The regulator, the whistleblower and the CEO: Key housing players reflect on the financial crisis 10 years later

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Ten years ago, a simmering financial crisis finally bubbled over. Lehman Brothers failed, credit markets seized up, the two behemoth mortgage companies were taken over by the government, and big banks merged, were bailed out, and took on brand new shapes.

The crisis rocked Wall Street and Washington. But it grew out of the housing market - and the deep distress the subprime mortgage bubble had wreaked on communities all across America. Over the coming years, it would mean roughly 6.5 million homes lost to foreclosure, and nearly $10 trillion of equity wiped out, according to records from Attom Data, with those effects more pronounced in communities of color.

MarketWatch spoke to several people who had watched the gathering housing storm for their reflections on this anniversary. They spoke candidly, often sharing a sense of regret that it took a near meltdown of the global financial system for anything to be done about systemic failures in the mortgage markets, and a sense that even with the crisis as a cover, too many opportunities were missed.

The regulator

Sheila Bair became the head of the Federal Deposit Insurance Corporation, the federal agency that insures bank deposits, in 2006, and immediately began pushing for some regulation of a mortgage market that had run amok. In 2007, Bair testified that the Fed should use its existing authority to set prudent mortgage lending standards, a step the Fed refused, and which the Financial Crisis Inquiry Commission later called a “pivotal failure.” She also advocated strongly for widespread mortgage modifications, a step she thought was commonsense for its benefit not just to homeowners, but also financial institutions and the broader economy. Those efforts were beaten back by investors, industry, and even the government officials charged with stabilizing the financial system in 2008.

The core problem was all these unaffordable mortgages that had brought valuations well into bubble territory. The correction that occurred was the catalyst. It was the thing that drove me and my colleagues to focus on restructuring these mortgages, making them affordable. It was a frustration to me that we never did that effectively as we should. I think our emphasis at the FDIC probably saved several hundred thousand homes from foreclosure. I wish we had done something radical, like writing down the principal, and freeing all these people from their underwater mortgages. We just couldn’t get traction.

The whole focus was on the banks, saving the banks. We stabilized the banks, we had success with that, (but the mortgage meltdown) hurt the broader economy. The deep recession was caused by the retrenchment in consumer spending which had been previously supported by home equity loans. The fiction of deadbeat speculators playing the system, no doubt there was some of that, but there were far more people working hard, trying to stretch themselves to continue making the payments, people desperately trying to save their homes. I hope it’s one of the lessons we learn moving forward. We should have done more.

I think there is some acknowledgment from people in government and academic researchers that we should have done more. Household borrowing is a key indicator. In the short term it will provide some fiscal stimulus, but in the long term it becomes unaffordable. I think there is a growing recognition of this among people who look at this and understand it. Whether there’s a broader recognition in the broader population I don’t know. There is a broader recognition of the uneven response. I think that’s an undercurrent of the populist movement now. I think there’s general public acknowledgment that the response was too tempered toward the banks and not homeowners.

The advocate

Mike Calhoun is the president of the Center for Responsible Lending, a policy affiliate of the nation’s largest community development lender, Self-Help. In 2006, CRL put out a report estimating that 2.2 million homeowners could face foreclosure. The group got pushback from industry and investors, including the Mortgage Bankers Association, which later performed its own strategic default, walking away from a mortgage on a new headquarters it could no longer afford.

We had seen the unsustainability of these mortgages going back to the early 2000s when we looked at the performance of loans that did not have traditional underwriting and had payments that borrowers couldn’t afford. They were structured so that people could only maintain the loans as long as they could refinance. With subprime loans, the odds were one in four that you would end up losing your house. The vast majority of these loans were going to existing homeowners. Most were refis where people were in sustainable existing mortgages and were being enticed to lower their payments or take equity out.

