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All the Devils Are Here

Page 30

by Bethany McLean; Joe Nocera


  The president of the New York Fed by then was one of Rubin’s protégés from the Clinton Treasury: Tim Geithner, who had risen to be undersecretary for international affairs while still in his thirties. When he was named to head the New York Federal Reserve in 2003, he was all of forty-two. Having studied at the feet of Rubin, Summers, and Greenspan, it was perhaps inevitable that he would share their mind-set about the virtues of the market. As the guidance was being discussed within the government, there were bank supervisors who were arguing that the Fed needed to clamp down on both mortgage lending and commercial real estate practices, especially given the rapid growth of both asset classes since 2000. But there were, shall we say, alternate concerns, which were expressed by Geithner and others who shared his views. What would the effect be on the mortgage and housing market if the Fed were heavy-handed? What would the effect be on the bottom lines of banks? “The Fed slowed down the guidance,” says one person. “It was slowed down by internal debates about how far the regulators should go since most of the mortgages were sold into the market—and this guidance would replace investor risk appetites with regulatory standards.”

  As the mania reached its peak, an odd problem loomed: who was left to borrow money? Historically, the subprime lending business had leaned heavily toward refinancings. Sometimes that meant persuading people who had a thirty-year fixed loan—or had paid off their old mortgage entirely—to remortgage their home. Other times the homeowner was already a subprime borrower who needed to refinance after a few years, when the interest rate on his loan ratcheted up beyond his means to pay. But by 2006, 40 percent of actual home purchases in the United States were made with a subprime or Alt-A loan, according to Deutsche Bank. Why? Because soaring real estate values had priced legitimate buyers out of the market, and because brokers were seeking out borrowers who had never even thought about owning a home and who, under normal circumstances, would have no hope of doing so. Loans were being made to people who couldn’t even afford the teaser rate, much less the reset rate. Borrowers would sign the papers, get the loan, move into the house—and stop paying within the first few months.

  At the same time, the rapid rise in home values finally began to slow. That meant that homeowners who had known from day one that they would need to refinance before the loan reset didn’t get the appreciation they needed to make a refinancing possible. “Whoever made that last loan, they were the lender of last resort,” says an industry veteran. In other words, both the borrower and the lender were stuck with the bad loan.

  In loan offices around the country, the tension grew, particularly for those lonely souls whose job it was to prevent bad loans from being made. Such as veteran appraiser John Ferguson, who had gotten his start at the Money Store (“the sleazy edge of subprime,” he says) and then moved to BankUnited, a Florida-based bank whose exposure to subprime mortgages would eventually help bankrupt it. Ferguson had started rejecting more and more deals as he saw the quality declining. In the spring of 2006, he wrote to his boss at BankUnited’s Walnut Creek, California, office: “When everything is going great guns and you kill a couple of deals then so what. But when it gets to be crunch time… every time you become an obstacle to someone getting their pay check things get ugly. It becomes sales vs. the review department. In this office in CA everyone knows that when I cut/kill a deal then that hurts the production numbers.”

  By the following spring, the panic was evident in the office-wide e-mails sent by the sales manager of the office Ferguson worked in. On April 2, 2007, he wrote, “We almost broke 36 million for 92 units, which is lower than February’s numbers, which is the lowest we have been since we opened, almost…. I never thought we would get to this low number… but we did and hopefully we can learn from what we have done and do better…. WE JUST HAVE TO…. We are moving in the wrong direction folks and something has got to change.”

  The subprime companies were like rats racing on a wheel, going faster and faster, knowing that if they stopped, the jig was up. They had to keep their volume up; their very survival depended on it. They needed a constant influx of cash—either from the sale of loans to Wall Street or from selling equity and debt—to keep going. Slowing volume would be a sign that the party was coming to an end. Investors and lenders would bolt.

