Monday, June 16, 2008
The mortgage executives who gathered in a blond-wood conference room in Southern California studied their internal reports with growing alarm.
More and more borrowers were falling behind on their monthly payments almost as soon as they moved into their new homes, indicating that some of them never really had the money to begin with. "Nobody had models for that," said David E. Zimmer, then one of the executives at People's Choice, a subprime lender based in Irvine. "Nobody had predicted people going into default in their first three mortgage payments."
The housing boom had powered the U.S. economy for five years. Now, in early 2006, signs of weakness within the subprime industry were harder to ignore. People with less-than-stellar credit who had bought homes with adjustable-rate mortgages saw sharp spikes in their monthly payments as their low initial teaser rates expired. As a result, more lost their homes; data showed that 70 percent more people faced foreclosure in 2005 than the year before. Housing developers who had raced to build with subprime borrowers in mind now had fewer takers, leaving tens of thousands of homes unsold.
People's Choice was feeling the slowdown, too. It had been generating about $500 million in loans each month, but profit fell by half in the first quarter of 2006, according to documents filed for an initial public offering that was later abandoned.
Zimmer saw the mounting problems as head of the department that worked with Wall Street to package mortgage loans into securities to be sold to investors. Such securities had fueled the housing boom by pumping trillions of dollars into the mortgage market.
Two decades earlier, Zimmer had been among the young salesmen pitching early versions of mortgage-backed securities. He had stayed in the field, becoming a top salesman at Prudential Securities before moving on to help run a big investment fund that specialized in those exotic products.
Now he was trying to make sure People's Choice could continue to raise money by pooling subprime loans. Zimmer and some other executives urged the company to tighten its lending standards. That could lower the rate of defaults. And the better the quality of the loans, the more investors would want them, he figured.
But "there was always push back" from sales executives when he advocated more conservative lending, Zimmer said. Like most big lenders, well over half of the loans made by People's Choice came not from its own employees but from independent mortgage brokers. If the company stopped taking the brokers' riskier loans, the brokers might take both those and their higher-quality loans elsewhere. What's more, People's Choice's own loan sales force -- at about 1,000 employees, the bulk of the company -- worked largely on commissions from loans they made.
"There were times when voices would get raised," Zimmer said. A colleague would pound the table, asking: Why don't you see this?"I was not," he said, "a popular person."
As his team analyzed the individual loan files, Zimmer said he was struck by evidence of fraud, such as doctored bank statements. "Fraudulent loans were a big part of the subprime mess," he said. Mortgage brokers forged borrowers' signatures and pumped up their income, he said. People seeking to buy and sell a home for a quick profit lied that they were going to live in the home -- qualifying for a lower interest rate. But People's Choice calculated that it would have been too complicated and expensive to go after fraud, Zimmer said.
Even as People's Choice sought to preserve its business, the housing climate continued to deteriorate. Many borrowers were defaulting so quickly that the company did not have time to pool those mortgages and sell them off as securities.
C hapter VI What Else Is at Risk?
Feb. 7, 2007 . A few hours separate startling announcements. HSBC, a 142-year-old London-based bank that was one of the largest subprime lenders, says it must set aside $10.6 bi llion to cover expected losses. Then another industry giant, New Century Financial, says it will have to redo almost a year of accounting to reflect the depth of its losses.