by Gary Rivlin
“With that case it started to become clear that lenders are not afraid to loan more than a house was worth,” Deutscher said. “It became all about maximizing the up-front profit and then moving on to the next loan, with no conscience about how that was going to play out.”
The big rating agencies would play similarly destructive roles as well—and not out of ignorance, Kevin Byers told me when I visited him in Atlanta. To make his point he grabbed a stack of reports he keeps handy in a desk drawer. One is from Moody’s and is dated May 2005. It explores what its analysts called the “payment shock risk” associated with the 2/28s as lenders continued to lower the teaser rates to make loans seem more affordable. “The resulting differences in potential payment increase,” the analysts note, will have a “meaningful” impact on the financial soundness of these loans. Another, written by two Standard & Poor’s analysts in April 2005, explores what the pair describe as the “continuing quest to help keep the loan origination flowing.” Lenders are resorting to any number of new products to keep loan volume up, they wrote, including mortgages that mean people will own less of their home over time rather than more and the repurposing of interest-only loans for the subprime market, a product that really only made sense for a rich client who can afford the balloon payment on the other end. “There is growing concern around the increased usage of these mortgages,” they wrote.
“It’s not like they didn’t know that all this was going on,” Byers said. “They just didn’t want to do anything about it because they had a vested interest.” The institutions putting together these packages loaded with toxic loans were the very ones paying the credit agencies to evaluate the creditworthiness of the loans, and so the agencies would liberally hand out top ratings while relegating their concerns to the occasional research report. “I think they saw their role as ending once they put the investor community on notice that there are structural issues that they need to watch out for,” Byers said. The attorney general of Ohio was among those suing the major credit rating agencies, claiming their stamping of a triple-A rating on high-risk and wobbly securities cost state retirement and pension funds more than $450 million in losses.
Alan Greenspan shares some of the blame—a lot of the blame, according to some. Congress had deputized the Federal Reserve to enforce a sense of fair play inside the subprime market but the Fed chair steadfastly maintained a hands-off approach even as subprime grew from 5 percent of the mortgage market in 2001 to a 29 percent share by 2006. Worse, Greenspan kept interest rates historically low through the first half of the decade—at 1 percent in 2003, the lowest rate in half a century. “I’m sitting there watching Greenspan continuing to lower interest rates,” Kathleen Keest said, “and I’m going, ‘I thought your job was to take the punch bowl away and you’re pouring more rum into it.’” Federal Reserve Governor Edward Gramlich would rebuke Greenspan for showing no interest in investigating the predatory behavior of the subprime lenders.
There were those who said Wall Street was primarily responsible. Their insatiable appetite for these loans—the New Yorker’s Connie Bruck called it Wall Street’s “addiction”—kept everyone motivated. But then one can also fault those wanting to buy small tranches of a mortgage-backed bond for keeping demand high. And to say “Wall Street” is to miss out on a broader range of culprits. In the mid-2000s, it seemed every major financial institution in the world had a hand in this dirty business. By 2006, Wells Fargo, through its Wells Fargo Home Mortgage unit, ranked as a top-ten subprime lender, as did Citigroup, which ranked fourth. Washington Mutual placed eleventh on that same list and Chase Home Financial, a division of JPMorgan Chase, seventeenth. HSBC, the London-based financial giant that had purchased Household Finance, was number one on the list in 2006 after its subsidiary, Household Finance, regained the top spot with $53 billion in subprime loans. A chastened Ameriquest, which paid a $325 million settlement earlier that year, fell to seventh.
And the big financial conglomerates were hardly the only major corporations to aggressively jump into the subprime mortgage business. The money H&R Block made offering refund anticipation loans had apparently given the tax preparation giant a taste for subprime profits because in 1997 it paid $190 million for Option One and in short order transformed it into a top-tier subprime lender. General Motors aggressively entered the subprime market through its GMAC unit, which bundled together nearly $26 billion in mortgage-backed securities in 2006, and General Electric owned WMC, a subprime lender that made $33 billion in mortgage loans in 2006, ranking it fifth on the Inside B&C Lending list.
Glen Pizzolorusso, a WMC sales manager, gave a sense of what life was like in the middle of the credit cyclone when he agreed to an interview in 2008 with the radio show This American Life. Pizzolorusso, in his mid-twenties, seemed to be living the life of a mini-celebrity. He bought $1,000 bottles of Cristal champagne at bottle clubs in Manhattan and rubbed shoulders with the likes of Christina Aguilera and Cuba Gooding, Jr. He bought a penthouse on Manhattan’s Upper East Side and a $1.5 million house in Connecticut and owned a Porsche and two Mercedes to get him back and forth. He was making between $75,000 and $100,000 per month and suspected something might be seriously wrong in his life when one month he was paid $25,000 and that wasn’t enough to cover his expenses. “I did what YOU do every day, try to be the best at my job,” he wrote on a blog he created to defend himself after his story appeared on the radio. He didn’t create the rules, he said, and the corporation he worked for had stayed within the law. His sole regret, he wrote, was that he had spent his money so foolishly.
