How apt that a book offering a graphic account of the worst financial crisis since the World War should coincide with the ‘Occupy Wall Street' protests gathering steam worldwide. The subprime crisis and its spill-over impact on society are, after all, a key trigger for the protests.
Michael W. Hudson, staff writer at the Centre for Public Integrity, takes us through the fraudulent world of mortgage financing in the US, where it all started. Lest the title conjures up visions of ‘Jurassic Park', the rather longwinded sub-title says it all: “How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America – And Spawned a Global Crisis”.
Despite all that text on the cover, the book proves to be quite a racy read. Most accounts of the crisis meander into dry stuff such as adjustable rate mortgages and collateralised debt obligations. But Hudson's narration is more gripping, thanks mainly to his fly-on-the-wall approach. It describes in detail the rise of Roland Arnall and others in the business of mortgage financing and how Arnall's Ameriquest went on to become the largest subprime lender in the US and attracted big money from Wall Street investors. It points out that lax regulation, focus on business volumes, compromises on quality and a skewed incentive system all played their part in weakening the system.
In their obsession with steep targets, the book observes, sales reps for mortgage companies used many fraudulent means and predatory lending practices, pushing already indebted American citizens (especially minorities) into a debt trap.
Who's to blame?
The book debunks the notion that ‘greedy borrowers' living beyond their means had brought the crisis on themselves by biting off more than they could chew. Instead, it blames Wall Street bankers, the sales force and brokers who misrepresented and violated all procedures in order to get fat bonuses and/ or keep their jobs. It shows that financing companies misled customers into going for expensive loans. While borrowers thought they were lowering their interest rates, the prepayment and processing charges were so steep that they were saddled with more, and not less, debt.
The very first chapter of the book describes a ‘bait-and-switch' method, in which sales reps marketed one product to a borrower and then switched documents when it came to signing on the dotted line. Here's a telling anecdote about Ameriquest, the then largest subprime lender in the US: “At company-wide gatherings, Ameriquest's managers and sales reps loosened up with free alcohol and swapped tips for fooling borrowers and cooking up phony paperwork.” And when the customer asked questions... “Many Ameriquest salespeople learned to position a few fixed-rate loan documents at the top of the stack of paperwork to be signed by the borrowers… then, after the borrower had flipped from signature line to signature line, scribbling his consent across the entire stack, it was easy enough to peel the fixed-rate documents off the top and throw them in the trash.” They were also equipped with many ‘tools' to manufacture and manipulate official documents.
Loan turnover, too, was fast and borrowers who prepaid older loans returned within a few months to the same financier for another loan at a higher interest. Mortgage companies too pocketed hefty processing fees each time they lent. The book points out that many of the loans went towards prepaying old loans, making for a classic debt trap. “In 2004, just one-quarter of 1 per cent of its (Ameriquest's) mortgages went towards home purchases; the rest were re-financing or home improvement loans.” The adjustable rate mortgage was a hit with sales reps, as they didn't disclose to buyers that interest rates were floating and would rise after the initial years. Now isn't that reminiscent of Indian teaser loans? Explains why RBI frowns on the practice.
Monster in the making
The book title refers not to any person or company that duped borrowers. In fact, it happens to be the business jargon for a mortgage savings presentation. The book details how First Alliance Mortgage trained new employees at its induction programme to use ‘Monster' to deceive borrowers.
Greg Walling, a former employee of First Alliance Mortgage, who later turned whistleblower, was forced to lie and persuade a borrower with decent credit history to refinance his loan when he wanted to reduce his interest outgo. You simply couldn't reduce the interest outgo after paying a processing fee of 15-20 per cent, Walling reasoned.
Wall Street bankers
Another takeaway from the book is that Wall Street bankers' appetite for such loans added fuel to fire. Fraudulent income and property prices meant that investment bankers were wrongly pricing these securities. “In one instance, a loan officer demanded a $500,000 valuation in a town where the most expensive house was worth no more than $425,000, recalled Michael Filio, an appraiser in New Jersey.”
Ameriquest's Vice-President said during one of his interactions that investors audited only 10 per cent of the loans in the mortgage loan pools. If they found the loan was misrepresented, they would replace it with a new loan and move it to another pool, hoping it would not be audited. Such were the ways of mortgage financing companies.
Towards the end of the book, the author shares a telling anecdote about how one sales rep, Mark Glover, lost most of his money because his adviser persuaded him to invest in what turned out to be a Ponzi scheme that preyed on both investors with lots of cash and ‘unsophisticated, racial minorities and elderly victims' who wanted to buy homes in Las Vegas.
In India?
There may be no subprime crisis waiting to happen in India, given that not many Indians take home loans from the organised financial system in the first place. Moneylenders collecting usurious rates have no connection with the formal financial system.
However, the bribe-for-loan scam in which a top LIC Housing Finance official was accused of mis-selling financial products does suggest that frauds happen. Of course, mis-selling of financial products is rampant in India — unit-linked insurance plans are likely to be sold as fixed deposits or plots as a sure-shot investment.
The book offers a fresh take on the subprime crisis, and shows how a great number of ordinary citizens fell prey to it. The storytelling style makes for a gripping read. The book doesn't focus merely on the Wall Street angle but also exposes a breed of fraudsters who may have escaped the attention of the angry protestors. The excessive information on various mortgage companies and their main actors, however, makes for a confusing read.