Something had gone wrong in O’Connelly’s California; a state whose economy was equivalent to that of Spain’s, the world’s eighth largest. Its civil servants were being paid in IOUs and unemployment had reached the highest level in over seventy years.
O’Connelly had always felt pride in being a Californian, since his days at UCLA, and as owner of a home in San Francisco his ties with the state remained close. It was as if it was one of his adopted countries, in the same way as France. Things had changed dramatically and in so little time. The cities, the buildings, the beaches and the perfect weather were still there, as was Hollywood. California remained, in spite of all its difficulties, a playground of the glitterati.
The state, where for ordinary folks, the American Dream came true, was on the verge of collapse. California was on life support; the crisis had hit its economy, its politics and its way of life. The state government was so deeply in debt it was forced to issue ‘promise to pay’ warrants ― IOUs ― instead of wages as cash reserves dried-up. At the same time unemployment soared to more than twelve percent; the highest level in seventy years as the state cut jobs and slashed spending on education and healthcare.
In a land where the automobile was king, where cities and their sprawling suburbs stretched over thousands of square miles, the collapse of the housing bubble had made tens of thousands of families homeless and impoverished millions. As the state cut deeply into its welfare programmes twenty percent of Angelinos found themselves living below the poverty line and without healthcare.
The once rich state’s economic problems dwarfed those of Iceland and Ireland. The nation’s largest state, with a population of almost forty million, found itself in the unenviable position of being the first failed state in the US as its government-issued bonds were lowered to junk status.
Only recently California had boasted, as an independent country, it would have qualified for membership of the G8. So where did it all wrong? O’Connelly asked himself. All of a sudden many hapless Californians woke up to find themselves living in squatter camps that had materialized overnight in supermarket carparks and abandoned lots. Families slept in their vehicles as fathers and mothers lost their once well paid jobs. Vociferous radical groups preached revolution and violence.
Were these portents of things to come in Greece or Ireland? After a ten year long housing boom, homes that had sprung- up besides strip malls and freeways were boarded-up, abandoned, hit by foreclosures and repossessions. Prices had crashed by as much as seventy percent. Developments looked like ghost towns, as homes, the essence of the American Dream, were left to rot under California’s mocking blue skies.
It had all started in an orgy of greed and recklessness, and ended, after the initial crash of 2008, with the largest bankruptcy in history when Lehman Brothers filed for bankruptcy protection, on Monday, September 15, later that year.
At the height of California’s boom, anybody could walk into a mortgage broker and sign up for a home loan. It did not matter whether the borrower could make the mortgage payments or not. What counted for the seller was the commission that could be earned each time a borrower signed on the bottom line. A system built on crooked hard sell methods, which inevitably led to every kind of fraudulent practice imaginable, as banks, mortgage companies and real estate agents piled into the business.
The introduction of sub-prime mortgages allowed those on low incomes to qualify for loans. However, the crunch came when introductory interest rates were reset and home owners were unable to service their repayments.
One of the main culprits was the mortgage bank Countrywide, headed by Angelo Mozilo, the son of a Bronx butcher, one of its cofounders. Mozilo, known as the Golden Boy, because of his permanent tan and worth, built a network of cronies, composed of politicians and influential business leaders known as the Friends of Angelo. Amongst these were Paul Pelosi the son of Nancy Pelosi, Speaker of the House of Representatives; the Senate Banking Committee Chairman; the Senate Budget Committee Chairman, all bought with sweet-heart mortgage deals at steeply discounted rates.
Whether the borrowers paid or not was not Mozilo’s problem, since the loans did not remain on Countrywide’s books; they were promptly sold to Wall Street, where with other mortgages, they were bundled together, tranched and transformed into mortgage backed securities, before being unloaded to naïve or unsuspecting investors all over the world.
In 2006, Countrywide financed twenty percent of all mortgages in the United States. In 2008, when Countrywide was facing bankruptcy, it was bought by Bank of America for over four billion dollars, a fraction of its estimated worth when business was thriving.
Mozilo’s contract with Countrywide assured him of regular salary increases, guaranteed bonuses and options worth hundreds of millions of dollars. In 2005, he pocketed a total of more than one hundred and sixty million dollars in compensation for his dual role as chairman and CEO, more than that of any other top executive in America’s, and no doubt the world’s, leading financial institutions.
