The Countrywide Charges: Yes, They Could Have Kept Housing from Imploding, But They Weren't the Only Ones

You are probably aware that the SEC has accused former Countrywide CEO, Angelo Mozillo, and two of his chief lieutenants with fraud. The SEC complaint document makes for fascinating reading. It demonstrates that Mozillo and others were acutely aware and concerned with the risks they were running while steadfastly painting a different picture to investors and regulators.

Here are a few of the passages that I found captivating:

On 100% subprime loans:

Mozilo further stated that the 100% loan-to value (also known as 80/20) subprime product is “the most dangerous product in existence and there can be nothing more toxic and therefore requires that no deviation from guidelines be permitted irrespective of the circumstances.”

Then, in an April 13, 2006 email, Mozilo informed Sambol, Sieracki, and others that there were numerous issues that they must address relating to the 100% subprime second business in light of the losses associated with the HSBC buyback. One issue in particular that Mozilo identified was the fact that the loans had been originated “through our channels with disregard for process [and] compliance with guidelines.” Mozilo went on to write that he had “personally observed a serious lack of compliance within our origination system as it relates to documentation and generally a deterioration in the quality of loans originated versus the pricing of those loan [sic].” Mozilo noted that, “[i]n my conversations with Sambol he calls the 100% sub prime seconds as the ‘milk’ of the business. Frankly, I consider that product line to be the poison of ours.”

On Option ARMs:

[w]e have no way, with any reasonable certainty, to assess the real risk of holding these loans on our balance sheet. The only history we can look to is that of World Savings however their portfolio was fundamentally different than ours in that their focus was equity and our focus is fico. In my judgement, as a long time lender, I would always trade off fico for equity. The bottom line is that we are flying blind on how these loans will perform in a stressed environment of higher unemployment, reduced values and slowing home sales. (emphasis added)

Finally, on November 4, 2007, Mozi advised the president of the Bank and Sambol that “[pay options have hurt the company and the Bank badly…. World Savings culture permits them to make these loans in a sound manner) our culture does not …. fico scores are no indication of how these loans will perform.”

On Stated Income Loans:

Finally, both Mozilo and Sambol were aware as early as June 2006 that a significant percentage of borrowers who were taking out stated income loans were engaged in mortgage fraud. On June 1, 2006, Mozilo advised Sambol in an email that he had become aware that the Pay-Option ARM portfolio was largely underwritten on a reduced documentation basis and that there was evidence that borrowers were lying about their income in the application process. On June 2, 2006, Sambol received an email reporting on the results of a quality control audit at Countrywide Bank that showed that 50% of the stated income loans audited by the bank showed a variance in income from the borrowers’ IRS filings of greater than 10%. Of those, 69% had an income variance of greater than 50%. These material facts were never disclosed to investors.

A couple of things really took me back when I read this document. First off, Mozillo comes off as a guy who recognized early on that Countrywide was way too far out on the risk horizon. He talks and analyzes mortgages like a guy who has been in the business all of his life. Frankly, he sounds like one very sharp businessman. How in the world did he screw the pooch so badly?

I like the comment about trading FICO for equity. Too little has been written about this. FICO as a predictor of credit performance is, in my opinion, highly over rated. Unfortunately, we haven’t learned the lesson. Fannie (FNM), Freddie (FRE) and most egregiously FHA continue to live in the fantasy world that says you don’t need a lot of skin in the game so long as the FICO score meets certain thresholds. How much money do we have to pour down a rat hole before we learn that down payments matter?

The data on the degree of borrower fraud is staggering. We all knew that people were fudging but I had no idea that it was as widespread as Countrywide’s numbers would suggest. Furthermore, one would think that variances of 50% would have been somewhat evident simply by the application of common sense by underwriters. Evidently not or maybe they were under instructions not to bother.

Based on the dates of the various pieces of evidence contained in the complaint it’s obvious that very early on Countrywide knew that the end game was going to be a disaster. If they knew this, then so did others. Where were Fannie and Freddie? Countrywide was their biggest customer. Institutionally, they knew the mortgage business as well as Mozillo and most likely were drawing the same conclusions as he. Why didn’t they speak up?

The implosion of housing need never have occurred. The risks were evident and now we see openly discussed. Mozillo’s prosecution might with luck lead to the exposure of many others who share his culpability.

Comments

[PlanetHead:]

Angelo is the scapegoat. Just one in a ship of fools.

Jun 05 02:43 PM

[Living4Divi...:]

Great Article!

It alleged that Lee Mozilo earned $140 million while fully aware Countrywide's business was deteriorating and facing a dismal future (misleading shareholders). Additionally, he has to face up to charges of insider trading.

I like the mythical letter you wrote - very funny.

