Richard is an acquaintance of mine, someone I came to know when he worked on my house several years ago. I recommended him to other friends and we kept in touch sporadically. He’s a big guy, an ex- Marine, a family man and a very decent fellow. A few years ago he bought one of these fancy new mortgages with an adjustable rate. Recently his rate reset, has gone up by more than $2,000 a month and he’s fallen behind on his payments. Richard, like more than 4 million Americans is fighting to keep his home.“At one point, my son had $7,000 in a CD and I had to break it. That really hurt. I was saving that money for his college. I put $2,000 back but it’s hard.”
Richard worked 3 jobs, one in construction, and made a total of roughly $50,000. He got himself into trouble related to construction and needed money, so he took out a loan against his house. A big one–call it $500,000 in round figures. He borrowed that from the bank and they didn’t check his income. It’s a no-income verification loan. Banks never used to do that. He said, “Even though there are a lot of papers that get filled out it’s like you pass a guy in the street and say: lend me 500,000 dollars? He says, what do you do? Hey, I got a job. OK. It is essentially that casual. I wouldn’t have loaned me the money. And nobody that I know would have loaned me the money.”
Richard hasn’t made a payment in almost a year, and his house is in the process of foreclosure.
“Nobody came and told me a lie. That wasn’t the situation. I needed the money. I’m not trying to absolve myself of anything. I thought I could do this and get out of it within 6 to 9 months. The 6 to 9 month plan didn’t work so I’m stuck. The bank made an imprudent loan. I made an imprudent loan. We’re partners in this.”
This imprudent partnership is new, and is at the heart the current financial crisis. For most of the history of banking, bankers wouldn’t have loaned Richard their money either. They didn’t let people like Richard near their money– people with part-time employment, and unpaid debts in their past. And then, suddenly, in the early 2000’s, everything changed, banks went out looking for partnerships with people like Richard—loaning him half a million dollars without even checking to see if he had a job. What happened?
Well, I happen to know another guy, let’s call him Bill, who worked at a large private mortgage bank with his friend Glen. I met him through mutual friends and we talked to each other at a recent get together. Bill got into the mortgage business straight from his previous job as a bartender. It seemed like a godsend—a great opportunity. Bill’s job was to buy up individual mortgages (like Richard’s) mainly from mortgage brokers, bundle two or three hundred of them together, and sell them up the chain to Wall Street. When he first started working back in 2000, he’d only buy mortgages that were pretty standard and pretty safe. Mortgages where people had come up with a down payment and proven they had a steady income and money in the bank. But Bill and all the others sold so many mortgages that there came a point in 2003 where just about everybody who wanted a mortgage and was qualified had gotten one.
Just as Bill was starting his new career, the world was starting a new career too. A gigantic pool of money had just gotten started. As I discussed in my Stoner Question—WHAT pool of money? Where did this come from? In this case, it was a global phenomenon. The global pool of money, a huge pool of money out there, which is basically all the money the world is saving now. Insurance companies saving for a catastrophe, pension funds saving money for retirement, the central bank of England saving for whatever central banks save for. All the world’s savings.
The International Monetary Fund says it’s about 70 trillion. Think about all the money that people spend everywhere in the world. Everything you bought in the last year, all of it. Then add everything Bill Gates bought. And all the rice sold in China and that fleet of planes Boeing just sold to South Korea. All the money spent and earned in every country on earth in a year: that is LESS than 70 trillion, less than this global pool of money.
And that money comes with a herd of very nervous men and women watching over the pool of money: investment managers. This herd is nervous because they don’t want to lose any of that money and they also want to make it grow bigger. But to make it grow, they have to find something to invest in. And for most of modern history they bought really, really safe, really boring investments: things called treasuries and municipal bonds. But then, something changed, something happened to that global pool of money.
The IMF said that this number doubled since 2000. In 2000 this was about 36 trillion dollars. How’d the world get twice as much money to invest? All sorts of poor countries became kind of rich making TVs and selling us oil: China, India, Abu Dhabi, Saudi Arabia. They made a lot of money and banked it. China, for example, has over a trillion dollars in its central bank, and there are office buildings in Beijing filled with math geniuses looking for a place to invest it. And the world was not ready for all this money.
There’s twice as much money looking for investments, but there are not twice as many good investments. So, that global herd of investment managers was hungrier and twitchier than ever before. They all wanted the same thing: a nice low risk investment that paid some return. That’s their job as investment managers.
At this precise moment, one guy took one of that herd’s favorite investments and made it a lot less attractive. Our friend, Alan Greenspan. He really is Dr. Evil. In one of his speeches he totally drove that herd of investment managers into a stampede. He said “Hey, global pool of money – screw you.” He said he’s going to keep the Fed Funds rate at the level of only one percent. He told every investor in the world: you are not going to make any money at all on US treasury bonds for a very long time. Graze elsewhere.
