"Mortgages and Madness"

This is long, but really worth reading - quite eye opening. I never really understood the subprime mortgage debacle, and I had no idea that this kind of local chicanery was part of it. Of course the real crime is that state and federal regulators stood by and watched, and in some cases, prevented local regulation from intervening. To add insult to injury, our tax dollars were used to bail out Bear Stearns, which enthusiastically participated in this insanity.

http://www.newsweek.com/id/138503

NEWSWEEK
May 24, 2008
Mortgages and Madness
by Michael Hirsh

Questionable lending practices turned a peaceful Cleveland neighborhood into a blighted slum.
[ . . . ]
In the surrounding neighborhoods are scores of boarded-up, abandoned homes—ramshackle hulks that have turned otherwise peaceful neighborhoods into slums. True, these old working-class shotgun houses—lovingly nicknamed because you could fire a shotgun at one end and the pellets would go straight through—were never going to make the pages of Better Homes and Gardens. But at least they once had local owners or tenants who fixed the walks, painted the trim and worried over the monthly mortgage payments, aided by a city revitalization program.

Now the houses sit empty in legal limbo, foreclosed on by lenders that don't want them, or traded on eBay by buyers from as far away as San Diego and Tulsa, Okla. Some homes have been boarded up for so many months that a local artist, Chuck Gliha, has begun painting ghostly blue portraits on the plywood in the windows to "freshen things up." Vandals regularly comb the neighborhood, sometimes setting fires. In many houses the aluminum siding is ripped away, the copper wiring yanked out, because with a building boom overseas, demand for nonferrous metal is huge.

This was once the sort of "product" that dazzled Wall Street, feeding the subprime-mortgage bubble. How did it all start? How did distressed properties like these become "collateral" for loans that were bundled into high-priced securities, then bought by huge banks and pension funds around the world? How did Slavic Village contribute to a global credit crunch? Now, hundreds of lenders, securitizers and brokers like Kellogg are being investigated by the FBI, IRS, state attorneys general and county authorities nationwide for their respective roles in this global confidence game, which authorities are just beginning to piece together.

According to county records obtained by NEWSWEEK, Kellogg was the broker of record for the purchase of 71 houses in Slavic Village from 2003 to 2006—during the height of the subprime investment boom. All of them went into foreclosure within a year or two. In each case, mortgages were issued for Kellogg's houses—by well-known nationwide lenders, such as Argent Mortgage and New Century—for multiple times the value of what the home had been purchased for, often only months before, the records show. Local Councilman Tony Brancatelli, who first passed on information about Kellogg to county prosecutors, says the prices were so inflated beyond the house's actual value that any income gained from rent or resale could not possibly pay off the huge mortgage, and the borrowers quickly defaulted. In one instance, a house purchased for $14,000 on Feb. 9, 2005, was sold three months later, on May 9, 2005, with Kellogg acting as broker, for $84,000; it went into foreclosure a year later, on May 31, 2006.

In transactions with what Mason's office describes as artificially inflated home prices—courtesy of a friendly appraiser—the brokers would get up to 8 percent of the total in fees (the maximum allowed by law), and they often split much of the loan proceeds with the seller and other parties, perhaps anywhere from $10,000 to $50,000. (Kellogg's appraiser on most deals, Bruce Hoover, was disciplined by the Ohio Department of Commerce on May 9 for failing to report, on another appraisal, that a home had been previously sold for much less; he did not respond to numerous phone calls asking for comment.) Some purchasers of record who are in foreclosure claim they were set up by Kellogg as "straw" buyers—neighborhood acquaintances who say he paid them a few thousand dollars to sign their names as the owner of record.

Some buyers say they didn't comprehend what they were signing at the time, but discovered they were left legally and financially accountable—their credit destroyed—as the lenders foreclosed. "He ruined my life," says Lakiesha Williams, a mother of two girls who was working as a nursing assistant when she says she was approached by Kellogg, who persuaded her to invest in 11 homes and take on tenants. But Williams found the properties were in worse condition than she thought and, when the tenants left, she couldn't keep up with the mortgage payments. "I'm broke. I've got nothing," she says.

