Inside Job (11 page)

Foster
also
began to see evidence that Countrywide’s corporate Employee Relations department was protecting fraudulent activity. It did this in several ways, including not reporting
it to Foster’s organization; reporting fraud allegations to the perpetrator; identifying informants and whistle-blowers to the perpetrators; failing to act on complaints of retaliation
against whistle-blowers; and by retaliating directly against them itself. (She told
60 Minutes
that a senior Countrywide executive had ordered the ER to circumvent her
department.
²⁶
) Foster
complained to the senior executives in charge of Employee Relations, at which point Countrywide’s ER
department began to investigate
her
. In May 2008 Foster spoke to the executives in charge of Countrywide’s Internal Affairs unit, describing both the pervasiveness of fraud and also
ER’s conduct. As we shall see shortly, this did not go well.

When the bubble peaked and everything at Countrywide started to go bad, Angelo Mozilo resorted to various forms of deception, both personal and corporate. First, he intensified efforts to get
rid of dubious loans fast, so that Countrywide wouldn’t be caught holding them when they failed. Throughout the e-mail trails, he crassly urges his subordinates to “comb the
assets” and sell off the riskiest ones while there is still time. As he well knew, however, the documentation of every loan sale or securitization states that the instruments being sold are
representative of all loans of that type in possession of the seller—that they have not been selectively chosen to off-load risk. So this remedial strategy was itself fraudulent.

Then Mozilo protected himself financially, as many executives did. As Countrywide started to fail, Mozilo used $2 billion of Countrywide’s borrowed money to repurchase its own stock, in
order to prop up the share price. Mozilo also repeatedly made representations to analysts and investors with respect to the high quality of Countrywide’s credit and control processes, the
good performance of its products, and the company’s financial soundness. One lawsuit lists some three dozen separate occasions in which Mozilo made or confirmed statements about the
company’s lending and credit oversight policies. Based on what we now know, all of them were false.

However, at the same time that Countrywide was buying back its shares and Mozilo was telling the world that everything was fine, Mozilo was actually selling
his own
Countrywide
stock—over $100 million in the year before the firm collapsed. His total compensation during the bubble was more than $450 million, and as a result of his stock sales over the years he
remains extremely wealthy, with a net worth estimated at $600 million.

When collapse could no longer be postponed, Countrywide sold
itself to Bank of America; the deal was signed in January 2008 and finally completed in July. The acquisition
was to prove a very costly mistake for Bank of America, causing many billions of dollars in further losses. By 2012 Countrywide’s losses and legal liabilities were so severe as to threaten
Bank of America’s continued viability.

In July 2008, when Bank of America officially took over Countrywide, Eileen Foster was offered the position of Senior Vice President, Mortgage Fraud Investigations Division Executive, which she
accepted. However, the Employee Relations organization continued to investigate Foster and question her colleagues, one of whom warned Bank of America executives, including its general counsel and
its chief operating officer. On 8 September 2008, Eileen Foster was told by senior Bank of America executives that she had been terminated. She filed a whistle-blower lawsuit, which she won; OSHA
ordered her reinstatement and awarded her damages of over $900,000. In her interview with
60 Minutes
, Foster stated that the immediate cause of her firing was that she refused to be coached
appropriately about what to say to government regulators. She also stated on camera that as of the time of the interview in 2011, she had never been interviewed by any US law enforcement
official.

While WaMu, New Century, and Countrywide were among the largest subprime lenders, there were many others just as bad. Fremont, for example, was one the country’s largest,
and sold its loans to the top banks in securitization—Goldman Sachs, Merrill Lynch, Bear Stearns, Deutsche Bank, Credit Suisse, Lehman Brothers, Morgan Stanley. That is, it did so until March
2007, when the FDIC forced it out of business, and into bankruptcy, for multiple violations of law and regulations. In 2008 the Massachusetts Supreme Court, on an action brought by the state
attorney general, affirmed a prohibition on foreclosures of many Fremont mortgages, on the ground that they had been designed to be predatory.
²⁷

In lawsuits, a long list of confidential witnesses drawn from former employees recited the usual frauds. Allegedly, underwriters were instructed “to think outside the
box”, and “make it work”.
²⁸
If borrowers’ actual incomes were not sufficient to support a mortgage, loans were converted to
stated income loans at whatever level was necessary. A series of forty loans was allegedly accepted from one broker even though all of them had identical bank statements.

