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Gotta love the aftermath. And the people who continue to say that this is just a tiny problem that they can simply sweep under the rug. New lending standards are set to kick in this June--things should start to get interesting. Sorry for the length (and the formatting), but it reads fairly quickly.
| quote: | Subprime Fiasco Exposes Manipulation by Mortgage Brokerages
2007-05-30 00:01 (New York)
By Seth Lubove and Daniel Taub
May 30 (Bloomberg) -- Taher Afghani was working for discount retailer Target Corp. near San Francisco when friends told him about the riches to be made in California's Mortgage Alley.
It was 2004, and the U.S. real estate market was on fire. Down
in Southern California, a hub for lenders specializing in loans to
people with weak, or subprime, credit, Afghani's pals were making a
fortune pushing risky mortgages on homebuyers. After tagging along
with a buddy on a company trip to Los Cabos, Mexico, Afghani quit
Target, headed south and began hustling loans at Costa Mesa-based
Secured Funding Corp.
``I had never seen so much money thrown around in one
weekend,'' Afghani, 27, says of the Cabo getaway. ``It was crazy.
All these kids, literally 18 to 26, were loaded -- the best
clothes, the cars, the girls, everything.'' Soon Afghani, who'd made
$58,000 a year managing a Target distribution center, was pulling
down $120,000.
Mortgage salesmen like Afghani, many of them based in Orange
County, near Los Angeles, lie at the heart of the once-profitable
partnership between subprime lenders and Wall Street investment banks
that's now unraveling into billions of dollars in losses.
After years of easy profits, a chain reaction of delinquency,
default and foreclosure has ripped through the subprime mortgage
industry, which originated $722 billion of loans last year. Since
the beginning of 2006, more than 50 U.S. mortgage companies have put
themselves up for sale, closed or declared bankruptcy, according to
data compiled by Bloomberg.
California Connection
Lenders such as Irvine, California-based New Century Financial
Corp.; Orange, California-based ACC Capital Holdings Inc.; GMAC LLC's
Residential Capital home lending unit; and General Electric Co.'s WMC
Mortgage Corp. division have slashed more than 5,000 jobs. On May
22, Santa Monica-based Fremont General Corp., whose loans helped
trigger the subprime crisis, agreed to sell its commercial real-
estate unit for $1.9 billion.
The upheaval in Orange County, home of Disneyland and
birthplace of Richard Nixon, has sent shockwaves throughout the
financial world.
Brokers are merely the first link in a chain stretching from
mortgage companies, which originate loans; to wholesale lenders,
which bundle them together; to Wall Street banks, which package the
bundles into securities; and finally to commercial banks, hedge funds
and pension funds, which buy these investments.
Subprime Sinkhole
The pain has only just begun. As home prices sink and mortgage
defaults climb, bond investors who financed the U.S. housing boom
stand to lose as much as $75 billion on securities backed by
subprime mortgages, according to Newport Beach, California-based
Pacific Investment Management Co.
Companies from Detroit-based General Motors Corp. to Zurich-based
UBS AG have fallen into the subprime sinkhole.
At GM, profit plunged 90 percent during the first three months
of 2007 because of mortgage losses at its 49 percent-owned GMAC
finance company.
Swiss banking giant UBS said in May that it would shut its
Dillon Read Capital Management arm after the hedge fund manager lost 150
million Swiss francs ($123 million) in the first quarter, partly
on subprime investments.
Subprime originations fell 10.3 percent to $722 billion in
2006 from a record $805 billion in 2005, according to JPMorgan Chase &
Co. Credit Suisse predicts a 40-60 percent slide this year.
The party is over in Orange County. These days, Secured
Funding's once-buzzing office building in Costa Mesa, near John Wayne
Airport, is gutted.
Cutting Back
The imprint of ``Secured Funding'' is all that remains of the
corporate logo that once graced the outside of the two-story
building. Above it is a ``For Lease'' sign advertising the 82,333-
square-foot (7,649-square-meter) building.
``They cut way back,'' a construction worker says, shrugging.
What little remains of Secured Funding is now housed in a building
across the near-empty parking lot, where a receptionist tells a
caller: ``Our wholesale division is closed. We're no longer doing
business with brokers.''
The subprime industry -- and investors' losses -- would never
have gotten so big were it not for a small army of independent
mortgage brokers and hustling salesmen like Afghani, who was fired
in October.
