You remember what happened, don’t you? Everything started to unravel late in 2007. The first one who was found without a chair when the music stopped was Countrywide. Bank of America was able to buy Countrywide for $4 billion (a stock swap) in early 2008. Just a year earlier Countrywide was worth over $50 billion. Countrywide’s founder and CEO Angelo Mozilo (Time wrote that he was one of the top 25 people to blame for the financial crisis) was once the darling of Wall Street. He ended up being charged by the SEC for taking more than $139 million in profits. It was Countrywide who first introduced us, the American people, to credit default swaps and CDOs. In a wonderful bit of irony, IndyMac was founded in 1985 by David Loeb and Angelo Mozilo as a means to collateralize Countrywide Financial loans that were too big to be sold to Freddie Mac or Fannie Mae. In 1997, IndyMac (Independent National Mortgage Corporation) was spun off as a separate company. I mention all this about Countrywide because we’re going to see this exact same cycle again with IndyMac. IndyMac, Washington Mutual and Countrywide were birds of a feather. Each company pushed subprime mortgages. Each company pushed adjustable-rate mortgages. Each company packaged the mortgages into securities which could be sold to Wall Street.
Case: 80-year-old retiree in Savannah, Georgia, loan in 2005 to build a modular house. The mortgage was approved by IndyMac. They approve the application based on the applicant’s Social Security income, which was written down as $3825 per month. The only problem is the maximum social security benefit is less than half this amount.
In late June of 2008, Senator Chuck Schumer released a letter which was volatile to say the least. Unfortunately, I’ve been unable to find the original letter on the Internet. I have been able to find portions of the letter quoted in several articles. (If someone is able to find the letter please send me the link.) In a statement the senator mentioned that he was “concerned that IndyMac’s financial deterioration poses a significant risk to both taxpayers and borrowers.” He went on to say that IndyMac “could face a failure if prescriptive measures are not taken quickly.”
Let’s back up and look at what the Los Angeles Times wrote in January of 2008. (This was six months before Schumer opened his yap.) This particular article looked at adjustable-rate mortgages. The author noted that adjustable-rate mortgages were usually given to small business owners, self-employed professionals and salespeople with consultative finances and fluctuating earnings. The article notes that adjustable-rate mortgages were given out by Countywide and IndyMac to people who previously would not qualify. Adjustable-rate mortgages usually have a “teaser rate” for around two or three years. So loans written in 2005 and 2006 were now resetting at their higher interest rate in 2008. The article noted delinquency rates in some parts of California of 13-15%. (One particularly egregious variation of adjustable-rate mortgages for something called an option adjustable-rate mortgage. This mortgage gave the homeowner three choices at the end of every month — pay principal plus interest, pay interest only or pay less than interest-only and allow the principle to increase.) So, in January, the Los Angeles Times called out Countrywide, which had just been bought by Bank of America, and IndyMac by name.
IndyMac Stock Price
A report that was published by the Department of Treasury after IndyMac’s implosion shows us the magnitude of the problem. According to this report, by May 2005, officials at IndyMac were aware of problems with their adjustable-rate mortgages. This market completely collapsed in 2007. The bank could no longer sell its mortgage securities because there were no buyers. By May 2008, over 12% of these loans were greater than 90 days in delinquency. Another reason for IndyMac’s failure lies in its lack of deposits. The bank did not have many retail branches. Therefore there were many customers opening up savings accounts and checking accounts. IndyMac had to rely on Federal Home Loan Banks and brokered deposits for funds. Basically, as I understand it, this is simply another way to borrow money. At one point in 2006, IndyMac had over $9 billion in these loans. Finally, every bank is supposed to have a certain amount of cash on hand to balance out possible loan losses. In early 2008, IndyMac hired an outside accounting firm and the firm showed that IndyMac did not have enough cash on hand. As if this wasn’t bad enough, Standard & Poor’s and Moody’s decided in April 2008 to re-rate the number of mortgage-backed securities (before this time they simply rubberstamped many of the securities that were brought to them by J.P. Morgan and Goldman Sachs). This included over $160 million in mortgage-backed securities that Indy Mac was holding, thus lowering IndyMac’s capital ratio (when it rains it pours). Around the same time, IndyMac announced its third consecutive quarterly loss (see graph).
