COUNTRYWIDE FINANCIAL CORPORATION AND THE …



COUNTRYWIDE FINANCIAL CORPORATION AND THE SUBPRIME MORTGAGE DEBACLEBusiness Policy and Strategy - CASE STUDYNIVASEN GOVENDER95250016065500The financial meltdown of 2008 proved that actions in the market place do not occur in isolation. When these actions are aggregated, the consequences can be devastating. Many lessons can be gleaned but the question is whether people are able to learn from them or continue along the same course of action due to situations of financial leverage that many possess over others. A solid understanding of the history of the mortgage industry is crucial in contextualizing the financial crisis of 2008. An analysis of the practices and scope of operations of one of the largest players in the mortgage industry, Countrywide Financial, can shed further light on the events leading up to 2008. To help achieve this, Porter’s Five Forces Model will also be used. Upon drawing a conclusion as to the causes of the financial crises, the Political, Economic, Social and Technological Impacts on the financial industry will be evaluated. Lastly, a set of recommendations will be made to companies like Bank of America to ensure long-term financial prosperity for all parties involved. Overview of Mortgage Lending In the United StatesThe policies or pieces of regulation passed by government with regard to the mortgage industry can be considered as individual blocks of wood that helped slowly fuel a fire that would eventually burn uncontrollably. Before the year 1929, loans were limited to a select number of clients and loan terms ranged between 3 to 10 years. It is also interesting to note that loan- to- value ratios were average, approximately 60%1. This means that lenders would only provide roughly 60% of the money necessary to purchase a home. The remainder would have needed to be financed by the buyer’s own savings. Due to the fact that loans were non- amortizing, only interest payments would be made monthly, while the principal amount would be due at the end of the loan term in the form of a lump sum. As a result, homeowners would have needed to take steps to ensure that they have enough money at the loan maturity date to settle their obligations. The pressure to meet these terms would have made this form of lending risky. The Great Depression further compounded this risk and many people failed to make their payments. The US government responded by creating:The Federal Home Loan Bank to provide short term funding to financial institutions so they could have more money to lend for home mortgages The National Housing Act, which insured loans made by lenders in the event borrowers defaultedThe Federal Housing Administration, which compensated lenders for losses associated with defaultsThe Federal National Mortgage Association to provide a secondary market for mortgages; this means that once a loan is made it can be repackaged by the bank and sold to investorsFannie Mae which was the old Federal National Mortgage Association was now a government enterpriseFreddie Mac which combined conforming loans with Mortgage Backed Securities and sold shares to those portfolios After the savings and loans crisis in 1970, (financial institutions were not receiving enough interest from the mortgages they held to pay savings account holders), mortgage originations and loan servicing become different functions. Institutions could now sell Mortgage Backed Securities to investors and not have to hold these loans for 25 or 30 years. As a result, more institutions sprung up making mortgage loans and then selling them to investors. In 1987, there were 7000 of these loan originators1. By 2006, there were 530001. In an effort to expand home ownership after 1970 the government:Created the Community Reinvestment Act to provide financing to minorities in low income areas Created the Depository Institution Deregulation and Monetary Control Act in 1980 which lowered standards for qualifying borrowersElements of subprime (below the prime lending rate) mortgages were evident in the above-mentioned regulations but it only became prominent in the early 1990’s. This series of regulation or lack thereof enabled 70% of Americans to own a home by the year 2004.See Appendix 1 (US Ownership Rate, 1930-2004)This expansion in home ownership pushed home values higher, which in turn caused people to make renovations and other big purchases because of this increase in equity they could realize should they decide to sell their homes. But as the US economy began to weaken with inflation and interest rate hikes people began to default on mortgages, financial institutions lost value on mortgage backed securities and credit was scarce. Thus, the entire financial system was heading for disaster. To gain a deeper insight into the effects of the financial collapse, it would make sense to analyze one of the biggest players in mortgage lending at that time, Countrywide Financial Corporation. Countrywide Financial CorporationCountrywide was a financial services provider founded in 1969 with a core business of mortgage banking. Its key strength early on was the ability to expand throughout the country. It took the company only 11 years to create a presence in eight states with 40 offices1. By 2006, the company was valued at 24 billion dollars with assets exceeding 200 million dollars1. The company had several business segments:Mortgage Banking - Includes the origination, purchase, sale of non-commercial mortgage loans; In 2006, this core business generated 48% of their pretax profitsBanking – Collected retail deposits (savings) which it used to invest in mortgage loans and home equity creditCapital Markets – Broker trading which excelled in underwriting and selling mortgage backed securities Insurance – For property, life and underwriting disability insuranceGlobal Operations – The licensing of proprietary technology to other mortgage lenders and outsourcing some administration functions to IndiaEven before the subprime mortgage crisis, the company was in the spotlight for a number of incidents. Employees complained about being overworked, racial bias was demonstrated towards minority borrowers and friends of the