All the Devils Are Here [143]
Then, starting in 2005, Countrywide began to keep both pay option ARMs and a chunk of home equity loans—both the loans themselves and the residuals from home equity securitizations—on its balance sheet as well. In theory this made sense. Countrywide wasn’t just a mortgage shop, dependent on the vicissitudes of the mortgage market—it was a financial institution that could thrive in all markets. The rationale, once again, was that while there would be some delinquencies, the income stream from these loans would provide stability during tougher times. But, of course, that depended on the quality of the loans.
In the spring of 2005, Kurland argued that Countrywide was taking on too much balance sheet risk in home equity loans, according to the SEC. But the numbers just went higher. By the end of 2006, Countrywide had more than $20 billion worth of home equity loans on its books, almost double 2004’s level. And while Kurland had entered into hedges with Wall Street firms, offsetting the risk if the value of the residuals declined, those hedges were removed once he was pushed aside, according to one former executive. After all, by early 2007 they were in the money, and you could book a gain! “It wasn’t supposed to be about the gain,” says one former executive. “It was a hedge.”
Finally, Countrywide was putting pay option ARMs on its own balance sheet instead of selling them to Wall Street. By the end of 2006, Countrywide had $32.7 billion worth of pay option ARMs on its balance sheet, up from just $4.7 billion at the end of 2004. As Mozilo later wrote in an e-mail to Sambol and Sieracki, “We have no way, with any reasonable certainty, to assess the real risk of holding these loans on our balance sheet.... The bottom line is that we are flying blind on how these loans will perform in a stressed environment.” He began urging Sambol to sell the portfolio of option ARMs. But by that time, it was way too late.
There were some inside Countrywide who worried that the risks weren’t being adequately disclosed to investors. The SEC would later charge that, throughout 2006, McMurray “unsuccessfully lobbied to the financial reporting department that Countrywide disclose more information about its increasing credit risk, but these disclosures were not made.” In early 2007, McMurray provided Sambol and others with an outline of where it was likely to suffer losses.He asked that a version of the outline be included in the company’s year-end financial report. It wasn’t, according to the SEC. Later that year, he again argued that the company should disclose its widened underwriting guidelines to investors.
According to the SEC, Sieracki and Sambol made the decision not to include McMurray’s concerns about the underwriting guidelines in the company’s financial report. But it doesn’t seem like McMurray exactly laid his body across the tracks, either. He later said in a deposition that he was “comfortable” after discussing his issues with Anne McCallion, Countrywide’s deputy CFO. McCallion, for her part, said that “there were disclosures that were contained in the document that addressed the substance of his comments.”
But whether Countrywide was under a legal obligation to disclose more is almost beside the point. It was particularly important for a company like Countrywide that the market not get any nasty surprises, because Countrywide lived and died on the market’s confidence in it. Like all nonbank mortgage originators, Countrywide relied on cash from sales of its loans, and from selling equity and debt, to fund itself. Countrywide also relied on its ability to pledge its mortgages as collateral for loans in the overnight repo market. In fact, Countrywide was even more reliant on these funding sources because it also kept the rights to service the mortgages that it made, which it valued at $16.2 billion at the end of