While Wall Street financiers stoked today's financial meltdown with
explosive investing in high-risk mortgage loans, politicians, federal
officials and lobbyists shielded them from lawsuits that would have
protected borrowers and tempered the frenzy.
FIRST OF TWO-PART SERIES
A principle known as assignee liability would have allowed borrowers
to sue anyone holding paper on their loan, from the originators who sold
it to them to the Wall Street investment bankers who ultimately funded
it.
Without the measure in place, Wall Street increased by eightfold its
financing of subprime and nontraditional loans between 2001 and 2006,
including mortgages in which borrowers with no proof of income, jobs or
assets were encouraged by brokers to take out loans, according to
statistics provided by mortgage trackers.
The Bush administration and members of Congress -- including a key
Republican subcommittee chairman who was later sent to prison for
political corruption -- sided with lending-industry lobbyists and free
marketers who hotly and successfully opposed blanket liability for Wall
Street firms selling mortgage-backed securities, according to
congressional testimony, other records and interviews.
Those loans are what taxpayers will be buying under the $700 billion
bailout plan approved by Congress and signed by President Bush last
week.
The Seattle P-I examined the roots of today's mortgage crisis from
downtown Seattle to Wall Street in New York. The research included
government records, court cases, industry reports, congressional
testimony and interviews with experts from all sides of the issue.
Although many factors contributed to the crisis, including low interest
rates, demand for housing and predatory lending, experts agree that the
lack of liability played a key role.
Beginning in the 1990s, Wall Street financiers have increasingly sold
investment packages known as mortgage-backed securities, which contained
thousands of high-risk mortgages. In doing so, they sent gushers of
money back to lenders who invented new and riskier ways to structure
home loans so they could distribute the money and collect their fees.
Subprime and nontraditional lending, once a niche, shattered records at
more than $1 trillion in 2006. Along with that came a rise in complaints
about predatory lending, according to state regulators and attorneys who
represent borrowers.
Seattle-based Washington Mutual and its subsidiaries were among the
biggest providers of nontraditional and subprime loans, made to
borrowers with checkered credit or unconventional assets and income
sources. The lending and buying frenzy ultimately led to a bank run that
broke that institution's back, along with many others.
Securities investors also were at risk. Enticed by high profits, the
protection against legal liability and reviews by rating bureaus that
failed to forecast the dangers ahead, they flocked from every corner of
the globe. But investors also included government-sponsored entities
such as Fannie Mae and Freddie Mac. Originally formed to guarantee home
loans and provide Americans with easier access to credit, they, too,
have cracked in the fire created by mortgage-backed securities.
Other Wall Street securities are subject to assignee liability,
including ones containing loans for cars, refrigerators and even home
improvements.
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Ney |
Experts on both sides of the issue say one member of Congress stood
out in his opposition to assignee liability, former Rep. Bob Ney,
R-Ohio, once the powerful chairman of a subcommittee focusing on home
financing. Ney even drafted legislation in 2005 with Rep. Paul
Kanjorski, D-Pa., that would have more decidedly and clearly protected
mortgages from both federal and state assignee liability.
Ney promoted a philosophy that protecting financial institutions was
protecting the little guy, assuring an easy flow of money to lenders
willing to help folks with bad credit buy houses.
"These strict (state) assignee liability laws threaten the
availability of credit, frankly, in the subprime market," Ney said as he
opened a June 2004 hearing focused on the subject. "Acting as a usury
cap on mortgage lending, these laws effectively prevent people from
receiving mortgages."
Ney's arguments were repeated by lenders, financiers and other
lawmakers for years afterward, but he was removed from the debate.
Because of influence peddling in a scandal involving lobbyist Jack
Abramoff, Ney went to prison last year. Recently released and operating
his own consulting business in Newark, Ohio, according to his father, he
declined an interview request.
Those opposed to holding Wall Street legally accountable acknowledge
that it would have made fewer subprime and nontraditional loans
possible. What was seen as a negative then would have cooled the market.
"What we would have had happening was a drying up of the market for
folks who can make payments but have blemishes on their credit," Bill
Himpler, executive vice president for federal affairs for the American
Financial Services Association, representing lenders,
and a former HUD official, said in an interview.
