I’ve offered some criticism in the past about the Occupy Wall Street for a general lack of focus or articulation of an endgame. However, I don’t want this to be mistaken for a lack of empathy for their cause. On the contrary, the basis for the outrage as expressed by Occupiers is at the heart of the years-long financial crisis from which most of us are still reeling.
But my concern is that too many people still don’t entirely follow the insanity that has led us to where we are now.
I’ve read dozens of articles and a few books about the mortgage meltdown, but nothing has summarized the economic crisis spurred by the mortgage lending sector better than last night’s “60 Minutes” investigation of Countrywide and Citigroup. For those still scratching their heads about how we ended up here, this is my assessment of what went down:
Mortgage lending officers who worked at various banks and companies, like Countrywide, were paid on a commission basis for producing complete mortgage applications. The incentive for their compensation was principally based on quantity – not quality. As a result, loan officers dug deeper and deeper into so-called “subprime” markets, meaning that they actively sought out clients who traditionally would be considered a risky investment, or who at the least would not qualify for loans as large as they were being offered.
After a while, the books began to tilt too heavily toward these high-risk lenders, yet the loan officers wanted more loans to produce more commissions. Many mortgage loan departments resorted to fraud, forging signatures on official documents and knowingly doctoring income and asset statements.
In general, a primary mortgage lender doesn’t hang on to those loans for the life of the loan. instead, they bundle these loans together based on level of assessed risk of default, then they’re graded as a bundle and sold as a commodity to investment banks. By bundling the mortgages together, the bundled commodities can tolerate certain a percentage of defaults within that bundle. And in the cases when the risk of that default is clear, those buying the bundle do so fully knowing what they may lose. In turn, those borrowers generally pay a premium of interest on their loans, so there is a high-risk, high-reward balance.
The problem is that the real risk of these garbage loans was willfully hidden by those bundling them and selling them to investment banks.
The investment banks have their own checks-and-balances system, complete with internal auditors whose job it is to go through the loans in these packages to ensure they are what the primary lenders say they are. The primary lenders also have their own auditors who are supposed to spot when their loan officers are twisting prospective borrowers’ profiles into something they’re not.
The “60 Minutes” investigation on Sunday, December 3rd, 2012 focused on two such auditors. One, a senior vice president at Countrywide, made numerous appeals to the company’s leadership to investigate her findings of pervasive fraud. Their response was instead to fire her, then offer her a large settlement to buy her silence should the Securities and Exchange Committee of the Justice Department come calling. She refused the payoff, and recently won a $1-million-plus lawsuit against Countrywide for wrongful termination.
The vice president at Citigroup, who worked as an auditor in the investment banking sector (the group who bought these crap bundles of loans from companies like Countrywide) made a number of formal appeals to the top brass in the investment banking department of his company. He noted, both in person and in writing, that as many as sixty percent of the loan packages crossing his desk showed sings of fraud. Rather than look into the garbage loan bundles they were pouring money into, they looked the other way and continued to buy more. The vice president in the story notes that the level of fraud reached beyond eighty percent before he was blackballed for shedding light on this problem.
So why wouldn’t Citigroup want to know that what they were buying was junk? The same two reasons the top dogs at Countrywide didn’t want to know. First, they all got paid based on volume, not quality, of loans. Second, Citigroup (like Countrywide) had no plans of holding on to these loans any longer than it took to re-label and sell them to others in the stock market.
This product that banks like Citigroup peddled, pervasively graded falsely as a more reliable investment than they really were, are called mortgage backed securities. Basically, this meant you were buying shares in these bundles which were backed by home mortgage loans. The problem is that the banks were selling these securities as top-tier mortgage bundles in most cases, when actually they were very high risk (often fraudulently processed) loans falsely labeled as a good bet.and lest anyone wonder if the banks knew they were selling crap, consider the fact that the investment banks were turning around after selling the securities to the public and betting that these same investments would fail. This, I believe, is a product that was called the credit default swap. This is common in the investment world, effectively buying insurance to help mitigate the risk of investment. But when the investment you’ve bet against is toxic, and you know this because you lied about the quality of those securities, it’s simply criminal.
There are two major government bodies who potentially have oversight authority with regard to these big banks and the mortgage companies who originated the loans. One is the Securities and Exchange Commission (SEC), and the other is the Justice Department. As for the former, the SEC really has very little power. They can levy fines, though they are generally minimal in comparison with the damage done. For example, the CEO of Countrywide at the time of all of this fraud, Anthony Mozillo, was routed out of his job after an SEC investigation into insider trading. Though he agreed not to serve as head of another mortgage lending company and paid over $20 million in fines, the total penalties totaled less than five percent of the total income he realized in his eight years as head of Countrywide.
The Justice Department has more power, and wields the ability to bring criminal charges against individuals, as well as exacting enormous fines against the banks and related businesses. In fact, President George Bush singed into law the Sarbanes Oxley Act in 2002 to empower the Justice Department with even more explicit authority to oversee the banking sector. However, throughout the entire mortgage lending crisis, and despite the fact that taxpayers have offered up hundreds of billions in bailout dollars to these entities deemed “too big to fail,” the Justice Department has not brought a criminal case against a single executive in any of the related banks, mortgage lending companies or those who facilitated the transactions.
The former Senior VP at Countrywide has offered to speak to anyone at the Justice Department or the SEC, and yet no one has taken her up on her offer. Same goes for the VP at Citigroup who, though he wasn’t fired after raising these concerns to his superiors, was demoted to a position that involved no further oversight power. He was also asked not to return to the office in any physical capacity to do his work.
In large part, the banking industry is responsible for policing themselves. To the degree that the government has the power to enforce legal consequences in this arena, they clearly demonstrate a profound lack of will. Sarbanes Oxley is a joke; until it’s used to bring at least one banking or mortgage executive to justice, it’s a waste of paper. The Justice Department is either hamstrung by a lack of personnel and funding or by outside political pressure to stay out of the banks’ business. That, or the level of incompetence throughout it is staggering.
There are nominal regulations now in place, but no one is enforcing them. The SEC can, as one professor said in the “60 Minutes” piece, “gum people to death,’ but they haven’t even done that. The rewards of fraud and corruption are still too great when compared with the chances of getting caught, or the minimal fines and wrist-slaps if they even are found out.
So what to do?
While the idea of “Occupying Wall Street” is appealing and makes headlines, I’m not sure it will help us achieve our end goal of rooting out the poison in the financial and mortgage lending sectors. So perhaps it’s time to retool the movement. Consider “Evacuate Wall Street” as a new call to action. Yes, many Occupiers speak of standing against the banks, but if millions of Americans quietly begin to move their loans and other business out of the major banks and into credit unions or the like, the supply line is cut off. The corruption cannot continue without money – our money – so until we stop feeding the best, we’re somewhat complicit in feeding the very beast we’re fighting against.