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.

Even banks that managed to dodge much of the carnage created by the subprime meltdown -- like Goldman Sachs -- were invested in the subprime mortgage business. Goldman in May 2005 submitted a prospectus so that it could sell more than $425 million in securities known as "mortgage pass-through certificates."

Those securities were sold from an underlying pool of 9,388 second-lien loans that Goldman Sachs bought from Long Beach Mortgage Co., a company that ranks No. 5 on the Center's list of the top 25 subprime lenders. Long Beach was a subsidiary of Washington Mutual, which collapsed in 2008 thanks largely to losses in the subprime mortgage market. It was the biggest bank failure in U.S. history.

Included in the prospectus for those Goldman Sachs securities was a boiler-plate warning to investors considering buying subprime mortgages. It says the borrowers, "for one reason or another, are not able, or do not wish, to obtain financing from traditional sources" and that the loans "may be considered to be of a riskier nature than mortgage loans made by traditional sources of financing." Goldman eventually received $10 billion from the government TARP program, a sum the bank says it would like to pay back as soon as possible.

Goldman has been more conciliatory than some banks as far as accepting responsibility for the economic collapse. "Much of the past year has been deeply humbling for our industry," bank spokesman Michael DuVally wrote the Center. "As an industry, we collectively neglected to raise enough questions about whether some of the trends and practices that became commonplace really served the public's long-term interest."

Morgan Stanley owned a subprime mortgage company, but its volume wasn't high enough to make the Center's top 25. The investment bank, which has also received a $10 billion TARP investment, was far more active as an underwriter. It backed $74.3 billion of subprime loans during the peak years of 2005 and 2006, according to Inside Mortgage Finance, ranking it fourth for that period.

In 2006, Morgan and French banking firm IXIS Real Estate Capital Inc. (now part of Natixis) hoped to sell $1.3 billion in subprime mortgage-backed securities to investors, according to a prospectus. It included 6,755 loans originated by 20 different lenders, including First NLC Financial Services LLC, Accredited Home Lenders and Countrywide.

In addition to Wall Street, the Federal National Mortgage Corporation (Fannie Mae) and the Federal Home Mortgage Corporation (Freddie Mac) also fed the subprime monster. Fannie and Freddie were created by the government to promote home ownership by buying mortgages from lenders and selling them to investors, thus freeing up cash for banks to make more loans.

With investment banks buying more and more loans themselves each year, Freddie and Fannie began buying a huge volume of mortgage-backed securities from Wall Street as a means to foster affordable housing goals.

As of the end of February 2009, Fannie and Freddie held a combined $292.1 billion in private mortgage-backed securities in their portfolios, according to monthly statements from both companies. On September 7, 2008, the government took control of the two entities.

Abusive Lending

The subprime lending business has had its share of public relations problems. Subprime lenders say they serve an important function -- offering credit to people who have been snubbed by traditional mortgage lenders. But regulators and consumer advocates say some are "predatory" lenders who take advantage of people with little knowledge of how the financial system works and few options when it comes to borrowing.

Indeed, subprime lenders have paid billions to settle charges of abusive lending practices. At least 11 of the lenders on the Center's list have paid significant sums to settle allegations of abusive or predatory lending practices.

Two of the largest settlements ever reached for lending problems were with AIG and Citigroup, two financial institutions that have received billions in federal aid. Citigroup has a history of subprime lending, dating back to its purchase of Associates First Capital Corp. in 2000. Citigroup at the time was building a global banking empire thanks to its success in convincing the government to deregulate the financial services industry the year before.

Associates had been criticized by some as a predatory lender, and in 2002, Citigroup paid a price for it. The bank agreed to pay $215 million to resolve Federal Trade Commission charges that Associates had engaged in "systematic and widespread deceptive and abusive lending practices."

In 2004, the bank was hit again, this time by the Federal Reserve. The Fed levied a $70 million civil penalty against CitiFinancial, Citigroup's subprime lending unit, for abuses during 2000 through 2002.

A Citigroup spokesman said the bank does not sell or securitize its loans. It does a small portion of adjustable rate mortgages, but does not offer "teaser rates" that so often get borrowers in trouble. Citigroup has caught heat from other big banks for supporting a bill, backed by consumer advocates, that would give judges more leeway in reworking mortgage loans of people in bankruptcy. The bill died in the Senate on April 30.

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