CEO were given special concessions2. A reduction in lending regulation by government provided Countrywide with the opportunity to extend as much credit as they could even thou borrowers were unqualified to meet those obligations. They also discovered that the demand for mortgage-backed securities by investors was increasing and this presented the prospect to shift the liability away from its books and onto investment banks. The profits realized in the short run were staggering and they chose to be ignorant about future consequences. It is to be noted that Countrywide was just one of the institutions partaking in this activity. Thousands of brokers as well as other banks were doing exactly the same. With regard to employee compensation, incentives were paid based on the amount of loan originations, with loan defaults not factored into the equation. This system was set up to encourage the wrong type of behavior. The CEO, Mozilo exercised 121 million dollars stock options in 2007 and received between 80 and 115 million dollars after the sale to Bank of America1. -66675466725By using the conventional Value Chain Structure below, we can integrate and analyze some of Countrywide’s activities. Supply Management: Gathering savings which would be used to fund mortgage lendingSearching and inspecting potential borrowers who required loans, but with the “inspecting” part fairly non-existentOperations: Securing mortgage deals, extending lines of creditObtaining ratings on loans from outside agenciesInsurance underwritingSales/Marketing:321 million dollars was spent by Countrywide in 2007 for advertising and promotion1Promotions included the “bait and switch” which advertised initial low interest rates without warning borrowers about later fluctuations See Appendix 2 (Online article from )Distribution: Individual mortgages were bundled together as mortgage-backed securities and collateralized debt obligations, and sold to investment banks. These securities and derivatives were traded on capital marketsServices: These included various administrative and legal functions related to mortgage bonds and their other financial products like insuranceProfit:Massive short- term profits were realized because Countrywide and other lenders did not need to hold these mortgages for long periods of timeTo further characterize Countrywide Financial, we can consider the microenvironment of the company. To accomplish this we can turn to Porter’ Five Forces Model. Porter’s Five Forces Model for Countrywide FinancialSubstitute Products: Few alternatives exist for obtaining money to finance large purchases like homes. Some individuals will access their reserves or savings. Others will look to make use of regular interest payments received from their investments in shares or bonds to cover monthly installments for their homes/vehicles. A few fortunate people will have access to trusts or foundations to acquire funds. However, the majority of people will turn to the conventional means for financing in the form of loans through financial institutions like Countrywide. With regard to these loans, an alternative is also refinancing through more than one institution should interest rates become unmanageable. Buyers: A weak bargaining power on the part of borrowers stems from a few factors. Firstly, there was a lack of knowledge on the part of borrowers in terms of contract/loan provisions. As a result, buyers were partially at fault for signing and agreeing to terms that they did not fully understand. Institutions were aware of this and leveraged the situation in their favor by manipulating borrowers and engaging in predatory lending practices. The asymmetry of information also played a part. In other words, some borrowers were not aware that their loans were being sold to investment banks and that the banks were not the ones holding the title deeds to their homes anymore. This makes a difference when defaults caused homes to be repossessed because the banks no longer had the right to sell people’s home’s as they no longer had ownership of those titles. Buyers did have some bargaining power in the form of multiple mortgage brokers to choose from, especially when re-financing became necessary. Suppliers: The large supply of private and corporate savings held by financial institutions, made lending money for mortgages simple. These huge reserves of cash were used to finance homes for buyers. However, the loans held by banks would soon be dumped to investors. Government agencies like the FHA, tipped the scales in favor of banks by insuring loans that went into default. This incentivized reckless loan originations by banks with little concern for anyone else. New Entrants: The threat of new entrants (suppliers) of mortgages was very high. This is due to the amazing short- term profit potential. The lack of proper regulation surrounding mortgage companies and issuing loans also made it easier for potential entrants to penetrate the market. From 1987 to 2006, the number of loan originators had increased by 657% to reach approximately 53 0001. Rivalry: With the demand for mortgage-backed securities on the rise in the early 2000’s, the banks aggressively pursued loan originations and competed heavily with other institutions. As means to competing, they indulged in employee incentives, deceptive marketing and predatory lending amongst other factors. These non-ethical competitive methods formed the basis of their activities in the pursuit of profit. See Appendix 3 A (Employee Incentives from 1992 – 2007) ANDAppendix 3 B (Online article from TIME Magazine, “25 People to blame for the Financial Crisis”)The financial crisis caused partly by these irresponsible actions would temporarily cripple a large portion of the US and the world. It would take time and intervention before nations could get back on their feet. Nevertheless, before we draw a conclusion, what does a Political, Economic, Social and Technological analysis of the financial crisis reveal? PEST AnalysisPolitical Factors: The Great Depression from 1929 to the early 1940’s had proved the risks associated with non-amortizing mortgages. As part of the “New Deal” legislation, President Franklin Roosevelt