Donald Luskin

by I Am John Galt

  He knew that any pullback in business or acknowledgment of risk to the markets would expose his house of cards for what it was, and bury his remaining fortune under a crush of rubble. In 2006 Mozilo had written about his concern that a “reputational event,” as he euphemistically called it, could destroy Countrywide’s ability to offload its poison onto a marketplace tricked into thinking it was good medicine.15 All he needed was a few more months. He had to hide the truth under a facade of business as usual. Now, on the conference call in front of hundreds of analysts and members of the media, Angelo Mozilo was about to pull off the snow job of his life—a con that would make the slickest grifter blush.

  “We remain optimistic at the long-term future growth prospects and profitability of the Company,” he began on a high note. “We believe that the Company is well positioned to capitalize on opportunities during this transitional period in the mortgage business, which we believe will enhance the Company’s long-term earnings growth prospects,”16 he assured the audience.

  When asked point-blank by an analyst how many shares of stock he currently held, Mozilo acted like a kid caught with his hand in the cookie jar. “I don’t know the answer to that question,” he stammered. “I own, including options—I think it’s around 11 million, 12 million, something like that,” all the while knowing he held a dwindling stake of just a few million shares after a blistering selling spree during the prior nine months. (See Figure 4.1.)

  Figure 4.1 Countrywide’s Stock Price History. (Left axis) Countrywide Financial (CFC) Stock Price; (right axis) Angelo Mozilo Insider Stock Sales (Value in $ Millions)

  Source: United States Securities and Exchange Commission Form 4 filings

  What about downside risks to current shareholders? “There is a limit to this in terms of our total,” Mozilo stated authoritatively. “The total residual on our balance sheet is about $400 million. If everything collapsed, that would be the extent of our residual exposure.”17 In hindsight, $400 million would have been a gift, a mere rounding error in the eventual collapse of his own creation that Mozilo knew was looming.

  Just three weeks later, on August 16, Countrywide announced that it would tap its entire $11.5 billion line of credit just to meet immediate cash demands.18 Moody’s immediately downgraded the company’s senior debt to one notch above junk status, warning that further deterioration was imminent.19 Countrywide shares took their largest drop ever, surpassing even the losses borne during the crash of 1987. The same stock that Mozilo had pumped up to analysts three weeks earlier (while furiously dumping the day before at $34.22 per share) fell to the midteens.

  Global stock markets went into a tailspin. Credit markets across the world froze. The Federal Reserve injected $62 billion in reserves into the market that week to boost liquidity.20 Then, on Thursday, August 17, the day after Countrywide’s meltdown, the Fed cut the discount rate by half a percentage point to 5.75 percent from 6.25 percent.21 Analysts suggested bankruptcy was possible and hinted at the prospect of a worldwide recession.

  Little did they know. . . .

  The Birth of Countrywide

  James Taggart got his inferiority complex from being born rich, and unworthy of his fortune. Angelo Mozilo got his by being born to humble circumstances, but without any humility. He was born to immigrant parents in a Bronx rental flat in 1938. As he was growing up, his father encouraged him to follow his footsteps into the butcher’s trade, but Angelo and his mother had bigger plans. At the age of 14, his uncle helped him break into the white-collar world by arranging a job for the scrappy youngster as a messenger for a small Manhattan mortgage company. It was there that he would earn enough to pay his way through college at Fordham University. In the process, he’d rotate through all the company’s departments, learning the business from the ground up.22

  In 1960, the year he graduated from college, his employer merged with the larger United Mortgage Servicing Company, headed by a man named David Loeb. Although 15 years his senior and the conservative antithesis to Mozilo’s pitchman style, Loeb would become a mentor and partner to his young protégé.