Afghani and other subprime veterans say their job was to reel
in borrowers, period. Never mind whether customers needed loans or
could manage payments.
Making the Pitch
Afghani says sales pitches typically focused on what a
borrower could do with all of that money rather than on fees
buried in paperwork or annual interest rates as high as 10.5 percent
at the time, at least 2 percentage points more than the rates that
banks charge people with good credit.
``Even with explanations, most borrowers didn't really
understand what types of loans they were getting,'' says Maureen
McCormack, another former Secured Funding employee. ``They just cared
about the monthly payment.''
The sales job was made easier with exotic mortgages such as so-
called no-doc loans, which enable borrowers to get loans without
having to supply evidence of income or savings, and option ARMs,
adjustable-rate mortgages that let people pick how big a payment
they will make from month to month. The loans offer upfront teaser
rates at the cost of tacking the deferred payments onto the balance
of the loan.
``Heavy sales pressure has been part of the most-egregious
lenders for a while,'' says Kurt Eggert, a professor at Chapman
University School of Law in Orange, California, who has studied the
role of aggressive sales tactics in subprime lending and sued
lenders on behalf of elderly borrowers caught up in home equity
scams.
Sold to Wall Street
However brokers snared customers, lenders in California
typically sold the loans to big banks or Wall Street firms. Under
U.S. law, investors who buy mortgages or securities backed by them are
typically not susceptible to lawsuits alleging fraud on the part of
brokers.
Such protection partly explains why the U.S. mortgage-backed-
securities market has ballooned. The market more than tripled since
2000; $2.4 trillion of MBSs were issued last year, according to
the Securities Industry and Financial Markets Association in New York. Last
year was the first time more than half of the securities issued were
backed by subprime and other nonconforming loans, according to the
trade group.
``The market is driven by volume and passing along the risks
associated with it,'' says Paul Leonard, director of the California
office of the Center for Responsible Lending, a Durham, North Carolina-
based consumer advocacy group. ``With the appetite of the secondary
market, neither brokers nor originators had much accountability.''
Down the Chain
Lenders push sales of subprime loans as far down the chain as
possible to vast networks of brokers. While independent brokers
account for about half of all mortgage originations, they handle as
much as 70 percent of subprime originations, according to the
Mortgage Bankers Association of America.
Many of the biggest subprime casualties, including Fremont
General; Kansas City, Missouri-based NovaStar Financial Inc.; and New
Century Financial, would never have grown as fast as they did
without their ability to outsource the bulk of their sales to
outside brokers and salesmen.
New Century, before tumbling into bankruptcy on April 2, used
a network of 47,000 mortgage brokers and 222 branch offices to grow
to $59.8 billion in annual loans last year from just $400 million
in its first year, in 1996, according to company filings.
Lawsuits Mount
Fremont originated a peak of $36.2 billion in subprime loans
in 2005, up from $3.3 billion in 2001, largely through
``independent loan brokers,'' according to company filings. The
company ended its subprime business in March.
Even before the bottom fell out of the subprime market,
NovaStar and other lenders were defending themselves against
lawsuits that accused the companies of using independent brokers
and branch salesmen to exploit borrowers with high-cost loans.
A lawsuit filed against NovaStar in federal court in Memphis,
Tennessee, in April 2006, for example, centers on allegations that
NovaStar used mortgage brokers to prey on minority borrowers, in
this case a 61-year-old black woman who claims to have heard
pitches for ``easy money'' on a local gospel radio station.
Among other allegations, the plaintiff, Mae Jackson of Memphis,
claims she was never informed about the terms of the loan,
including the amount, the interest rate or the closing costs. In her
complaint, she attacks NovaStar's practice of using mortgage brokers
who employ ``deceptive high-pressure tactics to foist these unfair
and discriminatory subprime loans onto unsuspecting minority
borrowers.''
Blaming Brokers
In court filings, NovaStar pins the blame on the mortgage
broker, Memphis-based Worldwide Mortgage Corp., which filed for
bankruptcy in April 2006. In a separate statement, NovaStar says
that contrary to the plaintiff's portrayal of herself as naive,
Jackson was a ``real estate investor who owned five properties at the
same time.'' Neither she nor her attorneys have provided any
evidence of discrimination, NovaStar says. Jackson couldn't be
reached for comment.