  By comparison, the fact that the loans were getting worse and worse was a nonissue. Who cared? Regulators and executives alike assumed they had kicked the can to someone else—namely, the investors who purchased the mortgage-backed securities where most of these loans wound up. In a 2005 memo about Washington Mutual, the FDIC summed up the prevailing sentiment: “Management believes, however, that the impact on WMB [of a housing downturn] would be manageable, since the riskiest segments of production are sold to investors, and that these investors will bear the brunt of a bursting housing bubble.”

  And what did Wall Street think about the way the subprime business had gone mad? Wall Street didn’t care, either. If anything, Wall Street was encouraging the subprime companies in their race to the bottom. Lousier loans meant higher yields. “A company would come to us and say, ‘We can’t believe your FICO doesn’t go to 580,’ ” recalls a former Morgan Stanley executive. “ ‘You’re 620, but Lehman will go to 580.’ ”

  Here was the ultimate consequence of the delinking of borrower and lender, which securitization had made possible: no one in the chain, from broker to subprime originator to Wall Street, cared that the loans they were making and selling were likely to go bad. In truth, they were all taking on huge risks in granting these terrible loans. But they were all making too much money to see it. Everyone assumed that someone else would be left holding the bag.

  15

  “When I Look a Homeowner in the Eye…”

  By 2006, there was a distinct Dr. Jekyll and Mr. Hyde-like quality to Angelo Mozilo. The good Angelo had been warning for a surprisingly long time that his industry was heading into dangerous territory. “I’m deeply concerned about credit quality in the overall industry,” he said in the spring of 2005. “I think that the amount of capacity that’s been developed for subprime is much greater than the quality of subprime loans available.” A year later, he said to a group of analysts, “I believe there’s a lot of fraud” in stated-income loans. And he flatly told CNBC’s Maria Bartiromo that a housing recession was on the way. “I would expect a general decline of 5 percent to 10 percent [in housing prices] throughout the country, some areas 20 percent. And in areas where you have had heavy speculation, you could have 30 percent,” he said.

  The bad Angelo insisted that none of this would be a problem for Countrywide. Countrywide wasn’t just some fly-by-night subprime lender; it was “America’s Number One Home Loan Lender!” Mozilo and other executives repeatedly stressed the high standards that Countrywide used to make its mortgages. Countrywide’s “proprietary technology” would help it “avoid any foreclosure,” Mozilo told investors, according to the Los Angeles Times.

  Inside Countrywide, however, Mozilo was not so sanguine. In the spring of 2006, he wrote an e-mail describing Countrywide’s 80/20 subprime loan as “the most dangerous product in existence and there can be nothing more toxic.” Around the same time, Mozilo sent another e-mail saying that he had “personally observed a serious lack of compliance within our origination system as it relates to documentation and generally a deterioration in the quality of loans originated versus the pricing of those loan [s].” He clearly seemed worried.

  The discrepancy between private worry and public proclamation would later cause the SEC to charge Mozilo and several of his top aides with fraud for not disclosing Countrywide’s growing risks to investors. In Mozilo’s case, the government also charged him with insider trading: from November 2006 through August 2007, he got total proceeds of almost $140 million from cashing in stock options. A judge overseeing a class action lawsuit filed against Countrywide wrote in one ruling that it was “extraordinary” how the “company’s essential operations were so at odds with the company’s publ
ic statements.”9

  There is little question that the money, and the accolades, had come to matter too much to Mozilo. And yet it’s unclear whether Mozilo was, in fact, trying to deceive Countrywide’s investors, or whether he was so desperate to win the market share battle that he simply couldn’t see the ultimate cost of the bad loans Countrywide was making. He remained, quite simply, the truest of true believers, both in his company and in the transcendent virtue of subprime loans Countrywide made. He used to say that if 10 percent of subprime borrowers defaulted, that meant 90 percent were paying their mortgages on time, every last one of them a borrower who wouldn’t have otherwise had a shot at the American Dream. “Angelo, he totally believed,” says a former executive. “He’d say, ‘When I look a homeowner in the eye, I can tell if they’ll pay.’ We’d say, ‘Angelo, we don’t even do a personal interview anymore—would you stop saying you can see it in their eyes?’”

