Read Online All The Devils Are Here: Unmasking the Men Who Bankrupted the World by Joe Nocera, Bethany McLean - Free Book Online Page B
Authors: Joe Nocera, Bethany McLean
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Arnall had what Daurio calls a “brilliant” idea: the company offered to put $1 million toward partnerships with community groups for consumer education. Patrick and the FTC went along.
What the case mainly showed, though, was how difficult it was for the government to crack down on companies that were offering credit to people who would otherwise never be able to own a home. On the one hand, the Clinton administration’s explicit policy was to get millions more American families into homes. Men like Arnall were making that possible. On the other hand, making it possible for poorer people to buy homes was inevitably going to mean charging higher fees and interest. Practices that banks viewed as disreputable were widely accepted in the subprime world. Cracking down too hard on the subprime companies might hurt their ability to make loans to their customer base—who were the exact same people the government was trying to help.
Ultimately, this was a heavily politicized gray area, difficult to police. It raised difficult questions about which practices were legitimate and which were not. The government’s dilemma was obvious in the statement Patrick released when he announced the settlement. “We recognize that lenders understand the industry in ways we don’t,” he said. “That is why there is so much flexibility in the decree.”
Clearing up the gray required a willingness to tackle the hard questions about what subprime lending was, and what was the proper way to conduct it. But that willingness was always in short supply, both then and later.
By the mid-1990s, the subprime market was exploding. Companies like Long Beach had shown how much money could be made, but the business got another kick from a different source: the Federal Reserve. In 1994, the Fed began to raise rates, and refinancings plummeted. That left “prime” lenders, whose loan volume dropped by as much as 50 percent, looking for a new source of loans. Guess what they found? Subprime.
The changes in interest rates also left Wall Street firms searching for a new product to sell. They had been making huge sums selling mortgage-backed securities that were tranched according to their interest rate and prepaymentrisk. When rates had fallen, so many people refinanced that the riskier tranches of the mortgage-backed securities lost much of their value.
Just in time came this new product: bonds backed by subprime mortgages, goosed by those “credit enhancements.” For Wall Street, this new business presented a trifecta of opportunity. Street firms could make money selling and trading the mortgage-backed securities. But they could also make money by providing a warehouse line of credit so that the mortgage companies could make the loans in the first place. And they could make money by taking subprime specialists public.
It quickly became a frenzy. Traditional hard-money lenders like Associates, Household, and the Money Store saw their stocks soar. Subprime founders got very rich. For instance, the Money Store, which had been started by Alan Turtletaub in 1967 and became a household name after signing up Hall of Famer Phil Rizzuto to be its spokesman (1-800-LOAN-YES), went public in 1991 at $16 a share. By the spring of 1997, its stock had risen fivefold. In 1998, First Union bought the Money Store for $2.1 billion. Turtletaub’s stake was estimated at $710 million.
There was also a proliferation of start-ups, making mortgage finance, for a brief moment, as hot as Internet companies. Dan Phillips, an ex-Marine who had been a loan officer at Beneficial, founded a company called FirstPlus Financial. The stock soared. Phillips, who once described old-school bankers as “accountants who make loans,” made a fortune as well. He began building a 31,000-square-foot estate in North Dallas, complete with a pool house and lighted tennis court, according to the
Dallas Morning News
. Right around that time, Dan Quayle joined the board of FirstPlus.
There
What the case mainly showed, though, was how difficult it was for the government to crack down on companies that were offering credit to people who would otherwise never be able to own a home. On the one hand, the Clinton administration’s explicit policy was to get millions more American families into homes. Men like Arnall were making that possible. On the other hand, making it possible for poorer people to buy homes was inevitably going to mean charging higher fees and interest. Practices that banks viewed as disreputable were widely accepted in the subprime world. Cracking down too hard on the subprime companies might hurt their ability to make loans to their customer base—who were the exact same people the government was trying to help.
Ultimately, this was a heavily politicized gray area, difficult to police. It raised difficult questions about which practices were legitimate and which were not. The government’s dilemma was obvious in the statement Patrick released when he announced the settlement. “We recognize that lenders understand the industry in ways we don’t,” he said. “That is why there is so much flexibility in the decree.”
Clearing up the gray required a willingness to tackle the hard questions about what subprime lending was, and what was the proper way to conduct it. But that willingness was always in short supply, both then and later.
By the mid-1990s, the subprime market was exploding. Companies like Long Beach had shown how much money could be made, but the business got another kick from a different source: the Federal Reserve. In 1994, the Fed began to raise rates, and refinancings plummeted. That left “prime” lenders, whose loan volume dropped by as much as 50 percent, looking for a new source of loans. Guess what they found? Subprime.
The changes in interest rates also left Wall Street firms searching for a new product to sell. They had been making huge sums selling mortgage-backed securities that were tranched according to their interest rate and prepaymentrisk. When rates had fallen, so many people refinanced that the riskier tranches of the mortgage-backed securities lost much of their value.
Just in time came this new product: bonds backed by subprime mortgages, goosed by those “credit enhancements.” For Wall Street, this new business presented a trifecta of opportunity. Street firms could make money selling and trading the mortgage-backed securities. But they could also make money by providing a warehouse line of credit so that the mortgage companies could make the loans in the first place. And they could make money by taking subprime specialists public.
It quickly became a frenzy. Traditional hard-money lenders like Associates, Household, and the Money Store saw their stocks soar. Subprime founders got very rich. For instance, the Money Store, which had been started by Alan Turtletaub in 1967 and became a household name after signing up Hall of Famer Phil Rizzuto to be its spokesman (1-800-LOAN-YES), went public in 1991 at $16 a share. By the spring of 1997, its stock had risen fivefold. In 1998, First Union bought the Money Store for $2.1 billion. Turtletaub’s stake was estimated at $710 million.
There was also a proliferation of start-ups, making mortgage finance, for a brief moment, as hot as Internet companies. Dan Phillips, an ex-Marine who had been a loan officer at Beneficial, founded a company called FirstPlus Financial. The stock soared. Phillips, who once described old-school bankers as “accountants who make loans,” made a fortune as well. He began building a 31,000-square-foot estate in North Dallas, complete with a pool house and lighted tennis court, according to the
Dallas Morning News
. Right around that time, Dan Quayle joined the board of FirstPlus.
There
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