sought to provide Relief, Recovery and Reform to remedy the situation. Relief came in the form of The FHA, FHLB and other agencies to promote homeownership during these tough times. One type of Reform was protection for loan makers against defaults. Firstly, this type of reform instituted does not promote long-term economic progress. It incentivizes behavior that is counterproductive to financial prosperity. Secondly, not enough significant reform materialized to ensure that institutions act in the best interest of all parties involved and that un-creditworthy applicants are denied credit. Instead of using money to insure losses or extend additional credit to banks, which was bound to be lost, the government could have better used that money. The government could have implemented programs to build homes for the people using those funds. Immediately, jobs would be created. Then those who wanted homes would now pay the government monthly installments at a very favorable rate, with the goal not being to exploit. In this way the government could better serve the people and the money spent, would be recovered over time as opposed to being put in the hands of greedy investors. As the 1970’s approached, social activists raised concerns about minorities’ lack of opportunity to acquire funds. Under pressure from the people, the government created the Community Reinvestment Act and the FHA adopted 95% loan-to-value ratios1. It appears that throughout time, more reactive strategies were established as opposed to proactive reformative ones. However, a possible concealed viewpoint of the government could have been that stricter controls would limit a lot of people from acquiring financing. These people would then see the government as not creating enough opportunities and as a result, affect popularity polls and re-election. Economic Factors: Home ownership in the US rapidly increased. However, this increase was primarily due to home financing becoming easier to obtain as well as tax credits and not because the wealth/income of the nation was rising. Therefore, this can be considered artificial increases in the prices of homes. Buyers were also leveraged to make profits given that no down payment needed to be placed to buy a home. For example, someone buys a house for $ 1 000 000 and places a down payment of $ 400 000. They then sell it for $ 1 200 000. The return on investment is 50% (200 000 profit over 400 000 initial investment). Now after some deregulation, someone for example, could purchase a home for $ 1 000 000 with no down payment and sell it soon after for $ 1 200 000 and realize a quick $ 200 000 profit, having invested no money. So what did the banks do with all these mortgages? They bundled individual mortgages and created mortgage backed securities and collateralized debt obligations, which they then sold to investors. -12382593345As inflation crept in, interest rates slowly rose and adjustable rate mortgages unleashed its destruction on people who began to default on home payments. People began to lose their jobs. The investors who held these mortgage backed securities lost billions of dollars. Not only did they lose their money, but also the money of those people they invested on behalf. Pension funds, which had shares in collateralized debt obligation and mortgage- backed securities, were drying out. Banks were afraid to extend any more credit. This in turn affected corporations who needed finance. Corporations were cutting back on production and reducing work forces, which added to unemployment. Shareholders of these companies on Wall Street were in major trouble. Moreover, with no credit structure, no financial system can survive. Thus, the government came to the rescue with bailouts such as that of AIG, just to keep the system running. See Appendix 4 (List of Companies Bailed out By the Federal Government)The financial crisis revealed another very important economic principle. It is a principle that draws upon the theories of the famous economist, John Maynard Keynes in “The General Theory of Employment, Interest, and Money.” Keynes pointed out, “There is no such thing as liquidity of investment for the community as a whole.” This means that investing in a MBS for example, on a small scale or individual level can be sustained. However, as soon as this behavior is aggregated in the market place it leads to a great calamity. In an analogy used by Princeton economist Hyun Song Shin, which was referenced in John Cassidy’s article, “Rational Irrationality, Why Markets Fail”, Shin likened pedestrians on a bridge to all the banks. The more pedestrians (banks) that stepped onto the bridge, the greater this unaccounted sideways force was, causing the banks to shuffle their stance in response. Price changes in the market also caused this bridge to sway and banks and investors began to panic more. As a result, this structure could not sustain this activity and trying to get off (sell at the same time) becomes very difficult. The actual bridge he was talking about was the high-tech Millennium Bridge that stretches across the River Thames in England that had to be closed due to that engineering anomaly. This is exactly what happens, in that financial markets are made up of individuals who are consistently reacting to what others in the market are doing. Although these actions are irrational, the only rational response that they see is to “jump on the bandwagon” so they do not squander this opportunity to make money even if it comes at a lethal price to others. See Appendix 5 (“Rational Irrationality” by John Cassidy)-219075144145Social Factors: The financial crisis brought with it severe social disruption. Loss of savings, jobs and homes placed peoples’ lives in disarray. The philosophy of greed meant relentlessly pursuing as much as you can acquire. However, the biggest issue resulted in the form of questioning the ethics and values of directors, loan officers, government officials and investors. Legislation like the Sarbanes Oxley Act is of no use if the leaders of the organizations (directors) do not embrace these standards and instill a sense ethical direction in the company. Having said that, many employees and