THEY ONCE WERE LENDERS – Understanding government’s failure to stop bankers OR scammers from destroying homeowners
In the fall of 2008, news stories about “scammers” taking advantage of homeowners at risk of foreclosure started appearing frequently in the media. I remember watching a prime-time national news magazine type program, I think it was 20/20, that was airing a story that featured a sleazy looking middle-age man in Denver, hurriedly walking from a small, strip mall store front to his car, his hand covering his face, as a reporter tried to ask him questions that he obviously did not plan to answer.
The story involved a company that had charged a handful of homeowners several thousand dollars up front to help them negotiate with their banks to get their mortgages modified. The core issue being raised by the show’s host was that the homeowners had been victims of a scam because, as a couple of the homeowners interviewed were saying, their loans had not yet been modified.
I remember wondering, to begin with, how in the world such a story had become the subject of a national news magazine television program. I mean, “Three homeowners get ripped off by small business in Denver,” is not usually the sort of event that makes national headlines. The implication being made was that this case was emblematic of a more widespread problem, but nothing further was offered in the way of proof… no statistics, no additional facts… just statements about how homeowners should NEVER pay anyone up front to help them negotiate with their bank over a loan modification because they were “scammers.”
Around the same time, I also remember quite clearly reading a newspaper story that appeared on the front page of a major mid-western paper… it might have been the Minneapolis Star, but I can’t be certain. The large photo on page one was of a young couple with a baby in arms and maybe a four year-old standing at Dad’s hip… there was a white picket fence in the background… and a for sale sign in the yard. I can easily sum up the story in a single sentence: About eight months ago the couple had paid a law firm $1,000 to help them get their loan modified… and that’s the reason why they were now losing their $300,000 home.
And I remember thinking how ridiculous that sounded. I remembered the time that my wife and I paid a contractor $2500 and he never came back to even start the work on our deck. We were plenty angry, all right, but we didn’t even come close to losing our home because of it.
Now, you have to understand that, at the time, I was devoting my weekends to driving around Southern California conducting on-camera interviews with homeowners who either had already saved their homes from foreclosure, or were in the process of trying to get their loans modified, and the reoccurring theme was coming across loud and clear: “We tried contacting our bank on our own for a year and got nowhere, so we hired a law firm or mortgage expert company for $3,000, give or take, to help us and they saved our home from foreclosure.”
In addition, I had visited with several mortgage experts and lawyers back then, and they had let me sit by their side as they contacted banks on behalf of their clients… with their client’s permission, of course… so I knew that calling one’s bank to apply for a loan modification was not an easy thing to do. I remember once sitting waiting on hold for just under two hours only to hear the phone go dead.
And once, while I sat with a lawyer while he called a well-known bank on behalf of a client… with that client on the 3-way call… and the first thing the woman from the bank said upon hearing that the homeowner had hired an attorney was: “You know… you don’t have to pay him.”
I was taken aback, and since we were on speaker phone, I just couldn’t help but say something, so I interrupted the conversation, introduced myself as a writer, and asked the question: “How do you know she’s paying him, I mean, maybe her lawyer is her son-in-law or a friend of the family… how do you know whether he’s even being paid? Are you instructed by the bank to say that to anyone that hires someone to help them? Do they tell you to do that as part of your training?”
The line went dead. I remember saying: “She did not just hang up on me, did she? Call her back.” The lawyer explained that we’d never get her back on the phone, but he dialed the number anyway and a full 60 minutes later… it was still ringing. “Okay, I think I’ve got the picture,” I said. I thanked him for everything and left.
I can’t tell you the name of the bank in question, except to say that when they’re a “bank,” and their name starts with “IndyMac”. You’ll have to put it together yourself from there.
Within a month or two, the number of stories appearing in the media warning homeowners about “scammers” who offered to help prevent foreclosure, increased to the point that one might have easily started to believe that tens or even hundreds of thousands of “scammers” had mobilized to overrun the country.
I found it very hard to believe that there were large numbers of such “scammers.” I mean, how many people would be willing to take advantage of working class homeowners, many of whom had lost jobs and now were at risk of foreclosure? What would be next, mugging the blind?
Many of those I spoke with back then told me that I was naïve, but I just couldn’t believe that all of a sudden there were that many people willing to steal three grand from a middle or working class family at risk of losing their home. It was like hearing about an epidemic of criminals stealing food stamps from octogenarians on fixed incomes. Really?
I’m not saying that such aberrations never happen in this country, but it’s at least somewhat rare. Our society simply doesn’t produce that many people willing to commit such despicable acts. You might find thousands willing to rip off rich people, or big companies… but working class families losing homes? How many would sign on for a job doing that?
Well, apparently… quite a few.
