Countrywide Financial Corporation and the Failure of Mortgage Socialism
by Eric Englund
by Eric Englund
Angelo Mozilo is the Chairman, President, and Chief Executive Officer of the failed Countrywide Financial Corporation. Mr. Mozilo co-founded this company, nearly 40 years ago, in 1969. To be in business for almost forty years, and to become America's top private home-mortgage lender, are testimonies to genuine business acumen. However, success can breed arrogance, and a sense of supreme power, to the point where a corporate chieftain believes his personal will can override the free market and reshape society according to a grand vision — which, for Angelo Mozilo, entailed making America a better country by bringing home ownership within reach of all and sundry. For Countrywide Financial, unfortunately, Mr. Mozilo's dream of social engineering demanded that sound credit-underwriting principles be abandoned. And now, Countrywide Financial Corporation's failure stands as a monument as to how integrating egalitarianism and political correctness, into a business plan, is downright poisonous.
February 4, 2003 marks the day when Countrywide Financial's shareholders should have dumped every last share of their stock. For on this day Angelo Mozilo made a presentation, at The Joint Center for Housing Studies of Harvard University, titled The American Dream of Homeownership: From Cliché to Mission. This is the day that Mr. Mozilo revealed to the world that political correctness had infected his mind. He openly declared that sound credit underwriting was tantamount to judgmentalism and, therefore, anti-egalitarian. How dare anyone judge anyone else — credit standards be damned. Subprime mortgages, accordingly, were going to be a blessing for America since everyone deserves a house. Oh how political correctness feels so good. He worshiped the mortgage socialism hatched in the New Deal along with every federal-housing program introduced in the succeeding decades. A true credit professional would have been horrified by this speech; which indubitably was met with approving applause by the pseudo-intellectual, limousine liberals populating Harvard University. February 4, 2003 is the day Countrywide Financial's Board of Directors should have fired Mr. Mozilo.
Over the years, Angelo Mozilo has been handsomely rewarded by Uncle Sam's mortgage socialism. Here's how it works. Countrywide Financial makes a conforming home loan, sells it to Fannie Mae or Freddie Mac (both are government sponsored enterprises), and has its coffers replenished in doing so; hence, allowing Countrywide to keep churning out loans. Countrywide, in turn, remains the mortgage servicer on each loan and earns a fee for doing so. These fees most certainly add up when you are servicing $1.5 trillion in home loans (not all of which are Fannie and Freddie loans). Needless to say, Countrywide had other sources of revenues but mortgage servicing was top-shelf when it came to profitability.
Thus, it is no wonder why Mr. Mozilo waxed fondly, in his Harvard speech, regarding America's foray into mortgage socialism. After all, it made him very wealthy. Here is an excerpt:
Our Nation took another important step in 1938 — in fact, 65 years ago this week — when Fannie Mae was created to buy those FHA loans, and as a result, the secondary mortgage market was born. We took a few more giant steps in the 1940s with the G.I. Bill in 1944 and the Housing Act of 1949, which stated the goal of "a decent home and a suitable living environment for every American family." We witnessed the Fair Housing Act in the 60s, the creation of Freddie Mac in 1970, the expansion of Fannie Mae's activities, the Community Reinvestment Act in the 70s, the introduction of adjustable-rate mortgages in the 80s, and more recently, the National Affordable Housing Act of 1990.
We have traveled so far — thanks to a mortgage-finance system that remains the envy of the world; thanks to a constant stream of creative and innovative mortgage products, and efforts directed at encouraging the offering of loans to those who have been previously shut out; and simply put, thanks to housing being an enduring public policy objective and the lasting commitment to that objective symbolized by our partnership.
We have transformed from a Nation of renters to a Nation of homeowners. The overall U.S. homeownership rate, which was at 44 percent in 1940, hit 68 percent by the end of the third quarter of 2002.
