Chain of Title (4 page)

Big investors didn't like the uncertainty in mortgages: you never knew when homeowners would pay them off, so you never knew the length of the loan and the projected profit on interest. So in 1983 Ranieri and his counterpart at First Boston, Larry Fink, created the collateralized mortgage obligation (CMO), the basic securitization structure used during the housing bubble.

Instead of investors buying bonds backed by mortgages and getting a proportional share of monthly payments,
CMOs created different classes for investors with different risk profiles. Typically there were three tranches: the senior tranche, the mezzanine, and the equity tranche. When mortgage payments came in, the senior tranche would get paid first. Whatever was left over went first to the mezzanine and then to the equity tranche. Lower tranches received higher interest payments on the bond to accommodate their higher risk. Investors buying senior tranches had confidence they would get paid off within a short time frame, usually five years. They didn't
have to worry whether each individual borrower could afford the payments; by selling a pool of thousands of mortgages, the odd default here or there wouldn't matter. The higher-risk tranches had longer terms, from twelve to thirty years, and stronger payoffs. These more complex securitizations converted the mortgage, a hyperlocal, idiosyncratic, individual instrument, into a bond, a defined security that investors could buy and sell with confidence.

The initial CMOs needed Freddie Mac: it was still the only way to get them sold nationwide. But once the securitization structure was in place, Ranieri went to work legalizing it. As a trader told Michael Lewis about Ranieri,
“If Lewie didn't like a law, he'd just have it changed.” In 1984 Congress passed the Secondary Mortgage Market Enhancement Act (SMMEA), which eliminated the ban on private banks selling mortgage-backed securities without a government guarantee. SMMEA also preempted state restrictions on privately issued mortgage-backed securities; no longer did investment banks have to register with each state to sell them.

The most important part of SMMEA involved the rating agencies, companies that assessed the risk of various bonds. Under SMMEA, institutional investors who previously were barred from making dangerous investments could purchase mortgage-backed securities as long as they had a high rating from a nationally recognized statistical rating organization. Investors could outsource their due diligence to the rating agencies; they didn't have to examine the salary of some home buyer in Albuquerque in order to buy an interest in his loan.
President Reagan signed SMMEA in October; Ranieri showed up for the ceremony.

Next Ranieri secured a tax exemption for pools of mortgages held in a special investment vehicle known as a
real estate mortgage investment conduit (REMIC). The REMIC operated like a trust, able to acquire mortgages and pass income to investors without paying taxes. Investors would pay taxes only on the bond gains, not on the purchase of the mortgages. The Tax Reform Act of 1986 legalized the REMIC structure and made mortgage bonds more desirable.

The mortgage-backed securities market reached $150 billion in 1986.
It probably accelerated the demise of the S&L industry, which finally imploded in the late 1980s. The money used for making mortgage loans, instead of coming from depositors, now came from investors all over the
world. Ranieri and his allies insisted the goal was to free up more funding for mortgages.
He was a dream salesman who just wanted to give every American a piece of something better, a nice house for their families.
But homeownership rates rose nearly twenty points from the 1940s to the 1960s under the old system. From 1970 to 1990, during the handover of mortgage finance to Wall Street, rates only went up two points.

While Wall Street did well with securitization, it could not dislodge the GSEs from their market dominance. The GSEs still had that implicit backstop of a government rescue. Investors valued that and bought most of their mortgage bonds from Fannie and Freddie. As long as banks tried to compete on a level playing field, packaging carefully underwritten thirty-year fixed-rate loans, they couldn't win.

Salomon Brothers fired Lew Ranieri in 1987. He was a victim of his own success. When the mortgage business standardized,
Wall Street investment banks staffed up with Ranieri's old traders. Another generation would crack the code and beat Fannie and Freddie, finding a new set of mortgage products to slice and dice. Ranieri, who started his own firm, never saw that coming. As he would later tell
Fortune
magazine,
“I wasn't out to invent the biggest floating craps game of all time, but that's what happened.”