After two and a half years spent covering the financial and foreclosure crises, I have come to realize that there are a whole lot more people in this country willing to take advantage of homeowners at risk of foreclosure than I would have ever thought possible. In fact, I’d have to say that if you throw a dart at the front page of Google when looking for advice related to preventing foreclosure, the odds of being scammed are absolutely excellent. It’s shocking to me that this is the case, but it unquestionably is.
Look, I grew up in Pittsburgh… born in Brooklyn, hung out in places like Philadelphia, Chicago, Los Angeles… and I’ve traveled all over the world… but I’ve never heard about large numbers ripping-off working class people suffering the trauma of losing their homes. To say nothing of the risk involved… I mean, aren’t most people in this country still afraid of going to jail?
A change in our cultural norms…
Consider that in the mid-1990s, headline crimes in New York City started including descriptions of mob hits that shocked even members of the Italian mob and NYPD, including: “Arms hacked off with an ax.” “Victim castrated with crescent-shaped knife.” “Man was gutted like sheep.” “Victim buried to the neck in gravel.” What kind of person that grows up in our society does these types of things?
But, it was after the fall of the Soviet Union, and the murders were being committed by a new group of gangsters that had only recently arrived in this country, and they had very different ideas about violence than our home grown gangs. They quickly became known as the “Russian mob.”
You see, the Russian gangsters that appeared on the scene after the fall of communism didn’t exactly grow up in New Rochelle watching Leave it to Beaver and drinking Tang… in fact, many grew up in the gulags of Siberia… places where right and wrong have very different definitions than they do in our country. One member of the Russian mob vocalized his contempt to the NYPD saying: “I did time on the Arctic Circle. Do you think anything you’re going to do is going to bother me?”
The fact is… before the current financial and foreclosure crises, I don’t remember there being nearly as many scammers looking to con anyone, anytime, anywhere. Where did the incredible numbers of scammers willing to defraud anyone without giving it a second thought come from, that is to say, what were they doing five or ten years ago? Did someone put something in the water since then? Could alien spaceships have dropped them off in 2007? Is it possible that the Internet just brings out the worst in people?
It seemed to me unlikely… nothing I could think of would change societal norms to the degree seen today over such a short period of time. I set out to analyze the situation more closely and I began by profiling a sample of those individuals that had been shutdown by authorities for scamming homeowners, and those that I’ve come across quite willing to continue operating even though they are not operating legally.
The construct of my focus group sample…
Had they all come from faraway lands, as in the Russian mob example, I would have looked at cultural differences as being the root cause of their apparent willingness to scam anyone at anytime, but the group was not predominately from anywhere, and the majority could be described as being “average Americans.”
The most common factor was their chosen profession prior to the financial meltdown of 2008… almost all had come from the mortgage industry. In fact, depending on whether I looked at a sample of 25, 50, or 100 individuals… the number of ex-mortgage people was always above 80%.
I realize that should not be surprising when you consider the target for these scammers is homeowners at risk of foreclosure, a group well-known to those that worked in the mortgage industry, but I also know many that came from the mortgage industry that would be no more likely to scam a homeowner in distress than I would.
The other commonality that I found to be present was their age… most were relatively young. Depending on the sample group I looked at, three-quarters were under 40… and more than half were under 35. It was difficult to be precise but I think it’s safe to say than fewer than 20% were over 45.
Education was the third commonality I was able to identify, and I estimate that 80% of the group never earned a college degree, although more than half reported that they had attended some number of college classes after high school. Almost all said they never finished college because the mortgage business paid so well.
I also found it interesting that a large percentage, perhaps just over half, reported having lost a home or homes as a result of the economic meltdown, and my sense was that a very low number saw the meltdown coming, fully understood its causes, or recognize the permanent or long-term nature of the changes to the mortgage industry.
In terms of the U.S. economy, they are a very optimistic group. I would say that 80% believe that worst case, the housing market will bottom out in the next 2-3 years, and many think that some areas have already hit bottom, and a similarly large percentage think that what they’re doing today is temporary… and at some point they will return to careers in mortgage lending. The longest timeframe for our country’s economy to recover that I heard from 90% of the group was 5-7 years.
The absolute ineffectiveness of the government’s response…
Over the last year, there have been a flurry of new state and federal laws ostensibly created to protect distressed homeowners from scammers, and one would have to assume that awareness among distressed homeowners about the potential for being scammed is certainly higher than ever.
However, there is absolutely no evidence that any of this legislation has reduced the number of scams, and in fact, my research strongly indicates that the number of scams targeting distressed homeowners has continued to increase. But the effect of the new laws has also caused scammers to diversify their illicit offerings and therefore will now be more difficult for regulators to address and law enforcement to police.