investors also displayed their lack of personal integrity with regard to their own dealings. The following actions that had taken place prior and during the financial crisis helps assess peoples’ behavior: Intentionally misrepresenting information Failure to disclose all terms of the contractCreation of predatory lending practices like adjustable mortgage ratesCoercing people into loans, despite knowing that some people would not be capable of repaying their debtMaking deals with rating agencies to issue high ratings to un-qualifying securities Granting loans and donations to politicians and their campaigns (Senator Christopher Dodd, and Kent Conrad, Chairman Of the Budget Committee at the timeSee Appendix 6 (“Countrywide’s Many Friends”, By Daniel Golden) AND See Appendix 7 (“Countrywide Claims its Ads were Mostly Lies” by Jim Edwards)Another major controversy surrounded the Directors of Goldman Sachs who purchased risky mortgages and then made private bets with other investors against those people defaulting. These Directors also explicitly expressed what they were doing which shows no regard for anyone or anything. See Appendix 8 (“Revealed: Goldman Sachs 'made fortune betting against clients'” by Terri Macalister) Technological Factors: The introduction of computer systems made managing trades much easier and more accurate. In fact, Countrywide possessed some technological innovations, which it licensed to other countries. The rise of the internet meant that information could be better shared and aggregated from anywhere in the world. In particular, information and news about stocks and trends could be obtained in real time. This is crucial in an industry were timing of decisions is pivotal. A boost in technology had positive impacts for this industry but also one that worked against individuals. Information conveyed in electronic mails could be tracked and used in investigations, which was the case with Countrywide’s Executives. ConclusionIt took a financial disaster of catastrophic proportions for some people to open their eyes to the consequences of their actions. In the process, it also taught us valuable lessons.It is a misconception to believe that market forces (supply, demand, competition etc) are enough on its own to shield society from extreme financial risk. Regulation to protect the interests of everyone is crucial because the mortgage market as we discovered the hard way is not self-regulating. The notion that all individuals will act in the best interest of society is false. People do not always consider all the necessary benefits and costs of their decisions. This could be attributable to being shortsighted and the fact that the ones’ responsible for these financial collapses in most cases are not the ones’ who experience the full after effects. This also ties in with the moral hazard issue. Investors were insulated from risk, which caused them to behave less prudently because it was not their money they were investing with but rather, borrowed money. This type of financial leverage has to be eliminated to ensure that the same situation does not occur again. At the end of the day, people respond to incentives, and the incentive was present to engage in this activity. Future incentives need to be carefully constructed and reformed so that they may work in harmony with a company’s or country’s economic objectives. In summary, the blame for the financial crisis can be apportioned between a few factors. Absence of proper government regulation with regards to lending and investing, predatory lending practices by financial institutions, greed and moral hazard that faced investors as well as irresponsibility on the part of borrowers helped fuel this disaster. Some people have blamed Capitalism for the economic disaster. This political philosophy has helped the US achieve great things. However, Capitalism can be seen analogous to a child with a very bright future. The opportunities of this child should not be restricted but rather regulated and supervised along the right path so that it does not veer away from a productive outcome. Recommendations to Bank of America Executives One of the fundamental components to ensuring long- term financial success is instilling a sound ethical environment and corporate governance structure. Shareholders need to place more pressure on the Board of Directors to create greater transparency with regard to the company’s practices. Executives need to display these ethical values so that it sets a good example for the rest of the organization to follow.1. The current employee incentive system needs to be reformed. Managers should have groups of employees that they oversee and are accountable for. These employees’ bonuses should take into account loan originations as well as periodic comparisons of loan payments from their clients. This will ensure they do not frivolously extend credit. Part of this Manager’s bonus should be tied to how well he or she managers those employees under their control with regard to their performance. 2. There should be a limit on the amount of mortgage-backed securities that is sold to each investment bank. This will reduce the leverage that these institutions have with borrowed money from investors and protect these investors to a certain extent, should people default on loans. 3. Executives compensation must be assessed taking into account good decisions made to increase shareholder wealth in the long run. Any unethical behavior that arises should traced to those responsible and they must be held accountable. 4. All necessary information with regards to the mortgage should be disclosed to clients. Employees need to take more time in making sure borrowers are fully aware of all conditions. Further Questions for AnalysisMost of the questions have been integrated and addressed in the paper. However, further responses have been provided. 