I don’t know why, but what they all wanted—and thought were very safe –were more mortgage backed securities. So Wall Street had to find more people to take out mortgages, which meant lending to people who never would’ve qualified before, like Richard.
And so my acquaintance, Bill, noticed that every month, the guidelines were getting a little looser. Something called a stated income, verified asset loan came out, which meant you didn’t have to provide paycheck stubs and w-2 forms, as they had in the past. You could simply state your income, as long as you showed that you had money in the bank.
Bill told me the next guideline lower is just stated income, stated assets. Then you state what you make and state what’s in your bank account. They call and make sure you work where you say you work. Then an accountant has to say for your field it is possible to make what you said you make. But they don’t say what you make, just say it’s possible that they could make that.
Bill said, “Yeah, and loan officers would have an accountant they could call up and say “Can you write a statement saying a truck driver can make this much money?” Then the next one, came along, and it was no income, verified assets. So you don’t have to tell the people what you do for a living. You don’t have to tell the people what you do for work. All you have to do is state you have a certain amount of money in your bank account. And then, the next one is just no income, no asset. You don’t have to state anything. Just have to have a credit score and a pulse.” I can attest to that statement—I’ve been in his office when he did that.
An interesting fact here. Bill’s bank did not care how risky these mortgages were because banks didn’t have to hold on to these mortgages for 30 years, as they had in the past. They didn’t have to wait and see if they’d be paid back. Bank’s like Bill’s just owned them for a month or two and then sold them on to Wall Street. Wall Street would sell them on to the global pool of money. And if you don’t own something–if you’re just a middle-man– you don’t care so much about it, which is how we get half-million dollar, no income, no asset loans.
During this period, there’s another thing going on: housing prices were rising, fast. Lots of people in the mortgage industry had this faith that housing prices, in the US, simply would never go down. So, from the bank’s perspective, even if the worst happens and someone defaults, the bank would then own the house which is now worth even more than when they gave out the loan. I can attest to this belief too—living in Los Angeles, housing prices have rarely gone down; VERY rarely.
All Bill cared about was whether or not his customers–the Wall Street investment banks–would buy those mortgages from him. He was a salesman. And he was under pressure to approve more and more loans, because other guys in his company—their commission depended on selling more loans. And occasionally, those guys would hear about some loan that some other mortgage company offered that they weren’t allowed to offer, and they’d complain to Bill.
Bill said, “Three of them would show up at your door first thing in the morning and say, ‘I lost 10 deals last week to Such-and-So bank. They’ve got this loan. Look at the guidelines for this loan. Is there any way we can do this?’ We’re losing deals left and right. I’d get on the phone and start calling all these street firms or Countrywide and say “Would you buy this loan?” Finally, you’d find out who was buying them.”
So, Merrill Lynch would say no. And Goldman Sachs would say no. And you’d finally hit on somebody and they’d be like “Yeah, we’ll buy that loan.” Once one person buys them, all the rest of them follow suit.
I asked him if he understood how crazy this was. “Yeah. And my boss was in the business for 25 years. He hated those loans. He used to rant and say, ‘It makes me sick to my stomach the kind of loans that we do.’ But it’s a business and when other people are offering those kinds of loans, you are going to offer them too.” Besides, everyone could see that house prices were booming, everything’s gonna be good. And the company was just rolling in the cash, just raking it in. Bill and his friend Glen were making between 75 and 100 grand A MONTH at the height of this craze.
Glen is a lot younger than Bill, and he loved his job—the pressure, the wheeling and dealing. And he PARTIED! When he wasn’t working, he was spending; going to clubs, drinking Chystal. He had five cars, a 1.5 million dollar vacation house and he made all this money making very large loans to very poor people with bad credit. These people can barely make a car payment and Glen and Bill were giving them a 300, 400 thousand dollar house. But Glen didn’t worry about whether the loans were good. That’s someone else’s problem. And this way of thinking thrived at every step of this mortgage security chain.
Now, all these mid-sized companies, like the one Bill and Glen worked for, were not using their own money to fund these loans. The way it worked was that the small bank, where they worked, would borrow money from a big bank, say Citibank, or Washington Mutual. Bill’s employer would use this borrowed money to buy up a bunch of loans, and then pay back the big bank once it sold the pools to Wall Street. These smaller banks were highly leveraged, meaning even though it only had 5 million of its own dollars, it could borrow 20 times that, 100 million, to buy loans with. So in late 2006, Bill is busily at it, borrowing, buying, selling, paying back, and borrowing again, when the e-mails started coming.