  When United Mortgage was acquired in 1968, Mozilo and Loeb set out to start a business of their own. Like Taggart, Mozilo was spurred on as much by malice as by a desire to build. “I think it was vengeance,” Mozilo posited years later as his prime motivation for launching the new company. “We ran into tremendous problems with these people and were essentially forced out,” he said about the conglomerate that swallowed up his lifelong employer. “So, naturally, we were out to get them.”23

  Mozilo sank his life savings of $25,000 into the venture and secured a personal bank loan for $75,000 more. Whatever else may be said about him, at least this man who conned so many Americans into going so deeply in debt wasn’t afraid to get in hock up to his eyeballs personally. Loeb invested another $300,000, and with a third partner they capitalized themselves as a private company with a total of $500,000. Just nine months later, in 1969, Mozilo and Loeb took the company public. They failed to raise the $3 million in new capital they had hoped for, but at least they got a couple of status symbols: a ticker symbol and a board of directors.24

  Though they weren’t the first nonbank mortgage company, they were the most ambitious. While others in their sector were typically small local shops, Loeb and Mozilo had national aspirations. They would dub their new creation “Countrywide” to remind them daily of the prominence they hoped to achieve.

  The going was tough at first. Without a banking charter, Countrywide was prohibited from taking deposits and found itself completely dependent on outside lines of credit to fund its loans. Once these credit lines were fully tapped, Countrywide had to sell the loans off of its balance sheet to generate more lending capacity. But at that early stage in the development of the mortgage market, they could sell only a small number of the mortgages that qualified for government insurance, namely Federal Housing Authority (FHA) or Veterans Administration (VA) loans.

  Then, in 1970, Congress unwittingly gave the company a lifesaving jolt by allowing federal Fannie Mae to buy so-called conventional non-FHA or VA loans from private originators, and back them with an implicit government guarantee. The loans had to conform to a strict set of standards, including a borrower’s credit score, ability to repay, and loan-to-value (LTV) ratio. Despite these conservative restrictions, this single legislative change unleashed a flood of new capital for mortgage companies like Countrywide desperate to find willing buyers for the loans they originated.

  In just a few years, nonbank mortgage companies like Countrywide began to overtake the commercial banks. The market share of mortgage originators like Countrywide went from near zero to 19 percent by the end of the 1980s. By 1993, they accounted for more than half of the mortgage business done in the country. In 1990, Countrywide wrote $3.6 billion of mortgages, reaping revenues of $104 million. It was still a tiny drop in the $3.4 trillion ocean of U.S. mortgage debt outstanding that year, but Countrywide was now definitely on the map.

  The Loeb Years

  While Mozilo pushed relentlessly for business expansion and drove for market share with entrepreneurial zeal, David Loeb, his partner and Countrywide chairman, remained largely behind the scenes, managing risk and acting as a sober check on Angelo’s hyperactive run at market dominance.25 Instead of making high-risk loans for high fees, Loeb steered the ship with a steady hand, focusing on high credit quality coupled with efficient operations.

  For years, mortgage lending at Countrywide was a plain-vanilla affair. Up to 95 percent of the loans originated by the company were basic fixed-rate obligations. The company held its costs of servicing a loan to about one-third below the industry average by rolling out optical scanning equipment and automated systems that slashed manual paperwork. All of its nationwide branches were simple, low-overhead operations consisting of one loan officer and two assistants.

  Even more unusual, the loan officers all earned a fixed salary instead of the industry-standard commission. Performance
bonuses were based not on sales volume irrespective of the loan’s soundness, but on the number of borrower delinquencies. If branch loan officers signed up too many loans that defaulted, they’d be fired. This operating discipline cost Countrywide business at times, but it also helped keep the company’s delinquency rate below the national average. From 1985 through 1989, the portion of Countrywide’s loans that were over 90 days past due on their payments was only 0.7 percent, compared with national averages prepared by the Mortgage Bankers Association of over 0.9 percent.26 Yes, as hard as it may be to believe today, Countrywide was once a model of probity—at least under the watchful eye of David Loeb.

  Mozilo was unsatisfied. Among the staff, his motto was “We don’t execute, we don’t eat.” He once told a Countrywide executive, “If you ever stop trying to make your division the biggest and the best, that’s the day you die.”27 The problem wasn’t that he pushed his people hard. The problem was that he pushed the boundaries whenever Loeb didn’t stop him.

