Who Stole the American Dream? (33 page)

In hindsight, it seems hard to understand why sophisticated investors like the Royal Bank of Scotland would get sucked into buying $840 million worth of highly dubious mortgages from Goldman. One reason is that mortgage loans had long been very safe investments. But that changed with the emergence of junk mortgages, except that the bond-rating agencies, Moody’s, Standard & Poor’s, and Fitch Ratings, kept on rating most mortgage bonds as AAA in terms of safety.

Financial experts point out that “
without those AAA ratings, the flow of money” into the secondary mortgage market would have stopped. “I view the ratings agencies as one of the key culprits,” said Joseph Stiglitz, a Nobel Prize–winning Columbia University economist. “The banks could not have done what they did without the complicity of the ratings agencies.”

The ratings agencies had, and still have,
a conflict of interest to this day. They were supposedly rating the quality of mortgage loans and other bonds for potential buyers. But they were being paid huge fees by the sellers, the investment banks, which need the raters’ vital seal of approval for their mortgage pools. Bank traders were constantly threatening rating agencies to take their lucrative business elsewhere if they didn’t get AAA ratings. The agencies were making huge earnings.
Moody’s earnings from exotic financial vehicles tripled from 2001 to 2007, and it enjoyed operating margins of 50 percent, more than three times higher than ExxonMobil’s—and they didn’t want to rain on the parade of profits.

Even if bank insiders belatedly realized that lots of loans were rotten,
they engaged in a game of hot potato. They just kept passing on risky mortgages and derivatives to someone else, piling up profits. In May 2007, the Fed’s Ben
Bernanke said he saw no threat to U.S. prosperity and “no serious broad spillover” from the troubled subprime market to the big Wall Street banks, because, he said, they were not involved in subprime. Bernanke was wrong. They were deeply involved. Two months later, with the housing market already in steep decline, Citigroup CEO Charles Prince pooh-poohed the dangers. “
When the music stops, in terms of liquidity, things will be complicated,” Prince told the
Financial Times
. “But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Prince had a tin ear. Within a week, Wall Street’s
bond-rating agencies turned thumbs down on hundreds of subprime mortgage bundles on Wall Street, and the liquidity on the mortgage secondary market froze. As Eric Kolchinsky, a dissident bond rater at Moody’s later admitted, Moody’s inflated ratings had “
caused hundreds of billions of losses for the world’s financial institutions.”

Even the sellers got burned. “
Making liars’ loans is not risky—it is suicidal,” said fraud expert William Black. “That is why every significant lender specializing in liars’ loans has failed.”

Black was right. By October 2006, the housing market was into its sharpest fall in thirty-five years and the junk mortgage dominoes began to fall: New Century, Ameriquest, Bear Stearns, Countrywide, IndyMac Bank, and, finally, Wall Street titan Lehman Brothers, filing for bankruptcy on September 15, 2008, setting off global shock waves.

Ten days later came the biggest bank failure in American history—Washington Mutual—eight times larger than any previous bank failure. At the eleventh hour, the bank had desperately sent emissaries abroad to Asia, to
find buyers who didn’t yet know the score. Its
number crunchers had figured out which of WaMu’s loans were the most default-prone, and WaMu’s high command cynically gave the go-ahead to sell them. WaMu managed to sell $1.5 billion worth without warning investors of their poor quality. But that did not save WaMu from going broke.

The bank swooned into bankruptcy and a federal takeover on September 25, 2008. Its books listed $307 billion in assets, but it was sold for a pittance—$1.9 billion—to JPMorgan Chase.

Hundreds of bank failures like WaMu’s hit middle-class Americans in multiple ways. Borrowers were not the only ones burned by predatory loans; employees and investors were also affected. At WaMu, CEO Kerry
Killinger walked off with more than $100 million in salary and bonuses, but bank employees saw their retirement fund collapse from $300 million to virtually nothing. They filed suit, but with WaMu gone, there was no one to pay. The terms of JPMorgan Chase’s buyout barred lawsuits against either WaMu or JPMorgan Chase. The same happened to several pension funds for police and teachers in Detroit, Ontario, and Pompano Beach, Florida, which had invested in WaMu and were stuck with millions of shares of worthless WaMu common stock and bonds.

What is striking about the housing crisis is that unlike the savings and loan scandal of the 1980s, where hundreds of bank officials and board members went to jail on felony charges, only relatively low-level officers have been criminally prosecuted in the housing bust. Only belatedly have a few high-level government officials even acknowledged massive deception. Late in 2010, Alan Greenspan conceded that fraud had played a central role in the crisis, though he did not say whether the Fed’s lax oversight had contributed. “Things were being done which were certainly illegal and
clearly criminal in certain cases,” Greenspan told a Federal Reserve conference in November 2010.

Even that
did not trigger criminal action by the Justice Department. Government agencies pushed for fines and won modest settlements with big banks like Citigroup and Wells Fargo.
Countrywide, an aggressive subprime lender, paid the largest residential fair-lending settlement in U.S. history—$335 million on civil charges that it had levied higher fees and loan rates to more than two hundred thousand minority borrowers than to whites with similar credit ratings. The firm’s CEO,
Angelo Mozilo, agreed separately with the SEC to pay a $67.5 million fine, $20 million of which was paid by Bank of America, which bought Countrywide.
Mozilo’s personal fine amounted to less than 10 percent of the $500 million fortune he amassed at Countrywide, and by settling, Mozilo avoided criminal prosecution and the risk of jail.