The first overt sign of trouble came in February 2007, when HSBC announced that it was writing down its subprime mortgage holdings by more than $10 billion. The housing market had peaked in 2006 and began its inexorable decline, and in short order HSBC would not be the only large institution to announce a loss in the double-digit billions. By the time the banks were lining up for TARP handouts from the federal government in the fall of 2008, the U.S. stock markets had lost more than $8 trillion in value. Finally, the country woke up to the problem that Bill Brennan, Martin Eakes, Jim McCarthy, and others had been warning about for years.
In Dayton, it fell to people like McCarthy and Beth Deutscher and Deutscher’s old employer, Consumer Credit Counseling Services, to handle the fallout. The civil courts also absorbed much of the burden; by 2006, foreclosures represented 49 percent of the civil caseload in Montgomery County. Bankruptcy attorneys like Chuck Roedersheimer worked to sort out the mess.
Roedersheimer worked at Thompson & DeVeny, located a few miles from downtown on a street crowded with insurance agents, medical professionals, and fast-food purveyors. There a basic bankruptcy could be had for a couple of thousand dollars. Business in recent months had been very good at Thompson & DeVeny, Thompson told me prior to my arrival in December 2008, but that turned out to be a major understatement. I entered the waiting area in a low-slung bunkerlike building and found no seats. A loud-voiced receptionist called out people’s names as if we were all crowded in a bus terminal. The firm has three lawyers, Roedersheimer told me, and they were seeing as many as two hundred new people a month and taking on forty to fifty as clients. He figured he saw two or three clients a day but the other two lawyers (the firm has since added two young associates), well versed in the intricacies of bankruptcy law and unburdened by the complexities of the subprime loans that were his specialty, were seeing ten a day.
The phone rang constantly during the hour I spent with Roedersheimer. He took several calls, from a judge and from opposing counsel, but that only gave me more time to behold the veritable skyline of paper that dominated his office. Stacks of folders were piled high on his desk and there were more sitting on a credenza behind him. One reached so high I feared Roedersheimer would be lost in an avalanche if it fell. There were files stacked on the floor next to him and more piled behind me and on every chair in the room except his and mine. There were more mentions of Ameriquest in those stacks than any othe
r lenders, Roedersheimer said, but Option One and CitiFinancial were also well represented. He seemed to hold American General Finance, AIG’s subprime mortgage division, with a special contempt but that might be because AIG played so hideous a role in the subprime mess through its sale of a subprime insurance product (the so-called “credit default swaps”) that didn’t come close to covering the losses when disaster hit.
Roedersheimer is a slight man with short gray hair and pouchy Fred Basset eyes. He walks with a slight slouch as if carrying his client’s collective burdens on his back. For twenty-six years he oversaw procurement contracts for the U.S. Defense Department, and though he had risen to assistant regional counsel, he left because he couldn’t take the commute anymore, 170 miles roundtrip to Columbus five days a week. In 2001 he took a job with the local legal aid office in Dayton, hoping to carve out a specialty in subprime mortgage loans, but the funding for that project lasted only a few years. Among those clients he took with him when he left legal aid was an elderly couple from Kettering (he had worked as a bricklayer; she had retired from the phone company) who had been talked into so many refinancings that they owed $126,000 on a house that was worth maybe $80,000. “One of the things you look for when you deal with predatory lending is can the person afford the loan when all is said and done,” Roedersheimer said. Because this couple couldn’t, he was able to get the woman (her husband had since passed away) some money from their mortgage broker and also another $5,000 from an appraiser who had worked on her mortgage application.
But such outcomes are depressingly rare, Roedersheimer said. “Unless there’s out-and-out fraud, if people signed the papers, there’s not much I can do for them,” he said. He gets people the bankruptcy that brought the client to the office and that’s about it. Sometimes, he said, he can’t believe the shamelessness of lenders, but often he can’t fathom how little people understand basic finances, his more middle-class clientele included. Clients took out home equity loans not appreciating that they were risking their home on their ability to pay. He shook his head over all those who used payday loans to try to forestall the inevitable, not recognizing that they were only digging a deeper hole for themselves. But if he’s learned anything in his five-plus years handling bankruptcies, it’s that people will use whatever they have at their disposal—a rich brother, a credit card, the corner pawnbroker—if it means holding on for one more month.
Before someone can complete bankruptcy proceedings, he or she must first attend a short financial education course taught by people like Ken Binzer, a retired military educator working for Dayton’s Consumer Credit Counseling Services. To Binzer, the requirement that people endure at least two hours of class time so they can better handle their finances is about the only good thing to come out of the otherwise pro-lender Bankruptcy Abuse Prevention and Consumer Protection Act that George W. Bush signed into law early in his second term. Even people who theoretically have nothing are vulnerable, he said, because of those who might be the ultimate financial vultures of the poverty business: those who view a declaration of personal bankruptcy as a profit opportunity. The worst, Binzer said, are the car dealerships that comb the legal records for the names of those who have recently filed.
