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With strong employment and interest rates near historic lows, subprime lenders filled a mortgage pipeline that extended all the way to Wall Street. Once there, leading investment banks pooled thousands of loans together and packaged them into securities that they sold to pension funds, hedge funds and overseas investors."
Reuters
Frenzy of risky mortgages leaves path of destructionBy Peter Henderson, Tim McLaughlin, Andy Sullivan and Al Yoon
Tuesday May 8, 2007
SourceLOS ANGELES (Reuters) - On September 15, 2004, the clock was ticking on Lelon DeWitt's life and his subprime loan.
When the transmission repairman underwent open-heart surgery, he told his mortgage broker he didn't want a housing loan that was in the works.
"I didn't know if I was going to be dead or alive," DeWitt later recounted.
But the mortgage broker, Troy Musick of Wholesale Mortgage Co., was so eager to clinch the deal, he followed the couple into the hospital, said DeWitt's wife, Ruth DeWitt.
As a surgeon cracked Mr. DeWitt's chest open for a quadruple heart bypass, the broker approached her in the waiting room of Elkhart General Hospital in Elkhart, Indiana.
"It's now or never," she remembers him saying.
Afraid of losing out on the chance to buy a home, she left the hospital and signed the loan documents. Lelon DeWitt survived the surgery, but not the $143,400 loan from Irvine, California-based Argent Mortgage.
In the go-for-broke home loan industry of the past few years, the DeWitts quickly became another statistic. They lost their home in the midst of a crisis that has driven U.S. homeowners into foreclosure at a record rate.
Musick could not be reached for comment. Argent said it no longer does business with Musick, an independent mortgage broker.
In the latter stages of the housing boom, armies of independent mortgage brokers like Musick, and a new breed of subprime lenders like Argent, helped bring a whole new class of borrowers to the housing market, a boom that led to bust for thousands, including the DeWitts.
Lenders offered high-cost, risky mortgages -- called subprimes -- that put people with poor credit in their dream homes. Subprime lenders profited from returns far superior than from traditional fixed-rate, 30-year mortgages. Big blue-chip lenders also joined the fray, dropping their standards as they went.
SUBPRIME SATURATION
For nearly a decade, investors were rushing to real estate, creating enough capital to build a new class of homeowners -- loaded up with an incendiary mix of debt from car loans, credit cards and mortgages. Federal tax deductions and housing programs also fueled the boom.
Wall Street investment banks funded new subprime mortgage lenders, many based in California, by packaging their loans into mortgage-backed securities. That expanded the size and reach of the subprime lending, dovetailing with a long-held government policy of putting more Americans into their own homes.
The home-ownership rate surged to 69.3 percent in 2004, up 5 percentage points in 10 years. It was a stunning expansion, considering the rate rose only 2.2 percentage between 1965 and 1995, according to the U.S. Census Bureau.
But the subprime market began to sour in 2006 as home values leveled off. Lenders whose profit margins contracted in an increasingly crowded market were forced to repurchase a growing number of bad loans. When they couldn't, Wall Street pulled their funds, forcing many subprime lenders to shut down, sell assets or file for bankruptcy.
Some of the biggest names in the industry have closed operations. Leading the pack is New Century Financial Corp.(Other OTC:NEWC.PK). The Irvine, California-based lender landed in bankruptcy in April after originating $52 billion in subprime loans in 2006.
Even more unsettling is that the subprime problems are arising at a time when employment is strong and interest rates are hovering near historic lows, leading to fears that if the economy worsens, the situation would become even more bleak.
Delinquencies, which made up 13 percent of all subprime loans at the end of 2006, and foreclosures could mount, says the Mortgage Bankers Association, an industry group.
That's already playing out in Detroit, the hub of the struggling U.S. auto industry. It has the highest foreclosure rate among the top 100 U.S. large cities, according to RealtyTrac. One in every 21 houses in the city was in foreclosure in 2006.
Detroit's foreclosure rate was 4.5 times the national average in 2006. The metro areas of Atlanta and Indianapolis ranked second and third, respectively.
NEW NO-RULES PARADIGM
Even established lenders of high-quality mortgages lost their compass and chased bad business as competition increased, said Angelo Mozilo, chairman and chief executive of the largest U.S. mortgage lender, Countrywide Financial Corp. (NYSE:CFC).
Mozilo said he saw the industry's long-established standards come unglued in the face of new competition.
"I've been doing this for 54 years," Mozilo recently said during a speech in Beverly Hills, California. For many years, he said, "standards never changed: verification of employment, verification of deposit, credit report."
But then new players came in with aggressive lending policies. Names like Ameriquest, New Century, NovaStar Financial and Ownit Mortgage Solutions set a new, lowered standard, changing the rules of the game, Mozilo said.