Washington Mutual was targeted by the FDIC in a $900 million lawsuit against its top executives—CEO Kerry Killinger, COO Steve Rotella, and home loans president David Schneider. The FDIC accused them of taking “extreme and historically unprecedented risks” and pursuing policies “… to increase their own compensation, with reckless disregard for WaMu’s long-term safety and soundness.”
The bank executives scoffed at the government action as “political theater.” Ultimately, the
FDIC collected $190 million in damages, mostly from WaMu assets or executive insurance policies. Killinger and his two lieutenants paid only $425,000 in cash penalties, though they also forfeited nearly $25 million in funds they claimed WaMu owed them.

Senator Carl Levin, a Michigan Democrat who led a Senate investigation of Washington Mutual, was deeply disappointed. “Today’s settlement,” Levin asserted, “shows again how
bank executives can beat the system. Former WaMu executives Killinger, Rotella, and Schneider are truly the 1 percent: they got bonus upon bonus when the bank did well, but when they led the bank to collapse, insurance and indemnity clauses shielded them from paying any penalty for their wrongdoing.”

In case after case,
the pattern was familiar: legal charges of fraud, deception, or violation of securities laws, followed by a financial settlement
but no admission of guilt by the banks, except as implied by the bank’s promise of better behavior in the future—never to violate the anti-fraud provisions of securities laws in the future. But when
The New York Times
checked the record after Citigroup agreed in November 2011 to a $285 million settlement, it found that Citigroup had made the same vows of good conduct in July 2010, May 2006, April 2005, and April 2000. In fact, nineteen of the biggest financial firms, the major Wall Street banks, were repeat offenders.

The Wall Street bust and bailout offered an opportunity to correct some of the misguided policies that led to the financial collapse, through regulatory reform and rescue measures for millions of homeowners in trouble. But despite getting a taxpayer bailout and
going back to multibillion-dollar profits, the big banks blocked Washington from taking strong action to rescue average Americans. Instead of using some of the $700 billion taxpayer bailout to help 22 million homeowners stuck with high-interest loans and houses “under water,” the banks mounted
a foreclosure assembly line against 6.7 million families. One result was that by mid-2011, banks
found themselves stuck with a glut of 820,000 unsold and largely unsalable properties.

Some foreclosures were so slipshod that bankruptcy judges objected to what they feared were bogus evictions. In the frenzied finale of the housing boom, so many mortgages had been bought, sold, repackaged, and resold that banks lost track of the documents that proved who actually owned the homes and the right to evict. At Bank of America, GMAC, and JPMorgan Chase, employees confessed to being “robo-signers”—signing thousands of affidavits to oust people from their homes without even reading the documents. Under threat of prosecution from state attorneys general, the
banks agreed in February 2012 to set up a $26 billion fund to compensate some homeowners who were unjustly foreclosed and to adjust the
principal on some loans of people whose homes were “underwater.” But rather than offer immediate relief, the process would take three years and would cover only a fraction of the millions of homeowners who were forced out or put under financial pressure by banks.

Earlier, the banks had fought off the Obama administration’s appeal to Congress in early 2009 for legislation to pressure banks into rewriting bubble-era mortgage loans at lower interest rates. Part of the bill passed, the part that left bank participation voluntary. But the mandatory part was eviscerated, with the result that the administration’s hopes to provide relief for up to 4 million families was defeated, and
only 894,000 were ultimately helped to refinance their homes. Among them was Eliseo Guardardo. The Treasury Department under Timothy Geithner
compounded the problem by moving slowly to help beleaguered homeowners, spending only $217 million of the $7.6 billion fund set up to help “the hardest hit.”

A stronger measure for middle-class relief that would have given bankruptcy judges the power to modify the terms of home mortgages for creditworthy borrowers was stymied by bank lobbyists. The banks objected that the bankruptcy provision would undermine the sanctity of contracts, even though the 1978 bankruptcy law already gave bankruptcy judges the power to rewrite business contracts with unions and to modify mortgages on vacation homes, farms, and even luxury yachts, but
not primary residences
. Extending those provisions to average homeowners, bank lobbyists told Congress, would be unfair.

The House Democratic majority overrode the bank lobbyists and passed the bankruptcy provision. But in the Senate,
the banking lobby succeeded in getting the bankruptcy provision stripped from the bill. Senator Richard Durbin, the measure’s main sponsor, was almost speechless with frustration and incredulous at the political clout that banks still had in Congress. “
Hard to believe in a time
when we’re facing a banking crisis that many of the banks created, they are still the most powerful lobby on Capitol Hill,” Durbin told a radio interviewer, “and they frankly own the place!”

If middle-class Americans find the political domination of the banks unacceptable, they will have to make housing fairness a more salient political issue through direct citizen action.
The experts have come up with ideas for reform and recovery. Both Republican and Democratic economists have offered specific measures to help hard-pressed homeowners refinance their bubble-era mortgages at lower interest rates, arguing that would help generate more consumer demand and accelerate economic recovery. But the banks, joined by Freddie Mac and Fannie Mae, have resisted pressures or regulations that would force them to write down large numbers of old loans—even though most economists say this would
give a shot in the arm to the economy.

The nation has paid a steep price. Five years after the housing bubble burst, the backlog of foreclosed homes and the depressed housing market are a huge drag on economic recovery, crippling construction and consumer spending. As investment guru Warren Buffett noted: “
We won’t come back big time until we’ve worked off the excess inventory that was created during our binge on housing …”