Like many subprime lenders, NovaStar spread its tentacles by
tapping into a broad base of mortgage brokers and so-called net
branches. A net branch enables an independent broker to set up
shop under NovaStar's or some other company's banner with little
upfront investment, much less a state license, and quickly begin
brokering loans to kick upstream to the parent.
NovaStar made great use of the technique: By the end of 2004,
it had expanded its number of branches to 432 from four at the
beginning of 2000. At their peak in 2003, NovaStar's branches
brought in $1.2 billion of loans, a fifth of the total $6 billion
in subprime loans originated by the company that year.
`Competitive Advantage'
``The branches represent a competitive advantage for NovaStar
as we seek greater market share,'' the company said in its 2003
annual report.
Several lawsuits filed against NovaStar paint a more sinister
picture. They claim the company played fast and loose with state
licensing requirements in an effort to make results look better
than they might have without the aid of the branch loan sales.
``NovaStar had woefully failed to comply with federal and
state regulations as a result of defendants' efforts to expand the
company's business at all costs,'' alleges one 94-page complaint
filed in November 2004 in federal court in Kansas City and certified
as a class action this past February. The firm is facing at least
seven class actions, according to Bloomberg data.
Among other allegations, the Kansas City lawsuit claims NovaStar
fraudulently puffed up borrowers' assets to qualify customers for
loans. One unnamed former employee, identified as a ``loan
officer'' who worked in California from 2002 to '03, told
plaintiffs' lawyers that employees would apply an ``X-Acto knife and
some tape'' to borrowers' W-2 forms and paychecks to qualify them
for loans.
`Inflammatory Allegations'
The same employee said that on other occasions, the company
would temporarily deposit $5,000 in the bank account of a potential
borrower to inflate his or her assets. NovaStar would either take
the money back or increase the loan fees, according to the lawsuit
filed by co-counsel Milberg Weiss & Bershad LLP of New York.
``NovaStar believes it is irresponsible to continue to print
the false and inflammatory allegations regarding lending
activities contained in this lawsuit, given that the plaintiffs
have never produced any evidence to support them and they are not
actually a part of the underlying claim,'' NovaStar spokesman
Richard Johnson said in a statement.
Johnson says three state and federal licensing and compliance
actions involving the branches filed against NovaStar that are
detailed in the lawsuit amount to much ado about nothing.
``None of NovaStar's operations in these states, or nationwide,
were materially affected or in danger of being materially
affected, in any way, and therefore those actions did not require
disclosure at the time,'' Johnson said in his statement.
Regulatory Patchwork
The company announced in April it was exploring ``a range of
strategic alternatives,'' including a sale.
The proliferation of lightly licensed sales branches was
enabled in part by a patchwork of regulations that cover
independent mortgage brokers and lenders. While banks are overseen
by federal and state regulators, mortgage brokers and independent
sales outfits are overseen by a menagerie of state authorities,
some of which also look after barbers and masseuses.
In California, which accounts for about 40 percent of
subprime borrowing in the U.S., no one even knows how many people
are originating loans, according to an October 2006 report by the
California Association of Mortgage Brokers. That's because while the
state licenses individual mortgage brokers, anyone can work for a
big lender under the umbrella of a single corporate license. The
group estimated that a minimum of 600,000 people were peddling
loans in the state last year.
``In other words, the corporation can hire a loan originator
right off the street and have them originating loans that day
without any education, licensing or individual accountability,''
the report said.
California Law
``That's the way the law is in California,'' says Mark Leyes,
director of communications of the state's Department of Corporations.
``We license the entity. They can have people working for them who
are not licensed by us.''
Such loose regulatory oversight, combined with California's
frenzied real estate market, helped make the state a natural
destination for the subprime business.
Even NovaStar, while headquartered in Kansas City, maintained a
large presence in Orange County. Half of the 20 biggest U.S.
subprime lenders were in California, including three in Orange
County's Irvine, according to Inside Mortgage Finance, a Bethesda,
Maryland-based industry newsletter.
Orange County was also the home of Secured Funding, which
specialized in home equity loans, or second mortgages, to people
with lousy credit. The firm was founded in 1993 by Lorne Lahodny, who
eventually built it into a 1,000-employee operation in Costa Mesa
that closed more than $1.25 billion of loans by 2005, according to
a company fact sheet. Neither Lahodny nor his partner in Secured,
John Lynch, responded to messages left by phone and in person at
their offices.