"Traditional lenders such as ourselves looked around and said, 'Well, maybe there's a (new) paradigm here. Maybe we've just been wrong. Maybe you can originate these loans safely without verifications, without documentation,"' Mozilo said.
In 2006, Countrywide originated $461 billion worth of loans. Nearly $41 billion of that activity was in the subprime market, where Countrywide ranked third behind No. 1 HSBC and No. 2 New Century. Countrywide also competed against Accredited Home Lenders Inc., formed in 1990 above a San Diego auto-repair garage.
Bill Dallas, chief executive of Ownit, the nation's 20th-largest subprime lender in 2006, said he saw the handwriting on the wall in April 2005 after he overheard a rival account executive tell a customer how to get a better rate by committing occupancy or income fraud.
"I just went, 'We are hosed as an industry,"' Dallas said. "I told our guys, 'We're the problem."
The structure of the industry was part of the problem, he said: "Our account reps are talking to the mortgage broker, the mortgage broker is talking to the borrower, and they're teaching them all the wrong things."
Ownit tightened its lending standards, Dallas said, but eventually filed for bankruptcy in December after Merrill Lynch & Co. (NYSE:MER), a large investor, froze funding.
Dallas and others more than doubled their original investment in the firm, but hundreds lost their jobs. About that time, Merrill sealed the acquisition of its own subprime originator, First Franklin Financial Corp., which Dallas had founded and previously sold.
'COFFEE IS FOR CLOSERS'
Interviews with borrowers, mortgage executives, loan officers, appraisers and brokers describe a subprime industry engaged in the systematic abuse of prudent lending standards. There also was plenty of outright fraud by lenders and borrowers, they say.
Borrowers lied about their income, sometimes encouraged by unscrupulous subprime sellers. Property appraisals were faked to justify inflated loan values. Loans were closed at fast-food restaurants or across kitchen tables at midnight. Brokers sometimes skipped the signings altogether, sending a notary to clients' homes.
"They basically put you in the closet, turned out the lights, and said, 'Sign here,"' said Bill Purdy, a California lawyer who represents homeowners with predatory lending claims.
Lenders often teased borrowers with low initial payments that later soared, leading to onerous penalties or higher rates. And better yet, Wall Street investment banks stamped their approval on no-money-down mortgages and loans widely known as "liar loans," which allow borrowers to state their income without verification.
It was a dangerous mix, said Chris Lefebvre, a Rhode Island lawyer who represents families with mortgage problems.
"You had consumers that really weren't creditworthy and lenders who were irresponsible," he said.
Some subprime mortgages had features that were bound to produce disasters. "Stated income" loans didn't require borrowers to produce pay stubs or tax returns. Option adjustable rate mortgages (or option ARMs) typically let borrowers choose a monthly payment, but instead of paying down mortgages they often paid interest-only. That put borrowers deeper into debt after each payment.
Purdy, the California lawyer, calls these "neutron bomb loans" because they clear out the buyer but leave the house standing.
Sometimes subprime lenders drew their inspiration from Hollywood to motivate employees to sell more loans. Branch managers showed movies that celebrated bullying and high-pressure sales tactics.
Account executive Mark Bomchill said he was given his role model soon after arriving at Ameriquest Mortgage. He was Jim Young, the sleazy salesman played by Ben Affleck in "Boiler Room," a movie about a stock brokerage that scams investors by getting them to invest in fake companies.
Bomchill watched the movie as part of training at the Plymouth, Minnesota, branch, where he said he also watched colleagues falsify income statements and push customers into high-priced loans. They would treat borrowers, he said, as if they had no place else to go to buy into the American Dream.
"I was taught and encouraged to close loans without regard to the customers' financial ability to make payments on the loans," Bomchill said in a federal lawsuit against Ameriquest, a leading subprime lender.
Ameriquest said if what Bomchill described happened, it would be against policy. The company closed its network of 229 branches last year.
Others in the industry were told to model themselves after Alec Baldwin's hard-as-nails character in the movie "Glengarry Glen Ross." The 1992 film, based on David Mamet's play, depicts desperate real estate salesmen trying to unload undesirable properties while the home office threatens their jobs.
"Put that down," Baldwin yells at Jack Lemmon's character as he pours a cup of coffee during a sales meeting. "Coffee's for closers only. You close or you hit the bricks."
Thomas Marano, global head of mortgages and asset-backed securities at Bear Stearns Cos. Inc., said he never heard about any subprime lenders using "Glengarry Glen Ross" for training.
"If I knew a company was doing that, I would cut them off," said Marano, whose company was the No. 1 U.S. underwriter of mortgage-backed securities in 2006.
DIALING FOR DOLLARS
The branch offices of subprime lenders operated much like telemarketing outfits, with a big difference. Some paid salaries of hundreds of thousands of dollars for big producers. Computers spat out leads, such as from Internet sites where prospective borrowers checked interest rates. Loan officers with headsets raced rival lenders with the same leads to offer a quick refinance or new home loan.