I say let the bastard rot in jail. I wish the government would charge more of these reckless financial executives with criminal charges, including:

AIG Execs for the same reasons - taking on huge leverage (investors thought they were investing in an insurance company, not a hedge fund). They were "picking up pennies in front of a steamroller"

Moody's Exec's - For taking utter crap and rating it AAA. This despite the fact that many of Moody's own employees informed Senior Management that they were rating crap. However, those who informed Senior Management faced chances for advancement/promotion/... employment. The AIG Execs should be the hardest hit with criminal charges.

The Banks and Financial Firms used off balance sheet vehicles as a way to hide true risk and high leverage from investors. Off balance sheet items should be outlawed, and should be rolled into a companies main balance sheet immediately. Once transparency is achieved, the investor will see that the firm is "picking up pennies in front of a steam roller." If the investor still invests, it's his fault.

Jun 05 02:58 PM

[FDNY RET:]

And left unmentioned is the ship's Captain--our one and only---beloved"""""BARNEY FRANK"""""".

Jun 05 02:59 PM

[PlanetHead:]

Agreed also Angelo's good friend Chris Todd Didn't he get some special loan

Jun 05 03:08 PM

[PlanetHead:]

Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis (Hardcover)

Gr8 book about Angelo and his subprime buddies.

Jun 05 03:13 PM

[Fighting Yoda:]

Everyone knew what was going on. There were jingles and radio and TV day and night for years –“No down payment required, no income verification”. Home prices shot up like a rocket – Greenspan is did not see the bubble when home prices shot up 50% in three years. Barney Frank- “let’s roll the dice a little bit”.

Mozillo is to be blamed, so are many many others – all must be punished. Private label mortgages (securitized by Wall Street) account for only 15% of total mortgages but are 51% of the seriously delinquent. So there is one big guilty party.

Jun 05 03:29 PM

[User 357705:]

Perhaps Mozilo will also take a trip to Snowmass before he's to be sentenced.

Jun 05 04:10 PM

[jay brebner:]

Could it be that the whole mortgage business were all counting on immigration reform? 10 million new leagl citizens would have taken up the slack and would have kept the housing market from going off a cliff. Did Karl Rove promise the industry that Bush had the power to deliver reform in his second term ? This is the only reason I can think of that these guys would risk letting their businesses fail.

Jun 05 04:30 PM

[Thomas J. G...:]

I claim countrywide couldn't exist without fnm and fre. i guess they had a channel for their subprime that was not fnm or fre. but I think they got their start originating and selling the loans to fnm/fre. that's why they don't care about their underwriting that you see in the quotes above. it wasn't their money being lent, if it was, they'd be a lot more careful. I think the gov't creating fnm/fre created the q42008 financial panic. it was the first time housing prices dropped nationwide since fnm/fre were created.

Jun 05 04:49 PM

[SouthernBea...:]

So how about also blaming Barney Frank and the other Congress Member that put pressure on the Banking Industry to give Loans to people that couldn't afford them? Congress tell you to do something...you do it or they make your life miserable.
So how about some personal responsibility from people for buying a House that they knew that they couldn't afford? I wanted to buy a House the past 3 years, but I saw that they were not worth the Price, so I have continued to Rent. Stupid People do not get my sympathy.
People that have lost their jobs, that is a different story, they are just an unfortunate circumstance of the Economy.
The Mortgage industry is also to blame, but equally with Congress and the Dump Homeowner.

Jun 06 10:12 AM

[Chris77:]

ANYONE that didn't know just how much BS went into a no-doc loan shouldn't be writing about financials. EVERYONE knew that the whole point of the no-doc loans was for people to buy WAY more house then they could actually afford. Most of the loans were used by speculators for buy rental properties that they could not afford without the renters. These loans were really only intended for people that owned their own small businesses and had trouble documenting their income, but did anyone really believe that people working for companies they didn't own couldn't produce a copy of their checks?

The same can be said for the no down payment loans. WOW what a surprise that someone with no skin in the game would walk away when things turned sour. That's like letting me invest 100% on margin with no equity of my own.

Finally, option-arms. LOL "I can afford this house and loan, but I know I won't be able to afford it some months so I got a higher interest rate option-arm for those month" YEAH, OK, that's what good credit risk borrower would say.

When these loans first started coming out everyone knew they are garbage loans and that's why they carried such a high interest rate compared for conventional loans. As greed and competition rolled in, they offered these loans with much smaller rate deltas to conventional loans, which effectively guaranteed they would deteriorate for the lenders with the lack of risk/return increase.

It should also be noted that the first lenders to start these type of loans were the small local lenders to help them compete with the big boys. They actually KNEW their borrowers and the properties and could rate the risk properly. When the bigboys got in the game, they didn't know the borrowers or the properties, I don't know how they could have expected these loans to perform.