1. Was the US Federal Government’s 1932 intervention in the market for home ownership desirable? How did the creation of Fannie Mae in 1938, Ginnie Mae in 1968, and Freddie Mac in 1970 expand homeownership and shape lending practices at banks and other mortgage-lending firms?As mentioned in the paper above, the Federal Government’s intervention with the Federal Home Loan Bank and Federal Housing Act sought to provide relief to institutions to insure loans and cover losses. This signaled to these financial institutions that the government was there to protect them when the market suffered. As a result, banks could issue as many loans as they wanted because they were insulated from the risk. As opposed to providing so many Relief initiatives, more reformative actions should have been instituted. Although intervention was realized in 1932, it came in a form that was not conducive to the housing market. In 1938, The Federal National Mortgage Association (FNMA) was created which established a secondary market for mortgages. This meant that mortgages issued by banks could now be converted into securities and traded to investors. The FNMA then became Fannie Mae, a government sponsored enterprise. Fannie Mae then transferred its non- conforming loans (loans that did not meet government standards) to Ginnie Mae in 1968 while holding onto conforming loans. In 1970, Freddie Mac was created which operated very similarly to Fannie Mae. Their goal was to extend mortgage-backed securities to the capital market. The value to investors was that this debt would be insured by the government should defaults arise. Banks began to issue more loans, which they easily unloaded on the markets. Homeownership began to rise as well as home prices, which was an artificial price increase. 2. Why did the US Congress enact the Community Reinvestment Act, the Home Mortgage Disclosure Act, the Depository Institution Deregulation and Monetary Control Act, and the Housing and Community Development Act? Was the legislation effective in expanding homeownership? Did the government’s promotion of subprime mortgages and high loan-to-value (LTV) subprime mortgages create additional risks for lenders and the holders of mortgage-backed securities (MBSs) or collateralized debt obligations (CDOs)?The CRA and HDMA were created in response to mounting pressure from social activists and minorities who complained that financing was difficult to obtain. It was also done to provide money to low-income areas. The Monetary Control Act of 1980 gave financial institutions more flexibility in terms of underwriting standards and charging higher interest rates to riskier borrowers. No one denies that the legislation helped increase home ownership or “temporary home ownership”, but at what future cost would this increase in home ownership come. It raises many questions such as “Were people that na?ve that the markets could sustain this activity indefinitely?” or “Did government officials throughout the years not care because the collapse would come long after they had left office?”The promotion of subprime mortgages by the government created minimal risk for lenders because most of the loans they issued were either insured or packaged and sold to investors. Financial institutions could also have secretly taken advantage of the fact that since everyone was issuing subprime mortgages, it was not possible to punish everyone once the system collapsed and that government would have no option but to bail them out. As a result, most of the risk gravitated towards the holders of these securities should borrowers default on payments. 3. Did subprime mortgage loans contribute to the housing bubble? Why did the bubble burst? What were the consequences of the housing bust to borrowers, loan originators, and MBS and CDO holders? Did subprime mortgages contribute to the US financial crisis of 2008?Please see “Economic Factors” in the PEST Analysis section of the paper. (Page 9)4. How did Federal legislation concerning mortgage loans affect Countrywide Financial Corporation’s (CFC) business strategy? Did the government’s encouragement of subprime mortgages have an impact on the company’s number of loan originations between 1990 and 2007?Firstly, the lack of federal legislation benefited Countrywide and other mortgage lenders. It allowed them to set their own interest rates as well as issue loans to borrowers that had not been thoroughly scrutinized. On top of this, they masked risks to borrowers, which enabled them to extend more loans. The secondary markets created by Freddie Mac allowed them to shift as much loans as they could onto investors. As a result, their initial strategy would have been to cautiously extend debt but the incentives for this had disappeared together with the legislation. Their new business strategy would have changed to aggressively issue as much loans as they can through whatever means possible, which would translate into amazing short- term profits. From 1990 until 2001, there had been a slow but steady increase in the number of loan originations made by Countrywide with a large portion being conventional conforming loans. However, Countrywide began issuing non-conforming loans in 2002 and the amount of subprime mortgages began to increase. The years in which the most number of subprime mortgages were issued were 2004, 2005 and 2006. There was an increase of 7% in subprime mortgages from 2003 to 2004. For the period 2004 to 2006, immediately before the financial collapse, Subprime mortgages accounted for approximately 11% of all loan originations at Countrywide. Lender Ranking by Residential Volume in Mortgages – 2007 Full Year (in billions)1. Countrywide $408.22. Wells Fargo $272.03. Chase $207.74. Bank of America $188.65. Citigroup $151.95. What effect did the housing boom and the growth in origination of subprime mortgages have on CFC’s financial performance? Evaluate the financial rations presented in case Exhibit 8 and calculate compounded annual growth rates for items in CFC’s Statement of Operations? Did the company’s growth rate vary significantly between 2003 and 2007? Did CFC retain most of the loans originated for investment? What is your overall assessment of CFC’s financial performance between 2003 and 2007?With the growth of subprime mortgages and the housing boom, Countrywide was able to realize incredible short- term profits especially between 2003 and 2006. Data Used Appears in the Case StudyIn 1000’s2006200520042003Gains on sale of loans$ 5 681 847$ 4 681 780$ 4 824 082$ 5 887 436Net Profit$ 2 674 846$ 2 528 090$ 2 197 574$ 2 372 950Compounded Annual Growth Rate for Net Profit (2003-2006) = 3% From 2003 to 2006, the growth rate was fairly constant before recording their first loss in 2007. Some other interesting figures to consider are the CAGR of Compensation and AdvertisingCAGR for Compensation from 2003 to 2007 = 9.95%CAGR for Advertising from 2003 to 2007 = 25.3%This was part of their strategy to aggressively expand loan originations. In the end, their loss of $ 703 538 000 in 2007, is nothing compared to the huge profits they made in the years leading up to the financial crisis. The profit made from 2003 to 2006 totaled a staggering $ 9 773 460 000. 