  In the 1980s, tax law changes eliminated the deductibility of interest payments on normal consumer debt like credit cards and auto loans, while mortgage interest remained tax-deductible. With his gift for slick sales angles, Mozilo realized that he could use this new asymmetry in the tax law to get people to favor deductible mortgage borrowing over other nondeductible forms of borrowing.

  Thus was born the idea that one’s home is not just a residence, not even an investment—but a source of equity to borrow against, a piggy bank, an ATM. With Countrywide’s help, homeowners could extract wealth from their homes by borrowing to pay for everything from investing in junior’s college education to outright consumption of vacations, cars, boats, large-screen TVs, or anything else. Thanks in large part to Mozilo’s marketing and spurred on by declining interest rates, “refi” would enter the popular vernacular.

  In 1992, refinancings accounted for 58 percent of Countrywide’s business. In 1994 they accounted for a whopping 75 percent. In many ways the refinancing boom was the result of a brilliant innovation that took advantage of a tax asymmetry and arguably created more liquidity in the overall economy. From one perspective, this was simply capitalism at work—adapting to the reality of a government-induced fiscal distortion. In the real world where such distortions exist, rational self-interest calls for the productive innovation required to adapt.

  But in Atlas Shrugged we see that the heroes are doing something better than this—they are creating value de novo. It is the villains like James Taggart and his steel tycoon crony Orren Boyle who profit from adaptation—and who corrupt government specifically to create the distortions that they can adapt to, dressing up their ambitions with altruistic rhetoric. At this point Mozilo’s days of corrupting government were still in the future, but he was already limbering up his rhetoric. Relentless pushing of refi loans was cloaked in high-minded collectivist talk about the virtues of home ownership. He was already setting the stage for the next phase of his shady dealings, one that required the active assistance of the government using the banner of home ownership to shroud their corrupt arrangements.

  In the meantime, to generate even more deal flow, Mozilo had another big idea. Looking at Countrywide’s already low-cost branch structure, he thought he could do even better. Rather than pay fixed salaries and overhead to staff loan officers in company branches, he pushed Countrywide to begin using independent mortgage brokers to originate loans. Usually these were refugees from the defunct savings and loan industry, local operators who already knew the grassroots markets and Realtors. Even better, they worked on 100 percent commission. If they didn’t produce, they didn’t cost Countrywide a dime.

  Loeb was decidedly against his young partner’s approach. Brokers had no skin in the game. Once they passed the loan off to Countrywide and collected their fee, there was no further responsibility or recourse back to the originator. “They’re crooks,” Loeb said about brokers, with a reputation for falsifying documents for the sake of commissions. Mozilo prevailed, however, and the seeds were sown. “I think it’s going to be a big mistake”28 was Loeb’s final summation. He would prove to be dead right.

  But thanks to Mozilo, the U.S. housing market would turn out to be just plain dead.

  Unholy Alliance with Fannie

  Longtime Democratic politico James “Jim” Johnson was named chairman and CEO of Fannie Mae in 1991. Sensing an opportunity to use his new position for personal enrichment far in excess of his previous go-around in Washington as Vice President Walter Mondale’s executive assistant, he lost no time going on the road to schmooze with potential collaborators.

  Fannie’s West Coast office was strategically located just across the street from Countrywide’s headquarters, where it babysat an already significant volume of conforming loans.29 Johnson wanted even more volume to catapult his government-wage public utility into financial stardom complete with Wall Street–style bonuses for senior executives like himself.

  It didn’t take long for Jim Johnson to realize that Mozilo “was the guy,” said one of Johnson’s aides. “When Jim realized how much volume Countrywide was taking down, especially in California, he made it his mission to get to know Angelo,” said the anonymous aide. “Jim knew that he had to do everything he could to make Angelo think, ‘I’m his best friend.’ If Jim was traveling to the West Coast he’d say, ‘We need to call Angelo and set up a golf game.’”30

  As much as Johnson needed loan volume from Mozilo, Countrywide needed Fannie’s flow of cheap, government-subsidized cash to keep its loan machine humming. In Atlas Shrugged, James Taggart conspired with government officials and other corrupt businessmen in a dark saloon designed to look like a dank cave. Mozilo and Johnson and their cronies did it a little differently: playing golf together, flying around on Countrywide’s corporate jet, and watching plays from box seats at the Kennedy Center. But the result was the same—they concocted the beginnings of a symbiotic relationship based not on value-added business, but on gaming the system through politics and pull.

