All the Devils Are Here [21]
Yet he was never, ever rude to people the way Mozilo sometimes could be; that wasn’t his style. On the contrary, he was gracious and polite to everyone, from janitors to community activists. He had old-world manners, was an avid reader and an intellectual. He was the sort who liked to remind people that if they had their health and their family, they had everything. And he gave away millions to charity. “He was quite concerned with society as a whole,” says Robert Gnaizda, the former general counsel of the Greenlining Institute, a public policy and advocacy group, who spent a great deal of time dealing with Arnall’s companies and came to know him well. “Except,” Gnaizda added, “for this little niche, where he wasn’t.”
That little niche, of course, was subprime lending.
The way hard-money lenders had always made their money was simple: knowing that the default rate among their borrowers was likely to be high, they imposed onerous terms on their customers, who had no choice but to agree to them. They claimed collateral on anything they could haul away—cars, household goods, you name it. They extracted high fees just for making the loan. And they charged as much interest as they could get away with. They were also extremely tough-minded about collecting what was owed them, which meant they usually got paid back. And the high fees meant that those who paid up more than made up for those who defaulted.
The biggest hard-money lenders, finance companies like the Associates, Beneficial, and Household Finance, also made second-lien mortgages, which allowed strapped consumers to borrow against their homes to raise cash. But hard-money lenders had never offered first-lien mortgages, because the economics of a thirty-year fixed mortgage with a sizable down payment simply made no sense in that sector of the market.
What changed was the law. Specifically, a series of laws passed in the early 1980s, intended to help the S&Ls get back on their feet, wound up having profound unintended consequences. (They also backfired spectacularly and helped create a second S&L crisis within a decade.) The first law, passed in 1980, was the Depository Institutions Deregulation and Monetary Control Act; among other things, it abolished state usury caps, which had long limited how much financial firms could charge on first-lien mortgages. It also erased the distinction between loans made to buy a house and loans, like home equity loans, that were secured by a house, which would prove critical to the subprime industry.
Two years later came the Alternative Mortgage Transaction Parity Act, which made it legal for lenders to offer more creative mortgages, such as adjustable-rate mortgages or those with balloon payments, rather than plain vanilla thirty-year fixed-rate instruments. It also preempted state laws designed to prevent both these new kinds of mortgages and prepayment penalties. The rationale, needless to say, was promoting homeownership. “Alternative mortgage transactions are essential . . . to meet the demand expected during the 1980s,” read the bill.
As the rules changed, the “Big Three” hard-money lenders—the Associates, Beneficial, and Household—began to expand into first-lien mortgages, which made economic sense for the first time. S&Ls, of course, had also gained new freedoms from the series of laws designed to get them back on their feet. The new breed of thrift operators started lending to consumers who would have never previously qualified for a mortgage. Thus was the subprime mortgage industry born.
One of the first to take advantage of the new opportunities was a thrift called Guardian Savings & Loan, run by a flashy, aggressive couple named Russell and Rebecca Jedinak. As federal thrift examiner Thomas Constantine would later write, “It started at Guardian.