6. Was CFC pursuing an ethical strategy? Were all of the CFC’s business practices ethical? Were CFS’s compensation practices ethical and in the best interest of shareholders? Did its lending practices harm borrowers? Is there anything unethical about its VIP loan program? To what extent, if any, were unethical strategies or business behavior a problem at CFC? To what extent, if any, was CFS’s CEO involved in unethical behavior?Please See “Social Factors” under the PEST Analysis (Page 12)Bibliography1. The case study; Countrywide Financial Corporation and the Subprime Mortgage Debacle by Ronald W Eastburn2. Online Article from Wikipedia, Accessed on December 17, 2011, remainder of the sources can be found in the Appendix Booklet-54292514001750APPENDIX 1APPENDIX 2 (EXTRACT)Online Article from 28, 2009Attorney General Corbett announces settlement with Countrywide Financial Corporation worth more than $150 millionHARRISBURG - Attorney General Tom Corbett today announced that the Attorney General's Office has reached a more than $150 million settlement with Countrywide Financial Corporation to obtain mortgage relief and cash assistance for thousands of Pennsylvania residents with loans through Countrywide.Corbett said his office has been investigating Countrywide for several months and the investigation has centered on the subprime mortgages that were sold through Countrywide."Thanks to this agreement, Pennsylvania homeowners will now receive direct relief that will make a real difference, helping consumers caught in the subprime lending crisis," Corbett said. "We allege that Countrywide's practices misled many Pennsylvanians and encouraged them to take out loans they did not understand and ultimately could not afford."More than 10,000 Pennsylvania homeowners may be eligible for loan modification, relocation assistance and mortgage foreclosure relief as part of the negotiated settlement.The investigation found that Countrywide allegedly violated Pennsylvania's Consumer Protection Law by:Misrepresenting the quality and benefits of its products and services to consumers;Misrepresenting in its advertising that mortgage and loan packages were created by "personal loan consultants," tailored to the needs of individual consumers;Failing to exercise due diligence when recommending mortgage loan products to consumers and failing to meet heightened expectations caused by their advertising;Increasing its sales and profits by relaxing its underwriting standards, which allowed consumers to obtain loans that were risky and ill-suited for their income levels;Making deceptive and misleading representations or omissions regarding the terms and charges of the loans, including, the interest rate, the adjustable nature of the interest rate and the credit status of the consumer;Engaging in "bait and switch" tactics by offering one interest rate, but actually giving a higher one;Failing to clearly disclose the financing terms to consumers.APPENDIX 3 AINCENTIVE PAY AS A % OF BASE PAY FOR ALL EMPLOYEES OF COUNTRYWIDE, 1992-2007-190500250825APPENDIX 3 B25 People to Blame for the Financial CrisisThe good intentions, bad managers and greed behind the meltdownStory All Best and Worst Lists Angelo MoziloPhoto Illustration; Mozillo: Mark Wilson / Getty; GettyThe son of a butcher, Mozilo co-founded Countrywide in 1969 and built it into the largest mortgage lender in the U.S. Countrywide wasn't the first to offer exotic mortgages to borrowers with a questionable ability to repay them. In its all-out embrace of such sales, however, it did legitimize the notion that practically any adult could handle a big fat mortgage. In the wake of the housing bust, which toppled Countrywide and IndyMac Bank (another company Mozilo started), the executive's lavish pay package was criticized by many, including Congress. Mozilo left Countrywide last summer after its rescue-sale to Bank of America. A few months later, BofA said it would spend up to $8.7 billion to settle predatory lending charges against Countrywide filed by 11 state attorneys general. 4 From , Journalism in the Public InterestAPPENDIX 5 (EXTRACT)Annals of EconomicsRational IrrationalityThe real reason that capitalism is so crash-prone.by John Cassidy October 5, 2009 Text Size: Small Text Medium Text Large Text On June 10, 2000, Queen Elizabeth II opened the high-tech Millennium Bridge, which traverses the River Thames from the Tate Modern to St. Paul’s Cathedral. Thousands of people lined up to walk across the new structure, which consisted of a narrow aluminum footbridge surrounded by steel balustrades projecting out at obtuse angles. Within minutes of the official opening, the footway started to tilt and sway alarmingly, forcing some of the pedestrians to cling to the side rails. Some reported feeling seasick. The authorities shut the bridge, claiming that too many people were using it. The next day, the bridge reopened with strict limits on the number of pedestrians, but it began to shake again. Two days after it had opened, with the source of the wobble still a mystery, the bridge was closed for an indefinite period.Some commentators suspected the bridge’s foundations, others an unusual air pattern. The real problem was that the designers of the bridge, who included the architect Sir Norman Foster and the engineering firm Ove Arup, had not taken into account how the footway would react to all the pedestrians walking on it. When a person walks, lifting and dropping each foot in turn, he