By Greg Gordon | McClatchy Newspapers
IRVINE, Calif. — Goldman Sachs was one of the last Wall Street giants to enter the subprime lending world, but when it did, it quickly climbed into bed with profligate, highflying firms — companies such as New Century Financial Corp.
In at least nine deals from 2002 to 2007, Goldman sold bonds backed by more than $5 billion of New Century’s mortgages, one even after the California lender’s underwriting criteria all but disintegrated and a cash squeeze paralyzed its operation. Goldman also marketed at least three secret offshore deals bearing New Century’s name.
Goldman has yet to explain why it risked its blue-chip reputation and financial health to buy and repackage at least $135 billion in loans mostly originated by companies that have since gone bust.
Goldman spokesman Michael DuVally stressed, however, that the firm “was not the largest purchaser of loans from any of these mortgage originators, and in some cases was actually quite a small purchaser.”
A glimpse inside New Century’s operations sheds light on how one of Wall Street’s proudest and most prestigious firms helped create a market for junk mortgages, contributing to the economic morass that’s cost millions of Americans their jobs and their homes.
Perhaps no mortgage lender was more emblematic of the go-go atmosphere in the sprouting industry that was seizing an outsize share of the home loan market.
Traversing the country in private jets and zipping around Southern California in Mercedes Benzes, Porsches and even a Lamborghini, New Century executives reveled as the firm’s annual residential mortgage sales rocketed from $357 million in 1996 to nearly $60 billion a decade later.
To be a subprime lender at the industry’s height was to join in a dash for cash, and New Century was an Olympic-caliber sprinter.
Its top five officers, who received nearly $40 million in salaries and bonuses from 2002 to 2005, could peer out the 10th-floor windows of their gleaming onyx headquarters in Irvine and see the offices of more than a dozen rivals.
“A friend of mine said you couldn’t fire a .22-caliber rifle and not hit a subprime lender in Orange County,” recalled a former manager of a company that reviewed subprime loan files before Goldman and other Wall Street firms bought the mortgages.
For $100 million in mortgages, New Century could command fees from Wall Street of $4 million to $11 million, ex-employees told McClatchy. The goal was to close loans fast, bundle them into pools and sell them to generate money for the next round.
Inside the mortgage company, the former employees said, pressure was intense to increase the firm’s share of an exploding market for mortgages that depended almost entirely on Wall Street’s seemingly unlimited hunger for bigger, faster returns.
Michael Missal, a federal bankruptcy examiner who investigated New Century’s operations after it sought Chapter 11 protection on April 2, 2007, reported last year that the firm’s lax lending and accounting standards “created a ticking time bomb” as it pushed for ever-higher loan production.
The incentives for high-risk behavior reached all the way to Manhattan.
Goldman and other investment banks could put $20 million in the till by taking a 1 percent fee for assembling, securitizing and selling a $2 billion pool of mostly triple-A rated bonds backed by subprime loans — and that was just stage one.
Goldman entities earned millions of dollars more by servicing many of the loans and arranging sophisticated interest-rate swaps to guard against inflation.
As profits poured in, Wall Street firms extended lines of credit to New Century — known as “warehouse loans” — totaling billions of dollars to finance the issuance of more home loans to other marginal borrowers. Goldman Sachs’ mortgage subsidiary gave the firm a $450 million credit line.
As the economy slowed, the mortgage industry couldn’t keep up with Wall Street’s loan demands, but that actually generated leverage.
Kevin Cloyd, the New Century executive vice president who dealt with Wall Street and in 2006 also oversaw loan production, told examiner Missal that a tacit understanding developed with Wall Street firms that were trying to edge out each other for loans, said a person familiar with Missal’s inquiry.
Cloyd revealed that investment banks willing to scale back their scrutiny of mortgage applications got to buy more loans, said this individual, who declined to be identified because the material is confidential.
Reached at his Los Angeles home, Cloyd declined to comment.
The former project manager who oversaw the review of tens of thousands of subprime mortgages for Goldman and other Wall Street firms said that in 2005 and 2006, subprime lenders gradually got investment banks to reduce the percentage of loans that were reviewed before deals closed.
“It went from 100 percent in the late ’90s to probably less than 10 percent in 2006,” said the ex-manager, who declined to be identified for fear that it would hurt his career.