Internet Trolling
Secured Funding's success was fueled by sales leads generated
by millions of pieces of direct mail and Internet trolling, Afghani
and other former salesmen say. Typical of the direct mail was a
credit card offer. When potential customers called to activate the
card, they were instead hooked up with a Secured Funding account
executive such as Afghani.
Afghani describes chaotic office scenes that recall ``Boiler
Room,'' a 2000 movie about stock brokers at a Long Island wire
house. To spur sales, Secured Funding broke its salesmen into
color-coded teams.
``If you weren't turning those calls into applications, they
would drag you out and make your life miserable,'' he says. ``The
turnover was unbelievable,'' says Afghani, who says he watched
eight people pass through the neighboring desk in seven months.
``If you didn't cut it right off the bat, you were just fired.''
Dane Marin, who worked at Secured Funding for a year, says
managers harangued everyone. ``If you weren't on the phone very
long, you'd get an e-mail saying, `Get your head out of your
ass,''' he says.
Easy Money
Afghani says he and fellow brokers dispensed with details
about rates and fees and instead talked up how borrowers could use
home equity loans to pay down other debts. ``It was easier than
financing a car,'' Afghani says of getting a mortgage.
At times, Secured Funding salesmen broke the rules, according
to at least three lawsuits filed last year in federal courts in St.
Louis and Milwaukee. The plaintiffs accuse Secured Funding of
accessing their credit reports without permission for the purpose of
sending them unsolicited loan offers.
In one case, Secured Funding sent the plaintiff a
``personalized Platinum Equity Card'' offering ``$50,000 or more in
cash'' just for calling Secured's toll-free telephone number. In the
other two lawsuits, Secured sent bogus $75,000 checks that
reassured the recipients their ``Less Than Perfect Credit Is OK!''
Afghani says the firm was blasting consumers with as many as 4
million pieces of mail a month.
In answers to the complaints, Secured Funding denied
wrongdoing. The company said it followed federal regulations when
accessing ``consumer reports'' to pitch customers.
Lakers and Limos
Secured Funding's attorney in the lawsuits, Richard Gottlieb of
the Chicago office of Dykema Gossett PLLC, resigned in April, citing
``irreconcilable professional differences'' with Secured Funding.
Gottlieb declined to comment.
However the leads came in, Secured Funding's salespeople made
sure the fish stayed on the hook. ``You would say anything to get
the loan through,'' says Cristopher Pike, who worked at Secured in
2005 and '06.
Secured Funding hung photos of sales incentive trips, like the
one to Cabo, around the office. As sales boomed in early 2006, limos
would pull up at the office to take salesmen to Los Angeles Lakers
basketball games, Pike recalls. The parking lot was so clogged
with luxury cars that employees had to valet-park or board a shuttle
bus to get to the office.
Watching Salesmen
Charlyn Cooper, a former Secured underwriter, says she kept
an electric scooter in her trunk to travel as far as a mile from
her car to the office. ``They all used to laugh at me,'' says
Cooper, who was dismissed in October. ``They had a van that would
come by and pick you up from your car, but the van was always
full.''
Cooper's job was to rein in the salespeople and make sure
paperwork was legitimate so Secured Funding could sell its loans
upstream. She says Secured Funding unloaded most of the loans on
HSBC Holdings Plc's HSBC Finance unit, which has been racked by the
subprime blowup. The bank said profit at its U.S. unit plunged 39
percent during the first quarter, primarily because of an increase
in U.S. loan defaults, including the second-lien loans that were
Secured Funding's specialty. Provisions set aside for credit losses
almost doubled to $1.7 billion.
Unwanted Scrutiny
Secured Funding salespeople didn't always appreciate Cooper's
scrutiny of loans, she says. ``Sales guys are always going to cry
because they work on commission,'' she says. Salesmen such as
Afghani made as much as $3,250 on each loan.
Cooper cross-checked borrowers' stated salaries to, say, weed
out any custodians or maids who claimed they earned $10,000 a
month. ``There's that push-pull with sales because they're like,
`Why are you arguing with me,' and I say, `Sorry, a bus driver is
not making $10,000 a month,''' Cooper says.