WMC was yet another. It was the sixth-largest subprime originator in the country in 2004, when it was sold to GE Capital (yes, General Electric) by its owner, the private equity investment firm
Apollo Management, whose CEO, Leon Black, spent $1 million to have Elton John play at his birthday party. For several years GE made lots of money, but it shut the company down in September 2007,
swallowing a $400 million charge.

WMC’s lineup of Wall Street securitizers was much like Fremont’s—the largest and most prestigious firms on Wall Street. Yet WMC was fourth on the Comptroller of the
Currency’s 2010 “Worst Ten in the Worst Ten” list—the ten worst lenders in the ten most decimated housing markets in the US. A postmortem conducted as part of a civil fraud
suit by PMI, Inc., a mortgage insurer like MBIA, found the usual story—widespread breaches of securitization warranties, missing or obviously falsified documentation, and so
forth.
²⁹

Ameriquest was yet another, and the US leader in subprime lending in 2003, having driven its volume to $39 billion, up from just $4 billion in 2000. An assistant attorney general in Minnesota
requested Ameriquest files in 2003, and was amazed to see file after file list the applicant’s occupation as “antiques dealer”. Borrowers told of signing a loan application and
finding at closing that an entire financial recordtax forms and everything—had been fabricated for them. Ameriquest, too, was on the “Worst Ten in the Worst Ten” list. It speaks
volumes for the cluelessness of Citigroup senior management that it purchased Ameriquest in the summer of 2007, even as the subprime bubble was collapsing.
³⁰
Ameriquest was the object of major lawsuits filed by more than twenty state attorneys general during the bubble, while
government regulators and law
enforcement agencies did nothing. In 2005 its CEO, a major Republican donor, was appointed US ambassador to the Netherlands by President Bush.

Another subprime lender, Option One, was a subsidiary of H&R Block, the tax preparer. Tax preparers were incented, in effect, to say, “Your interest on that mortgage seems high, why
don’t you visit our mortgage consultant before you leave. We may be able to find you a better deal.”
³¹

So the lenders wanted everyone to borrow ever more, and actively
preferred
borrowers who didn’t understand mortgages, shouldn’t have them, could be defrauded, and/or
couldn’t fight back after being screwed. For a while, the bubble covered all this up, at least to naive investors outside the industry. Ironically, the huge increase in lending and the
collapse of lending standards made subprime loans and mortgage securities seem much safer than they really were because it kept driving up home prices. Rising home prices allowed even unemployed,
fraudulent, and/or delinquent borrowers to avoid (or simply
postpone
) default through refinancing, home equity loans, or selling at a profit. As the bubble progressed, teaser rates,
deception, and/or unsustainable mortgages became normal. A standard broker sales pitch was “Don’t worry about the high post-teaser payments.” When it was time, the broker would
refinance you—at another teaser rate—because the value of your home would already have gone up.

This kept money flowing through the system to naive investors such as municipal pension funds and small overseas banks, which collected high returns without any defaults for a few years until
the music finally stopped. In the meantime these high returns led them, of course, to purchase even more of the same junk. The same mechanism also allowed fully knowledgeable but unethical
investment managers—hedge funds, private wealth managers within investment banks—to do the same thing. The temporarily high returns kept their clients happy for several years, and kept
their annual bonuses high. When the music stopped, the fund managers closed the fund or resigned, taking their money with them and leaving the losses to their clients.