By pitting firms such as Lehman Brothers, Bear Stearns, Credit Suisse and Goldman against each other for a shrinking supply of loans, mortgage bankers were able to sell loans in which borrowers’ ratios of debt to income inched up to 50 percent, to 55 percent and even into the 60s, this person said. That didn’t include what they owed in taxes, meaning that some borrowers could be left to live on 20 percent of their paychecks.
Mortgage lenders also extracted promises from Wall Street firms not to “kick out” as unacceptable more than 5 percent of the loans in a pool.
Goldman spokesman Michael DuVally denied that the firm felt pressure from mortgage lenders to relax its loan quality standards to win bids on pools of mortgages. He said that Goldman’s standards were at least as tough in 2006 as they were in 2002, but he declined to describe them.
Goldman Sachs Mortgage, however, published guidelines in early 2007 indicating that it would accept a “stated income, stated asset” loan for a person with a subpar credit score of 600 who was borrowing 90 percent of his or her home’s value. The designation meant that although the borrower had poor credit, his or her claimed income and financial background would go unchecked.
Deep in a Feb. 13, 2007, Goldman prospectus offering bonds backed by 9,800 New Century mortgages were these disclosures:
- 3,422 of the borrowers had credit scores below 600, levels that experts say could include applicants with past bankruptcies.
- 3,688 of the borrowers were required only to state their incomes, not to document them — mortgages that became known as “liars’ loans.”
- More than a quarter of the borrowers had combined first and second mortgage balances that equaled or exceeded 90 percent of their homes’ values at the time.
As was typical, 34 percent of the loans in the 2007 deal were in California, and 9 percent were in Florida, markets where home prices were rising so fast that all the players shrugged off the risk that borrowers might default. If a loan soured, they thought, they could seize and easily resell the house without a loss.
With that philosophy, from 2004 to 2006 New Century executives relaxed their lending criteria to levels previously unimagined. The shift would have huge consequences: The looser the credit, the greater would be a torrent of loan foreclosures that would sink the housing market and force downgrades in supposedly safe subprime mortgage securities.
To make matters worse, the incentives inside New Century seemed to invite trouble.
For example, account executives, whose job was persuading mortgage brokers to steer clients to them, were paid largely in sales commissions. The more loans they secured, the more money they made.
To garner more loans, some female executives sauntered into mortgage brokers’ offices wearing “short skirts, cleavage showing, looking like hotties,” said Christine Fidler, a former company vice president.
Roxanne Bones, a former senior underwriter at New Century, said she was told that the women “spent a lot of time schmoozing with brokers at their offices, doing stuff with them on the weekends and getting drunk at night.”
Some New Century sales executives passed monthly kickbacks of $1,000 or more to company loan processers responsible for closing the loans, Bones said. It was a small tip to pay for salespeople who could earn as much as $1 million a year if their loans went to closing, she said.
The company also rewarded sales and underwriting staffs with lavish junkets. In 2004, Fidler said, as many as 300 New Century employees spent a week at the five-star Arts Hotel in Barcelona, Spain, where rooms today run from $400 to $16,000 a night.
Others scuba dived, golfed, took catamaran rides and sipped cocktails at Marriott’s Ihilani Resort and Spa in Hawaii, shared a Caribbean cruise, made a summertime sojourn to Banff in the Canadian Rockies or were handed fistfuls of company cash before hitting the gaming tables during a conference at the MGM Grand in Las Vegas.
When the sales teams weren’t frolicking, they were finding it easy to write loans.
New Century tossed out a requirement that every homebuyer make a down payment and began lending up to 80 percent of a property’s value for a first mortgage and up to 20 percent for a second. It also lowered borrowers’ minimum required credit scores into the 500s, although 700 or better is typically considered a good credit score. The nationwide average is 693, according to the consumer credit rating agency Experian.
By 2005 and 2006, ex-employees say, it got crazy.
Tim Lee, a former New Century underwriter in the Chicago suburb of Schaumburg, said his bosses relented and killed a $275,000 loan sought by a third-year kindergarten teacher who claimed a $180,000 salary. In most other cases, however, his objections led to a scene in a manager’s office like this one:
Manager: “We’re going to go ahead and do this loan.”
Lee: “So you do it.”
Manager: “No, you’re gonna do it.”
Lee: “I’m not going to.”
Manager: “Then I’m going to write you up.”
