Ever wonder how so many people ended up in subprime mortgages? It wasn’t just that people with bad credit got loans they probably shouldn’t have. As the Wall Street Journal reported last month
“…as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.”
Of course many of those borrowers are now defaulting and their numbers are so large that the debacle has put in question the financial soundness of banks worldwide. Why would otherwise creditworthy borrowers enter into these transactions? And why would banks make those loans?
Meet Angelo Mozilo, CEO of Countrywide Financial, the largest mortgage lender in the country. In a piece for the NY Times
Gretchen Morgenson examined the business practices of Countrywide and found that
“Such loans were made, former employees say, because they were so lucrative – to Countrywide….
As a result, former employees said, the company’s commission structure rewarded sales representatives for making risky, high-cost loans. For example, according to another mortgage sales representative affiliated with Countrywide, adding a three-year prepayment penalty to a loan would generate an extra 1 percent of the loan’s value in a commission. While mortgage brokers’ commissions would vary on loans that reset after a short period with a low teaser rate, the higher the rate at reset, the greater the commission earned, these people said.
Now. Take a step back from this and think about what’s going on. By stealth and strategy a lender has gone to great lengths to make risky loans; they are trying to avoid making low risk loans. Normally you’d expect the opposite.
Of course that’s assuming the lender is concerned about being repaid. And there’s the rub. Countrywide was able to pass off the risk of default to others. At least for the short-term.
Of course it was clear that someone somewhere would have to worry about repayment. But that was long term. And Mozilo had no plans for the long term. Correction: he had no plans for the company, its employees or shareholders long term. He had excellent plans for himself. According to a Paul Krugman article back in October 2007:
“In late 2006, even as Countrywide began using shareholders’ money to buy back its own stock at more than $40 a share–it’s now worth only $19–Mr. Mozilo was selling. Between November 2006 and August 2007–that is, during the months before investors fully realized the extent to which his company would be hurt by the subprime mortgage crisis–he unloaded $138 million worth of Countrywide’s stock.”
When the scam began to really unwind—last week amid talk of bankruptcy the stock was trading at $6 a share—Mozilo engineered the sale of Countrywide to Bank of America. Details of the deal revealed that he had negotiated a severance package for himself that would pay him $140 million. Plus health insurance for life.
This is the difference between the 19th century and today: back then a snake oil salesman could only victimize one town at a time. In the 21st century the same guy can victimize the world economy.