Once she understood the securitization structure, Lisa Epstein could identify all the component companies and their involvement in her mortgage. DHI Mortgage was the originator that sold Lisa her loan. DHI immediately flipped it to JPMorgan Chase, which became the “depositor,” in industry parlance. JPMorgan acquired thousands of loans like Lisa's, pooling them into a mortgage-backed security to sell to investors. To securitize the loans, JPMorgan placed them into a trust (JPMorgan Mortgage Trust 2007-S2), which qualified for REMIC status and its significant tax advantages. The REMIC forced JPMorgan to add an additional link in the securitization chain—in this case, U.S. Bank, trustee for all the assets in the trust. U.S. Bank hired a servicer, Chase Home Finance, to collect monthly payments, handle day-to-day contact with borrowers, and funnel payments to investors through the trust. So Chase had one link in the chain as a depositor and a separate link as a servicer, basically a glorified accounts receivable department.

Investors in the trust get their portion of the monthly mortgage payments, but under the law they're merely creditors, holders of JPMorgan Mortgage Trust 2007-S2 pass-through certificates; the trustee, the entity passing payments through to investors, owns the loan. That's why U.S. Bank, not JPMorgan Chase, sued Lisa. JPMorgan Chase gets its proceeds from the sale of the mortgage bonds and walks away. U.S. Bank earns a fee for administering the trust. For performing day-to-day operations on the loans, the servicer, Chase Home Finance, gets a small percentage of the unpaid principal balance, along with any fees generated from servicing. This securitization added an additional wrinkle: the inclusion of Wells Fargo as the securities administrator, with the function of calculating interest and principal payments to the investors. As this involved scrutinizing cash flow from the servicer, it also made Wells Fargo the “master servicer” on the loan. When Chase Home Finance informed Lisa that Wells Fargo was blocking mortgage modifications, it probably had to do with this master servicer role.

At no time was it made clear to Lisa that when she sent in her mortgage payment to Chase Home Finance, somebody at Wells Fargo crunched the numbers on it and told a colleague at Chase to send the money through U.S. Bank to investors, whether a Norwegian sovereign wealth fund or an Indiana public employee retirement plan. Heck, nobody told Lisa that DHI Mortgage would grant her a loan and immediately sell it off to a
different
division of JPMorgan Chase from the one she'd been paying all these years. This idea of banks trading mortgage payments like they would baseball cards didn't sit well. And it made it all the more galling to Lisa that Chase Home Finance would tell her to stop paying: according to the securitization chain, they didn't even own the mortgage. Maybe they profited so much off late fees, they
wanted
to push people into foreclosure.

But while this was all critical information for Lisa to know, it only raised more questions. She had to understand why securitization translated into suffering for so many homeowners, especially in her backyard.
By 2009, one out of every four Floridians with a mortgage was either behind on payments or in foreclosure. How was that even possible? It wasn't like someone detonated a bomb in Miami and Orlando to wipe out businesses. No plague triggered all the state's crops to rot in the fields. Depressions like this—and
Florida was experiencing a depression, in Lisa's eyes—didn't happen spontaneously. Who put this in motion? Who prospered from the pain?

A week after receiving her foreclosure notice, Lisa stumbled across a blog called
Living Lies
. Neil Garfield was a former trial attorney in Fort Lauderdale, and in his biography he also claimed to be an economist, accountant, securitization expert, and former “Wall Street insider.” He had striking features, big eyebrows, and a perfectly cropped, jet-black beard. He looked like a character actor in a 1970s cop movie. Garfield started
Living Lies
in October 2007. The site featured day-to-day commentary on the mortgage crisis, a large volume of legal resources, and a mission statement:
“I believe that the mortgage crisis has produced manifest evil and injustice in our society. . . . Living Lies is the vehicle for a collaborative movement to provide homeowners with sufficient resources to combat bloated banks who are flooding the political market with money.”

It didn't take much digging to see that Garfield was running a business. He sold manuals on how lawyers and laypeople could defend themselves from foreclosure. He conducted paid seminars across the country. He had an ad for something called “securitization audits.” Many people presenting themselves as lawyers descended on homeowners at this time, making optimistic yet vague promises that they held the secret to saving homes from foreclosure. State and federal authorities warned homeowners to proceed cautiously with “foreclosure rescue” specialists, especially in Florida, where white-collar scams were a local specialty, even an economic growth engine.