"You have to call your leads three times a day, minimum," said Amy Kay Vandeventer, who worked at Home Funds Direct, a unit of Accredited Home Lenders Inc.
Loan officers at Accredited Home Lending, Ameriquest and New Century Financial, for example, said it wasn't unusual for them to dial more than 100 numbers in a day. Once they hooked a perspective borrower, they reeled in the prospect using scripts to overcome objections.
"They're the ones who call you during dinner when you have a spoonful of applesauce in your mouth," said Paul Lukas, a Minneapolis attorney who represents workers who have sued mortgage lenders for overtime pay.
Supervisors checked how much time the salespeople were on the phone. Those who fell behind were encouraged to stay late, work on Saturdays -- or pack their bags.
Bonuses were tied to sales, and the best sales people could move from company to company as they pleased - raising pressure on lenders to underwrite loan applications generated by their stars, even if credit standards were being stretched.
PIPELINE TO WALL STREET
With strong employment and interest rates near historic lows, subprime lenders filled a mortgage pipeline that extended all the way to Wall Street. Once there, leading investment banks pooled thousands of loans together and packaged them into securities that they sold to pension funds, hedge funds and overseas investors.
For some of those on the other end of this pressure, serious financial trouble wasn't far away.
Kelly and David Graham of Westminster, Massachusetts, refinanced their home in 2003 with an adjustable rate mortgage from Ameriquest to consolidate their debts.
A few months later, the couple received a call from Dream House Mortgage with an offer to refinance the Ameriquest loan at a lower rate. The Grahams, in a federal lawsuit, say they refinanced again, but didn't know their Dream House loan was funded and underwritten by Argent, Ameriquest's sister company.
The Grahams say the relationship among lenders was concealed so the companies could collect on more than $10,000 in prepayment penalties triggered by the couple's second refinance, court records show. The combination of prepayment penalties and medical bills from the illness of their newborn daughter caused the couple to fall behind on their mortgage payments in late 2005. They went to court to stop foreclosure on their home.
The lenders deny any wrongdoing in court papers. Dream House has been dropped as a defendant in the case.
Bear Stearns' Marano said he doesn't think lenders purposely originated loans they thought would fail.
He said investors were comfortable with subprime lenders stretching their lending standards, partly because rapidly rising housing prices were building equity. Even a loan with no money down from the borrower looked like a good bet.
A former chief executive at a failed subprime lender, who asked to remain anonymous as his company unwinds, said as long as Wall Street was willing to buy the risky loans and package them into securities, the market was going to create them.
"You act very differently when you know somebody is willing to buy the loans," the executive said.
REFORM DENIED
Ameriquest, one of the aggressive companies that led the subprime boom, resisted attempts at reform, said Wayne A. Lee, former chief executive of the company's closely held parent company, ACC Capital Holdings Inc.
Standing in his way, Lee said, was company founder Roland Arnall, who became a billionaire building Ameriquest.
Lee said he wanted mortgage underwriters to be free from the influence of branch managers on commission.
"Branch managers had both the authority as supervisors and the motive as employees paid on commission to influence and override the supposedly objective operational decisions of the (loan underwriters)," Lee said.
He aired his conflict-of-interest claims in a legal dispute with Ameriquest over his $50 million consulting deal.
Ameriquest lawyers said Lee made baseless claims to extract money from the company.
"Mr. Lee's complaint is a ridiculous work of fiction." said Bernard LeSage, an attorney for the company.
Lee negotiated the consulting deal when he quit his post in 2005. He did not return telephone calls seeking comment. Ameriquest said the lawsuit was settled.
In January 2006, Ameriquest agreed to pay $325 million to settle predatory lending investigations by state attorney generals throughout the United States.
The company admitted no wrongdoing but agreed to several reforms. Borrowers, for example, would receive a simple, one-page form clearly describing all loan terms at least three days before closing.
The bad press didn't hurt Arnall's profile. Since 2002, he and his wife, Dawn, have raised at least $12.25 million for President George W. Bush, the Washington Post has reported. In February 2006, a month after Ameriquest agreed to settle one of the largest predatory lending cases in U.S. history, Arnall was sworn in as U.S. ambassador to the Netherlands.
While Arnall represents the U.S. government the Netherlands, the DeWitts live in a trailer home in Elkhart, Indiana. They couldn't afford the Argent loan they say Ruth was pushed into while Lelon was in heart surgery.
The DeWitts sold the house to get out from under the loan with Argent, triggering several thousand dollars in prepayment penalties. Faced with a stack of medical bills, they filed for bankruptcy.
After his open-heart surgery, Lelon DeWitt was no longer able to repair transmissions. He remains bitter about how he says his wife was treated during the loan-closing process.
"It was very wrong. They took advantage of my wife. She wasn't in her right mind," he said. "(That loan) ruined everything."