Making Recessions Great Again: The Many Myths — And Frauds — Of The 2008 Financial Crisis
Before effective reform can be enacted, the many myths about the crisis have to be busted. Bankers have firmly embedded several fake news versions of the causes of the crash of 2008 in the minds of the politicians and the public.
In this article, I will write about only one of these myths of banking. it’s a big one — with a depth of deception equal to the width of its spread.
The Big Myth
Bankers say, “Hey we were incompetent but not criminal. We foolishly believed that the housing market would always go up so we could recklessly lend.”
To the contrary, there were two levels of fraud: one at the mortgage application stage by retail banks and private lenders; the other at the investment bank stage in creating CDO’s knowingly using these toxic mortgages.
There is a surprising story behind how this massive fraud came about and was successfully obfuscated. It provides one of the best examples of how highly intelligent people can twist programs designed to help the underprivileged so they help only themselves, the privileged.
Our story will begin with the creation of a program to help Americans buy homes, the government agency founded to buy mortgages from banks so they could lend to more applicants, andthe ingenious packaging of these mortgages into large billion-dollar investment packages for sale to wealthy investors.
This investment structure was so successful in producing profits for the lending banks and the investors (along with increasing home buying) that investment banks fashioned their own version of this mortgage package and also sold it to high-end investors.
Lending banks didn’t have to wait 30 years to have their principal paid back with their interest as profit. Each time the government, or the investment bank, bought a mortgage from the lender, they gave that lender a whopping amount of upfront cash; the principal was immediately returned with much of the interest as profit. The entire risk of default was pass on.
The lending banks paid their loan officers huge commissions, often $10,000 a pop, for every successful application to keep that gravy train rolling. So, you can guess what happened when the pool of applicants who met lending standards dried up. The loan officers and the executives at the investment banks we’re not going to let this money machine crash. Now we will look at how that all took place.
The Birth of Fannie Mae
Fannie Mae was established in 1939 so that low-income earners could afford homes. Her mortgages proved over decades to be reliable investments. Its foundation principle was: applicants had to have the ability to pay back the loan. Specific criteria were the same as for a high-income person: a good credit score, a job history with enough income three times the mortgage payment and so on. The only difference was requiring a 5% not a 20% down payment.
Conventional wisdom predicted that lower down payment meant there would be more defaults.
But history proved it was not so. From 1939 onward, these low-income, low down payment mortgages performed just as well as the high-income prime mortgages. And in that success, lay the seeds of the near destruction of our economy by 2008.
Reverse Alchemy In Banking
You need the mind of a banker to comprehend the following section on how bankers turned gold to lead and yielded million-dollar paychecks to themselves in doing so. Here’s how bankers achieved this feat of wizardry by taking this truly brilliant idea to help low-income people and warped it to do the opposite causing the housing market to crash.
Some unrecognized financial genius developed a plan that could make government programs to help low-income people nearly self-funding.
Instead of making loans, the government sponsored enterprises (GSEs) like Fannie andFreddie would buy low-income prime mortgages from commercial banks and private mortgage companies (sometimes called shadow banks because they were unregulated). The GSEs would bundle these together in packages of say 1000 and sell them off to wealthy investors.
With proper timing, the money paid by the investors could flow through to buy more mortgages from the banks and private mortgage lenders. Little need for government funds.
Investors loved them because they paid double the interest rate on U.S. Treasury bonds and had proven over time to be just as safe — AAA strong and secure.
The First Level Of Fraud — At The Lending Banks
The model for mortgage lending changed to “originate and sell”. Private mortgage lenders (shadow banks) couldn’t believe their luck. There was little need for capital. They could sell their mortgages before the ink was dry on the application forms. The money would flow through from Fannie and Freddie. It was in such big chunks there was lots of cash to pay the sales staff, any broker who could find a willing applicant, and, of course, the executives.
The money rolled in to pay those$10,000.00 per mortgage application commissions. And the best part: they got full commissions — even if the applicant failed to make the first mortgage payment. So, with that system of financial reward in place, what happened when the market of qualified applicants dried up?
Yes, you guessed it. Mobile mortgage brokers were loosed like bloodhounds to sniff out anybody that was capable of signing their name. Staff were hired to do cold calls during power hours to lure new customers. Used car salesmen were recruited to man the phones. With the easy money came housing price jumps.
Lending giant Ameriquest Capital Corporation’s (ACC) biggest moneymaker became the ‘cash out’ loan. Sales staff ferreted out people who were not looking for mortgages but had existing mortgages on their homes. These homeowners were told of the great opportunity for instant cash because of the increase in their home value, then offered refinancing of their existing mortgage with a bigger one and a basket full of money to spend.
When the application forms could not meet Fannie and Freddies lending standards, loan officers did what ever it took to make them look as if they qualified.
By 1992, Countrywide Financial rose from nowhere to become the largest private mortgage lender in America. Ellen Foster was the vice president in charge of fraud protection — for a very short time — at Countrywide.