  As if to cement this unholy alliance, in 1999 Fannie Mae reached a “strategic agreement” with Countrywide wherein Mozilo would sell certain Countrywide loans exclusively to Fannie. In exchange, Fannie agreed to lower its guarantee fee on Countrywide loans. The relationship tacitly amounted to a noncompete agreement, designed to lock Fannie’s sister company Freddie Mac out of the market for Countrywide’s production. But it was so much more. By striking a chummy deal with Countrywide, Johnson had bought himself a pit bull for his front yard. Feeding and sheltering the beast ensured fiercely loyal protection against any who might try to intrude on their conspiratorial collaborations. Put more tartly, Mozilo said that when Fannie catches a cold, “I catch the fucking flu.”31

  To add a sweetener to the already saccharine deal, during the very time Countrywide was negotiating with its governmental benefactor, Mozilo offered and personally approved the first so-called VIP loans to employees of Fannie Mae. All told, Mozilo would make over 150 loans to Fannie employees granting below-market interest rates, reduced fees, or manual overrides to approve loans to buyers who would not have qualified under standard programs. Johnson alone would receive more than $10 million worth.32 The value to the borrower often represented hundreds of thousands of dollars over the life of the loan. If that kind of money had been handed to a politician in cash, there’d be just one word for it: bribe.

  It’s not like Johnson needed the money. Yes, government pay is typically limited at the top, even for officials who run enormous agencies. The postmaster general, for example, running an agency with more than 700,000 employees and more than $65 billion in revenue, was paid a flat $175,000 a year during the time Johnson presided at Fannie.33 But during 1998, the last full year of Johnson’s tenure at Fannie Mae, he would receive $21 million in compensation.

  That same year, Johnson also improperly deferred $200 million in corporate expenses to ensure that he and his subordinates received their full annual bonuses. Johnson himself received an
additional $2 million in bonus money as a result. His successor, Franklin Raines, collected $1.1 million in undeserved compensation. Without Johnson cooking the books, bonuses that year would have been exactly zero.34

  According to the Washington Post, Fannie Mae had become a place where former government officials and others with good political connections could go to make millions of dollars. Franklin Raines was about to get his share, and then some.35

  Slide into Subprime

  When David Loeb retired from Countrywide in 2000 and died a few years later in 2003, there was nobody left to hold back the scheming Mozilo. “With Countrywide, you could see there was a cultural change when it was David and Angelo to when it was just Angelo,” said Josh Rosner, a mortgage securities expert at independent research firm Graham Fisher in New York. “Before David died, he seemed to recognize the company’s future was predicated on taking risks he wasn’t comfortable with.”36

  In the hypercompetitive mortgage brokerage market of the housing boom era, borrowers with solid credit and plenty of income were already saturated with plain-vanilla, low-interest loans. The only way to gain market share was to lower lending standards and tap the remaining higher-risk population. But once he’d originated them, how could Countrywide sell these riskier loans off in the vast volumes Mozilo sought? The free market would place a natural cap on the amount of risk investors were willing to take on at any given price, and that price wasn’t cheap enough for him to realize the riches he dreamed of.

  For businessmen like Mozilo or Taggart, if the free market won’t play along, then it’s time to get the government involved. The timing was perfect.

  Franklin Raines, Johnson’s successor at Fannie Mae, was seeking new ways of transforming the GSE from a boring but stable financial institution dedicated to making homes more affordable into a risky venture that exploited its special government status for Raines’s personal profit. Improved earnings meant multimillion-dollar bonuses for executives, but Fannie was effectively locked out of the most lucrative loans for the very reason that they were too risky. Or were they? Like Taggart and his fellow parasites in Atlas Shrugged, Mozilo and Raines together would concoct a backroom scheme to corrupt the markets and trick the nation into backing the risks they took, all the while blathering about the noble-sounding virtue of social equality.