While no hard numbers exist yet, officials say fraudulently inflated values and other schemes figured in a huge percentage of subprime loans that were turned into securities during the boom—possibly at least 50 percent nationwide, according to county and state officials as well as real-estate experts interviewed around the country. One piece of evidence: during the height of the bubble it became standard practice to solicit borrowers by giving them "no document" loans, known in the industry as "liars' loans," in which all the borrower must put down to qualify is "stated income" (write anything you want; no one will be checking). Stated income was once a little-used perk that banks granted to trusted wealthy borrowers who paid large down payments. But by 2006, 44.7 percent of all securitized subprime mortgages in the country were stated income or no-document loans, according to Patrick Madigan, an Iowa assistant attorney general. "There's only one reason for that high number, and that's fraud," says Madigan, who helped to negotiate a $325 million settlement in 2006 over alleged abuses by Ameriquest, the nation's largest subprime lender. (Ameriquest spokesman Chris Orlando said the company admitted no wrongdoing.)

Now the investigations are going all the way up the pipeline—to Wall Street. According to FBI spokesman Bill Carter, 19 "large institutions" are being investigated for corporate fraud, in addition to more than 1,200 individual cases of mortgage fraud. One area of inquiry, Carter says, are deceptive sales practices related not just to mortgage fraud in places like Cleveland but to how such mortgages were packaged into complex securities called "collaterized debt obligations." Among the targets are "major subprime lenders" and investment banks, Carter says. "We're going after people right at the top," says another FBI spokesman, Steve Kodak.

Earlier this year the city of Cleveland, suffering one of the highest foreclosure rates in the country, filed a lawsuit in the Court of Common Pleas in Cuyahoga County against 21 major investment banks and lenders. The suit contends that major Wall Street firms such as Goldman Sachs, Citigroup and Bear Stearns were a "public nuisance" that depleted Cleveland's tax base and destroyed its urban-renewal programs. "Over the course of several years, financial institutions routinely made money available to unqualified borrowers who had no realistic means of keeping up with their loan payments," the suit says. "This phenomenon claimed entire streets, blocks, and neighborhoods."

An astonishing 80 percent to 85 percent of the Cleveland loans bought up by Wall Street from 2003 to 2007 went into foreclosure. Asked to assess the economic damage, Cleveland Mayor Frank Jackson told NEWSWEEK: "You give me a number." County Treasurer Jim Rokakis tries: "More people have left Cuyahoga than any other county in the U.S. with the exception of New Orleans. They had a hurricane; we had lenders." Lawyers for the investment banks dismiss the claims. Shawn Riley, a Cleveland lawyer with a firm representing two of them, says that public-nuisance laws "written to address leaf burning in the neighbors' backyard can't be applied to a sophisticated financial transaction."

Slavic Village seemed, at first glance, an unlikely spot for investors in mortgage securities to place their bets. The childhood home of Rep. Dennis Kucinich, it was for decades a chronically depressed steel-mill town noted for its kielbasa shops. But like other rust-belt cities, Cleveland was trying to rehabilitate itself, pouring money into revitalization programs.

Yet insidious forces were at work in the neighborhood. After the mortgage-refinancing boom of 2003–04, demand for fresh subprime "product" grew so intense that lending standards nationwide disintegrated. To meet Wall Street's demand for a steady supply, lenders kept reaching lower and lower down the scale of quality in both property and borrowers, until the street hustlers jumped in to offer up their "product." Not surprisingly, the once shunned inner city became a prime lending spot across America. That, in turn, led to the phenomenon of reverse redlining. More than a decade ago, the big story was the redlining of low-income, often African-American, neighborhoods by banks that refused to lend there. Now the opposite happened.

