Broke, USA

by Gary Rivlin

  We entered Santa Clara, a white neighborhood that the Dayton Daily News had recently featured in a series that took a closer look at the destructiveness of the subprime mortgage meltdown. Here Ken McCall, a reporter with the News, discovered a four-block stretch he dubbed the “ground zero” of the area’s foreclosure crisis. It’s here in Santa Clara where I learned why McCarthy had previously shrugged at the sight of a few boarded-up houses. On a single block in Santa Clara, fifteen of twenty-eight properties had been sold at auction in the previous thirty-nine months, and an average of ten families lost homes during that period on the other three blocks the News featured. This was once a solidly middle-class neighborhood seemingly built on bedrock. Now anyone can buy a 1,500-square-foot house there for $30,000—if they don’t mind the drug dealers who now brazenly sell their wares on a street corner.

  McCarthy headed toward Wright-Patterson Air Force Base, a sprawling facility that employs some twenty-two thousand people, most of them young and modestly paid, many of them non-military. He wanted to make sure I saw Huber Heights, and not because this once model suburb built in the 1950s heralds itself as “America’s largest community of brick homes.” The concentration of name-brand Poverty, Inc. outposts in this one town, which McCarthy dubs Dayton’s only truly integrated neighborhood, is at once astonishing and overwhelming. A partial list includes Rent-A-Center, Jackson Hewitt, H&R Block, ACE Cash Express, Advance America, Check ’n Go, Check Into Cash, CheckSmart, QC Holdings, and Cashland. In all, the state has issued fourteen licenses to payday operators in Huber Heights. CitiFinancial has its offices a few blocks from the town border and it was at a Household Finance in Huber Heights where Tommy Myers said he got “took for a screwin’.”

  McCarthy lives not far from here and can remember Huber Heights as a thriving community. But the nearby giant Delco factory shuttered its doors in 2007 and all those people he described as earning $75,000 or $80,000 with overtime could no longer make the payment on their $600-a-month gas guzzlers or the adjustable rate mortgages they could barely afford in flush times. “I hate to say it because it’s cliché, but it really was the perfect storm,” McCarthy said. “You had all this predatory lending going on at the same time all these people were living beyond their means and overconsuming.” When the job losses hit, he said, it all turned very ugly very quickly.

  One perspective on how the poverty business has grown so vast in so short a period of time holds that corporate America has so thoroughly chewed up the nation’s once-solid middle class that the country’s poor and working poor were pretty much the last consumer segment left to exploit. Witness the credit card industry: The charge card is barely fifty years old but whereas the country was a collective $20 billion in debt to credit card companies in the mid-1970s, that figure would exceed $600 billion by the end of the 1990s. Looking for fresh fields to harvest and inspired by the profits posted by the pioneers of the subprime charge card, the big banks began peddling credit to those on the economy’s fringes.

  Elizabeth Warren, a Harvard Law School professor who has written extensively about consumer debt, would learn firsthand about the financial value of the customer who is barely making ends meet. When she was talking with a group of senior executives from Citigroup about how the bank where they worked might lower its default rate by more accurately determining which customers could least afford to carry credit card debt, a man at the back of the room interrupted her. Cutting off our most marginal customers, he told her, is out of the question because it would mean giving up a large portion of the bank’s profits. Warren quotes a MasterCard executive who described for her the perfect credit card customer. It’s someone who has recently emerged from bankruptcy protection because it will be years before they are permitted under the law to file for bankruptcy again yet they also have what he described as a “taste for credit.” (At the end of 2008, Warren would be named chairwoman of the five-person oversight committee Congress created to oversee spending of the $700 billion TARP bailout money.)

  The tax preparation business has followed a similar arc. For years those running H&R Block, which was founded in 1955 and went public in 1962, were happy to stick to the core business of preparing tax returns for the middle class. As long as there was still a long list of cities and towns to conquer, they could simply open more storefronts each year to reliably post the double-digit growth revenues that Wall Street expected. But by 1978, confronting a map of the country that was more or less filled in, Block tried moving into the temp agency business (their logic being that a corporation that earned virtually all of its revenues during a four-month period was already in the temporary employee business) and then in 1980 purchased CompuServe, at the time a computer time-share company. Block even tried getting into the legal services business in a short-lived partnership with Joel Hyatt. But it wasn’t until the second half of the 1980s that the company wowed Wall Street with the refund anticipation loan. Block’s long-stagnant stock price soared by 118 percent over the next four tax seasons.