or she produces a slight sideways force. If hundreds of people are walking in a confined space, and some happen to walk in step, they can generate enough lateral momentum to move a footbridge—just a little. Once the footway starts swaying, however subtly, more and more pedestrians adjust their gait to get comfortable, stepping to and fro in synch. As a positive-feedback loop develops between the bridge’s swing and the pedestrians’ stride, the sideways forces can increase dramatically and the bridge can lurch violently. The investigating engineers termed this process “synchronous lateral excitation,” and came up with a mathematical formula to describe it.What does all this have to do with financial markets? Quite a lot, as the Princeton economist Hyun Song Shin pointed out in a prescient 2005 paper. Most of the time, financial markets are pretty calm, trading is orderly, and participants can buy and sell in large quantities. Whenever a crisis hits, however, the biggest players—banks, investment banks, hedge funds—rush to reduce their exposure, buyers disappear, and liquidity dries up. Where previously there were diverse views, now there is unanimity: everybody’s moving in lockstep. “The pedestrians on the bridge are like banks adjusting their stance and the movements of the bridge itself are like price changes,” Shin wrote. And the process is self-reinforcing: once liquidity falls below a certain threshold, “all the elements that formed a virtuous circle to promote stability now will conspire to undermine it.” The financial markets can become highly unstable.This is essentially what happened in the lead-up to the Great Crunch. The trigger was, of course, the market for subprime-mortgage bonds—bonds backed by the monthly payments from pools of loans that had been made to poor and middle-income home buyers. In August, 2007, with house prices falling and mortgage delinquencies rising, the market for subprime securities froze. By itself, this shouldn’t have caused too many problems: the entire stock of outstanding subprime mortgages was about a trillion dollars, a figure dwarfed by nearly twelve trillion dollars in total outstanding mortgages, not to mention the eighteen-trillion-dollar value of the stock market. But then banks, which couldn’t estimate how much exposure other firms had to losses, started to pull back credit lines and hoard their capital—and they did so en masse, confirming Shin’s point about the market imposing uniformity. An immediate collapse was averted when the European Central Bank and the Fed announced that they would pump more money into the financial system. Still, the global economic crisis didn’t ease up until early this year, and by then governments had committed an estimated nine trillion dollars to propping up the system.A number of explanations have been proposed for the great boom and bust, most of which focus on greed, overconfidence, and downright stupidity on the part of mortgage lenders, investment bankers, and Wall Street C.E.O.s. According to a common narrative, we have lived through a textbook instance of the madness of crowds. If this were all there was to it, we could rest more comfortably: greed can be controlled, with some difficulty, admittedly; overconfidence gets punctured; even stupid people can be educated. Unfortunately, the real causes of the crisis are much scarier and less amenable to reform: they have to do with the inner logic of an economy like ours. The root problem is what might be termed “rational irrationality”—behavior that, on the individual level, is perfectly reasonable but that, when aggregated in the marketplace, produces calamity.Consider the freeze that started in August of 2007. Each bank was adopting a prudent course by turning away questionable borrowers and holding on to its capital. But the results were mutually ruinous: once credit stopped flowing, many financial firms—the banks included—were forced to sell off assets in order to raise cash. This round of selling caused stocks, bonds, and other assets to decline in value, which generated a new round of losses.A similar feedback loop was at work during the boom stage of the cycle, when many mortgage companies extended home loans to low- and middle-income applicants who couldn’t afford to repay them. In hindsight, that looks like reckless lending. It didn’t at the time. In most cases, lenders had no intention of holding on to the mortgages they issued. After taking a generous fee for originating the loans, they planned to sell them to Wall Street banks, such as Merrill Lynch and Goldman Sachs, which were in the business of pooling mortgages and using the monthly payments they generated to issue mortgage bonds. When a borrower whose home loan has been “securitized” in this way defaults on his payments, it is the buyer of the mortgage bond who suffers a loss, not the issuer of the mortgage.This was the climate that produced business successes like New Century Financial Corporation, of Orange County, which originated $51.6 billion in subprime mortgages in 2006, making it the second-largest subprime lender in the United States, and which filed for Chapter 11 on April 2, 2007. More than forty per cent of the loans it issued were stated-income loans, also known as liar loans, which didn’t require applicants to provide documentation of their supposed earnings. Michael J. Missal, a bankruptcy-court examiner who carried out a detailed inquiry into New Century’s business, quoted a chief credit officer who said that the company had “no standard for loan quality.” Some employees queried its lax approach to lending, without effect. Senior management’s primary concern was that the loans it originated could be sold to Wall Street. As long as investors were eager to buy subprime securities, with few questions asked, expanding credit recklessly was a highly rewarding strategy.When the subprime-mortgage market faltered, the business model of giving loans to all comers no longer made sense. Nobody wanted mortgage-backed securities any longer; nobody wanted to buy the underlying mortgages. Some of the Wall Street firms that had financed New Century’s operations, such as Goldman Sachs and Citigroup, made margin