The Bad Guys of Subprime Lending Are Raking in Bailout Billions

By John Dunbar and David Donald, The Center for Public Integrity. Posted May 20, 2009.

Since the confusion and panic of 2008 has receded, angry taxpayers have been looking for someone to blame for the mess. Subprime lenders that originated loans they knew were likely to fail are widely cited as a good place to start. But the subprime lenders could never have done so much damage were it not for their underwriters -- those giant investment banks in the U.S., Germany, Switzerland, and England.

Wall Street Cash Pours In

During the boom years, investment banks provided a staggering amount of cash to subprime lenders so they could make loans.

Between 2000 and 2007, backers of subprime mortgage-backed securities -- primarily Wall Street and European investment banks -- underwrote $2.1 trillion worth of business, according to data from trade ublication Inside Mortgage Finance. The top underwriters in the peak years of 2005 and 2006 were Lehman Brothers at $106 billion; RBS Greenwich Capital Investments Corp., at $99 billion; and Countrywide Securities Corp., a subsidiary of the lender, at $74.5 billion. Also among the top underwriters: Morgan Stanley, Merrill Lynch, Bear Stearns, and Goldman Sachs.

When New Century filed for bankruptcy, it listed Goldman Sachs Mortgage Co. as one of the 50 largest unsecured creditors. Other New Century creditors include Bank of America, Morgan Stanley, Citigroup, Barclays, and Swiss bank UBS.

New Century earlier reported to its shareholders that it had lines of credit totaling $14.1 billion from those five banks, plus Bear Stearns, Credit Suisse First Boston, Deutsche Bank, and IXIS Real Estate Capital, a French banking firm (since taken over by a company called Natixis) that frequently worked with Morgan Stanley.

An investigative report prepared for the U.S. Trustee overseeing the bankruptcy case described a "brazen obsession with increasing loan originations, without due regard to the risks associated with that business strategy" at New Century. It said the company made loans "in an aggressive manner that elevated the risks to dangerous and ultimately fatal levels."

In December 2006, Citigroup pooled $492 million-worth of mortgages to sell to investors as securities, one of several major offerings the bank had packaged for Wall Street. Sixty-three percent of the mortgages were originated by New Century, according to the lengthy prospectus. Eighty-one percent of the loans were adjustable rate mortgages.

Despite their massive investment in subprime loans, some of the nation's most powerful bankers continue to deflect responsibility.

"Demonizing the bankers as if they and they alone created the financial meltdown is both inaccurate and short-sighted," Citigroup chairman Richard Parsons told reporters recently. "Everybody participated in pumping up this balloon and now that the balloon has deflated, everybody in reality has some part in the blame."

A lawyer for former New Century CEO Robert K. Cole said he would have no comment.

Attorney Bert H. Deixler, who represents another former New Century CEO, Brad Morrice, was reached by e-mail. He was asked to comment on New Century's ranking as well as the contention that subprime loans originated by banks like New Century led to the collapse of the financial industry. Deixler described the Center's conclusions as "ludicrous." Several calls and e-mails asking him to elaborate were not returned.

Ameriquest, according to Center research of prospectuses, had relationships with virtually every major Wall Street investment bank. The lender sold billions of dollars in loans to Lehman Brothers, Bear Stearns, Goldman Sachs, Citigroup and Merrill Lynch. Some of its other financial supporters included Morgan Stanley, JPMorgan Chase, Deutsche Bank, UBS Securities, RBS Greenwich Capital, Credit Suisse First Boston, and Bank of America.

Countrywide, in addition to capital from shareholders, also had credit agreements with Bank of America, JP Morgan Chase, Citicorp USA (part of Citigroup), Royal Bank of Canada, Barclays, and Deutsche Bank.

Some investment banks owned subprime lenders. Merrill Lynch bought First Franklin Corp. (No. 4 on the Center list) in late December 2006 for $1.3 billion -- just before the bottom fell out of the market. Bear Stearns bought Encore Credit Corp. in February 2007.

The British banking giant HSBC got into the U.S. mortgage business in a big way when it bought Household International in 2003. It also purchased Arizona-based DecisionOne Mortgage, and operated under the Beneficial and HLC brands. An HSBC spokeswoman said HSBC Finance was primarily a portfolio lender, meaning it did not sell mortgages to third parties. HSBC, however, did package loans from its subprime subsidiaries into securities, according to SEC filings.

Lehman Brothers, now bankrupt, ranked No. 11 on the subprime list. The bank was a pioneer of sorts in investing in subprime lending. It owned several subprime lenders, including BNC Mortgage, Finance America, and Aurora Loan Services LLC.

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