But Garfield had attracted a following. He told NBC News in early 2009 that
the site had jumped from 1,000 hits per month a year earlier to 67,000 per month. And he did pull together the loose threads Lisa craved to comprehend: how securitization drove people into foreclosure, who profited from the outcome, and whether their financial machinations violated the law. More important, Garfield maintained an open comment section, so everyone in the then-small community of people willing to talk about their foreclosures online could share stories and swap information. It was like two parallel websites existing in the same space: Garfield on top, and the rabble of dispossessed homeowners underneath.

They included Andrew Delany, known online as Ace, a licensed carpenter from Ashburnham, Massachusetts, who lost his income due to a spinal disorder. Alina Virani (Alina), a paralegal from Orlando, her lender told her
she couldn't refinance, and when she called to complain, she discovered they went out of business. James Chambers (Jim C), of Clearwater, saw his business devastated by the downturn, and faced bankruptcy. These stories were familiar to Lisa: personal misery combined with underhanded behavior. James Chambers said Chase sued him but Washington Mutual owned his loan. Alina Virani got some help from an attorney in Ohio, who found that her lender violated federal consumer protection laws. Ace never could find out who owned his mortgage.

There was no support group for foreclosure victims; nobody wanted to even talk about it. It reminded Lisa of when everyone called cancer “the big C,” not daring to utter the word. But the commenters at
Living Lies
represented the stirrings of a community, all focused on solving the same problem, like a distributed network. Lisa bookmarked the site and returned to it daily. There was a spirit there, the opposite of the shame and humiliation everyone assumed foreclosure victims should feel. These people were ready to fight. And as Lisa read on, the schemes they related sounded less like the sober processes of modern finance and more like a crime spree.

Michael Winston, a new executive at Countrywide Financial Corporation, pulled into the company parking lot one day in 2006 and read the vanity license plate on the next car over: “FUND-EM.” Winston asked the man getting out of the car what that meant.

“That's [CEO Angelo] Mozilo's growth strategy. We fund all loans.”

“What if the borrower has no job?” Winston asked.

“Fund 'em.”

“What if they have no assets?”

“Fund 'em.”

“No income?”

“If they can fog a mirror, we'll give them a loan.”

Countrywide, which came out of nowhere to become the nation's largest mortgage originator, was part of a new system of mortgage financing that realized Lew Ranieri's master plan for Wall Street domination of the residential housing market. Congress shepherded the industry down this path, eliminating roadblocks so lenders could issue mortgages to people with bad credit.

The
Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 preempted state anti-usury caps, which limited the interest rate lenders could charge borrowers. Two years later, the Garn–St. Germain Depository Institutions Act eliminated mortgage down payment requirements for federally chartered banks. Embedded in Garn–St. Germain was the
Alternative Mortgage Transaction Parity Act. This also tossed out state restrictions on mortgages, allowing all lenders, federal or state, to offer adjustable-rate mortgages with steep resets, where the interest rate went up sharply after the initial “teaser” rate. It also permitted interest-only or even “negative amortization” loans, where principal increased in successive payments.

Congress was trying to save the savings and loan industry by making mortgages more profitable, effectively legalizing consumer abuse to aid a class of financial institutions. That didn't work: S&Ls blew up by the end of the 1980s. But without the elimination of these anti-predatory lending laws, argued Jennifer Taub of Vermont Law School in her book
Other People's Houses
,
“subprime lending could not have flourished.”

Wall Street figured out how to outflank Fannie Mae and Freddie Mac by securitizing alternative loans, which didn't conform to GSE standards.
Investment banks made the securities attractive with “credit enhancements,” guarantees to investors in the form of insurance or letters of credit. With these enhancements, even packages of the worst mortgages could achieve super-safe credit ratings. Riskier mortgages were more lucrative for Wall Street, because these “subprime” loans reeled in higher interest rates over the thirty-year terms. In other words, subprime loans were prized precisely because they gouged the borrower more. And as long as investors received assurances of risk-free profits, they would buy the bonds.