calls. Federal investigators began looking into New Century’s accounts, and the company rapidly became one of the first major casualties of the subprime crisis. Then again, New Century’s executives were hardly the only ones who failed to predict the subprime crash; Alan Greenspan and Ben Bernanke didn’t, either. Sharp-dealing companies like New Century may have been reprehensible. But they weren’t simply irrational.APPENDIX 6Countrywide's Many 'Friends'by Daniel Golden Jun 12 2008Senators Dodd and Conrad are among the government officials who scored V.I.P. loans from C.E.O. Angelo Mozilo. An exclusive Portfolio investigation.Angelo's Friends View SlideshowA rogues gallery of Countrywide "V.I.P." loan recipients.See All Video & MultimediaAngelo Mozilo, chief executive of Countrywide FinancialImage: Mark Wilson/Getty Images1 of 3NEXT Two U.S. senators, two former Cabinet members, and a former ambassador to the United Nations received loans from Countrywide Financial through a little-known program that waived points, lender fees, and company borrowing rules for prominent people.Senators Christopher Dodd, Democrat from Connecticut and chairman of the Banking Committee, and Kent Conrad, Democrat from North Dakota, chairman of the Budget Committee and a member of the Finance Committee, refinanced properties through Countrywide’s “V.I.P.” program in 2003 and 2004, according to company documents and emails and a former employee familiar with the loans.Other participants in the V.I.P. program included former Secretary of Housing and Urban Development Alphonso Jackson, former Secretary of Health and Human Services Donna Shalala, and former U.N. ambassador and assistant Secretary of State Richard Holbrooke. Jackson was deputy H.U.D. secretary in the Bush administration when he received the loans in 2003. Shalala, who received two loans in 2002, had by then left the Clinton administration for her current position as president of the University of Miami. She is scheduled to receive a Presidential Medal of Freedom on June 19. Holbrooke, whose stint as U.N. ambassador ended in 2001, was also working in the private sector when he and his family received V.I.P. loans. He was an adviser to Hillary Clinton’s presidential campaign. James Johnson, who had been advising presidential candidate Barack Obama on the selection of a running mate, resigned from the Obama campaign Wednesday after the Wall Street Journal reported that he received Countrywide loans at below-market rates.Most of the officials belonged to a group of V.I.P. loan recipients known in company documents and emails as “F.O.A.'s”—Friends of Angelo, a reference to Countrywide chief executive Angelo Mozilo. While the V.I.P. program also serviced friends and contacts of other Countrywide executives, the F.O.A.’s made up the biggest subset.According to company documents and emails, the V.I.P.'s received better deals than those available to ordinary borrowers. Home-loan customers can reduce their interest rates by paying “points”—one point equals 1 percent of the loan’s value. For V.I.P.'s, Countrywide often waived at least half a point and eliminated fees amounting to hundreds of dollars for underwriting, processing and document preparation. If interest rates fell while a V.I.P. loan was pending, Countrywide provided a free “float-down” to the lower rate, eschewing its usual charge of half a point. Some V.I.P.'s who bought or refinanced investment properties were often given the lower interest rate associated with primary residences.Read more: 7 (ABSTRACT)January 21, 2009 12:08 AM Bank of America/CountryWide Claims Its Ads Were Mostly LiesByJim Edwards (MoneyWatch) CountryWide, the subprime mortgage lender acquired by Bank of America, has repeatedly said in ads and in Congressional testimony that it wanted to work with homeowners whose payments had gotten beyond them. But a lawsuit in New Hampshire claims those promises are false and that anyone trying to reorganize payments on a CW loan only gets the runaround. In response, CW lawyers have argued that their own ads are mostly lies -- "mere commercial puffery ... only Countrywide's vague advertisements," according to MSNBC.right0CountryWide's web site currently offers six ways in which the company promises to help troubled lenders whose homes are threatened with foreclosure: RefinancingExtending the term of the loanInterest rate reductionsTemporarily freezing monthly mortgage paymentsExtended repayment schedulesDecreasing the principal balance of the loanGary and Jessica Raymond of New Hampshire claim in their suit that none of those options were available to them when they got into trouble on their mortgage. Their adjustable rate increased by $700 a month and their interest rate was at 12.8 percent. 8Revealed: Goldman Sachs 'made fortune betting against clients'Chairman of Senate's Wall Street investigations committee accuses beleaguered bank on websiteTerry Macalister The Observer, Saturday 24 April 2010Article historyThe beleaguered Wall Street bank Goldman Sachs boasted that it was making tens of millions of dollars of profits daily by betting against its own clients' investments, according to internal emails released yesterday by a US senator.The annual report of the bank, which is currently facing fraud charges in the US, denied that it had generated enormous revenues by wagering on the US housing crisis. Yet an email apparently from chief executive Lloyd Blankfein to his colleagues says: "Of course we didn't dodge the mortgage mess. We lost money, then we made more than we lost because of 'shorts' [bets that the market would get even worse]."The damning material from the senate's permanent subcommittee on investigations, which is reviewing the role of Wall Street banks in the financial crisis, was posted on the website of its chairman, Senator Carl Levin. It will be used in what promises to be an incendiary public hearing on Tuesday when Blankfein is scheduled to testify in front of the subcommittee.In a statement, Goldman stood by earlier claims that it never made significant profits out of the housing market and said that the emails proved nothing. ................
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