  As for Countrywide, Mozilo was convinced that it had become so big and so strong that it was impregnable. By 2006, it ranked 122 on the Fortune 500, with $18.5 billion in 2005 revenue, $2.4 billion in profits, and a mortgage origination engine that had generated a staggering $490 billion in loans. Surely, a company with that kind of financial might could weather even a severe housing downturn. It might even help Countrywide in the long run, by putting some of its subprime-only competitors out of business. During an investor presentation in 2006, Mozilo read the names of some of the companies that had exited the business: Great Western, Home Savings, Glen-Fed, American Residential, and others. “These are the very ones that equity analysts told me that I should be fearing… all gone,” he said. “And ten years from now when we read this list, you’ll see that most of the players today will be gone. Except for Countrywide.”

  Yes, Mozilo saw that Countrywide was making some risky loans, but what he didn’t see—what he couldn’t see—was that these loans could make his company every bit as vulnerable as the competitors he disparaged. “If you’re a true believer, you can ignore things you shouldn’t ignore!” says one former Countrywide executive. “That was Angelo Mozilo’s problem.” Another puts it a little differently: “He’s a great salesman, and great salesmen are often the guys who get sold.”

  Mozilo had long planned to retire from Countrywide at the end of 2006. He was approaching seventy years old, and he had been in the mortgage business, in one way or another, for over fifty years. Although he still held the title of CEO, he was no longer involved in the day-to-day realities of running the business, thanks in part to his undisclosed health problems. His trusted lieutenants, with whom he’d built the company, were taking charge, starting with Stan Kurland, who was his designated successor. A transition had been set in motion.

  But in 2005, Mozilo began to feel better. As he regained his health, he became less sure he wanted to leave the company he often called his “baby.” Another executive recalls a conversation he had with Kurland around then. “You realize I run this company,” Kurland said to this person. “Angelo doesn’t know any of the details.” A few weeks later, this same executive was with Mozilo, who said abruptly, “All Stan is interested in is the hedging reports,” referring to the ways in which Countrywide hedged its interest rate risk. “All he does is the daily hedge. He really doesn’t want to run this company.”

  Executives at Countrywide noticed another change, too. Decisions had always come from Angelo and Stan; now they came from Angelo, Stan, and Dave—Dave Sambol.

  At the same time, Sambol and Kurland were increasingly disagreeing about key aspects of Countrywide’s strategy. With the Fed tightening interest rates, Kurland, fearing its effect on the housing market, wanted to pull in the horns a little, say several former executives. Sambol wanted to keep gunning for growth. And more and more Mozilo was siding with Sambol. Those in the Kurland camp felt increasingly marginalized: “2005 was tough,” says one of them. “You were always trying to say no.” One former executive recalls hearing Kurland’s voice, raised and angry, coming from his office during an apparent argument with Sambol. The culture, which had been tough to begin with, became “a culture of intimidation,” says another ex-executive. A turning point for this executive came when he saw Drew Gissinger, the six-foot-five former San Diego Chargers offensive lineman who served as Sambol’s number two, standing over John McMurray, Countrywide’s chief risk officer, browbeating him, or so it appeared to this person. “Your chief risk guy should be the most respected person in the organization,” another former executive says, recalling the incident.10

  In the fall of 2005, Countrywide’s board asked Kurland for guidance on how he envisioned dividing responsibilities with Mozilo once he became CEO. What ensued became a topic of much discussion and speculation in Countrywide’s top ranks. As other former executives recount the story, Kurland was furious. He didn’t want any division: either he was going to be CEO or he wasn’t. He didn’t want the title if he wasn’t going to truly be in charge, especially given that Mozilo could be a loose cannon and that Sambol, in his view, needed reining in. Kurland sent Mozilo an e-mail that became infamous in Countrywide’s upper ranks, outlining his expectations for the role Mozilo would have when he stepped down. Essentially, Kurland outlined a structure in which he would be running the company and Mozilo would assume the classic role of the ex-founder: “non-executive chairman of the board,” an honorific with no power. Kurland, says one person, was even reluctant to have Mozilo continue as the company’s spokesperson on CNBC.