Bill remembers, “We’d get an e-mail from a Street firm, just say Credit Suisse/First Boston. It’d say, ‘As of December 29th, we are no longer buying Stated Income with a FICO less than whatever. There will be no exceptions. Please do not call the pricing desk.’ And you just start freaking out. Then you start to scramble trying to get this stuff out of the door as soon as you can. You’ve got 20 million sitting there, and you say oh crap, I better get those out the door. Within a week, you can expect to see the same email from all them. You’re scrambling to sell them, going off sheer relationships. Like okay, I’ve still got 10 million of these. I know you’re not buying them anymore. But come on … you can’t just leave me like this. There comes a point where all of them said, we’re not buying anything.”
For guys like Bill and Glen and their bank, that meant that they’d borrowed tens of millions of dollars to buy loans, that now they couldn’t sell. And since the bank they worked at had very little of its own money (just like Richard and the others whose mortgages they’d purchased) they had no choice but to default on their loan. Their bank’s nearly 600 employees were suddenly out of work.
And now we should meet some guys I don’t actually know, I’ll call them Jim and Frank. I heard their story on NPR. They are actual people; they are the Wall Street dudes. Jim created the financial instrument that was central to this global credit crisis we’re in. It’s called a Collateralized Debt Obligation, or CDO. (Bear with me—this will be painless and short.) CDO’s are mortgage-backed securities, those things the herd of investment managers were dying to buy instead of Treasury Bonds. Jim was the guy buying all those mortgages from Bill and Glen.
A mortgage-backed security is a pool of thousands of different mortgages. These are all put together and divided into different slices. Jim uses the word tranche. Some of these slices are risky, some are not. OK, a CDO is a pool of those slices. A pool of pools.
And Jim and most companies like his weren’t buying the top-rated tranches – the safest ones, the AAAs. They were buying the lower-rated, high-risk stuff. Jim’s company was buying tranches that came from Glen’s company. (The guy who hung out at nightclubs. The guy who said he was selling mortgages to people who didn’t have a pot to piss in.)
They call these lower-rated tranches toxic waste. They’re so high-risk, they’re toxic. So, a CDO is sort of a financial alchemy. Jim takes that toxic stuff, these low-rated, high-risk tranches, puts them all together. Re-tranches them, and presto: he has a CDO whose top tranche is rated AAA, rock-solid, good as money. If this seems too good to be true to you, you’re in good company; Warren Buffet said the very logic was ridiculous.
But back in 2005, 2006, the global pool of money couldn’t get enough of these things. And the CDO industry was facing the same pressures everyone else was at every other step of this chain: To loosen their standards. To make CDOs out of lower and lower rated pools.
Jim and Frank, they knew this type of business was a crap, but they were in a competitive business. On that NPR interview they said:
“In 2005, we had an internal debate here because there were two banks coming to us, why don’t you do a deal with us, BBB securities, you get paid a million bucks in management fees per year. And we declined those deals. We just don’t believe those BBB RMBS assets are money-good. And we thought if we do a CDO of those, that’s gonna blow up completely. We were early in ’05 by not wanting to do those deals. People were laughing at us. Saying you’re crazy. You’re hurting your business. Why don’t you want to make $X Per deal, you could make a million dollars a year.”
From 2003 to 2006, the housing market was in a classic speculative bubble. Home loans were easy to get, so more and more people were buying houses. The increased demand for houses caused the price to increase. The rising prices created even more demand, as people started to look at homes as investments. It’s not too hard to convince yourself that this investment will never go down in value. In 2003 and 2004, 2005, they didn’t. You could buy a house with no money down, turn around and sell it a year later for in some areas double what you paid. (When I sold my house, I had made a gross profit of 360% in 20 years.) People who’d never invested in real estate before started buying multiple properties as investments. There were shows on TV that I used to watch all about how to do it, like “FLIP THIS HOUSE.” It looked so easy and exciting.
Jim and Frank’s company owned a slice of 16 MILLION mortgages on homes like Richard’s. Each of those homes has lots of other owners–people in other CDO offices around the world–there are lots of them. And other investors. You start to see what a crazy web of confusing interconnections this whole process is. Jim was one link in a chain that connected the global pool of money to its new favorite investment, these residential mortgages, the US housing market, and people like Richard.
Knowing about all those pools and slices of people’s houses, you’d think that the people like Frank and Jim—the investors at the top of the food chain—and people like my friend Richard had no idea about each other. I learned through that NPR interview that they know quite a lot about each other. They just see each other through a computer screen.
Frank and Jim have a software program that actually looks at every one of the 16 million loans. From the NPR interview, where they were interviewing Jim’s IT guy, Steve:
Interviewer: Are you, Steve, seeing lives here? (as Steve shows the interviewer the printout.)
Steve: I definitely see lives. The human drama here is you have someone paying their loan, then something happened. They’ve gone 3 months, delinquent…They got to this point of 6, then fought back to current.