Wall Street's insatiable demand inspired the local shop owner and plumber to go into the mortgage business—what Brancatelli calls "station-wagon brokers."

"There are a lot of former drug dealers who have gotten into the business," adds Ed Kraus of the Ohio Attorney General's office. Many brokers simply invented biographies and jobs for their indigent borrowers, officials say. In one case, says Brancatelli, Kellogg saw a lawn mower in a truck belonging to Williams's husband and declared him a "landscaper" for the mortgage records.

Rokakis compares the small brokers and borrowers to drug users whose weaknesses were exploited. "The police don't really want the small-time drug dealer or user," he says. "The guy they really want is the drug lord in Colombia. In this case the drug lord was Wall Street."

And who was the middleman? Farther along the pipeline from local brokers like Kellogg was the man who started Argent Mortgage—Roland Arnall of Beverly Hills, Calif. A Holocaust survivor and cofounder of the Simon Wiesenthal Center, the billionaire entrepreneur was known as an L.A. bon vivant, a cultivator of the rich and famous.

While Arnall—who died of cancer in March—seemed to inhabit a different social universe entirely from Mark Kellogg's, the two were effectively in business together. Argent handled more bad loans—27 percent of foreclosures—than any other company in Cleveland during the boom (including several loans to Kellogg). The first company that Arnall founded, Long Beach Mortgage, was bought by Washington Mutual, which is now being investigated by New York Attorney General Andrew Cuomo for conspiring to inflate real-estate values. (Washington Mutual did not return a call asking for comment.) Long Beach is the company listed in Cuyahoga County records as the issuer of most of Kellogg's loans from 2004 to 2005, when the hunger for new product reached its crazed heights.

National and state regulators, meanwhile, paid almost no attention despite pleas for help from the local officials. It was way back in 2000 that Rokakis led a local delegation to the Federal Reserve Bank of Cleveland, asking for help. After much pleading, the Fed scheduled a daylong conference in March 2001 titled "Predatory Lending in Housing." "We asked them to step up and take action," the county treasurer recalls in his office in downtown Cleveland. "But here's what I learned about the Fed. They do wonderful lunches. But the Federal Reserve Bank is not there to protect us. It's there to protect the banks."

So cities like Cleveland sought to take action themselves. In 2001 Mayor Jackson prodded the city council to pass an antipredatory lending act that would have "slowed the Mark Kelloggs down," says Rokakis. But within a year the state, heavily lobbied by Ohio banks like National City, stepped in to void the local law, saying authority lay with the governor and legislature in Columbus. Then the U.S. Office of the Comptroller of the Currency issued a pre-emption order saying the states did not have the authority to enforce laws against national banks. (OCC spokesman Robert Garsson counters that states are the ones that oversee "nonbanks" like Argent.) When the Feds and state officials tied the hands of the locals, Rokakis says, "it was clear this was the Wild West, and there's no sheriff in town. If you're a lender, there's nobody who can stop you. The only difference is that in the old days, people robbed the banks. Now the banks were robbing the people."

Whether any Wall Street bigs ever face prosecution, the localities are still suffering from the fallout. Cuyahoga County, which includes Cleveland, now has about 22,000 vacant foreclosed properties—more than 5 percent of its 395,000 houses.

Foreclosures in Slavic Village have ballooned from 114 in 2001 to 840 last year, and the rate is now at two a day, Brancatelli says. As thousands of distressed houses have been stripped and gutted, local youth gangs have begun using the hulks as hideouts. Father Mike Surufka, the Franciscan rector of St. Stanislaus Church, frets that his parishioners are moving out as a result. "For me the real sin is that people made huge amounts of money precisely by destroying neighborhoods," says Father Mike. Ultimately, many in Cleveland believe the only way to rebuild those neighborhoods is to return mortgage finance to where it started—to local lenders, local borrowers and local government. At least that way, everyone can keep an eye on one another.