After an investigation for fraud Mozilo got off lightly with a fine of just seventy million dollars, peanuts considering his estimated net worth ― over six hundred million dollars.
One of the first places the newly invented mortgage backed securities made their appearance was the City of London, during what could now be considered as its golden age. At that time, Liam Clancy, whose working knowledge of high finance in those early days of the housing bubble was near to zero, was laying-about wondering what to do next in Enniscorthy, his home town in County Wexford in south east Ireland.
Liam had graduated, sine laude, from Trinity College after struggling for four years in ‘Philosophy, political science, economics and sociology’. Although his degree bore an impressive in title, the Celtic Tiger’s booming export oriented businesses did not seem to be in a rush to hire him.
Luckily, Liam was told of an opening at the Anglo Irish Bank’s investment branch by a cousin. Although economics had been part of his degree course, he knew almost next to nothing of markets and trading. That was of little importance, his cousin’s recommendation was sufficient. The bank, given the difficulty of finding staff in Ireland’s flourishing economy, would undertake the necessary training for a suitable candidate.
The idea of working in a bank did not really appeal to Liam, but on learning the proposed job was in the bank’s trading room, where he had heard fortunes could be made, he perked up. A trader’s role, the cousin told him, was to persuade investors to buy the bank’s financial products, and beyond everyday trading room activities, was the job of entertaining clients: restaurants, bars, night clubs, hotels, weekends, all on expenses.
Markets always went up and the more money splashed out on Champagne entertainment the greater the rewards. In 2004, Clancy was taking home, including his annual bonus, over one hundred thousand euros a year. It was a joyous time, an age of irresponsibility, and life at the bank’s investment branch, situated in a prestigious office building in the centre of Dublin was a gas. Liam Clancy, like his co-workers, did not have the slightest understanding of how banks functioned. Their job was selling securities at inflated market values, products derived from the lure of the easy credit boom that had triggered the property bubble in the US and other developed economies.
In May 2006, Henry Paulson was nominated as Secretary to the US Treasury by George Bush. Some six weeks later, at his swearing in, the first signs of the coming Californian real estate bust were already visible. It was the start of the sub-prime crisis. Banks all over the world were about to discover their books were overflowing with horrendously bad US securities. The French bank BNP was the first to wake-up, halting withdrawals from its funds in mid-2007.
Earlier the same year, signs of stress in the international financial system were being felt, forcing Adam Applegarth, the head of the British bank Northern Rock, to shuttle back and forth between London and New York buying and selling securitized debt. The reasons for the banker’s haste went curiously unremar
ked on Wall Street.
In 1999, the directors of Northern Rock had already realized that mortgage securitization was a smart method of boosting the mortgage lender’s growth. Borrowing money on worldwide credit markets was a simpler and less costly way of raising funds than from their traditional savers, which required investing in new branches to attract more deposits.
A specialized offshore firm owned by Northern Rock in Jersey had the task of bundling its mortgages. The sale of the securitized bonds was underwritten by international banks, including Barclays in London, JPMorgan Chase and Merrill Lynch in New York, and UBS in Zurich.
By 2006, sixty percent of the bank’s total mortgages were securitized. ‘The appetite for securitization, particularly in the U.S. and Europe, remains huge,’ Applegarth reassured the bank’s shareholders. Putting all his eggs in the one basket was Applegarth’s undoing. The bank’s business entirely dedicated to providing home loans had become almost exclusively funded by mortgage securitization.
When the global credit crisis broke, US banks were hit by heavy losses, with the result liquidities dried-up overnight. Applegarth found himself at the head of a bank that had just three months of funding reserves for its home loan operations. His system collapsed with the market value of the bank plunging over eighty percent and in February 2008, the British government had little alternative but to nationalize the Northern Rock.
It was a sad end to one hundred and fifty years of history. Founded in the middle of the 19th century, in Newcastle-upon-Tyne, in northeast England, by the merger of two small banks, initially created to help thrifty locals buy homes, the Northern Rock had transformed itself into the UK’s third-largest lender with over six thousand employees.
When in 2001, Adam Applegarth, at the age of 39, became the Northern Rock’s chief executive officer, the bank took off on its ballistic trajectory, its assets growing to over one hundred billion pounds sterling. Applegarth’s ambitions came to a dramatic end with the first run on a UK bank since 1866, when fearful customers rushed to its branches after news of a government bailout was leaked to the press in August 2007.
Chapter 42 BONUSES