Like here, he was on time for a bunch of months. This one, he was on time, 30 days, 30 days, then he went two months behind, came back. And now he’s just behind. And what’s really hard about this, is you can watch people cycle on and off.
We’re human beings
Interviewer: But these guys are hurting you. Their irresponsibility is costing you money and work.
Frank: That was up to us to think about 3 years ago.
Interviewer: Do you have any anger when you look at this?
Jim: Not at all. This is pure sadness.
This is where the partnership of borrowers like Richard and investors like Jim has ended up.
Jim estimated that most of AAA rated mortgage-backed CDO’s that the industry created since 2006, are now worth less than half their value. Some are worth close to zero. But remember to all the investment managers in the global pool of money who bought them, AAA meant safe as government bonds. It’s as if the global pool of money put trillions of dollars in a savings account, came back one year later, and found out that half was gone. Put another way, it’s as if the global pool of money thought it was putting trillions of dollars in a savings account, but really, half of it was going into a furnace.
The money is gone, burned up, never to come back. Easy come, easy go. And that’s what’s led to the new term we’ve all been hearing: credit crisis. The global pool of money still has no idea how much money they lost. How much went into the furnace. And because of that, they’ve totally changed their thinking—for now. They used to be obsessed just with getting some profit, trying to make a slightly higher interest rate return. Now the global pool of money has the exact opposite obsession: SAFETY.
Each link in this chain is at its essence nothing more or less than human nature, human foible, human bondage. No one, really, sees themselves as connected to the millions of others who are living their lives and doing the same things. No one individual can claim they caused all of this pain. But each person played an infinitesimal part. All of out rationales, all of our downright greed for more and more. All the homeowners who wanted a nice house and were offered an easy way to get it; all the mortgage brokers who wanted to make a living getting their customers those loans and finding banks making it outrageously easy for them to sell them; all those banks with sales staffs who were making a fortune providing what seemed like a very safe bet; and all those Wall Street folks doing the same. Don’t forget: money is a fiction, it’s a game, a delusion.
There is this long chain of people that starts with the herd of global investment managers, and these Wall Street guys and ends with people who stand to lose their houses. All along that chain there were Franks and Jims and Glens and Bills, and Richards–bankers and brokers and investors and homeowners. Everybody deluded themselves, thinking they could throw out the old rules. What nobody ever considers is that rules are made necessary to ameliorate human nature.
“Rules are not necessarily sacred, principles are.” –Franklin D. Roosevelt
Richard has applied for mortage modification. If he defaults on his mortgage, nobody wins. He doesn’t want to leave his house, and the investors who own his mortgage, the last thing they want is to own a house in the Sane Fernando Valley, in a declining market with no buyers. So you think it’d be easy for both sides to modify Richard’s mortgage, do something he can afford. But as we now know, that’s not the case.
Richard told me that meeting with the counselor was the first time someone looked at his finances. Not to say the original broker didn’t have a process. It just had nothing to do with reality. The original loan documents, filled out by his broker stated his income was $16,250 a month. He wishes! Another thing the loan docs reveal is that the broker made $18,500. That’s 18,500 reasons to falsify Richard’s mortgage documents and to put him in a house he can’t afford.
At the end of Richard’s budget process, the math they come up with is fairly stark. Richard makes more money now–he got a new and better job, so he makes an average, before taxes, of $8,000 a month. Which means, after taxes, he brings home exactly enough to pay his mortgage and nothing else. They need to get his mortgage down to 3%, and need permission from the note holder. Of course, they have no idea who that is. Richard’s loan has been bought and sold, and re-sold and put into one of those pools, owned by investors. Maybe an investor like Jim.
For Glen, the mortgage sales manager who – not to dwell on this detail – was living the life of a B-list celebrity, the end came too. He can no longer live the life, can’t pay all his bills
He borrowed some money from his dad. He’s living in his house right now, and working with the bank to try to avoid foreclosure. He’s trying to figure out if it just makes sense to walk away from the house. He hasn’t made his mortgage payments in over a year.
So picture the whole chain. You have Richard. He gets a mortgage from a broker—who had 18,500 reasons to get him that mortgage. The broker sells the mortgage to a small bank, to people like Bill and Glen. The small bank sells the mortgage to a guy like Jim at a big investment firm on Wall Street. This is where the partnership of borrowers like Richard and investors like Jim has ended up.
And it’s why the repeal of Glass-Stegal was such a disaster, and why President Obama and Timothy Geithner, and all the financial advisors have such a hard time trying to fix this mess. They are, for all their credentials and brilliance, just people too. Human nature means ALL humans. No one is exempt, just more or less at its mercy. I hope they remember mercy when they make policy that affects we humans.