"Liability just creates an additional risk to the investor, risk that
is difficult to manage," said Steven O'Connor, senior vice president for
government affairs at the Mortgage Bankers Association.
But proponents said a slowdown was just what the doctor should have
ordered. Wall Street needed to be careful with subprime lending, and
shun the most toxic loans.
With civil liability threatening them, "I have no doubt the industry
would not have made those (risky) loans. They would have put controls in
place," said University of Connecticut law professor Patricia McCoy, a
former securities and banking attorney and a recognized expert on that
type of liability.
"There was a lot of legal talent hired by the industry to try to
figure out ways to make sure that nobody along the chain (including Wall
Street) had to suffer legal accountability," said Kathleen Keest, a
former Iowa assistant attorney general who now studies lending activity
for the Center for Responsible Lending.
The battle for and against assignee liability was hotly waged
starting in 2002 in Congress, state legislatures and city council
chambers, though it received scant publicity. Some 20 states and a few
cities passed anti-predatory lending laws that contained assignee
liability provisions, but federal law and the federal agencies that
charter banks and thrifts such as Washington Mutual shielded them from
the state laws.
What the states were worried about turned out to be an issue at the
heart of today's debate over the financial crisis. Free markets are one
thing; unfettered greed is another.
"History is clearly working out right in front our eyes telling us
the total laissez faire operations of the last couple of decades have
some consequences," said Scott Jarvis, director of the Washington State
Department of Financial Institutions. "And they are substantial."
The Great Depression forged the underpinnings of today's
mortgage-lending system but Wall Street fomented a significant change
starting with small steps decades ago, said University of Utah law
professor Chris Peterson, who wrote an award-winning law review article
last year linking the sale of Wall Street securities to predatory
lending.
Since the 1930s, prime mortgages have been guaranteed by
government-sponsored entities that then reinvest the money and provided
more funds down the pipeline for more loans. Fannie Mae, and later
Freddie Mac, accepted only certain loans, creating more sober -- and
some say stifling -- mortgage-underwriting standards for decades,
Peterson said.
In 1977, Lewis Ranieri, a self-taught bond seller at Salomon
Brothers, invented with colleagues an alternative -- the private
mortgage-backed security. Each contains hundreds of mortgages arranged
in subcategories known as "traunches" that provide diversity of payout
and maturity. Ranieri, a company owner on Long Island, didn't respond to
interview requests.
The subprime loan business grew slowly to $34 billion in originations
in 1993, the Mortgage Bankers Association says.
Then in 2002, an unstable mixture of high housing demand,
deregulation, avarice, technical know-how and low interest rates
detonated the market. Subprime and nontraditional lending grew fivefold
from $215 billion to $1 trillion between 2003 and 2006, and the
percentage of those loans sold in private securities went from nearly
half to 80 percent, said Guy Cecala, publisher of Inside Mortgage
Finance, a newsletter.
Like smoke after an explosion, mortgage delinquencies and
foreclosures rose to record heights in 2007, followed by a collapse of
housing prices and mortgage-backed securities.
Looking back, Cecala thinks Wall Street wizards would have searched
for ways around assignee liability, but if it was imposed he wonders:
"We certainly wouldn't have had Wall Street blindly securitizing
whatever was thrown at them."
Predatory lending and reckless borrowing seemed to rise in parallel
with Wall Street's financing of subprime and "creative" loans, said
several regulators and attorneys. Loan originators were inventing new
ways to indebt people, increasing product menus tenfold, said Cecala. A
huge borrower population was refinancing homes over and over again to
the tune of $200 billion, he said, turning mortgaged dwellings into "ATM
machines."
Congress passed an anti-predatory lending law in 1994 that contained
extremely limited assignee liability. It had a threshold that covered a
tiny minority of the highest-priced mortgage loans. Congress empowered
the Federal Reserve board to lower the threshold to include more loans.
It slightly lowered it in 2001, without capturing a significant number
of additional loans, and again in July announced another lowering that
will take place next year.
Too little, too late, said McCoy. "That barn door's been open for a
while."
During congressional and legislative debates around the country,
misleading information was circulated, the P-I found in records and
testimony.