We expanded that study in 2006. The foreclosure crisis and the slowdown in house prices affected different states at different times. In the Midwest, particularly Ohio, they were in the midst of their foreclosure crisis in 2004 because the slowdown in house prices occurred there because of the loss of manufacturing jobs. This was the insight that John Paulson and other Wall Street types recognized. Our data showed that failures would occur if there was just a slowdown in house price growth. It did not require a plunge in prices. Foreclosures precipitated the huge plunge in prices because the market was flooded with all these houses that were being foreclosed on.

We saw that this boom had facilitated a mass increase in equity withdrawal, cash-out refinances, approaching 10% of consumer spending in 2005. Then when the crash hit in 2007 it went to near zero. That was a key factor in the recession, a huge reduction in consumer demand that happened as a direct result of the housing crash.

It was frustrating because of the huge harm that was unnecessarily felt by homeowners and throughout the whole economy. This was not an inevitable crisis. It could have been avoided. Financial services at that time was the largest political contributor and had a large lobbying effort in the Congress and the states. A bill in Congress in 2005, for example, wanted to relax mortgage standards by pre-empting all state laws. The industry was upset with state laws. It was painful to watch that.

We had over $5 billion of loans outstanding to low-wealth homeowners and we had 100% of the credit risk on those loans. The losses were 4%. Overwhelmingly our borrowers had 30-year fixed-rate mortgages, fully documented. They performed well through the crisis, the people who were not able to hold on to their homes were victims of the larger recession.

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The controversial middleman

Daniel Mudd was elevated into the CEO role at Fannie Mae, one of the government-sponsored mortgage backers, late in 2004, when the then-CEO was ousted over an accounting scandal. Mudd ran the company until it was hustled into government control in the summer of 2008, and then fired by Treasury Secretary Henry Paulson. Critics have blamed much of the mortgage meltdown on management of Fannie and its counterpart, Freddie Mac. For his part, Mudd has spoken little to the press. In 2010, he told the Financial Crisis Inquiry Commission that “the cause of the GSEs’ troubles lies with their business model.”

As we wound through 2008, there were two dynamics going on. One was a continual ebbing of confidence in institutions and policymakers, whether government or private sector. Because financial markets fundamentally trade on the confidence that you’ll be paid back in the future, liquidity began to tighten up and increasingly got very tight. Combine with that, on the part of market participants, was a lack of pattern recognition. Most of the events of 2008 had never happened before. Until 2007, on a national basis home prices had never gone down a percent for a single year. Understanding the outcomes that such a pattern might produce was extremely difficult. Without that confidence, both policymakers and market institutions were kind of figuring it out as they went along, which in turn didn’t restore confidence, so we were in a spiral that extended all the way through to September.

I was surprised by the margin by which the housing market was much more political than any other financial market that I had been in. That was clear to me from the first day I was at Fannie Mae. When you run a business with a fairly clear objective, you can line up a whole bunch of initiatives and efforts around it and say, is this feeding into our overall objective as an organization? Fannie Mae in fact had two: one was to succeed as a shareholder-owned corporation and the other was to increase affordability and liquidity in the housing market. For 40 or 50 years those two things coexisted happily. And then when we rolled into 2008 it became increasingly difficult and subsequently impossible to rectify both sides of the institutional objectives for Fannie. When you’re statutorily limited to be in one market and to be providing liquidity into that market 24/7, at some level you could say it’s quite remarkable that it wasn’t stressed for the prior 40 or 50 years, but when it was stressed, it wasn’t just a 5-10% stress, it was a 30% stress.

I think it’s an untold story as to the high degree with which Fannie Mae’s people under circumstances that were vastly different than what they would have envisioned when they took their jobs, continued to work really hard all the way until the early days of September 2008, to serve both those missions, increase capital and increase liquidity, and working in a spirit of goodwill with regulators and others who didn’t in retrospect completely share that goodwill. Through it all a surprisingly large percentage of those people retained an enormous amount of motivation to try to do the right thing to keep people in their homes, refinance mortgages, abate the effects of the market, and all that. That always actually surprised me because normally when a crisis hits, people will go back to their own corners.