Lee said that his office processed 2,000 to 2,500 loans each month, and he could recall few that weren’t approved with an “exception” waiving a key financial issue that otherwise might’ve torpedoed the deal.
Missal’s examiner’s report estimated that 40 percent of the company’s mortgages were “liars’ loans” because any income claim on an application was accepted as truthful. A SIVA meant “some income, verified assets,” but it went downhill to the NINA — no income, no assets.
Lee said he nicknamed it “the no-doc, drug-dealer loan,” because even “a street pharmacist” could qualify by listing his income but not his employer.
Top New Century officials, including the late Vice Chairman Edward Gottschall, told skeptical underwriters not to worry because “volume outpaces bad debt all day long,” Lee recalled.
The loans laid out financial terms that protected investors but punished homebuyers. They offered above-market interest rates, typically starting at 8 percent, with provisions that Lee said were “rigged” to guarantee the maximum 3 percent rise in interest rates after two years and almost assuredly another 3 percent increase through ensuing, twice-yearly adjustments.
Loan prospects with higher credit scores but otherwise dicey credentials were given options such as “pick-a-payment loans” that allowed them to choose during an introductory period whether to pay the usual interest and principal, interest only or a minimum amount.
“Everybody would pick the minimum,” Lee said.
When the introductory period ended and interest rate adjustments kicked in, he said, someone who borrowed $750,000 could owe $850,000 and see his monthly payment shoot from $1,000 to $7,000.
If the noose around borrowers wasn’t tight enough, those seeking to refinance on safer terms faced stiff prepayment penalties.
New Century, like other mortgage lenders, would soon face its own cash squeeze, however.
Wall Street firms required lenders to buy back a loan if the borrower defaulted on his first payment or there was a major defect in the mortgage.
Missal’s report said that New Century was faced with an “alarming” wave of payment defaults beginning in mid 2004 — a wave that later turned into a multibillion-dollar tsunami of loans being rejected by Wall Street. New Century desperately needed cash to buy back thousands of deficient loans it had made.
In late 2006, however, Goldman Sachs and other Wall Street firms cut off the lender’s credit lines. The cash squeeze, as well as admitted misstatements on its 2006 year-end financial statement that had turned a loss into a profit, halted New Century’s operations and sent it careering into bankruptcy.
The lender’s demise, however, didn’t stop Goldman, which unloaded a $1.7 billion pool of bonds tied to New Century loans in February 2007. In May, weeks after New Century’s bankruptcy filing, Goldman started selling securities backed by New Century mortgages in a secret deal based in the Cayman Islands, a tax haven for U.S. companies.
Months after the February offering, Goldman’s lawyers filed additional disclosure documents with the SEC advising investors who’d bought its subprime bonds of disturbing patterns: rising defaults on subprime mortgages and declining home prices.
New Century, Goldman disclosed, not only was bankrupt, but also had received notices to cease and desist operations in multiple states. Furthermore, Goldman said, the mortgage banker was facing Justice Department and SEC inquiries — inquiries that apparently are still ongoing.
“In response to the deterioration in the performance of subprime mortgage loans,” Goldman advised, “the rating agencies have recently lowered ratings on a large number of subprime mortgage securitizations.
“… You should consider … the risk that your investment in the offered certificates may perform worse than you anticipate.”
(Tish Wells also contributed to this article.)
PAUL JAY, SENIOR EDITOR, TRNN: Hi. I’m Paul Jay from The Real News Network, and joining us from our studio in Washington, DC, at the McClatchy offices is McClatchy journalist Greg Gordon. Thanks for joining us again, Greg.
GREG GORDON, INVESTIGATIVE JOURNALIST, MCCLATCHY NEWSPAPERS: Thank you, Paul.
JAY: So Greg has been doing a series on the Goldman Sachs subprime mortgage business, and one of the companies Goldman Sachs did business with was something called New Century in California. Their officers earned something in the range of $40 million in salaries in about three years between 2002 and 2005, much of it in deals with Goldman Sachs. Greg, tell us how this all worked.
