All the Devils Are Here [54]
Spooked by the write-downs, Wall Street began to pull the plug on the subprime machine, withdrawing the warehouse loans that had been its lifeblood. One after another, the companies went bankrupt. Much of their supposed profit turned out to be illusory. One company, FirstPlus, had reported $86 million in earnings in the first nine months of 1997, but had eaten through $994 million in cash and had had to raise a stunning $1 billion in Wall Street financings, according to a presentation given by hedge fund manager Jim Chanos. Those were the kinds of “results” that can exist only in a bubble. In 2000, First Union shut down the Money Store, the subprime lender it had bought just two years earlier for $2.1 billion. “At the end of the day, we’re saying we made a bad acquisition,” First Union CEO G. Kennedy Thompson told the New York Times.
Along with the bankruptcies came a wave of lawsuits and complaints from consumer advocates, who accused the subprime industry of engaging in predatory lending. Customers, they said, had been gulled into taking on expensive mortgages—and paying exorbitant fees—by unscrupulous lenders. Many subprime refinancings replaced simple, affordable thirty-year fixed mortgages. “We and others were saying to the Fed, state legislators, anyone who would listen in D.C., that lending was getting out of control,” says Kevin Stein, the associate director of the California Reinvestment Coalition.
Even back then, there was a legitimate debate over who ultimately was more culpable: the lender or the borrower. After all, borrowers often wanted to get their hands on the money every bit as much as lenders wanted to give it to them. Not everyone was being gulled; many borrowers were using the rising values of their homes to live beyond their means. And there were plenty of speculators, betting that they could outrun their mortgage payments by flipping the house quickly. The line between predatory lending and get-rich-quick speculating—or a desperate desire for cash—was often difficult to discern.
But in the larger scheme of things, did it really matter who was at fault? The key point was this: A lot of people were getting loans they couldn’t pay back. Wasn’t that the real problem?
Prior to securitization, lenders had to care about the creditworthiness of borrowers. They held the loans on their books, and if a borrower defaulted, they took the hit. That’s why borrowers who didn’t have much money couldn’t get mortgages: lenders were afraid they would default. Securitization severed that critical link between borrower and lender. Once a lender sold a mortgage to Wall Street, repayment became someone else’s problem. The potential consequences of this shift were profound: sound loans are at the heart of a sound banking system. Unsound loans are the surest route to disaster. But at the time, almost no one seemed to realize that the wave of poorly underwritten loans that securitization seemed to encourage was a monstrous red flag.
The subprime business back then was still relatively small. The collapse of dozens of subprime companies didn’t remotely threaten the banking system. It didn’t have much of an effect on the housing market, either. But it was still significant. For the bank regulators charged with ensuring that the banking system remain sound, this was the canary-in-the-coal-mine moment, the signal that something was seriously wrong.
Or rather, it should have been.
In Alan Greenspan’s memoir, The Age of Turbulence, a five-hundred-plus-page tome published the year before the financial crisis, the phrases “subprime mortgage” and “predatory lending” don’t merit so much as a mention. Greenspan’s book is a triumphant account of his eighteen and a half years as Fed chairman