I think it’s been pretty much established that the Office of Thrift Supervision ignored warning signs. Had they acted in a timely manner, the implosion could have been prevented. There is one little side note that I thought was interesting. The Office of Thrift Supervision allowed Indy Mac to accept an $18 million deposit from its holding corp. and backdate that deposit in order to help balance its books. This transaction happened on May 9, 2008. On May 6, 2008 the FDIC told the Office of Thrift Supervision that Indy Mac was “close to failing and needed new money quickly.” (Some at OTS were forced to resign because of IndyMac.)
So, I think that after further investigation it is clear that IndyMac was going to fail with or without Chuck Schumer’s help. Did Senator Chuck Schumer drive the final stake through the heart of a dying Rasputin who already been shot, poisoned and burned? Yes, I think that’s a fairly accurate metaphor. On the other hand, I have clearly shown that IndyMac was dying. Federal regulators were going to have to step in soon. In hindsight, they should’ve stepped in sooner. IndyMac was going to die with a without Chuck Schumer’s help. Their business model simply could not stand the catastrophic failure of the subprime mortgage market.
Hey, good post on IndyMac. I agree. Schumer was the least of IndyMac problems. IndyMac crashed because they made too many bad loans. In the end, that’s why IndyMac failed. Too many people couldn’t pay their note.
I think that we both are probably in agreement. Here’s where I think the standard liberal analysis fails.
First, here’s the million dollar question. Why did they make so many bad loans? Simply saying they were greedy is not an answer. Giving a loan to people who can’t pay you back is a poor way to make money.
Second, the paper you referred to hardly mentions the of speculators. Significant percentage of these borrowers were buying homes to flip. The teaser rates didn’t matter if you had planned to sell the home before the higher rates kicked in. A survey by the National Association of Realtors found that in 2005 28% of home buyers bought homes as an investment rather than to live in. In 2006, 22% of home buyers bought homes as an investment. If you are getting a home for no money down and at 2% interest, that’s like getting a free role of the dice. Some people made big money but when prices collapsed the party was over. When the speculators walked away, the banks were toast. The combination of no money down and interest only loans was the perfect deal for an investor. If the home went underwater or the balloon payments came due, walk away. They had no equity, Why not? In Albuquerque, one investor owned 30 homes and dumped them.
Finally, the normal control on this reckless lending is the desire not to lose your money. Indymac and Countrywide seemed not to care about the risks. Why? The government bought the loans. Your article noted that IndyMac could no longer sell to Wallstreet. Indy capitalized themselves through to FHLB, then sold the loans to Fannie Mae and Freddie Mac who were eager to buy these loans.
Congress (under Pelosi and with no objection from Bush) even lifted the cap on these loans so that Freddie and Fannie could buy more expensive loans.
Rather than discourage risky lending, the government through Freddie and Fannie encouraged risky lending by IndyMac and Countrywide.
From my reading is that most of the loans were brought not by Freddie and Fannie but by Wall street.
I must admit that I'm still trying to figure out this complex mess.
Thanks for your comments. I clearly have more reading to do.
Another aspect that I haven't read enough about is those speculators.
Great comment. Thanks.
The difference in what the LA Times said and what Senator Shumer said is that Shumer had access to confidential information as a member of a committee that oversees banks. The LA Times did not.
Therefore, what the Times says is looked at in a far different light than what Shumer said.
Shumer should be stripped of his committee membership and publicly censured by the Senate until such time as the voters of his state wake up and vote him out of office.
Shumers letter clearly was a key event in causing the dominoes to begin to fall in the summer of 2008, just prior to the presidential election. Chuck's 'October surprise' was a bit early but there is little doubt that the Senator had his party's interests, rather than the interest in the health of the American economy in mind when he publicly used confidential information to cause a run on one of the nations largest banks.
[…] would figure after I was challenged about Senator Schumer causing IndyMac to fail (and I proved that any reasonable person would conclude that IndyMac self-imploded because of risky […]
It is good to occasionally see a corporate CEO who engaged in fraud, finally held accountable. That happens far too infrequently in America. The meltdown of our economy can be traced directly to corporate wrongdoing, and unfortunately was blessed or at least ignored by the government, and ignored for sure by mainstream media when it was going on. Consumer groups were trying to get something done about this kind of thing years before. HADD.com and HOBB.org are just two groups concerned with building industry fraud; there are many groups who tried to fight this and the whole darn economy had to tank before it was really in the news. The financial influence that corporations have over govt and media has to be stopped or we will be a third world country due to these CEO’s greed.
@Joe White
Exceptional insight on how the Democrats won the election in 2008.