  The subprime mortgage market, however, followed the opposite trajectory. It proved so successful among the working poor that it was reinvented and repurposed for middle-class borrowers. These borrowers, because they had deep scars in their credit records, or because they were self-employed and could not produce the W-2s needed to verify their income, or simply because they wanted more house than their income could justify, were offered mortgages on less favorable terms than conventional borrowers. A problem once isolated on Dayton’s black west side spread to the white east side and first-ring suburbs and quickly climbed up the hills in search of people living in higher tax brackets. By 2007, every county in the Miami Valley experienced a triple-digit increase in foreclosure filings since 1995—except Warren County, an exurb to the south that saw a four-digit increase of more than 1,000 percent in foreclosure filings.

  The cast of companies making these loans changed as well. Subprime pioneers like Household Finance didn’t drop out of the game but they weren’t the same powerhouses that reigned during the 1990s. Most of the big consumer finance companies, for instance, no longer sold credit insurance, and if they did, they no longer folded it into the principal of a loan and financed it at shocking rates. And while the middle class might be perfectly happy to use a subprime product to buy the house they coveted, they certainly weren’t visiting some make-believe banker in a box in a strip mall as Tommy Myers had done. The era that Kathleen Keest would call the “third wave” of subprime finance was dawning, and the early years of the new century would see the mortgage broker emerge as a central player in the home loan business, selling to a new crop of companies.

  Any list of the most successful third-wave companies would have to include Ameriquest Mortgage, the lender that so aggressively fought Vincent Fort and Roy Barnes in Georgia and the outfit that the Wall Street Journal would single out when looking at the role lobbying money played in the subprime meltdown. Ameriquest’s founder was Roland Arnall, an Eastern European Jew born in 1939 to a family that survived the war by pretending to be Roman Catholic. In Los Angeles after the war, a young Arnall got his start in business selling flowers on the street and eventually had enough money to start buying real estate. He pounced when Congress eased the restrictions on savings and loans in the early 1980s and then jumped on the mortgage lending boom in the mid-1990s. In 1996, Arnall paid a $4 million fine to the U.S. Justice Department to settle a lawsuit accusing his company of exploiting minority borrowers and the elderly. He declared that he was a changed man and promised that Ameriquest would serve as a model for the industry. In 2006, after raising $12 million on behalf of George Bush and other Republican causes, the president named Arnall the American ambassador to the Netherlands. By that point he had a net worth of $3 billion. He owned a $30 million estate in Los Angeles and a $46 million ranch in Aspen but also proved a generous philanthropist, making large donations to local animal shelters and hospitals and serving as co-founder of the Simon Wiesenthal Center in Los Angeles.

>   Like Household and the other consumer finance companies that preceded them into the subprime field, Ameriquest and rivals like New Century, Option One, and Countrywide Financial did not have depositors like a traditional bank would. Instead these operations arranged what in the trade are called “warehouse lines”—outsized lines of credit for businesses needing access to tens of millions of dollars in ready cash that Ameriquest used to make home loans to individual borrowers. But unlike the consumer finance shops, Ameriquest and its ilk did not hold these loans but immediately sold them at a quick profit to big investment banks like Bear Stearns, Lehman Brothers, or Merrill Lynch. (Sometimes they sold them to middlemen who put together big pools of these loans on behalf of its Wall Street brethren.) Bear, Lehman, Merrill, or other big investment houses on Wall Street would in turn sell pieces of these repackaged mortgages to pension funds, state and municipal entities, and other clients who thought they were buying something safe and reliable, as the A ratings bestowed on them by the big rating agencies implied. No subprime mortgage lender proved more proficient at this game than Arnall. In 2004, Ameriquest made $55 billion in subprime loans, topping the league tables published by Inside B&C Lending. The company would again rank first in 2005 with $54 billion in subprime loans, $15 billion better than Countrywide Financial, its closest competitor, and two or three times the loan volume of Household or CitiFinancial.