During a battle over proposed city ordinances in California that
contained assignee liability in Oakland, Los Angeles and San Jose four
years ago, George Wallace, a Virginia attorney, provided city officials
with "independent" computer analyses painting a reassuring picture of
the prevalence of high-risk loans in their communities, records show.
Wallace was a former registered lobbyist for the American Financial
Services Association. His board members were then officers of that
lender organization, although leadership has since changed. Recently
deceased, Wallace explained before his death the apparent conflict in an
interview with this reporter.
"I have some standards. I am retired. I am no longer working for
these folks," he said. "I am basically trying to produce some reasonable
stuff."
Mark Harris, a Sacramento attorney who represented AFSA at the time,
said Wallace never acknowledged his affiliation to him or others in his
presence. He was angry it wasn't disclosed. No longer associated with
AFSA, Harris said he believes assignee liability would have saved this
country from the crisis.
Other opponents argued that assignee liability would kill the
subprime market completely. To bolster their argument, they frequently
told lawmakers that rating agencies such as Standard & Poor's, Moody's
and Fitch won't rate securities containing any loans exposed to
liability.
"The rating agencies could not rate an issuance that had liability,"
said Chris Stinebert, president and chief executive of AFSA, in a P-I
interview. "They wouldn't know how to rate it."
Not true, said officials at two rating agencies, Standard & Poor's
and Moody's. They have issued written guidelines for rating
mortgage-backed securities containing what they call "exposed loans,"
meaning they are exposed to civil liability. They have repeatedly rated
loans originated by state-chartered lending institutions where assignee
liability applies.
"In only a very few instances have we ever said we would not rate
pools that includes those loans," said Natalie Abrams, associate general
counsel for Standard & Poor's in a rare on-the-record statement
regarding assignee liability.
Opponents also argued that Wall Street securitizers don't have the
tools to detect predatory and reckless loans inside the huge pools of
mortgages. It makes no sense for a securitizer or an investor to be
responsible for something a mortgage broker did in some distant city,
said Washington, D.C., attorney Laurence Platt, who represents Wall
Street financiers.
"If there were assignee liability as a matter of law, there would be
no assignees," said Platt, a co-leader of the mortgage finance practice
for K&L Gates. "Assignees will not bear the risk of loss based on errors
or legal violations of other people."
Securities handlers are fully capable of detecting bad loans, and if
they were misled they can use that as a legitimate defense, said
University of Minnesota law professor Prentiss Cox, former head of
consumer protection for the Minnesota state attorney. He said the real
reason assignee ability has gotten nowhere is a strong banking and Wall
Street lobby.
Since 2001, the financial sector has given more than $2.1 billion to
state and federal politicians, according to data from legislative
watchdog groups. Of that, more than $900 million came from securities
firms, banks and mortgage banks.
"Who is in a better position to police and be cognizant of the sales
practices? The institutions that are funding this or the naïve consumer
who is taking out the loan?" asked Cox. "Would that have impeded funding
into the market? Yeah. Should it have been impeded? Yeah."
Without assignee liability, investors in mortgage-backed securities
relied on the analysis of rating bureaus to assure the soundness of
their investments. Though rating bureaus issued general warnings about
the securities, today's events show the system was imperfect. As Claire
Robinson, senior managing director of the rating team at Moody's, put
it: "We rated mortgage-backed securities using the best information we
had at the time."
With today's financial crisis blowing hot winds, changes are afoot.
House Financial Services Committee Chairman Barney Frank, D-Mass.,
ushered a bill through the House last November containing limited
assignee liability, but it died in the Senate. His spokesman, Steven
Adamske, said assignee liability could have curbed the "wild, wild West
behavior coming out of Manhattan."
Richard DeMong, a University of Virginia Bank Management professor
who testified against assignee liability before Congress in 2004, will
never advocate judicial intervention in the market. He said he prefers
to think there were a "lack of critical thinking" and a failure to
"challenge assumptions."
But as the market crashed around him on a recent afternoon, he
reflected in an interview his growing concerns, perhaps even doubts:
"You are asking the right questions," he said.
"Clearly, broadly assigning liability would have disrupted the market
considerably," he said. "Could you argue that would have been a good
thing? Probably. Because it turns out people were buying stuff they
didn't understand."
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