'If you had a pulse, we gave you a loan'

Even when she pointed out obvious fraud, she said, there were instances when representatives of the investment banks took the loans anyway.  “It took the wind out of my sail,” said Loiacono.

When she saw so many bad loans making their way through the financial system, she said, she realized there were going to be serious ramifications for the financial system.

Information withheld
Her concern was echoed by former People’s Choice COO LaLiberte, particularly with regard to disclosures made to Wall Street investors buying loans from People’s Choice.  LaLiberte said he believed his company withheld pertinent information from Wall Street about the true risks of some loans.  

He said that there were two ways in which this happened.  First, he said, some loan files were “scrubbed,” meaning documents with potentially conflicting information were removed.  Sometimes, he said, the information removed was innocuous. Other times, however, he said information that might reflect a lower income was removed. Secondly, he said, sometimes after a loan was sold, the lender would get information such as income tax records (which borrowers authorize lenders to obtain when applying for a loan) that showed a borrower had overstated income on the loan application. 

LaLiberte said he went to see the company’s general counsel about the issue. “I inquired as to what our obligation was to notify investors of defective loans and/or repurchase them. He indicated he believe we did have an obligation to notify, and allow the investor to make the decision to repurchase the loan.”

LaLiberte said that, as far as he is aware, People’s Choice did not share such information with investors.  Another former manager agreed with him.

But the former director of Investor Relations for People’s Choice, John P. Salvador denied LaLiberte’s assertions.  “It was the policy and practice of the company to make certain that everyone knew that no documents could be removed from a loan file,” he said.  Investors, he added, “were always given everything they asked for.”

Through his spokesman, former CEO Kornswiet called LaLiberte’s statement “flat out untrue…. People’s Choice DID make full disclosures” and gave investors full access to both physical loan files and electronic data “to do whatever level of due diligence they wanted with the [sic] all of the facts in front of them.” 

He said that the company had to repurchase bad loans from Wall Street, so it had no incentive to push them through. He also said that investments profited far more than People’s Choice, claiming that on $5 billion in loans, People’s Choice made profits of “less than $13 million” while investment banks made $150 million or more off repackaging and reselling the same loans.

Even if lenders and investment banks were not doing an effective job weeding out bad loans, there was another actor in the system that might have been able to figure out the true risk: ratings agencies like Moody’s, Fitch, and Standard and Poor’s.

Over the years, the ratings agencies had developed sophisticated systems to analyze the risk of mortgage-backed securities.  According to Richard Gugliada, a former managing director of Standard and Poor’s, those securities had proven extremely reliable.  “The historical experience of mortgage-backed securities was, plain and simple, these securities do not default,” Gugliada said in an interview.  “They were very solid investments.”

He said that his company did the best job possible with the information it had at the time. He added that when Wall Street invented CDOs, which are super complex in comparison with regular mortgage-backed securities, his firm adapted accordingly, developing even more sophisticated models to assess the risk.

“We had two guys who came out of NASA,” he said, “NASA scientists.”

Some critics, including members of Congress who held a hearing on the issue, have accused ratings agencies of disregarding risks to please their customers: namely, the investment banks that paid Standard and Poor’s to rate their securities.

Gugliada acknowledges that approximately 90 percent of the time, his group at Standard and Poor’s rated CDOs AAA, the highest rating possible.  But Gugliada denied there was any impropriety.  “Nobody was giving away ratings,” he said.  “Every single deal that went out the door had to meet our criteria standards.”

In retrospect, he said, he would not have given any CDOs tied to mortgages a AAA rating. But he is adamant that it is not the fault of the experts.  “It's not the rocket scientists who were to blame.  It was the lack of data to support some of the assumptions that were being made.”

For financial writer Paul Muolo, that defense is weak. “I don't care if you're from NASA or Vassar,” said Muolo. “There was no history at all of a market where you were lending money to people with bad credit to buy a house and you were accepting downpayments that were zero.”

But with AAA ratings, many CDOs ostensibly were solid and, at the same time, paid a high rate of return. Those were strong marketing points for the investment banks selling them.  “Wall Street has got this reputation for being the smartest guys in the room,” Muolo said.  “When someone from a reputable Wall Street firm calls you up and says they have a great investment, you tend to believe them.”

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