  “Associates, Household, CitiFinancial, and the Money Store proved to be very good at subprime lending,” Jim McCarthy said. “But Ameriquest became the experts at it.” Where the old-line companies focused primarily on refinancings and home equity lines of credit, Ameriquest included new financings in its offering.

  The three hundred retail offices that Ameriquest maintained in thirty-eight states might have been better appointed than those of Household or CitiFinancial, but Ameriquest at its core seemed familiar to McCarthy and his fellow housing advocates. Early in 2005, three years before personalities on the cable news networks started talking about mortgage-backed securities and credit default swaps, the Los Angeles Times ran a story by E. Scott Reckard and Mike Hudson revealing the darker side of this huge lender in its backyard. Ameriquest, the paper reported, seemed little more than a collection of “boiler rooms” scattered across the country, each stuffed with loan agents cold calling borrowers and then burdening them with higher rates than promised and fees they never bothered to disclose in loan agreements. In a suburban Minneapolis office, an agent named Mark Bomchill told of colleagues so eager to cross into six-figure salary territory that they forged documents. They were spurred along, Bomchill said, by a “little Hitler” of a manager who hounded them to sell more loans—in between reminders of how easily they could be replaced. Other former sales people told much the same story. It didn’t matter to Ameriquest’s bottom line whether customers could afford the high-cost loans they were being sold, because they would be off the books long before a borrower defaulted. “Proud sponsor of the American dream” was the Ameriquest motto but Ameriquest paid $325 million in 2005 to settle actions against it taken by forty-nine states and the District of Columbia, suggesting that for many its financings proved to be nightmarish.

  Ameriquest, of course, was hardly alone in its relentless, reckless pursuit of borrowers and profits. Massachusetts Attorney General Martha Coakley singled out Option One Mortgage in 2008 when she sued that company, alleging that it engaged in “unfair and deceptive conduct on a broad scale by selling extremely risky loan products that the companies knew or should have known were destined to fail to Massachusetts consumers.” The complaint also charged that Option One specifically targeted black and Latino borrowers in its marketing push and routinely charged them with higher points and fees than similarly situated whites. Agents for Option One, it seemed, were particularly fond of “no doc” (no documentation) and “low doc” loans and also so-called “2/28” adjustable rate mortgages, sometimes called “explodable ARMs.” Often borrowers could afford the monthly payments during the first two years because a teaser rate remained in effect but not once the interest reset at a higher rate. “Brokers and agents for Option One often promised borrowers they could simply refinance before the ARM adjustment,” the Massachusetts complaint read, “without disclosing that such refinancing was entirely dependent on continued home price appreciation and other factors.” Yet Option One did not even make the top three in customer complaints with the Federal Trade Commission. Ameriquest was the clear leader, with Full Spectrum Lending (Countrywide’s subprime subsidiary) in second and New Century in third place.

  Which subprime lender ranked as the worst? I asked that question of a wide range of people, from the banking analysts I met at an FDIC event in Washington, D.C., to the wide array of consumer activists I encountered across the country. Ameriquest was the clear winner in my unscientific straw poll but Countrywide, a latecomer to the subprime sweepstakes, received more than a few votes, and many chose CitiFinancial (Jim McCarthy’s pick), New Century, and Option One. The CRL’s Mike Calhoun named Countrywide (“you wouldn’t believe some of the stuff they were pushing out the door,” he said). Kevin Byers, a CPA and financial consultant whom Kathleen Keest had commended to me as her “favorite forensic accountant” (“he’s the only person I know who reads SEC filings for fun,” Keest said), cast Countrywide as the “most aggressive” of all the aggressive lenders attacking the subprime market in the 2000s.