Many subprime sales techniques are now spilling out in the
lawsuits, advocacy reports and Congressional hearings that predictably
follow such industry meltdowns. Several lawsuits illustrate the
lengths to which the big wholesalers, and ultimately Wall Street,
were able to outsource the selling of the loans as far down the
chain as possible. Fremont General's Fremont Investment & Loan, Wells
Fargo & Co.'s home mortgage unit and a rogue's gallery of mortgage
brokers come under such scrutiny in a lawsuit filed in August 2006
in San Mateo County, California, state court.
Claims of Fraud
Plaintiff Johnnie Damon claims he was ``fraudulently induced''
to take out a $484,000 loan from Irvine-based mortgage broker Peak
Funding Inc., which allegedly falsified Damon's financial records to
qualify him for the loan. Damon claims he asked for a reverse
mortgage, which enables homeowners to borrow money in the form of
payments charged against their home equity, and instead got a
``traditional refinance loan'' without his knowledge.
Also without Damon's knowledge, the claim says, the mortgage
broker falsified information on his loan application, such as his
monthly income, to qualify him for the loan.
Fremont sold servicing rights on the loan, which is the right
to process monthly payments, to San Francisco-based Wells Fargo and
flipped the loan itself to Paris-based Societe Generale SA. Wells Fargo
is also named as a defendant for ignoring ``fraudulent and
predatory lending practices'' in the loans it purchases and
services, according to the lawsuit.
The complaint also alleges that Fremont, prior to its recent
decision to exit the subprime business, was using mortgage brokers to
do its dirty work.
`Trivial Role'
``Fremont has a history of intentionally turning a blind eye
to fraudulent and predatory lending practices by the mortgage
brokers who generate home loans for the company,'' the lawsuit
alleges without citing any other specific examples.
Expanding on the accusations, Damon's attorney, Aaron Myers of
Howrey LLP, says Fremont funded a loan made ``by a bunch of crooks
who completely misled the borrower, falsified his income, coerced
him into the loan and then tricked him into sending the loan
proceeds back to the company.''
In answers to the complaint, all of the defendants deny the
accusations.
``Wells Fargo's trivial role in this case is punctuated by
the fact that it has not caused the plaintiff any harm,'' Wells
Fargo's attorneys said in an Oct. 10, 2006, court filing, adding that
they put a hold on the loan after the dispute erupted. ``Wells
Fargo does not belong in this case.''
Robert Cannone, a former chief financial officer and director of Peak
Funding who's also listed as a defendant by name, says the firm
closed last October after it ran out of money. He neither admits
nor denies wrongdoing.
`So Embarrassed'
``I'm so embarrassed,'' Cannone says in a telephone interview.
``I feel really bad.'' He says that of the 100 loans made by Peak,
this is the only one in dispute. He says an employee connected with
the Damon loan ``went off the reservation.''
When the boom went bust, even people on the periphery of the
industry got caught in the downdraft.
Carrie Feinman worked in Scottsdale, Arizona, in the wholesale
prime lending division of New Century Financial, which acquired
nonsubprime loans from smaller lenders and mortgage brokers.
The relative health of her side of the business, which New
Century acquired from Royal Bank of Canada in 2005, couldn't stop New
Century's troubled subprime lending from dragging the entire
company into Chapter 11 on April 2.
Feinman says the news that the company was filing for
bankruptcy came out of the blue, leaving her and most other
employees out of pocket on unused vacation time and severance pay.
``We were shocked,'' says Feinman, who's looking for a job.
``If I had quit the week before, I would have gotten my vacation
time. You wonder why no one is loyal to employers anymore.''
`Enough Is Enough'
A month after leaving Secured Funding, Afghani took a new job
at Irvine-based Solstice Capital Group Inc., another subprime lender.
HSBC, the same bank that had been buying loans from Secured
Funding, bought Solstice last year for $50 million. Afghani quit
in April, vowing to find a new line of work.
``Enough is enough,'' he says, adding the good times are long
gone. ``I'm so rock bottom I had to move out of my apartment in
Irvine and live rent free with my girlfriend.''
The hard knocks have taught him a lesson, Afghani says. ``It
was tough love and a great learning experience to live within your
means and not end up like the individuals on the other side of the
phone,'' he says.
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**physically sick now** 
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