GORDON: Well, these companies that started making subprime loans were pretty small companies in the mid-’90s, and they were using credit criteria that were generally passable. They had a slightly higher mortgage default rate then maybe the conventional mortgages, but they weren’t a huge risk at that point. But something happened in the ensuing five, seven years: Wall Street started getting into the game, the subprime game of buying up these mortgages and converting them to bonds, high-yield bonds that were very attractive because they had AAA ratings on the bulk of the securities. So when this secondary market began to grow and it got to the point where the appetite of these Wall Street firms was insatiable, this just fueled the entire housing market, because the subprime lenders were cranking out more and more loans, the demand was greater and greater from Wall Street, and they were selling these packaged securities all over the globe. And Goldman Sachs got into the game in 2001. It had had a mortgage operation for 17 years, and basically they just bought and sold loans. And all of a sudden they were buying loans and converting them into securities, and they did so. They were not the biggest player in this. I think that the closest to the top that they ever came was a sixth-place ranking in 2006. But having said that, Goldman Sachs bought and securitized, converted into bonds at least $135 billion worth of these mortgages from 2001 until it got out in early 2007.
JAY: Now, just for people to get a sense of the atmosphere or the culture of this business, you point out something quite interesting in your fourth part, fourth segment of your series. You say that in the loans that were reviewed—it means somebody goes out, as I would—if you go get a loan from a bank, someone has to review your income and are you a real person. Well, the number of loans they reviewed in the late ’90s were 100 percent, but by 2006 less than 10 percent of loans were even being reviewed. Goldman Sachs must know this.
GORDON: One would think. I asked Goldman Sachs whether they felt pressure from mortgage lenders, subprime lenders, to ease up on the number of mortgages that they were reviewing, to ease up on their so-called due diligence standards, and Goldman said that their standards were at least as strong in 2006 as they were in 2002. But in this story, I quoted from Goldman’s own prospectus on one of these bundles. It was a 9,800-mortgage bundle in early 2007. And over 3,400 of those loans were stated-income loans, which means that they were essentially what became known as liars loans. There was no verification of an employee’s income. So if a gardener came in and said he earned $5,000 a month and signed a certification at the bottom of the application, that was it. There was no further questioning. And so the due diligence that was done, the contractors who were hired by Goldman and other firms now say that when they raised questions about it, they were told just follow the guidelines of the mortgage lender.
JAY: And the guidelines included a first mortgage for 80 percent, a second mortgage for 20 percent, in other words a mortgage for the entire value of the house that clearly the person couldn’t make the payments on.
GORDON: The entire value of a house that everybody assumed was going to go up in value. But of course the gigantic risk here for all the parties involved, well, especially for Wall Street and the bond buyers and for the homeowners or borrowers, was the possibility that housing prices instead of going up would go down, and suddenly they would be, quote-unquote, “under water”—the value of their home would be worth less than the balances of their mortgage or mortgages.
JAY: So the people organizing this—I don’t know any other word than Ponzi scheme—are making millions and millions of dollars in fees and salaries. You talk in your article about New Century taking 300 of their staff to Spain for a vacation, spending anywhere from $400 to $16,000 a night for a hotel room. The excess is the lavishness. This is past excessiveness. So in the final analysis, then, this Ponzi scheme, for Goldman Sachs, they start to realize—now we’re going back to part one of your series—they start to know at some point this is all going to explode. They start, one, to insure themselves, which I guess is legal enough, except that insurance winds up being to some extent with AIG, so you wind up with in the end taxpayers’ money is actually becomes the insurance for Goldman, and somehow Goldman’s quite clever at making sure that that’s going to happen. But the other thing they do, which you pointed out in point one, is they do dump a lot of this on their clients without telling them. So in the final analysis, isn’t all this illegal?
GORDON: That is the question that the courts will probably have to decide, ultimately. At least one of the experts, the law school securities experts that we spoke with, predicted that the disclosure of these secret bets in the same time period as they were selling all these securities was going to trigger some more lawsuits against Goldman Sachs and maybe some of the other firms, but particularly against Goldman, because they were the smart ones who got out and made bets the other way when they saw potential trouble ahead. And the question is: what is the obligation? And what did Goldman know about these mortgages? Is it really possible, given what’s in their own prospectuses, that Goldman Sachs didn’t know that these mortgages were way, way overrated?
JAY: Well, it seems not only must they have known; they seem they actually took measures to protect themselves, knowing that this thing was going to blow up in their face. I think let’s do one more segment of the interview, Greg, and in that I want to ask you: has anything changed? What’s to stop this all from happening again in one form or another? Please join us for the last and final segment of our interview series with Greg Gordon.
Please note that TRNN transcripts are typed from a recording of the program; The Real News Network cannot guarantee their complete accuracy.