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By Root 3639 0

studied at the feet of Rubin, Summers, and Greenspan, it was perhaps inevitable that he would share their mind-set about the virtues of the market. As the guidance was being discussed within the government, there were bank supervisors who were arguing that the Fed needed to clamp down on both mortgage lending and commercial real estate practices, especially given the rapid growth of both asset classes since 2000. But there were, shall we say, alternate concerns, which were expressed by Geithner and others who shared his views. What would the effect be on the mortgage and housing market if the Fed were heavy-handed? What would the effect be on the bottom lines of banks? “The Fed slowed down the guidance,” says one person. “It was slowed down by internal debates about how far the regulators should go since most of the mortgages were sold into the market—and this guidance would replace investor risk appetites with regulatory standards.”

As the mania reached its peak, an odd problem loomed: who was left to borrow money? Historically, the subprime lending business had leaned heavily toward refinancings. Sometimes that meant persuading people who had a thirty-year fixed loan—or had paid off their old mortgage entirely—to remortgage their home. Other times the homeowner was already a subprime borrower who needed to refinance after a few years, when the interest rate on his loan ratcheted up beyond his means to pay. But by 2006, 40 percent of actual home purchases in the United States were made with a subprime or Alt-A loan, according to Deutsche Bank. Why? Because soaring real estate values had priced legitimate buyers out of the market, and because brokers were seeking out borrowers who had never even thought about owning a home and who, under normal circumstances, would have no hope of doing so. Loans were being made to people who couldn’t even afford the teaser rate, much less the reset rate. Borrowers would sign the papers, get the loan, move into the house—and stop paying within the first few months.

At the same time, the rapid rise in home values finally began to slow. That meant that homeowners who had known from day one that they would need to refinance before the loan reset didn’t get the appreciation they needed to make a refinancing possible. “Whoever made that last loan, they were the lender of last resort,” says an industry veteran. In other words, both the borrower and the lender were stuck with the bad loan.

In loan offices around the country, the tension grew, particularly for those lonely souls whose job it was to prevent bad loans from being made. Such as veteran appraiser John Ferguson, who had gotten his start at the Money Store (“the sleazy edge of subprime,” he says) and then moved to BankUnited, a Florida-based bank whose exposure to subprime mortgages would eventually help bankrupt it. Ferguson had started rejecting more and more deals as he saw the quality declining. In the spring of 2006, he wrote to his boss at BankUnited’s Walnut Creek, California, office: “When everything is going great guns and you kill a couple of deals then so what. But when it gets to be crunch time... every time you become an obstacle to someone getting their pay check things get ugly. It becomes sales vs. the review department. In this office in CA everyone knows that when I cut/kill a deal then that hurts the production numbers.”

By the following spring, the panic was evident in the office-wide e-mails sent by the sales manager of the office Ferguson worked in. On April 2, 2007, he wrote, “We almost broke 36 million for 92 units, which is lower than February’s numbers, which is the lowest we have been since we opened, almost.... I never thought we would get to this low number... but we did and hopefully we can learn from what we have done and do better.... WE JUST HAVE TO.... We are moving in the wrong direction folks and something has got to change.”

The subprime companies were like rats racing on a wheel, going faster and faster, knowing that if they stopped, the jig was up. They had to keep their volume up; their