  Countrywide CEO Angelo Mozilo, as tawny as a movie star, the George Hamilton of subprime mortgage lending, had initially resisted the temptations of the subprime market. But the profits were too alluring and once the company made the jump, Mozilo seemed determined to make his company number one. “Countrywide wanted to lead the market and so they adopted whatever product innovation was out there,” said Byers, who runs a consulting firm in Atlanta called Parkside Associates. They were happy to put people in a high-priced product nicknamed the NINJA loan (No Income, No Job, No Assets, also called a “liar’s loan” because it essentially invited a borrower to obtain a loan with virtually no documentation) and they paid what they needed to pay to convince brokers to steer borrowers to a higher-cost loan from Countrywide. In 2009, the Securities and Exchange Commission charged Mozilo with stock fraud, citing email messages in which Mozilo himself referred to some of his products as “toxic” and “poison.” Mozilo, who had received as much as $33 million in annual compensation and cashed in hundreds of millions in options, was also charged with insider trading.

  There were other culprits, of course, starting with all those mortgage brokers willing to accept fees for steering clients into the 2/28 teaser loans they couldn’t possibly afford in year three. “The brokers were the drivers, as far as I’m concerned,” said Chuck Roedersheimer, a bankruptcy attorney I met in Dayton who specializes in cases involving home foreclosure. They worked on commissions, Roedersheimer said, that could reach 3 or 4 percent of the loan’s value if it included a generous yield spread premium—the bonuses a lender gave brokers who steered borrowers into higher priced, more profitable loans. Early on, Option One was among those lenders refusing to pay a yield spread premium, essentially a bribe for putting people into higher-priced loans. “But then brokers stopped sending them business,” the Center for Responsible Lending’s Mike Calhoun said. “So they turned around and endorsed yield spread premiums because that’s what they needed to do to compete.” (A study commissioned by the Wall Street Journal found that more than half of the borrowers taking out a subprime loan between 2000 and 2006 had a credit score high enough to qualify them for a conventional rate loan.) Mortgage broker might once have been considered an honorable profession, but by the start of the 2000s it seemed nothing more than a quick way to become rich. “Literally you saw people going from used car dealer to mortgage broker,” Jim McCarthy said.

  Yet the system worked after a fashion—as long as home prices continued to rise at a brisk rate. The broker was happy to put a homeowner holding an adjustable rate mortgage about to reset into
a new mortgage if a $300,000 house was now worth $350,000, as was the lender. Everyone earned another fee, and the ultimate stakeholders would even hold collateral that was appreciating in value. There would only be a problem if home prices fell. Without the ability to refinance, people would be trapped in adjustable rate mortgages they couldn’t really afford and as more families were forced into foreclosure, prices would fall further, widening the gap between the amount owed on a property and the price it would fetch at a sheriff’s sale. Only then would it seem as if everyone had been living in a perversely rosy world.

  “Losses were remarkably low given the crazy lending they were doing,” Mike Calhoun said, “but that was because they were doing even crazier stuff, putting off foreclosures by refinancing people into even less sustainable loans.” The most maddening part, Calhoun said, was that the more lenders loosened their terms, the more it reinforced a perception that there was nothing wrong. Home ownership was on the rise, the stock market was soaring, and politicians on both sides of the aisle were happily accepting campaign contributions from these rich new benefactors. “It was a hard time to say this giant storm is building but it’s beyond the horizon,” Calhoun said.

  In places like Ohio that weren’t experiencing the same boom in home prices as other parts of the country, consumer advocates started talking about another problem: appraisal inflation. For Beth Deutscher, an early member of the Predatory Lending Solutions Project that Jim McCarthy helped put together, the case that alerted her to the problem involved two sisters in their sixties, both legally blind and living on a fixed income. The sisters were in a house in such poor shape that the dining room sloped downhill, Deutscher said, and cracks were visible in the foundation. Yet somehow they owed a lender $100,000 after a broker sweet-talked them into signing papers they couldn’t read for a loan they couldn’t afford. Initially Deutscher, who by this time was running an organization she helped found called the Home Ownership Center of Greater Dayton, read the appraiser’s report and wondered if the crazy real estate inflation taking place in other locales had hit Dayton. The house to her seemed worth less than half that $100,000. But the case of the sisters taught her that as bad as waves one and two of the subprime mortgage fiasco had been, there were still new shocks to be had in wave three. Select appraisers, it seemed, were happy to enrich themselves by fabricating a report when a lender needed the justification for an outsized loan.