The information contained in this blog is taken directly from “Chain of Blame”, http://www.chainofblame.com/a fascinating commentary on the meltdown of the American financial system which was named one of the ten best business books of the year by Bloomberg News. http://www.bloomberg.com/apps/news?pid=20601088&sid=am5wffhiJV9c
The current meltdown of the American economy began in Southern California in the late 1980’s. Southern California remained the epicenter of the meltdown in 2006 when eight of the nation’s top 15 subprime firms were headquarted in Southern California. Seven of the 15 that survived were nonbanks that survived on wharehouse lines of credit from Bear Stearns, Credit Suisse, Lehman Brothers and Merrill Lynch. After Savings and Loans crashed, a variety of mortgage brokerage firms sprung up to fill the void in lending left from the S& L crash. Countrywide Home Loans began as a tiny player in the residential lending market but by 1991 Countrywide was the largest lender in the United States.
When the S & Ls failed, Countrywide and other mortgage lenders stepped in to pick up the pieces. In 1991 there were 14,000 brokerage firms in existence. By the end of 2006 there were 53,000 loan brokerage firms operating in 50 states, employing an estimated 200,000 people. By comparison, the Mortgage Bankers Association (vestiges of the old S & L’s) had just 2,300 members.
Between 2004 and 2007 Countrywide had originated $150 billion in subprime loans in the US and in 2006 alone, Countrywide was the largest option ARM lender in the country, originating $11 billion each quarter. There were 44,000 brokers in the US and 38,000 were approved and signed up to do business with Countrywide. Countrywide was focused on churning a massive volume of loans, without regard to the quality of the loan or the borrower””the fees were being made when the loans were closed and sold.
The Time Before SubPrime
For well over 50 years, savings and loans financed most homes purchased by Americans. Non-bank mortgage lenders like Countrywide were limited to making FHA/VA loans which had higher delinquency rates than the loans written by the Savings and Loans, but because the delinquent loans were underwritten by the US government, the risk to lenders like Countrywide was relatively low.
In the early eighties a powerful alliance was created between the National Association of Home Builders, the National Association of Realtors, Fannie Mae, Freddie Mac, and the National Mortgage Bankers Association. These groups pushed for deregulation at the state and federal level of the Savings and Loan industry. When the regulations fell, the S&L started an orgy of irresponsible and sometimes outright fraudulent lending. The resulting collapse of the S& L’s cost American taxpayers more than $150 billion.
In Steps Countrywide
In 1981 before most S&L’s failed, Countrywide raised $3 million in an IPO. After mass failures in 1983 Wall Street titans had nowhere to go with their money and Bear Stearns sold $11 million in Countrywide preferred stock. The Money Store, Beneficial, Associates First Capital and Aames Financial and Household Finance were all involved in making small second mortgage loans in the 1980s. There numbers were tiny, but the percentage yield (in the neighborhood of 14%) on those loans was tantalizing. Wall Street briefly got into the game of funding these pools of loans in 1996-1998, but the market shut down and the money disappeared for these types of loans during the Russian debt crisis of 1998. (While these rates in general were high it is important to keep in mind that when Reagan took office in 1981 mortgage rates were in nosebleed territory””14%, a year later the rate would rise to 16%.) Other larger lenders (Like Countrywide) eventually took notice of the yield on these riskier loans and between the early nineties and the crash, the existing lenders and hundreds of others began creating business models based on the larger yields of riskier loans.
Between 2002 and July 2007, home lenders had originated $2.6 trillion in mortgages to people with bad credit but loan delinquencies were rising to 20 year highs.
The Role of Wall Street
The biggest names on Wall Street, Citigroup, Lehman Brothers, Merrill Lynch, Credit Suisse, Bear Stearns, were all making massive amounts of money trading on subprime mortgages. It seems counter-intuitive that big firms would make more money on ” bad” mortgages, but the higher interest rates on those mortgages commanded higher fees”¦..for every player in the game. From the broker who sold the loan to the homeowner, to the Bear Stearns manager that sold the pool”¦.the worse the credit, the higher the risk of the loan, the more money there was to be made. A consumer loan broker could make three or four thousand dollars on a $100,000 loan, but a bond salesman from a Wall Street brokerage house could make $62,500 on a $50million bond.
As the 1990s progressed, Countrywide and other lenders grew rapidly. Concurrent with this growth, Wall Street firms like Bear Stearns, Lehman Brothers and Merrill Lynch grew rapidly and were making massive profits. The subprime lenders could not close and fund the volume of loans they were writing””they simply didn’t have that kind of cash. The lenders closed billions of dollars in loans a month. These loans were bundled into Mortgage Backed Securities, which were sold to the Wall Street firms who in turn replenished the lender’s capital so the cycle of loan making could continue. The Wall Street firms took a massive commission on the Mortgage Backed Securities when they sold them to investment outlets like Police, Fire and Teachers union pension funds. The Mortgage Backed Securities were not just sold to U.S.-based investment outlets, but to unions and the like all over the world.
In 2000 Wall Street firms had securitized $74 billion in subprime loans or just 7 percent of all loans originated that year. Two years later that figure had more than tripled to $233 billion.
The Fall of Countrywide (and the crash of the subprime industry)
In a conference call to investors on July 24, 2007, Angelo Mozillo said, ” We are experiencing a huge price depression, one we have not seen before”¦.not since the Great Depression.” The next day, Countrywide stock dropped 11% and the stock market dropped 226 points. Despite the fact that Countrywide had made $2 billion the year before, his comment was the concrete indicator that something was wrong in Countrywide (and the subprime industry as a whole) and neither ever recovered.
Bank of America Purchases Countrywide
With Countrywide in trouble, a bailout was absolutely necessary and Bank of America became the only real suitor. After analyzing the purchase however, an independent research firm (Friedman Billings Ramsey) predicted that Bank of America would have to write down the value of Countrywide ‘s Mortgage Holdings by up to $30 billion because of delinquencies and defaults.
On January 11, 2008, Bank of America announced that it planned to purchase Countrywide Financial for $4.1 billion in stock. On June 5, 2008, Bank of America Corporation announced it had received approval from the Board of Governors of the Federal Reserve System to purchase Countrywide Financial Corporation. On June 25, 2008, Countrywide announced it had received the approval of 69% of its shareholders to planned merger with Bank of America. On July 1, 2008, Bank of America Corporation completed its purchase of Countrywide Financial Corporation.