The data on the degree of borrower fraud is staggering. We all knew that people were fudging but I had no idea that it was as widespread as Countrywide’s numbers would suggest. Furthermore, one would think that variances of 50% would have been somewhat evident simply by the application of common sense by underwriters.

Jun 06 10:55 AM

[MLKlein:]

Although it would take an army of auditors to enforce, how about prosecuting defaulting borrowers that lied on their loan application. While this is not an argument to let the loan originators off the hook - they should be held accountable to the full extent of the law - lying on your loan application is bank fraud. Our politicians talk of borrowers as victims, and there definitely are some or many, but not addressing the fraudulent acts of all the conspirators in this mess addresses only half of the problem and is a huge ethical lapse. I have no sympathy for someone that knowingly misstated their income or any other material fact on their loan application and is now losing "their" house (the excuse that the broker filled out the application and I only signed it is awfully weak too).

Jun 06 12:05 PM

[crawlars:]

Economic pressure is why legalization will happen in spite of resistance by US citizens. So, the housing market reaches a bottom when newly legalized "citizens" can afford property?


On Jun 05 04:30 PM jay brebner wrote:

> Could it be that the whole mortgage business were all counting on
> immigration reform? 10 million new leagl citizens would have taken
> up the slack and would have kept the housing market from going off
> a cliff. Did Karl Rove promise the industry that Bush had the power
> to deliver reform in his second term ? This is the only reason I
> can think of that these guys would risk letting their businesses
> fail.

Jun 06 12:29 PM

[Buckoux:]

Astute observation. I was in the middle of real estate finance as a "hard money lender" for 20 years. In 2004 I stopped lending as I just could not see the wisdom of these extremely risky loans. When Bank of America began accepting Mexican Consulate ID to open checking accounts, I figured some kind of fix was in. As Bush's 2nd. term unfolded and "comprehensive immigration reform" became the political and media editorial buzzword, I knew the Republicans and Democrats were pandering to a growing Latino demographic. This is not the whole part of the sub-prime puzzle, but an important insight into why the US, both publicly and privately, continued to "roll the dice".


On Jun 05 04:30 PM jay brebner wrote:

> Could it be that the whole mortgage business were all counting on
> immigration reform? 10 million new leagl citizens would have taken
> up the slack and would have kept the housing market from going off
> a cliff. Did Karl Rove promise the industry that Bush had the power
> to deliver reform in his second term ? This is the only reason I
> can think of that these guys would risk letting their businesses
> fail.

Jun 06 12:51 PM

[notsosmart:]

too big to fail,too many to jail. this should be the new motto on our monopoly money.all the scoundrels knew what they were doing.the real smart ones got out in time & their legacy fortunes are hidden in offshore tax havens. their children & grandchildren will be ok-dumb-dumbs.

Jun 06 03:08 PM

[Diegojames:]

If mortgage origination was controlled by licensing , auditors ,federal auditors or boards and each individual mortgage was filmed and recorded at its conclusion for later investigation as in my industry ....this gigantic event would not have happened.

Now it is time to follow Mozillo/Money trail to Congress and Wall Street and New York and build a new JAIL. This will surpass Watergate and Nixon

Jun 06 11:31 PM

[Tom Lindmark:]

Diego,

Are all prescriptions that are filled, filmed? It's an interesting idea that you put forth. Tell me more about the procedure.


On Jun 06 11:31 PM Diegojames wrote:

> If mortgage origination was controlled by licensing , auditors ,federal
> auditors or boards and each individual mortgage was filmed and recorded
> at its conclusion for later investigation as in my industry ....this
> gigantic event would not have happened.
>
> Now it is time to follow Mozillo/Money trail to Congress and Wall
> Street and New York and build a new JAIL. This will surpass Watergate
> and Nixon

Jun 07 12:54 AM

[Crocodilian:]

The fault lies beyond Mozillo: he merely picked up the money that the Federals left lying on the street.

None of this would have happened without the asset securitization/guarantees of Fannie and Freddie, and Fannie and Freddie couldn't have made these guarantees without the disastrous "implicit guarantee" of the taxpayer.

Mozillo acted precisely as he was incentivized to do: write as many mortgages as you can, to as many people as you can. That's what the system "paid him to do"-- so that's what he did. Kerry Killinger at WaMu did the same thing . . . and if neither Killinger nor Mozillo had existed, it would have been someone else, somewhere else.

The problem here is systemically disastrous incentives, not the particular bad acts of one person or another.

Jun 07 01:18 PM

[Moon Kil Woong:]

He is no more guilty than GS who sold these mortgage bonds, got AIg to back them, and sold them short. However, that doesn't mean he should not be convicted. The sad fact is the SEC is about 2 years too slow. And even today, other government agencies like the Fed and Treasury, and comptroller of currency are still against prosecuting and favor hiding gross misconduct and criminality.

How far we have fallen in such a short period of time.

Jun 08 02:55 AM