The lawyer

Alys Cohen is a staff attorney at the National Consumer Law Center. In this role, and in a prior one at the Federal Trade Commission’s Bureau of Consumer Protection, she’s focused her efforts on predatory mortgage lending and on protecting borrowers.

I was working on these issues for almost a decade and a half before the crisis hit. These were well-known problems for lower-income borrowers and borrowers of color long before it hit the economic system.

The Federal Reserve had some hearings before they issued some updated rules on subprime loans, and when I testified at one of the hearings and talked about the abusive loan terms that people were receiving, I asked for a show of hands of how many people had terms like that in their mortgages in that room. The room was filled with privileged people who work on banking policy in Washington and of course no one had any personal experience with that. If it’s not hitting the pocketbooks of people in power, it is too often not a priority.

What’s eternally frustrating is that the average person is often only helped when there’s an argument that it’s also good for the market. There are a lot of reasons to ensure the market is healthy, but a lot more could have been done for homeowners while keeping the market safe. One of the biggest missed opportunities was that Congress did not approve bankruptcy opportunities for homeowners to reduce their mortgage balances. That would have made a huge difference. It’s currently available for people who have investment properties and is still unavailable to struggling homeowners.

The crisis highlighted how hard it is for homeowners facing hardship to get a workout plan that’s a win-win for the homeowner and the investor. The extreme loss of equity and personal wealth in communities of color will follow these generations for a very long time.

The whistleblower

Gary Crabtree was a real estate appraiser in Bakersfield, California, who discovered a mortgage fraud scheme and brought it to the attention of the FBI. The case was finalized in 2014, nearly a decade after Crabtree’s discovery, although two appraisers who were part of the scam got off with just a slap on the wrist, he said. The frothy housing market of the mid-aughts provided an ideal cover for the two men, who inflated purchase prices and flipped properties between straw buyers.

I was a whistleblower because I had discovered in my community the beginning of what turned out to be one of the top 10 mortgage fraud equity skimming scams. This was back in ‘04-’05-’06, when we had a very lax credit market and the 100% financing loans were being made, appraisals were being falsified, the NINJA loans were being made with borrowers that falsely stated incomes, straw buyers and the like. As an appraiser, you’re responsible for establishing the value of the property but also for verifying sale data. That’s when I began seeing properties selling, most of the time they’d be selling at $500,000, $600,000, $700,000 and would be flipped to a straw buyer for $900,000. The largest one I had was a new construction in a gated golf community that sold for $1.2 million and two months later was flipped for $1.8 million.

I took it to the Bakersfield Police Department and they had no idea what white-collar crime was. I took it to the district attorney. I tried calling all the banks that were being scammed, I tried to call their fraud departments and they didn’t care anything about it. The lenders didn’t want to know because they were selling these things as mortgage-backed securities on Wall Street and there was so much money being made, everyone looked the other way.

It decimated our community. In 2005, the Bakersfield median sale price was $300,000. When it hit bottom in April 2009 the median sale price was $115,000. We have never recovered. We are still about 17% below June 2005. It was very devastating for the entire Central Valley of California because it is a lower-income area relying heavily on oil and agriculture, so we have reasonably low-paying jobs and these people were making $15 an hour and qualifying for a $300,000 house.

For me it was an assault on my profession. I believe that honesty and integrity is the only thing that an appraiser has to sell. With these guys out there playing loosey goosey, if they did not have the appraisers’ falsified numbers, they wouldn’t have had a fraud. I got damaged financially because all my work dried up. Eight and a quarter years of agony working with the FBI. I went through four special agents during the case.

I can’t afford my overhead any more. I’m closing my offices and moving into my bedroom and trying to cut back on my services. I’ll be 80 in December so maybe it’s time to retire. I spent 57 years in the industry.