In an interview on 60 minutes in December 2011, she told Steve Kroft of a typical finding when she inspected offices: “All of the — the recycle bins, whenever we looked through those they were full of, you know, signatures that had been cut off of one document and put onto another and then photocopied, you know, or faxed and then the — you know, the creation thrown — thrown in the recycle bin.”
She also told Kroft that she was told to suppress evidence when government regulators interviewed her, and when she refused was fired. Here’s an excerpt from the transcript:
Foster: I got a call from an individual who, you know, suggested how — how I should handle the questions that would be coming from the regulators, made some suggestions that downplayed the severity of the situation.
Kroft: They wanted you to spin it and you said you wouldn’t?
Foster: Uh-huh (affirm).
Kroft: And the next day you were terminated?
Foster: Uh-huh (affirm).
It was the same throughout most of the private mortgage lenders. For another example of the many, Lisa Taylor, a loan agent at Ameriquest, told the Los Angeles Times she had seen co-workers use the bright side of a Coca-Cola machine as a tracing board to copy applicant signatures. She was also fired when she complained.
Retail banks were eventually forced to pay their loan officers similarly or lose them to the private label lenders. The fraud spread to them.
A Legal Geek Point: There were, and are, no government regulations restricting any bank or mortgage company from leading to anyone they wish. They are free to decide the risks at first instance. In fact, much of the private mortgage lending business properly comes from lending to people rejected by the commercial banks.
There was absolutely nothing wrong with the mortgage companies lending to subprime applicants as long as they kept these mortgages and the extra risk on their own books. However, they passed off these subprime loans, and in doing so, presented them as if they conformed to Fannie and Freddie lending standards.
In April 2005, Fed Chair, Alan Greenspan, praised subprime lenders “Where once marginal applicants simply have been denied credit, lenders are now able to quite efficiently judge the risks posed by individual applicants and to price the risk according.”
But Alan, what about the new business model of originate and sell? The lenders now could pass on the risks to Fannie Mae by faking the application forms. Did you assume that money lenders would never do such a thing?
The Second Level Of Fraud — Investment Banks
In the 1980s, investment banks copied this golden goose of financial products. They started with only prime mortgages — home and corporate.
Bankers found packaging these mortgages into investments called CDOs -collateralized (the house is the collateral) debt obligations (the loan is the debt) wildly profitable for themselves. They got a 1% commission for assembling the bundle. Let’s do the math: 1% of 1 billion is $10 million. Not bad for a few day’s work!
Now the second massive fraud came into play.
By the year 2000, or so, investor confidence in prime mortgage CDOs had been thoroughly baited by superb result.
When the pool of prime mortgage applicant dried up, the investment banks told the mortgage lenders to send up the subprimes. Recall, subprimes are mortgages to people with bad credit.
In the chapter, I Like Big Bucks and I Cannot Lie in their book All the Devils Are Here, the authors repeat a tale told by Jon Daurio, a former executive at Ameriquest of a meeting with Bear Stearns.
“How can you increase your volume?” The Bear Stearns bankers asked him.
“We said, talking tongue in cheek,’ Well, we can do a 100% loan to value stated income loan for 580 FICO scores.
Daurio continued: “They said ‘ okay!’ We said,’ No problem! Let’s do this all day!’ And we did it in massive quantities.”
In banker speak “stated income loan” meant accepting whatever the applicant says at face value and never checking. “Loan-to-value” meant giving a loan for 100% of the purchase price of the house — not requiring even a 5% down payment.
Then, the investment banks switched the quality by slipping subprime mortgages in with true primes and getting rating agencies to still bless them with an AAA.
When the economists gave their analysis of the causes of the 2008 meltdown, they misled journalists by giving the impression that Fannie Mae mortgages were known to be subprime mortgages. Therefore, Wall Street and its supporters could say the crisis was caused by those bleeding-heart Democrats who encouraged the banks to lend to the unworthy poor — those who drink the water. Now governments should help those who carry it — for example, the bankers — with bailouts.
“It was not the banks that created the mortgage crisis. It was, plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp… They [governments] were the ones that pushed the banks to loan to everybody. And now we want to go vilify the banks because it’s one target, it’s easy to blame them and Congress certainly isn’t going to blame themselves.”
We can’t single him out for blame. He is an example of a typical politician. They know no more about banking than the bankers want them to know.
Subprimes became universally mocked on the net as Ninja loans — no income, no job, no assets — as if they were Fannie Mae conforming loans. The internet completely bought and promoted the banker initiated propaganda, and far better than the bankers could do themselves.
In spite of this amazing fraud and cover up, no individual banker, except one Egyptian national, was punished. If you have any misconceptions about the true power of bankers today, consider that while they were committing fraud on the government enterprises designed to help low-income families, they were also found guilty of money laundering for drug lords and Al Qaeda—with petty fines paid by the banks and no jail!
Bankers had tested the system. They knew that if they weren’t going to jail for washing the blood off money, they weren’t going to go to jail for merely screwing low-income Americans.
When serious banker fraud is given penalties that do not punish, the only question is what form banker fraud is taking as you read this. We are proving Aldous Huxley’s insightful quip as modernized: we have not learned from the history of the 2008 Crisis, and we are doomed to repeat it— and soon.
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