The latest count, as listed on California’s Office of the Attorney General Website dedicated to loan modification fraud as of April 23, 2011, lists 55 individuals and 32 companies, against which the AG has taken legal action related to fraudulent loan modification, forensic loan audit, and related foreclosure-related services, to-date. Considering the size of the State of California, the numbers are essentially zero.
The California State Bar is reporting the same numbers of consumers filing complaints this year as last, although the number of disciplinary actions taken by the bar hasn’t changed in any meaningful way, indicating that they are having a difficult time both investigating and prosecuting lawyers accused of being “scammers”.
This article seeks to explain where today’s proliferation of scammers came from, who they are… why they are the way they are…
… And why their presence is all but certain to continue to impact our society for a generation unless we come to understand that the same people that caused of the crisis, also created the scammers.
They Once Were Lenders…
Being a lender of money… the phrase itself congers up images of stature and great wealth. Investors funding loans providing the capital that drives our economy, building industries, creating prosperity… to be a lender of money has always meant having power and prestige… to be the person with the gold that makes the rules.
To be the provider of funds is to have a seat at the proverbial table. In our society, such a person is to be respected, their opinions are sought out… when they talk… others listen. And although in the past, being a lender meant being a “banker,” over the last thirty-odd years, the advent of securitization and financial innovation, supported by ongoing legislation favorable to the finance industry, a series of disastrous attempts at deregulation, and the growth in equities markets, all combined to broaden the types of lending and increase the need for “lenders.”
The type of lending that grew the fastest over the last three decades was “sub-prime.”
Sub-prime lending began its meteoric rise in the late 1970s, but the lowering of interest rates in the early part of the 1980s was the fuel it needed to explode. And from the start, sub-prime lending attracted individuals with very a very different set of ethics than were found among the traditional bankers and financiers of Wall Street. Many, in fact, came from failed Savings & Loans.
You see, the 1970s, with the decade’s spiraling interest rates were very difficult for the Savings & Loan industry ironically because of over-regulation.
S&Ls were originally a very important component of the government’s response to the financial disaster that caused the Great Depression, because they made it possible for people to buy homes at a time when our nation’s bankers were reluctant or incapable of lending.
S&Ls were required to pay a regulated amount of interest on short-term deposits that were insured up to $40,000 by the FSLIC, and then invest those deposits in 30-year fixed rate mortgages on residential real estate within a 50-mile radius of the S&L’s home office. In the 1970s, an S&L might pay 5.25% to 5.5% on deposits, and because long-term interest rates were generally higher than short-term rates, the owner of a Savings & Loan could make a fairly nice, if somewhat boring living.
Of course, that was fine during the decades of relative stability that followed WWII… before the inflation of the 1970s appeared on the scene thus causing interest rates to rise.
Higher rates caused homeowners to keep their homes longer, first-time buyers were forced to delay becoming first time homeowners, and rising unemployment all combined to significantly reduce the demand for housing.
Those that did buy homes more frequently took advantage of the “assumable” clause in mortgages that allowed them to take over the mortgage at the existing interest rate. The typical S&L’s mortgage portfolio, that had traditionally turned over every 5-7 years, stagnated during the latter part of the 1970s… and S&L earnings followed suit.
At the same time, S&Ls were finding it increasingly difficult to attract depositors as well. The five percent interest rates they were permitted to pay out started to look pretty silly with inflation at 12% a year… and climbing. Depositors flocked to Money Market mutual funds that pooled deposits in order to purchase large Certificates of Deposit from banks and S&Ls, and on which there were no interest rate controls.
S&Ls were now stuck between the rock of the rising costs of funds, and the hard place of stagnant incomes, and with only 30-year fixed rate mortgages to provide returns on invested capital, the S&L industry was doomed even before deregulation and other legislation would start it on a rollercoaster ride that would end in its demise.
When the pendulum swings too far…
First, Congress and the Carter administration gave us the Depository Institutions Deregulation and Monetary Control Act of 1980, which abolished state usury laws that limited how much interest could be charged on primary mortgages, began a six-year phase out of deposit interest rate ceilings, and raised the deposit insurance provided by the FSLIC from $40,000 to $100,000.
Then, a couple of years later, the Gain-St Germain Depository Institutions Act of 1982, expanded what S&Ls were allowed to invest in, permitting investment in short-term consumer loans, credit cards, and commercial real estate, among others.
The idea was simple… allow S&Ls to diversify their portfolios in order to increase their short-term earnings and it would help shield them from economic instability in the future.
But, it’s not hard to imagine that many owners of S&Ls were a less-than-happy group back in 1980. Many S&L owners were second-generation owners… in other words… they were the sons of founders. For the last decade they had watched their institution’s capital erode as the housing market had essentially slowed to a standstill… and their customers started saving in Money Market mutual funds.
