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

CDOs were not for the small investor. Pension funds bought in. So did some municipalities like Springfield, Massachusetts.  Many CDO investors were overseas in Europe, Asia, and Australia.  Some of the biggest investors were investment banks themselves.

But, by 2005, some experts on Wall Street began to have their doubts about the market in mortgage-based investments.  At Deutsche Bank, which was a major player in the mortgage investment business and backed some CDOs, top analyst Karen Weaver realized there might be serious trouble ahead.

In April 2005, she took a group of investors to visit lenders in California. “It was the first peek behind the green curtain, if you will, sort of-- to-- how these mortgages were being underwritten,” Weaver said in an interview.

She said she was stunned by some of the reasoning she heard, especially concerning risky subprime loans.  Lenders did not see them as long-term investments, but more as short-term bridge financing, she said.  “What was disconcerting was it meant that they weren't really vouching for the fact that they were creating a loan that they felt was credit-worthy.” 

She said she discovered that lenders were encouraging borrowers to plan to refinance adjustable mortgages within two years or so. In other words, before borrowers defaulted, the underwriters reasoned, they could pay off their risky loans with yet other risky loans. “They were saying that essentially the problems could roll off down the line,” Weaver said.

She believed lenders were just putting off the inevitable day of reckoning. While she foresaw major trouble ahead, she said she did not know how bad it would get.

In September 2005, her group at Deutsche Bank issued a report predicting that "subprime mortgage losses will increase significantly" and recommending that investors bet against the mortgage market.

While Weaver is credited with being among the first to sound a warning, Harvard Law School professor Elizabeth Warren, who specializes in consumer finance and bankruptcy, believes that many on Wall Street must of have had an inkling of the trouble looming.  “I'm sorry, the only people who can say we never knew are people who didn't want to know,”  Warren said in an interview. 

Warren, who is now chairing a Congressional panel overseeing the massive federal bailout, said that the system was bound to blow up, “because it was based on a scam.”  She added, “This is about buying toasters that, at the moment they were sold, the person selling them knew these things are going to explode.”  She had harsh words for lenders, accusing them of selling “mortgages to people who simply weren’t going to be able to pay them off.”

The beginning of the end came in 2007, when borrowers like Paula Taylor found themselves unable to meet the mortgage payments.  A community group in Boston tried to help Taylor stave off eviction, but failed.  Taylor, who said she is still embarrassed about what happened to her, lost her condominium.

The bad loans start surfacing
Across the nation, borrowers defaulted in droves.  As the bad loans surfaced, it set off a kind of nuclear chain reaction.  When the loans went bad, so did many of the securities created from them and the CDOs built off of those mortgage-backed securities.

Consider what happened to the investments derived from securities that held Taylor’s Countrywide mortgage and Delores Parker-Jackson’s with People’s Choice Home Loan.  Out of the 54 different CDOs that purchased portions of those mortgage-backed securities, 21 have defaulted; many others are worth a fraction of their original value.

Compounding the problem, many of those securities were hedged by insurance policies called credit default swaps, which were peddled heavily by the now-notorious insurance group, AIG.

When it all blew up, stalwarts of Wall Street like Bear Stearns and Lehman Brothers collapsed.  The mortgage business dried up. Ameriquest closed up shop. Countrywide was bought up by Bank of America. (A spokesman for Bank of America said the company is looking into how Paula Taylor got her loan.)

The much smaller People’s Choice Home Loan filed for bankruptcy.

Now, everyone is trying to figure out whom to hold accountable.

Given the number of mortgage applications possibly processed with false information, technically hundreds of thousands of borrowers, loan officers, and underwriters could be considered liable. 

Kourosh Partow, the former Countrywide manager who went to prison for processing “liar loans” put it in perspective.  “You know, and if you ask a loan officer, he's going to probably say, ‘I blame myself a little bit because the underwriter was supposed to catch any mistake in the file.’ And all the way down to Wall Street and so on.  Everybody blames themselves a little bit.  Meanwhile, we have a major problem in this country.”

Should they all go to prison, as Partow did?

“That's a question that you have to ask America,” said the Iranian-born Partow. “I think there's going to be a very, very, very high percentage of those loans with the information will not be matching their tax returns.” 

Last week, FBI Deputy Director John Pistole told the House Committee on Financial Services that the Bureau currently has approximately 2,000 open investigations into mortgage fraud, up dramatically from 881 in 2006.  In addition, Pistole said, there are 566 corporate fraud investigations underway, including at least 43 into “matters directly related to the current financial crisis.”

For Harvard professor Elizabeth Warren, it is the people at the top of the chain — like former Lehman CEO Richard Fuld, former Bear Stearns chief James Cayne, and Countrywide founder Angelo Mozilo — who deserve the most scrutiny.

“They didn't get it wrong from their point of view,” said Warren.  “They made big money.  Go back and look at the compensation.”

According to Forbes magazine, Cayne took home $155 million in his last five years on the job; Fuld $354 million; and Mozilo nearly $400 million.

Once upon a time, these financial powerhouses were happy to speak their mind. Now they tend to keep a very low profile. Mozilo has not been heard from in months. Fuld did speak up when he was called to testify at a Congressional hearing chaired by Rep. Henry Waxman last fall.  “Given the opportunity to look back, I would have done things differently,” Fuld said.

Elizabeth Warren said the toughest question she would ask the fallen CEOs is: “So what do you plan to do now?  Here we are, you're rich.  But what are the rest of us going to do?”

That is what a lot of people are wondering, including many interviewed for this report, who have lost jobs or homes or both.

James LaLiberte, the former chief operating officer of People’s Choice Home Loan said he is looking for work.  Meanwhile, he is living off the proceeds of a home he sold before the bubble burst. 

His former boss, CEO Neil Kornswiet is a consultant to a company called Value Home Auctions, which is auctioning foreclosed properties.  He lives in a multi-million dollar home overlooking the Pacific Ocean and owns a private plane. Like many others who got tangled up in the subprime mess, he may also be facing litigation. According to a letter filed by lawyers for People’s Choice unsecured creditors, Kornswiet is facing several potential legal claims, including one that he improperly withdrew more than $13 million of deferred compensation from a company trust.

Kornswiet’s spokesman said that the allegations are “untrue” and that Kornswiet was entitled to withdraw the money.  “The documentation is entirely clear on this.”

As the battles mount over settling scores, the public is trying to sort out how to get out of this mess in one piece.

The average American family is crashed and burned, according to Elizabeth Warren.  “Families are wiped out over this,” she said.  “We're bankrupting people who worked their whole economic lives.  And we're saying, 'Hey, you know, this is how markets work.'”

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