  The memo led to a bitter—and childish—feud between the two men, one that consumed inordinate amounts of everyone’s energy. Mozilo was deeply offended and, as the story goes, when Kurland tried to apologize, Mozilo refused to accept it. “There’s no way I deserve this after a thirty-year relationship,” Kurland told one person.

  Increasingly, Kurland felt like he was fighting a losing battle on two fronts, according to someone he confided in. “A period of torture” is how this person says he described Kurland’s time at Countrywide after the feud began. As the Fed continued to increase interest rates—it did so seventeen times in a row between June 2004 and June 2006—Kurland became increasingly worried about the housing market. But within the company, he and others who felt that way were the Chicken Littles. Kurland, according to another person, also agreed with Countrywide’s supervisors at the Federal Reserve, which oversaw the holding company (while the OCC regulated Countrywide’s bank), about the importance of both the proposed industry-wide guidance on nontraditional mortgages as well as uniform standards for appraisal practices. Both Mozilo and Sambol pushed back. Kurland told a confidant that he didn’t think he could win a battle for control with Mozilo, because the board was in the founder’s pocket. He felt that he could have gotten the executive ranks to line up behind him. But doing so would have required cutting a deal with Dave Sambol and giving him more control than Kurland wanted him to have. “Maybe I’m not cutthroat enough,” Kurland said at one point.

  Finally, Kurland reached his limit, according to executives who watched the feud play out. The entire company had become obsessed with what some called “the battle at the top.” It was distracting. The company needed to be focusing its energies on the housing market, not its internal soap opera. Kurland told Mozilo that if their standoff didn’t end, it would destroy the company. Although no one on the outside knew it, by the spring of 2006 Kurland was essentially out of Countrywide’s management.

  By the summer, people who paid attention to Countrywide were starting to realize that something was up. “I was in Denver with Angelo,” recalls one analyst. “We were riding in the car, and Mozilo said something to me about how unique Sambol was, that he had technical knowledge, plus he was an excellent salesman. The comment came out of the blue. I wasn’t asking about Sambol, and I began to wonder why he was telling me this. Was Sambol in the running?”

  He was. In September 2006, just after the American Banker gave Mozilo its Lifetime Achievement Award, Countrywide announced that Stan Kurland wa
s leaving the company and Sambol would replace him as president and COO. Mozilo would stay on as CEO until 2009, by which time he would be seventy-one. Kurland’s departure was the culmination of the estrangement that had developed between the two men, who had worked together for three decades. Kurland left without so much as a good-bye e-mail to the staff. Hurt and embittered, he told a friend that he didn’t see the point in pretending otherwise.

  One former Countrywide executive recalls explaining to Mozilo why Sambol was the wrong choice: “I tried to get Angelo to appreciate where Sambol was coming from. I’d say, ‘He’s not strategic and he’s not long term.’ Angelo would just stare blankly back at me.”

  But to anyone who thought about it, there wasn’t really a big mystery as to why Mozilo had fallen so hard for Sambol. Sambol was a salesman, just like Mozilo. Sambol craved market share, just like Mozilo. He was passionate about Countrywide. He was a believer. With Sambol as president, he didn’t have to turn over the reins of his company to anyone else, not just yet. What’s more, with Sambol as his number two, Mozilo could avoid having to face the hard choices that needed to be made. Sambol didn’t seem to want to play defense, even if that’s what the company needed, as subprime madness spread and interest rates continued their ascent. In the spring of 2006, he told investors, “We’re extremely competitive in terms of our desire to win and we have a particular focus on offense.”

  A few months before Kurland officially left, Mozilo had sent an e-mail to Sambol, CFO Eric Sieracki, and other executives. It could have been written by two different people. (Kurland was only CC’d.) He began the e-mail with what amounted to an acknowledgment of reality: “As we are all aware Stan has begun a major undertaking to assure that we reduce midline expenses as rapidly as possible and to be reduced at least in concert with expected revenue reductions from our production divisions.” He continued, “I want you to examine our risk profile.”

 

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