In other words, spending the 1970s running the S&L your Dad founded was no fun whatsoever, and by many wanted out badly enough that they weren’t all that picky about the price, so when deregulation of the S&L industry soon created buyers for S&Ls that saw nothing but opportunity ahead, many were more than ready to sell.
Most were initially under-capitalized, however, but the new owners found that they could get their hands on almost unlimited funds simply by raising the interest rates they offered on deposits, and since such deposits were insured by the federal government, the financial health of the S&L didn’t much matter to anyone. The new owners raised rates and money flooded in.
Deregulation also meant that there were now plenty of investment opportunities available to S&Ls for the first time, in much riskier commercial real estate developments, for example, and the S&Ls could compete with the banks by making loans based on more relaxed credit standards, such as home loans that required no down payments.
These new S&L owners, however, were poor managers and as many S&Ls failed, the deposit premiums paid by those that remained went steadily higher. And because there was no distinction between well-capitalized S&Ls, and the ones that were taking on too much risk, the well-capitalized and more conservative institutions found themselves forced to match the competing interest rates offered by their problem competitors, causing their costs of funds to increase.
It was a recipe for the disaster stew that was about to boil over… and yet, Congress kept its collective head firmly planted in the sands of short-term thinking. (It’s nice to know that some things never change.)
Had the federal government empowered the regulators to take a tougher stand on S&Ls in 1982, it’s likely that the whole mess could have been avoided, but notwithstanding the extreme pain felt during the Great Depression, regulating financial institutions has never been our government’s strong suit. Back then, because virtually every congressional representative had at least one “good friend” that owned an S&L in his or her district none was in any hurry to cause immediate problems for their important constituents, even to ensure their longer-term financial health.
If we hit the jackpot, what have we won?
As described by Michael Hudson in his fabulously detailed if terribly disturbing book about sub-prime lenders, titled “The Monster,” when President Ronald Reagan signed an S&L deregulation bill in 1982, he is said to have quipped: “All in all, I think we’ve hit the jackpot.”
State governments, Hudson explains, immediately started competing for S&Ls by offering the lowest barriers to entry and the most lenient oversight. And one didn’t need much start-up capital to open an S&L, in fact, you could list “non-cash” assets to establish that you could operate in a stable manner. As in, “gosh… I don’t have any cash right now, but I do own a 4-plex in Poughkeepsie, a ’67 Mustang that’s totally cherry, and I suppose I could throw in my baseball card collection from the 60s.”
The State of California was among the most aggressive in terms of marketing to the S&Ls, in fact in Hudson’s book, he recalls seminars being held all over the state that promised to teach attendees how to start their own Savings and Loan, including one in particular titled: “Why Does It Seem Everyone is Buying or Starting a California S&L?”
At the end of the decade, when the Bush administration and congress were finally forced to deal with the failed industry’s problems, all S&Ls were tarred with the same broad brush. The Financial Institutions Reform, Recovery and Enforcement Act of 1989, didn’t distinguish between well-run S&Ls and insolvent institutions, it took away from the entire industry, most of the investment freedoms granted at the beginning of the 1980s.
An Industry About to be Born…
It seems to me that two key pieces of legislation, the previously mentioned Depository Institutions Deregulation and Monetary Control Act of 1980 (“DIDMCA”), and the Alternative Mortgage Transactions Parity Act of 1982 (“AMTPA”), worked like sperm and egg to give birth to sub-prime lending, with securitization being the incubator.
The AMPTA, which was intended to provide “parity” to non-bank lenders, preempted many state laws that had precluded lenders from offering anything but conventional fixed-rate mortgages, and in practice, allowed for the obfuscation of a loan’s total costs. This was the legislation that led to the creation of a variety of new types of mortgages, including the different flavors of adjustable rate mortgages (ARMs), interest only mortgages, and those offering balloon payments.
Because of AMPTA, consumers could now be titillated by teaser rates for the first few years, only to be slammed when the adjustments caused payments to be reset. And even worse were the loans that gave the borrower the ability to decide how much they would underpay during the first few years, with the amount of the underpayment being tacked onto the loan’s balance. Now your mortgage balance could actually increase from $300,000 to $350,000 in the first few years, destroying any equity a homeowner had in his or her home when they bought it.
Of course, many would argue that it’s not the loans themselves that were the problem, rather it was the people that chose these loans that caused their own future grief. These are the same people that continue to oppose anything even remotely resembling a bailout for homeowners, and according to Fannie Mae’s most recent survey, it remains a sizable group, roughly 53% of their survey’s respondents, which is why even after three years of watching the foreclosure crisis drag our economy straight down, our government lacks the political will to address the problem and stop the carnage.
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