Binzer asked his class how many had received an offer from an auto dealer since initiating bankruptcy proceedings. “Almost always one hundred percent of the hands go up,” he said. Often people emerge from a bankruptcy without a vehicle but a ready market of prospective customers needing transportation is only one reason the dealers are so eager for their business. There are solicitations from new car companies and solicitations from those selling used cars but invariably the come-ons are all the same. “They’ll offer them a loan at eighteen to twenty-two to twenty-five percent but make it sound affordable by giving a person eight years to pay back the loan,” he said. Interestingly, Binzer said, eight years is precisely the amount of time a person must wait before filing for another Chapter 7.
Late in the afternoon of my Dayton drive-along with Jim McCarthy, he asked if I would “indulge him” and visit a neighborhood not on our tour. I had asked him to show me the city’s white working-class neighborhood but he wanted me to see at least a small patch of the predominantly African-American west side. Later, Fesum Ogbazion, the CEO of Dayton’s Instant Tax Service, would tell me that if it weren’t for the instant-tax mills and the payday lenders, the check cashers, and the occasional pawnbroker, there would be no businesses operating in poor minority communities other than a few convenience stores and the ubiquitous hair and nail shops. His claim was an exaggeration but only a slight one. It was on the black side of town where all these low-rent credit shops had first taken root and it seemed every major payday chain had at least one outlet on the west side of the river, and most seemed to have two. Cashland operated no less than five payday stores in west Dayton. Even the Sunoco station we passed shortly after crossing the river sported a sign advertising its check-cashing services, allowing the proprietor to charge up to 3 percent of the face value of a check.
McCarthy drove slowly through a west side neighborhood called University Row (the streets have names like Harvard and Amherst). Many of the homes are magnificent, or at least they were not that long ago: wooden beauties with leaded glass and architectural touches like turrets and gables and wraparound porches. I had gasped earlier in the day when I saw three or four boarded-up houses clumped near one another and there were those few blocks in a row in Santa Clara where nearly half the homes had been foreclosed. Here, however, it seemed that half the homes on every block had been abandoned. Paint was peeling, exteriors were crumbling, multiple windows were broken, lawns were overgrown, and the occasional roof had buckled in. This is a place, McCarthy said, that not so long ago he would have described as a stable, solidly working-class community. No longer. “We’re seeing the sex trade here,” McCarthy said as he drove. “There’s drug stuff going on inside a lot of these boarded-up properties.”
And there are similar communities elsewhere in the country. One, South Ozone Park, a predominantly black neighborhood near New York’s Kennedy Airport, is populated by postal workers, bus drivers, teachers, and clerks. These people were solidly middle class and yet it was South Ozone Park and several other black enclaves in the southeast corner of Queens that the New York Daily News declared the “ground zero of New York’s subprime mess.” For decades the story of neighborhoods like these was their stability; houses weren’t sold so much as passed down from generation to generation. But that was before the mortgage brokers set up shop in the early 2000s. In South Ozone Park, the Neighborhood Housing Services of New York City, an organization that offers financial education and affordable lending products, started to see changes in South Ozone Park and several of the neighborhoods around it. Soon, Sarah Gerecke, the group’s CEO, told me, where less than 5 percent of the homes in South Ozone Park would change hands in a given year, that number rose to 20 percent. By 2008, she said, the turnover rate on some blocks was approaching 50 percent.
“When you look at communities like South Ozone Park,” Gerecke said, “you can’t help but think that abusive lending was often more racial than economic.” Gerecke’s claim has been substantiated by any number of studies, including a May 2006 report by the Center for Responsible Lending that demonstrated a significant racial bias in subprime mortgage lending even taking into account income and credit score.
In the car with McCarthy, looking at all those once-beautiful homes now serving as nothing more than well-dressed drug houses, I couldn’t help speculating about whether I was seeing a vision of the future. It was here, in communities like Dayton’s west side, where the subprime mortgage disaster that would engulf the country first reared itself. It’s here where the disaster has had the longest to play itself out—and it was clear as we wound up our tour that it’s far from over.
Epilogue
Borrowed Time
NEW YORK, FALL 2009
Allan Jones had opened 1,300 payday stores yet
through much of our two days together in Cleveland he bellyached how it could have been more. Several times he brought up Europe. Advance America operated stores in the United Kingdom; Check ’n Go bought a small chain in Scotland. The payday loan was becoming so popular in the UK that Kevin Brennan, its consumer minister, told the BBC he was “concerned that so many people are relying on these forms of high-cost lending.” But Jones had never been to Europe, so in the summer of 2007 he and his family spent several weeks hopscotching their way across the continent, never staying in one place for more than two days. “I was trying to learn culture,” he said. “Trying to get myself up to speed. So basically it was up and out with the tour guide at nine each morning and go through five.” By the time the trip was over, everyone was happy to be home and Jones expressed no desire to ever return.
“I was all set to take the plunge but I was afraid of Europe,” he said. Instead he opened some stores in Texas, a state he had always avoided because the rules required a payday lender to partner with a local bank. “I was ignorant of Europe,” Jones said. “But Texas I understand, I told myself. Why go to Europe if you haven’t been to Texas yet?” He found a partner bank and together they opened sixty stores.