubling their mortgage payments or worse. Unable to meet that steep bill, they got talked into refinancing their mortgage with a larger loan principal and a new low teaser rate. As Bre Heller explained, this started a refinancing cycle, with borrowers going deeper into debt each time, while the brokers and bankers kept pocketing handsome fees on each new loan.

With low-income borrowers, the 2/28 ARM was often combined with “the piggyback loan”—a second 20 percent mortgage piled on top of an 80 percent first mortgage. That dramatically increased the risks of default, but the sales pitch was almost irresistible—no money down. The downside was that this dangerously eliminated the time-tested credit requirement that the buyer have some financial stake in the home as protection for the bank. But by 2000, that requirement had largely gone by the boards at Long Beach, WaMu, and elsewhere.

WaMu’s longtime credit expert Lee Lannoye found 100 percent financing inconceivable, especially for subprime borrowers with poor credit. Such loans were doomed at the outset, Lannoye told me, because the borrowers could simply default and walk away. “
The only way to repay this loan is to refinance and refinance again, and at some point, the merry-go-round stops,” Lannoye said. “Home prices don’t always go up. We know that from experience.”

But on the front lines, what Bre Heller recalls is the frenzy to buy, buy, buy, get your offer in before the house price goes up again, and the bottomless appetite for 100 percent financing and low teaser rates. “
The big thing was the sign up there in front of the new development: ‘100% Financing and No Money Down,’ ” she said. “People think, ‘I can buy this house, this brand-new house’—and everyone wants a brand-new house—‘and no one can tell me I don’t qualify.’ ”

“They [the banks] were playing to brokers who specialize in driving people into loans that people don’t understand,” observed
Kathryn Keller, an experienced, play-it-safe-and-fair broker with Guarantee Home Mortgage in Seattle. “They take
a product that was exotic and move it to the category of a weapon—seriously. These loans go from being an exotic product to a hand grenade, and WaMu clearly did it only for marketing reasons.”

Eliseo Guardado was one of millions enticed by a gossamer story of the American Dream of home ownership with 100 percent financing. Guardado had come to America in 2003 as a legal immigrant from El Salvador. An earthquake had laid waste to parts of his country, and the U.S. State Department agreed to permit thousands of Salvadorans to come work in the United States under “temporary protected status,” a designation that has enabled them to obtain annual extensions until the present. Guardado, who was in his late thirties and spoke no English, got a steady job as a subcontractor for HMS Drywall in Laurel, Maryland, installing walls in new homes. By his account, he made about $2,000 a month, and, living alone in a one-room basement apartment, he saved about $15,000.

But by late 2010, when I first met Guardado, he’d been through “a nightmare.” Now in his midforties, he said he’d been lured into a subprime loan based on false income figures that he blamed on his broker; had been slapped with repeated foreclosure threats; had lost one job and found another; and had spent all his savings trying to hang on to a tiny two-bedroom cracker box house in Hyattsville, Maryland.

Buying a home in America was never his idea, Guardado said. “I didn’t think I made enough money.” Then in January 2006, he got a cold call. “There were realtors calling people all the time,” he told me. “
One guy called me, a real estate man who spoke really good Spanish. His name was William, but we called him El Gringo. He said to me, ‘With the money you are making, you should buy a house. You are throwing your money away by renting. You’ll be approved
for a loan, fast and easy.’ He told me I could refinance in six months and be making money on the house.”