Fannie Mae and Freddie Mac are not, of course, literally mortgage lenders. They purchased, insured, and securitized loans sourced from mortgage lenders; Countrywide was their
largest single source of loans. They also bought and held enormous portfolios of mortgage-backed securities for investment purposes, which caused a major fraction of their losses during and after
the crisis.

Fannie and Freddie are both government-sponsored enterprises (GSEs) created by the US government to support home ownership and affordable mortgage lending. But over the three decades prior to
the crisis, Fannie and Freddie had gradually freed themselves from regulatory constraint in the pursuit of profits. They went public and, more important, masterfully neutered both congressional
oversight and Office of Federal Housing Enterprise Oversight (OFHEO), their ineffective and understaffed regulator. They accomplished this through a combination of extraordinarily aggressive
lobbying, patronage, revolving-door hiring, and flat-out deceit. Their hires ranged from Newt Gingrich ($1.6 million from Freddie Mac’s chief lobbyist for “strategic advice” and
“outreach to conservatives”) to Tom Donilon, who was Fannie Mae’s chief lobbyist for years and is now President Obama’s national security advisor. Both firms appeared to
have neutered effective corporate governance by stacking their boards of directors with the compliant and the politically connected, who were overpaid and who were expected to keep quiet. And they
instituted the same compensation structures found universally in the financial sector, which provided large bonuses based upon short-term performance.

And, just to leave no stone unturned, they also allegedly engaged in accounting fraud to ensure that their publicly reported performance enabled them to
collect
those bonuses.

Concerns about Fannie and Freddie’s accounting were first publicly raised in congressional hearings in 2000, before a subcommittee of the House Financial Services Committee. In those
hearings, Fannie Mae and its then-CEO, Franklin Raines, were defended by congressional
Democrats, including Barney Frank of Massachusetts. Other defenders included
Representative Maxine Waters of Los Angeles (and other members of the Black Caucus), in part because Raines was a well-connected African American (Clinton’s former budget director), and in
part simply because Fannie Mae was so politically powerful in urban congressional districts where it operated, lobbied heavily, and was a major campaign contributor.

The first major allegations of misbehaviour came in 2003, when OFHEO sued the executives of Freddie Mac. Freddie Mac paid a $125 million fine. (Later, in 2006, Freddie Mac was also fined $3.8
million by the Federal Election Commission for making illegal campaign contributions.) In 2004, OFHEO and the SEC both released extremely critical reports on Fannie Mae. Then, in 2006, OFHEO sued
Raines and two other former executives of Fannie Mae in an attempt to recover bonuses linked to the accounting frauds. Raines alone had received more than $90 million; he was also one of many
executives and government officials who received favourable loans from Countrywide’s VIP programme. Later settlements for all three executives allowed them to keep the majority of their
bonuses, and did not require any of them to admit guilt. Fannie Mae paid a $400 million corporate fine to settle the SEC lawsuit. No criminal cases were brought.

Both Fannie and Freddie certainly contributed to the bubble, although they were late to the party. In part due to the discovery of their accounting frauds, in the early years of the bubble they
remained fairly conservative with regard to the loans they were willing to purchase and/ or insure. Starting in 2004, however, they began to increase the number of Alt-A loans they purchased, and
to relax their credit standards. They remained a minority of the market for junk loans, and such loans constituted only a small percentage of their total loan purchases. However, they were such
large firms that their losses were huge, comparable to those of the worst firms in the purely private sector.

Fannie and Freddie also contributed to the bubble in another way—as massive investors in mortgage-backed securities. From 2004 through 2006, Fannie and Freddie purchased $434 billion in
mortgage-backed
securities that had been created by Wall Street.
³²
They did this primarily because their executives had the same
toxic incentives as everyone else, and these securities paid high interest rates. Both Fannie and Freddie had AAA credit ratings, of course, and so they could borrow money at very low interest
rates and use it to purchase much higher-yielding mortgage securities. It was insanely easy and insanely profitable—until it wasn’t. In the end, the two firms’ investment losses
were almost as large as their losses on mortgages that they had purchased or insured.