One can only imagine Mr. Mozilo's broad smile as he delivered these words. Between his compensation and stock sales, Angelo has made hundreds of millions of dollars. Socialism certainly can be beneficial for an elite few.
Do you remember President George W. Bush's initiatives to increase homeownership in the United States? His administration definitely played a role in creating America's housing bubble. When speaking about housing assistance, President Bush evoked the emotion of envy and declared that the U.S. had a "homeownership gap." Angelo Mozilo, being a kingpin of political correctness, couldn't resist playing the envy-card to an approving Harvard audience. He stated:
It started with the New Deal, and now, we're in a new century. But through it all, one thing has remained, more or less, constant. This constant is our challenge. And this challenge is to increase the access to affordable housing. And in order to do this, we must close the homeownership gap that still exists.
As President Bush said last October:
"Two thirds of all Americans own their homes, yet we have a problem here in America because fewer than half of the Hispanics and half of the African Americans own their home. That's a homeownership gap. It's a gap that we've got to work together to close for the good of our Country, for the sake of a more hopeful future. We've got to work to knock down the barriers..."
While the number of minority homeowners has advanced recently, climbing from 9.5 million in 1994 to 13.3 million in 2001 — an increase of 40 percent — the fact remains that it is still not at a level equal to that of white homeownership. And as President Bush pointed out, the homeownership rate for African Americans is 47 percent and for Hispanic Americans it is 48 percent, a stark contrast to the homeownership rate of 75 percent for white American households. That means there is currently a homeownership gap of over 25 points when comparing white households with African Americans and Hispanics. My friends, that gap is obviously far too wide. It has been far too wide for far too long. And when adding new factors into the equation — like an influx of new immigrants or continued reduction in the supply of affordable housing — it has the potential to become far worse.
Credit underwriting has nothing to do with race, creed, skin color, gender, or religion. Sound credit underwriting has everything to do with the "Five Cs" of credit — i.e., character, capacity, capital, collateral, and conditions. Under pure capitalism, a credit underwriter is not concerned about making people happy by lending money regardless of a person's creditworthiness. An underwriter's primary objective is to make profitable loans and this demands nothing less than effectively assessing risk on a case-by-case basis. This, undeniably, requires underwriters to exercise learned judgment. Ah, but to say this in the cradle of political correctness (Harvard) would have been met with resounding "boos."
To be sure, Mr. Mozilo did not disappoint his fellow limousine liberals. He goes on the attack and smears credit underwriters as being judgmental — the antithesis of political correctness. Considering that Countrywide had become the largest private mortgage lender in the U.S., the following words depict a man who had taken leave of his senses:
I have two issues with our industry's current underwriting methodology. The first is that the automated underwriting systems kick far too many applicants down to the manual underwriting process, thereby implying these borrowers are not creditworthy; and the second issue is that once arriving in the hands of a manual underwriter, the applicant is subject to basic human judgment that can be influenced by the level of a borrower's credit score.
Let's address my first issue. I acknowledge that credit scoring uses proven statistical methods to provide lenders with the ability to quantify the risk of extending credit. And there is little question that the technique effectively and efficiently separates those with very good credit from those with questionable credit.
However, far too many borrowers are being referred to an arduous manual and cumbersome underwriting process. To me, that is clear proof that the level deemed to be an acceptable risk by our automated underwriting systems is much too high. While many of these borrowers may ultimately be approved, it is because the manual process, or human underwriter, has analyzed non-traditional factors such as the borrower's rent and utility payment history, which should be imbedded in the automated underwriting process.
Now, let me address my second issue, and that is the manual underwriting process itself. While Countrywide's own internal evidence supports the notion that manual underwriters are approving a good majority of the loan applications that get referred, the fact of the matter remains that a human is involved in this step of the process thereby creating the possibility that a decision is made based upon the level of the borrower's FICO score.
Thus, the current protocol intentionally creates an environment where borrowers with lower FICO scores are subject to being disproportionately affected by the manual underwriting process. I say we need to amend these systems to do more than just approve the "cream of the crop," by creating a system that says "no" only to those deemed unwilling to make their mortgage payments.
