All the Devils Are Here [186]
“We are experiencing home price depreciation almost like never before, with the exception of the Great Depression,” said Mozilo on the company’s conference call that day.
Morgan Stanley analyst Ken Posner was startled by the news. “That is just not a charge-off ratio one would expect for a—at least for an old-fashioned prime portfolio,” he said on the conference call.
“Countrywide is a mortgage supermarket,” responded chief risk officer John McMurray. “So it is my belief that the portfolio that we have for the most part is going to be a good reference for what exists on a broader basis.”
At another point during the conference call, McMurray noted, “So the way I think about prime is that it covers a very vast spectrum....” The implication was clear. Countrywide was acknowledging that prime and subprime weren’t as clearly delineated as most had believed. While investors who dug through the prospectuses for Countrywide’s mortgage-backed securities might have known that, it came as a shock to many.
McMurray also had two messages that were contrary to everything Mozilo had preached over the years. “Leverage at origination matters,” he said. “More leverage means more serious delinquencies.” That is, the more debt the customer borrowed, the more likely he was going to default. And he said, “Documentation matters. The less documentation, the higher the serious delinquency, all else equal.”
That day Countrywide’s stock fell more than 10 percent, to close at $30.50. Research analysts at Stifel Nicolaus, which had turned bearish on Countrywide earlier in the year, wrote in a report to clients, “[G]iven the magnitude of credit problems in the bank, we think mgmt made serious miscalculations (and possibly misrepresentations) about the quality of the loans added to the bank.” They found that Countrywide’s supposedly prime home equity securitizations were performing in line with a competitor’s subprime deals.
Soon after that conference call, McMurray resigned. Later that fall, Walter Smiechewicz, the senior executive in charge of enterprise risk assessment, met with Countrywide’s audit committee. Smiechewicz had been warning since 2005 that the residuals and the loans Countrywide had retained on its balance sheet posed a much bigger risk than was being acknowledged. According to several former executives, he said that if nothing was going to change, then he had no choice but to resign. He, too, left the company.
IKB—the German bank that was on the other side of John Paulson’s Goldman-arranged Abacus trade—was beginning to spook the market. Over the weekend of July 28 and 29, state-owned German banks brokered a bailout of the bank that would eventually rise to $13.5 billion. It was the first bank to be rescued because of the securitized mortgages on its books. It would not be the last.
Then came August. On August 8, BNP Paribas, France’s largest bank, suspended redemptions from three of its investment funds because it couldn’t value some of its subprime mortgage-backed securities. Australia’s Basis Yield Fund, which had bought into Goldman’s Timberwolf deal, suffered severe losses. It would soon go into liquidation because of its exposure to subprime assets.
August home prices fell 4.4 percent from the previous year, the largest decline in six years. Youyi Chen, the head of mortgage portfolio management at Washington Mutual, sent an e-mail to a group of colleagues entitled “Scenarios.” He wrote, “A 20 percent down in HPA. From today’s meeting, I understand that we don’t have the courage to evaluate this scenario.”
On August 9, five central banks around the world coordinated to increase liquidity for the first time since 9/11. Within a week, the Federal Reserve would begin cutting interest rates in an attempt to prop up the market.
It didn’t work. The securitization market for mortgage loans shut down. First Magnus, a lender of mostly Alt-A mortgages, collapsed