Mortgage-backed securities are debt obligations on mortgage loans, which are purchased from banks or mortgage companies. During the height of the mortgage boom, investment banks started devising innovative “products”—in particular, the means of packaging subprime mortgages into securities that would be sold to other investment banks and presented to investors. These mortgage securities were quite lucrative when times were good, but when people began defaulting on their loans, the securities plummeted in value. The concept of mortgage-backed securities was originally developed by Lewis Ranieri, a Salomon Brothers bond trader, in the 1980s. During his career, Ranieri received wide acclaim for the concept, which produced huge profits for Wall Street.
Major investment banks were caught holding the bag—billions of dollars worth of so-called tier-three assets, the riskiest mortgage assets. Quarter after quarter, investment banks were forced to take write-downs against earnings. But even huge write-downs weren’t enough because the market never loosened up. No one wanted mortgage securities anymore.
In retrospect, the fact that so few people saw the danger building during the boom years is remarkable. There are many explanations for why this is so. Ed Lazear was an insider throughout the panic, as chairman of President Bush’s Economic Council. (He’d replaced Ben Bernanke in 2006, when Bernanke became chairman of the Fed.) “It’s not that events like this hadn’t happened before,” he said, “but events of this magnitude had not happened before. So if you look at the housing data you’ll see a nearly uninterrupted pattern of housing-price increases. And it wasn’t like these guys were fools. They were performing stress tests; they were doing analysis. But their models were based on the historical precedent, and, unfortunately, we hadn’t seen an event like this historically. When they set up their models and asked what were the right numbers, the right parameters, these were not the ranges we saw in this particular collapse.”
That was all well and good, but on the ground, people were struggling to get their heads around such a devastating failure on the part of those who were supposed to know better. Lazear recalled that he saw it frequently. “When I was working at the White House, I used to commute home to California every second or third weekend,” he said. “So I was on planes a lot. And I always talked to the flight attendants because flight attendants know everything. They’re like the cab drivers of the air. They’re in touch with people. So I was talking to this one flight attendant, and he was disgusted, saying, ‘I can’t understand how people could be so stupid. They’re making these loans to these guys who have no income, no jobs, no ability to pay. That’s totally nuts. Any idiot could see it.’ And my answer was that he was right. Any idiot could see it, and, in fact, the market saw it. That’s why it was called subprime. And so it wasn’t that these guys didn’t see it. They surely saw it. They understood that the default risk was much higher on those loans, and that’s why the interest rates were also much higher. What they didn’t see was that the default rates would be significantly higher.”
I got his point, but all explanations seemed feeble. One thing was unmistakable: By 2007, the boom times were effectively drawing to an end. No more lavish parties. No more euphoria. It was Judgment Day.
Angelo Mozilo was never one to show fear. I interviewed the chairman of Countrywide Financial on several occasions during 2007, and he was determinedly optimistic, as if by force of personality and will he could halt the rapid decline of Countrywide’s stock. Mozilo, the rough-hewn son of a butcher from the Bronx, had started the company in 1969, and by 2007 it was the largest lender in America, with sixty-two thousand employees and nine hundred offices. Mozilo was the king of home loans, and during the phenomenal housing boom, being number one also meant doing substantial business in subprime loans. As one investor remarked to me, “Mozilo was the Crazy Eddie of the housing market. No deal was impossible. He was giving it away.” He wasn’t, of course, giving it away. Over a period of years, as the fees multiplied and the ARMs came due, these were extremely lucrative loans, far more so than conventional mortgages—until they began to default in high numbers.
When I spoke with Mozilo in March 2007, as the cracks were starting to appear in the real estate industry, he was on the defensive, feeling misunderstood and wrongly targeted. Like some of his counterparts, he was quick to blame the media for creating the aura of crisis where he felt none existed. “It’s distressing to me to see the piling on that’s taking place by the media and regulators,” he complained. “This was a system that was working very well, providing an opportunity for people to get over that barrier of entry to owning a home. Now what you have is panic setting in.”
But the system was hardly “working very well” by that time. I pointed out to Mozilo that it wasn’t the media that was to blame for an epidemic of home foreclosures. Mozilo brushed me off. Throughout our interview he touted his company’s affinity for the little guy with aspirations of home ownership. The question was, could the little guy afford the loan that Countrywide and other lenders were selling him? “Countrywide for forty years has been on a mission to lower the barriers of entry for the American people to have the opportunity of home ownership,” he said with emotion. “And every application we take is within that framework of making certain as best we can that these individuals can afford the home. And so my response is simply that we have not been an opportunist, but have created opportunities for individuals and families to own a home.”
It was true that Mozilo was helping