We must understand that the credit scoring system we have built is still imperfect, and that if we are to have any chance at closing the homeownership gap, we must make a serious investment in improving its capacity and capabilities. We must do this through improved automated underwriting models that take into account more variables, and measure true indicators of risk and willingness to pay. We need an ongoing educational process, not only at the primary market level, but also in the secondary markets and with mortgage insurers to help lead this effort to recalibrate the scoring system. And finally, it must be recognized that borrowers with credit scores below what is currently defined as "creditworthy" levels can still be acceptable credit risks. Thus, the credit score bar dividing creditworthy from high-risk borrowers, must be substantially lowered by the GSEs, the secondary market in general, and with bank regulators. The GSEs have made good progress over the last few years in expanding their credit criteria, but I encourage them to become much more aggressive in this regard.
What Angelo Mozilo desires to accomplish is to replace human underwriters with computers. He never mentions the Five Cs of credit because sound credit underwriting requires human judgment; which can be aided with, yet never replaced by, technology. In Mr. Mozilo's daffy world of credit progressivism, he may as well distill the mortgage application down to a one-page document containing a single question: Are you willing to make your mortgage payment? If the answer is "yes" then the loan is approved and if the answer is "no" then it is declined. Under such circumstances, a computer would work perfectly.
As I have asserted before, political correctness is an enfeebling infection of the mind. Mr. Mozilo's vision of politically-correct, and "enlightened," credit underwriting was nothing short of daffy. Yet, one can only imagine how approvingly this pabulum was met by his Harvard chums.
Angelo Mozilo had no intention of disappointing his fellow travelers. There was hope as to closing the homeownership gap. It was something called the subprime mortgage. In his bizarre mind, the more subprime mortgage originations there were, the better off America would be. To wit:
Historically low interest rates along with new, creative and flexible underwriting techniques are continuing to fuel a record period of growth for our industry. According to the Federal Reserve, the amount of overall mortgage debt outstanding is nearly $6 trillion. And, increasingly, the sub-prime market is boosting that number and the industry as a whole. During the first nine months of 2002, sub-prime originations rose an estimated 26 percent over the same period in 2001 — outpacing the overall market.
Had Mr. Mozilo delivered this speech today, he would have immediately been fitted into a straightjacket and then driven to the nearest loony bin.
Countrywide Financial and many other financial institutions ended up throwing all credit standards out the window in order to package and sell as many subprime mortgage-backed securities as possible. To be sure, many did not do so sharing Mozilo's politically-correct and egalitarian hallucination — they just wanted to make a fast buck.
An important distinction to convey here pertains to the fact that Countrywide and others were not selling all of their loans to Freddie and Fannie. The aforementioned mortgage-backed securities were purely packaged and sold under private labels. When America's housing bubble was expanding, buyers of such subprime securities obviously felt there was no downside. Such are the delusions that materialize when central bankers flood the world with the opiates of easy money and credit.
Regrettably, by completely ignoring underwriting fundamentals, Countrywide and its ilk have set up so many borrowers for failure (as have the king and queen of mortgage socialism, Freddie Mac and Fannie Mae; both of whom, by the way, may be on the brink of their own financial meltdowns). The pain and anguish of losing a home, and having one's family displaced, will be visited upon countless families. Of course, such borrowers must look in the mirror when the urge, to pass around the blame, emerges. Nonetheless, Angelo Mozilo's dream has transmuted into a nightmare for millions.
My, oh my, aren't political correctness, egalitarianism, and social engineering wonderful? You be the judge.
January 28, 2008
Eric Englund [send him mail], who has an MBA from Boise State University, lives in the state of Oregon. He is the publisher of The Hyperinflation Survival Guide by Dr. Gerald Swanson. You are invited to visit his website.
Copyright © 2008 Eric Englund